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The Neoclassical Apology for Monopoly Capital

Rahul Varman (rahulv [at] iitk.ac.in) is on the faculty of Indian Institute of Technology, Kanpur, India, where he teaches and writes about corporations and the working class in the neoliberal order, and participates in the struggles of contract workers. The writer is grateful to Michael Yates, Manali Chakrabarti, and Rajni Desai for their criticisms and suggestions on earlier drafts. He also thanks Parthasarathi Banerjee, Amit Singh, and Durga Prasad for their critical comments. Readers can write to the author for a detailed bibliography of further readings.

While the global economy is mired in ever-deepening crisis, there is no abatement in the propaganda rationalizing free markets and perfect competition. In the world of “perfect competition” governed by the “invisible hand” of market forces, no single actor (or even a combination of a few) is in a position to influence the market equilibrium, and prices are determined by the balance of demand and supply. This is a win-win world, where actors have sufficient information for arriving at their respective choices, consumers are free to make the correct decisions, and this self-governing system leads to progressively increasing welfare for all. Further, such competitive forces are expected to result in optimal allocation of investments, an equitable distribution of returns to capital and labor, and the highest levels of productive efficiency and technological development. In this mythological world, there is also a hell, whose name is monopoly or oligopoly, the exact opposite of perfect competition, where a few sellers or producers distort the markets and generate inefficiency, monopoly profits, and compromise consumer choice. In other words, in the world dominated by oligopoly, producers are not “price takers” but “price makers.”1

The only difficulty with this mythology is that, while we are constantly told that the world is increasingly being governed by competition and market forces, the real world of business and industry is moving rapidly away from such free competition, as concentration, domination, and control of most economic activities has become common place. The public might assume that the rivalry between Coke and Pepsi or Apple and IBM means that there is market competition, but in neoclassical economic theory, the fact that these companies are “price makers” means that there is monopoly and not competition. It might be that perfectly competitive markets will provide answers for all of our ills, but in the real world, there is an absence of “free markets,” with market rigging and failure everywhere in the economy.

This yawning gap between the theory and reality of markets is what the program of “organizational economics” developed by Oliver Williamson and his associates attempts to fill; that is, they seek to make the theory of “free markets” consistent with the practice of corporate concentration. This is the contribution for which Williamson was awarded a Nobel in 2009.

To verify his theoretical concepts, Williamson has drawn heavily on the evidence provided by the pioneering and enormously influential work of business historian Alfred Chandler. Hence, the attempt to show that oligopoly and monopoly do not negate the social benefits of competition will be called the Williamson-Chandler (W-C) model.

How does this model work? Very briefly, it argues that in particular situations it is better to conduct certain economic activities within the confines of a corporate organization instead of markets, because such activities can be conducted more efficiently inside an organization than through a market-based transaction. In the past four decades, the W-C model has gathered a large and influential following among the multiple fields in academe that study large business organizations and has come to dominate several areas of inquiry in business, management, and economics. Perhaps in some measure due to the arguments of Williamson-Chandler and their progeny, since the mid–1970s courts and enforcement officials have come to support the view that antitrust policy should not follow social and political aims that get in the way of the operations of large monopolies and, therefore, undermine economic efficiency.

Why Corporations? The W-C Framework

While economists have ignored the black box of the inner functioning of business organizations, students of business take this organizational form as given; this is where business historian Chandler attempted to bridge the gap by linking up micro-level observation of the operations of firms with macro-level analysis of the pattern of certain forms that corporations adopted. He did this by looking into large-scale evidence on early U.S. corporations like railroads, General Motors (GM), DuPont, and General Electric (GE), to answer the fundamental question of why such large organizations came into being in the first place. Chandler’s answer is that such large organizations were formed and took particular shape at specific moments in history, whether railroads in the middle of the nineteenth century or GM in the early twentieth century, because such organizational forms offered significant “economies of scale and scope” due to emerging technologies and economic context. According to Chandler, mass production technology offered economies of scale which made it imperative that production organizations in various sectors like steel, chemicals, sugar refining, and cigarettes operate at high volumes. And in addition, the economies of scope—the result of emerging technologies in transportation, like railroads and telecommunications—could link up and even integrate distant markets, making it possible to bring operations like distribution and retail within the fold of the existing activities of the corporations. Chandler asserted that the new technologies resulted in an increase in scale and the integration of new functions into corporate organizations. Thus such business activities, which earlier were performed either by competing firms or by complementing companies, now were progressively enveloped within a handful of organizations in large parts of the economy. Large organizations supplanted markets across various sectors and business activities and the “visible hand” of management replaced the “invisible hand” of markets. What made this possible, according to Chandler, was the emergence of a new profession, that of managers, who had the competence to undertake the complex operations of such large corporations and its various functions.

Williamson recognized the need to fit Chandler’s narrative into a broader theory of the firm, and his explicit project is to integrate his model with neoclassical economics. In keeping with the whole edifice of neoclassical economics, Williamson begins his analysis with a micro unit of analysis—the “transaction.” The idea of a transaction is close to the notion of exchange in a spot market and yet different from it in the sense that it is supposed to subsume interfaces and transfer of a product and/or service through various steps/interfaces within an organization as well. Thus a transaction occurs not only when a casting is bought by a manufacturer from a supplier but also when it is transferred from the casting unit to the production shop within the same organization. For Williamson, such transactions have costs, and he likens transaction costs (TC) to friction. Just as a body moving on a surface has friction losses, similarly any real life transaction has TC—costs involved in undertaking, implementing, and monitoring a transaction, such as information collection, working out the deal, and then monitoring that it is properly implemented. Thus the whole problem of choice between markets and “hierarchy,” that is, conducting transactions within large integrated organizations, is reduced to minimizing transaction costs.

Williamson’s conceptual structure is built upon certain assumptions about human behavior and the context in which the choice of markets versus hierarchies is exercised. First is the notion of “opportunism,” which he attributes to at least some of the human agents involved. As he puts it, the notion of opportunism expands the idea of self interest to include not just people maximizing their utilities, but also their willingness to take advantage of others, what he calls “self interest seeking with guile” (for example, distorting or hiding information). A second behavioral assumption, which Williamson borrows from Herbert Simon, is that of bounded rationality, meaning that there are limits to the human capacity to collect and process information. Thus, humans are not “hyper rational”; they do not “maximize” but “satisfice” their objectives. They choose the “best option” available within given time, information, and cognitive constraints.

Williamson adds two assumptions regarding the context of transaction to the above behavioral assumptions. First he assumes small numbers; that is, in any given situation there are only a handful of agents (few firms competing against each other) who are in a position to influence the market. Second, transactions are assumed to take place in an environment of uncertainty: supplies may not come on time, the quality can vary, breakdowns can happen, agents may renege on their commitment, and so forth.

These four assumptions provide the basis for the development of Williamson’s argument. Given that there is a small number of agents, opportunism is a problem in the sense that a single agent might be in a position to take advantage of others (if there is a large number of actors who can provide the same product or service, then this problem would disappear). Similarly, bounded rationality is an issue only because of the context of uncertainty; in a situation of certainty, there is hardly any need to process information in order to arrive at the best possible choice.

Given all of this, Williamson argues that if (1) organization-specific investments in skills or assets need to be made that are not simply transferable to another organization (for instance a special purpose machine or say a die for a specific casting); (2) transactions are to be repeated frequently (buying the same supplies repeatedly in great volumes or utilizing a particular skill on a regular basis); and (3) uncertainties are high (a perishable product that might spoil if not cared for properly by the distribution chain), then it is likely that transactions will be taken up within organizations rather than through markets. For Williamson, such transactions can be done more economically through a system of common organizational goals, employee incentives, and fiats instead of price-based system of markets.

Williamson employs his model to explain:

  1. The rise of large, functional, command-and-control organizations like railroads, where fiat was a more efficient mechanism to deal with complexities and specificities than outsourcing.
  2. Multidivisional firms like GM, where day-to-day operations could be delegated to division heads, while the headquarters could think long term and act like an investment bank deciding in which divisions to invest more and where less. A quasi-market evolves within an organization as a substitute for markets.
  3. Why, as corporations went multinational, such multidivisional forms were deployed further.

From an apparently very different conceptual apparatus, Williamson comes to conclusions similar to those of Chandler: large corporations came about as an efficient substitute for markets and hence do not signify market failure. Large corporations are thereby made consistent with neoclassical theory.

Though the W-C defense and justification of corporations occupies the central place in economics and business studies, criticisms have been offered on various counts in multiple fields. The W-C argument is fundamentally flawed on five key aspects. Finally, the W-C presents an ideological discourse aimed at rationalizing what large corporations do because the unspecified agenda is to make their existence consistent with the overall apparatus of neoclassical economics and the neoliberal agenda—while ignoring certain other significant aspects of corporate behavior by labeling them “political,” “vague,” or “irrelevant.”

1. W-C Ignores Socio-Political Complexities in the Functioning of Corporations

For Williamson, large organizations are in a much better position to deliver goods in circumstances requiring complex collective actions, where uncertainties are endemic, goods and services of certain specifications have to be repeatedly produced, and deployment of specific skills and resources is required to produce such goods and services. The basic problem with this formulation is that though managers (and especially top managers) may often claim in their official discourse that organizations work (or ought to work) in a machine-like fashion with well-defined common goals, elaborate procedures, sharing of information, and teamwork lubricated by both monetary incentives and command and control systems, real life accounts (especially by subordinate groups) suggest otherwise. Even in a field like organization theory, whose purpose is primarily to understand the functioning of corporate organizations and which is mostly based in business schools, one can find plenty of evidence that organizations do not work as W-C suggests. They are essentially socio-political entities that always function in a much messier manner. Within organizations power struggles abound, which means that their actual functioning can be very different from what W-C implies. Contrary to what corporate managers would like to project and what W-C assumes there are often unintended and dysfunctional consequences. As John Kenneth Galbraith says:

Everyone is influenced by the stereotyped organization chart of the business enterprisethose at the top give orders; those below relay them on or respond. This happens but only in very simple organizations—the peace time drill of the National Guard or a troop of Boy Scouts moving out on Saturday maneuvers. Elsewhere the decision will require information. Some power will then pass on to the person or persons who have the information.2

More importantly, readers of Monthly Review are familiar with the idea that capitalist work organizations are a site of oppression, where individuals are forced to work as “wage slaves,” and that such structural asymmetry reveals itself in everyday resistance or downright sabotage and may evolve at particular moments into structural conflicts, such as class war, working- class movements, and new institutions like labor laws and trade unions.3 Such everyday resistance also means that daily corporate functioning will be very different from the way W-C claims it will be driven.

2. W-C Disregards the Political Nature of Costs Involved in Working of Corporations

W-C illustrates its argument about economizing on transaction costs through an examination of U.S. railroads in the nineteenth century, the nation’s first big business. “Railroads were not just the harbingers of the modern corporation, until the very end of the century, they were corporate capitalism.”4 By the 1850s the railroad industry was the largest consumer of iron and a major buyer of coal, wood, machinery, felt, glass, rubber, and brass. Chandler argues that given the complex and extended expanse of its operations, such a vast railroad network required a fundamental break in organizational structure. As the speed of the locomotives multiplied, managerial and organizational aspects became critical to avoid accidents and implement proper scheduling. Thus, sophisticated organizing with appropriate command and control systems having precise scheduling, centralized fare setting and collections, elaborate procedural manuals, and so forth were devised. A decentralized divisional form of organization was created whereby day-to-day operations were delegated to the station masters, while functioning across stations and over a long geographical area were integrated through detailed and standardized procedures developed by staff headquarters. Critical aspects like commerce and maintenance were supervised by the head office, and communication lines were maintained through the newly invented telegraph system.

The W-C economizing argument is simplistic in nature; it ignored the existing political matrix and how costs involved in railroad operations were overlaid on it.5 Accounts of early U.S. railroads suggest that: (1) inefficiencies abounded; (2) costs were socialized and paid by state agencies, society, and the working class; (3) corruption served as an instrument to achieve ownership objectives; and (4) financial manipulation was used to consolidate the monopoly power of the railroads after the Civil War.

Several scholars have questioned the transaction cost minimizing view by comparing the development of contemporary railroads in Europe. They emphasize that the United States was the only industrialized nation to completely privatize a public good of such major consequence. Frank Dobbin, in a comparative account of railroads in France, England, and the United States, informs us that when rail transport began in France, the country had a state organization, the Bureau of Roads and Bridges, that ran the railroads, provided loan guarantees, and allowed only a passive role for private capital.6 Private firms had little say over the location of lines, construction priorities, standards for track and engines, safety devices, and fares. Similarly in England, the state played a pivotal role in the development and standardization of the railroads. Therefore, if contemporary railroads in other nations with similar technology took different institutional forms than the lightly regulated private corporations of the United States, then there is little case for the technological imperative and economic reasoning of efficiency and minimizing transaction costs. This is all the more so if railroads were considered better run in other countries. For instance, after the Civil War railroad executive Charles Francis Adams complained that the French had nationalized the railways and developed a modern, well-functioning, widely used system, in stark contrast to America’s “lemon socialism.”7

State patronage and thus socialization of costs was an important part of the railroad tale even in the United States. The initial railroads were joint public-private investments, and prior to the Civil War state and local public investment accounted for over 25 percent of the total. Nearly one-tenth of the continental United States was given over to the railroads; much of it became extremely valuable as the industry grew.8 Such corporate privileges could always be justified in the name of “prosperity” and growth, but such generous state sponsorship came with little corporate accountability. In 1857, the Pennsylvania Railroad was exempted from all tonnage taxes levied by the state legislature, a decision ultimately validated by a federal court. When the next legislature tried to overturn this ruling, the court ruled that the contract had to be honored. Railroad costs were also regularly passed on to workers, and no cost accounting was made for the abominable worker safety record of the U.S. railroads, which faced limited government regulation. For instance, the Safety Application Act of 1893 made it mandatory for railroads to use couples and automatic brakes twenty-five years after their invention (ironically in the United States), while these were adopted much earlier in Europe. The rate of injuries was alarming. By one account, one in seven switchers were disabled between 1874 and 1884, disabilities the Supreme Court justified on the grounds that “higher wages compensate risk.” In 1889, for every 117 men employed, one was killed, and for every twelve, one was injured; in England the corresponding statistics were one trainman in 329 killed and one in thirty injured.9

Corruption was a key ingredient of the entire process. It enabled large centers of capital to shape the system in their interests and made the possibilities of regulation in the public interest remote. Even Lance Davis and Douglass North, who otherwise were votaries of the economic rationality of the railroads, had to confess, “the location of those roads, twisting and turning across the plains like a terrified snake, can only be explained in terms of the bribes certain towns and counties were willing to pay.”10 Trains never ran; ties were untreated and rotted; wooden rather than iron tracks were laid and were useless within a year; bridges collapsed; competing lines chose different track sizes; routes zigzagged; and lines were abandoned. Major subsidy laws for railroads were written by the railroad executives themselves. Archival documents illuminate the systemic, large-scale, and persistent bribing of legislators. There are several incidents of public assistance for lines that had no chance of making money; for example, the Erie Railroad won its charter in 1832 with a stock of $1 million and was subscribed for an estimated construction cost of $3 million. After several rounds of changes in estimation, insolvency, and state subsidy, the road finally opened in 1851 at an actual cost of $50 million. The directors realized that manipulating the stock was far more profitable than the mundane task of running the railroads. Within four years they recapitalized the company from $17 million to $78 million. In one case the directors purchased a worthless railroad—the Buffalo, Bradford and Pittsburgh—for $250,000, then issued $2 million worth of bonds in the name of the company, and finally leased the road to Erie for 499 years. Erie then assumed the bonds leaving the directors with handsome profits.

Finally, Wall Street completed the story of the centralization of the railroads into a few giant corporations. An intense period of speculative construction followed the Civil War, in large part by locally controlled roads, though often financed from Wall Street. But in the years following the crash of 1873 over half of the track was in bankruptcy and the largely publicly financed transcontinental part of the new construction was involved in the biggest financial scandal of the century. Between 1875 and 1897, 700 railroad companies went into receivership, local control of smaller lines was lost to the representatives of the Wall Street bondholders, and even the large systems strained under conditions of intense competition. The great centralization that took place around the turn of the century, when the railroad companies coalesced into six major groupings, was driven by the desire to eliminate competition (“rate wars”) and for the immense speculative profits made possible by the reorganizations, not by supposed economies of scale. This centralization could only take place once the New York capital market had itself been centralized under the direction of J.P. Morgan. The Morgan firm eventually controlled 63,000 miles of road equal to one-sixth of the nation’s total, whose combined revenues were equivalent to half of the total receipts of the federal government.

The giant railroads used a small number of suppliers to reduce transaction costs, so there was a tendency for suppliers of steel like Carnegie, and several other kinds of suppliers, to become some of the largest manufacturing companies in the world. A disproportionate number of industries that became concentrated in the 1870s and ‘80s had high transportation costs, and their dominant companies enjoyed rebates or other special relationships with the railroads. Lower transportation costs and wider markets have been emphasized as the manifestations of railroad efficiency. Because of the corporate financial devices used by the railroads, William Roy estimates that until the 1890s the enormous profits of the railroad companies came at least as much from constructing and merging of railroads as from operating them. Thus, from a Chandlerian point of view, even “very inefficient firms could be considered profitable because they could convince those with the capital to buy stocks or bonds that the corporation would survive, and could convince the government to give them grants, loans, and free land.”11

3. The W-C Account of the Rise of Large Corporations Is Acontextual and Ahistorical

The W-C thesis seems to assume that corporations emerged in a socio-political vacuum. Williamson explicitly assumes that “in the beginning there were markets” and then tries to find answers for its substitution with firms. But as Daniel Ankarloo and Giulio Palermo point out, there cannot be a market without production and regulation functions being simultaneously performed, and hence in actual capitalist history, unlike what Williamson assumes, markets coexisted with both firms and the state. Thus they conclude, “The as-if method of historical analysis does not even try to explain the present as the result of the processes of the past; instead, it assumes the past in order to make the present appear Pareto superior.12 The whole background of the American state, which was fairly supportive of corporations, which were very ably supported by the judiciary, hardly receives any attention in the ahistorical and apolitical account of W-C. In fact, the cost-benefit matrix of W-C is embedded in a specific institutional matrix that is taken for granted by them and assumed as natural and neutral.

The earliest forms of corporations were those that had the clearest public purpose: churches, schools, universities (Harvard, for example, was chartered in 1688), and cities. Over time, the institution was used for public needs with clear economic benefits: canals, banks, bridges, and turnpikes. In the eighteenth century, corporations could originate only in the public domain through special parliamentary charters. They were provided with privileges like eminent domain, tax breaks, or monopoly rights, only because they were supposed to deliver public goods, those that governments felt could not or should not be provided privately because it would be too risky, too expensive, or too unprofitable to do so. That is, these corporations would perform tasks that would not have gotten done if left to the “efficient” operations of the markets. Thus, corporations arose as quasi-government agencies; some of their particular features, such as limited liability, perpetual life, and parcelized ownership, were established not so much because they were efficient but to compensate for the inefficient tasks that they were assigned, tasks that markets would not support. They did not grow through an evolutionary process by which an organizational form was perfected to its “maximum efficiency.”

The law that “corporations can have private rights” came through an interesting turn of history in a Supreme Court ruling in 1819, when the state of New Hampshire made a reasonable demand (and lost) to place its representatives as trustees for Dartmouth College in exchange for tax benefits. One may cite two of the more celebrated instances in this regard. First, the Fourteenth Amendment to the U.S. Constitution, which was enacted after the Civil War to end racial discrimination, was quickly turned into an instrument upholding the “equal rights” as “citizens” of corporations, especially railroads. Corporations were not to be “over taxed” or subjected to regulation for the working hours of the employees. The Southern Pacific Railroad added a plea under the Fourteenth Amendment that states had no right to tax corporations differently, and the Supreme Court ruled in 1886 that “the defendant corporations are persons within the intent of theFourteenth Amendment” and thus have a right to equal protection under the law.13 Of the 307 Fourteenth Amendment cases brought to the Supreme Court before 1910, nineteen dealt with race discrimination and 288 were brought by corporations. Similarly, under the First Amendment corporations have been granted the right to free speech, and thus the government has little power to regulate harmful advertising, even that aimed at children. Further, a 2010 Supreme Court judgment allows corporations the right to unlimited commercial spending in elections, again as a “natural person.”14 Since corporations do not have a tongue to speak like humans, they can speak through money, or so the Supreme Court ruled in 1978, citing the 1886 Fourteenth Amendment case.

Similarly, the idea of limited liability was institutionalized through a long, drawn-out process. Harvard president Charles Elliot called limited liability “the corporation’s most precious characteristic” and “by far the most effective legal inventionmade in the Nineteenth century.”15 As many have pointed out, all it does is shift the risks from owners to creditors, suppliers, and workers. At the time, various states employed different checks against such a transfer of risks; for instance, in the 1890s Michigan and Ohio required that stockholders be liable to laborers and some states necessitated that owners be liable at least to the extent of double their stocks. Until the end of the nineteenth century, Pennsylvania specified that corporations could only conduct business for which they were chartered and could not be chartered merely for owning other companies; out-of-state corporations were not allowed to own real estate except what was directly needed for their business. Fledgling corporations, though, were able to play states against one another, avoiding chartering in those states with tighter regulations. Today, corporations overwhelmingly “book” financial transactions (not the actual operations) in tax havens, subverting the very notion of a nation-state and public regulation.

Given that we take the corporate persona for granted today, it is instructive to know that it came about through a protracted process. The debate whether a company could own shares in other companies was intense and continued for decades. Holding companies appeared and were outlawed, followed by trusts, which were then outlawed, and finally by multi-product firms, which successfully completed the redefinition of the nature of corporate property. States varied considerably in their laws permitting stock ownership. At one extreme, Virginia prohibited stock ownership by corporations in other companies in the 1880s, while Pennsylvania allowed manufacturing companies to own railroad stocks to create spur lines to link their factories. When, in 1888, New Jersey first allowed any corporation that incorporated in the state to own interests in other companies, corporations flocked there for registration. By 1901, 66 percent of U.S. firms with $10 million in capital or more, and 71 percent of those with $25 million or more, were incorporated in New Jersey.16

Besides favorable governments and laws, the emerging institutions of finance capital—Wall Street, investment banks, brokerage houses, and interlocking directorates—also played a crucial role in the formation of large corporations. The growing concentration of wealth in the hands of financiers (and the corresponding development of new financial instruments such as call loans), especially in New York, facilitated the development of a symbiotic relationship between railroads and Wall Street, which led to the rapid development of corporate capital. From 1830 to 1843, U.S. states increased their debt, much of it foreign, from $26 million to $231.6 million; about one-quarter went directly to construct railroads.17 Foreign capital was interested in bonds rather than the more risky stocks. Both the developments led to a power shift in favor of finance capital.

Relative to other industrialized nations, the U.S. states tended to increase the power of corporate directors. Finally, the states made it very difficult for shareholders to remove directors, who (in place of the shareholders) increasingly were treated as true representatives of the corporations. Moreover, as discussed above, these directors gradually attained the power to shape the company by building new facilities, taking over other companies, and so forth. Such close ties between financial institutions and the corporate elite brought in a whole new dynamic, as demonstrated by the U.S. railroad companies .

4. W-C Does Not Account for the Problem of Capital Accumulation and Unutilized Capacities in Large Corporations

Due to their narrow focus on developing the managerial or at best the owners’ point of view from a limited perspective of efficiency, W-C ignores the significant problems that arise from creating massive production capacities using enormous capital. In the name of “economies of scale,” which is almost taken for granted, the compulsions and dynamics that massive built-in production capacities entailed has hardly received the attention from W-C that the phenomenon deserves. Railroads were perhaps the first industry to bring out so dramatically the problem of fixed costs that needed to be amortized over a long period. Until 1904 the book value of capital in the railroad industry exceeded the aggregate capital invested in the entire industrial sector. Due to the mercantilist mindset, in the early years of railroads there was no accounting for the capital assets, and since maintenance costs were low, especially in the beginning, most of the revenues were booked as profits leading to high dividends and stock market frenzy. But such frenzy led to the building of overcapacities and cutthroat competition, with rival railroads continually undercutting one another. However, if everyone followed this strategy, disaster was bound to follow for the industry as a whole, and that is precisely what happened. By 1893 one third of the railroads fell into receivership, which forced a drastic restructuring of the industry. Andrew Carnegie posed the problem:

As manufacturing is carried out today in enormous establishments with 5 or 10 million dollars of invested capital and with thousands of workers, it costs the manufacturer much less to run at a loss per ton or per yard than to check his production. While continuing to produce may be costly, the manufacturer knows too well that stoppage would be ruinit is in soil thus prepared that anything promising relief is gladly welcomed. Combinations, syndicates, trust—they will try anything.18

So, another way of looking at the drive towards the consolidation of the railroads after the Civil War and manufacturing industry at the turn of the twentieth century is to appreciate that they were driven not so much by the idea that large organizations are more efficient than markets but to save themselves from the market and the ruinous competition entailed by the compulsion of large fixed costs. The first step towards this “cooperative system” was the drive towards pool formation across a diverse set of industries with differing arrangements after the Civil War, where producers agreed to collectively set output levels and prices. Once the attempts at cartelization through pooling and forming trusts failed, corporatization through mergers and acquisition within an industry followed, especially after the 1888 New Jersey law that legalized holding companies. The process of overcapitalization, failure, reorganization, and merger was an important part in the course of the concentration of capital; it eventually fuelled the creation of large industrial corporations. Between 1898 and 1903, money poured into manufacturing and mining, and in the process, the aggregate value of listed stocks and bonds went up from $1 billion to $7 billion. It also led to a massive wave of consolidation and concentration; 75 percent of merged companies joined together five or more enterprises.19 The primary purpose of the merger movement of the 1890s was control to maintain production, prices, and profits. The strongest predictor of whether or not an industry participated in the merger movement was whether or not its member firms had participated earlier in cartels. Moreover, the central factor in the formation of cartels was the high level of capital investment and the low level of profits in the particular industry.20 Chandler says that large modern corporations arose as vertically integrated firms so that they could control their operations efficiently from materials to sales, but N. R. Lamoreaux has shown that the overwhelming majority of mergers were horizontal and not vertical.21

In any case, the attempt to create monopolies did not end the problems of corporations. By 1919 about 60 percent of large mergers had failed, apparently gaining little from economies of scale. In fact, production costs often increased because firms were difficult or impossible to manage. Even Chandler accepts that the “building of the giant systems during the 1880s and ‘90s resulted in non-productive rather than productive expansion of railroad enterprises,” as the costs of such expansion were far greater than any savings that could have been achieved from more efficient operations.22

5. W-C Makes Simplistic Assumptions about Human Nature

Williamson’s theorization is based on certain assumptions about an archetypal human nature, what he calls “opportunism,” and according to him it becomes especially significant in case of a small number of actors, where such opportunistic individuals have the potential to take advantage of others. Williamson proposes that in such situations fiat and rule-based governance of a corporation can mitigate opportunism and lead to efficient outcomes. In Chandler’s account there is also a tacit assumption of self-seeking individual rationality, which leads towards a teleology of large corporations. However, when the basic assumption of W-C is critically examined, counter evidence of the existence of alternative forms of organizations can be found at every juncture in history in almost every place where the modern corporation has evolved. Such alternative forms signify other facets of human behavior like trust and cooperation. The argument here is not about an alternative quintessence of human behavior, but simply that it was possible to organize the same activity in other forms than corporations with equal effectiveness, if not more. If such alternatives are less prominent today than corporations, rather than looking for some basic human nature or attributing corporate success to the structural-functional outcome of efficiency, the political-economic reasons need to be examined.

Perhaps the most interesting case here is that of the comparative account of the textile mills of Lowell, Massachusetts and Philadelphia, Pennsylvania in the nineteenth century. There were large integrated textile mills in New England where the Boston Associates lobbied successfully for high tariffs to protect their products, but defeated a tariff on goods of their competitors in Philadelphia. Gumus Dawes brings out in detail the externalities involved in such corporate structures.23 For example, to ensure water for the mills, for years their owners collectively blocked municipal water distribution in the town that could have prevented cholera epidemics. Moreover, New England mills had poor records of innovations and adaption to changes, while they earned enormous returns, partly through excessive insider trading. In Philadelphia, the industrial structure was sharply in contrast to that of Lowell. Here each unit was involved in doing a small portion of work—spinning, weaving, dyeing, designing, and supplying—and each firm had to work with many others in order to deliver a complete product. A large number of these firms often rented different rooms in the same building. The more flexible Philadelphia mills changed their structure to fit the new technologies that came along, drew on small artisan shops for innovations, had a more skilled labor force that could accommodate changes, and being smaller, were less likely to have large groups with vested interests. According to Dawes, lacking concentrated capital, they were small but innovative and had far more positive externalities for workers and the community in comparison to Lowell. For instance, they could quickly adapt to the realities of the Civil War, while mills in New England closed their shops. In New England, large numbers were laid off during the war, but in Philadelphia wages were paid even to those who became part of the militia. There were relatively fewer work accidents at Philadelphia; there was better street lighting, less child labor, and so on. Such small firms, which cooperated with as much as competed against each other, successfully dominated the high-end textiles market for sixty years. By the 1880s, production in Philadelphia was higher than in New England, even with small firms drawing upon half the capitalization of the New England firms. In Philadelphia, there were 849 firms with 55,000 workers. Charles Perrow asserts that productive efficiency was higher and social efficiency even higher in Philadelphia due to the nature of organization and ownership. Philadelphia prospered and grew throughout most of the nineteenth century, and its long decline thereafter was simultaneous with that of Lowell.

The case of the Philadelphia mills is not an isolated example of success of such a network of small firms; on the contrary, such a model of production has continued through the course of history, whether in nineteenth-century Europe, contemporary industrialized nations, or across the third world. Economies of scale and scope in such networks are achieved through cooperation and collaboration among the actors, and yet firms often intensely compete for orders and markets. So, though units may be competing with one another for the same buyer, they may concurrently share orders, know-how, facilities, resources, or set up common norms for their operations, like wages and work hours. Lack of opportunism is ascribed to local customs and history, where such behavior is rooted in a language well understood by everyone, thus mitigating fraud and providing a trusting environment. For making such a normative order that everybody is expected to follow, there is a need for resilient institutions, such as strong local government, basic labor standards, common facilities, and collective organizations, including trade unions and associations. Such collaborative ties are often based on trust and tacit understanding, combined with decentralization and the flexibility that small size offers and thus results in transactions that are more economic than what is possible in large corporate forms with massive bureaucracies.

But Williamson denies the very possibility of such trust-based ties and alternative business institutions. For him, trust is a “diffuse and disappointing concept” because inherent in the idea of trust is calculation, especially when it comes to commercial relations. Hence, trust is of little consequence. What is often called trust in economic exchanges can be explained, in his view, as “a farsighted approach to contracting.”24 At best, he is willing to say that trust relationships may work due to specific cultural or ethnic circumstances, but these are not replicable and generalizable. But given the volume of literature that has been emerging on the sustainability and economic success of such small firm networks and even the alternate forms of railroads in Europe and the United States at various points of time, the burden of proof is on W-C to establish the inherent superiority (not based on its mere survival) of the corporate form over the alternatives that have been discussed here.25

The Ideological Nature of the W-C Program

Unlike what W-C claim, corporations did not evolve into their present form because the large-scale corporate form was the most efficient. Rather, this form was forged at the turn of the twentieth century because it was the most effective means available to generate profits in the prevailing historical context of capital, technology, finance, state, and judiciary. It was actively aided by other professional classes, like managers, but it was also fought and resisted by the working classes and the common people. The W-C account is acontextual and ahistorical and systematically ignores alternative business forms. By ignoring the social and political contexts in which corporations in fact developed, the W-C program serves the purpose of celebrating corporations as rational, universal, and natural, evolving naturally in response to technological change towards optimal efficiency. The W-C program is very much ideological in nature, with the implicit agenda of fitting monopoly corporations into the neoclassical ideal of free markets, its exact opposite in theory.

Perhaps most interesting is the way concepts of power and efficiency are counterposed by W-C. For them the idea of power holds little promise: “Power is very vague and has resisted successive efforts to make it operational, whereas efficiency is much more clearly specified.”26 One of the repeated lines of defense for W-C is that organizations and industries would not have shown so much variety if it was only for power. In other words, if power was the explanatory variable, corporations should have kept growing and become larger and larger in order to acquire more power and thus “vertical integration should have known no limits,” and all the industries should have vertically integrated and acquired similar structures.27 It is naive or disingenuous of W-C to claim that those who are making a political argument about corporations are contending for an unchecked and unrivalled power, as if corporations could keep growing indefinitely or all corporations could become similar. What is being claimed is that a large part of corporate evolution and behavior can be better explained through the lens of power, but it also means that corporations had to face rival power centers and resistance from other interest groups like workers, citizens, and state and local economic interests. Further, as shown above, large capital investments frequently became liabilities for corporations in times of economic downturn, when on the one hand, corporations were propelled to grow further in order to better control markets, but on the other, they were forced to limit their increasing accumulation and investments.

Further, concepts like technology, scale, and opportunism, and the relationship of these to corporations, have been selectively deployed by W-C. With regard to technology, the case is not that production, transportation, and communications technology did not influence the course of development of corporations or did not bring in any efficiency but simply that W-C overstates its case. Like the institutions of judiciary and state, technology was another means available to be deployed and molded in the service of profits and power by the managers and owners. Similarly, W-C exaggerates the importance of scale economies; large size can often create as much diseconomies as economies. Another way of looking at scale is to see it as a smokescreen created to obfuscate the real issues of power that come with size and may facilitate transferring the costs and risks onto weaker constituencies.

Inconsistencies in the assumption of opportunism can also be identified; for Williamson there are “those who are opportunistic” and “those who are not.”28 And very predictably, while rank and file are opportunistic, the owners and managers at the top are not. The latter, not surprisingly, are “social” and “disinterested” and in tune with the systemic interests of the corporations. From Enron to WorldCom to the recent failure of financial institutions, this has been shown to be untrue, but every time the phenomenon is reduced to individual “shortcomings” by the corporate apologists rather than any systemic problem.

Even the facts have been selectively deployed in the W-C arguments to further the idea of managerialism. For instance, a serious collision (two killed, seventeen injured) occurred on the Western Railroad in 1841. Alfred Chandler and S. Salbury assert that, “Western’s management responded spontaneously to the crisis of the moment.”29 But Perrow points out that the railroad was investigated by a state committee and ordered to change its practices, as Chandler-Salbury themselves note. More importantly, there had been a series of accidents and fatalities on the same railroad before this one, but without any corrective response forthcoming. Thus the reaction was not “spontaneous” but a delayed response to the state investigation, which resulted in a clear division of the 160-mile road into three parts and well laid-out procedures like timetable, instructions, and manual. In several significant aspects, the W-C discourse appears to run independent of the actual reality.

It is this tendency to generalize, universalize, and naturalize the particular that is highly problematic in the W-C project. And this takes a sinister turn when it is taken under consideration that the corporation is an institution that serves primarily the agenda of the global elite and is deeply political, divisive, and dysfunctional for the society as it appropriates human rights, like due process and free speech. At the same time modern society and polity have little means available to hold such firms accountable either as institutions or those individuals responsible for their conduct, or deriving primary benefit out of them. No wonder people across the globe are up in arms against corporations, something incomprehensible within the fairytale world of W-C and its adherents.

Notes

  1. Here, monopoly refers to both monopoly and oligopoly; in the latter, a few corporations dominate large sectors of the industry, economy, and market.
  2. John Kenneth Galbraith, The New Industrial State (Boston: Houghton Mifflin, 1967).
  3. On the manufacture of Apple iPads in China, see Charles Duhigg and David Barboza, “In China, Human Costs Are Built Into an iPad,” New York Times, January 25, 2012 , http://nytimes.com.
  4. William G. Roy, Socializing Capital: The Rise of the Large Industrial Corporation in America (Princeton: Princeton University Press, 1997), 96. Much of the details for U.S. railroads in this section are from this work.
  5. Since W-C arguments are primarily built on historical data of early corporations, the focus here is on the development of corporations in the nineteenth-century United States. But similar arguments can be developed through contemporary data as well. See for instance my “The Political Economy of Corporations: Behind the Veil of ‘Corporate Efficiency’,” Aspects of India’s Economy, June 2012, http://rupe-india.org.
  6. Frank Dobbin, Forging Industrial Policy (New York: Cambridge University Press, 1994).
  7. Roy, Socializing Capital, 74.
  8. Lloyd J. Mercer, Railroads and the Land Grant Policy (New York: Academic Press, 1982), 7.
  9. Charles Perrow, Organizing America (Princeton: Princeton University Press, 2002).
  10. Lance E. Davis and Douglass North, Institutional Change and American Economic Growth (New York: Cambridge University Press, 1971), 155.
  11. Perrow, Organizing America, 200.
  12. Daniel Ankarloo and Giulio Palermo, “Anti-Williamson: a Marxian Critique of New Institutional Economics,” Cambridge Journal of Economics, 28 (2004): 426, emphasis added.
  13. For a brief development of the idea of corporate personhood, see my article “Corporate Personhood: Rights Without Responsibilities,” Infochange, December 2011, http://infochangeindia.org.
  14. Such positions by the judiciary become even more interesting when they are juxtaposed with the rulings made in cases of individual citizens. In the celebrated Plessy vs. Ferguson case in 1896, Plessy, who was classified a “black” (he was seven-eighths “‘white” it seems) under a Louisiana law, and thus required to sit in the “colored” car, sat in a “white only” car in a railroad and was jailed. When a remedy was sought under the Fourteenth Amendment, the Supreme Court ruled that the amendment “could not have been intended to abolish distinctions based upon color, or to enforce social, as distinguished from political equality.” See Thom Hartmann, Unequal Protection: How Corporations Became “People” and How You Can Fight Back (San Francisco: Barrett-Koehler, 2010), 54.
  15. Quoted in Roy, Socializing Capital, 158.
  16. Ibid.
  17. Ibid.
  18. Neil Fligstein, The Transformation of Corporate Capital (Cambridge, MA: Harvard University Press, 1990), 38.
  19. Roy, Socializing Capital.
  20. Fligstein, The Transformation of Corporate Capital.
  21. N. R. Lamoreaux, The Great Merger Movement in American Business 1895–1904 (New York: Cambridge University Press, 1985). Vertical integration incorporates new functions within a corporation like retailing, while horizontal integration is acquiring competitive companies with similar activities.
  22. Alfred D. Chandler, The Visible Hand: The Managerial Revolution in American Business (Cambridge, MA: Harvard University Press, 1977), 487.
  23. Zehra Gumus-Dawes, Forsaken Paths (unpublished PhD dissertation, Yale University, sociology department, 2000), cited in Perrow, Organizing America.
  24. Oliver E. Williamson, The Mechanisms of Governance (New York: Oxford University Press, 1996).
  25. Here, this is a relative argument about small firm networks (SFN) as an alternative to the large corporations within the existing system, and not an absolute point of such an alternative being some sort of an ideal; such SFNs can be quite exploitative and wasteful in their own right.
  26. Oliver E. Williamson and William G. Ouchi, “The Markets and Hierarchies Programme of Research: Origins, Implications, Prospects,” in Andrew Van de Ven and William Joyce, eds., Perspectives on Organizational Design and Behavior (New York: John Wiley & Sons, 1981), 364, emphasis added.
  27. Oliver E. Williamson and William G. Ouchi, “Rejoinder to Perrow,” in ibid., 388.
  28. Williamson and Ouchi, “The Markets and Hierarchies Programme of Research,” 351.
  29. Alfred D. Chandler and Stephen Salbury, “The Railroads: Innovators in Modern Business Administration,” in Bruce Mazlish, ed., The Railroad and the Space Program (Cambridge, MA: Harvard University Press, 1965), cited in Perrow, Organizing America, 161, emphasis added.
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