4. Markets, Contracts, and Firms
In this second chapter on capitalist institutions, I try to integrate a discussion of markets and firms in capitalism, and the contractual relationships upon which both depend. Contracts establish, with the sanction of the state, the legal and property relations that are essential to markets and firms, and to all individuals and groups in capitalism, including the state itself. It is almost impossible to exaggerate the importance of contracts to capitalism, and to its political legitimacy. Contracts are how private property “actually operates” in capitalism. To start, however, let’s turn to a few crucial preliminaries.
“The” Market?
In capitalism, the market is often treated like one of the fundamental forces of the universe, as independent of human desires as gravity. This deified market is obviously mythical, but the myth did not arise without reason. Markets really are central to the operation of capitalism, the first mode of production in history in which the market is the principal means of coordination. The principal, however, does not mean the only: the idea that markets determine all resource allocation in capitalism is categorically false. “Nonmarket” influences like coercion, tribute, and command still matter a great deal—especially within the firm, and often in the family (which remains an important institution of social reproduction in capitalism). Markets are nevertheless the main means of coordination and allocation in the capitalist world today; where widespread subsistence production has disappeared, markets are the principal way people meet their basic (and nonbasic) needs. Very few people in the global North today can provide for themselves the shelter, food, and water necessary to survive without engaging in market transactions—and those who can often choose to use markets anyway. Even for those of us radically opposed to it, living in a society organized by capital makes it very difficult to avoid market participation.
This, in fact, is one of Marx’s principal historical conclusions: if markets are the way things get distributed, and you do not have access to the means of production yourself, then you must purchase your subsistence on the market. However, because capitalist markets are fully monetized—you cannot walk into 7-11 and barter for a carton of milk—participation is restricted to those with money. Since most of us can only access the means of production, and thus a way of making a living, by selling our labour-power to a capitalist, we have no choice but to enter the labour market to obtain the money with which we pay rent, buy groceries, feed and clothe the family, etc. Getting by in capitalism, in the material if not the emotional sense, is almost entirely a market-mediated experience, even for those who curse the thought. This vicious cycle is a big part of the reason many people see few options other than shutting up and doing their jobs—an imperative that only grows in force as opportunities for paid work decline in “tough times,” and the fear of unemployment disciplines us more harshly.
Abolishing or finding a way out of this “wage-worker’s bind” is one of the most significant challenges for anticapitalist politics. Millions, even billions, of people all over the world today feel trapped in their current capital-imposed position, quite reasonably terrified of rejecting it, since as it stands there is no other way to put food on their table and keep a roof over their children’s heads. This is precisely what Marx described with bitter irony as the condition of the “free worker” in capitalism. Any successful anticapitalism must both explain and upend the forces that produce the wage-worker’s bind, and make a compelling case for how a better getting by will be possible when existing structures are no longer standing. Indeed, making arguments like this is a big part of what “politics” is.
Making that case will be difficult, but not impossible. A first step is to expose the myth that we are beholden to impersonal market forces that no one really controls. Contrary to the impression one gets from the media, just because the market is essential to capitalism, does not mean that capitalism is the market. That it appears to be is a crucial thread in the wage-worker’s bind. In truth, markets are only part of the capitalist system, a substantial and essential part to be sure, but there are others: state, firm, family, nonmarket institutions like community groups and teams, and so forth. Nor are markets neutral realms in which supply and demand coolly intersect via the logic of competitive prices, as the harmonious classical and neoclassical models suggest. Markets are principal sites of conflict in capitalism, usually between actors who are not themselves organized according to market logic. If you think about it, even though the capitalist enterprise, the family (however defined), the state, and workers’ organizations are among the key participants in capitalist markets, and some of them (especially firms and the state) are the loudest proponents of the benefits of market organization, not one is internally organized according to market principles. Internal relations in firms are not determined by atomistic competition any more than internal distribution of incomes in the civil service are determined by individual marginal contribution to productivity.
The internal structure of most “capitalist” organizations is proof that capitalism is not only not the same as the market, but that much of capitalism is constituted in, and depends upon, a vast array of nonmarket institutions and relations. Virtually all capitalist firms have a command structure much more like the military than the market, and families have a whole range of structures, even within one society. The state is a massive and often uncoordinated mess of different interests and actors—nominally pyramid-like but in reality many little pyramids—and unions are never, as far as I know, structured by market principles. Despite what you might expect, not all orthodox economists have ignored these nonmarket forces. Many working in the field of institutional (or “new institutional”) economics have struggled to understand them, because according to their assumptions about human motivation, willing participation in nonmarket relations only makes sense if it provides access to benefits that capitalist markets, by definition, should be better at providing.
That the main theoreticians of what we might call “capitalist reason” recognize the importance of nonmarket spaces is not academic trivia: their ideas can help us understand institutions anticapitalists sometimes confuse as safe havens from the power of capital. These scientists of capitalist reason—today found mainly in economics and political science departments at the most influential universities in the global North, and in the international institutions whose managers they train (the International Monetary Fund, the World Bank, the World Trade Organization, and finance ministries and central banks)—have formulated increasingly sophisticated ways of understanding nonmarket institutional foundations, and of using and shaping them in capital’s interest. They know, for example, that many migrant workers could never survive on what they get paid, but they also know that a significant portion of them rely in some way on family-based forms of subsistence, so they can be paid less than if they were fully market-dependent. This means that some common staples of “left” critique are questionable. On one hand, it means capital is not necessarily always interested in the destruction of communities, although it may of course have an interest in destroying a particular community, like that of an indigenous people whose territory sits atop oil and gas deposits. On the other hand, it also means that subsistence-based communities do not necessarily offer an escape from the power of capital. They might, but that potential cannot reside merely in the fact that they are not market-based or fully monetized. There has to be something more specific to a community and its relations to capitalist markets, firms, and states to ensure freedom from the dictates of capital.
Relations between market-organized and nonmarket aspects of capitalism are complex, subject to the imperative to accumulate and to the specific histories and cultures, and sometimes even the individuals, in question. People come to the market, as a realm of social interaction, with widely varying degrees of power to shape the relationships that make up the market. The laissez-faire claim that prices and distribution are determined via neutral exchange between equals is poppycock.
Economists are not entirely blind to this, of course, although they tend to emphasize only the most blatant violations of the “law of one price” associated with monopoly and other forms of “market power” or “price discrimination.”29 “Market power” is an umbrella term describing the capacity of any market actor to influence market dynamics in their favour. Orthodox analysts, like the rest of us, recognize that market power is ubiquitous, but, since it is assumed to be impossible in perfectly functioning markets (because perfect competition between many buyers and sellers prevents any one agent from affecting the equilibrium price), there is a special term for it. “Price discrimination” is one way a market participant can exercise market power. It means having the power to buy or sell at a “special,” nonequilibrium price. This dynamic operates throughout contemporary capitalism. For example, if only a few large corporations produce a commodity in high demand—personal computers or gasoline, say—then competition will not necessarily drive prices down, because the producers can develop a pricing “norm” that is not too close to the bone. They don’t even have to do this illicitly, via collusion or “price-fixing”; the general rate of profit can evolve as a tacit understanding, around which minor innovations in quality or production costs create slight movements, but no drastic change in consumer prices. This market structure may even drive prices up, since in markets for luxury and high-price goods, consumers frequently will buy a more expensive item because they assume its price accurately indicates its quality. Corporations like Apple understand this very well. There is a reason why, when you hear of a $100 laptop, it never turns out to be an Apple or an IBM product.
Take another, better-known example, one many of us have seen in our neighbourhoods. If Walmart wants to crush local competition (which it does), it can price some goods below cost and handle the temporary losses because it is so big. In the lingo, Walmart is a “price-maker.” Since smaller operators cannot compete with these prices for more than brief periods (they are “price-takers”), and they have less size and capital to fall back on, they eventually shut their doors. At that point, Walmart usually raises its prices back up to highly profitable levels, confident in its new monopoly. When I was living in Guelph, Ontario, in the mid-1990s, I witnessed a particularly nefarious version of this. At that time, Guelph was still a mostly non-“box store,” downtown-business kind of place, perhaps because it was surrounded by land zoned, and used, for agriculture. Its city council refused to approve a massive Walmart on the edge of town. So, Walmart purchased empty retail space on the main street and opened under the name of “Bargain! Bargain! Bargain!” (I could not make that up.) It proceeded with the standard discriminatory pricing practice its market power affords, killed off local competitors, and when it finally wore down resistance to the box store, it shut its doors and opened a monster on the edge of town, leaving downtown to rot.
This story exemplifies a larger process of which Walmart is only a part. Many argue that contemporary capitalism is increasingly characterized by so-called “monopolistic competition” between a limited number of very large players. This is indeed the norm in many sectors and markets, not just box-store retailing. Monopolistic competition persists because of market power and significant “barriers to entry” in many industries. It is difficult to get in on the action because you need a lot of money or land or connections, and there are many ways existing firms secure control of the market. The banking and oil industries are classic examples; it is basically impossible to go out and start your own bank or oil company.
As these dynamics suggest, prices are ultimately the product of a whole range of relations that includes, but is in no way limited to, competition. It is probably better described as a struggle—this is obvious with wages (the price of labour-power)—that introduces considerable uncertainty and instability into capitalism. However, while economists pay more attention to uncertainty and (limited) instability these days, much of modern economic theory continues to assume, for purposes of analysis if not its practical implementation, that markets are “perfect”: it assumes that everyone is a “price-taker,” that prices are instantly and infinitely flexible, that participants have all necessary information about present and future prices, and that everyone will act “rationally” to optimize their self-interest or utility according to preferences that are entirely determined outside the market. This last is essential to orthodox theories of capitalism, but it is particularly bewildering, given how central the market god is to their account of social life. It means that the neoclassical or market-centred theory of value and distribution paradoxically asserts that market relations have no effect on your likes, desires, or needs; for the theory to work, these must be determined “somewhere else.”
To say “perfect” markets are purely mythical seems like stating the obvious. But I mean it in two precise ways. First, they are mythical in the straightforward sense that they can never exist outside the imagination—as mythical as Hercules cleaning the dung out of Augeus’ stables by diverting two rivers. This is no surprise to noneconomists among us. But, contrary to a common (and misleading) anticapitalist criticism, it is no surprise to economists either. Orthodox economists do not walk the Earth naïvely believing all markets are actually perfect, if only the rest of us could see it. They know full well they are not. But orthodox capitalist analysts do not assume perfection because it accurately represents the world, but rather because without it, the formal modeling they do is impossible.30
Second, and to my mind more significant, perfect markets are mythical in the Utopian sense. They are not only a dream, they are an ideal to which we are supposed to aspire, a model we are told we should emulate. Modern economic theory is “performative”—a fancy way of saying it purports to describe a situation that it is in fact trying to produce—and in that sense, the perfect market of neoclassical Assumptionland stands today as the standard by which actual markets are judged; it is the perfect 10 of efficiency, productivity, and neutrality. This is the principal justification for opposition to any regulation, stipulation, or social barrier that represents a reduction in the “freedom” of markets to operate “unfettered”: they make it impossible to get to the promised land.
One of the biggest problems with this myth is that since the assumptions that make it possible can never be realized (we can never have perfect foresight or respond to market shifts instantaneously) it is unclear if the maximizing, efficiency, and utilitarian welfare claims can ever be realized. Even on modern theories’ own terms, markets will only perform all their supposed magic—optimize individual and collective welfare efficiently—if the assumptions hold. If they don’t (and we know they don’t), then if is not clear what markets can and cannot actually do. It is no exaggeration to say we have no evidence to suggest that “more” perfect markets are worth pursuing. The faith that tacitly underwrites orthodox wisdom—although, as far as I know, never stated explicitly—is that the “perfection” of markets is a sort of “the closer the better” intuition. The closer the market to mythical perfection, the more efficiency, productivity, and neutrality we should expect to enjoy. There is an implicit assumption that there are no “threshold” effects at work, that the “perfect market” is not an all-or-nothing affair, but something we can aim at, like the bull’s-eye on a target. If we hit close to the mark, well then that is better than being far away, right?
But what if, even if we adopt the orthodox faith that markets can in principle do all this fantastic work, the benefits provided by “perfect” markets are an all-or-nothing thing? If so, it is bad news for capitalist reason, because we know for certain that the “all” option—100 percent perfect market—is impossible. In the economics profession, the modeling that formulates the as-near-as-possible-to-perfection argument involves a sort of staged analysis. It begins with a set of propositions about the dynamics of interest in an assumed “perfect” market. Next, some of these assumptions are “relaxed,” so the model more closely approximates the “real world.” For example, to model the effect of an unexpected shift in the supply of oil, the first step would be a bare bones model constructed assuming perfect markets, fully formed and perfectly ordered preferences, etc., from which basic relationships can be constructed. In subsequent steps, restrictive assumptions—say, the assumption that all the world’s oil supply is equally and instantaneously available—are relaxed, to yield a more “realistic” picture. Usually, this means the models get more and more complicated as the analysis unfolds, since they need more variables to take account of real-world complexities, like geographical barriers to some oil supplies.
But this process builds two potentially fatal weaknesses into the argument derived from the model. First, the more “realistic” conclusions, formulated with relaxed assumptions, are still built upon the infrastructure of a mythical market Utopia. The “real world” is posited as a second-rate variation (the technical term is “second-best”) on an a priori ideal. Its dynamics are always a flawed version of those at work in Assumptionland. The real world is never taken in its own actuality as the basis for understanding. Yet the real world is all we ever have—and the real world is imperfection. Perfection—in markets or anything else—is not some deep-lying or transcendent feature we have to uncover or attain. It is not there at all, anywhere.
Second, the only way modeling can handle the “real world” features that emerge when assumptions are relaxed is to incorporate them as variables. But variables are only useful for representing things that are, at least in theory, measurable. I do not mean to say that variables are useless. The common claim that economics is evil because it “quantifies” everything is a weak and distracting argument; too many radical critics give it too much emphasis. It is hard to imagine that whatever world anticapitalism produces will not require lots of “quantitative” analysis. The very notion of redistribution—central to any anticapitalist politics—is unavoidably, if not completely, quantitative. My point is that the only assumptions modelers can relax are those that define “market perfection.” They cannot, therefore, take into account either the necessary but by no means stable nonmarket dynamics that undergird “perfection”—social peace, the language mix, the politics of gender, noncatastrophic weather, for example—or market dynamics that are resistant to measurement, like “expectations.”31
Orthodox arguments about what markets can do only understand the “market” dimensions of markets, and can only understand those relative to a mythical standard. They cannot comprehend markets as dynamic social institutions, embedded, sometimes deeply, sometimes precariously, in real times and places. They cannot comprehend politics as anything other than external “disturbance” of the market, an obstacle to perfection.
Ultimately, orthodoxy does not have a very strong argument for the superiority of market organization, in the sense that it cannot base it on any sort of proof or logic. On the contrary, the commitment to the market is more a leap of faith; a leap, we are told, that if we all take it together, will performatively make it so. The fact that many of us are reluctant to take the leap has paradoxically become one of the go-to excuses for the failure of markets to work their magic. When capitalism does not deliver the goods, free marketeers almost inevitably attribute it to the fact that we are not committed enough to the market, that somehow we still intervene, preventing competition from realizing its potential.
It should be noted that the economic justification for capitalist markets I have criticized over the last several pages is a particularly rigid variety. It has several names and manifestations, but at its strictest it is labeled “Chicago School” economics, because much of its argumentative and technical power was developed at the University of Chicago’s economics department. Many people I know, after reading books like Naomi Klein’s Shock Doctrine, are under the impression that since Keynesianism fell out of favour in the early 1970s, all economics is Chicago economics, which is not so. While modern economics, at least in its neoclassical varieties, is heavily influenced by Chicago-style thinking, not all neoclassical economists are the same, and not all neoclassical economists justify markets the same way. This is important because it means that the capitalist case for market-organized society is not entirely undone by the failures of classical and neoclassical mythology. There is, for example, a relatively influential “Austrian” perspective whose most famous advocate is Friedrich von Hayek, maybe the most famous free marketeer outside of Adam Smith and Milton Friedman (the high priest of Chicago).
Hayek and the Austrians argue that markets are the optimal institutions for coordinating social life for reasons very different from the Chicago Schoolers. They say (as I have) that perfect markets assume impossible cognitive capacities for calculation, foresight, and information organization. No one—no person, no firm, no institution, no state—can handle all that knowledge, even if it were available. According to the Austrian tradition, markets are good not because they approximate perfection, but because they deal with uncertainty and change better than other ways of allocating resources and disseminating information. A lot of this is because they “distribute,” or “decentralize,” knowledge and decision-making power to market participants. This flexibility allows them to organize people, things, and information in ways that suits their needs, and to innovate in ways that centralized coordination and resource allocation generally inhibit.
Chicago School orthodoxy is often targeted by the anticapitalist left, especially in the superficial “you can’t quantify love” way, because it is an easy target for ridicule. When Hayek comes up at all in critical accounts, he is almost always lumped in with Chicago-style thinking. But the Austrian critique is sharp, and makes a lot of sense. It is far more important that critics of capitalism engage this argument for “free” markets than that of classical or neoclassical orthodoxy, not least because it is much more compelling. It also shares certain features with a radical analysis in its focus on the limits of the state and formal institutions, and it is no accident that Hayek is often associated with a libertarianism not always very far from some varieties of anarchism.
Given some of the more terrifyingly disastrous experiments in “planning” and non-market-based modes of social organization that cloud twentieth-century history—Stalinism, Maoism, etc.—there seems to be very good reason to believe that even a well-meaning “coordinator” of economic life is doomed to fail. Not only were these episodes devastating political and economic calamities, but the vast majority who bore the costs, millions of them with their lives, were those at the bottom of the socioeconomic ladder, precisely those with whom anticapitalism is most concerned. If anticapitalist goals demand a renewed energy for planning—something far more likely than I believe many of us are willing to admit, and which should not be undertaken lightly—then it must struggle mightily with the problem posed by the Austrian analysis, which defends markets not because they might be perfectly efficient, but because their imperfections are preferable to a coerced, nonmarket “perfection.” It is worth remembering that Hayek wrote not to propose some capitalist dream come true, but to provide an antidote to totalitarianism and fascism—two tendencies we still need to be vigilant to avoid.
What Markets Can and Cannot Do
With this in mind, let us turn to a more specific analysis of markets in actually existing capitalism. There are in fact many different markets, and many different kinds of markets, the relations between which vary a great deal. Sometimes markets overlap, sometimes they intersect occasionally, and sometimes they are almost completely distinct. Examples include money markets like those discussed in Chapter 3, financial asset markets, labour markets, and producer markets (both for intermediate goods that firms buy for production purposes, and for consumers purchasing “final” goods). There are also hybrids, like carbon offsets or pollution permits markets, which are a little harder to place in more conventional categories.
However we conceive of markets, though, there are situations in which they don’t seem to work all that well—and not merely relative to the perfection some assume they should attain, but even relative to suitably diminished “real-world” expectations. Economists call these “market failures,” and perhaps the most commonly noted is the case of so-called “public goods.” In political economy, public goods are not just things that are good for the public, but goods or services that it helps everyone to have, but for which there is insufficient incentive for capitalist investment. Think about air quality, for example. Clearly, clean air is something everyone wants, and from which everyone benefits. But even if an entrepreneur could come up with a way of “cleaning” the air, there is no way he or she could make a return on their investment because it would be impossible to prevent people from breathing cleaned air for free. Clean air, at least so far, is what economists call “nonexcludable” and “nonrival”—you may be able to provide it for a price, but it is impossible to prevent someone from using it at no cost (nonexcludability), and no matter how much one person uses, it does not diminish available supplies (nonrivalry). In the case of clean air, then, there is no market incentive to provide it: you can’t exclude those who don’t pay from using it, and no matter who or how many uses it, there is always enough left for others. In other words, you can’t control its distribution via contract and you can’t make it scarce enough to merit a price.
Orthodox economists consider the failure to provide public goods a “market failure,” and it is one instance in which many of them endorse the state as the logical provider. Even Adam Smith listed public goods like infrastructure as part of the state’s necessary tasks in capitalism.
Other market failures have little or nothing to do with the nature of the goods or services in question. Monopoly is, as we noted earlier, a common problem, usually viewed by economists and policy-makers as a market failure. Because monopolistic firms are not price-takers—participation is not broad or deep enough to prevent some from exercising market power—markets don’t do their job well, at least as that job is described by neoclassical or Austrian theory. This is because economic power in capitalism becomes highly concentrated, a developmental pattern it has never escaped. Which suggests that it is less a “failure” of capitalist markets than an almost universal tendency. Again, the frame of analysis—a mythical Utopian standard of perfection by which actually existing economic and social relations are judged—determines the conclusion. Rather than delineating the limits of markets’ utility, and therefore the realms in which they are socially inappropriate, what capitalist markets cannot do is defined as a “failure”—relative to an impossible dream.
Another important problem in marketized relations of all sorts is a condition economists have given the ugly name of “asymmetric information.” This is the basically universal situation in which one party in a contract has some meaningful information not available to the other party—usually called the “counterparty” (a term that says so much so succinctly). This asymmetry in knowledge builds uncertainty, complexity, and contingency into virtually all contracts, dynamics that usually increase in importance the longer the term of the contract and the further the geographical distance between the parties. For example, if a firm in Germany contracts a factory in my home of Vancouver (Canada) to produce something, one of the main things on the German firm’s mind will be making sure that they are not getting ripped off, and that the Canadian firm is doing a good job. If they sign a long-term contract, the risks only get bigger, because if they are getting taken for a ride, or if the product is of lower-than-expected quality, they are trapped in the relationship for a long time. Also, the fact that the factory is thousands of miles away will worry them. It is not as if management can just drop by to check in on the way home from work. Consequently, the German firm will almost certainly try to write a contract to take account of these concerns, perhaps including opt-out clauses if quality drops below a certain level, or if competitors drop their prices a certain amount, etc. All these bits and pieces of the contract are part of the German firm’s attempt to manage the fact that on these questions—quality, timing, cost, etc.—the people at the Canadian factory know far more than them. The distribution of information is “asymmetric.”
Some of the most influential ideas concerning these problems are the focus of the subfield of “economics of information” (Obama advisor, Nobel Prize-winner, and former World Bank chief economist Joseph Stiglitz is its best known practitioner), and of the new institutional economics mentioned earlier. Together, they constitute a kind of hybrid of neoclassical market-clearing ideas and Keynesian uncertainty. These economists commonly frame challenges to market function like asymmetric information as “principal-agent” problems: the principal is the contractor and the agent is the “contractee,” the person or firm hired to do the work. In every such two-party (“bilateral”) contract, one party is usually asked to do something (build a boat, work at the factory, provide information, or care for a sick patient) and one party requests the service, goods, or information. The doer is the “agent” in the relationship, the asker or hirer is the “principal.” As in any other social interaction, it is likely that one party to the contract has access to information that the other does not. Usually, this is understood as a problem for the principal, i.e., information asymmetry favours the agent.
There are countless examples of this in everyday contracts. Imagine I hire you to build a boat, with agreed-upon material and labour costs. I am the principal. Now suppose that you, the builder (agent), find a cheaper supply of timber or fittings than you anticipated. Will you tell me, and reduce the price of the boat? I am a fisherman; I have no access to the people and suppliers you do, I have little knowledge of what constitutes a “normal” price for timber or fittings, and I have no networks with which to find a “good deal” on these supplies. Alternatively, imagine that the state hires my firm to deliver the mail, for which I hire individual carriers. Since recipients of mail rarely know if or when they will receive it, it is difficult for the state, or my firm, to know if I am adequately fulfilling my contractual obligations. Carriers could just pile the mail up in their apartment each day. Monitoring their work, my speed, etc., is very difficult for the state, and my firm has little incentive to do so (I am being paid by the state anyway). As contracts accumulate, the principal-agent problems become complicated; the state is a principal, the carrier and I are both agent and principal; and the recipient, whose taxes fund postal services, is also a principal.
For capital, such problems can become extremely complex with big-money, long-term contractual arrangements, like labour recruiting or supply-chain management. If I hire you to set up my factory overseas, for which I pay the construction costs, how do I ensure you are seeking the best deal or best-quality workers, firms, materials, and sites? How can I know you will ensure maximum efficiency in construction, if you are not responsible for, or may even benefit from, cost and timeline overruns? That you are being careful not to (blatantly) violate environmental or human rights laws, for which I might get pilloried on the front pages in five years? These principal-agent concerns upset the supposedly competitive market price determination process, and the most common solution to them are explicitly non-market-based, noncompetitive arrangements: cost-sharing deals, independent subsidiaries that free firms from legal obligations, time-sensitive contracting, security forces to watch workers work. Sometimes, one party might even purchase the other firm, eliminating the market mediation of the relationship, and moving the agent inside the nonmarket command hierarchy of the principal.
Institutional economics has long been interested in this last option, what is commonly described as the firm’s choice between “markets” or “hierarchies.” In every transaction, the capitalist firm decides whether to do something in-house or to obtain the same goods or services on the market, by subcontracting, purchasing, etc. To go outside of the firm is to choose markets, to keep it in the firm is to choose hierarchies. The idea is that markets may not be able to solve coordination, information, and efficiency problems, as neo/classical theory claims. These other informational and transactional concerns sometimes mean it is better, although not necessarily cheaper, to keep it in-house.
Despite the either/or framing, in capitalism the realms of market and the firm are in fact necessary complements. There is choice regarding markets and hierarchies because both are essential to capitalist relations of production, distribution, and consumption. It is not like capitalism can only have one or the other. In fact—and this is crucial to an examination of modern capitalism—the capitalist firm is a response to the information, coordination, and social conditions that limit what markets can do. In other words, one of the fundamental institutions of capitalism exists precisely because orthodox economics is wrong, and markets cannot do the work they are supposed to do.
Here, we are looking beyond “microeconomic” or firm-scale decisions with respect to contractual “counterparties” and more at capitalism’s “macro” social institutions and relations, which dominate and determine the limits of the micro. At a similar macro-scale, contractual relations between individuals, firms, and other actors (the state, for instance) in capitalism are determined by the inequalities that differentiate market participants. It is not just firms that vary in market power—different social groups and classes come to the market on unequal footing. The structural advantage enjoyed by capital in the labour market, especially in the “neoliberal” era, is a clear example (see Chapter 6). There is an even greater power asymmetry between labour and capital inside the firm, because the composition and level of demand for labour is largely determined by capital. It decides, almost unilaterally, the how much, who, and where of wage work, while supply, as we know from earlier discussions, is not a choice for most workers. The wage-worker’s bind means they have to supply labour to get by.
The conflict here is necessarily entangled in the larger conflict over the distribution of surplus and social power in economic activity. That conflict impinges upon virtually all markets and enterprises because it concerns the most common contract in capitalism: the employment contract. Workers sell labour-power to firms, but labour-power is not like other commodities. Buyers of other commodities can separate them from the producer. But when you are hired for wages, you—your person, your will, your politics, your energy, and so on—come with the commodity, irreducibly bound to it. It is not nearly as easy for the firm to determine the disposition of the commodity—the worker’s time and energy.
This problem is most notable in struggles over the labour process—the ways daily work is organized. The classic example is the “factory floor,” but any workplace has similar issues. Workers and capital have long fought over the content and form of work: capitalist specialization and division of labour; mechanization and deskilling (so-called “Taylorism”), and the end of, and nostalgia for, craft work; the Fordist “compromise” or Great Accord between big labour, big business, and big government that lasted for a quarter-century after World War II (see Chapter 5). Labour process is the object of some of workers’ most effective resistance tactics, like strikes or work-to-rule struggles.
Large-scale and incredibly complex problems also arise over regulation in capitalism. This is, in fact, one of the classic real-world challenges that spurred the study of contracts and information. For almost all regulation—environmental, economic, electoral, and so on—the regulator, as principal, is at a massive disadvantage. They may have the heavy hand of the state on their side, but monitoring behaviour across an enormous range of tasks, firms, environments, territory, and activity is never easy. In environmental regulation alone—something that concerns even those opposed to the state—the cost of adequately monitoring capitalist environmental impacts would be staggering (this is not the only reason we don’t do it, unfortunately). Imagine trying to ensure all mining corporations respected groundwater protections or timber companies adhered to stream-buffer regulations during harvest. The troubling truth is that in most capitalist nation-states, the regulator’s information concerning firm behaviour comes mostly from the firm itself. This is a very real, and very big, problem, and while it is particularly evident in geographically remote resource extraction, it is also a problem in more “fixed” sectors, like banking or telecommunications.
As the recent financial crisis demonstrates, firms need not operate in a roadless Arctic tundra to lie beyond the eye of the regulator and the public. The organizational technical complexity of many industries has reached a point, and changes so rapidly, that it is impossible for regulators to keep up. In fact, it is often difficult for regulators to even understand what is going on, or, if they do, to determine if it falls under existing regulations, or if it is so new it does not fit at all.
Take the financial sector. As most of us have now learned, the financial crisis that began in 2007 was triggered by the collapse of a vast pool of “securitized” mortgages in the US. And, as most of us have heard, these securities were incredibly “complicated,” produced by the technical and mathematical genius of “financial innovation.” Both claims are debatable (that they were complicated or that geniuses were involved), as is whether securitization was really where the most important dynamics were at work. But there is no denying that from a computational perspective, securitization has become almost overwhelming. The technical modeling through which new securities are created or derived from other financial assets (hence the blanket term “derivatives”), and how their prices are determined, often requires years of training in financial economics or computer science. Almost all the people with those skills work for the firms, not for government, and even if the state manages to hire a few of them—inevitably paid much less—there aren’t enough to go around. Since the firms are doing all the “innovating” via fancy mathematics and contractual design, it is very hard for the state to avoid a level of “asymmetric information” that forces the regulator (the principal) to simply accept the firm’s (the agent’s) assurance that everything is under control, and all important risks are understood and accounted for. That is precisely what Goldman Sachs and Bear Stearns and the rest of the most powerful perpetrators of the crisis assured the financial authorities over and over—then, boom! Up in smoke went the credit market, and with it much of the global economy.
Obviously finance is not the only sector we can characterize in these terms. Regulating biotechnology, for example, entails similar challenges. Biotech firms create new genes and seeds with state-of-the-art knowledge and technique, and then report to the state what they have done. Regulating agencies hopefully do their utmost to understand what new seeds or genes can do, how they work, and what risks they pose. But that is not easy, even with the expertise to understand the process. With few exceptions, after a few tests, the regulator says “be careful,” and hopes it all works out. This is to say nothing of the common problem of “regulatory capture” in capitalist (and noncapitalist) states. In innovation-driven sectors like biotech, pharmaceuticals, energy, and finance, the very same people doing the regulating have often worked for, and have close personal and professional ties to, the firms they oversee. The well-documented “revolving door” between regulating agencies and firms means that regulators are for all intents and purposes colleagues of those they are supposed to monitor.32 The fact that Hank Paulson, former head of Goldman Sachs, was the US secretary of the treasury—for both Bush Jr. and Obama—says it all.
Just as workers might slack off if they are not being watched, capitalist “cheating” limits effective regulation. Firms will often ignore, break, or lobby against any rule that limits profitability—witness the 2012 revelation that big banks have been profitably manipulating the most important interest rate in the world (LIBOR, the London Interbank Offered Rate) for years.33 However, many serious regulatory problems arise not only because firms behave “opportunistically,” breaking rules when violations are not immediately observable, like looking over both shoulders and then dumping the recycling in the trash can. Further limits to what regulation can and do originate in complicated, “structural” ways that are not addressed simply by putting more inspectors on the ground or demanding more frequent reporting.
For example, in media coverage of the recent financial crisis, you may have come across the problem of “moral hazard.” This term describes how, with certain kinds of contracts (including “implicit” contracts like that between a regulator and a regulated firm), the agent might not exercise due caution because, if things go awry, the cost of risky or ill-conceived action will be borne all or in part by the principal. The classic case of moral hazard is capitalist insurance markets. We have all heard of someone intentionally burning down their house or factory for the insurance money. I have no idea how often that actually happens, but the fact that the insured (the agents) might act that way is of great concern to insurers (the principals), and creates all sorts of contractual and pricing complexities that prevent markets from finding an equilibrium price and clearing. It is also how insurers justify how expensive their services are: since principals have a hard time identifying a “really” trustworthy agent, they charge everybody more.
Moral hazard becomes extremely significant when the principal is the “people” or “citizenry,” as represented in the capitalist state.34 If the state, in its modern guise as the institutional manifestation of the principal’s authority, has to bear some or all the costs associated with firms’ malfeasance—as it readily did during the financial crisis—it is the public who bears the costs. When states bailed out banks and other financial firms that had taken seemingly crazy risks with their assets and those of others, those states were potentially making the next crisis even worse by increasing the risk of moral hazard on the part of banks and finance capital in general. By making it clear the state would help clean up the mess, the state essentially assured the firms that it was acceptable to take risks with the global economy: when it works out, all profits are retained by the firms, but when it flops, the government will step in to socialize the losses. So why not take a big chance on financial assets? Indeed, this is the lesson many learned; the management of J.P. Morgan Chase, one of the largest financial firms in the world, actively encouraged risky investment since the financial crisis.35 And why not? As is commonly said in banking circles, “We have capitalism for when things are good, and socialism for when they fall apart.”
The contracts that legally bind most capitalist markets together—facilitated by the state’s regulators, police force, and courts—are often not straightforward relations of competitive exchange. They are far more complicated, shaped inescapably by nonmarket forces. Markets are social institutions; they reflect the fact that social relations are neither blindly mechanical nor immune to “noneconomic” considerations.
If we accept this, then one way to deal with these information problems might be to base exchange on more intimate social relations. This “communitarian” response is alluring. It echoes a common complaint that capitalism is “greedy” and “antisocial,” and that we don’t sit out on our front porches anymore. However (leaving aside the nostalgic small-town mythology), in a world where many of the most significant connections we make—political, social, cultural—are widely spatially dispersed, a return to “local community” can help, but it cannot address many pressing concerns. Cities, for instance, are big places, far too big to have a “personal connection” upon which to base all of one’s exchange or production relations.
Yet it is true that one of the more effective ways to address principal-agent problems is to build relationships that last over time. A principal might limit information asymmetry by using the same contractor again and again. Even assuming only the most base, self-interested motivations, he or she will have an incentive to treat the principal well: if they don’t, and word gets back to the principal, they will not return and future contracts are lost.
Labour Contracts
The language of contracts might seem cold and legalistic, the talk of lawyers and bankers. But we all participate in a range of everyday contracts without even thinking about it. The most obvious one is with your employer, if you have one, but there are many others: your relationship to your car or bike mechanic, for example. Many of us trust our mechanics because we have determined over time that they are not going to take advantage of what is for most of us massive information asymmetry. I cannot fix my own car. So, I return to Ed, my mechanic, not because of a utility-maximizing imperative to get the best deal, but because of a relationship of trust that has built up, which often is paired, however irrationally from a cost perspective, with the knowledge that while I may not be getting “the best deal possible,” the quality of the relationship makes it make sense. When we act like this (which happens all the time), we are not always acting like “rational,” optimizing market participants.
An excellent example of this kind of behaviour is the contractual employment relation at the heart of the capitalist labour market. Employers commonly deal with information asymmetry, and the problems of monitoring workers, by paying higher wages. These so-called “efficiency wages” are intended to reward high-quality workers in order to retain them. They serve two purposes, one at the firm level, the other at the level of the labour market and the economy as a whole. First, firms pay higher wages than would supposedly exist in a “perfect” labour market because even in jobs for which little job-specific skill is needed, there are training costs, and a period of low productivity while the worker is learning. It is also difficult, tiresome, and costly to have a lot of turnover. So firms arguably pay more to keep people after spending all that money and time.
Second, and more important, if workers could make the same money anywhere at any time—which would be the outcome of a “perfect” labour market, since it would result in a single, market-clearing wage for any particular occupation—there would be no income-based reward for staying with a firm. If wages were sufficiently flexible to clear all labour markets, then all firms would pay the same wage for the same work, and all workers could find work (the definition of market clearing). From a worker’s perspective, quitting would be virtually costless. From an employer’s perspective, commitment to the employee would be useless because they are all replaceable. This would build an unmanageable instability into capitalism, and—as unfortunately little-known economist Michał Kalecki has pointed out—is patently against capital’s interests.
As Kalecki puts it, if the labour market ever worked the way neoclassical theory imagines it—if wages were flexible, Say’s Law held, and all willing workers found jobs in some orthodox “full employment” dream—then workers would have no fear of “the sack.” Without a scarcity of jobs, through which workers get money to participate in the market and put food on the table, capital would lose its power in the labour market. Quit your job? There is another, paying exactly the same, right next door. Thus, while capitalist reason promises that free, unfettered markets will put all the economy’s resources to efficient use in an all-engines-firing productive Utopia, in perhaps the most important market of all, the labour market, it has no interest at all in full employment. Full employment would put the workers in charge; indeed, it might even put the unemployed in charge, since they could easily drop in and out of the labour market as they chose, causing trouble in their “leisure” time.
In other words, despite any claims to the contrary, capitalism must have unemployment. It is essential to the system’s political stability (by disciplining workers) and productivity (by keeping the production process in motion). This only further weakens the edifice of neoclassical “market-clearing” theory, because even if unemployment were not in capital’s political economic interest, joblessness would persist. If workers cannot hop from job to job, and employers want a stable workforce, then equilibrium wages determined purely by labour supply and demand are impossible. And if even one flexible price is impossible (remember, wages are the “price” of labour-power), then perfect competition is impossible. This “imperfect competition,” a term coined by some of Keynes’ disciples, means some firms have more market power, are better to work for than others, and some workers are better at their jobs than others. The competition between the players in this situation, is not just price-based: it will not just lead to a different “equilibrium price.” Instead, it will generate price or wage differentiation (or “premia”).
Kalecki’s point is not only that full employment is impossible in capitalism, but that any substantial effort to provide full employment—perhaps through the state, or reduced work-weeks—would be aggressively opposed by employers. Marx made a similar argument when he said capitalism produces a “reserve army of labour.” The reserve army is the mass of unemployed men and women whose desperate need to work looms over those with jobs, and disciplines them into doing as they are told, or being replaced. In Marx’s day, however, it seemed that in general, the reserve army was made up of the dispossessed, those driven off the land and out of noncapitalist ways of living, and forced therefore to wait on capitalism’s sidelines looking for work. Kalecki’s crucial intervention—an elaboration of Marx’s insight—was that in contemporary capitalist societies, the reserve army is not external to the capitalist labour process—it is “endogenous,” generated by the capitalist system itself.
Virtually all contracts—like many other aspects of markets and firms, and perhaps labour contracts especially—are first and foremost human social relations founded in real space and time, heavily determined by norms, custom, culture, personality, geography, and so on. This has crucial effects both on specific contractual conditions—the prohibition against interest in Islamic banking has driven innovations that allow banks in Islamic nations to still earn profit, for example—and on rather everyday, superficially “noncontractual” realms.
This list is a mild reminder that the market is always a dense network of social relationships, a dynamic emphasized by another prominent theorist of capitalism, Karl Polanyi. Polanyi has been rediscovered by critics of capitalism in recent years for two principal reasons. The first is his argument that capitalism only developed via the evolution of three “fictitious commodities”—things that it must pretend are produced for sale on the market, but are not: land, labour, and money. Polanyi says that none of these are a commodity in the “widget” sense. Yet, because land, labour, and money must circulate on markets like other commodities to make capitalism work, we accept the fiction that they are commodities.
Polanyi’s second contribution is his account of modern capitalism’s attempt to produce a social structure that “disembeds” the market from its broader historical and geographical context. This allows it to appear “self-regulating,” divorced from the life-world in which all human activity is unavoidably embedded. Polanyi argues the market can never be an autonomous realm, independent from social relations in general. There will always be social and spatial relations (culture and geography) that prevent economic activity from achieving anything like a condition of laissez-faire. The upshot is that the contractual relations that define markets and firms in capitalism hinder by their very structure the creation of perfectly efficient, autonomous markets.
Markets in actually existing capitalism cannot be perfectly “efficient,” in the sense the term has acquired in neo/classical economic theory. If we ever had markets like that, capitalism would not work. If this is so, it presents a very interesting problem. It means that if the dominant or orthodox theory of capitalism were an accurate description of reality, then capitalism could not exist. This is related to, but still quite different from, the Marxist idea that capitalism is so internally contradictory that it will eventually implode and become something else. There may be some strategic lessons here. One political conclusion of this analysis might be that to overcome capitalism, we should force it truly to “realize” its theoretical claims—because if it came close to doing so, it would shut down.
I am unsure of this tactic’s potential, as it would appear to be quite easily derailed halfway, but it is something anticapitalists should consider. What would it mean for us to embrace “flexible wages” in the interests of “full employment?” Capital says it would love that; what if we gave it to them? It could mean the end of capitalist rule, at least in the workplace and labour market. But this is another instance in which the wage-worker’s bind comes into play. Strategies like demanding that capital deliver on promises that would prove its undoing depend on mass solidarity in the face of significant uncertainty. But they give inadequate attention to how we might collectively supply the material security most people need during the struggle, and may need more urgently if it were in fact successful.36
Historically, mass movements have arisen due to prior long-term immiseration. But the wage-worker’s bind in modern capitalism is effective because, at least in the global North, people feel like they do in fact have something to lose. To convince them to lose it—as opposed to merely taking it away—is the principle task of anticapitalist politics, but the constraints are important to recognize.
29 The “law of one price” states that in perfect markets, where all participants are “price takers” with all relevant information, the price for any particular commodity will be the same in all markets.
30 I think it worth stressing the adjective “formal” here, as opposed to the common description of modern economics as “mathematical” or “quantitative,” It is true that some fields of economic study—especially statistics-driven econometrics—are very mathematical or quantitative in this sense. But modern economic theory, which at first glance looks very mathematical, is more often than not using symbols to describe qualitative relations. Readers of contemporary economic theory rarely see actual numbers. It is all about formal abstraction via symbols. The real numerical “values” are not the point.
31 Expectations play a crucial part of modern economics, but there is still no way to directly measure them. Models use some “proxy” that is measurable, like the price difference between bonds of different maturities, or assume that everyone expects the future to be like the past or the present—which just sweeps the problem under the rug.
32 See “Regulator Capture, A Case Study,” Financial Times, 29 June 2012.
33 Financial Times, 24 July 2012.
34 This is of course not to say that the capitalist state does in fact “represent” the people.
35 Guardian, 3 April 2012; Financial Times, 29 June 2012.
36 See Simon Critchley, Infinitely Demanding: Ethics of Commitment, Politics of Resistance (London: Verso, 2007).