A Quiet Revolution in Welfare Economics- by Michael Albert and Robin Hahnel



OUR PRINCIPAL AIM in this chapter is to use our new welfare theory to examine the effects of private enterprise on the production process. We analyze weaknesses in previous criticisms of the traditional analysis and focus our attention on how the "conflict theory" of privately owned firms can be better formulated using our new paradigm. But before tackling that agenda, we have some unfinished business from chapter 7 on markets. In our discussion of overzealous defenses of PuEMEs we mentioned that some claim PuEMEs would be immune to income distribution "problems" that plague PrEMEs. While set in a market environment, the question is what, if any, are the implications for income distribution of public as opposed to private ownership. We treat income distribution in conjunction with ownership in this chapter.


8.1 Ownership and Income Distribution

Opponents of private enterprise economies frequently object that PrEMEs generate unacceptable distributions of income. Of course, the third fundamental theorem of welfare economics is the ultimate defense against this charge. As we saw in part 1, this theorem is traditionally interpreted as guaranteeing that private enterprise market economies are completely flexible with regard to income distribution. However, critics have refused to accept these assurances on grounds that while this may be the case in theory, there is little reason to believe it will be so in practice.

Besides the difference between income flexibility in theory and practice, we believe there has been some confusion regarding exactly what the third fundamental theorem of welfare economics means and what cond*tions guarantee income flexibility even in theory. Since our new paradigm highlights complications infrequently considered, we will treat them here as well.

Broadly speaking, critics argue it is hard to imagine a private enterprise market economy with a highly inegalitarian income distribution undergoing a radically egalitarian redistribution of income. Critics reason this would first require a successful "revolution" in which the "have nots" succeed in expropriating the property of the "haves." Then, if private enterprise market institutions were maintained after such an upheaval, the vagaries of luck and talent in combination with ample opportunities to accumulate assets would require that lump-sum redistributions be repeated over and over again to maintain an egalitarian outcome. As conservative opponents of such practices hasten to point out, even should sufficient political "will" be forthcoming repeatedly, 1 predictable redistributions necessarily affect incentives when "rational expectations" catch up to redistributive manipulations. 2

In our view, egalitarians' intuitions are sound. To expect real, private enterprise market economies to generate acceptably equitable income distributions that are stable over time is naive. 3 But some who criticize private enterprise market economies on these grounds claim their public enterprise counterparts are not plagued by similar problems. We will end by disagreeing, but let us reexamine income distribution in private and public market economies step by step.

8.1.1 The Flexibility Theorem Reconsidered

Returning to the level of pure theory, it is important to distinguish between "initial endowments" that prove to be income generating assets that are transferable and those that are. not. The difference between alienable and nonalienable productive assets is hardly highlighted by the traditional paradigm. 4 In fact, our ready acceptance of the meaningfulness of the third fundamental theorem of welfare economics for PrEMEs results in no small part from the fact that the traditional paradigm blurs this distinction. The third theorem states only that any Pareto outcome can be achieved as the equilibrium of an appropriate PrEME. The translation of this theorem into the language of "under an appropriate redistribution of initial endowments" presumes that all initial endowments can be transferred. Shares of ownership in firms and stocks of physical goods can obviously be transferred, in theory. But productive initial endowments in the form of human talents and skills presumably cannot be so easily transferred, even in theory. 5

It appears the existence of productive assets that are inalienable even in theory casts a new light on the most common interpretation of the flexibility theorem for PrEMEs. But at first sight the implications for public enterprise market economies are more striking. If PrEMEs are only flexible to the extent that alienable productive assets can be transferred, how are PuEMEs to have any flexibility since individuals gain no income through ownership of nonhuman productive assets in public enterprise economies?

While the dilemma is only temporary in both cases, it does highlight common misperceptions. Even if we imagine private enterprise ' market economies achieving income flexibility by arranging transfers of alienable assets to compensate for differences in nonalienable assets, strictly speaking this does not guarantee complete income flexibility. Complete income flexibility requires that we be able to reduce an individual with aproductive nonalienable asset to zero income. In other words, in PrEMEs complete income flexibility requires more than reshuffling alienable assets in the presence of nonalienable assets. It must be possible to reduce peoples' income through negative lump-sum assessments.

But once the existence of inalienable productive assets forces us to recognize that full income flexibility of PrEMEs ultimately rests on the possibility of lump-sum assessments, some of which may be negative, the appearance of income inflexibility in PuEMEs vanishes as well. For while there are no alienable productive assets that can be transferred to compensate for differences in nonalienable assets in PuEMEs, complete income flexibility can be achieved via an infinitely flexible system of positive and negative lump-sum assessments. In fact, complete income flexibility in both private and public enterprise market economies hinges on an infinitely flexible system of positive and negative lump-sum assessments. 6 The "redistribution of initial endowments" is neither a sufficient nor necessary mechanism for complete income flexibility in either system.

So rather than think in terms of redistributing initial endowments, it is more appropriate to think of income flexibility via a system of handicapping. The pre-race potential of all the horses is determined by preferences, technology, and economic as well as noneconomic institutions, which combine to determine the "productivities" of the different inalienable human assets each possesses. With no handicapping, free labor markets will translate this into a particular pattern of income distribution. If we wish to be able to achieve all conceivable income distributions, we must be able to supplement or subtract from individuals' incomes to whatever extent necessary to alter how our "horses" finish. That is, we must have a free hand in handicapping that does not affect how fast our horses try to run. If we handicap once, for races in all periods, prior to any races taking place, all horses must run to their full potential in every race to maximize their income. The only remaining subtlety is that as soon as we change the income distribution by our handicaps we change the weights attached to different individuals' preferences, which affects the "productivities" of assets (the "natural speeds" of our steeds). But this merely complicates the job of handicapping, and perfect knowledge on the part of our handicapper was already required in order to handicap all races before any were run.

Of course, in PrEMEs individuals can be permitted to receive income from alienable, nonhuman assets-whose "productivities" are determined by the same interaction of preferences, technologies, and institutions that determine the "productivities" of human assets. But this is just a particular kind of handicapping. Positive and negative assessments are like starting horses ahead and behind the starting line. Doling out inalienable assets is like pulling weights out of saddlebags or giving injections of drugs. In general, in either a PrEME or PuEME would be a prehandicapped outcome. In PuEMEs the prehandicapped outcome is determined only by the natural speeds of steeds. In PrEMEs, weighted saddlebags and drug injections modify "natural potentials." In either case, to get any other outcome we must have flexible handicapping that does not induce horses to perform below their capabilities in hope of influencing their handicap. In either case, to have complete income flexibility we must be able to start some horses ahead and others behind the starting line. In theory, a one-time-only system of lump-sum positive and negative assessments calculated with perfect knowledge will do the trick for both public and private enterprise market economies.

To recapitulate, what the third fundamental theorem of welfare economics says for PrEMEs is that a particular initial endowment will generate any possible Pareto optimum. What the third fundamental theorem says for PuEMEs is that a particular initial endowment will generate any possible Pareto optimum. But once we recognize that incomegenerating assets in PuEMEs are almost entirely inalienable, it is obvious that it may be impossible, even in theory, to achieve a particular Pareto optimum as the equilibrium of a PuEME via a reshuffling of existing endowments. But the presence of inalienable productive assets in PrEMEs implies that reshuffling is incapable of generating the endowments necessary to generate some Pareto optima as the equilibria of PrEMEs as well. Fortunately (or not) a substitute flexibility Theorem 6.5 saves the day for both kinds of economy-at least in theory.

ALTERNATIVE FLEXIBILITY THEOREM 6.5. An appropriate one-time-only system of lump-sum (positive and negative) assessments will give us any Pareto optimum we desire as the equilibrium of any PrEME or PuEME under all traditional assumptions with either exogenous or perfectly informed endogenous preferences. In other words, under any set of initial endowments in either PrEME or PuEME we can still get any Pareto optimum by appropriate handicapping.

This leaves us with the following conclusion: at the purely theoretical level, in a world of perfect knowledge and "Debreuvian" rather than "real" time, PuEMEs and PrEMEs are both completely flexible-although not via the mechanism usually presumed. On what basis, then, might one argue that PuEMEs would be less likely to generate "unacceptable" income distributions in practice than PrEMEs?

8.1.2 Income Distributions in Practice

There are two issues here:

If one adopted the view that income differentials based on differences of human productive assets were appropriate, whereas income differences resulting from unequal ownership of nonhuman productive assets were objectionable, one would have every reason to conclude that PuEMEs have "practical" immunities to income distribution "problems" that plague PrEMEs. In other words, under this definition of appropriate and inappropriate, while theoretically PuEMEs could deviate from the "approved" distribution by "inappropriate" handicapping, there would be little reason to expect them to do so.

In PuEMEs "inappropriate" handicaps in the form of privately held alienable assets are ruled out by the substitution of public for private enterprise. And the translation of economic wealth into political power should work against the possibility of establishing "inappropriately" egalitarian handicaps in the form of redistributive lump-sum assessments that modify the "natural" outcome of the "free" labor market as those with greater wealth exert greater political influence to block such initiatives. Moreover, the complications of real time and uncertainty impose the practical necessity of continual reassessments if more egalitarian distributions were to be preserved. This would necessarily affect incentives and efficiency, which opponents of redistribution would presumably explain in very convincing ways. In any case, in the real world "inappropriately" egalitarian redistributions would require unlikely repeated political victories of "have-nots" over "haves." So those who approve of income differentials based only on differences in productive human assets have every reason to expect the practical conditions of PuEMEs to militate against handicaps they deem "inappropriate." 7

But on what basis are unequal incomes that result from unequal distributions of human productive assets deemed appropriate? Just because the operation of a "free" labor market generates differential wages and salaries due to differences in talent, training, and/or education, why are these considered acceptable?

At this point, especially those who have "invested" in more than the average number of years of education would likely remark on the importance of differentiating between inherited talent and training/education, insisting that time and effort (of trainee and trainers alike) spent in training and education should be compensated. It is certainly a common view that this is fair, as well as an important incentive for people to "better" themselves. Feelings run so strong on this subject we prefer to defuse the situation through a device. Let us stipulate that all training and education is paid for at public expense, that the time spent in such endeavors is time that otherwise would be spent working, 8 and that time spent in training/education is at least as pleasurable as time spent on the job. 9

Under these circumstances we see no reason to accept the proposition that unequal incomes deriving from unequal endowments of human productive assets are justified. In our view, genetic advantages and education or training that were in no sense obtained through individual sacrifice are no more justifiable excuses for differential economic well-being than inheritance of property. In neither case is there anything particularly fair about the birth lottery.

The view that differential income based on differential genetic endowments is justified is the PuEME analogue of Nozick's thesis that historical initial endowments of alienable productive assets give rise to just distributional outcomes in PrEMEs. That is, Nozick and supporters of PrEMEs implicitly defend the maxim:

DISTRIBUTIVE MAXIM 1. From each according to genetic inheritance, to each according to genetic and property inheritance. 10

Supporters of PuEMEs implicitly defend the maxim:

DISTRIBUTIVE MAXIM 2. From each according to genetic inheritance, to each according to genetic inheritance.

In our view, both maxims are arbitrary and unjustifiable. In theory they merely rationalize the outcome of different random lotteries. In actual historical settings they rationalize the status quo which serves the interest of those who benefit from obstructing redistributions that would benefit the disadvantaged. For us, equal effort is a sufficient and necessary condition alike to merit receiving an equal share of whatever the economy has to offer, while in the long-run it is desirable if people become sufficiently trusting and empathetic to adopt distribution according to need. To put it in terms of alternative maxims that have received some attention and, in our opinion, have much to recommend them:11

DISTRIBUTIVE MAXIM 3. From each according to genetic inheritance, to each according to effort.

DISTRIBUTIVE MAXIM 4. From each according to genetic inheritance, to each according to need.

8.1.3 Economic Systems and Implicit Maxims

The point here is not to debate the relative philosophical merits of different distribution maxims. We merely seek to identify the maxims implicit in different distribution outcomes, and determine whether there are practical reasons to expect different maxims to be achieved by different economies. The "practical" considerations to which most allude reduce to: (1) a positive correlation between economic and political power, (2) uncertainty requiring continual readjustments to preserve any of the "infinitely possible" income distributions other than the one that would prevail without "assessments," and (3) the undeniable incentive implications of predictable readjustments. We have discovered that these same practical considerations imply: PrEMEs' "natural tendency' -although we hesitate to use the terminology -is to "gravitate" toward an income distribution expressive of the maxim for which Nozick sought to provide a philosophical justification (distributive maxim 1). While PuEMEs' "natural tendency" is to "gravitate" toward an income distribution expressive of distributive maxim 2.

Moreover, the link between economic institutions and ideology is strong. While this is not a matter of concern in the traditional paradigm, it is something our new paradigm takes more seriously. Private enterprise market economies induce people to maximize return on all their assets. That is what competition in PrEMEs enforces. But people have a strong propensity to rationalize what they do. In people's minds, the outcome of what they strive for must be justified, and they tend to ensure that it is by molding our thoughts and values accordingly. Hence private enterprise market economies are likely to generate an ideology for which the likes of Nozick have merely provided refined philosophical elaboration, i.e., historic endowments of productive assets are nothing more than fruits of prior efforts and are thereby justified. Further, to be constantly "expropriating" those fruits is unjustifiable--except, perhaps, in cases of extreme humanitarian concern.

Similarly, public enterprise market economies induce people to maximize return on their human productive assets. That is what competition in PuEMEs enforces. And once again, people have a strong tendency to justify the distributional outcome of what they strive for. In this case, the fruits of maximizing return on one's stock of "human capital" in the labor market come to be seen as justified, and arguments for egalitarian "compensating differentials" come to be seen as "expropriation." All of which simply adds to the list of reasons to doubt that sufficient political will could be mobilized in stable PuEMEs in practice to generate outcomes we would consider sufficiently egalitarian.

In conclusion, if opponents of private enterprise who claim public enterprise market economies would not be subject to income distribution "problems" that plague private enterprise market systems mean that PuEMEs can be expected to gravitate toward distributions expressive of maxim two rather than maxim one, we are in agreement. Moreover, it is obvious the number of income-generating assets that can lead to inegalitarian outcomes is greater in private than public enterprise market economies. And since inalienable assets must be "embodied" in mere mortals, the possibilities of vastly inegalitarian distributions of "initial endowments" through accumulation is far greater in the case of private enterprise economies as well. So PuEMEs may well prove less likely to yield distributions as inegalitarian as their PrEME cousins, thereby lending credence to claims of greater egalitarianism on their part. 12

But if supporters mean that PuENIEEs will not be plagued by distributional "Problems'~--specifically inegalitarian tendencies that in practical terms would be most difficult to overcome-we do not agree. For we personally do not accept the definitions of "appropriate," and "objectionable" implicit in distributive maxim 2, and see no reason to expect real PuEMEs to generate distributions that are sufficiently egalitarian to be expressive of distributive maxim 3, much less sufficiently humanitarian to be expressive of maxim 4. 13


8.2 Weaknesses in Conflict Theory

In chapter 2 we reviewed criticisms by a number of authors of the traditional treatment of production under private enterprise. According to the traditional theory of production, profit maximization under the restraining influence of competitive labor and product markets should lead to: (1) choice of efficient production techniques, (2) job design in accord with the principle of "producer sovereignty," and (3) wage differentials reflective only of differences in marginal productivities and desirabilities of jobs. What has come to be known as the "conflict school" has challenged these conclusions as we elaborated in chapter 2. We begin our efforts to strengthen the theoretical argument of the "conflict school" by discussing weaknesses in previous formulations.

8.2.1 Rebuttal to "Labor Power" versus "Labor"

A traditional theorist might respond to criticisms based on the distinction between "labor power" and "labor done" along the following lines.

Granted the labor market in PrEMEs is formally a market for "labor power" rather than actual labor services, but this is of no practical consequence. Just as employees whose expectations about working conditions are unfulfilled will find out soon enough, and move on to anotherjob where their expectations are realized, employers have a clear enough idea of the work services they expect to receive, and should those expectations go unfulfilled the employer will change employees soon enough. In other words, while the market is formally a market for labor power, it is implicitly a market for labor services. Of course, all this assumes competitive, anonymous, labor markets. But in any other context traditional theory has always admitted "all bets are off."

Similarly, if critics want to insist on labeling the decision-making process under private enterprise "dictatorial," and point out that the labor exchange leaves important aspects of the situation unsettled by binding contract, so be it. But to imply that "dictatorial" employers can settle such matters entirely to their own satisfaction after employees show up for work, without taking employee preferences into account, is to ignore the fact that competitive labor markets permit unsatisfied employees to vote with their feet if their expectations are unmet. Competition for labor means that employers must offer a wage/work effect package that continues to attract employees in the context of uncountable other employers' demand for workers. Likewise, competition for jobs means that employees must abide sufficiently by the implicit integrity of the labor contract not to be replaced by uncountable others looking for the best wage/work effect package they can find.

In general, a plausible traditional rebuttal is to appeal for a reasonable assessment of "expectations." Especially in a "steady state" model there is no reason the full consequences of decisions and actions that are repeated over and over again would not become fully known to all involved. Hence we have the traditional conclusion that the formal distinction between labor and labor power disappears in a full information world.

8.2.2 Rebuttal to Asymmetrical Information

This same line of defense can be used to good effect against theorists who base their "conflict theory" of the firm entirely on asymmetrical information sets of employees and employers. In a steady state model there is no answer to the question why the "principal" would not find out anything he or she did not know at first. To put it in Coase/Simon terms: the worker who disappointed the boss' expectations by shirking or disobeying orders would be sent packing after two or three periods. And if the problem is that the employer does not know what expectations to have regarding capabilities of employees, competitive labor markets will take care of that problem over the long run. With enough competition among workers for jobs, employers will be able to discover what employees are capable of doing, if not through repeated observation of performance in their own firm, from studying the results other employers are able to elicit.

In this context it is worth noting that those who have treated the employment situation in a multiperiod, principal-agent model have been very careful not to assume that the principal comes to full knowledge as time goes on. 14 If this were the case one of the conditions requiring principal-agent modeling in the first place would disappear. But in any case, the final rebuttal to this line of criticism is that traditional welfare theory never claimed that organization of the production process via private enterprise institutions would be efficient if one of the contracting parties was systematically and continuously deprived of information available to the other.

So while any conclusions of inefficiency deriving from asymmetrical information are perfectly interesting to the extent that employers and employees do have asymmetrical information in a real world characterized by continual changes in productive possibilities, they do not contradict the conclusions of traditional welfare theory under a perfect knowledge assumption.

In our introduction we warned the reader we would not be reviewing a considerable new literature in welfare theory on uncertainty, because we did not believe progress in this area required a major shift in paradigm. This is an appropriate place to clarify this issue. Many have remarked on the extent to which the "real" world of uncertainties diverges from the "steady state" world, which implies full and symmetrical knowledge within which traditional welfare theory has long operated. In the last decade many have responded by reworking traditional welfare theory under assumptions of uncertainty. But this work has yielded few "surprises." Reworking welfare theory under assumptions of uncertainty has proved to be "normal science" in Kuhnian terms-reaffirming the original vision and conclusions in slightly more complex settings, requiring no substantial change in paradigm.

At the risk of oversimplifying, if uncertainty is symmetrical, agents who maximize the expected value of utility or profits replicate the welfare theoretic results of traditional theory. If uncertainty is asymmetrical, certain traditional welfare theoretic conclusions no longer hold, but the social inefficiencies are intuitive rather than surprising, and principal agent theory is well suited to elaborating these complexities. Moreover, these results contain few critical implications for major economic institutions because they apply generally to all economic systems. Rather than clarify fundamental characteristics and/or weaknesses of economic institutions, such work demonstrates that welfare losses can be diminished in any economic system by diminishing uncertainty in general and by eliminating any asymmetrical uncertainties that grant some agents "uncompetitive" advantage over others. But work on this frontier of welfare theory neither requires nor compels a major change in welfare paradigm, whereas work on other frontiers does. It was for this reason we ignored the numerous recent advances in this area and not because we do not appreciate the advances that have been made.

8.2.3 Rebuttal to Alienated Labor

The criticism that private enterprise production dooms most to the status of "alienated labor" has not moved traditional theorists to respond. While putting words into people's mouths is always of questionable value, we might hypothesize that traditional theorists find this charge naive. They might argue the criticism stems from a romantic comparison of modern economies to the presumed "golden age" of craft production in which self-sufficient, independent producers could conceive and direct their own work activities. And they might argue that what seems to be "formal" alienation from control over work process, product, and whatever else, upon more sophisticated analysis, turns out not to be a "practical" alienation at all.

In the traditional view, workers have control over the work process through their supply of labor function that will be different for activities whose "process" or "products" the workers evaluate differently. If the work is debilitating or boring, presumably workers will insist on a sufficient wage premium to exactly "compensate" the differential displeasure. If the work "product" is deemed less worthy than average, presumably here as well employers will demand compensating differentials." 15 In the traditional view, as long as labor markets are competitive, the worker has "practical" control in the same sense that the consumer has "practical" control over what products private employers "choose" to produce.

As a matter of fact, traditional theory suggests the influence permitted workers over the work process and product through their supply of labor functions backed by their freedom to "vote with their feet" is all they should be permitted. Even within the framework of working for an employer, different kinds of jobs and occupational categories permit varying degrees of self-direction over one's laboring efforts. Carpenters engage in more self-directed work than assembly-line workers, and if "self-determination" is important to people this should be reflected in compensating differentials between jobs that differ in this respect.

Moreover, contrary to what traditional Marxist analysis implies, the dividing line between employer and employee in private enterprise economies is not completely impermeable. 16 Presumably, if self-directed labor were sufficiently important to individuals they would work, as many do in all private enterprise economies, as self-employed, accepting compensating differentials in income. And if the desire to conceive and coordinate activities involving more than one's own efforts is strong enough, perfectly competitive capital markets permit people to take out loans and start their own businesses. In any case, in the traditional view to allow any greater control over the product by individual workers would rob consumers of their say over what they will consume. One might even say that if we "de-alienate" workers from their products we necessarily "alienate" consumers from the objects of their consumption!

In fact, as soon as one concludes that private entrepreneurs' freedom to manuever is nil within the "black box" because they are completely hemmed in by competitive labor and product markets, the "problem" of "alienation" vanishes. In this traditional view, producer and consumer sovereignty are the appropriate concepts concerning influence over decision making, and the Marxist concept of alienation, which focuses exclusively on an individual worker without reference to other workers or consumers, is seen as an inappropriate concept for evaluating effective influence over decision making in modern, integrated economies.

8.2.4 Malfeasance Is Universal

As we saw in chapter 2, Bowles argued that private enterprise aggravates the problem of malfeasance. But this amounts to the claim that there are alternative ways to organize production that either alleviate the problem of malfeasance or reduce the costs of combating it. A skeptic might counter that people will shirk unpleasant work under all organizations of production. More specifically, a skeptic might ask why a worker would shirk less in a publicly owned, employee-managed enterprise than in a privately owned and managed enterprise.

The skeptic's point is not that malfeasance is independent of surveillance, punishment, and reward, but precisely that these are the factors, and the only factors, that affect the amount of shirking a rational, self-interested actor will engage in. Consequently, the rebuttal to Bowles' critique would be that under the same system of surveillance, punishment, and rewards, malfeasance would be the same under either private or public ownership. In which case, the social costs of combating malfeasance would be equal in both systems of ownership-provided individuals behave as rational, self-interested actors.

Of course, this is precisely the position Bowles, to his credit, identified as the "Neo-Hobbesian" view. And in fairness to Bowles, he did not so much intend to rebut the Neo-Hobbesian view in his American Economic Review article as to clarify and contrast that view with what he called the "Marxian" class conflict view. But if what we prefer to call the "radical" class conflict school is to have anything to contribute beyond a "Neo-Hobbesian" analysis of malfeasance, it must explain why workers would not be just as likely to "cheat" on one another as on a private employer. While Bowles hints at the answers, we show below how our new paradigm helps clarify the reasons. Of particular interest is whether or not the reasons given by the radical conflict school assume that workers behave other than as rational, individual maximizers in public enterprise, employee-managed environments. For if this is the nature of the explanation, no matter how reasonable the argument, traditional theorists would be justified in concluding that it lies outside welfare theory proper, that a Neo-Hobbesian view of malfeasance is sufficient in welfare theoretic terms, and that Bowles' critique of private enterprise rests on the assumption that workers' behavior in some environments is influenced by factors other than rational, individual maximization.

8.2.5 Limitations of Single Period Models

As we saw, Michael Reich's model responds directly to the traditional objection to "divide and conquer" theories of racially motivated employer behavior that they are, ultimately, "conspiracy theories." As Kenneth Arrow explained, while employment discrimination may well be in the interests of employers as a class, one must provide compelling reasons for why it would not be profitable for individual private employers to cheat on the discriminating employer cartel in order to avoid concluding that competitive private enterprise economies tend to alleviate, rather than aggravate, racial and sexual discrimination. 17 put differently, if class-dividing effects of individual employer actions are merely positive externalities for an employer's classmates, then traditional theory teaches us not to expect such effects to be taken into consideration. And if there is one point on which our new theory agrees with traditional theory it is that effects external to a decision-making process will not be taken into account! But Reich provides a reason why the effects are not external to the individual employer.

If an employer could get the same work done by paying whites no more skilled than blacks the same wage rate, it would be unprofitable to pay whites more. And if an employer could get the same work from an equally capable all black work force as employing more than a proportionate share of whites, it would be unprofitable to hire whites at a higher wage rate. But Reich voices a reason to doubt the assumption that an employer can get the same work done in both situations and, therefore, gives a reason employers might do just what traditional theory suggests they will not, except at the expense of their own individual profits. What Reich's argument boils down to is that since wage discrimination and employment discrimination increase the amount of work an employer can extract from labor hired, doing so up to the point where the increased costs equal the benefits is part and parcel of profit-maximizing strategy for individual employers, rather than contrary to profit maximization, as traditional theory would have us believe. 18

In our view, Reich's argument succeeds in overcoming the "conspiracy theory" rebuttal of traditional theory. Moreover, Reich points the way toward a more general view of how the conflict of interests between employers and employees works itself out in ways that are not necessarily socially efficient. But we believe his model fails to suggest the extent to which employers have an individual profit incentive to engage in discriminatory actions. Nor does his model enable us to assess all the factors that play important roles in the battle between employers and employees as each pursues individual interests.

By treating the issue in a single time period model, Reich limits the extent of benefits that accrue to discriminating employers regarding extracting labor from labor power and fails altogether to show how such actions can benefit employers in wage negotiations as well. A traditional theorist might well respond to Reich's argument by admitting the logic of his demonstration, but challenging the significance of the effect. If the only benefit to the employer of what Reich admits is cost-increasing behavior is to make employees more manageable in the present, one might wonder just how much extra cost would be warranted. 19 What Reich's model, which should be seen as a pathbreaking first step, fails to indicate is that by far the most important beneficial effects to employers of discriminatory actions today are greater divisions among their employees throughout the future.

By choice of technology and reward structure employers can affect the human and group characteristics their employees will have in the future, thereby affecting what they must pay their employees in many future time periods in addition to the effort they can extract from the labor they hire during many time periods. Choice of technology and manipulation of reward structures that affect the individual and group characteristics of employees in ways that weaken their ability to resist future efforts to extract greater work effort are also likely to permit employers to pay less for that labor power in many future time periods. In sum, Reich's model correctly identifies the "wage increasing effect" of employer discrimination since this is the effect on the wage bill in the period in which the discriminatory actions are taken. But his model is blind to the "wage diminishing effect" of employer discrimination since this effect occurs in periods after the discriminatory actions.

Moreover, expanding our view of what is at stake for employers and employees alike in discriminatory behavior clarifies the importance of factors not highlighted in Reich's model. Most obviously, the importance of the rate of labor turnover becomes immediately apparent. A multiperiod view of what is at stake in discriminatory behavior is no different from a single period view if there is 100 percent labor turnover in each time period! For with 100 percent turnover all future "beneficial" effects of discriminatory behavior that employers might carry out would vanish for those employers and accrue only to their classmates as "positive" externalities. But the traditional claim that discriminatory actions only generate positive externalities for other employers is most certainly not valid if labor turnover is less than 100 percent each time period and if employers compete for profits over the long haul rather than simply in the present. In the far more realistic case of competition for profits over the long run and less than 100 percent labor turnover, the benefits of discriminatory behavior to individual employers are far greater than suggested by Reich's limited model, as we will see when we embed Reich's logic in the formal model we developed in chapter 6. In our model it is much easier to see why the total future profit-enhancing effects can provide a powerful incentive capable of outweighing substantial present costs. Moreover, the critical nature of labor turnover on employer incentives is readily apparent in our formulation, while it was invisible in Reich's model without a future.

8.2.6 The Importance ofHuman Characteristics

More fundamental is the importance of the individual and group characteristics of employees. What is really at stake is nothing less than the fact that employers and employees have directly opposed interests not only with respect to the real wage, but also with regard to the human characteristic transforming effects of the production process. 20

Without a paradigm and welfare theory that explicitly identifies individual and group characteristics as "state variables" for which private employers have important interests in determining values quite different than those employees would choose, the generality of the problem, the critique of "producer sovereignty," and the profit-enhancing logic of economic discrimination are not apparent. The conflict between employer and employee in private enterprise economies is a complicated battle waged over time. In any period what is at stake is not only the present outcome in terms of wage rates and effort extracted, or "real wage," but changes in employee characteristics that powerfully affect the terrain of future battle. While implicit in Reich's reasoning, he never defines the key variables-the human characteristics of the employees.

In other words, while it is an important response to the "conspiracy theory" rebuttal to "divide and conquer" theories of discrimination, Reich's model is not sufficient for our purposes. But by embedding his idea in a more general framework we strengthen the conclusions he drew.

In sum, as previously formulated, many challenges to the traditional analysis of production under private enterprise are subject to rebuttal. Criticisms based on the distinction between "labor power" and "labor performed," on the formally dictatorial nature of entrepreneurial prerogatives, and on asymmetric information sets for employers and employees are less than compelling in steady state models with their full information implications. And the ethical imperative to eliminate "alienated labor" appears less than categorical upon closer inspection, leaving in doubt whether or not private enterprise misapportions decision-making influence regarding production. Reich's critique can be greatly strengthened and expanded in a multiperiod model in which the critical role of changing human characteristics can become apparent. The same might be said for the pioneering work of Gintis. While Gintis' critique loses bite in a steady state world in which employers and employees learn what to expect from one another, it gains significance in a multiperiod model where the batt e over the human characteristic transforming effects of production is waged for higher stakes.


8.3 Reformulating Conflict Theory

What, after all, is really at stake in the conflict between private employer and employee? From the employer's perspective, division of the net product, or the wage rate, is of great importance, as is the degree of effort and diligence employees exert in concert with their capabilities. From the employees' perspective, their wage rate is important, as is the extent to which they receive positive or negative satisfaction from their work. All of which can be summarized as a direct conflict of interest over the "real wage." What we might call the human fulfillment effect of their work is a function not only of the meaning and interest the activity holds for them, but of the extent to which they are compelled to exert greater or lesser effort. This implies a "double" conflict of interest between employer and employee over division and extraction, which can be usefully summarized as a "struggle" over the "real wage." 21

8.3.1 Human Characteristics and Conflict of Interest

But the struggle over division and extraction is waged over time. And both the individual and group characteristics of the employees in each time period play a critical role in the outcome of that struggle. Moreover, the characteristics employees will have in future periods 22 are influenced by the nature of their productive activity in this time period. So, while the -conflict of interest is ultimately over division and extraction, there is also an all-important conflict of interest over the human characteristic transforming effects of laboring activity, since these will largely determine the advantages and disadvantages of employees and employers in their future struggles over division and extraction. 23 So the double conflict of interest over division and extraction implies a third conflict over the human characteristic transforming effects of the labor process.

We might pause to consider how traditional theory missed such an obvious conflict of interest. While the traditional paradigm ignores the human development effects of economic activities, under some circumstances this is justified. And the labor process under private enterprise has some of the markings of just such a situation. In traditional theory employers had no interest in opposing organizations of work that fulfilled employees' preferences provided they did not diminish productivity. As a matter of fact, the conclusion of "producer sovereignty" hinged on the assumption that * employers would seek such improvements in working
conditions in their efforts to pay lower wages, which competitive labor markets would provide in the form of compensating wage differentials. Had the traditional paradigm permitted traditional theorists to see the preference development effect of work activity, they no doubt would have come to the same conclusion: employers have no reason to oppose, and a wage-reducing reason to seek, changes in work that generate ftiture preferences that employees prefer.

Moreover, traditional theorists are quite aware of the difference between PrEMEs and slavery. While slave owners have every reason to concern themselves with the effects of the work process on their slaves since they may sell their slaves as well as the products they produce, private employers do not own and cannot sell the workers who bear the imprint of the work activity they carry out under their employers' direction. Herein lies temptation to conclude that employers have no axe of their own to grind regarding the human characteristic transforming effects of labor activity, but only an incentive to search for arrangements employees most prefer.

But as we have just explained, employers have a very big axe to grind in this matter because their employees' characteristics will have an important impact on their ability to lower wage bills and extract greater effort from these employees in the future. Private employers cannot "cash in" on the extent to which they organize production in ways that enhance the attractiveness of those who have worked for them to other employers by selling their employees to other private employers; in PrEMEs workers must sell themselves and only for a limited time. But individual employers can benefit from producing transformations of human characteristics advantageous to employers simply by rehiring those they employ today, tomorrow!

The qualitative economic model we developed in chapter 5 facilitates a careful analysis: any economic activity, including production, can be characterized by its material and human inputs, by the transformations in the "state" of the physical productive machinery and the individual and group human characteristics of those who carry out the activity, and by the material and human outputs of the activity.

Beyond caring about the wage they receive, employees are also logically concerned with (1) the number of hours of different kinds of work as well as the degree of effort exerted, or what we have called the human inputs of the production process, Ei; (2) the transformation of their human characteristics, or what we have called the difference between the beginning and final values of the "state" variables representing their individual and group human characteristics, (Pf-Pb), (Sf-Sb), (Kf-Kb), (Vf-Vb), and (Gf-Gb); and (3) the degree to which their needs are met or unmet, or they are satisfied or unsatisfied by their work activity, which we have called the human outputs of the production process, U0.

The Ei matter to employees because the kind of work affects their well-being and because the time spent and degree of effort expended affects their well-being. Changes in human characteristics matter to employees both because (1) changes in individual characteristics parameterize their preferences and earnings functions and, therefore, future abilities to enjoy different activities and earn labor income, and (2) because changes in individual and group characteristics affect their future bargaining strength regarding division and extraction vis-a-vis their employer. U0 represents the obvious direct preference fulfillment (traditionally termed the "disutility of work") effects of their work activities.

Beyond caring about how much they pay for inputs, including labor time, and how much they are paid for material outputs, employers are also logically concerned with (1) the quantities of inputs used, Ri and Xi (2) the number of hours and the degree of effort employees put forth, Ei (3) the transformation of their employees' human characteristics, (Pf-Pb), (Sf-Sb), (Kf-Kb), (Vf-Vb), and (Gf-Gb), that occurs at work; and (4) the quantities of material outputs produced, X0. Since employers pay positive prices for inputs they wish to minimize quantities used. Because the labor contract does not guarantee the effort that employees will exert, employers must seek to induce employees to exert maximum effort. Since changes in the individual and group characteristics of their employees will affect their future bargaining strength regarding division and extraction, employers wish to maximize the erosion in future bargaining strength among their employees. And because employers gain revenues only from the sale of material outputs, they wish to maximize the quantities of material outputs produced.

We can assume that the prices of nonhuman inputs and outputs are fixed exogenously if they are bought or sold on competitive markets. But to some extent the price of human inputs, or wages, is endogenous to the production process in the sense that future wage rates may be affected by present decisions provided labor turnover is not 100 percent. This is not to deny that competitive labor markets place limits on wage rates. Competitive labor markets presumably guarantee, among other things, compensating wage differentials for work that generates different degrees of satisfaction, which in turn implies that employers will have an interest in the kinds of work employees do and the degree to which they garner satisfaction from that work to the extent such factors are translated into market wage differentials. But traditional theorists are correct to see this kind of interest as being in harmony rather than conflict with the social interest. However, to some extent the wages an employer must pay are not totally determined by labor market conditions, no matter how competitive they may be. To some extent, wage determination is endogenous to the organization of the production process.

Interestingly enough, the relation between extraction and competitive labor markets is totally analogous. Competitive labor markets place both lower and upper limits on the degree to which employers can extract effort from their employees, just as they place limits on wage rates. As a matter of fact, competitive labor markets place limits on the wage/effort package, or real wage, since just as even the most competitive labor markets permit a degree of indeterminacy in payments that can be affected by the organization of production in previous periods, they permit a degree of indeterminacy in the degree of effort that can be extracted as well. Which means in a multiperiod model in which the possibility of influencing payments emerges along with the possibility of affecting extraction, Reich's assumption of exogenous payments (to which employers can add a discriminatory bonus for whites if they choose) but endogenous degrees of extraction was arbitrary. The two are equally exogenous, to the extent that competitive labor markets hem employers in, and equally endogenous, to the extent that present choices of technology and reward structure can transform the human "state" variables in ways that affect the relative bargaining strengths of employees and employers in the future. 24

Our model allows us to pinpoint the difference between a fully elaborated "conflict theory" and the traditional analysis of the production process. In the traditional view, employers do not care about transformation of the human "state" variables. (Private employers are not, after all, slave owners.) And it is precisely this omission in traditional theory that renders the real wage just as exogenous as the prices employers must pay (and receive) for nonhuman inputs and outputs under the assumption of competitive markets. In complete information worlds, competitive markets do limit decision making Within the black box so severely as to eliminate all room for maneuver. In other words, perfect information, competitive models generate determinate solutions. But recognition of the human characteristic transforming effects of production changes our view of what decisions are eliminated by competitive labor markets and what decisions are "predestined" for employers who are to succeed in competition with others.

The decision that is compelled by competitive labor markets takes into account the degree to which future profits can be enhanced by diminishing the bargaining power of one's employees through appropriate choice of technology and reward structure today. And, of course, the definition of appropriate choice is precisely the technology and reward structure whose marginal loss of present profits from lost output or higher costs is exactly as great as the discounted marginal gain in future profits from enhanced leverage over division and extraction. The decision that is eliminated by competitive labor markets is precisely the one traditional theory believes is compelled: a decision in which the employer abides entirely by employee preferences regarding human characteristic transforming effects of the production process eschewing the possibility of expanding profits by contributing toward human characteristics that weaken employees' bargaining power.

8.3.2 Competition and Power

Ultimately the issue reduces to the question of the relative power of employers and employees-something traditional theory implies is irrelevant under competitive circumstances. So it is important to clarify the relation between competition and power and exactly what we are arguing here. A traditional theorist might formulate the following rebuttal to our argument, similar to the rebuttals to previous contributors to the conflict theory we reviewed previously.

If an employer offers lower payment than other employers, don't competitive labor markets imply workers will seek, and find, better employment elsewhere? If an employer tries to extract more effort than other employers without paying a wage premium, don't competitive labor markets imply workers will seek, and find, better employment elsewhere? If an employer structures work roles in ways that have less desirable preference fulfillment and/or development effects for employees thanjobs offered by other employers, don't competitive labor markets imply workers will seek, and find, better employment elsewhere? 25 And finally, if an employer manipulates choice of technology and reward structure to affect employee characteristics in ways that diminish their ability to secure favorable employment circumstances in future negotiations, don't competitive labor markets imply workers win seek, and find, better employment elsewhere?

We wish to respond to this line of reasoning explicitly and precisely, because in our view this is the "bottom line" to the debate over the welfare theoretic properties of private enterprise. 26 Suppose the competition among employers for employees was so strong that the answer to all of the above questions was "yes." In our view, this amounts to stipulating that circumstances are such that the balance of power between employers and employees over all the conflicts of interest between them is entirely in the employees' favor. It amounts to assuming labor markets are so "tight" that employees' threats to vote with their feet are sufficient to extract any and all concessions from employers short of ones that would literally bankrupt them. Of course, if this were the case we would expect employees to leave employers no part of the net product 27 and insist that the work-roles/payment/effort trade-off be entirely in accord with employee preferences. As a matter of fact, if this were the case, there would be no difference between a private enterprise market economy in which employers hired employees and one in which employees hired employers. 28

But this could not be the case unless, among other conditions favoring employee power, the human characteristics of the work force were such as to maintain a monopoly of power in employees' hands. So we logically expect such a situation to coincide with a condition in which employees have whatever individual and group characteristics guarantee them advantage in their negotiations with employers. And if this situation is to persist as a steady state, we naturally assume employees are taking care to reproduce these characteristics as reproductive transformations of human characteristics that are "empowering" for employees.

So our answer to the question, "Isn't this what competitive labor markets imply?" is, "Yes, this could be what competitive labor markets imply 29 but they might imply something very different." Let us pose the following questions:

If an employee tries to insist on higher payment than other employees, don't competitive labor markets imply employers will seek, and find, lower cost workers? If an employee tries to get away with less effort than other employees without accepting a wage reduction, don't competitive labor markets imply employers will seek, and find, more willing employees? If employees insist on work roles that have more desirable human consequences than those offered by other employers, don't competitive labor markets imply employers will seek, and find, more reasonable employees? And finally, if employees only tolerate technologies and reward structures that affect employee characteristics in ways that maximize their ability to secure favorable employment circumstances in future negotiations, don't competitive labor markets imply employers will seek, and find, less combative employees?

If the competition among employees for employers were sufficiently strong, wouldn't the answer to all these questions have to be "yes"? And doesn't this amount to saying that circumstances are such that the balance of power between employers and employees over the conflicts of interest between them lies entirely in employers' favor? Haven't we simply stipulated that the competition for jobs is so fierce that the threat of unemployment is sufficient to extract any and all concessions from employees short of ones that would not permit them to sustain themselves and their families? And if this were the case, couldn't we expect employers to leave employees no part of the net product beyond subsistence needs and insist that the work-roles/payment/effort trade-off be entirely in accord with employer preferences?

But, once again, this could not be the case unless the human characteristics of the work force were such as to maintain a monopoly of power in employer hands. And we would logically expect such a situation to coincide with a condition in which employees have whatever individual and group characteristics are required to grant their employers full negotiating advantage. If this situation were to persist as a steady state, we would have to assume employers are taking care to reproduce these human effects of the production process. In other words, all this is also consistent with "competitive" labor markets. 30

The issue here is the same as the issue of the normal rate of profit to which traditional theory has not exactly provided a clear-cut answer. IMn most traditional treatments, the long-run normal rate of profit is zero on the assumption that any activity that generates positive profits will be expanded until those profits are "competed away." But traditional theorists seldom consider competitive circumstances under which long-run profits may not be "competed away." If financial capital is sufficiently scarce, 31 and inputs must be financed in advance, activities may not be expanded to the point that normal profits are competed away. If employers have been accustomed to earning a positive normal rate of profit and labor's bargaining strength does not increase, productive potentials may go unleashed unless they continue to generate positive profits.

While "Sraffians" expend little more effort than neoclassical theorists analyzing the particular circumstances that generate higher or lower rates of profit, they do not presume the long-run rate of profit will be zero. Instead, the normal rate of profit in Sraffian models is seen as determined jointly with the wage rate by the relative bargaining strengths of employers and employees. What we are arguing here is implicit in Sraffian theory, namely that many wage rates and normal rates of profit are consistent with -competitive" labor (credit) markets. Moreover, we claim the individual and group characteristics of the work force go far toward establishing the relative bargaining power of employers and employees and that they are, therefore, important determinants of what the "competitive" wage rate and "normal" rate of profit will be. More to the point, unless labor holds a complete upper hand, the kind of employer tactics envisioned by the conflict school which we have attempted to clarify are part and parcel of the employer behavior that is compelled by competition among them. 32

The point is that stipulating "competitive labor markets" does not answer the question of relative power between employers and employees. 33 Instead the "assumption" of "competitive labor markets" neatly sidesteps this question-which in some situations is highly ingenious! If we are examining a situation where the relative bargaining strengths of an employer and his or her employees does not matter, then sidestepping an admittedly ticklish but irrelevant issue is totally justified. 34 But the problem here is we are dealing with a situation in which the issue at stake depends precisely on the balance of power between employer and employees. And since stipulating "competitive labor markets" merely sidesteps the question rather than answering it, the "assumption" of competitive labor markets has nothing to contribute whatsoever. To proceed we employ a different, but productive simplifying assumption.

For the unproductive assumption of "competitive labor markets" we substitute the explicit assumption that employees have something less than a complete upper hand in their bargaining with employers. 35 For in a private enterprise economy, under any of the infinite possible relative bargaining strengths between employers and employees consistent with competitive labor markets, other than the extreme case in which employees have employers entirely at their mercy, the conclusions drawn by traditional welfare theory do not hold. Instead, as we demonstrate next, the conclusions of the "conflict theory" obtain' 36

In sum, if employers rehire at least some of their employees, and if employers are not completely at the mercy of their employees, employers will be able to achieve a positive normal rate of profit. 37 And in doing so they will choose technologies and,reward structures that equalize the (long-term) profit gains from influencing employee characteristics in ways that reduce their bargaining power with the (short-term) profit losses of less productive technology and higher cost wage bills. All of which sustains the conclusions of the conflict theory that we cannot rely on private employers to choose the most productive technologies available, nor can we trust them not to engage in discriminatory systems of rewards. Competition among profit-maximizing employers will drive them to search out ways to transform the human characteristics of their employees in ways beneficial to employers. And there is every reason to believe this will be, to some extent, at the cost of social efficiency.

But before examining what human characteristics we can expect employers to foster to promote their interests in the conflict over division and extraction, we reconsider the conclusions of Gintis and Katzner concerning sufficient conditions for profit maximization to coincide with social efficiency. At first glance they seem to contradict the conclusions we have just drawn.