Excerpt from the book: "Capitalism, non-capitalism and market economy" Author: Mirko Katic Publisher : TKD Sahinpasic,

Sarajevo/Zagreb, 2009

Non-capitalism and freedom

Without economic freedom there is no either political or civil freedom. There is no economic freedom without the market economy and free entrepreneurship. Nobody questions truthfulness of these Milton Friedman's words anymore. He wrote in the famous book "Capitalism and Freedom": "Economic freedom is necessary condition for civil and political freedom, political freedom, desirable though it may be, is not a necessary condition for economic and civil freedom."1...." The existence of a free market does not of course eliminate the need for government. On the contrary, government is essential both as a forum for determining the "rules of the game" and as an umpire to interpret and enforce the rules decided on. What the market does is to reduce greatly the range of issues that must be decided trough political means, and thereby to minimize the extent to which government need participate directly in the game." 2 At the beginning of introduction of the book, he criticizes Kennedy's message to the American voters, "Ask not what your country can do for you, ask what you can do for your country." He warns that neither half of the statement expresses a relation between the citizen and his government that is worthy of the ideals of free men in a free society. Then he presents his vision of this relationship, "The free man will ask neither what his country can do for him nor what he can do for his country. He will ask rather, "What can I and my compatriots do through government to achieve our goals and purposes, and above all, to protect our freedom?"3 The previous quotes served to me as an introduction to the topic on non-capitalism and freedom in order to briefly explain what kind of freedom is this about. I hope that the readers, just like me, will agree with the quoted opinions of Milton Friedman on significance of the economic freedom for the political and civil freedom of every human. Milton Friedman equates capitalism with the free market, implying the market economy dominated by the privately owned companies. However, as I explained in the previous sections, the private ownership is not the essential determinant of capitalism, although it is the determinant of the market economy. This is why it makes no sense to equate capitalism with market economy. The essential determinant of capitalism arises from the treatment of the company assets and the treatment of money. If the company assets and money are treated as capital, then we may call such economy capitalism regardless who the company owners are, i.e., who owns some amount of money. If neither the company assets nor money are treated as capital, then such market economy cannot be called capitalism any longer, but another term must be found. I have decided to use the term non-capitalism. Accordingly, Friedman's appeal to protect the market economy from too much government interference in economic affairs does not and cannot mean simultaneous appeal to protect capitalism, but only the appeal to protect personal freedom and private property. At the time Friedman was writing his book, there were two mutually opposed economic systems in the world: capitalism and socialism. The difference between them was reflected in
1 2 3

Milton Friedman, "Capitalism and Freedom", 2002, The University of Chicago, p. IX Ibid, p. 15 Ibid, p 2.

different ownership structures. In the economy of capitalism, privately owned companies dominated. In the economy of socialism, government-owned companies dominated. All decisions on the production, exchange and prices of all commodities in capitalism were made at the microeconomic level, but at the macroeconomic level in socialism by a relevant government planning authority. So, the market economy was on one side and the command (planned) economy on the other side.4 At the time Friedman was writing his book and delivering lectures (period from 1956 to 1962), it seemed that socialism prevailed over capitalism, so very few people believed in Friedman's visions at that time. However, the time has shown that Friedman was right as to the advantage of the market economy over the command (planned) economy. At the time he was writing the book, he had to use the word capitalism as a synonym for the market economy because the market economy he was able to see was actually capitalist. 5 It was important to protect this economy from the ideological onrush of the socialist planned (command) economy. However, we have to make a step further today and reject a broadly widespread belief that capitalism is a synonym for the market economy and that market economy must be capitalist. I have already mentioned that the essential determinant of capitalism derives from the treatment of the company assets and treatment of money. If both the company assets and money are treated as capital, then we may refer to such economy as capitalism regardless who the company owners are, i.e., who owns money. Money will be treated as capital only if there is a possibility in the market economy that any money owner may expect some annual income from the money. For example, just like a sheep herd owner expects the herd to give some minimal number of lambs or some quantity of wool and milk annually, so the owner of the money functioning as a capital expects this "herd" to bring an annual minimal yield. Money owners may accomplish this goal only if they invest money as the interest-bearing savings in a commercial bank.6 The banks may pay an interest on saving deposits of their clients only if they lend these deposits to other persons on interest. If the banks are not able to convert all of their clients' savings into the loans, the process of the interest-bearing savings cannot be preserved, meaning that in this case money could not preserve its treatment of capital. So, the interest-bearing savings has a role of the shelter for monetary capital. Without the shelter, money could not be treated as capital. Without the shelter for monetary capital, the modern capitalism could not be preserved. This shelter for monetary capital may be preserved only if the government appears as a debtor ready to absorb all surpluses of the saving deposits that the banks are not able to invest through the loans to other people and companies. The government pays the loan interest from its
4

The only exception was the economy of Yugoslavia in the period from 1956 to 1974, when the decisions on commodity production, exchange and prices were made at the level of individual companies, although all companies were government property. After 1974, this economy made a transition by the force of the law into a special form of a planned economy that Branko Horvat, Ph.D., renowned Yugoslav economist called decentralized monopoly. However, this is a separate subject that goes beyond this book. 5 If we are to define capitalism in accordance with the way I have explained this term, then we may say that then socialism and then capitalism were essentially the capitalist economies. 6 Money owners may also earn additional yield if they invest money in another business project. However, on this occasion it is the case of the interest-bearing savings because it represents the last and the least profitable alternative to the money investment, which is always available to the money owners in capitalism and serves as a measure (benchmark) for a minimal profit rate that the money owners expect from investments in other fields.

tax revenues. As I explained in the previous sections, the price for the shelter for monetary capital is thus paid by the country taxpayers although nobody has asked for their opinion. Such economy cannot be referred to as the free market economy and it cannot provide economic freedom to the people in the sense Milton Friedman elaborated this category. If money is treated as capital, then the monetary value of the company assets must have the same treatment. Truly, this relationship cannot be clearly seen in practice because of other reasons imposing the treatment of capital to the company assets. To explain this, I will use the same analogy as in the previous example. A herd of sheep functions as capital for its owner. For a company owner, company assets also function as capital. However, while the size of the herd of sheep is expressed by the number of sheep, the size of company assets is expressed in money. If the herd owners want to ensure the same annual yield received from the herds in lambs, wool or milk, they have to maintain the number of sheep in the herds at the same level both quantitatively and qualitatively. If the company owners want to ensure the same annual yield from the company assets, they have to maintain the same level of the monetary assets value both quantitatively and qualitatively. In this way, the truth from the cattle breeding entered the economic practice of the market economy where it turned into its antithesis. The capital is no longer sheep, cattle, machinery, buildings, knowledge and technology, but their monetary (exchange) value. The assumption in the previous example was an ideal case of the simple reproduction of the herd. The losses that may occur for foreseen and unforeseen reasons have not been taken into account. Therefore the herd owners must always keep the larger number of sheep than the number sufficient to ensure some planed annual yield. This means that only the part of the herd, not the whole herd, may have the function of capital. By making a parallel between the value of company assets and the value of herd, the conclusion must be that the company assets cannot be entirely treated as capital beacuse these assets are exposed to the risk of possible foreseen and unforeseen losses. This fact is not important for the companies whose business is directly run by their owners, but it is important for the companies whose business is directly run by non-owners. Namely, when the company is directly run by its owners, their business goal is not profit maximization but cash flow maximization.7 However, when the company is directly run by nonowners, then they face a task to maximize profit, not cash flow, because in this case the profit, not the cash flow, is the only source of revenues paid by the company to its owners. The difference between the two goals is that in the first case the accounting does not treat whole company assets as capital, whereas there are no exceptions in the second case: the accounting must treat the whole value of the company assets as capital. This means that the company must first compensate from its current revenue all asset value losses incurred in the reporting period,
7

The cash flow represents a share of company monetary revenue left when the costs that do not include the costs of depreciation and amortization of real capital are deducted from the revenue. Therefore it may be said that the cash flow represents a mixture of depreciation (amortization) and profit, without clear delineation which part pertains to the depreciation (amortization) and which one to the profit. It is important for the company owner to accomplish return of invested sum of money as soon as possible, and the cash flow exactly meets this requirement. Distribution of cash flow between depreciation (amortization) and profit is resulting from the tax policy of the state, not from some objective criteria. Specifically, the state prescribes the maximum allowable rate of depreciation (amortization) that would prevent companies to calculate depreciation (amortization) costs applying rates higher than prescribed, and thus reduce the basis of the tax on profit.

including depreciation and amortization costs; then, what is left, if there is anything left, represents the profit. It is very clear that this is why the economic freedom of the company managers-owners is different from the economic freedom of the managers-non-owners. The latter ones are in a slave position in relation to the company capital and thereby to its owners. So, these people are not free, and all the talk about the market economy as a prerequisite for achieving economic freedom does not make any sense if the profit is the measure of business success of the companies operating in the market economy. Only the substitution of the profit with the profitized rent may ensure the same degree of economic freedom to all persons who directly run company business, regardless whether they are company owners or non-owners. The next topic I would like to elaborate on this occasion is distribution of the owners' revenues between investments and expenditures. A natural or legal person may appear in the role of company owner, including in this role another company that also has its owners. The latter firm is usually known as holding company. The role of the holding company may belong only to the company whose assets are separated from its owners' assets and that assumes responsibility for the payment of own liabilities only from its assets but not from its owners' assets. It is the case of the corporation in the role of the owner of other corporations.8 Legislation in the market economies protects corporation assets in the same way it protects assets of any natural person. Therefore I will elaborate the topic on distribution of the owners' revenues bearing in mind a holding company which occur as the primary owner of companies directly engaged in production and/or sale of goods. In other words, the topic of allocation of owners' revenues, I will elaborate taking into account only the primary holding company.9 The relationships between the primary holding company and its companies may be organized in different ways. However, on this occasion I will only stress the fact that in capitalism the primary holding company retains all profit made by its companies.10 It is logical to expect that the primary holding company will reinvest a part of its owners' revenues so as to ensure real basis for the increase in its owner's revenues. The rest of the revenue will be paid to its owners as dividends. The larger the holding company revenues, the larger its' owners' revenues. So, the primary holding company is guided by the same business logic as any other private owner. It is not important for the topic discussed here what part of owners' revenues the holding company will allocate for investments, and what part for dividend payment to its owners. It is
8

Readers may find detailed description of an origin of a holding company in the economy of the United States of America in the book "The Speculation Economy" by Lawrence E. Mitchell, First edition, USA, 2007. The author emphasizes that the emergence of holding company caused turbulent development of the stock market speculations and thereby enabled the financial sector to triumph over the industrial sector of the American economy. This is why he called the book "The Speculation Economy". However, in my opinion, the source of financial sector triumph over the industrial sector should be looked for in the monetary capital, not in the emergence of holding companies. 9 Primary holding companies belong to the first layer of ownership of companies that are directly engaged in production and/or sale of goods. Other holding companies, which belong to the second and higher layers of ownership, we named secondary holding companies. 10 In capitalism, primary holding companies may retain the whole amount of cash flow earned by their companies. The persons who run the primary holding company will determine which share of the cash flow pertains to depreciation (amortization), and which to profit. The number of various criteria for this distribution is limitless, particularly in the situation where the company must pay tax on earned profit. However, this is a separate subject that will not be elaborated here.

important to note the fact that such distribution is sine qua non for the market economy growth and development. This is why it must not be subordinate to any profitability calculations of future investments. That is to say, the holding company management must first determine the part of revenues to be allocated for investments, and then look for a less unfavorable alternative for investing that amount. If the holding company is run by its owner(s), it may be expected that the owners infringe this rule using personal interests, not the market economy interests, as a starting point and give up the investments if all available alternatives are burdened with high risks of possible loss of invested money. However, if the holding company operations are run by its non-owners, it is realistic to expect that they continue with investments, using personal interests as a starting point and choosing the least unfavourable of all available alternatives11. If they gave up the investments and allocated money surpluses for dividend payment to the holding company owners, then neither they nor the holding company owners could expect any increase in revenues provided by the holding company. Besides, in such distribution it would be difficult to run the holding company business, because the holding company managers would lose the development fund. This is why it may be said that the personal interests of the managers-non-owners are in greater harmony with the general conditions of the market economy growth and development in relation to the personal interests of the managers-owners. Yet, in capitalism there is a difference between owners and non-owners in the role of the holding company managers, which reduces the economic freedom of the non-owners in relation to the economic freedom of the owners. Namely, the managers who are not the holding company owners are not allowed to treat the share of owners' revenues allocated for investments as the development fund, but only as retained earning that still represent a basis for dividend payment in the future. If the holding owners were in managerial position, it would be very clear to them that the money invested from the retained earning cannot be any longer treated as a basis for dividend payment. However, when the persons who are not the holding owners appear as the managers, then the owners give managers the task that they themselves will not be able to perform in the role of managers. If distribution of the holding company owners' revenues between the development fund and the dividends had the characteristic of parametric distribution, and company were obligated to regularly pay to its owners a share of its revenues intended for dividend payment in money or in shares, depending on owners' preferences, then the managerial economic freedom would not be endangered regardless whether the company owners or non-owners appear in the managerial role. Besides, the source of development fund would be preserved within the market economy, which would enable the market economy to develop to its full extent conditioned by possible services consumption. It is not possible to achieve this goal in the economy where money is treated as capital, meaning that it is not possible to meet this requirement in capitalism but only in non-capitalism. Accordingly, there is unambiguous conclusion arising from these several examples that non-capitalism frees the market economy from the chains of the financial capital and enables a higher degree of the economic freedom to the people, so it makes no sense to equate capitalism with market economy. To be free, the market economy must be non-capitalist.

11

In addition to the salaries, these persons are usually entitled to bonuses whose amount depends on the amount of owners' revenues of the holding company. Taking into consideration that capital losses do not affect the calculation of the current profit, owners' revenues will not be threatened until the additional investment does not jeopardize the current profit.

The capitalist market economy had the characteristics of the free market economy in those development stages when the active price competition governed the market, where certain commodity had the role of money, where agriculture could have role of the shelter for labor, where some material goods, not their monetary value, had the role of capital. With time, the capitalist market economy irreversibly lost all these characteristics. The marketing philosophy displaced the price competition and thereby the invisible hand of the market, of which Adam Smith wrote as something led by the personal interests of individuals for common good. Instead of the commercial and the industrial capital, the financial (rentier) capital ruled the market with generous assistance of the government from its taxpayers' pockets. This assistance is based on a misinterpretation of John Maynard Keynes's economic theory, elaborated in the book "The General Theory of Employment Interest and Money". Thus the capitalist market economy irreversibly lost its characteristics of a free economy, and people lost their economic freedom. Supporters of liberalism or, in modern terms, neoliberalism, would have to take this fact into account. If they want to achieve the idea of freedom without forcible equality, except for the equality before the law, they must abandon support to capitalism. Otherwise, it will remain intellectually inferior and morally unattractive alternative in the group of projects for building of the future society.

Any comment has to be sent by e-mail to mikatic@interlog.com