Tuesday, April 19, 2011

Burke, Veblen, and the New Feudalism: Part II -- The Economics of Thorstein Veblen

"The highest achievement in business is the nearest approach to getting something for nothing."

--Thorstein Veblen
The Vested Interests and the Common Man

Thorstein Veblen is one of the black sheep of economics. Possibly one of the blackest of the black sheep. The quote above, which is fairly typical of his thinking, turns the capitalist accusation against the social welfarist on its head. In case you haven't quite gotten the barb of it, it rests on the notion of the capitalist as a profit maximizer, and highlights quite effectively the fine line that can separate 'good business' from chicanery, theft, and fraud, as well as the strong potential for business indifference towards the economization and community well-being that free-markets are supposed to be all about, at least in theory.

Veblen is probably best known for coining the phrase 'conspicuous consumption' and his biting criticisms of businessmen, dissecting their psychology and practices like worms under a microscope. He is also known as a sociologist, and that aspect of his work will come out later. For now, I will try to confine myself to his economics. Veblen's thoughts are not so easy to unpack, as his point of view is so disparate from what is commonly understood and so many of his ideas are so tightly wrapped up together that they become difficult to disentangle. If I had not first encountered the Austrian school and Edmund Burke, I probably would not be able to take him seriously. A systematic presentation will be difficult, but I shall give it a try.

The Economy as a Tangled Mechanical Mess

Veblen describes the modern physical economy as the 'machine process,' a term that will become very important later. He thought that the rise of the use of industrial machinery and manufacturing to increase output had a transformative effect on the entire economic and social picture. For now, it is important to see that the use of machines necessitates conformity and standardization in output, 'low tolerances' in engineering terms, as materials and parts feed from one process to another in an ever increasing web of complexity and interdependence. 'Concatenation of processes' is his description.

This concatenation creates a situation in which changes in one process can have radical rippling effects across the entire interdependent economy. Canny businessmen know this, and readily see that 'interstitial disturbances' and adjustments in processes can create opportunities for profit, and not necessarily 'disturbances' that increase efficiency. Individual businessmen with control over particular processes look out at the 'concatenated' system opportunistically, to see how their own actions might increase their own profits, or how their profits might be vulnerable to the actions of others. But they aren't necessarily concerned with the integrity or efficiency of the system, in part or in whole. 'Disruptions' can often create advantages for individuals that are as profitable as efficiencies.

In fact, it was Veblen's opinion that, on the whole, businessmen actually retard advances more than drive them as they seek advantages over one another and extend their own individual wealth and power. Their interests are their own individual ownership and control, not community well-being, and if a particular change does not benefit them, they will not pursue it, and will actively attempt to impede it if they believe it hurts their interests. They will seek ways to overpower or disrupt the operations of others in an attempt to thwart competition. In any change or combination of processes they encounter, they will tend to push for their own interests by whatever means are at their disposal, without regard to the overall function or the interests of others not connected with themselves. Often as not, they act to hinder rather than expedite 'economic progress' as they search for selfish advantage.

Veblen has a whole litany of examples of such behavior, most of which will be familiar to the reader -- seeking monopoly pricing and other uncompetitive activities, disrupting competitors' operations, parasitic behaviors, 'advertising' and 'salesmanship,' both of which he considered wasteful, and many, many more, some of which will probably come out later. He points out that, to the businessman, the serviceability of the product is not necessarily of interest so much as saleability, and that the utility of work to the consumer has no direct bearing on remuneration. It is the utility of work to the businessman as employer that counts, and parasitic 'work' may even be highly lucrative.

In short, Veblen saw the 'business community' as economic parasites. I cannot convey the scathing criticism of Veblen on this point any better than to quote a particular section where he contemplates the possible limits of such parasitic opportunism as the capitalist system creates --
A disproportionate growth of parasitic industries...would lower the effective vitality of the community to such a degree as to jeopardize its chances of advance, or even its life. ... But owing to the very high productive efficiency of the modern mechanical industry, the margin available for wasteful occupations and wasteful expenditures is very great. The requirements of the aggregate livelihood are so far short of the possible output of goods by modern methods as to leave a very wide margin for waste and parasitic income. So that instances of such a decline, due to industrial exhaustion, drawn from the history of any earlier phase of economic life, carry no well-defined lesson as to what a modern industrial community may allow itself in this respect.

While it is in the nature of things unavoidable that the management of industry by modern business methods should involve a large misdirection of effort and a very large waste of goods and services, it is also true that the aims and ideals to which this manner of economic life gives effect act forcibly to offset all this incidental futility. These pecuniary aims and ideals have a very great effect, for instance, in making men work hard and unremittingly, so that on this ground alone the business system probably compensates for any wastes involved in its working. There seems, therefore, to be no tenable ground for thinking that the working of the modern business system involves a curtailment of the community's livelihood. It makes up for its wastefulness by the added strain which it throws upon those engaged in the productive work.

In other words, businessmen make up for the wonton waste and destruction of their parasitic activities and mismanagement by structuring the system so that the productive elements of society work themselves to the bone to make up the difference. See -- it all works out in the end!

Veblen's Business Cycle and the Evil's of Corporate Finance

I was quite surprised to find embedded in Veblen's theories a business cycle theory very similar to the Austrian school's. This is particularly impressive considering that, to my knowledge, the first clear articulation of Austrian Business Cycle Theory (ABCT) did not appear until 1912 in Ludwig von Mises' Theory of Money and Credit. Veblen's Theory of Business Enterprise was published three years earlier in 1909. His theories also strongly emphasize the individual aspect of the interests of businessmen, so in at least one aspect, he recognized the pitfall of the mistake of aggregation. This is another of the hallmarks of the Austrian treatment. It would not surprise me to learn that Mises had read Veblen and been influenced by him before producing his own theory.

Veblen sees the process of 'corporate finance' as creating an inflationary boom and the following deflationary bust. By 'corporate finance,' he means the process of what he calls 'capitalizing' a company's physical capital by issuing securities against it, for example, using capital equipment as collateral for loans and offering corporate bonds and shares for purchase in capital markets. Today, we would probably call that process 'securitization.'

He notes that the sum total of the various claims thus issued amount to many times the actual cost of the initial physical capital, yet in the final analysis all such paper assets amount to claims against the same thing. The disparity is created by the practice of valuing a company on the basis of earnings, while the physical capital assets are valued at their replacement cost. Most analysts today would refer to these types of calculations as 'earnings multiples' and 'book value' type assessments of the value of a company. By corporatizing their business models, businessmen gain access to an immense quantity of purchasing power against a relatively small upfront physical asset base. They effectively 'sell' their businesses while still retaining control over them if they can maneuver skillfully with the new shareholders, plus control over the pile of financial assets now at their disposal. These they put to use vying with other businessmen to pursue their individual designs, which may or may not concern themselves with the interests of the actual company they are heading. Remember, they are individuals, and no longer necessarily 'own' the companies they manage. Veblen considered this situation of diffuse ownership and a separation of ownership from management to create conflicts of interest, an insight not unique to himself.

The net effect of 'corporate finance' is to pyramid securitized claims against a capital base, analagous to the pyramiding of bank deposits against a monetary base by the practice of fractional reserve banking. Veblen also included the monetary inflation of the banking system as part of the inflationary buildup, lumping them all together as parts of the same process. He apparently saw no reason to distinguish between them. In this he departs from the Austrian school, and his analysis smacks strongly of the modern 'deflationist' model, in which all claims are considered equivalent and amount to 'money' whether they are money proper or not. I think this is a mistake, but then again, Veblen didn' have the benefit of the Austrian model at his fingertips.

As the inflation builds, the businessmen use their financial instruments to bid up the price of capital and production goods as they compete with one another, while non-capital goods remain largely out of the inflationary fray. The escalating price of capital goods allows businessmen to issue further securities against their capital base as the perceived value of the capital base grows, exacerbating the cycle.

Eventually, wages get bid up, or some other such occurrence causes the future earnings of the business model to come into question. At this point, the capital base can no longer be further securitised, perhaps a few loans are called in, and the process begins to reverse. As business prospects wane, investors become unnerved at the degree of securitization and many want their money back. However, 'unsecuritization' is not generally as smooth a process. Prices begin to fall, businesses fail, bankruptcies begin to cause rampant destruction of securities and money (back in the old days before the FED and FDIC, anyway) and the deflationary crash gets fully underway.

Meanwhile, for people not intimately tied to the capital markets, not a great deal is happening. Wages get cut and some people lose their jobs, but prices are falling, too, offsetting much of the pain. For those who do keep their jobs, the crash may in some ways actually be beneficial. The boom and bust is primarily a businessman's affair, both in the mania and the crash.

Veblen's Cycle vs. The ABCT

Veblen's model obviously has a great deal in common with the Austrian model. In particular, he had the insight that there were effectively two parallel markets in operation -- capital markets and consumer goods markets, 'inflation' only effectively able to impact one of them because of the availability of increased purchasing power being limited to 'credit markets.' He also keenly sees that the boom is a fraud, the result of illegitimate practices, and is actually the damaging part of the cycle. Most economists have considered booms to be legitimate and have concerned themselves with ways of trying to prolong them and eliminate busts.

However, his model is different, and in my opinion incorrect, on several important points, the most obvious being his lumping together of all financial claims as being effectively equivalent. Money clearly must be separated out as unique, and according to the Austrian school, is the sole cause of the cycle. It surprises me that he did not question that the proliferation of shares and bonds, for instance, should actually result in the suppression of their prices as their supply balooned relative to the supply of money used to bid on them. Veblen's 'boom' should theoretically suppress stock markets, not inflate them.

He also did not think that the business cycle actually had any material impact on the physical economy itself. He thought that the ups and downs were principally a matter of perception. He apparently did not think that the pricing system allocated resources efficiently, such that rising capital goods prices would necessarily divert resources preferentially into capital goods production and accumulation and away from consumer goods, or that the price changes would alter modes of production away from their most efficient arrangements. He never explicitly says so, but based on my reading I suspect that he thought the price structure was effectively arbitrarily set by businessmen struggling against one another, such that prices conveyed no meaningful information. Veblen considered economic efficiency to be increased principally by the mechanical considerations of the machine process, such that economizing and increased productivity was chiefly a result of the efforts of engineers, scientists, technicians and the like operating on scientific principles of mechanical efficiency.

Once again, to Veblen, efficiency was not the role of the businessman. The businessman did not dirty his hands with labor and concerns of actual production. Rather, his role, like the nobility of old, was the powermongering intrigue and violence of the business battlefield. His peasant is the laboring employee of this age.

But more on that later.

Corporatism's Evolutionary Vise

The advantages of the corporate model to the businessman are substantial, thanks largely to the system of corporate finance. Participation in capital markets is a must, in more ways than one.

Veblen, like Herbert Spencer and others of his era, was very much a subscriber to the ideas of evolutionary theory and its application to other fields. He saw that a business which refused the 'perks' of corporatism was not merely turning away great material advantage. In fact, it was voluntarily placing itself at a 'selective disadvantage,' at risk of becoming prey to the predatory tendencies of more aggressive market participants. In the final analysis, capital markets did not so much pose a boon to businessmen on the whole as to the individual businessmen skilled in navigating them. They constituted yet another battlefield of competition. Participation was mandatory to survival, and those that learned their lessons early and were able to maneuver successfully greatly magnified their power to outmuscle and devour others.

Moreover, 'winnings' in capital markets 'count' in the goods market as well. After all, wherever you make it, the money is still green. The multiplying tendencies of the capital market attract the attentions of those with an eye for gains, and one of the signs of modern times is that the capital markets have subsumed all others in their festering growth and the attentions showered on them. Soon it becomes necessary to invest just to 'keep up.' Veblen believed that this had a 'crowding out' effect, as the captains of finance found that they could indulge their 'conspicuous consumption' habits at the expense of those of other walks of life by the use of inflating money and capital.

Through the evolutionary lens, Veblen saw that all businesses would inevitably seek whatever advantages they could over others by practically whatever means were necessary. This is particularly the case for the pursuit of monopoly pricing and the evasion of competition that would allow businesses to increase their profit margins. Any enterprise which lost its pricing power would suffer the double blow of reduced profits and the inability to securitize its capital as the company's value based on its earnings approached the value of its underlying assets. Veblen thought such companies would not last long, thus practically all companies presently in existence must have achieved some level of monopoly pricing.

Clearly, it would take quite a powerful force to keep such tendencies in check.

The Lords of Finance vs. The Laws of Nature

Many of Veblen's accusations against 'the system' will be familiar to those interested in such topics. You may or may not think that Veblen's postulations about the abilities of businessmen to manipulate the capitalist system are valid. I certainly reject a lot of them, especially his utter lack of faith in the price mechanism, and question many others. But what their very plausibility should illustrate is just how precariously capitalism is secured from corporate piracy and the out and out gangsterism that dominates so many of the world's economies.

What is it that his capitalist critics will cite that will protects us from the tender mercies of predatory businessmen? Why, none other than Natural Law, of course, that veritable darling the Enlightenment! And, as they say, therein lies the rub...

The student of economics can no doubt name several of the economic principles that work against the machinations of businessmen to establish the outsized profits they so desire by riding roughshod over the rest of us. Competition pushes down profit margins, eventually to the limit of zero, in theory. Innovation and new modes of production threaten established monopolies and existing capital structures, in theory. Diminishing marginal utility should prevent any one interest from being able to grow too large and powerful.

But do they really? The dynamics of 'corporate finance' and inflation clearly allow businessmen to slip the leash of Natural Law. So does the interference of government, monopoly creator extraordinaire, especially under the financial influence of the corporations whose excessively rapacious behavior they are supposed to check. These are obvious. There may be others.

Clearly, it would take a very well designed legal system to allow natural law to operate the way it is theoretically supposed to. Is such a system even possible?

What would it the economy produced by such a system look like?

Veblen's 'Perfect' Economy

Veblen postulated a hypothetical world without 'corporate finance' and the sin of monopoly pricing that looks very different from our own, and in it we find at least two very interesting insights.

The first is that it is remarkably similar to the Austrian prediction of a world with an ideal money system -- one that is stable -- and an ideal economic order -- a free market. The two hypothesized worlds are for all practical purposes identical. There is no business cycle. Prices across the board slowly fall as higher productivity increases the supply of goods while the supply of money remains stable. Wages, like other prices, remain permanently flat or falling, but at a slower pace than goods prices as the productivity of labor continually increases. Interest rates, yet another 'price,' are stable, low, and almost always in a slow fall. Capital goods prices slowly fall, too, as these goods are ever being outmoded by newer and more efficient methods of production.

It is, overall, a rapidly changing but extremely boring world, economically speaking. There is potentially an awful lot for a businessman to do, as it is a busy place, but critically, there is not really a lot of money in doing anything. The competition is positively ferocious. There are practically no profits, and no ways to disrupt the system to get them. It is the engineers, scentists, laborers and innovators who rule this world, not the businessmen.

That is the second important point -- Veblen's ideal economy does not need the businessman. Veblen made the critical insight that the modern, staggering accumulations of wealth by certain businessmen is entirely made possible by fluctuations in the value of money, and, an Austrian would add, therefore by changes in the money supply. Many Austrians are quite sure of this insight, and certain among the super rich, like Jim Rogers the multibillionaire investor, are quite open about it. Without the wrenching changes caused by the whiplash of the business cycle, there would be no way to accumulate such staggering sums in the market in one man's lifetime. Investors need substantial price changes to make significant returns in a relatively short period of time, and in this idealized world everything would be too stable.

In other words, the businessmen need the inflation, the monopoly power, the coercion of the markets, even though they do not always recognize this. A truly free market with honest money would destroy them. For the businessman of Thorstein Veblen, the ability to corrupt the system is a matter of survival. It is the aforementioned departures from this ideal that create and sustain him.

The tentative, fragile, Enlightenment ideal, which is the perpetual target of their attempted violations.


There are clearly other very important issues to get into, even more important than those raised here, but to do so at this point would require me to invoke other, less strictly 'economic' aspects of Veblen's model to deal with them adequately. So, instead, I will finish here with some parting questions:

How much faith do we have in natural law operating in the marketplace to protect us from unethical, predatory behaviors?

How much faith do we have in government to protect the functioning of natural law and maintain its own integrity in the face of withering corrupting influence?

How much faith do we have in ourselves to detect the machinations of those who would do us harm, under a legal order that respects freedom of contract, even 'bad contracts' entered into by parties with an imperfect ability to represent their own interests, and eschews moral judgment in the interests of individual liberty?

To the extent that reality will necessarily depart from the ideal, from a practical point of view, how 'bad' will it get?

Is a social order based purely on the Enlightenment a stable, sustainable one in the real world?


  1. Fascinating commentary. Can you tell me where Veblen discusses "The net effect of 'corporate finance' is to pyramid securitized claims against a capital base, analagous to the pyramiding of bank deposits against a monetary base by the practice of fractional reserve banking." Does he explore the linkages?

  2. Blogger seems to be freaking out. To the anonymous commenter:

    From page 105 of Theory of Business Enterprise:

    "So long as times are brisk this discrepancy [between (financial) business capital and physical industrial equipment] ordinarily goes on widening through a progressive extension of credit. Funds obtained on credit are applied to extend the business; competing business men bid up the material items of industrial equipment by the use of funds so obtained; the value of the material items employed in industry advances; the aggregate of values employed in a given undertaking increases, with or without a physical increase of the industrial material engaged; but since an advance of credit rests on the collateral as expressed in terms of value, an enhanced value of the property affords a basis for a further extension of credit, and so on.... The extension of loans on collateral, such as stock and similar values involved in industrial business, has therefore in the nature of things a cumulative character.



    Chapter three mostly deals with his ideas of credit and the business cycle, but if you really want to understand it, it is probably best to read the whole book.

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