Monday, April 25, 2011

Are Businessmen Really Parasites?

Before going much further in this series on the Enlightenment and its relationship to the modern economy, I thought that I would stop and address a couple of fairly controversial ideas that appeared in the second essay – namely, whether businessmen really are economic parasites, and the idea that an ideal economy would have near zero profits.  I thought that I'd start with the second one first, because it is a little less controversial and easier to explain.

Profit in a Free Economy

This isn't going to be so much an argument as an exercise in defining and labeling.  Labeling things doesn't really change them, but sometimes it helps to think about a situation more clearly.  Most people most of the time play fairly fast and loose with language.  Most of the time one is talking in a fairly general manner, so it doesn't matter too much and can be a time saver to use words so generally.  Thus we typically speak and think of profit in general, rather than profit in particular.  And yes there is a particular.  In the present case, such use of the word 'profit,' as well as 'monopoly' and 'capital' (and a few others), can cause considerable confusion once one begins to talk of matters in anything approaching a specific sense.  For the present case, I think it is extremely useful to resurrect an old, and now somewhat defunct, standard of terminology.

Economists have variously classed the factors of production in different ways according to the understanding of the time and the particular theory of the economist.  In the early days, three general classes of factors were recognized:  land, labor, and capital.  Each of these terms has an associated 'economic return:'

The return on land is called rent.
The return on labor is called wage.
The return on capital is called interest.

Sometimes other variants and 'subspecies' are used, such as salary as payment for management, dividends as the return on capital, or interest as the return on credit, etc.  The variations for returns on 'capital' should illustrate how muddled and controversial the subject is, the main sticking point being how to classify financial 'capital.'  Even 'profit' is sometimes used to denote the return; I'm treating that as a mistake.  But that is not part of the present controversy.

In modern times, a fourth major category has been added:  entrepreneurship.  As you may presently be guessing, the return on entrepreneurship is profit.  This is a highly specific notion of profit, and strictly speaking, the correct notion, depending on your exact economic school.

In assessing business 'profit' in the strict sense, the calculation is quite easy:  revenues minus costs.  But it must be remembered to include all costs, however 'theoretical,' if this is to be a meaningful calculation in the strict sense.  Thus when I am saying that 'profits approach zero' what I am saying is that costs approach revenues.  I am not saying that the proprietor of the business doesn't make any money.

The classical economists thought that prices were set by production costs for a reason:  in a free, competitive market, most of the time they are.  This is because of competition and simple supply and demand.  If any good attracts a price significantly above its production costs, new supply will tend to come to market as either the present producers increase their levels of production, or new businesses enter the market to compete with them.  Either way, the increase of supply will tend to push prices down until there is practically no profit, in the strict sense of the word, to be had.

That does not mean that nobody makes any money.  The workers are compensated for their labor, the landlord collects his rent, and the owner of capital collects interest.  Oftentimes, the 'businessman' is actually the manager of the company, owns the building and the production capital.  He may make out quite handily, even if his company is technically unprofitable.  But here's the thing – he has an active, productive role in the company and has made real investments.  If he borrows the money to buy the capital, rents his building, and hires someone else to run the place, he won't make anything as a mere businessman. 

(Also note – a 'businessman' to Veblen refers more to a man of the second sort and not necessarily the first.  But I'll get to that later.)

Profit in the strict sense is entrepreneur's profit, and it is practically always derived from a restriction in the marketplace.  This is what Veblen refers to as 'monopoly.'  He means some sort of restriction in supply or barrier in the market such that a price substantially higher than production costs over the long term may be fetched.  Most people consider certain cases of 'monopoly' to be perfectly justified, such as through innovation, a sterling reputation for quality, trademarking, intellectual property, etc.  Others are considered sinister, such as government interference, the formation of cartels, collusion, etc.  Veblen always considers market barriers in the negative, since in every case market restriction results in a lower overall level of economic production.  However, the reader is free to render his own judgment. 

That is the point here – in an idealized free market where market restrictions are forbidden, in order to make a profit in the strictest sense, a businessman must always act as an entrepreneur.  If he is not acting as an entrepreneur, – i.e. he is not innovating – he cannot expect to profit.  And as competition in a free market is fierce, the entrepreneur must produce a constant supply of new innovations, otherwise the innovation and competition of others will erode his pricing advantage and render him just another businessman.  Of course, there will be all those weird exceptions that you heard about in school, like 'natural monopolies.'  But by and large, most companies will fall under the 'no profits' rule rather than the exception.

Hopefully, that has cleared up any confusion in the matter.  For a person committed to the free-market, high profits in the general sense of 'making money' are not an evil, but high profits in the strict sense, and especially over the long term, probably are.  That is the nature of capitalism.  There are no free lunches.  One can love it or hate it, but it is what it is.

Are Businessmen Really Parasites?

To me, this is a tougher question that it actually appears.  First, one has to have a clear idea what he means by the words 'businessman' and 'parasite.'  The answer will depend largely on what one means by either of them, and in economics, few things are so difficult or controversial as defining terms.  That is to say nothing of how one believes the economy to work.

First, let me begin by dismissing a certain point of view as being unworkable to any kind of discussion on this subject.  There is a certain way of thinking that asserts that no determination of the market can be incorrect as a simple matter of tautology – what the market determines is correct, period, end of discussion.  In the case of employment, since all position are open to all applicants in a free, or even in a markedly unfree market, such a thinker will hold that there can be no such thing as economic parasitism because no one can possibly be 'overpaid,' and unproductive work would perforce be purged from the system.  Market prices and dynamics inarguably are what they are.  In other words, there can be no complaining of anyone being 'overpaid,' because all were eligible for the position to begin with, and if the market has determined that such and such position is to be so remunerated, then that is all there is to it.  'Overpaid' is a nonsensical term.  There can be no complaints or discussion with such a person; all outcomes are correct and 'good,' and there can be nothing to talk about, except possibly the weather, sports, and Just How Good Every Thing Is All Of The Time.

It does not seem to occur to such such thinkers that if that really were the way the market worked, practically all positions of employment would receive identical remuneration, barring minor discrepancies such as the general enjoyability of a position or its physical difficulty, or perhaps specialized skill or training that will always form at least a small barrier.  Supply and demand, with which I would assume such a person was intimately familiar, would dictate that any 'overcompensated' position would remain only temporarily so as people rushed to compete for the job and underbid one another, or the number of such positions proliferated, diminishing the return as one competed with another.  The fact that the pool of available position is freely open for all applicants to compete also means that that all positions are freely competing for the pool of available applicants.  The competition works both ways in an ideal system, pretty well leveling everything.  While this person rationalizes to you the intricate machinations of how it came to be that professional athletes are paid many times more than garbage collectors, even as literally millions of highly competitive souls vie to be professional athletes and are summarily turned away, I shall take my leave and explain the issue of parasitism to those who are inclined to consider the possibility that there might actually be something fishy with markets as they stand at present.

By 'businessman,' I believe Veblen has something in mind that is somewhat different from what the average person might take him to mean.  Veblen is thinking of modes of employment that derive almost purely from the order of society, and he is referring to people employed in positions that he believes are artificially created by this order, and in the final analysis, are utterly unproductive and even counterproductive in that they often interfere with the productive efforts of others.  Basically, to him, businessmen are the equivalent of the libertarian-conservative's bureaucrat, and he has very specific reasons for thinking so.  Many of these positions he believes to be fantastically remunerative, such that those employed in them are able to consume far more than those who are actually more productive.  I think that if anybody viewed society as structured that way, he would believe such people to be parasitic.  The question, then, is whether or not one subscribes to his model.  So, his claim should be evaluated as such – is his model valid, or not?  I will leave that to the continuation of the series for the reader to decide for himself.

As for my own opinion, I think the matter is somewhat more complicated than he makes it.  Our economic system is exceedingly complex, such that even a semi-quantitative guess at anything beyond a trivial quantity is difficult, and the outright determination of whether a mode of employment is parasitic or not is I think beyond anyone's reach.  To simplify matters, I will avoid the outright determination of parasitism, and subdivide various aspects of business to give an opinion on the parasitic or productive nature of each.  All subsidies are in effect parasitism, and as I and many others have remarked before, practically all economic actors are the beneficiaries of at least one subsidy and probably many, as well as being on the losing end of subsidies to others.  I do not want a splitting headache, so I will not try to divine who comes out the overall winner in every type of transaction, simply to say that all people who benefit from such subsidies are acting parasitically in at least that one aspect of their business affairs.  We are all parasitic, businessmen included, in some capacity or another.  That is the nature of the system we operate in.

From a certain point of view, the simple determination of whether or not a mode of employment is 'overpaid' will determine whether or not that role is parasitic, as I hinted when I began.  An economic actor's pay simultaneously determines 'the market's' assessment of his value, and his level of consumption of goods out of the marketplace.  If we are to define parasitism as consuming in excess of what one contributes, then a simple determination that the actor is overpaid will suffice to confirm the charge of parasitism.  And I do think that businessmen are quite frequently overpaid.  I believe that the market routinely assesses their value inaccurately for a  number of reasons, most of which hinge on inflation. 

Inflation tends to artificially increase earnings.  This not only directly benefits the businessman disproportionately to the wage-earner to the extent that he is the recipient of any profits of the company, it also boosts the company's capitalization and allows businessmen who participate in capital markets to issue new securities at inflated prices, all more or less as Veblen describes.  I disagree with his assessment that all corporate finance is illegitimate, but do believe that monetary inflation corrupts the transactions.  Monetary inflation is to blame, not the securitization of capital per se.  Obviously, this will act as a larger subsidy for large corporations compared to small business. 

Inflation subsidizes credit, thus any economic actor who borrows money (which is practically everyone) is implicitly parasitic against savers and those who do not borrow, again, disproportionately for those who borrow more, like large corporations.

More subtly, and probably far more importantly, inflation lengthens the production structure and centralizes it, consolidating smaller businesses and producing the ubiquitous massive corporate structures that have come to dominate the marketplace (but didn't always...).  This 'corporate massification effect' sets up a quasi-cartel situation in which the overall number of corporations is artificially reduced.  This means that there will be overall fewer positions for corporate officers and other management positions, but overall the same amount of money bidding to fill these positions (assuming approximately the same sized economy, and neglecting effects of inflation on corporate earnings, which is to say, being very conservative).  Thus, these positions will be highly competitive, highly sought, and fantastically high paying, much like the situation for professional athletes.  Businessmen that manage to land them will find themselves fantastically well paid, while those that fail to do so will take an relative haircut filling subsidiary roles.  In addition, the inflationary process tends to divert resources to the higher orders of the division of labor, which is to say, straight into upper managements' pockets.

Obviously, as these positions are artificially created by debasing the currency, they are not the most efficient business structures, which is to say, they are wasteful.  And obviously, their artificiality and quasi-cartel status strongly suggests that they are heavily overpaid.  So, I would call that parasitic.  Notice, though, that smaller businesses that more closely fit the Veblen-Austrian hypothetical ideal would show far less of this parasitic tendency and perhaps none at all, especially if they stayed out of capital markets.  I keep coming back to the importance of that model, which was not obvious to me when I first encountered it.

As far as businessmen deliberately sabotaging operations of other businessmen, corrupting politics to their benefit, seeking regulations to exclude competitors, monopolistic behavior, representing their own interests over the company they actually run etc., etc., etc.?  Absolutely they do this.  I'm quite sure of it.  I see it all the time.  Businessmen are quite open about seeking out 'market barriers' and 'pricing power.'  This tendency will, of course, vary from one situation to another depending on exactly which businessman is under consideration.  But as Veblen explains, practically all businessmen will be under heavy pressure to do so, and when they do, it is definitely parasitic.

Veblen asserts that all business operations (vs. industrial operations, i.e. mechanical production, the  two sides of 'business enterprise') are actually parasitic in that their only purpose is in dealing with pecuniary interests and property rights, and are therefore not tangibly productive.  With this I disagree.  I can't reject the pricing mechanism as he does.  I think that monetary operations are extremely important to economizing production, so that a good deal if not most routine business operations, like book-keeping and accounting, are very necessary and quite important for the transmission of information and the securing of property.  Even if the scope of these activities have far outgrown their real usefulness as they try to compensate for (and take advantage of) the distortions and machinations of capital markets under the influence of monetary inflation, at least some level is absolutely essential to the economy and cannot be described as parasitic on its face, in my opinion.  But to the extent that this work is unnecessarily created by money supply manipulation, compliance with government regulation, tax policy, etc., it is parasitic.  Thank your government and the FED for that.

I also would disagree with the cruder notion that parasitic businessmen 'don't actually do anything but play golf and get paid for it.'  Obviously businessmen 'do things,' even if those things are not necessarily the most economical activities, and cannot be characterized as parasitic in this sense.  For certain, they accept a great deal of responsibility on themselves and provide leadership to businesses, even if it might be totally uneconomical leadership being artificially created and subsidized by the bizarre system that is presently in place.  You or I may totally disagree with exactly how businesses are run, but they are in fact run.

On the other hand, progressive taxation schemes would seem on their face to argue that on at least this one point, businessmen are the ones being parasitized.  However, in something of an act of serendipity, just as I was writing up these thoughts, I happened upon an economist making the point that the de jure object of taxation does not always wind up the taxed entity de facto.  This is the basic argument that conservatives tend to make when they say that you cannot really tax corporate earnings – the corporations will simply pass the tax on as a price increase to the consumer, who winds up bearing the burden.  So, like most things economical, even this determination looks sketchy.  Who really knows?

These new ideas really have my head spinning.  Veblen has me scrutinizing many of my premises in a big way.  As always, my opinions are my own, I'm not a professional and I may change them at any moment. 

Especially if I keep reading this kind of stuff...

About Those Professional Athletes...

In case you were curious about those professional athletes, here's my two cents –

Their case is analogous to the corporate officers of large corporations, with an interesting twist.  The professional sports are cartelized.  If I were to put together a new football team tomorrow, it would be summarily rejected by the NFL.  They allow in the teams they want, which above all else is few.

Because almost the entire national demand for 'professional football' is focused on a handful of teams, the owners of these few teams have enormous revenues at their disposal.  Which is, of course, the whole point of running a cartel.  Under normal circumstances, this surplus of revenues over costs would go straight into their pockets.  Why?  Because while the teams command enormous revenues courtesy of their cartel status, the objects of their expense are competing for buyers in the open market.  Therefore, the team owners mostly pay market prices for things like cameramen, secretaries, lightbulbs, etc., because almost all of the other buyers they are competing against do not have pockets as deep as they do.

...with one very notable exception, that provides the twist.  While their cartel status protects the owners from external price competition from other teams, it does not protect them against one another, as they all have deep pockets and an exclusive interest in football talent.  That is the nature of sport – their teams compete with each other.  Thus, the prices of those elements that go into producing a winning team will be bid up as the teams fight tooth an nail for the best players, coaches, etc., even as less essential elements are not.  The fact that players and coaches are not homogeneous 'goods' and that the odds of winning is highly sensitive to their makeup also helps.

And here we see the first law that we looked at – the tendency for revenues to approach costs – kick in with a vengeance.  Price competition for 'scarce goods' – the absolutely best players and coaches – causes player and coach salaries to rise to the very limits of revenue.  In fact, that's why the issue of the salary cap is so important and contentious in professional sports.  Without it, the benefits of cartelization flow exclusively to the players, just as the benefits of corporate cartelization flow to well-placed employees (corporate officers and management) rather than to the stockholder-owners.  The league's team owners got their salary cap, of course, because they are a cartel and the players have few comparable employment options.  So now the owners are positively rolling in money.

Just an odd thought, but I wonder what an upper management salary cap might do to the dividends and price behavior of corporate shares?

It may be argued that nothing is preventing me from starting my own football league, or that the NFL is those men's organization to run as they see fit, or that one likes football just the way it is, etc.  All of which is all well and good, but completely beside the point.  Whether or not a cartel's existence is legitimate or justified, or however it is arrived at, has no bearing on its economic outcome.  If the NFL were to open its doors tomorrow to all comers, there would probably be thousands of teams scrambling to take up the offer overnight.  There would be hundreds of games to see every weekend, competing for viewers.  There would be thousands of new positions for athletes and coaches.  The revenues of each team would fall, as would salaries, and pretty much everybody involved would be reduced to more or less average guys in terms of income.  But there might be a lot more people who got to make a living doing what they loved...

However the leagues arrive at cartel status, they are nevertheless cartels.  The owners may be fantastically wealthy because they are shrewd businessmen, but that doesn't change the fact that their wealth derives from collusion, wage-tampering, and cartelism. 

I suppose that, too often, that is what is meant by 'shrewd business.'

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