The Alchemy of Capitalism

by Dr. Yuval Noah Harari

Personal Lecture Notes from Lesson #13: The Capitalist Creed

(These are personal summaries and paraphrasings of some of the major points of the lectures that I felt to be important. They are not meant to be comprehensive records nor intended to be reproductions of copyright materials. I encourage you to participate in the course for better understanding. All ideas and examples are by Dr. Harari.)

The most unique and important characteristic of the modern capitalist economy is growth. The total global production of goods and services – ‘the economic pie’ – is constantly increasing and has been increasing since the emergence of capitalist economy. 

Consider a simple example. People deposit their earnings in the bank, and the bank loans out that money to investors. Suppose you want to start a bakery. You go to the bank and ask for the loan. A big contractor has deposited 1 million dollars in cash in his new bank account. The bank takes that 1 million dollars cash and loans it you. You take the money, and hire the same contractor to build your bakery, and you pay him 1 million dollars as fee. The contractor takes that 1 million dollars and deposits it again in his bank account. His bank account now contains 2 million dollars, even though the 'actual money in the account, or the money in cash, is still 1 million dollars. You can extend this scenario further. The cost of the bakery construction rises, and the constructor asks you for an additional 1 million dollars. You got to the bank again, and get an additional 1 million dollars loan in cash, which the bank again takes from the contractor’s account. You give that 1 million dollars again to the contractor, who deposits it again in his account. He now has 3 million dollars in his account, even though the actual money in cash is still the original 1 million dollars. This is possible because the banking laws allow the bank to loan out $10 for every $1 the bank actually possesses. Where does this extra $9 come from? What covers this extra $9 is actually our trust in the future. It is our trust that the investments will generate even more money which will cover the deficit between what exists and what has been loaned out. More than 90% of the money in all the banks of the world in this sense does not exist.

This is why the capitalist economy grows so rapidly. “The secret is a magic of capitalism is that it finances present expenses with make believe money that has no cover in the present and may only may have cover in the future.” (Dr. Harari)

This was not the case prior in history, where most of the money was frozen. It was extremely difficult to start new businesses and to expand existing ones. Capitalist system is based on ‘credit’, which is a special sort of money which represents future imaginary goods. Credit is based on trust in the future. Traditional economies only had trust in the present, because traditional societies did not believe in progress. People believed that the total amount of wealth in the world is limited and static. To get richer was to get richer at the expense of someone. The economic pie was of a fixed size, and taking a bigger piece meant taking a portion from someone else’s piece. This was why money and riches were considered as sinful. But capitalism believes that the economic pie keeps getting bigger, and credit is the difference between the size of the pie today and the size of the pie tomorrow.

As the scientific revolution led to an increase in the sum total of human production, human trade and human wealth, the belief in progress and trust in the future became more and more solid. In 1776 Adam Smith published The Wealth of Nations making a revolutionary argument: An increase in the profits of private entrepreneurs is the basis for the increase in collective wealth and prosperity. When business owners have increased profits, they use them to expand their businesses, which opens up more employment opportunities, increasing the overall amount of wealth in the community. What is radical about this argument from a moral-political perspective is that it links individual selfishness and greed with collective welfare.

However, this works, only, if the rich actually use their profits for new investments instead of spending them in ways that do not lead to further productivity. From this realization emerges the ethical code of capitalism: profits must be reinvested in production. This investment can be in many ways: opening new factories, enlarging existing businesses, funding scientific research, etc. This is what distinguishes between wealth and capital. Capital refers to resources that are invested in production. Wealth, on the other hand, is unproductive money.

Science has a close relationship with capitalism, because most scientific research is sponsored by governments or private businesses. The scientific projects that enable an increase in production are the ones that are preferentially funded. Scientific discoveries enable the development of technologies which will create new products and new businesses, fulfilling the promise of economic return on which we had pinned our trust. 90% of the money in the world has been created out of thin air. It is based on our hopes for the future.
“… if these hopes are not realized, it doesn't mean that we stay with what we have now. It means that more than 90% of the money, we think we have now, will just disappear.”

The history of capitalism is also interwoven with the history of imperialism. Credit and capitalism were not unique European inventions, but nowhere else did they enjoy the supports of rulers and governments. While previously in history and elsewhere in the world wars were funded through taxation of the people, the European conquests were increasingly financed through credit and therefore they were increasingly directed by capitalists, whose motivations were primarily to generate the maximum returns from their investments. To a large extent, the English, French and Dutch colonies were created and run not by the states but rather by private companies. The emergence of limited liability companies spread the risk of investment between many investors. A company would be set up to conquest a new colony, it would sell its shares in the stock exchange to a large number of investors generating a large amount of money, which would be used for exploration and conquest, and all investors would share the profits. These companies had their own private armies, waged their own private wars and ruled over conquered territories privately. Examples of these companies include 

* The Dutch East India Company (Vereenigde Oost-Indische Compagnie or VOC), which financed the military conquest of Indonesia and ruled over it privately till 1800 when the Dutch state assumed control.

* The Dutch West Indies Company, which operated in the Atlanic Ocean in order to control the trade on the Hudson River in North America. This company built the settlement called New Amsterdam, which was captured by the British and the name was changed to New York. “The remains of the wall that a Dutch company built to defend its colony against the British and the Indians, are today paved over by the most famous street in the world, it's called Wall Street”

* The British East India Company, which conquered and ruled over India, until 1858 when the British crown nationalized India along with the company’s army.

The nationalizations of the colonies did not sever the ties between capitalism and imperialism because by this point in history the governments in London, Amsterdam and Paris were being controlled by the capitalists and looked after their interests. “Karl Marx famously said that western governments, at least in the 19th Century, were actually the trade union of the capitalists.”

The issue of the relationship between politics and economics is one that has become quite contentious. Capitalists believe in the freedom of the market, and maintain that Government restrictions only stunt the economic growth, and that the markets make the wisest decisions by themselves. This belief in free market, however, when taken to the extreme has led to many terrible consequences.

The business owners can exploit and oppress the workers in the pursuit of profits, for instance by offering very low pay for long working hours. In a free market with competitors, the workers can simply quit to work for someone else who offers better pay and working conditions, but if the business owners have monopoly over the market or if all the competitors cooperate in this oppression, as happens in practice very often, then the workers have no way out. The whole Atlantic slave trade from Africa to America was a consequence of free-running capitalism. “[The slave trade was a] purely economic enterprise organized and managed and financed by the free market, according to the laws of supply and demand.”

A free market capitalist system adopts any means necessary to ensure profits. The outcomes are crimes against humanity such as the Atlantic slave trade and the Great Bengal Famine. Even though the global wealth has increased manifolds, many individuals around the world still work long hours and live in hunger.

Capitalists have two main responses to this criticism. First, they argue that capitalism has created a world in which there is no longer an alternative economic system (following the failure of communism) capable of running the world. Second, they say that capitalism has learnt from its mistakes of exploitation, and if we remain patient, the economic pie would grow large enough that despite inequalities of wealth everyone would receive a satisfactory share. Whether the economic pie can grow indefinitely and whether this promise will ever be fulfilled, only time will tell. 

(For prior posts covering this course, see the label A Brief History of Humankind.)


g2 said…
Thanks a lot for this!

This is an excellent project you have embarked upon. I took the course and absolutely loved it. I have been planning to do this myself but been putting off.

Looking forward to the other chapters too!