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The Theory of Business Enterprise Part 2: Neoclassical Economists and Veblen

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The material framework of modern civilization is the industrial system, and the directing force which animates this framework is business enterprise. To a greater extent than any other known phase of culture, modern Christendom takes its complexion from its economic organization. This modern economic organization is the “Capitalistic System” or “Modern Industrial System,” so called. Its characteristic features, and at the same time the forces by virtue of which it dominates modern culture, are the machine process and investment for a profit.

That’s the first paragraph of The Theory of Business Enterprise by Thorstein Veblen. The 1904 book is written in an unfamiliar style, combining words and formulations we don’t use any more with a decided lack of the kinds of references we’d expect in a work of sociology or economics. It shows a kind of subversive humor as well. The reference to Christendom is funny coming from an agnostic whose rejection of religion made it difficult for him to find work. And it’s blunt.

The first three chapters lay out several ideas about the way society was organized at the time he wrote. By then the industrialization of the country and the consolidation into trusts, holding companies and interlocking directorates was well underway. The dominant force in society, Veblen says, was the industrial process with its intricate workings that required coordination of workers across many plants and industries for maximum efficiency. It required standardization of processes and goods across the range of activity, from hours of operation to fine details about the items produced so that they could be used for many different purposes. That meant that a large segment of the population had to adapt the way they lived to accommodate the processes of industry. The people who controlled the great enterprises held direct or indirect control over a large part of the lives a vast number of working people.

At the beginning of the Industrial Revolution factories were owned an operated by individuals with a view to making a living. Over time the Captains of Industry (his words) built up capital and began to treat factories not as sources of livelihood but assets to be bought and sold, and operated as generators of profit from investment. As Veblen describes the activities of the businessmen, it feels like the creation of a market in plants and equipment and other rights of ownership like railroad rights-of-way and patents. The industrial processes themselves were not operated, or even necessarily understood, by the Captains. They were designed and operated by engineers, inventors and mechanics, ond operated by workers with varying degrees of skill. All of them were working to make production as simple and as useful as possible. They depended for their livelihoods on paychecks from the Captains of Industry.

As different parts of production moved from handicraft to machine process, ownership of parts of the industrial process often were not the most efficient, as with railroads and electricity. The boundaries were unstable because the Captains of Industry were constantly fighting with one another for control of different parts of the process.

Standard economics in Veblen’s time looked a lot like our neoliberal economics as taught by Mankiw. Veblen disagrees. He starts with the proposition that the sole point of investment for profit is profit, not efficiency or the good of the community.

1. Standard economics taught that businesses are efficient. The smooth working of industrial processes require constant attention and interstitial adjustments. Veblen points out that there are opportunities for profit when the smooth operation of industrial processes is disrupted. It doesn’t matter how the disruption comes about, whether there is an improvement that reduces a cost, or a spike in demand perhaps because of a war, or a drop in demand because of a depression, or whether the Captain of Industry disrupts his own operations or whether a competitor does so. Disruptions are opportunities for profit. It doesn’t matter that the workers are thrown out or the community suffers. There are profits to be made.

The outcome of this management of industrial affairs through pecuniary transactions, therefore, has been to dissociate the interests of those men who exercise the discretion from the interests of the community. This is true in a peculiar degree and increasingly since the fuller development of the machine industry has brought about a close-knit and wide-reaching articulation of industrial processes, and has at the same time given rise to a class of pecuniary experts whose business is the strategic management of the interstitial relations of the system. Broadly, this class of business men, in so far as they have no ulterior strategic ends to serve, have an interest in making the disturbances of the system large and frequent, since it is in the conjunctures of change that their gain emerges. Qualifications of this proposition may be needed, and it will be necessary to return to this point presently.

What this means that that there are people in businesses who job is to disrupt things to make a profit. Veblen doesn’t believe in the magic invisible hand of the market; he sees the fists of the Captains of Industry.

2. Standard economics taught that one of the main values provided by the businessman is the rationalization of industrial processes. Veblen says that consolidation is done not in the interest of smoother industrial processes, but in the interest of profits. It only happens when the Captains of Industry can profit, which is always long after the need becomes obvious, and only in the way in which the Captains of Industry can profit, which may or may not be most efficient. He admits that a businessman may be motivated by ideals of workmanship and serviceability (his word) to the community, but this is “not measurable in its aggregate results”. To the extent it is measurable, it comes from the elimination of the costs of the business transactions that are eliminated by mergers and “industrially futile manoeuvring” to gain leverage for deals, so that

… probably the largest, assuredly the securest and most unquestionable, service rendered by the great modern captains of industry is this curtailment of the business to be done, this sweeping retirement of business men as a class from the service and the definitive cancelment of opportunities for private enterprise.

3. Standard economics taught that businesses are subject to the indirect control of consumers, who decide by their purchases which businesses survive and which fail. Veblen says that businesses of his day, business owners are removed from actual contact with customers. There is plenty of money to be made cheating customers, he says, in part because industrial processes were so efficient that there was plenty of room for waste and war.

4. Standard economics taught that competition is the lifeblood of capitalism. Veblen says businessmen charge as much as they can. Competition is only a factor when the Captain doesn’t have a monopoly, and then it is only one of several factors.

But it is very doubtful if there are any successful business ventures within the range of the modern industries from which the monopoly element is wholly absent. They are, at any rate, few and not of great magnitude. And the endeavor of all such enterprises that look to a permanent continuance of their business is to establish as much of a monopoly as may be. Fn. omitted.

5. Standard economics taught that the market pays according to the value of the work done, which is taken to be proportional to the value to the community. Veblen says there is no relationship between the profits and wages of a business and value to the community, and that money is a poor proxy for value to a community. He also says that wages bear no relation to the productive value of the work done, but rather workers are paid only enough to get them to work hard enough to make the products of their labor saleable.

Standard economics from Veblen’s day is taught in Econ 101 today. Veblen is an astringent antidote.

Neoliberalism and Neoclassical Economics

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I’m new here as a poster, so I’ll start by describing my interests. As you may know from my work at Firedoglake under the name masaccio, I’m interested in the way the economy actually works. That’s why I like the work done by Thomas Piketty and his colleagues on wealth and income inequality: he has collected, refined and organized huge piles of data and made both that data and his analysis public. Piketty’s book, Capital in the Twenty-First Century, tells us that we can and should insist on data as a source of analysis, not the enormous array of cute stories mainstream economists like to tell us from their armchairs. Trickle-down, life-cycle consumption, pay based on marginal productivity, free markets, and most of the neoclassical economics taught in Econ 101 to pretty much the entire college population for decades, all of them are clever, easily explained in sophomore level calculus, and wrong.

The two parties cooperated to implement self-regulating financial markets, both through the gradual abolition of Glass-Steagall, and to gut regulatory agencies. They laid the groundwork for the Great Crash, and the cheats and thugs on Wall Street did the rest. Then the elites and their pet economists insisted that the solution lay in pumping money into the banking system with no thought of criminal investigation, let alone prosecution, and only the weakest forms of re-regulation, insuring that the criminals would not be deterred and would have plenty of ways to bring on the next disaster.

US voters were angry about the bailouts, but their wrath turned onto the victims of the fraudulent lending schemes and the interest rate swaps and the other financial innovations that the Alan Greenspans and Robert Rubins enthusiastically supported. Does your city or your school district have an interest rate swap? I live in Chicago, and our school district has a bunch. The Chicago Tribune estimated they will cost us $100 million that should be going to education but instead is going to the con artists on Wall Street. The cuts to education here are painful and unnecessary. The same is true all over the country

But it was bad luck homeowners who really got cheated. First, there were knowingly fraudulent loans, then knowingly fraudulent foreclosures, and now possibly knowingly fraudulent delinquency claims.

The vast majority of the public thinks this is just fine. Screw the victims, help criminal banks is a strange goal, but the worst part is that victims of this economic system frequently do blame themselves.

This outpouring of hostility towards the losers in the economic struggle should be seen as a natural consequence of neoliberalism. In that worldview, the market is an indifferent referee, doling out rewards to the successful, and pushing the losers off the playing field into the outer darkness. Everyone is required to be the entrepreneur of themselves, investing their money or their parents’ money or borrowed money in their own human capital in the hopes of beating out some other poor bastard for some bad job that pays poorly. If they win, they might get to retire. If they lose, there’s always bankruptcy, except for taxes and student loans, and they are trash. It’s a bleak world.

Neoclassical economic theory is the linchpin of neoliberalism. It provides a theoretical underpinning for the harsh world it envisions. In this world, humans are seen solely as consumers and producers. These calculating creatures are rational optimizers, constantly using the markets to achieve their own personal highest utility. It’s an evil, reductive idea, but notice how well it corresponds to the self images of the people described by Jennifer Silva in her book Coming Up Short, which I discussed here.  The encouraging thing about the people Silva talked to is that they see themselves as having agency, they see themselves as having problems, but they are convinced they can do something about those problems.

The middle class is shrinking. Social class mobility is falling. But no one seems interested in the possibility that the economic system is the problem. The Republicans love it, and the Democrats do too, only not quite as much: they offer timid solutions like Elizabeth Warren’s suggestion that we reduce the interest rate on student loans, or increase the minimum wage to $10.10 per hour. These are not the kinds of changes that will make a significant difference in anyone’s life. They will do nothing to dilute the power of the richest 16,000 US families. And yet these represent the extreme left in politics.

In the 1920s, there was widespread intellectual ferment around alternatives to capitalism, socialism and communism, and that forced questions about capitalism to the surface. As the Great Depression deepened, the rich and politicians were afraid that the working class and the unemployed would find those ideas superior to capitalism. Eventually they were forced to compromise a tiny bit, creating a more or less regulated system of markets. Even the conservative hacks on the Supreme Court (the Court is full of conservative political hacks almost all the time), bent to the will of the people, and allowed a range of FDR’s initiatives to stand. In some cases, for a while, the hacks even enforced those laws, though that ended years ago.

Partially regulated capitalism was a major force for the creation of what Piketty calls the Patrimonial Middle Class. This group, 40% of the population, roughly the 50th to 90th percentiles of wealth, at one time had enough wealth to live comfortably in retirement and leave an inheritance to their children. That group is dwindling. The bottom 50% of the population has little or no net worth. Piketty calls them the Lower Class. The top 10% he calls the Upper Class and the top 1% he calls the Dominant Class. The Upper class is taking all the money produced by the economy. These are the people who can make major donations to politicians and thus acquire influence they can turn to their cash benefit.

The Lower Class is becoming more and more angry as the recovery stomps their faint hopes into the dirt. The Middle Class is shrinking, and I hope is beginning to think that maybe it’s not their fault. Things won’t change until enough people figure out the connection between the economic myths they’ve been taught and the social and political institutions that enforce those myths, and structure their understanding of their place in the world. If Silva’s people are right, if Middle and Lower Class people do have agency, and if they learn to see through the smoke and mirrors of the neoliberals and their academic lapdogs, they can enforce demands that will actually improve their lives.

I like to think of this process as the way you’d peel an octopus off an aquarium wall: one tiny sucker at a time. Eventually it comes off, but it’s a lot of work, and the octopus resists with all its strength.
which is Piketty’s actual term