Branko Milanović – Distinguishing incomes from capital and labor

How capitalism has changed from its 19th century variety of industrial capitalism to the 21st century version where we think of capitalism as financial

Branko Milanović is an economist specialised in development and inequality. His newest  book is “Capitalism, Alone: The Future of the System That Rules the World”

Cross-posted from Branko’s Substack Site

When I recently received my copy-edited chapter dealing with Adam Smith (from my forthcoming book “Visions of Inequality”), I noticed that in several instances the editor changed my “the rate of profit on capital” to the “rate of profit on investment” or “profits on invested capital”. I changed it back to the original, but I thought that the edits summarize well very different visions of capitalism. Or how capitalism, in the eyes of many, has changed from its 19th century variety of industrial capitalism to the 21st century version where we often think of capitalism as financial, and of “capital” as “free” money in search of best placement. (Of course, capitalism is still industrial—somebody has to produce physical cars, smart phones and T-shirts—but that industrial aspect is concealed under the overwhelming financialization.)

Thus to the editor, who has a background in business, a capitalist is naturally an investor; to Smith, Ricardo and Marx, though, the capitalist was (preponderantly) somebody who used his own money to start the process of production, hire labor, advance wages, buy the machines, decide what to produce. As the business grew, the capitalist would hire others to do some of these tasks, but he would remain dedicated to, and in charge of, his business. This is still the role of capitalists/entrepreneurs in many advanced economies, and even more so in the less financialized economies, but, in common parlance a capitalist has become somebody who has enough money to “place” (‘invest”) in individual stocks, government paper,  mutual funds or other financial instruments.

This has led to the introduction of the misleading term “investor” that nowadays masquerades as an occupation. A number of times I have met people describing themselves as “investors” in a way that somebody would describe himself as a shoemaker, medical doctor, cashier, IT developer etc. The appellation which is misleading (except in cases which I describe below) is not only the product of financial capitalism as such but of deliberate attempts to “equalize” the two factors of production, capital and labor, Thus, you may be working ten hours a day in a warehouse, and I may working ten hours looking for the best investment opportunity for my money, and we are equal: we both work ten hours per day, and I am as much of a worker as you. You are just called a warehouse worker, and I am called “investor.”

Why is it misleading? Not that somebody cannot spend ten hours every day on his computer “investing”, but that the real earning from his work is only the additional income that he may make on top of what he would have earned if he did nothing but simply invested that money once (and let it “work”) or gave it to a mutual fund to invest. Thus if in ten hours of work, he earns $100 from his investment, and if with zero hours of work he would earn $90 with that same money, the labor earning for ten hours of work is $10. He needs to decide whether it makes sense for him to continue spending ten hours of work for $10. But this is entirely different from a worker’s situation: if our warehouse worker does not show up at the Amazon warehouse, his pay is  zero. Consequently,—and this is key—zero hours of work in one case gives you $90 and in the other case $0. “Investor” is not just another laborer like a warehouse worker.

(When I hear somebody describe themselves as “investor” I am reminded of people who define their profession as “philanthropist”, literally, a “lover of mankind”—a weird profession indeed. In both cases, they are rich people, who earn money for no work, but feel bad acknowledging it and thus when asked “what do you do?” they do not say, “well, I do nothing, I just live on money I own/inherited”, but rather “I am a lover of mankind” or “I am an investor”.)

However, the term investor is not misleading as a profession in the case of individuals who are hired workers working within the investment banks and paid to find the best ways to maximize return to the rich people who entrusted them with their money. Their income is indeed a wage income—even when they are paid exorbitant bonuses. In income distribution studies, we have this problem: how do we treat a CEO of an investment company who earns a wage of $1 million, and a bonus (in the form of shares) of $2 million? The answer simply is that we treat all of that income ($3 million) as labor income. If the CEO decides to go off to the Bahamas, and never shows up for work, his earnings would be zero. So for him, like for the Amazon warehouse worker, presence at his job (virtual  or in-person) is indispensable to earn an income. Hence that income is a wage.

Some people are confused by that classification because for them a trader for an investment company or its CEO are not workers since their income depends on the performance of stocks and their salaries are too high. But the amount of earnings does not determine whether it is labor or capital income. Capital income can be one dollar and labor income a million, but they are still labor income, and capital income. Neither does the payment in stocks, nor whether that income is linked with the performance of the stock market matter. Note that payments in stocks are done for ordinary workers too. When such a payment is made, it is always a wage. Only later, if the worker or the CEO decides to keep the stock, the return on that stock becomes capital income.

Now, what is the difference,  somebody may ask, between our individual “investor” whom we saw spending ten hours a day on his computer, and the trader in a wealth management company that also spends ten hours per day investing? The difference is that in the first case, a person’s labor earning (wage) is only the incremental amount of money made compared to what he would have earned with zero work: $10 in our example. In the second case, the trader is a hired worker and his income is entirely the result of his labor. Marx would have said that such a trader is no different from our Amazon warehouse worker. Both are working within companies they do not own, both are producing surplus value for the owners (Amazon and the wealth find) and both are hired workers.

When in a recent paper, authors claimed that the decrease in the US labor share was overestimated because up to a third of that decrease was due to the misclassification, that is to the failure to account for the specific labor inputs (including entrepreneurship) of individuals owning S-corporations, their point was accurate. That part which is linked to specific labor input cannot be ascribed to capital, but to labor and entrepreneurship.

Branko Milanović

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