Why Has the Old Institutional Economics Not Made a Comeback?

The Anti-Climax of the Old Institutionalism

Thorstein Veblen is an economist that I have admired ever since I was introduced to his work at graduate school; indeed, my research was to a great extent inspired by his ideas. In the past year, I have even come to relate to him on a personal level, since, like him, I have struggled to secure academic employment. Encouragingly for me, Veblen went on to become an influential economist and intellectual, despite having a somewhat troubled career. Veblen arguably founded not one but two schools of economic thought – the Institutionalist and Evolutionary schools – with his ideas also resurfacing in currently fashionable behaviouralist approaches, among others.

Unfortunately, with the ascendancy of Neoclassical Economics, the Institutionalist school with which Veblen is most closely associated suffered a critical defeat from which it has never fully recovered. The new orthodoxy dismissed all rival schools, including Veblen’s, as ‘soft’, insufficiently rigorous, or unscientific – this latter allegation being especially ironic given that, as we will see later, Veblen actually devised a number of his theories as substitutes for what he deemed to be the unscientific foundations of neoclassical economics, particularly its fantasy of homo economicus. Institutionalism was later revived by the self-declared ‘New’ Institutional Economics, but in bastardised, emasculated form that replaced much its distinctive content with the standard tenets of Neoclassical Economics, in much the same way as the Keynesian Compromise was forged.

More recently, in large part thanks to mounting disillusionment both within and without the economics profession, the so-called ‘Old’ Institutionalism has received renewed interest. It nevertheless remains relatively peripheral – not only in the ivory tower of mainstream economics, but even in forums dedicated to economic pluralism, which tend to favour Keynesianism, Marxian approaches, and even minor schools like Feminist Economics. In his celebrated book Debunking Economics, for example, Steve Keen provides a list of possible alternatives to the neoclassical paradigm, consisting of Keynesian, Marxian, Austrian, Complexity, and even Evolutionary Economics, but conspicuously lacking Institutional Economics (unless he treated it as included in or coterminous with Evolutionary Economics, which would be understandable given Veblen’s approach but inaccurate when it comes to the field as a whole).[1]


The Case for the Old Institutional Economics

As a social scientist interested in the economy (which is the definition of an economist in my opinion, although not in the opinion of most economists), and more specifically one who would identify as an Institutionalist if pressed to declare an allegiance, I find this state of affairs astonishing and lamentable. In my opinion, the Old Institutionalism is more relevant than ever, both to the discipline of economics and to the economy itself. To argue this case, I would like to consider some (but not all) of the core principles of Old Institutionalism in turn, focusing mainly on their relevance to current problems in the economy rather than current problems in economics, since the latter has been thoroughly covered by scholars like Geoffrey Hodgson who are sympathetic to the Old Institutionalist tradition.

1) The Technology-Institutions Dichotomy
Probably the most well-known contribution of Veblen’s institutionalism is the dichotomy between technology and institutions[2], which in fact encompasses a number of dichotomies, such as that between ceremonial and instrumental institutions and that between industry and business. The essence of all of these dichotomies is that the correspondence between those institutions that are oriented towards a technological or industrial imperative (“instrumental” institutions) and those that are oriented towards an acquisitive or predatory imperative (“ceremonial” institutions) is imperfect. Whereas instrumental institutions play a “serviceable” role in the community, for example by providing consumers with innovative or lower-cost products, ceremonial institutions are societally detrimental, generating excessive waste, parasitising on common resources, engaging in destructive forms of competition, and obstructing social progress.

It seems to me that advanced economies are currently experiencing a critical divergence between technology and institutions, between instrumental and ceremonial institutions, and between industry and business, not dissimilar from Veblen’s own era. The financial crisis is the most egregious example of non-serviceable business running amok, squandering social resources for purposes of private gain without contributing whatsoever to technological progress. More broadly, however, many commentators have declared that capitalism has come to revolve disproportionately around rent-seeking rather than value-creation. Whether or not you completely agree with that diagnosis, you only have to consider issues like exorbitant corporate salaries, tax- and regulation-dodging, patent trolling, financialisation, and share buy-backs – which propagate not only the deplorable levels of inequality but also the distressing degrees of stagnation currently afflicting our economies – to appreciate the aptness of Veblen’s analysis. Indeed, Veblen’s pet peeves included absentee ownership, “conspicuous consumption”, and an obsession with corporate profits, all of which remain salient issues today.

2) Cumulative Causation
A related aspect of Veblen’s framework was his conceptualisation of society (including the economy) as an evolving system akin to the biological systems studied by Darwin. As simple as this idea may sound, it actually flies in the face of most mainstream economics – including the ‘New’ variety of Institutionalism – which tends to espouse a simplistic model of natural selection whereby a single institution, namely the market, allows only those institutions that are fittest in some absolute sense to survive. By contrast, Veblen emphasised that institutions co-evolve through an endogenous, path-dependent process which called “cumulative causation”, whereby the selection mechanisms themselves alter over time. As a result, even completely “imbecile” institutions can persist, despite being undesirable from a technological or social perspective. The static analysis favoured by neoclassical economics is therefore incomplete, and even inappropriate – what matters is the context, the history, the trajectory.

This component of Veblen's work is also pertinent to the economic times in which we live. To be sure, with the rise of the New Institutional Economics, institutional shortcomings have become decidedly vogueish in comparative explanations of economic underperformance. However, Veblen’s theory implies that, contrary to the conventional wisdom, these shortcomings result not from ‘artificial’ interventions in the market mechanism, but rather from quite ‘natural’ processes of cumulative evolution. In fact, Veblen emphasised precisely that “purposeful action” would be required to intercede in these evolutionary forces in order to make society’s institutions more instrumental and less ceremonial. By the same token, his framework implies that the usual prescription of simply adopting so-called ‘good’ institutions – which, to complicate matters further, are not those that Veblen would necessarily identify as instrumental – is unlikely to improve matters, since ceremonial institutions entail “vested interests” which are likely to resist radical change. These interests may even capture the state apparatus itself, according to Veblen, so that public policy comes to perpetuate rather than counteract the status quo.

3) The Critique of Homo Economicus
In my view, Veblen’s critique of homo economicus – the superhumanly rational, purely self-seeking representative agent of mainstream economics – remains one of the most powerful to date. Veblen advocated an interdisciplinary approach to understanding human behaviour, drawing particularly on anthropology (the study of man and civilisation), psychology (the study of mind and behaviour), and evolutionary biology (the study of the evolution of living organisms), which he deemed to be qualitatively more scientific and more suitable to the subject in question than the neoclassical approach characterised by arbitrary assumptions. Veblen’s interdisciplinary synthesis held that humans act according to instincts and habits before even engaging in the sort of demanding calculations assumed by Neoclassical Economics to drive behaviour, and are furthermore motivated by loyalty and workmanship in addition to the self-interest assumed by that school to prevail exclusively. Crucially, Veblen insisted that individuals' means of decision-making and preferences, both of which Neoclassical Economics treats as predetermined, evolve over time through the processes of cumulative causation described above.

This aspect of Veblen’s Institutionalism may appear to be more an academic dispute than a practical tool. In fact, however, the way that human behaviour is conceived affects virtually everything in economic theory, which in turn shapes research and policy agendas. To name just a few applications, whether we consider individuals to be robotic “bundles of desire” or multifaceted “social animals”, to use Veblen's terminology, has an immeasurable bearing on whether we believe that benefit recipients will cheat the system, whether employees must be monitored and incentivised to do their jobs properly, whether markets will automatically self-equilibriate, and whether assets prices always reflect fundamental values – questions that are more pressing than ever, not only for economics, but also for the economy itself.


Explaining the False Dawn

I have made the case that the current neglect of the Old Institutionalism is unjustified. How, though, do we explain this neglect? It seems to me that there are three potential explanations, which are by no means supposed to be mutually exclusive.

1) Absorbed by the New Institutional Economics
One possible reason for the non-appearance of the Old Institutional Economics is that all of its meaningful material has already been been absorbed by its ‘New’ counterpart, as proponents of the latter indeed claim. I have already contended, however, this is not the case. On the contrary, the Old Institutionalism is needed at present precisely as a counterweight to the New variety, which, with its autistic assumptions, market veneration, liberal philosophy, Western prejudice, and conservative bias - to name a few of its faults - has engendered a dangerously lopsided economic paradigm.

2) Filtered into Other Schools
A second possibility is that the insights of Old Institutionalism have been variously adopted by other schools, which have in turn experienced a resurgence. This is the position of Geoffrey Hodgson, for example, who in his 2007 article entitled ‘the Revival of Veblenian Institutional Economics’ expounded the widespread influence of Veblen’s thought on contemporary economics, including the closely related Evolutionary school, ‘trendy’ fields like Behavioural Economics, and even relatively mainstream areas like game theory. It remains to be explained, however, why the Old Institutionalism itself has not re-emerged as a cohesive school, since there are elements in the work of Veblen and his successors apart from their ideas on behaviour and evolution that are essentially Institutionalist – not least the various dichotomies described above – which cannot be completely distilled into other schools.

3) Limited Applicability 
Another potential explanation is that the Old Institutional Economics, even in terms of its distinctive dichotomies, does not provide a comprehensive framework for understanding the economy. A comparison to this effect might be made with Austrian Economics, which has suffered a similar fate. While I would certainly agree that the Old Institutionalism is no panacea, the same is true for any school of economic thought; in fact, for the reasons submitted above, I would argue that the Old Institutionalism is one of the most widely applicable, offering a radical alternative to Neoclassical Economics. The Austrian school, by contrast, really does consist of a range of specific arguments relating to specific economic problems, and while it definitely offers an alternative perspective to the mainstream, it arrives at some of the same key conclusions and implications.

4) Overshadowed by Marxianism
The obvious reply to the foregoing is that the Old Institutionalism is neither comprehensive nor radical when compared to its Marxian cousin.  It could be argued, in particular, that the Old Institutionalism is just a counterfeit, diluted form of Marxianism that neglects the crucial dimension of class conflict. Indeed, Veblen borrowed extensively from Marx despite repeatedly (and often mistakenly) criticising his writings; even the Institutionalist dichotomies bear a striking resemblance to Marx’s distinctions between the forces and relations of production and between the social and technical relations. By the same token, the Old Institutionalism offers one of the only serious alternatives for those who would assume a radical perspective on society without placing class at its centre – indeed, Veblen deliberately conceived it as such. It is true that Veblen’s programme never received the same degree of traction as that of Marx, the latter of which has been continually expanded, clarified, and – dare I say – improved by subsequent adherents; but that only begs the question.


Concluding Remarks

In lieu of a conclusion, I would like to propose a research agenda based on the Old Institutionalist school which I have argued is unduly neglected in modern discourse. Veblen believed that economists should be concerned with identifying which of society’s institutions (or which aspects of a given institutions) are instrumental and which are ceremonial, and with devising ways to elevate the former over the latter. This seems as good a place as any to resume the Old Institutionalist programme, recognising that many have already taken it upon themselves to do so. Veblen’s own admittedly whacky idea – which, to his great credit, he attempted to implement in practice while at the New School in New York – was for a technocratic “soviet” of engineers to seize (or inherit) control of capitalism from the errant businessmen that he so harshly lambasted. This no longer seems feasible or even desirable, if ever it was; but perhaps, like Veblen, we can dare to challenge prevailing dogmas - or “habits of thought”, as he called them - in our pursuit of a better society.


Notes

[1] I admit that I have not provided much evidence to support my assertion that Old Institutionalism is neglected in pluralist circles, which is mainly based on my own anecdotal experience. I’m sure that others have had differing experiences in this regard.
[2] It is debatable whether Veblen ever really proposed such a dichotomy, which is more clearly embraced by Veblen’s disciple, Clarence Ayres. The subsidiary dichotomies, however, are indisputably Veblenian.

The Democratic Economy: a Hope and a Danger

Winston Churchill famously quipped that "democracy is the worst form of government, except all those other forms that have been tried from time to time". An analogous statement can be made regarding capitalism, which, for all its faults, basically works - at least, better than any other system that has yet been tried.

But what really has been tried? With the end of the Cold War and the fall of the Berlin Wall, it was widely proclaimed that the 'End of History' had been reached; capitalism had won a categorical victory against its arch-rival system of communism, which had proven to be unviable. It should not be forgotten, however, that the centrally-planned, authoritarian system of the Soviet Union was a far cry from the communist utopia envisaged by Marx, just as the corporatist, oligopolistic version of capitalism that predominates today is a far cry from the free-market utopia envisaged by neoliberals.

Indeed, just as the Left has struggled to find a concrete alternative on which to ground its identity since that momentous day 1989, the traumatic events of 2008 and their enduring aftermath have led many on the Right to grapple for their own alternative to the present system. In reality – and despite what many a sensationalist airport-book author would have you believe – modern capitalism continues to stagger on virtually unchallenged, with no definitive indication that it will collapse any time soon; but it is nevertheless clear that its problems are mounting, and that the solutions offered so far have been inadequate to avert further catastrophe.

There is, then, a growing a sense that neither corporate capitalism nor state socialism are fit for purpose, and that some alternative system is called for. Neither Left nor Right have managed to substantively imagine (or at least compellingly describe) what this alternative might be, and to the extent that they have, their formulations are in some ways diametrically opposed. There are, nevertheless, some common threads.

I would particularly draw the reader’s attention to the cross-cutting agreement that, in some way, shape, or form, society needs to be more democratic. One of the peculiar traits of neoliberalism – and indeed, one of its most impressive victories – has been its ability to convince the masses that democratic participation need only inhere in the political sphere, with labour-market choice sufficing to ensure equivalent freedoms in the economic sphere. Although many discontented right-wingers (especially of the libertarian ilk) buy into the false premise that ‘free markets’ are inherently democratic, and would thus have market forces permeate even more of our social relations, it is has become increasingly apparent that the economy is constituted by more than just the market. Indeed, most economic activity occurs within organisations like firms, which must therefore be explicitly democratised if the economy is to even remotely approximate the hallowed value of freedom supposedly intrinsic to markets.

Meanwhile on the Left, the rubric of ‘community participation’ has acted as a backstop for hopes of a fairer, more decent, and generally better socio-economy. Although this vision is often vaguely and incoherently articulated through a disparate range of permutations – unlike their libertarian counterparts, socialist dissidents lack a unitary idol like the market around which to centre their ideology – real-world examples have proliferated in recent times, or at least grown in prominence. The late Nobel prize-winner Elinor Ostrom, for example, compellingly demonstrated that communities are, directly contrary to the predictions of mainstream economic theory, often the best stewards of common resources, which may otherwise be depleted through overuse if managed by either private owners or public administrators. Solidarity/social economies, cooperatives of various sorts, transitional towns and more have all added to the repertoire of evidence that some kind of ‘communism’, defined loosely and without the authoritarian connotations, may be possible after all.

Opposite extremes of the political spectrum therefore converge, or at least overlap, in their aspirations for a democratic economy. In this vein, it is interesting to note that cooperatives often transcend traditional ideologies, appealing to thinkers and activists of all stripes and none but also repulsing mainstream party politics. Perhaps the only global ideology that has historically embraced cooperatives without reservations (for example relating to trade unions or 'private property') has been anarchism, which, as a political philosophy that can be formulated from both left- and right-wing perspectives (or from neither perspective), is itself located in the ‘no man’s land’ of political economy.

The allusion to anarchism is not coincidental, for so far the institution of the state has been conspicuously absent from our discussion; and it is here that the promise of a democratic economy becomes a danger. While freedom from government interference is a familiar mantra of reactionaries, it should not be forgotten that the dissolution of the state was an explicit objective of many communists, not least Vladimir Lenin. Of course, Lenin’s famous avowal was not borne out by the actual experience of the Soviet Union – quite the opposite, in fact. However, that same experience demonstrates the perils of mindlessly retrenching the state. The overnight liberalisation recommended by neoliberal economists ('shock therapy') led not the emergence of a free-market utopia propelled by citizen-entrepreneurs, but rather to a coup-d’économie by a select group of oligarchs, leaving the post-Soviet countries in a situation not far removed from the runaway inequality of Western capitalism.

Cooperatives again provide a microcosm of this danger. Despite their progressive potential, cooperatives have been increasingly co-opted by conservative politicians as a means of privatising social services through a more palatable back door – particularly in the UK, where their not-so-hidden agenda of dismantling the welfare state has taken root under the pretext of austerity.

The ambition to create a democratic economy is noble, and, given its cross-cutting allure, may just about be attainable. The road to reform, however, is fraught with peril. 

Money as Socialised Credit

I have been reading quite a lot recently on the nature of money (e.g. Felix Martin's Money: the Unauthorised Biography and various bits by David Graeber). The question of 'what is money?' intrigues me because, as an economist, I was long taught that money isn't really a thing - it is simply an index of value, a way of circumventing the inefficiencies of direct barter. Yet, it quite patently is a thing, for all sorts of reasons - it confers social status, is subject to hoarding, causes financial crises, etc. For me, the main problem with the economists' view of money lies in in its fiat property: unlike commodity or representative money, money in modern economies is literally created out of thin air by central and private banks, which doesn't sit well with the notion that money exists as some kind of 'natural law' of society.

Of course, it could be argued that the inflation brought about by money creation, by increasing prices of all goods by the same proportion, still retains an equivalence of relative value between those goods. Even if that is true, however, money creation and its consequences do have distributive consequences - for example between creditors and debtors in the case of inflation, or between asset-holders and everyone else in the case of quantitative easing. This, I believe, is where the heterodox definition of money excels - according to both Martin and Graeber, money is, by its very nature, a form of credit. In particular, I would say that it is a claim on society (and, for that matter, the natural environment) - its resources, its labour, or whatever.

The definition of money as socialised credit allows us to challenge the economic status-quo, along with its plethora of social disorders, in a way that is not possible with the definition of money as an immutable law of value. Take inequality, for example, perhaps the most prominent economic issue of our time. If we espouse the standard defintion of money, our ability to question the distribution of wealth and income is limited. We can still implement redistributive policies, of course, but there is a sense in which we are defying some kind of 'natural law' (such as c>g, perhaps!) in the process, unless we claim to be rectifying some previous infringement such as monopoly. If we espouse the definition of money as socialised credit, however, we can ask the fundamental question of whether society really 'owes' this person billions of dollars' worth of its resources or labour. What has that person contributed to society that commands such a hefty price tag? Has that person really contributed millions of times more (or, for that matter, anything more) than the average worker, whose wage has been stagnant for decades? Can we really justify a situation in which the 99% is in 'social debt' to the 1%?

Speaking of which, the issue of debt offers another lucid example of the contrasting definitions of money. From Germany's perspective, Greece must repay its debts, because it would be cheating not to - that's just the way that money works. When we conceive money as socialised credit, however, it becomes clear that such an assumption is moot in the context of the Eurozone, in which the mechanisms by which credit is socialised (such as a coordinated fiscal policy that could redistribute surpluses to deficit regions) are critically deficient and unfairly rigged.

In reality, of course, these examples are tremendously complex, involving numerous interacting elements; but how we understand money is surely one of the most consequential.

Cooperatives in the Organisation Economy

In previous posts discussing the relationship between cooperatives and archetypal economic systems (viz. communism and capitalism), I drew what I believe to be an important distinction between ownership of enterprises and coordination between them. I argued, moreover, that it is primarily the former criterion that defines these archetypal systems – capitalism consists of ownership (of the means of production, property rights, or whatever) by capital, whereas communism entails ownership by the community (broadly conceived). Cooperative ownership, I suggested, can be conceived as a variant of either of these ideal-types, or perhaps as a ‘third way’ between them - workers may be their own/each other’s capitalists, and/or they may circumscribe ‘the community’ to the level of the enterprise. I also proposed that the coordination criterion, while significant (especially given its interaction with the ownership criterion), is less consequential, because, crucially, it would be theoretically possible for common ownership to be coupled with market coordination in a sort of ‘market socialism'.

This point is made all the more clear when we consider that ‘actually existing capitalism’ is a far cry from the free-market utopia eulogised by neoliberal ideologues and the perfect-competition model depicted in economics textbooks. In fact, the market is not the primary means of coordination in modern capitalist economies; rather, most allocative decisions are made within organisations (such as firms, governments, and universities), or between them through non-market means (such as long-term agreements, joint ventures, and implicit collusion). As Herbert Simon once remarked, real-world capitalist economies are more accurately described as ‘organisation economies’ than ‘market economies’.

With this in mind, it is a moot point as to whether or not cooperatives can thrive in a purely market-based economy – the question that commentators on the subject usually pose – because such an economy is a fiction. Indeed, there are compelling reasons to believe that even capitalist firms would not be able to function effectively, or at all, in such an economy. For one thing, as Ronald Coase famously postulated in 1937, firms themselves represent ways to circumvent market transactions, the costs of which (owing to asymmetric information and whatnot) would prohibit economic activity. Coase actually understated his case, because firms intentionally avoid (and manipulate) the market even to coordinate with each other. At any rate, without firms – that is, in a situation characterised by sole entrepreneurs buying inputs and selling outputs – there would be nothing for capital to own; indeed, the distinction between capitalist and labourer would disappear. After all, from a Marxian perspective, it is precisely through the employment and agglomeration of workers that capitalists extract surplus value. From a Schumpeterian perspective, meanwhile, it is precisely the pursuit of monopolistic rents – which, by definition, cannot exist in a state of perfect competition – that propels innovation in a capitalist system.

How, then, would cooperatives fare in an organisation economy? To answer this question, we should first remember that, although both Marx and Schumpeter extolled (organisational) capitalism for its unparalleled ability to create wealth, they also bemoaned its tendency to stimulate individualistic behaviour, induce unemployment, and prevent workers from attaining their intellectual and moral potentials. Cooperatives, by contrast, have been repeatedly shown to generate employment, foster trust, and develop workers’ skills. Rent-seeking is also associated with other undesirable activities – such as extortionate pricing, regulatory corruption, and wasteful advertising – which cooperatives are supposed to eschew thanks to the principle of ‘concern for the community’ enshrined by the International Co-operative Alliance. Indeed, cooperatives have been widely lauded for integrating marginalised social groups, revitalising declining regions, and otherwise contributing to their local communities.

These positive spillovers would be magnified in an organisational economy dominated by cooperative ownership. For starters, the complementary principle of ‘inter-cooperation’ – that is, cooperation between cooperatives – would ensure that relations between firms are productively cooperative rather than wastefully competitive or collusive (although some degree of competition would undoubtedly be required) (Gregory 2013: 62; Bruni and Zamagni 2004; Zamagni and Zamagni 2008). This would essentially be what is often referred to as a 'solidarity economy' - a notion that is not as far-fetched as it would first appear when the organisational nature of economic coordination in existing economies is considered. Crucially, in such an economy, the rents that drive innovation would not vanish, but would rather be pursued in a more socially-beneficial manner. They would, moreover, accrue to cooperative worker-members, which would have far-reaching consequences given the relative immobility of labour: rents will tend to be reinvested within firms rather than siphoned off into private accounts, and will not be concentrated within the small section of society that happens to own capital.

In sum, the fact that modern economies are primarily coordinated through organisations rather than the market strengthens my case that cooperatives offer a means to harness the productive powers of capitalism while avoiding its adverse effects.



References

Gregory, D. (2013) 'Towards a New Economy Based on Co-operation' in Harrison, R. (ed) People Over Capital: the Co-operative Alternative to Capitalism (Oxford: New Internationalist Publications)

Bruni, L. and Zamagni, S. (2004) Economia Civile (Bologna: il Mulino)

Zamagni, S. and Zamagni, V. (2008) La Cooperazione (Blogna: il Mulino)

The Methodological Division of Labour in Economics

My very first post on this blog discussed the mathematical imperialism that has recently infiltrated the discipline of economics. In that post, I distinguished between pluralism in subject matter (e.g. paying more attention to issues like inequality) and pluralism in methodology (e.g. accepting historical approaches as legitimate), and argued that, at present, ‘New Economic Thinking’ relates primarily to the former. I promised, moreover, to explain in a subsequent post why I think that methodological diversity is also crucial to the renaissance of economics. Over ten posts later, that is precisely what I intend to do now, albeit by way of analogy, and in a rather tongue-in-cheek fashion.

Following Adam Smith, who is widely considered to be the ‘father of modern economics’, I accept that some degree of specialisation – in this case, with regard to methodology – is acceptable, and even desirable. Mathematics and econometrics (hereafter ‘MAE’) certainly have their place, and it stands to reason that the field of economics benefits when certain economists choose to specialise in using these tools. Smith (1776, Book I, Chapter 1), after all, argued that specialisation would increase productivity by improving workers’ dexterity and by facilitating innovations at each stage of production [1]. Specialisation in MAE thus produces better mathematicians/econometricians and better maths/econometrics. For a number of reasons, however, Smith’s logic also implies that this specialisation should not proceed indefinitely.

First, there are clearly limits – or at least diminishing returns – to the productivity gains that can be accrued by further specialisation in a given task or methodology. You can only get so good at casting or filing a pin (clearly, I don’t remember the actual stages of production involved in pin-making described by Smith), or, for that matter, doing MAE. Although innovations in casting or filing can surpass these limits, they are not costless – you might get away with paying a worker the same wage to do more work (or more productive work) in a given amount of time, but machines have to be built, purchased, operated, and serviced. The result is that a whole production process, including its own division of labour, emerges to focus on improving the particular task of casting or filing. A parallel in economics, for example, is that teachers require an increasingly higher level of training in MAE. Meanwhile, textbooks must be continually rewritten to reflect mathematical and econometric ‘advances’, giving rise to a vast industry in its own right, just as peer-reviewed journals must expand, change focus, or multiply to keep apace. At some point, the costs of this sub-division of labour must outweigh any benefits to economics of marginally superior (and increasingly less-superior) MAE.

A more glaring problem with unlimited specialisation in maths and econometrics, however, is that the whole point of specialisation, according to Smithm is to allow for more production to occur for a given amount of manpower. What we see in economics, by contrast, is the exponential proliferation of economists specialising in MAE. This proliferation, moreover, does not simply reflect the proliferation of the discipline itself, which would not necessarily defy Smith’s logic; rather, it is occurring to detriment of other methodologies. This relates to a third problem, which is that specialisation in a given task is only beneficial within a broader division of labour. After all, if specialisation in MAE is beneficial, then specialisation in other methodologies must be also [2].

In my initial post, I alluded to the proverb of the man with a hammer (i.e. skills in MAE) who thinks that everything is a nail. What we observe in economics is a vast population of workers, each equipped with a state-of-the-art hammer with which she has been trained to the level of expert. All of these workers are huddled around a single worktable, each trying desperately to push their way to the front so that they can impress the boss by hitting something (and don’t come at me with the benefits of competition, which Smith also emphasised – the whole point of a firm, at least according to mainstream economics, is to internalise transactions that would normally occur through the market). Meanwhile, all (at least most) of the other work stations are undermanned, laden with untapped potential for improvements in productivity. Thus, in a sort of reverse Lewis-model scenario, workers are flooding into the surplus-labour ‘MAE sector’, adding little in the way of productivity, despite other sectors remaining underpopulated. Furthermore, those work stations that are enjoying a much-needed increase in manpower, such as behavioural economics, remain disconnected from the other stages of production, with the lamentable result that the mainstream continues to rely on demonstrably false assumptions in order to facilitate hammering (i.e. modelling). The gross inefficiencies of this factory of economics are reflected in the quality of its final product, with which its consumers – that is, students, employers, and the like – are increasingly dissatisfied.

Finally, it should be noted that, despite singing the praises of specialisation within a division of labour, Smith also warned against its adverse effects on individual workers. Indeed, he (1776, Book V, Chapter 1, para. 178) went so far as to state that repetitively performing a narrowly-defined task would render a worker not only “stupid and ignorant”, but also “incapable of…conceiving any generous, noble, or tender sentiment”, even to the point of adversely affecting her “private life”. At the risk of (severe) generalisation, this is indeed what we observe in economics – flocks of idiot-savants who succeed in degrading the subject to a mere branch of mathematics, so devoid of any real-world foundation or application that academics and students alike have called for a ‘post-autistic economics’. Even specialists in MAE must have some knowledge of actual economies, as well as economic history, economic thought, and other methodologies. Indeed, Smith (ibid.) was so concerned about the adverse effects of specialisation on workers’ mental health that he believed government intervention would be required to curb it. Perhaps something similar is required in economics!

Notes:

[1] Another channel by which specialisation would increase productivity, according to Smith, was by eliminating the time wasted by transitioning between stages of production. This channel does not apply to the current discussion except insofar as time is required to learn new methodologies, which could be spent using the methodologies in which each economist is already proficient.

[2] Obviously, I am assuming here that other methodologies are useful, which is precisely what I am trying to argue. As stated at the outset, this is (admittedly circular) argument by analogy, not deduction. Incidentally, the exclusive use of deductive logic to the neglect of inductive approaches has been identified to be one of the major pitfalls of contemporary economics.


Reference:

Smith, A. (1904 [1776]). An Inquiry into the Nature and Causes of the Wealth of Nations (5th ed.). London: Methuen & Co. Retrieved from http://www.econlib.org/library/Smith/smWNCover.html

The Failure of the Anglo-Saxon Model of Business and the Worker-Cooperative Solution

Introduction

Discontent with the prevailing business model of the Western, capitalist economy, while arguably mounting for the past half-century, has reached a climax with the financial crisis of 2007-8 and its enduring aftermath. There is now a pervasive sentiment among intellectuals, policy-makers, and the public at large that the shareholder-oriented corporation is not fit for purpose, and that a fundamental change is needed in the way that businesses are run. The sources of this dissatisfaction are manifold, relating to the failure of the status quo both to maintain a robust economy and to deliver on social criteria like fairness and wellbeing. While there have been calls from many quarters for companies to include a wider variety of stakeholders in their systems of participation and decision-making, the worker-cooperative model, whereby workers own and control the firms in which they work on a democratic basis, is a largely overlooked alternative to conventional enterprise that offers some unique advantages in addressing some of the most urgent socio-economic ills of our era.

Inequality

Amongst those ills, it is probably the issue of inequality that has received the most attention in recent times. The work of renowned economists like Thomas Piketty and Joseph Stiglitz has exposed both the magnitude and the costs of a scandalously lop-sided distribution of wealth and income, which has provoked popular agitation against a system in which a small class of super-rich – the infamous ‘one-percent’ – grows increasingly richer while the rest of the citizenry endures hardship and stagnation. Although issues such as deregulation, union decline, and deindustrialisation are all contributing factors, the shareholder model of corporate governance has undoubtedly been complicit in causing and perpetuating this woeful state of affairs.

The capitalist corporation configures the firm to be a mere investment vehicle through which the wealthy can multiply their wealth without taking an active part in the production process; ownership of (limitedly liable) residual claims has become just another financial asset for an investor to add to her portfolio. Furthermore, due to the separation of ownership and control, especially when coupled with dispersed shareholdings, managers have become a class of their own, enjoying astronomically inflated levels of pay that are entirely inconsistent with their levels of productivity. The real wage of the average worker, meanwhile, has been stagnant for nearly half a century; the common citizen is no better off than were her parents, or even her grandparents. In short, while corporate profits boom and executive pay soars, workers are sharing less and less in the proceeds of growth. With the rise of ‘precarious employment’, they are also enjoying less in the way of promotional opportunities, critical welfare services, and job security.

By conferring both residual claims and ultimate authority to workers, cooperatives have the potential to generate a more equitable distribution of wealth and income: in a cooperative, worker-members enjoy both a stake in the firm’s profits and the power to determine their own wages. They also have the power to determine the salaries of managers, and thus to reduce the deadweight burden on society caused by inordinate executive pay. Furthermore, in addition to creating well-paying jobs, cooperatives have been lauded for preserving those jobs during economic recessions, a propensity that derives in part from the fact that worker-members can collectively choose to temporarily reduce their share earnings.

Economic Stagnation

The classic justification for inequality is that it is ‘good for growth’, which expands the total size of the economic ‘pie’. In recent years, however, we have instead witnessed economic stagnation, punctuated by financial bubbles that eventually burst and thus reduce the total wealth of society. The most convincing explanation for this deep-seated malaise, which has come to be known as ‘secular stagnation’, is the rising tendency for economic agents and institutions to forego value creation in favour of value extraction – that is, to leech on society’s resources – a practice that is intrinsically related to the rise in inequality.

Although the most obvious driving force of value extraction is the unrestrained ascendancy of the financial sector, which has directed its resources to ‘innovations’ that are not only unhelpful but in fact detrimental to the real economy, even non-financial companies are at fault. As economist William Lazonick has explained, large, investor-owned corporations, long the protagonists of Western economic history, are failing to invest in research and development, worker skills, and other productive assets that generate a social benefit. Instead, they are siphoning an ever larger share of their net revenue towards dividend payment and share buybacks, the latter of which are usually performed purely to boost the already-excessive pay packages of top executives.

Even amongst the investments that corporations do undertake, shareholder primacy (coupled with the excessive mobility of capital and the threat of hostile takeovers) leads to a bias against long-term and uncertain investments – precisely the ones that lead to the most significant innovations, and thus social rewards – in favour of ‘low-hanging fruit’ that temporarily boost share values and look good on quarterly reports. Indeed, non-financial corporations have developed an unhealthy taste for financial assets, further contributing to the ‘financialisation’ of the economy. The result of this neglect for productive investment is that, despite giving workers an increasingly unfair deal, Western corporations are increasingly unable to compete globally or deliver the level of social value that would be commensurate with the amount of economic resources they command. On the contrary, they are using those very resources to push for tax cuts, deregulations, and even subsidies – not to mention exploiting fiscal and regulatory loopholes that further reduce their contribution to society – or else abandoning the communities that have come to depend on them.

Worker cooperatives offer an expedient alternative to the myopic imperative of share-value maximisation. Because members of a cooperative are not only investors but also workers, they cannot withdraw their wealth without incurring either unemployment or a loss in the value of their firm-specific skills, and in some cooperatives the withdrawal of investment may anyway be limited or even prohibited. The livelihood of a worker-owner therefore depends to a greater extent than an investor-owner on the long-term prospects of her enterprise. This gives her reason to not only reinvest within the enterprise, but also to engage in those investments that secure the future of the enterprise, not least her own skills. It also contributes to the inherently ‘place-based’ nature of cooperatives – workers are members of a community, and are unlikely to pick up sticks in order to take their investment elsewhere.

Alienation and Antagonism

Concomitant with the recent surge in inequality is a sense of workplace alienation, which, given its documentation by Marx, Durkheim, and others, has been present at least since the Industrial Revolution. The activity of work, which occupies the majority of an adult’s waking hours, is increasingly seen a necessary evil that must be endured purely for the sake of earning an income, and ultimately for consuming goods and services produced by other people. This loss of personal and social meaning is not only deplorable in itself; it also leads to a decline in productivity, and thus contributes further to economic stagnation. As work conforms to its economic depiction as mere ‘disutility’, workers conform to the economic prediction that they will dodge their responsibilities, fail to take initiative, or at least work without enthusiasm, doing just enough to receive their wage and avoid the sack. A knock-on effect of this behavioural shift is that workers come to view managers as enemies, enforcers of an organisational objective that does not affect them, at least in a positive way. A vicious circle of distrust and disloyalty is therefore initiated, further impairing organisational performance.

Worker ownership not only provides material incentives for workers to perform above and beyond the bare minimum, but also, when coupled with worker-control, affords a moral motivation to pursue the ‘common good’ of the company, be it by working harder or by exerting social pressure on peers to do so. Worker-members can also democratically choose less alienating terms and conditions of work, and, because managers are ultimately accountable to workers, they are less likely to be seen as adversaries.  

Conclusion

Shareholder capitalism was famously justified by Milton Friedman on the grounds that maximising profits was the best way for a company to serve the common good. Although the investor-owned corporation remains predominant in the Anglo-Saxon world, Friedman’s argument has been called into question by a rise in inequality, economic stagnation, and workplace dissatisfaction. Social and economic prosperity clearly requires an alternative business model, for which I have argued worker cooperatives represent a promising candidate. Indeed, countries across the globe are already experiencing a trend towards employee participation in various forms. More public awareness and more public action will be needed, however, if worker cooperatives are to be given a legitimate opportunity to challenge the hegemony of the investor-owned corporation, and so help to remedy its adverse socio-economic effects.

Who Hires Whom in Cooperatives?

It is usually assumed in the literature that whereas in a capitalist firm capital hires labour, in a cooperative firm labour hires capital. This may be an accurate description of a capitalist firm, in which the owners of the firm’s capital enjoy residual claims and control rights, paying workers a rental fee (that is, a wage) in return for their labour. In cooperatives, however, even if ‘labour hires capital’ in some theoretical sense, worker-owners do not necessarily hire capital from somebody else (although they may). Rather, many cooperatives in the Western world are self-financing, meaning that members contribute both labour and capital, receiving both wages and dividends; the roles of worker and capitalist are merged into one person. In fact, it is almost as if workers have become “their own capitalists”, as Marx bemoaned, by hiring their own labour (and each other’s). This can be clearly seen when one considers that many cooperatives hire non-member workers, who receive only a wage and have no control rights. The only thing that distinguishes these non-member-workers from worker-members is that they have not contributed any capital in the form of a membership fee.

What about the fact that voting rights in cooperatives are usually allocated on a 'one-member-one-vote' basis? Doesn't this imply that control rights have in fact been allocated to labour rather than capital? That could well be the case - control rights could have been separated from residual claims, the former vested in labour and the latter vested with capital (but both ultimately remaining with the same persons). However, the equal-voting principle can also be explained by the fact that members usually contribute an equal amount of capital, at least with regard to their membership; in some cooperatives the membership contribution is set at a token $1, for example. Indeed, in some cooperatives that allow for variable amounts of internal investment by members, voting rights are allocated in proportion to capital contributions. And, of course, the principle could simply represent a historical or philosophical remnant of the cooperative movement rather than a necessary result of the way that cooperatives function.

To be sure, cooperatives may issue debt to outside investors, paying interest on the debt, which would indeed be a case of ‘labour hiring capital’. Furthermore, in post-Communist Yugoslavia, workers in self-managed enterprises did not own the capital of those enterprises, but rather rented it from (that is, paid interest on it to) the state. The workers received only wages as remuneration, but these wages were really a form of dividend as they were set by workers themselves according to the firm’s anticipated net earnings (akin to profits). This was also a case of labour hiring capital, with the capital owned by the government rather than by capitalists. However, a complication arises when cooperatives issue non-voting equity to investors – although the investors do not enjoy control rights, they do enjoy residual claims; so, although they do not hire labour, they nevertheless part-own the firm. And, of course, if those investors do enjoy voting rights, then the firm is no longer a cooperative in a strict sense but has rather ‘degenerated’ into some sort of hybrid between a cooperative and a capitalist firm, such as Spain’s sociedades laborales, which are at least 51% owned/controlled by their workers. In that case, it is impossible to say who is hiring whom! In fact, both capital-owners and worker-owners are hiring labour, the latter from themselves.

The question posed in the title presents even more surprising answers. A consumer cooperative, for example, can in fact be considered a variation of a capitalist firm, because the member-owners, who pay a membership fee and receive dividends (for example in the form of coupons), hire labour from employees. Conversely, you could say that a ‘classical firm’, in which the capitalist-owner also manages, is a variation of cooperative enterprise – as in a cooperative, a set of worker-capitalists are hiring their own labour, this time in the form of management (a particular kind of labour). One apparent difference between a cooperative and a classical firm is that the labour of non-owners is hired along with that of the owner; but as I mentioned earlier, this also occurs in many (hybrid) cooperatives! A partnership, moreover, would appear to be even less distinct from a cooperative. So really these archetypal firms are best conceived on a spectrum.

Another interesting case is that of the Mondragón group of cooperatives and those that have mimicked it. In Mondragón, workers receive wages that are connected to net earnings and so are similar to dividends. At the same time, they own ‘internal capital accounts’, which are essentially savings accounts within the firm that accrue interest over time. This system represents the inverse of a conventional cooperative: whereas in the latter, it is as if worker-capitalists own/control the firm and hire labour from themselves, in the former it is as if workers own and control the firm in their capacity as labourers, and instead hire capital from themselves!