A New Way to Think About Capital
Editors Note: The following essay presents part of the basic argument from the author’s new book, The Representational Theory of Capital.
Arguably, there is no concept more difficult to understand in economics than that of capital. However, capital is central to economic reasoning, so we must understand it rightly. In order to use this concept, economists tend to identify capital either as “goods” or “funds.” The conception of capital as “goods” considers capital as a collection of heterogeneous things that enhance the productivity of human labor—anything from an ax to a web browser could qualify. The conception of capital as “funds” reduces everything simply to its precise monetary expression. Capital in this sense refers to all the funds accumulated in the past that are available for future production.
Both in current economic debates and in the history of economic thought, scholars usually categorize capital theories as fitting into either or both of those two models. But this is a mistake. Understanding capital correctly requires a much more nuanced understanding of what capital is, and what role it plays in economic life.
In order to understand the nature of capital, we must first consider property. Everything that exists in the world belongs either to someone or no one. In other words, all the material and immaterial goods that exist in human societies are either represented by property claims of an individual or an entity, or are res nullius, “things with no owners.” Capital goods, like all other goods, are also represented by property claims. This representational character is key to understanding what capital is. Some property claims are titles so liquid that they are “as good as money,” such as bank deposits, or shares in a money market fund. Others are not. Capital is not only capital goods, things, processes, and ideas that exist in the real world. The property claims that represent them are also a form of capital, even if they do not have a precise monetary expression.
We need a representational theory of capital (RTC) to move past this false dichotomy. Not only are capital goods represented by property titles, but those titles form a continuum from the ones with low to high salability. Due to certain characteristics, some capital goods are much harder to sell than others are (say, ocean cargo ships versus trucks). However, even capital goods with the same characteristics may vary in salability depending on the kind of property title. For example, you may own some farmland with a free title, but it is difficult to assess the value of such land in the abstract. By contrast, one can freely buy and sell shares in a publically traded “Mid Cap” Real Estate Investment Trust (REIT) that holds title to similar farmland. The REIT shares can be traded daily at a price known by anyone, while the privately held farmland’s value can only be discovered through the actual process of sale. We can further situate the REIT shares on the salability spectrum: Those shares are obviously less liquid than shares in a “Large Cap” corporation, say, Alphabet, and much less than a bank deposit, since the price of the shares fluctuates in a way that bank deposits do not, and are usually more difficult to liquidate on an at-will basis.
Considering capital either as the object of property claims (capital goods) or as the most liquid forms of their representation (funds of money) misses two important issues. The first of these is the concept of representation itself. The idea of representation allows us to overcome the fallacy of understanding capital either as things that exist in reality or as a social construct, but accepts that it is both. The second error is to misunderstand the myriad forms in which capital may be represented, such as property deeds, shares in a partnership, bonds of a corporation, etc.
Understanding capital rightly creates the possibility for greater economic wellbeing. The application of this more robust ontology that sees capital not only as “things” or “money” but also as property represented by all sorts of claims—not only the most liquid ones—will allow us to make better-informed decisions about our own personal investments. This representational view will also allow us to better understand capital allocation in society. For example, understanding capital in these terms may help you avoid investing your savings in a financial instrument that does not represent a property claim on some piece of real wealth, like unsecured bonds of a corporation with a bad business plan and no free assets. It might also help you avoid funds guided by government-mandated investments in losing propositions like solar panels and windmills.
A comparative example can demonstrate how our understanding of both personal and public finance are advanced by the RTC. Let us suppose first that one individual has saved from his or her income an amount equivalent to, say, $10,000. He or she is considering two options to invest the savings. The first involves buying shares of a new venture, say, the Initial Public Offering of a company providing logistical support to small business. The second is to invest in bonds of the US Treasury.
Now, let us consider what will happen with the money in either case. If the money is invested in the new shares of the logistical business, the company will use the money in the acquisition of software, computer capabilities, warehouses, trucks, and the like. If the business proposition is a sound one, the residual income generated by the service they provide will be sufficient to maintain the value of the capital invested, or even to appreciate it, as well as providing for the distribution of dividends to the shareholders. Of course, if the business is not a good one, the residual value of the investment may be totally or partially destroyed and the investors will end up with a loss.
Next, let us consider what happens when the investor buys Treasury bonds. The US Government currently runs a huge deficit and, in more recent years, only about 12 percent of the federal budget was invested in capital formation broadly defined. The federal government now spends all of its tax revenue and engages in additional deficit spending amounting to about 20 percent of the entire budget. The hard-earned money saved by our investor will pass through the coffers of the Treasury and will be spent on things like the wages of public servants, pensions of retirees, lease of buildings and vehicles, office supplies, telephone bills, etc. In this second case, no new productive capacity has been added. If our saver is to see again the amount of his or her savings, let alone any interest on it, the government will need to tax that money from someone, because no investment has been made that would produce a stream of revenue to repay the bonds.
Using the framework proposed with the RTC, you can understand that not all savings correspond to capital formation. For instance, sovereign bonds are “Triple-A” investments according to the rating companies, and yet, regardless of how safe they are deemed, they do not add a penny to the productive capacity of society. The RTC offers a window to investors to understand what lies behind the ratings, and that hidden view is not pretty. If part of the money saved in society is invested not in things that will increase production in the future, but in things that are consumed with current government expenses, economic growth will stagnate. Lasting slow economic growth or “secular stagnation” may be explained by capital destruction, even if those savings have not been written off yet (or alternatively, never will), if the government was able to extract sufficient taxes from society to service it.
Jacques Rueff’s concept of “false rights” can help us to understand the relationship between capital and inflation. Inflation emerges as a natural consequence of the government’s ability to make claims on existing wealth without creating any corresponding wealth of its own. RTC offers us the tools necessary to understand the shortcomings of some ideas in vogue nowadays about public finance, such as Modern Monetary Theory. It also shows how post-Keynesian and Marxist-inspired proposals to use legal institutions to produce macroeconomic results, be that funding for the Green New Deal, the Great Reset initiative, or other schemes to reallocate resources through the political process, are just concealing a transfer of wealth for politically favored corporate interests behind smoke and mirrors.
Capital goods vary according to their characteristics. At the same time, the instruments that represent rights over real or false wealth are also vastly diverse. RTC proposes that there is a relationship between “goods” and “claims on goods”, and that we ought to aim at understanding that relation rightly. Unless we recognize the inadequacies of the instruments we use today to represent wealth, we will not be able to make wealth more productive, and that is to our detriment individually and as a polity.