Hobson's Choice: Some Discussion on "Industrial Systems"

May 20, 2006

Some Discussion on "Industrial Systems"

After I introduced the concept of the industrial system, John C. Halasz left a comment that I thought was so handy I would expound on it here. Rather than re-post the comment in full, I'm going to address it one sentence at a time.

Part 1

JCH: I'd doubt that the distinction between "risk" and "uncertainty" is all that clear-cut. After all, the effects of business cycles, inflation expectations, changing fashions in consumption, indirect competition, (such as between different modes of transportation or different sources of energy), would all effect business organization and production/investment decisions in ways that couldn't be predicted from probability distributions, except in hindsight and subject to certain conditions, even though they are established variables.

Perhaps there is no meaningful distinction; I am advised (Richard Sheffrin, Rational Expectations) that some philosophers have argued that, since the concept of quantifiable probability has conceptual flaws, it does not have a proper role in expectations theory. However, the orthodox economists of today take the distinction quite seriously, and Frank H. Knight made it the centerpiece of Risk, Uncertainty, and Profit. Rational Expectations (RE) theory distinguishes between risk, that can be estimated for the purpose of planning, arbitrage, and utility maximization, and changes between policy regimes (including changes inflicted by some unpredictable event, such as the 9/11 attacks). Policy regimes in which expectations are consistently wrong, or biased, are described in the same terms that Knight used to describe uncertainty.

In my opinion, uncertainty ought to be understood as a state in which it is impossible to optimize; if you plan for A, and B is what happens, there's no way you can reduce the consequences of what happens. For example, suppose you are planning to buy a new home. Using rental rates as a comparison, you observe that the time-discounted savings of buying a house (by not paying rent) are less than the time-discounted outlays. If you buy a house to avoid "throwing money away" on rent that does not contribute to equity, it turns out you'll wind up spending more money.

However, if the price of houses continues to rise, this increases the equity of your home, shifting the comparison in favor of buying rather than renting. Conversely, the price could fall, which would shift the comparison so far in favor of renting that even plausible upward movements in rental rates would fail to offset the benefits of renting. If you are liquidity constrained, and determined to absolutely maximize the wealth of your household, you are confronted with a probelm of uncertainty; there is no trade-off between a "low-risk" strategy and a "high-risk" strategy, although you might be able to optimize given a strategic decision. Risk, on the other hand, is the sort of thing one can insure against—whether one choses to or not.

JCH: On the other hand, I fail to see quite why considerations of "uncertainty" should be "political", rather than organizational, that is, as what organizations evolve to deal with. The primary motive is not profit maximalization, [...] but rather the maintenance of the organization under uncertain environmental conditions, ...

If you accept, at least tentatively, my premise that uncertainty is inherently different from risk, then some adjustments need to be made to my example of buying a house. One is that, in the case of buying a house, people usually make this decision based on deep-seated emotional preferences. In contrast, firms do have to ensure that their main operational units are generating revenues in excess of costs most of the time, which may be a demanding constraint. Second, if your choices as an individual homebuyer are a debacle, even if you are very rich and popular, you still can't overthrow the government in retaliation. Even if you are a firm, doing so is likely to be a stretch: for one thing, a ruined firm is typically a weak one. However, a group of firms engaged in an industry is likely to marshall political interests to deal with uncertainty pro-actively.

(In addition to the firms themselves, there will also be political groupings (factions within the main parties, for example) or industrial unions that defend different aspects of the industrial system's uncertainties. In some cases, these factions will have an adversarial relationship, but only insofar as to the distribution of the goodies. In regards to the flourishing of the industrial system, they will be on the same side.)

A third aspect, besides the more-pronounced maximizing tendencies of an institution, or the enhanced ability of the institution to make alliances and pursue stable goals, is the technology for mitigating uncertainty for institutions. When calamity strikes for an individual, and it's the sort of calamity against which insurance is impossible, there's little that can be done anyway. An example is the impact of Hurricane Katrina on New Orleans: while the danger of hurricane hitting and inundating New Orleans was quantifiable and could have been insured against, what made it a tragedy was the political calamity of having George W Bush president at the time. Even if one had played the game immaculately, insuring against every eventuality, the fact that entire swathes of the American Southeast were ruined meant that business would afterwards be plunged into depression.

An individual—even a large cohort of wealthy, Republican donors (of which there were many in the region)—might lose enthusiasm for the Bush dynasty. A large industrial firm, or several such, might file lawsuits to forestall bankruptcy, but of course routie due dilligence procedures such as that would occur even if the principals harbored no animosity toward the administration (perhaps owing to class solidarity). However, an industrial system is different. For one thing, the "mere" impact of Hurricane Katrina would not be sufficient to disrupt an industrial system; in contrast, the conflict over slavery in the territories created uncertainty for the linked set of industries and institutions that depended upon it. For the slavocracy (an industrial system), there was a conceivable remedy: secession.

In most cases, the method of industrial systems for coping with uncertainty is less flamboyent. I believe, for example, that the Cold War was stimulated IN PART by at least four distinct, mutually hostile industrial systems. Each of the ISes I'm thinking of had some consequential business relationship with at least one of the other three; two were based largely in the USA, one in w. Europe, and a fourth in the USSR. All of these were diffused throughout the world, albeit in different regions thereof (US industry being mostly barred from the 2nd world until 1989). All four adapted in different ways to the constraints imposed by national boundaries, regulatory regimes, and the Cold War; all three benefited handsomely from it. I want to make it clear that I do not think that these four were exclusively responsible for the Cold War, but they contributed immensely to it and were quite callous about profiting from the suffering it caused. The uncertainty that they needed to cope with was the survival of certain political regimes, the abolition of which might have eradicated their managers' positions.

JCH: In my limited understanding, the idealization of the basic neo-classical model, under the assumptions of perfect competition, perfect information, diminishing returns to scale, and utility-maximizing "rational" behavior among atomistic individuals, results in an absence of profit, since the surplus over revenues would just suffice to pay for the costs of the "factors of production", land, labor, and capital, (i.e. the interest cost of borrowing), which implies that any business organization whatsoever must rely on the identification and leveraging of some competitive advantage, however unconsciously and ex post facto, to exclude competition,- (or, alternatively, the incomplete development of idealized markets).
[predicate in red—JRM]

That's Ricardian Theory, which stimulated Marx to speak of the inherent contradictions of capitalism. Since that time, the failure of profits to vanish spawned "marginalism," which purports to establish a unique equilibrium for the economy for a given set of utility functions (the innovation of the marginalists, actually), capital & labor endowments, and technology functions. Part of the reason J.S. Mill converted to the marginalist position in the 1870's was that his earlier, classical position did not explain the persistance of profits. Later economists introduced the concept of sticky prices and "monopolistic competition." While few reviewers have anything nice to say about Chamberlain, I've noticed his thesis remains intact: firm earnings are, for the most part, monopoloid rents, not profits. This understanding is part of new classical (RE/RBC) economic thinking.

JCH: Obviously, the shake-out of organizational outcomes, together with the linkages formed with prior "victorious" elite strata, suggests the route of attempting to capture political power, in terms of the state and its agencies and in terms of the public opinion that ostensibly determines the former, in accordance with the motive of organizational self-maintenance. Equally, the capture of rents, both within and by organizations, while obviously implicated in the notion of the manitenance of organizations, is not endogenous to any organization, whatever its technical and operational means, since any organization only exists within an organization of organizations, as its environment, ad infinitum.

This points out a flaw of the definition of "rents" that I've been using. I'd realized this earlier. On the one hand, "economic rents" refers to the revenue stream from a productive factor in excess of what is needed to bring the item to market; it's the gap between costs and output that is allowed by possession of a monopoly or oligopoly. However, it can also mean the stream of revenue coming from occupying a position of authroity within the firm: the albility, in effect, to extort money from an enterprise in exchange for allowing it to persist. Hence, a rentseeking manager is supposedly one who has the extraordinary ability to determine his own compensation, given sufficient cleverness.

Both meanings are captured by the connotation of "rents" as a stream of secure income, income not contingent on provided value to the person forking over the dough.

The distinction between the two is in large measure one of boundary: the boundary between an organization and a cabal within that organization, e.g., a single person. In my view, there are indeed distinctions between the firm and other types of organizations—including organizations of which the firm is a member, or organizations within the firm. These distinctions, perhaps, need to be outlined elsewhere.

JCH: The political opens up when there are conflicts between organizations and counter-organization and their respective conditions of economic, social and moral survival, given changing environmental conditions and given the public, political resources that each and any can draw upon.

I would say the political opens up when an organization opts to confront the regulatory environment, and I think this is likely to occur as a response to systemic uncertainty.

[Economics] [US History] [Uncertainty]

Posted by James R MacLean at May 20, 2006 10:03 PM

Comments

O.K. Ever since industrial capitalism first emerged as a system there have been fundamental concerns about blockages in production due to resource constraints and concerns about the realization of capital investments through the development of adequate markets to dispose of its products profitably. In addition, a la Polanyi, it has exerted a persistent pressure on social structures and institutions to re-organize themselves in accordance with its systematic requirements. Further, the growth of industrial capitalism has resulted in the inter-sectoral differentiation of markets, as well as their extension, such that there are different market structures with different requirements, which, for all their interlinkages, are not reducible to a singular "logic" of market exchange. Given a highly inefficient distribution of "resources", there would be a set of exchanges that would improve "efficiencies" toward the "Pareto-optimal" frontier; but once a market system is in operation, very little improvement in outcomes could be expected from further exchanges. What characterizes the power of industrial capitalism is its recurrent capacity to produce real increases in economic surpluses, i.e. real, socially distributable wealth, which can't be simply explained through market exchanges, a la mercantile capitalism. Markets might stimulate and promulgate increased productivity, but they can not account for increases in real surpluses by themselves: that would be due to technical and organizational innovations within the sphere of production itself. Which is to say that the account of neo-classical economics can not account for the distinctive organizations that markets give rise to. There is a rationalizing, ex post facto, strain, a spurious "justificatory" air, to its apparatus.

The claim the market distributions can be explained by the "natural" returns to the "factors of production" supposedly rationalizes the existence of profit. But, IIRC, Boehm-Bawerk attempted to make that account work in terms of a "time theory of production", which ran aground on the impossibility of specifying a "unit" of capital, to which returns would "naturally" accrue, in part because different capital stocks from different production periods were not commensurable. Later efforts in the Walras-Pareto tradition of mathematical general equilibrium theory, by which all markets clear simultaneously with respect to all other markets, reduced production processes and technologies to mathematically tractable "sets", so that they could be regarded as "virtual" exchanges, disregarding any constraints involved in actual production processes and the "sunken costs" of capital realization. Of course, the development of capitalism has involved the financialization of productive assets in order the liquify them and enable the process of investment, but that does nothing to solve the technical and organizational problems of production in the "real" economy, upon which financial returns rely. But the idea that "economic" or allocative efficiency could really drive the whole system trades in a logical idealization of timeless "efficiency" rather than inversely in the notion of the reduction of inefficiencies and their allocations or distributions. In short, the neo-classical account really fails to account for the organization of production and the way that the reproduction imperatives of sphere of production,- (since different sectors produce for other productive sectors),- and the sphere of circulation/distribution condition each other. And that just mystifies the notion of profits, (which are necessary for the replacement of capital stocks, as well as, the remuneration of managerial services), and rents, (which result from differential market structures, the distribution of natural and social resources and the ineliminability of "inefficiencies"). The irony is that the neo-classical account "justifies" profit without explaining it satisfactorily.

So, yeah, I'm in favor of the "surplus product" account of classical political-economy and institutionalist strains of economic thinking. Marx rewrote Ricardo precisely to explain the origins of profit as "surplus value", that is, as the differential distribution of the surplus product between labor (wages) and capital (profits): "class struggle". The motive power of industrial capitalism for Marx was its functional imperative for the reproduction of surplus value, that is, the need to make profits from reinvested profits, from which he derived the relentless tendency of industrial capitalism toward self-expansion, in various forms. Without such expansion, capital, (measured for him in "labor-values" rather than nominal monetary accounts), would over-accumulate, leading to a disaggregation of the system that maintained the valorization of capital(s). He attempted to demonstrate from such an account the long-run tendency of industrial capitalism toward disequilibrium, via recurrent crises of over-production and underconsumption. The achilles heel of his account, of course, was his failure to account for the (potential) role of the state and the political, (which he tended to reduce to an effect of the economic, in accordance with his pre-establihed harmonies), which could and would result in efforts to regulate market externalities, provide for social security and, most of all, manage aggregate demand, whereby losses from misallocated productive investment could be ameliorated and further opportunities for capital realization be afforded. Sraffa revived the Ricardoan "surplus" approach in terms of technical coefficients of production rather than labor values to criticize sotto voce and demonstrate the inadequacy of neo-classical price theory; that is, to revive the question of the "internal" systematic ratios of "value" rather than the nominal effects of monetary prices. To be sure, the argument for "markets" is not simply that they allow for rapid adjustments to temporary fluctuations, but that they search out and provide a path for structural adjustments. But it doesn't follow that market mechanisms alone are sufficient for such adjustment, let alone that they can not or must refuse to be supplemented by other programs or policies. And it may well be that markets, in their unchecked operation, might impede the best path to adjustment, especially if markets are not just impeded by "exogenous" factors, but operate through them.

At any rate, without claiming to solve any problems, I think that the surplus approach provides for the best generic definition of economic activity: namely, as the seeking-out, realization and distribution of surpluses. That could occur through market exchanges, through technical improvements in production, through organizational or logistical innovations, or through the invention of new products and the development of markets for them. In the first place, that would allow for the effects of market competition without pretending that they are an exclusive and self-sufficient source of surpluses. And it allows for the question of distributional effects of productive surpluses without assuming that markets automatically optimize them. (And the definition would apply to all suplus-producing economies, beyond subsistence economies, not just "capitalist" ones.) But most of all, it allows for distinguishing economic activity and the institutional domains proper to it from other activities and institutional domains. If the criterion of business organizations is the "bottom line", the crierion of educational organizations is the promulgation of knowledges and statuses, and the criterion of state-political institutions is the securement of "legitimate" authority. Only if the criteria of institutional domains are clear , can their interactions and usurpations be clarified.

It is in that context of a "robust" institutional account, no matter how empirically dysfunctional the institutions might be, that I would draw into question your preoccupation with rent-seeking behavior. Wouldn't the obverse account be the displacement/externalization of costs/risks? Wouldn't cost/risk be like a "hot potato" tossed between various institutional/organizational domains, (especially between state and economy with their systemic interlock of taxation/budgets/regulations), even in their various dysfunctions? The idea that Mr. Smooth Rent-Seeker could drive the whole system not only flatters him too much, but reflects the obverse idea that it might all be just a lawful "natural" order.

Which brings me to my basic quasi-Arendtian objection: if any relation of power/domination is "political", especially since such relations involve displacements of costs/risks, then the economy is entirely political. But what then happens to the idea of the political, as the realm of freedom and equality, in contradistinction to the realm of socio-natural necessity? "Uncertainty", insecurity, belongs to us all, which is why we seek to live the "organized" life. But unless the production of surpluses is distinguished from conflicts over their distribution within a wider institutional realm, there is no real freedom, because there is no real politics. Criticizing a rent-seeking elite (within an elite) does little good, unless one can specify, not just a normative criterion for "freedom and equality", but a broader institutional matrix and alternative pathways in which such properly political notions can be secured.

That said, I think I can understand and agree with the idea that there is not one singular "global" capitalism, but different national/regional political economies of capitalism, with differing "structural" requirements. I think I also understand that you are trying to come up with an explanation of how narrow elites within such systems can usurp the "interests" of the system "as a whole", especially in response to endogenous crisis tendencies in such systems, since they are at once most capable of being informed and most vulnerable to them, in terms of their elite position. I'll look forward to your further eleaborations on "industrial systems".

Posted by: john c. halasz at May 23, 2006 12:57 PM

The gist of your first two paragraphs appears to be that the neo-classical school, by contriving a definite, stable, rate of profit in a freely-adjusting economy, was both approving of the existing set of economic relations, and also bogus. Bogus, because it made "natural" or "optimal" a set of transactions that really hinged on expropriation of surplus value.

The apologists were usually neo-classical; we seem to be in total agreement that the neo-classical school evolved largely as a form of justification of profits; I would add, for emphasis, "Not just any profits: profits at the expense of any other social concern." Hence, the screwed-up sense of priorities evident in Gilded Age court decisions governing property rights. By arguing that an equilibrium rate of profit could exist, the apologists argued that those proposing to interfere with this bore an extraordinary burden to prove it was necessary to do so.

The neo-classical conceptions of economic operation have remained with us to the present. They are mostly intact. On the one hand, arguments in favor of them remain largely circular and ad consequentium, a claim I need to defend in a future post. On the other hand, the concept of the utility function does have a compelling logical foundation. However, while the existence of the utility function may well be deduced logically, and with it the concomitant molding forces of arbitrage, neo-classical economists attribute to it powers it cannot have.

I think that the surplus approach provides for the best generic definition of economic activity: namely, as the seeking-out, realization and distribution of surpluses. That could occur through market exchanges, through technical improvements in production, through organizational or logistical innovations, or through the invention of new products and the development of markets for them. In the first place, that would allow for the effects of market competition without pretending that they are an exclusive and self-sufficient source of surpluses. And it allows for the question of distributional effects of productive surpluses without assuming that markets automatically optimize them. (And the definition would apply to all suplus-producing economies, beyond subsistence economies, not just "capitalist" ones.) But most of all, it allows for distinguishing economic activity and the institutional domains proper to it from other activities and institutional domains.

It depends. The corpus of economic thought since the 1870's contains a lot of useful work; I'd prefer to avoid throwing stuff out. Classical economics gave way to marginalism & then to neo-classical thinking for many reasons, some of which were insidious, others of which were legitimate.

Well, this is one of those obvious things in life (the existence of corruption, or "rent-seeking behavior") that the economist is inclided to average out. The official story is, since all opportunities for rent-seeking will be exploited by somebody, system-wide rentseeking will merely move downward your production function.

The internal and external rentseeking, therefore, comes together as a successful rentseeker contrives to transfer the costs of his thieving from the firm to society—or to the rest of the world; and the successful firm eliminates rentseeking opportunities within itself, while thwarting efforts by other firms to transfer the "hot potato" to it. As we all know, this hot potato of risk is not usually "passed" as much as "splattered," so that the nebulized residue of inciderated potatoes is transferred to the entire economy ("Socialization of costs, privatization of benefits").

My object has been to introduce the concept of a comprehensive system of firms and institutions within the economy, which has non-neutral interests in political action and peculiar notions of property rights. The industrial system has its own dynamics, quite apart from the orthodox laws of economics; it operates in an economy and contributes to the particular character of that economy's output and incentives.

However, unlike (say) a business group, the components of the industrial system interact chiefly with consumers on their own. There is no sharing of profits among them. An industrial system has decisive influence over the legal structure; a firm is very unlikely to. An industrial system tends to have a predatory stance towards other industrial systems, with an objective of eliminating them as competitors for inputs; in contrast, firms within the same industrial system tend to seek collusion.

Industrial systems tend to implement fundamentally different technologies, reflecting different paths of technological development. This, despite the fact that multiple technologies may be available for the producers; they are differently optimal, however, leading any pair of industrial systems to regard the other's technological preferences as hopelessly foolish or destructive.

Yes, this was brought to my attention a month ago when I was reading Peter Drucker's The Age of Discontinuity (1968). Evidently the term "global economy" was just then catching on with economists and he argued that the problem was that it was really an international economy, and that the only truly global institutions were the MNCs; they could arbitrage out of existence many, if not most, of the regulatory constraints that individual national governments attempted to impose on them.

Posted by: James R MacLean at May 24, 2006 04:54 AM

Well, James, your knowledge of economics is vastly greater, having done the drills and earned your degree, than my smatterings. And I wouldn't want to pretend to give ignorant dictates to economic theory as a whole, throwing the baby out with the bath water. But the "surplus" approach, which I think expresses best the basic point of their being something like economics, has not been definitively refuted by neo-classical marginalism, and there exist work by neo-Marxists, such as Kaliecki, left Keynesians and post-Keynesians and Neo-Ricardoans such as Sraffa that still make appeal to the classical analysis of the surplus product. And that tradition does make the point, that seems congruent with your idea of industrial systems that the sphere of production is subject to conditions and constraints that are not captured and resolved through the appeal to the market equilibrium of supply and demand and that behind the latter lies the determining factor of costs of production. Sraffans, in particular, emphasize the role that different income distributions play in the determination of outputs and the valorization of capital. The idea of surplus seeking agency as an entirely generalizable definition of economic behavior actually comes from a short paper by Maurice Allais, hardly a radical. The simple idea would be that a sufficient number of surplus seeking agents interacting would squeeze out inefficiencies without resorting to logical idealizations about optimal efficiency, maximized utility, and continuous equilibrium, which have a tautologous air to them, and perhaps can not be meaningfully measured. (Also agency is put back into the picture, in place of an entirely automatic operation of laws). At any rate, my recollection is that utility functions were first developed to account for the demand side, i.e. consumption behavior, which issue classical economics had largely ignored, and wherein they make a fair amount of sense, but they were so mathematically tractable and "sweet" that the effort was made to generalize them to the description of the economy as a whole. (Also, by eliminating "value" in favor of nominal empirical prices, the marginal revolution in economics was of a piece with late 19th century positivism, whereby only "appearances" and their formal-logical relations needed to be taken into account, without any appeal to underlying realities.) But the whole thrust of Sraffa's work was to demonstrate that their systemization could not really account for an industrial economy "as a whole", through he was never satified that he could provide a positive account of "value".

At any rate, the point of focusing on the surplus product is that that is what constitutes real distributable social wealth, and it is in conflicts over distributions that the political dimension begins to enter into the picture. After all, excessive rents do not just lower a "production function", but they undermine adequate distributions to both maintain demand and ensure intersectoral coordination and its reproduction. "Global imbalances" is the current name for the specter of under-consumption and over-production.

But I'd wanted to raise the political question because the obverse side of the dominant market power of oligopolies is the collapse of the public sphere, the diminution of any independent civil society and the obstruction of any independent regulatory powers of the state. That is, unless some account of a counter-organization within a broader institutional matrix can be attempted, we are just stuck with a potentially catastrophic fatalism.

Posted by: john c. halasz at May 24, 2006 08:45 AM