A Flaw in Capitalism
A description of a fundamental weakness in modern Capitalism and a prediction
of where it is doomed to go.
©1995 Jeff Lewis
This essay came about because of two warring factions: my father and
his friends, who were very much the ardent socialists. syndicalists and
anarchists and my friends, many of whom were equally ardent capitalists
(or capitalist wannabes). I sat between them and wondered how two groups
of people could both be so certain that they were right in an absolute
This led me to stop and analyse both views and therein, I saw that in fact,
both absolute models were flawed in some ways and that neither of them had
found the perfect truth they seemed to believe they had found.
I will not be discussing the flaws in socialism in this essay - to sum that
up briefly - people are inherently greedy - it's part of the nature of all
animals to hoard against future loss. That tends to work against any system
which requires people to take only what they need at the time. I do believe
that with enough training and with a system which does ensure that there
is always enough for anyone (and that's a pretty big if), people could be
conditioned to take only what they need at the time and to shed a need to
hoard personal items, but that's not likely to happen for some time.
The Basic Setup
To start off, let's imagine a hypothetical economic entity: a group of people
who trade mostly within themselves at the normal day to day trading level.
In our capitalist system, people work, get paid an amount of money for these
services, exchange goods and get paid for that exchange. If a person gets
more for a good or service than it cost in total for that good or service
- then that person gets a profit. With services, that cost of goods can
be very difficult to compute, and we'll discuss that in a later section,
but for now the principle still holds.
Ok, let's take this fictional country and take a snapshot of its economic
action for a period: say a year. During that year, goods will be manufactured,
services will be sold, people and companies will receive earnings. Profits
will be made. Let's add them up.
The total earnings made by all people and corporations in the year plus
any savings held over from previous years represents the total available
revenue to purchase any goods and services which are made available to purchase
during that year. Similarily, the total retail price of all goods available
and services sold during that year represents the total cost of all production
in that same period.
Herein lies the problem. If the system requires that a profit is made, or
at least breaking even if not a profit, the total earnings must be
less than or at most equal to the total retail value of goods and services
sold.This means that it is impossible, in a profit oriented system, to sell
all the goods and services created, based on earnings alone. (It can be
shown that because of entropy and inefficiencies in any production system,
you can't even do this if you try to go for no profits...) This leads to
overproduction no matter how efficient you make the system.
How We Used to Fix This
In the past, when there were only a couple of really effective (ie: technologically
rich) capitalist countries in the world and the rest of the world was predominately
resource rich with no way to exploit its wealth, the solution was easy:
you dump your surplus onto these other countries in exchange for raw materials
at way below cost. This, in effect, dumped a big negative earnings into
the system which reset the surplus for a bit.
Problem is, even the natives get restless and soon the technology poor countries
started to realise that if they wanted to make a profit, they'd have to
learn how to do technology and get in the game. Soon, all sorts of unexpected
players like Korea, India, Brazil and so on, started producing their own
goods - shoddily at first, then progressively better and better until they
too were effective competitors. But, since their labour had always been
accustomed to low earnings, they could produce these goods at lower cost
and be more effective at competition in a global market.
How We Try to Fix This (Badly)
In our system, we try to maximise profits. There are only a few ways to
do that: reduce cost of materials, reduce cost of labour or increase productivity.
The first is the most difficult to do. A car requires a certain amount of
raw materials, and while technology can find cheaper materials, there will
always be a basic cost of raw materials. The second is much easier
to do. With larger and larger populations, the pool of people desperately
looking for work is growing and faced with the choice of low wages or no
wages, most people will take the low wages. There is a cost to this not
often discussed, but I will discuss it shortly.
Finally, there is the last way - which is currently happening. Computer
technology and new machining methods are radically improving efficiency
and productivity. The very nature of our current recession and its jobless
recovery shows this - we have a slowly growing economy, with few to no new
jobs. Productivity is up, but we're not doing it by hiring more workers.
So does any of this actually help solve the underlying problem? Alas, no.
You see, no matter what you do to maximise profits, the underlying problem
is still there: you can't buy back what you make. Reducing cost of materials
means that someone else isn't making as much earnings as they used to, thus
they have less earnings to buy what you're making (although of the three,
this is least harmful change one can make). If you reduce your workers salary,
again, there's less earnings to buy the goods you make. And if you eliminate
workers, or produce more by being efficient, there's more goods to buy for
the same amount of available earnings, so you're still screwed.
Ok, So Why Are We Still Here?
Good question. The answer is simple. Capitialism, as we practice it today,
hasn't been around that long. We just like to think it has. In fact, capitalism,
like most social systems, undergoes constant change and revision.
Prior to the 1700's, most markets were small and geared mostly to subsistance
production. There was no standard of exchange to meter the relative earnings
and costs of goods from place to place, so there was no way to tell if you'd
really made a profit. Many people supplimented their earnings, if they had
any at all, with food grown by themselves on their own lands (or lands they
were permitted to live on in exchange for services). People themselves were
the technology which ran the world and everyone was, for all intents and
purposes, in a third world country.
As well, the world population was relatively low. There just weren't that
many people around to compete for jobs and resources. You see, there's a
basic formula which has to be considered here: take all of the world's useful
(to us) resources and divide that by the total population. That's a real
upper limit measure to the wealth of the planet as a whole. The world doesn't
change much over time. Our population does. It doesn't take a genius to
realise that a smaller population means more wealth per person.
In the 1700's, serious technology started to move from theoretical musings
to real world applications. In a real sense, engineering was created in
the 1700's. Adam Smith wrote his famous 'The Wealth of Nations' which clearly
defined capitalism (although he didn't call it that) and also defined the
concept of division of labour. We started specialising and improving our
means of production. We also started standardising things. The metric system
was created in this period as was standard money (although that one took
time to get a foothold). Now, when two people talked about the cost of a
certain amount of something, they knew they were both talking about the
For the first time, there was an objective way to measure profit.
The 1800's, contrary to the views of people like WIlliam F. Buckley Jr.,
were not a great time for workers. Capitalism in its most unbridled sense
was king of the U.S. and in a less unbridled form in other countries. Adam
Smith himself, a century earlier had noted that a free market system without
compassion is worse than any tyranny and there were many free market tyrants
around who ruled with an iron fist and more than a little lunacy.
Finally, the late 1800's and early 1900's brought the first major backlashes
against this sort of capitalism and introduced the labour union which fundamentally
changed the way capitalism worked. The depression of the 1930's and the
World War II paved the way for John Maynard Keynes and his brilliant observation
about the stability of capitalist systems: which is to say, they aren't.
Until the stock market crash of 1929, everyone firmly believed that a free
market system would always selfcorrect. Problem is that no one seemed
to be aware of the concepts of positive feedback and hysteresis. Market
hysteresis meant that markets could not shift quickly to sudden rapid changes
and positive feedback meant that when the system started to shift, that
shift itself could cause the shift to grow bigger as the market reacted
to its own shifting.
That brought us the Keynsian model of economics which added the government
as a 'flywheel' if you will. Its job was to deaden the economy when it started
to race too quickly, and to pump in capital when it was slowing too much.
It was to be an economic 'governor' in the same way a flywheel was the governor
of a car or bus. It provided negative feedback in the system.
This worked surprisingly well until the 1980's when suddenly we had very
conservative, anti-government governments in many countries at one time:
and in most of the G7 major economic powers including Reagan/Bush in the
States, Mulroney in Canada and Thatcher in the UK. All of these governments
collectively decided that Keynsian economics was wrong and that an uncontrolled
free market system should be reinstituted immediately. Thus Reaganomics
was invented again.
That finally brings us to where we are now. In Keynsian economics, the government
taxes during boom times to slow growth, then pumps money back in during
slow times to restart the economy: but during the 1980's, none of the major
economies did that. They basically let their economies run at full steam
collecting less taxes than ever. Then, as you probably guessed, the bust
side of the economy happened - and there was no money around to jump start
anything. Thus, we languish in an eerie half-recession. Our technology allows
production to continue with fewer workers, but fewer workers means fewer
people to buy those goods - and with so many layoffs and earnings reductions
in order to preserve profits, workers are frightened to spend.
Normally, the government would create work projects and pump money into
the public's hands to buy goods and get the economy running again, but they
don't have the money. In fact, they themselves are reducing staff - which
is adding to the stalling of recovery.
Another relatively new change in Capitalism is the widespread use of credit.
We've always had credit in some form or another, but it's only been this
century (and the latter half of it for the most part) where the organised
widespread use of credit has become required.
Credit, in effect, 'creates' money. You're making a promise that sometime
in the future, you'll return earnings in exchange for that future earning's
purchasing power and this allows you to buy more goods than you actually
should be able to - in the short term. However, since that loan comes with
profits attached, you have to pay interest, it actually has a double hit
on the problem: it makes it worse because now your future earnings can't
buy anything when they are earned and now there's more money tied
up in profits.
Now, Let's Go Global
Ok, remember a while back I noted that the way countries have dealt with
their surplus goods by dumping them onto unsuspecting non-tech countries
in exchange for raw materials at cut-rate prices? That worked well while
most of the world was non-tech and generally not capitalist. However, we've
been going out there and preaching to the world about the wonders of high-tech
And we've been good at it.
While the exact nature of each country's interpretation of capitalism varies,
more and more of the world now creates goods and services for profit. Moreover,
they're not accepting the 'here's some neat beads, can we have all your
fresh water' sales tactic which has worked so well up to now.
Japan learned that if you make it smaller, better and cheaper, you can fight
dirty and still be rich. Most of the Asian Rim countries are learning this
lesson too: we taught them it.
Problem is, where do you sell your surplus when everyone has a surplus?
Well, the answer is, you don't. That's where we're having problems. That's
why we're stuck in this stalled recession-limbo. We have goods and services,
we're not poor - but we can't seem to sell enough to make a profit, and
more and more people are losing work and not having enough to survive. As
a society, we're dying rich.
Unfortunately, trade deals which try to make the world a 'level playing
field' are really being used mostly to allow the lowest cost labour to be
accessed with the result that the available earnings will continue to go
down - which makes it less and less possible to buy all the goods produced.
The Unemployment Myth
One final note. We have a wonderful way of playing with numbers and definitions
to 'prove' to ourselves that something is right. Unemployment is one of
those areas which takes the greatest number of reality hits.
For example: what does that unemployment rate number really mean? Most people
think it means the percentage of the population who could work but aren't
employed. It doesn't. In most countries it represents the percentage of
people who are elegible for social support while looking for work who aren't
employed. A much smaller number.
In fact, prior to the 1800's, generally speaking everyone in a family, husband,
wife, children, would work. Usually on the family land to grow and harvest
goods but also for other people doing chores and the like to get a little
extra. In the 1800's, child labour was very common and was an essential
way to get enough money to survive.
The concept of a family where only the father worked is a very recent one.
So, if we're going to talk about earnings and employment, let's keep the
model constant. In the 1800's, employment was close to 90% of the population
- everyone worked in some capacity to earn either goods or earnings to buy
goods. By the 1900's, children didn't work - which dropped the employment
rate to around 50%. By the 1950's, women no longer considered appropriate
to work in an earnings capacity (and to all the women reading this - do
not get me wrong, I'm not saying women stopped working: I'm saying they
stopped earning revenue) which dropped the percentage of the population
employed in revenue earning capabilities to less than 30%.
This means that relative to the 1800's, our real unemployment rate: that
is, the percentage of the population who could be working for earnings
but are not, is close to 70%, not the 8-10% you normally hear about.
This means that on average, every person who earns revenue is supporting
three other people who are not. This gives you an indication of just how
efficient our means of production has become. Relative to the 1800's, each
person who works in a production job is creating three times his own needs.
The Curse of Societal Short-term Memory
There's one other force which has to be noted: societies as a whole have
a two generation memory. Anything which happened more than 40 years in the
past becomes irrelevent to the current generation.
Examples: Trade unions were created as a response to extremely poor treatment
of workers in the late 1800's. Today, people see unions as unimportant and
more a problem than a solution. Many honestly believe that whatever reasons
existed for the creation of unions no longer exist. Oddly though, what's
happening to workers today is almost exactly what happened to workers 100
World War II is just outside of the 40 year period and we're starting to
see a resurgence of neo-Nazi and fascist groups and governments which rule
using fascist methods. By this, I'm not saying that they're behaving like
Hitler, but rather are returning to the sorts of tactics used by the goverments
Unfortunately, this means that we're doomed to repeat the same mistakes
over and over in a roughly 40 year cycle. The actual cycle goes: 20 years
later is nostalgia and 40 years later is forgotten. This is why the Brady
Bunch and disco is coming back into vogue again. First we idealise the past,
then we forget it.
So, Where Does This All Lead?
Well, alas, I don't have good news here. While I'm pro-welfare, the fact
is that it doesn't work. Not for the reasons you might be thinking: the
fact that someone is getting a living without working for it isn't a big
deal, as I've just shown, three out of four people do that already. It's
the fact that welfare doesn't solve the underlying systemic problems in
Neither does working for a living. That just gets you a better slice of
the shrinking pie.
This whole game might have gone on a lot longer - well, a century or so,
maybe - if Keynesian economics hadn't been railroaded in the 1980's or if
more of the world hadn't adopted a capitalist variant when they did, but
they did and it was inevitable that this would happen.
Free market capitalism suffers from the same flaw, oddly, as socialism:
greed means that people won't play by the rules. In capitalism, people stop
competing to gain monopolies when they can. In socialism, people refuse
to share and reduce their wants down to needs. Any system which ignores
the combination of greed and cleverness which are the hallmarks of humanity,
is doomed to fail.
History shows that modern capitalism will change. If it can't change fast
enough, it will be torn down in a revolution to be replaced with something
which claims it's very different, but in reality ends up being very similar.
Given the current state of affairs, I'd have to say that this is the most
Unless there's a major shift away from the radical right in the UK, Canada
and the US - especially the US - within the next eight years, and unless
Keynsian economic methods are reintroduced (which may not be possible anymore),
then the gap between earnings and costs will become too great and the population
will be forced to break out of the system.
I'm inclined to say that if things continue as they are, this will happen
within twenty years starting in the US (southern US in fact, probably California).
The UK is next likely - the EC tends to moderate that probability somewhat.
Unfortunately, there's no simple solution as long as we have a system of
resource distribution based on earnings and cost alone. We can't continue
trying to distribute goods and services to an ever increasing population
- its very size becomes the bottleneck as the available resources in proportion
to the population dwindles.
It's going to be a rough ride.