Sunday, 22 April 2018

Thomas Sowell and Samuel Bowles on Marx

From Thomas Sowell's book "On Classical Economics":

Not everybody judges Marx quite so harshly. In a recent article on "Marx and modern microeconomics", at, Samuel Bowles argues that Marx has, in fact, contributed something significate to modern microeconomics,
Few economists doubt that Marx flunked economics, a judgement mostly based on his labour theory of value. But this column argues that Marx’s representation of the power relationship between capital and labour in the firm is an essential insight for understanding and improving modern capitalism. Indeed, this insight is incorporated into standard principal–agent models of labour and credit markets.
If the rejection of Marx is primarily about the labour theory of value then would we not also have to flunk Adam Smith? We don't so there must be more than this going on.

Bowles goes on to say,
But Marx chose to study a more challenging question: how could the domination of labour by capital take place in a private, perfectly competitive, economy governed by a liberal state? His answer was based on what seems a strikingly modern principal–agent representation of the employer–employee relationship, arising from a conflict of interest over the amount of labour effort performed that could be resolved in an enforceable contract.
In a sense, Bowles is wrong about the perfectly competitive model. Since this model is one of zero transaction costs there are no firms and the production environment is one without principal-agent problems. Firms and principal-agent issues only arise in a world of positive transaction costs.

Bowles continues by saying,
The final step in Marx’s explanation of domination in a liberal capitalist economy was the process of accumulation and technical change that supports a permanent “reserve army" (ibid) of the unemployed, and which provides the basis of the employer’s labour discipline strategy. The private ownership of the means of production conveys the right to exclude others from use of the firm’s assets, and therefore the owners of firms have a powerful threat to induce workers to supply the effort that could not be secured by contract: work hard, or join the "reserve army".
Marx did not explain why the labour contract was incomplete. He assumed this was an uncontroversial empirical observation and used it as the starting point for his economic theory.
Further on Bowles writes,
Just as Mendel underpinned Darwin, a more complete understanding of the incomplete labour contract developed in the twentieth century, but did not overturn Marx’s conclusions. Like Marx, Ronald Coase (1937) stressed the central role of authority in the firm’s contractual relations:

“[N]ote the character of the contract into which a factor enters that is employed within a firm ...[T]he factor ... for certain remuneration agrees to obey the directions of the entrepreneur.”

Indeed, Coase defined the firm by its political structure:

“If a workman moves from department Y to department X, he does not go because of a change in prices but because he is ordered to do so ... the distinguishing mark of the firm is the suppression of the price mechanism.” (ibid)

Herbert Simon provided the first Coasean model of the firm (Simon 1951). He represented the employment contract as an exchange in which the employees transfer control rights over their work tasks to the employer, in return for a wage. Simon stressed the advantage to the employer of this arrangement, because there was unavoidable uncertainty about the tasks that would be required over the course of the contract. Therefore there was a high cost of agreeing to a complete contractual specification of the activities to be performed. Simon did not know that he was modelling exactly the incomplete contract for labour that was the fulcrum of Marx’s economic theory.

Coase or Simon did not directly explain why control rights confer power. As an empirical matter, the firm appears to be a political institution in the sense that some members of the firm routinely give commands with the expectation that they will be obeyed, while others are constrained to follow these commands. If we say that the manager has the right to decide what the worker will do, this means only that the manager has the legitimate authority, not the power to secure compliance. Given that, in a liberal society, the manager is restricted in the kinds of punishment that can be inflicted, and given that the employee is free to leave, it is a puzzle that orders are typically obeyed.

Noticing this, Armen Alchian and Harold Demsetz challenged the Coasean idea that the firm is a mini “command economy”, suggesting that the employment contract is no different in this respect from other contracts:

“The firm ... has no power of fiat, no authority, no disciplinary action any different in the slightest degree from ordinary market contracting between any two people ... Wherein then is the relationship between a grocer and his employee different from that between a grocer and his customer?” (Alchian and Demsetz 1972)

Oliver Hart (1989) responded:

'[T]he reason that an employee is likely to be more responsive to what his employer wants than a grocer is that the employer ... can deprive the employee of the assets he works with and hire another employee to work with these assets, while the customer can only deprive the grocer of his customer and as long as the customer is small, it is presumably not very difficult for the grocer to find another customer."
In a footnote in his book "Firms, Contracts, and Financial Structure" Oliver Hart does note that,
Given its concern with power, the approach proposed in this book has something in common with Marxian theories of the capitalist-worker relationship [...]
But what is not clear is that the development of the incomplete contracts approach to the theory of the firm by Grossman-Hart-Moore owes anything directly to the Marxian theories. The connection between them seems to have been noted after the fact rather than being a driving force.

When discussing the why in the property rights theory firms rather than workers own the nonhuman assets used in production Bengt Holmstrom argues that one reason is that by putting the nonhumans assets under the control of the firm, those running the firm have the maximum power to decide how the firm is organised and run. He notes that Marx would have agreed with this, but Holmstrom disagrees with Marx about the purpose of the firm's concentration of power.

This brings me back to Sowell's point that a contribution depends not just on what is offered but also on what is accepted, and I'm not convinced that Marx's ideas were accepted in the sense that they actually drove the development of the property rights approach to the firm.

So I'm thinking that Sowell, rather than Bowles, is right in his assessment of Marx.

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