The completely just proposition that the worker is to receive the entire value of his product can be reasonably interpreted to mean either that he is to receive the full present value of his product now or that he is to get the entire future value in the future. But ... the socialists interpret it to mean that the worker is to receive the entire future value of his product now.
The free-market economy—laissez-faire capitalism—may be unpopular because people think it authorizes the exploitation of workers. They are not paid the full value of their product—or so it seems. This indictment has been wielded to justify not only full socialism but also substantial government interference with the market economy, including strong pro-union measures.
Few people realize, however, that the market economy was decisively acquitted of the exploitation charge back in 1884 by the second-generation Austrian economist Eugen von Böhm-Bawerk in his History and Critique of Interest Theories. The key to understanding the acquittal is time.
Ludwig von Mises, a student of Böhm-Bawerk, and Murray Rothbard, a student of Mises, refined Böhm-Bawerk's pioneering work when they examined the overriding importance of time in the market process. This sadly neglected matter is obviously relevant to the exploitation charge. Here's Mises in Human Action:
The prices of consumers’ goods are by the interplay of the forces operating on the market apportioned to the various complementary factors cooperating in their production. As the consumers’ goods are present goods, while the factors of production are means for the production of future goods, and as present goods are valued higher than future goods of the same kind and quantity, the sum thus apportioned ... falls behind the present price of the consumers’ goods concerned. This difference is the originary interest.... [Emphasis added.]
The difference between the sum of the prices of the complementary factors of production and the products which emerges ... is an outcome of the higher valuation of present goods as compared with future goods. As production goes on, the factors of production are transformed or ripen into present goods of a higher value. This increment is the source of specific proceeds flowing into the hands of the owners of the factors of production, of originary interest.
He went on:
Originary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remote periods of the future. It manifests itself in the market economy in the discount of future goods as against present goods. [Emphasis added.]
In other words, all action takes place in time, including the production of consumer goods, which in an advanced economy takes place through many stages over long periods, each progressively closer to the final consumer-goods stage. It is helpful to think of all the factors of production as unfinished consumer goods to some degree. The capitalist pays factor owners in the present to combine their labor, land, and capital goods to advance the "ripening" of the factors into future finished consumer goods. Consumption is what the market process is all about. He can do this through free market exchanges because some people more eagerly prefer money sooner, before the goods are finished and sold, rather than later, after the finished goods are sold. Because we prefer money sooner rather than later, present money is discounted against future money. Waiting for a future payment requires a premium, that is, interest; advance payment requires a discount of the future amount.
What looks to the unschooled like exploitation, is not exploitation at all. The workers and landowner must have found the exchange worthwhile or they would not have agreed to it. If the capitalist's vision of the future is wrong and consumers don't like the final product or the asking price, the capitalist is out of luck. He suffers losses. He can't get a refund from the workers and landowners.
In Man, Economy, and State, Rothbard explained the structure of production and the remuneration of the factor owners in much greater detail, drawing on the pioneering work in capital, rent, and interest theory by the American "Austrian" economist, Frank A. Fetter (1863-1949). Joseph Salerno has noted that Rothbard's 1962 treatise was a major original contribution to our economic understanding. Rothbard wrote (all emphasis in the original):
An individual or a group of individuals acting jointly can..., at present, offer to pay money to the owners of land and labor, thus buying the services of their factors. The factors then work and produce the product, which, under the terms of their agreement, belongs to the new class of product-owners. These product-owners have purchased the services of the land and labor factors as the latter have been contributing to production; they [product-owners] then sell the final product to the consumers.
What has been the contribution of these product-owners, or “capitalists,” to the production process? It is this: the saving and restriction of consumption, instead of being done by the owners of land and labor, has been done by the capitalists. The capitalists originally saved, say, 95 ounces of gold which they could have then spent on consumers’ goods. They refrained from doing so, however, and, instead, advanced the money to the original owners of the factors. They paid the latter for their services while they were working, thus advancing them money before the product was actually produced and sold to the consumers.
That is known as a harmony of interests, not exploitation. Diverging time preferences create opportunities for mutual gains from trade.
The capitalists, therefore, made an essential contribution to production. They relieved the owners of the original factors from the necessity of sacrificing present goods and waiting for future goods. Instead, the capitalists have supplied present goods from their own savings (i.e., money with which to buy present goods) to the owners of the original factors. In return for this supply of present goods, the latter contribute their productive services to the capitalists, who become the owners of the product.
Or as he put it elsewhere, "[W]hen a capitalist hires a worker or rents land, he will pay now, not the factor’s full marginal product, but the expected future marginal product discounted by the social rate of time-preference."
Rothbard emphasized that what prompts the capitalist's offer to workers and landowners is the anticipated spread between what he pays now and what he expects to reap when he sells his goods later. That spread is the interest rate. The return is not to capital; it's to waiting. Time and time preference permeate the market process.
Rothbard made a crucial point about the ownership of capital goods that further debunks the exploitation theory:
[T]hese capital goods, it must be stressed, do [the owner] no good whatever. Thus, suppose that a capitalist has already advanced 80 ounces over a period of many months to owners of labor and land in a line of production. He has in his ownership, as a result, a mass of fifth-, fourth-, and third-order capital goods. None of these capital goods is of any use to him, however, until the goods can be further worked on and the final product obtained and sold to the consumer. [My boldface emphasis.]
The capitalist's vulnerability is not to be envied. What does he own? Goods-in-process-of-completion (capital goods), which may require many more stages over a long period before they are ready for the retail shelves—assuming shoppers will want them at the price asked. Consumers have no use for unfinished goods. Rothbard wrote:
Popular literature attributes enormous “power” to the capitalist and considers his owning a mass of capital goods as of enormous significance, giving him a great advantage over other people in the economy. We see, however, that this is far from the case; indeed, the opposite may well be true. For the capitalist has already saved from possible consumption and hired the services of factors to produce his capital goods. The owners of these factors have the money already for which they otherwise would have had to save and wait (and bear uncertainty), while the capitalist has only a mass of capital goods, a mass that will prove worthless to him unless it can be further worked on and the product sold to the consumers.
Another reason the capitalist's revenues might exceed his payments to factor owners is pure entrepreneurial profit. Profit, as opposed to interest, is a confirmation of the entrepreneur's hunch that the market had undervalued the factors of production with respect to consumers' wants. Israel Kirzner, a student of Mises, would say that the entrepreneur has improved market coordination. The entrepreneur might have been wrong and suffered a loss. The future is uncertain. Profits do not last, however, because they attract competitors, who bid up the factor prices and lower the price of the consumer good.
The socialists have it wrong. What they see is not exploitation. Rather, it is all-pervasive time, time preference, interest, and risk tolerance.
