Capital Theory and Liberty | Mises Institute

[This article is based on an earlier essay published in German at “Wirtschaftliche Freiheit,” but has been abridged, revised, and adapted for an international audience.]

The catastrophic socialist experiments of the 20th century rest on a critique of capital. Economics should take this seriously and recall that capital theory is, at its core, also about questions of freedom and unfreedom. Economists would do well to re‑examine these issues in the tradition of Ludwig von Mises.

There is hardly anything more boring than capital theory. When one looks at what economics has to say about capital, one has to be careful not to fall asleep. It is not only that the theory itself is dull; the boredom stands in stark contrast to the gripping and historically momentous role that the concept of capital and its interpretation have played over the last 175 years.

For Western societies, the concept of capital is inseparably linked to the struggle for freedom. This is mainly due to the rise of socialism. For socialists, capital is an instrument of domination, a phenomenon of unfreedom. Karl Marx elaborated this at length in the first volume of Capital. The capitalist class—the owners of capital—exploits the workers.

Marx’s well-known argument runs as follows: the surplus value produced in the course of production is created by the workers. Since workers generally do not own capital, they cannot use their labor on their own account, as a craftsman in his own workshop still can. Instead, they must sell their labor as a commodity on the market. Capitalists hire the workers and pay them a wage that is sufficient for living, but does not cover the surplus produced by them. Capitalists therefore appropriate the surplus value of production without having created it or paid for it. In short: the working class is unfree, disadvantaged, and humiliated under capitalism; if one wants freedom for all, private capital must be abolished.

This critique of capital has fascinated millions and continues to do so. On the basis of Marxist ideas about the exploitative role of capital, numerous socialist experiments have been carried out worldwide, aimed at overcoming capitalism and abolishing private ownership of the means of production. These experiments have cost millions of lives. Already in 1997 the number of victims was estimated at about 100 million people.

One might think that, from the point of view of economics, nothing could be more important and interesting than grappling with the phenomenon of capital. This discipline, in particular, should have a lot to say here and should educate students about the theoretical and practical questions involved.

It may seem incredible to outsiders, but in the mainstream curriculum of economics one searches for this largely in vain. Students at typical universities who major or minor in economics are not—or only marginally—confronted with Karl Marx. Neither is his position laid out in detail, nor is it systematically contextualized or refuted.

Economists do, of course, talk about capital. In macroeconomics and, in particular, growth theory, capital even stands at the center of attention. These fields deal with the long‑run importance of capital for growth and prosperity. Yet in the standard textbooks one finds almost nothing that relates to the ideas, developments, and catastrophes sketched above. Instead, the word “capital” is given a meaning that allows economists to sidestep the problems raised by socialism.

Capital is introduced, without much hesitation, as a factor of production that stands on an equal and harmonious footing alongside labor. Capital consists of machines, plants, tools, buildings, and similar produced means of production. Just as labor is productive, so is capital; and just as labor yields a return, so does capital. Technically expressed: output Y is jointly produced by the two factors capital K and labor L. Capital and labor are not opposites, but rather are placed on the same level as complementary factors of production. This relationship is succinctly represented in the so‑called production function:

Y = F(L, K)

By taking such formulas and considerations as its starting point, growth theory brushes aside, without comment, not only the eventful history of socialist ideas and their implementation, but also the counterarguments and experiences accumulated over time. By defining capital as machines, plants, tools, buildings, etc., it ignores the important question of whether the structure of property rights and ownership relations might have any influence on the process or the outcomes of production.

Yet it is obvious that capital (K) and labor (L) do not stand on the same level. In a market economy, workers are usually employed by the owners or managers of capital. It is precisely at this point that many of the persistent fundamental attacks on capital and capitalism are directed.

With its approach, economics turns a topic that could be highly exciting and instructive for students—and that is of great importance for general education in Western societies—into a harmless technical exercise. Instead of discussing freedom and unfreedom, socialism and capitalism, the focus shifts to functions, derivatives, and marginal productivities.

In my book, Capital and Capitalism, I show that there is another, sadly-neglected, approach to capital theory in economics. Instead of simply ignoring the questions raised by Marx and socialism, this approach explicitly aims to understand the functioning of capitalism and the role of capital, and to distinguish them from socialist planned economies. The accusation that capital is an instrument of oppression and unfreedom is taken seriously and addressed directly.

The starting point is the Historical School of Economics, which already in the 19th century dealt intensively with the institutions of capitalism and asked how capitalism differs from socialism. Some economists and jurists belonging to this school drew attention to the crucial role of economic calculation (see chapter 5 in this book). It is calculating firms, seeking to invest their capital as profitably as possible, that make the miracle of the division of labor in capitalist societies possible. They predicted that nothing comparable would exist under socialism, and that planned economies would therefore fail to organize the division of labor rationally.

Ludwig von Mises developed a very similar argument at the beginning of the 20th century, thereby launching the well‑known debate on economic calculation under socialism. Neither Mises nor the Historical School understood capital as a factor of production. Rather, they took their orientation from business practice and defined capital as the sum of the monetary values of all assets of a firm that are devoted to earning income—that is, all items on the asset side of the balance sheet, whether buildings, land, machines, rights, patents, securities, money, or anything else. Capital is thus a money‑denominated measure of the physical and non‑physical means a firm employs to earn a profit.

Mises in particular developed this definition into a detailed capital theory in his Human Action. Capital, in this sense, is inseparably linked to the institutions that are central to a free society: private property, markets, entrepreneurship, and economic calculation. Such a theory is automatically also a theory of capitalism and its institutions. It thus provides the economic aspect of a theory of freedom in the sense of classical liberalism. At the same time, it can show why centrally-planned economies must end either in chaos, in dictatorship, or in both—but, in any case, not in the freedom of the individual or of the working class.

Within such an institution‑based theory it is hardly possible to construct consistent mathematical models. However, the theory is well suited, first, to understanding the functioning of capitalism—arguably its core task—and, second, to addressing and answering the critique of socialism. And, finally, it is not boring.