Can the Patient be Saved?
It is clear to everyone that the world economy is undergoing a deep crisis. The question on everybody's mind is whether this is just a “normal” part of the so-called “business cycle,” or whether it represents something more profound, perhaps even the end of that form of capitalism as it has existed for the better part of the last century. That is, have we just caught a cold, or do we have cancer? I hope the answer is the former; I fear it is the latter.
If it is the former, then it is likely that some form of government stimulus is the proper remedy, and as much as all sides may debate the particulars, they all agree on the medicine. There is good reason to believe in this medicine: it has worked well and often since the end of World War II; indeed, our economy has become dependent on huge government expenditures to remain in balance, and these temporary imbalances can be cured as they have been cured: by a little jiggling of the monetary and fiscal policy levers. If this is the case, then we will soon recover and go on as we have.
But there is a stronger reason to believe that it will not work as it has in the past, namely because it hasn't worked for the past eight years. The fact is, the economy has been operating under an extraordinary stimulus package since 2001. Think on this: George W. Bush took all the debt we accumulated between the time of Andrew Jackson (the last time the debt was paid off) up through Bill Clinton, and doubled it! He added $5 trillion to the national debt, a considerable stimulus by any measure.
Throughout it all, the economy remained anemic. Indeed, the “economy” was driven mainly by a housing bubble created not by any real growth, but by a compliant Fed and greedy financiers. An expansion of housing should be driven by an increase in wages, but median wages in this period actually fell. Hence, I think it reasonable to believe that what hasn't worked won't work; that another $800 billion, or even another $5 trillion will not do the trick. The old reliable system will not work any longer, and no amount of medicine can revive it. The system must change or die, or must change after it dies. Change is inevitable; death is optional.
The problem lies not with the banking system, although that system has its problems, but with the industrial and farming systems, the systems that actually create wealth. All other economic enterprises depend on these. Without fixing the industrial system, all other fixes will be either meaningless or, at best, temporary. Here we will look at the problems of the current system, and how distributism responds to these problems.
The “Supply-Push” Industrial System
While we may think of the current industrial system as a natural or eternal part of capitalism, it is in fact of relatively recent vintage. Indeed, when Adam Smith wrote about “the invisible hand” in the 18th century, he assumed an economy of small and mostly local producers, none of which had any market power, and hence no way to substantially alter the competitive outcomes. Most firms, save a few dealing with commodities that were traded internationally, had an incentive to remain small and employ as little fixed-capital as possible.1 But all that began to change in the 19th century, and especially in the second half of that century, with the development of the railroads. For the first time mass marketing over large areas became practical. The best way to take advantage of this new system was with highly expensive, special-purpose machinery. This made the capital employed in production very large indeed, which meant that finance became more critical to the economy than ever before; those without access to large amounts of capital had little chance of competing. By the late 19th century, a new form of organization had appeared, the “M-form corporation” (“M” for multi-divisional) which spread all phases of production, often for very diverse products, across many divisions of the firm, while imposing a hierarchical structure to keep track of so many diverse functions.
All of this resulted in firms of tremendous power, both economic and political. This power replaced the invisible hand of Adam Smith with the all-too-visible hand of managers and government. Firms were now not price-takers, as in Smith's model, but price-makers. They could drive out smaller competitors, to be sure, but they could also drive down the price of labor. But when you drive down the price of labor, while increasing its productive capacity, you run into the problem that is usually called “overproduction” but is really “underpayment.” By 1890, the system was already plagued with constant “overproduction” problems.
This structure is often called the “Sloanist” model, because it was perfected by Alfred Sloan, the legendary chairman of General Motors from 1923-1946. Kevin Carson describes the model this way:
The only way to keep the unit costs of such machinery down is large-batch production to utilize full capacity, and then worrying about making people buy it only afterward (commonly known as "supply-push distribution.") So Sloanist industry, under "Generally Accepted Accounting Principles," produces goods to sell to inventory, regardless of whether there are orders for it or even of whether the product works, and has an astronomical recall rate. It follows a business model based on consumer credit and planned obsolescence to keep the wheels running. As Ralph Borsodi described it, the push distribution system ... amounted to making water run uphill. The overall logic of the system is that instilled by hypnopaedic suggestion in Brave New World: "Ending is better than mending." "The more stitches, the less riches."2
In other words, what the system actually manufactures is landfill, objects that spend as little time as possible in the hands of consumers as useful products while on their journey to the dump as useless garbage. Thus, the production model requires a consumerist model; we must be constantly taught, through expensive, manipulative, and unrelenting propaganda (advertising) that our happiness lies not in persons, but in things, and not merely in things, but in constantly new things. The old is icky; worse, it is unfashionable. Only by constantly buying what we don't need or already have can the system sustain itself; the size of the garbage dump becomes the true measure of our “wealth.”
To solve the problem of overproduction, governments have resorted to growing the public sector to supplement demand. This is has been the greatest impetus behind not only the growth in government in the 20th century, but also for the extension of its imperialist and globalist reach in an effort to find, and force our way into, ever-new markets, as well as to guarantee sources of cheap labor and raw materials.
After World War II, the system reached some balance as the forces of the corporations, the government, and unions tended to balance each other out, and were sufficient, for a time, to keep wages high enough to absorb all the production, with some help from government spending. Since the 70's, however, productivity has exploded while median wages have stagnated. A vast gap opened up between the goods available for sale and the purchasing power necessary to absorb them. Markets could not be cleared. The obvious way to solve this problem is to fix the wage system. Without a just wage, without the worker getting a fair claim to his portion of the output through his wages, there is insufficient purchasing power to clear the markets. But rather than fix the wage system, the economy has relied on consumer credit; those with too much money simply lend it to those with too little, and at usurious rates. This solves the problem in the short term, but it makes the long-term problem worse. Because of high interest, more and more capital gathers at the top, and the day of reckoning is deferred, but not deterred.
The consumer's problem becomes the investor's dilemma; without sufficient purchasing power in the mass of men, the pool of good investments shrink, and the investor is forced to turn to pure speculation. He finds his portfolio full of exotic instruments he no longer understands. And what he primarily doesn't understand is that these instruments are not “investments”at all; that is, they do not provide funds to businesses to expand production. Rather, they are pure bets on the direction of some market, such as the housing market. Further, the excess capital tends to encourage leveraging; that is, investors lend huge amounts to other investors who place it in speculative instruments which are themselves dependent on an increasingly troubled productive sector. What you have is a dense network of highly leveraged bets that depend on other bets that depend on an increasingly shaky productive sector. The bets are so highly intertwined that a failure in one sector endangers every other sector. That is how a failure in a relatively minor market, like sub-prime mortgages, can bring down the entire credit system.
Meanwhile in the productive sectors of the economy, the combination of an oversupply of capital and an underfunded consumer makes it difficult for businesses to increase their profits. In an effort to improve their margins, they start by firing their workers and end by firing their machinery; more and more, the productive sectors move actual production overseas, leaving only a shell in the home country responsible for accounting, coordination, and marketing. Production is distributed, but legal control remains centralized. They invest their capital not in expanding production, since the consumer can't absorb any more production anyway, but in acquiring other companies to eliminate competition. The result is that ownership is increasingly concentrated in vast collectives known as corporations, even as production is distributed around the globe.
The argument infavor of the M-form mega-corporation has centered around the “economies of scale” that such large organizations can obtain. However, while there are some economies of scale, these are vastly outweighed by the dis-economies of scale; mere size brings great problems. But mere size also brings great power, and it is this power that interferes with the free market and hides the inefficiencies. Corporations can command the resources of government to obtain subsidies and favorable tax treatment, and they can raise barriers to competition through regulations whose main purpose is to raise the entry cost to small and more efficient competitors. Without the subsidies to hide the dis-economies and the barriers to keep out competition, the mega-corporation would not be a viable enterprise.
The Corporation as a Planned Economy
Economic literature is full of critiques of the socialist planned economies, all of which highlight the difficulties of trying to bureaucratically allocate resources in absence of a real market. But as it happens, all of these critiques can be applied equally to the modern corporation. After a certain size, the M-form corporation becomes indistinguishable from a planned economy, and convert what should be “free market” enterprises into bureaucratic structures that suffer from all the problems of a socialist state, with none of the benefits. To see how this happens, let us examine these problems in more detail.3
Lack of an Internal Market. In a corporation of any size, there is an enormous internal trade in goods and services. The outputs for one division are the inputs to another, and services such as accounting, computing, and marketing are offered across divisional boundaries.4 But there is no market for these goods and services. In general, each division does not have a choice about which products and services to purchase and to whom they will sell their product. Yet, without a market, how does one know how to price products or how to allocate resources? The answer is that products are priced, and resources allocated, bureaucratically, by administrative decisions. Managers often find that their main job is to constantly fight the “battle of the budget” since it is the administrative process, and not the market, that determines their success. Readers will recognize this as the primary critique of a socialist economy, but one that fits equally the corporate economy. But a bureaucrat, public or private, can only make decisions as good as the information he receives. And here we encounter another problem endemic to both systems.
Information costs. In a large organization with a highly complex structure, there is a separation of of knowledge from work and a distribution of information spatially across many offices that may be separated by thousands of miles. But before any decisions can be made, this information must be gathered, processed, assimilated, and judged. Further, the separation removes the information from any context, and as the people who must use the information have little knowledge of the work they remotely supervise, the ability to judge information gets lost. It is not that such organizations lack information; quite the contrary, they are inundated by it. But it is like doing a Google search and coming up with millions of sites, only a few of which are relevant. It is impossible to know in advance which sites have the needed content. Unfortunately, in a hierarchical structure, power relationships tend to determine the content; there is always the danger that a “rank-based” logic will prevail. Managers, intent on advancement, tend to supply the information they know their superiors want to hear, rather then the information they ought to hear. Large organizations tend, therefore, to become systematically stupid.
All of this imposes high information costs. But no matter how many resources are devoted to information gathering and analysis, there is no way to ensure the completeness, accuracy, or relevance of the information.
Agency Problems. In a socialist economy, the officers of the state are supposed to run an economy that is “owned” by the people and act as their agents. But in practice, the socialist managers become the effective owners of the system, constituting a privileged group with their own interests. No matter how democratic the political system, the public at large generally lacks the information necessary to manage large enterprises. The same critique, however, applies to corporate management. The board of directors is supposed to act as the agents of the stockholders, and the managers as agents of the board. But as with the socialist collective, the managers of corporate collectives become the de facto owners.
John Bogle, the founder and former president of the Vanguard Funds, has documented the ways in which the top managers have constituted themselves as a new class that appropriates to itself all the privileges of ownership without any of the risks.5 They appropriate to themselves outsized rewards that should, by right, go to the owners and the workers. How can they do this? Ownership of a business once designated active control of that business, but now, as John Bogle notes,
The position of ownership has changed from that of an active to that of a passive agent. The owner now holds a piece of paper representing a set of rights…but has little control. The owner is practically powerless to affect the underlying property through his own efforts…the “owner” of industrial wealth is left with a mere symbol of ownership while the power, the responsibility and the substance which have been an integral part of ownership in the past are being transferred to a separate group in whose hands lies control.6
In other words, “ownership” itself no longer has the meaning in the corporation that it does with any other form of property. “Ownership” has been attenuated to a mere claim to whatever portion of the profits that the directors care to distribute, and the right to vote for these directors. However, this “right,” from the standpoint of the average shareholder, is more formal than actual. In practice, the costs of running a campaign against board members is prohibitively high, and the right to vote means little to the average stockholder, who rarely exercises it. In absence of active owners, the executives become the de facto owners of the firm. The corporation becomes, in effect, a mass of unowned capital appropriated by the managers. This new class tends to push the burdens and risks of work downward, and the rewards upwards.
The Divorce of Technical from Entrepreneurial Knowledge. Socialist planners prided themselves on their technical expertise and their deference to engineering talent. However, as their critics point out, while technology provides us with an endless range of production possibilities, it is impossible to evaluate these possibilities without knowing the price of the inputs. Since so many of the inputs are internal to the corporation, and since the corporation benefits from so many public subsidies, it is impossible to say that one system is more “efficient” than another. One can easily point to engineering marvels, but one cannot say that they are economically efficient. For example, the distribution system built by WalMart is certainly a technical achievement, but it depends on subsidized transportation costs. Without these subsidies, would the system aid or bankrupt the company? Neither the engineer nor the entrepreneur can answer such a question in absence of market prices.
Regarding this phenomenon, Kevin Carson notes:
Fully rational decisions are possible only if the knowledge of the relative value of inputs is combined with knowledge of how those inputs are to be used internally. The separation of ownership of capital from the knowledge of the production process leads to decisions divorced from reality. The same is true of the separation of management from the direct involvement in the production process, and the accountability of management to absentee owners rather than to workers.7
For these reasons—and for many others—the modern corporations form, in the words of David Friedman, “indigestible lumps of socialism” in what is supposed to be a free-market system. Like any socialism, the system becomes increasingly dependent on state power and subsidies.
The Distributist Alternative
This critique would be pointless if distributism had no alternatives to offer. And the distributist alternatives would not be credible unless they were on the ground and working, and working in both large- and small-scale manufacturing. As it turns out, the distributist is offering not abstract panaceas, but systems which are on the ground and functioning; systems which any interested party may examine for their effectiveness. One such system is the distributive economy of Emilia-Romagna (Bologna) in Italy. As Kevin Carson describes it:
The closest existing model for sustainable manufacturing is Emilia-Romagna. In that region of 4.2 million people, the most prosperous in Italy, manufacturing centers on "flexible manufacturing networks" of small-scale firms, rather than enormous factories or vertically integrated corporations. Small-scale, general-purpose machinery is integrated into craft production, and frequently switches between different product lines. It follows a lean production model geared to demand, with production taking place only to fill orders, so there's no significant inventory cost. Supply chains are mostly local, as is the market. The local economy is not prone to the same boom-bust cycle which results from overproduction to keep unit costs down, without regard to demand. Although a significant share of Emilia-Romagna's output goes to the export market, its industry would suffer far less dislocation from a collapse of the global economy than its counterparts in the United States; given the small scale of production and the short local supply chains, a shift to production primarily for local needs would be relatively uncomplicated. The region's average wage is about double that of Italy for a whole, and some 45% of its GDP comes from cooperatively owned enterprises.8
The salient points of this analysis concern distributed and flexible manufacturing, the use of small-scale, general-purpose machinery, the gearing of production to demand (“demand-pull” rather than “supply-push”), local supply chains, and widespread worker ownership. Let us look at these points in turn.
Flexible Manufacturing, This allows for the quick movement among different product lines as demands shift. This is difficult in the M-form corporation, where a new product line often involves setting up a new division complete with its own capital requirements, not to mention management overhead. Moreover, it is easier to integrate this sort of manufacturing with craft production, bringing about the best of both worlds. “Craft” no longer has to mean a trade-off between quality and price, between single-piece and mass production.
General-Purpose Machinery. The use of general-purpose machinery means that the factory can shift easily from product line to product line, as demand dictates, without excessive re-tooling costs. The current system which relies on product-specific machinery cannot match this advantage. Moreover, such general-purpose machinery is already widespread. Most households already own quite a bit of it, and if you canvass any neighborhood, you are likely to discover a wealth of capital which can be joined together to produce a variety of products cheaply, efficiently, and locally.
Demand-Pull Production. Demand-pull manufacturing has a number of both economic and social consequences. Economically, it lowers the need for inventories, encourages the localization of those supply lines, and lessens the “boom-bust” cycle. But socially, it relies less on advertising to move goods. Currently, consumers are the victims of non-stop propaganda which appeals to their basest instincts. It is no more than commercial pornography, but it is necessary to the supply-push problem. This propaganda is especially directed at children, who must be socialized to the culture of consumerism if the current system is to survive.
Local Supply Chain. Local supply chains greatly lower costs and increase the utility of any firm to its own region. We have convinced ourselves that it is more “efficient” to ship a tomato 2,000 miles before we eat it, or to ship parts from the other side of the world. But obviously, there is something wrong with that equation, and even the most dedicated “flat-earther” would concede that local supply is better than remote, all other things being equal.
Since the manufacturing is divided up among largely local firms that are selling to one another and to the public, the system is free-market and all the inputs are priced at their market price. This means that correct engineering, product, and marketing decisions can be made and resources allocated much more efficiently than in the internal socialism of the M-form corporation.
Widespread Worker Ownership. Finally, widespread ownership overcomes the problems of the division of capital, management, and labor, and of the division between technical and entrepreneurial knowledge. Workers are no longer commodified cogs in an economic machine, but in control of their own destiny because they are the owners of their own properties, be it property in land, machinery, or skills. The problems associated with the division of ownership from work and management from knowledge of the production process are overcome. Moreover, a sense of community is encouraged and strengthened. And in the last analysis, this is the real purpose of an economy. It is never about just making piles of money, but creating real wealth that supports real families and real communities.
Scalability. The M-Form corporation depends on gargantuan size to achieve its power, and thereby opens up a gap between “business” and big business, two very different kinds of enterprises with two very different effects on the market. The distributed model has also shown itself to be effective in large-scale manufacturing (as we shall see in the next chapter) but it is also scalable down to the level of the family firm, or even the single individual. Indeed, the distributed model allows people to take advantage of the capital they have, but is currently unused. For example, one can use one's own kitchen and spare room to open up a small restaurant. Indeed, it is only the oppressiveness of zoning laws, regulations, and the need for extensive tax accounting that keeps this from being more common than it is.
Now, one can debate as long as one wishes the efficacy of the distributive system. However, there is one group that has decided in favor of distributism, and that is the manufacturers themselves. For the past 20 years, they have been busy creating a perverse simulacrum of a distributed system. They have realized that it is no longer profitable to hold expensive machinery, and have distributed their plants throughout the world, relying on cheap transportation and legal ownership of the patents to maintain control of the end product. In today's industrial system, it is considered somewhat vulgar to actually own a factory when all that is needed is to own the brand.9 This is the “Nike” system, where the “product” is not the shoe but the “swoosh” on the shoe. Indeed, Nike itself makes nothing but patents and advertisements; actual shoes are made in sweatshops. But the advertising allows Nike to sell a shoe with a dollar in direct labor costs for $100.
This sounds like a good business, but actually the company sows the seeds of its own destruction. Management guru Thomas Peters gushes that some 90% of a product's value is not in material or labor costs, but in “intellectual property.” What this means is that the corporation is able to exercise control through the patent laws. However, it will not take much for the actual factories to decide that the patent has no moral or economic justification. They will tear off the swooshtika and discover that they can sell their product locally for one-tenth of the price while paying their workers three times the exploitative wage. As the current economic order disintegrates, the corporations are likely to find that they have set in place everything necessary for their own replacement.
And that is good news.
1Pankaj Ghemawat, “How Business Strategy Tamed the "Invisible Hand" — HBS Working Knowledge,” Harvard Business School Working Knowledge, July 22, 2002, http://hbswk.hbs.edu/item/3019.html.
2Kevin Carson, “Industrial Policy: New Wine in Old Bottles.”
3Throughout Throughtout this discussion, I am highly indebted to Kevin Carson, Organization Theory: A Libertarian Perspective (Booksurge, 2008).
4I should note here, in passing, that goods sold internally do not have a sales tax, giving the corporation a government-sponsored advantage over other forms of organization.
5J.C. Bogle, The Battle for the Soul of Capitalism (New Haven & London: Yale University Press, 2005), xix.
7Carson, Organization Theory: A Libertarian Perspective, 198.
8Carson, “Industrial Policy: New Wine in Old Bottles,” 4.
9Naomi Klein, No Logo (New York: Picador, 2002), 3