Thomas McCraw

Making Modern Capitalism

The 'value' of a good or service means whatever price someone will pay for it. Previously, there had been widespread quasi-religious notions of a 'just price' above which one charged at the peril of one's soul. And buying anything on credit, even for purposes of investment, was often regarded as questionable. The transition from the old mind-set to the new was a long, gradual process that even today is not complete. We ourselves feel vestiges of the old virtues in our guilt (often appropriate) about the unrestrained use of consumer credit.

Capitalism relies heavily on investment credit as a means of financing innovation. In this respect the term 'capitalism' goes beyond the dictionary definition of 'capital,' which is an economic concept and a factor of production common to all economies. Capitalism characteristically employs not only accumulated wealth but also financial resources that don't yet exist in tangible form. It employs 'money of the mind,' as credit has aptly been called. Banks, the primary sources of credit, lend out money far beyond their cash reserves, on the expectation that borrowers will employ the money, pay interest on it, and repay the principal in the future. In so doing, banks create money out of nothing but faith and informed expectation, subject of course to reserve requirements imposed by banking authorities. Entrepreneurs and companies borrow this money. To get still more of the capital they need, they may also issue stocks and bonds, often backed by nothing except the anticipation of a future return on the companies' products.

'Capitalists,' then, are people who make bets on the future. The essence of capitalism is a psychological orientation toward the pursuit of future wealth and property. It's all about aspiration and striving, measured by gains and losses in wealth and income. It rests on a belief that economic growth, even substantial growth, is possible and desirable—for an individual, a family, a business firm, an industry, even an entire country.

Today most of us take this belief for granted. It is an unstated assumption behind much of what we do. But for many centuries, such a belief did not enter the minds of most people. Economic growth did not necessarily seem desirable, let alone possible. Nor was it commonly seen as related to individual effort. There was little expectation of change in any circumstance of life, economic or otherwise. Most people looked on the changes that did occur as the consequences of some outside force. They explained catastrophes such as the Black Death, which wiped out about a third of Europe's population during the fourteenth century, as God's punishment.

Many ethical systems contained stern warnings about how the pursuit of riches imperiled the soul. 'Many evil men are rich, and good men poor,' the Athenian statesman Solon observed in the sixth century B.C. 'It is easier for a camel to go through the eye of a needle, than for a rich man to enter into the Kingdom of God,' cautioned the Gospel of Matthew. In some religions, including Christianity and Islam, lending money at interest was forbidden as sinful. In Japan as late as the mid-nineteenth century, merchants had the most money but the lowest status. They ranked not only below the samurai (warrior class), but also below craftsmen and the mass of agricultural peasantry. They stood at the bottom of Japanese society because their lives centered around buying low and selling high.

For much of human history, and in most societies across the world, the prevailing mind-set was antimaterialistic and antigrowth. Even people with strong acquisitive tendencies, ranging from the conqueror Genghis Khan to the Medici bankers of Florence, bent their efforts toward gaining a larger share of what was thought to be a pie of fixed size. Their gain was regarded as another's loss, by definition. Life was viewed as a seesaw. If someone went up, someone else had to go down. That's one reason why acquisitive people were often relegated to low social status, unless their success came from military conquest or was truly spectacular. Even in eighteenth-century England, a relatively modern capitalist society, most people thought it unseemly that merchants should try to become 'gentlemen.' Gentlemen devoted themselves to their lands and surrounding communities, or to the church, the army or navy, or the civil service. They didn't pursue money as an end in itself.

Partly because of this kind of mind-set, there was minimal economic growth in most of the world for several thousand years. Although life was 'solitary, poor, nasty, brutish, and short,' as the English philosopher Thomas Hobbes put it, life was not necessarily filled with hard labor. Most people tended to work in 'lumps'—assiduously at planting and harvest periods, lackadaisically during the winter. Their sense of time came not from clocks but from the sun and the seasons. Circumstances didn't encourage or even permit them to work in a way we would regard as efficient. As a result, individual incomes didn't rise. Social mobility was extremely low. Few people were 'free' in the sense that we now use that term. In 1772, the English economic writer Arthur Young estimated that the world contained about 775 million people, only 33.5 million of whom were 'free.' The rest—96 percent of the total—were serfs, slaves, or vassals of some kind. They owed their loyalty and part of their labor to those above them in the social order, and ultimately to authoritarian kings, chieftains, or warlords.

Most agricultural lands in Europe were 'entailed.' They were parts of unitary feudal estates. They couldn't be sold or subdivided for ownership by individual farmers. Occupational and geographical mobility remained low. One usually did what one's parents had done. One lived where they had lived. A large proportion of the earth's people never in their lifetimes traveled more than thirty miles from their birthplaces. Incentives for change were very small. Institutional structures weren't geared toward economic growth. And so not much growth occurred. One essential condition of a dynamic economy, and of capitalism itself, is a relatively free labor market. Individuals must have some control over the disposition of their work. They must have a choice about whom they wish to 'sell' it to. They should also be able to keep most of their wages for themselves and their families. Yet for thousands of years, almost no free labor markets existed. Few jobs paid cash wages, and a portion of the returns of everyone's work went to the landlord, the chieftain, the king, the warlord.

Capitalism, by contrast, opened up labor markets and fostered cash wages systems. More broadly, capitalism promoted a dynamic, flexible, and future-oriented way of thinking. It injected a pattern of ceaseless and merciless competition into nearly every aspect of life. Politics, the military, even religion became more competitive, following the lead of the economic system and occasionally moving in advance of it. Martin Luther and John Calvin openly challenged the Church of Rome, which had dominated Europe's religious life for centuries. Their doctrines competed not only against Catholicism and Judaism, but against each other. And all of this religious competition tended to widen the opportunities for market forces to operate, and thereby to strengthen the spirit of capitalism even more.