Why Capitalism, Although Unfair, Kinda Works? - Part 1

“Capitalism is the astounding belief that the wickedest of men will do the wickedest of things for the greatest good of everyone.”

      -       J.M. Keynes

Me: Alright Dad, we going to talk about Capitalism and the many unfair outcomes that it brings with it, and how this initial unfairness actually helps the markets to be more and more competitive.

Dad: Okay. Just so you know, I am not really familiar with the foundational concept behind it. I don’t know if I can follow along.

Me: No worries. We will try to boil it down to its simplest form.

Dad: Cool! Let’s do it.

Me: All right! Here’s a thought experiment. Imagine you are with a bunch of people in a room and I have assigned you guys a task to make shoes. Let’s say there are 100 people in the room and there is a condition that each person can make only 1 shoe i.e., either for the left foot or the right one. This will happen randomly meaning you guys cannot talk and decide who is going to make a shoe for which foot. Also, you are going to spend a normal workday say, 8 hours doing it.

Dad: Okay, but when the workday is over, we will eventually know right?

Me: Yes! So the day is over. I have called you guys over and everybody assembles with a shoe in their hand. Let us take an extreme example in this case. Suppose there are 99 left shoes and just 1 right shoe.

You guys are also quite aware that shoes can only be sold in the open market as pairs. This means any left shoemaker has to meet with that 1 right shoemaker to discuss the price and distribution.

Dad: But how are they gonna divide the money they will get from selling that 1 pair of shoes? I mean let us say they decide that the pair can be sold at $100 in the open market. How much will each get? $50 each?

Me: Well, you hit the nail on the head with that one! Dad. Because that’s the most important question all the economic theories “try” to answer. What do you think? If you are that 1 person who has made the right shoe and there are other 99 people with just left shoes in their hand, would you go halfsies on the $100?

Do you think that $100 should be divided fairly and equally between the two laborers?

Dad: Well, yeah I guess! I mean it only sounds fair. Furthermore, those 99 people, even though they have all produced the same left shoes, have worked the same hours as me. So, I reckon they should be paid an equal amount as me.

Me: Guess what Dad? You are echoing the words of Karl Marx right now. He said that there is a labor value of goods which implies that a good’s value is determined by how much time it is required for the laborer to make it.

Dad: Yeah, sure. I agree!

Me: Okay, so now let’s look at the real world. Do you think this happens out there? Do you think those 99 people would be paid in the same way as you if that was actually the case? Imagine Dad, you have something that nobody has. What happens to the price of that good?

Dad: It will increase and I guess I can sell it at a higher price and earn a big profit. But what will those 99 people who only have the left shoes get?

Me: Well Dad, they will perhaps get close to nothing. And this is how the competitive markets work. In this framework, the supply and demand of goods and services are valued more than the laborer’s efforts. And, this is also exactly why you, the maker of that 1 right shoe, would get almost all of the $100. 

Dad: This is very unfair. If there is so much discrepancy, why then people don’t do anything about it? What is the reason for this phenomenon?

Me: Uhh! There are many reasons for this phenomenon and perhaps a couple of very strong reasons that emphasize the point that the unfairness actually is what makes the capitalist system work. But yeah, I think it’s enough for today. Let us continue this topic in our next session.

-Bibek Nepuane 

"Bivek Neupane is a recent graduate of MSc. Finance and Economics. He specialized in quantitative finance and research. After spending half a year as an intern in the quant team of Allianz Global Investors Frankfurt, he has taken the role of Management and Strategy Consultant in the in-house Consulting entity of the Allianz Group. Currently, he is also actively researching Machine Learning applications in the Nepalese stock market. If you have any questions, do not hesitate to contact him. You can connect with him via LinkedIn , his blog or e-mail."