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.

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.

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.

Reader Discussion

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on January 13, 2021 at 07:57:35 am

Dr. Z is more than merely "a breath of fresh air." His is the vision of a real economic oasis in a real political desert. First, I note that Dr. Z has a doctorate in a substantive field (unlike, say, "Dr. Jill Biden".) Secondly, after reading two articles in a row, it is apparent that he is quite adept at explaining-by-simplifying complexity. Thus, we have Dr. Z's prior article on the policy evils of LawMacro and today's neat analysis of the compelling economic advantages of Z's representational theory of capital. Together they offer theoretical guidance for a way out of The Swamp, with its fake economics-cum-politics of "rent-seek and ye shall be rewarded."

The overriding project of Washington DC's Swamp, second only to its Job One of destroying Donald Trump, is the confiscation of private wealth and reallocating it as public expenditure. Dr. Z has aptly described this Swamp project as "...post-Keynesian and Marxist-inspired... use (of) legal institutions to produce macroeconomic results, (such as) funding for the Green New Deal, the Great Reset initiative, or other schemes to reallocate resources through the political process, (which is) just concealing a transfer of wealth for politically favored corporate interests behind smoke and mirrors."

Alas, without first draining The Swamp, without eliminating The Swamp's raison d'etre and weakening its built-in incentives to see wealth wrongly, with a blurry-eyed conception, it is simply impossible to institutionalize a representational theory of capital or to oppose the meretricious political appeal and ingrained institutional power of LawMacro, which Dr. Z decries.

And that is why, for denizens of The Swamp, destroying Donald Trump has been Job One for the past five years, and remains the priority project which proceeds apace today on Capitol Hill, ahead of all other public business, and goes forward, literally, as I write this comment.

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on January 13, 2021 at 10:37:22 am

I’m left confused as to what Dr. Zelmanovitz means by capital (unsurprising since he’s correct that economists have employed multiple contradictory definitions of the term; he understates the confusion I think).

But I don’t get his solution. Suppose I own the following: a sailing ship with cannon, a pile of cash to hire crew, and a stock of provisions to keep the ship operating — that is, I have a stock of factors of production. It’s a confusion to call these factors “capital;” they are simply objects or goods at my disposal.

Suppose I come up with a business plan to generate a stream of money income with these factors. The discounted value of this stream is what Menger, Fetter, and Mises appear to mean by capital, and seems to match business usage. Note first that capital is thus speculative, and secondly that it is individual.

It appears to me that Zelmanovitz underestimates the speculative nature - hence refers to “unsecured bonds of a corporation with a bad business plan” and “If the business proposition is a sound one...” as if these are given data. This “good or bad business plan” is a matter of theory or judgment; hence trying to make the capital concept do the work of theory or judgment strikes me as an error. Second, the individual nature of capital seems to preclude summing into a national capital stock , which Zelmanovitz sometimes appears to be suggesting.

Return to my ship and business plan example, and suppose my expectation is present value of $1 million. That’s my capital. Does it matter for purposes of capital accounting whether my plan is to transport goods from port-to-port (thus benefiting others) or operate a pirate ship (thus harming them)? From the standpoint of capital accounting I can’t see why it matters.

This seems to me to sink the distinction between, say, a government bond and an investment in a business with a good plan to serve consumers.

I think Zelmanovitz is exactly right about treating capital as property rights; they should be more effort in combing the Menger-Fetter-Mises concept of capital with the Coasian property rights tradition. But capital theory remains what Kirzner has called “a can of worms.”

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Charles N. Steele
on January 13, 2021 at 12:09:21 pm

There is a conference going on right now, as we speak, at The Center For Ethics And Culture, Notre Dame, that touches on this subject:


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on January 13, 2021 at 12:12:17 pm


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on January 13, 2021 at 13:54:37 pm

It seems that at least one of the author’s objectives is to more clearly demonstrate the idea that most government spending has no investment effect. I applaud any such effort though I don’t think the general public is going to be dissuaded from using investment and government spending in the same sentence.
I would also agree with the author that the technical concept of Capital is not well understood by the general population, myself included. I have always considered capital to be wealth not needed to sustain life in the near term. That frees up everything to be considered as capital, including deployed capital. The later being valued at some discount allowing short term liquidation. So a $1 million investment in plant and equipment could be quickly liquidated for $750,000 allowing a capital redeployment. I may have muddied the water?

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on January 13, 2021 at 14:39:28 pm

As someone who, like Ebenezer Scrooge, freely, but not so exuberantly admits that "I don't know anything, I never did know anything [about money}, I find this essay quite helpful. I have always thought of capital as aspirational; that is to say that it is not only predicated upon past productivity / inventions, etc but that it, in the form of either private or government issued bonds is an expression of hope that productivity gains will continue and at a not dissimilar rate of growth.
Dr Z provides us with a means of delineating between those aspirations which are reasonable, albeit still fraught with some risk and those that are the expression of pure fantasy, i.e., an uncontrolled Federal Reserve issuing future obligations at a rate and on a scale that is both unprecedented and beyond the capacity of the economy to meet.
This is what MMT is: Fantasy generated economic, no - a Political construct intended to obviate any concerns / criticisms of an ever burgeoning welfare state whilst simultaneously permitting those select few to shape, control and profit from the resultant conditions.
As Paladin suggests, The Swamp needs this. How else can it pay its minions in the bureaucracies? How else can one maintain / sustain an economy when the Swamp creatures in both government and corporate America have deed over our productive energies, inventions and products to low wage competitors.
How can the enormous debt ever be repaid while still providing a vast array of entitlements to the new breed of supplicant citizens.
Why, let's convert money into a fantasy not at all unlike their political fantasies. That is the trick!

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on January 14, 2021 at 01:50:04 am

I have a couple of observations in the spirit of Einstein's observation that "Things should be made as simple as possible, but no simpler."

1. I think that examining the nature of capital should begin at the beginning; that is, we should assemble a class of objects that we call "factors that enable enterprise." This will be a large and heterogeneous class, and will include such things as favorable environments, turmoil, political calm as well as political upheaval, human ingenuity, talent, determination, planning, and resources. We can now divide this class into "capital" and "not capital." The rule of discrimination is likely to be somewhat subjective, but we should be able to agree that resources, of whatever kind are essential and fit most conceptions of what is meant by capital. It seems uncontroversial to say that these resources may include raw materials as well as "stores of value," i.e. money or monetary equivalents that can be traded for the necessary resources, labor and so forth that will be necessary to the enterprise. From this we note an essential element of capital in relation to enterprises: it is something that is necessary. Not all things that fit this description are used in enterprises at any given time, so we may conclude that capital is the resources and stores of value that can be used to initiate and sustain enterprises. Perhaps Einstein would object that we have made things too simple, but it least seems defensible that, even if not all things that are considered capital meet this definition, everything that does meet it is capital.

2. Capital must have some other qualities, which are alluded to by Dr. Zelmanovitz. The first is that someone must have the capacity to exploit capital; i.e. to use it for the purposes of the enterprise. This is also a characteristic of property, which simply means, as Dr. Zelmanovitz mentions, that capital must be capable of being used as property, regardless of who is considered to hold title to it, or who has the not only the capacity but the right to exploit it. This is the fundamental distinction between what we call capitalism, in which individuals may exploit capital and do so in their individual capacities, and socialist systems in which such capacity to exploit is limited to those acting supposedly as trustees of "the people."

3. The relative efficacy of capitalist or socialist systems is determined by which class of persons who have the title and legal right to exploit capital do so most efficiently and produce the most benefit. Since individual capitalism utilizes the optimizing mechanism of competition and continuous feedback through market mechanisms, free-market capitalism has the edge, at least as far as pure economic efficiency is concerned. (Distribution of wealth in a society is another issue).

4. Private exploitation of capital has another advantage, that lurks in the penumbra of Dr. Zelmanovitz's essay. Private exploitation of capital encourages the pursuit of risky enterprises. Since all endeavors with a desired future benefit involve some degree of risk, and in fact some of the most beneficial and consequential enterprises are quite risky, private capital tends to produce more failure, but much more success. This may help explain why buying Savings Bonds is an inefficient use of capital. The appeal of these investments is that they are safe. The reason that they are safe is that they are not used for the purpose of innovation and growth. They are not meant to entail the risks of discovery and entrepreneurial hazard. They are meant to keep the government running; to maybe here or there serve as patron to some technical innovation, but on the whole they are meant to "invest" in stability and predictability. Central planners tend to be risk averse, therefore the most efficient use of capital is likely to be found among entrepreneurs over the long run.

5. It appears that much of the dissatisfaction with concepts of capital come from the desire that an acceptable model be amenable to measurement, quantification and use in modeling. This may or may not be possible, especially when one considers that such model will likely need to account for things that are difficult to quantify, such as "human capital," goodwill, obsolescence, and as Prime Minister MacMillan noted, "events." The bigger issue however is that what determines the value of capital is, to a humbling degree, opinion. This is particularly true of money. If someone had all of their capital tied up in tulip bulbs when the mania ended, or in real estate derivatives in 2008, the idea of capital likely displayed an aleatory and transitory quality that confounds easy quantification.

6. The modeling of capital is complicated by the less of it that is required for the necessities of subsistence. It is easier to predict the allocation of capital, and assess its usefulness when a significant portion of it is dedicated to necessities (as that term may change over time). But when there is little scarcity of food or shelter, or emergent medical care, more capital is used for things like telling internet acquaintances about your breakfast or sharing gifs of dogs rollerblading. In such circumstances it becomes harder to determine the efficiency of capital and whether its use may be optimized. The economic reality of 21st century America is that more and more capital is consumed in experiencing than in accomplishing. This makes different uses of capital hard to compare.

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on January 14, 2021 at 15:06:23 pm

"The economic reality of 21st century America is that more and more capital is consumed in experiencing than in accomplishing. This makes different uses of capital hard to compare."

Luvv'd it! Saw a figure that indicates that the revenue stream from just the Big Three social media platforms is $130 billion. Bear in mind that this figure does not include TV, radio, paper, mailers, billboard advertising. Nor does it include video game entertainment, cable TV and other non-productive enterprises, the devices enabling this entertainment being produced offshore as well.
It may be more accurate to say that the modern American "economy" is consumed with experiencing (vicariously, at that) rather than producing either capital goods or efficacious capital (as you have defined it above).
In another sense, may we not suggest that given present globalist group think that we have seen, and will continue to see, an inexorable drain of "productive American capital" toward offshore locales.
How long may we mask this drain, how long may we counter the lack of productive capital with government issued "capital" in the form of eventually worthless promissory notes, i.e., Fed bonds, etc?
I think I need to talk with my investment advisors - right quick as my old Drill Sergeant would intone.

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on January 20, 2021 at 12:45:46 pm

Your comments in paragraphs 1 - 5 are right on, but I think you go off track (and maybe snagged Gabe in the process?) when you focus in paragraph 6 on consumption of whatever capital has created/produced . Thus, "... what determines the value of capital is, to a humbling degree, opinion" is very useful in identifying value as subjective across a range of human desires, rather than fully objective and "measurable".

Dr. Z probably has a good idea buried within this essay and it merits deeper consideration, but some things are already well established and may not require reinvention (I believe), so when you say "... such [a] model will likely need to account for things that are difficult to quantify, such as "human capital," goodwill, obsolescence, and as Prime Minister MacMillan noted, "events."; I would think human capital is defined by wages and salaries, good will is given some value by CPA's (don't know the details), obsolescence is valued by some write off value, and "events" are supposed to be addressed by the higher salaries/ benefits paid to executives to strategize on such black or white swans as are swimming in their respective ponds.

It may also bear restating that economies do not have to continually "grow" to provide for a decent civilization and quality of life/ life style. Our current $20+T GDP is not sub-tier in any way that decreases the ability of our population's "pursuit of happiness". The caravans from Central America attest to that. And growth from a higher baseline is more difficult than from a previously lower one (China, et al.) So while capital in physical and/or money form is needed to increase productivity, shouldn't we also consider the environment of a rule of law, mostly free entrepreneurial market society to also be part of that "social capital", or perhaps something outside of it? [i.e., a subset of your "capital/ not capital" comment above, that also merits deeper analysis.]

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on January 20, 2021 at 19:01:26 pm

Z9Z99, in fact, your point 1 is quite controversial. Austrian economists such as Menger, Mises, and Kirzner disagree and maintain productive factors and capital are two very different concepts. You consider factors of production other than labor to be capital, but then why do we even need the term “capital?” If the term is just shorthand for that, there’s no need for capital theory.

Capital is a value concept; that’s why Mises (correctly) insists it can exist only in a market economy with money. In contemporary finance and accounting, capital appears on a balance sheet as a monetary entry. Calling factors of production “capital” may be common practice, but it confuses everything.

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Charles N. Steele
on January 20, 2021 at 13:18:37 pm

I just stumbled across this year 2000 review citation http://www.torenewamerica.com/the-mystery-of-capital for the book by Hernando deSoto - The Mystery of Capital. Mr. deSoto also emphasizes the aspect of property rights and ownership titling as essential to the establishment and transfer of capital across an economy. This is (now) so well established and accepted within our Western civilization and rule of laws that we fail to recognize just how important that political and legal aspect of our "political economy" really is.

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