I’ve been asking myself something along the lines of “why does capitalism work, and alternatives don’t”, followed by “how does capitalism actually work”. I’m well familiar with the theory, but as we know from the case of Marxism, a theory can very poorly match reality. So let’s see what the system actually did, in case of Europe and America.

The original mechanism of supply and demand is well known and understood. You have initial scarcity, which creates demand; for instance, you need copper ore in order to manufacture bronze. That motivates someone to dig out the ore and offer it for sale. The first one that does it earns quite a lot of money. The others see it, get greedy and do the same thing, but now the supply is greater than the demand, and the ore can no longer be sold at a premium; it drops. Cheap copper ore motivates many people to think of ways it can be used for new things, because it is now cheaper and they can afford it. For instance, they make copper wires that can be used to produce magnetic coils. As they buy all the copper on the market, the new wave of scarcity is created and this raises the prices, motivating others to invest in copper mining.

The supply and demand of course works for the price of labor, as well. Initially, the process worked somewhat like this. Someone invented a way to automate a loom in a way that allowed one to connect it to a watermill or some other free source of energy, feed it wool or cotton and produce huge quantities of textile on the output. Since textile was usually produced quite slowly and laboriously by traditional means, its price on the market was quite high. By creating an automated method, one created greater demand for the raw materials and started buying them up on the market like crazy, raising the prices. Seeing that, the landowners decided to produce more of that expensive raw material, and since the traditional method of exploiting the serfs for ten percent of what they made doesn’t work for industrial monocultures (obviously, if you need to produce cotton or wool, you don’t need ten percent of milk, cheese, wheat and eggs, which is what the serfs would make, and you can’t make them produce cotton because they would decline, because it’s useless to them because they can’t eat it), the serfs were expelled from the land, which was transformed into something resembling industrial farming, driven by either slave or hired labor. This had three results. First, the labor in agriculture no longer worked on percentage of produce, but on money. Second, there was a huge excess of former serfs and their families on the labor market, which had neither property nor marketable skills, and became the proletariat, living in squalor at the outskirts of cities looking for work. Third, there was a surge in supply of raw materials, fed as inputs to the textile industry, requiring employment of additional labor, which can be cherry-picked from the proletariat for minimum wages, since the supply of labor far outweighed the demand. This abundance of cheap labor and cheap raw materials was wonderful for the manufacturers, at least initially, because the market was soon saturated; on one hand, when it was apparent that it worked and made some rich, everybody started doing it. On one hand, proletariat, which made up a huge portion of the population, was mostly priced out of the market because they lived on minimum subsistence wages, determined by the prices on the labor market. This is the makeup of a classical crisis of capitalism, and those crises repeat regularly and seem to be a normal part of the system, quite similar to what happens in nature on any given habitat: you have rabbits who eat grass, and hawks who eat the rabbits, and the number of predators is naturally limited by the numbers of their prey. When for some reason the population of rabbits explodes, the population of the predators grows to match the growing food supply. Then they overhunt the habitat, there is a decline in the rabbit population, and the predators die off. So basically the supply-demand economy mimics the natural evolutionary mechanisms, which is probably the reason why it is so flexible and why it works so well. Of course, some perceived the crises of capitalism as some great problem that needs to be solved, and in their shortsightedness created communism and its politically correct cousin called socialism, which basically stated that one should artificially manage the numbers of rabbits and hawks in the habitats and tell everyone what to do in order to avoid spikes in supply and the subsequent dieoffs. Of course, when you manage the habitat in such a way, both rabbits and hawks stop bothering to be efficient since they’re going to get the same results anyway, and the managers become increasingly powerful. Also, lacking positive motivation, the managers need to introduce artificial culling of the population and other forms of punishments for disobedience, which is why managed societies always turned into bloodbaths.

But I digress; let’s go back to capitalism. OK, so it has crises. It basically looks like this: some, essentially those who own the factories and the land for growing industrial crops, get immensely rich. Others, mostly the unqualified workforce, get immensely poor, due to great supply and low demand. This great social inequality creates great potential trouble which historically manifested in two forms: the communist movement which intended to revolutionize the society, introduce dictatorship of the proletariat and transform everything into a communist state, and the syndical rights movement, which used organized strikes as an instrument of displaying the important role of labor in the manufacturing process with purpose of using this control as a bargaining chip. The wealthy industrialists initially tried to solve the problem of unrests and strikes with repression – they sent the police to beat and kill the protesters. This never solved the problem, since the proletariat was already below subsistence income and had essentially nothing to lose, and in some cases, like in Russia, they actually lost control of the state. Having communism as an alternative to the syndicalist movement, they stopped to think about their options, and at some point someone said “Damn, this might actually solve our main problem. Guys, listen to this: those syndicalists demand better wages, and other things that essentially mean we can’t exploit them to death and rotate them. But if they get better wages, they will no longer be priced out of the marketplace and will actually start consuming the goods we produce, which will solve our problem of market saturation. In any case we lose a lot of profit trying to open foreign markets, and this might actually be cheaper in the long run. And besides, it’s not like we have many options; we can continue fighting the syndicalists and lose money doing it, and even risk the communist party becoming more popular among the proletariat, which already ended badly in Russia. Or we can redesign the whole system in a way that would institutionalize the syndicate in its role of bargaining for the price of labor on the market, and essentially grow ourselves a huge domestic population of new consumers ”. And so it was agreed.

The result of paying more for labor had complex results. The obvious result was that the level of prosperity of the workforce increased, to the level where it no longer met the definition of proletariat. This essentially removed the communist party from circulation, as the workforce no longer felt any need to overturn the system that gave them more prosperity than they have ever known, and hope that things might be even better in the future. Also, since child labor was outlawed, children could go to school and the level of education rose. Eventually this created a very substantial middle class – people who aren’t wealthy enough to own factories, but aren’t the poor uneducated laborers, either. This middle class opened the market for more sophisticated goods and services, consuming refrigerators, washing machines and TV sets, as well as babysitters, pool cleaners and cable TV installers.

And then someone in the upper management level of the companies looked at the expense chart of his company and said, “Damn, those labor costs are huge. But the unions don’t let us reduce the salaries, in fact they keep demanding more. If we could only get around the unions in some way… I got it! The syndical protections don’t apply to foreigners. We could outsource our call center to India, the labor is dirt cheap there, they speak English and it’s all legal, unlike what would happen if we tried it with the illegal immigrants here.” Since everybody forgot why there’s actually a middle class, why there is social prosperity and why the unions became so powerful in the first place, the outsourcing of labor to other countries looked like a great way of earning more profits. However, it undercut the entire construction that was established in the 1930s and now we are almost back to square one. If you don’t pay your local population big wages, they can’t afford your expensive products and you’re screwed, because the entire structure of social prosperity based on a distribution of profits to a larger demographic collapsed.

Furthermore, outsourcing actually exports the technological know-how needed for manufacturing the product to the foreign companies, and then IBM becomes Lenovo and Cisco becomes Huawei. They either completely take over your business or they start offering equivalent products for less, because they are smart enough not to be satisfied with selling you cheap labor; eventually they will want a share of the finished product market. So it’s basically a double-whammy – you priced your own workforce out of the market for your expensive products, and created a foreign competitor which now offers your own former customers cheaper equivalent products, which makes you doubly screwed.

Of course, I left out a few important things for the sake of brevity and I hope to revisit them in the following articles, but you probably get the basic picture.