The connection between Distributism and Libertarian economics

I’m probably never going to find the perfect words to explain this, so after many false starts it’s going to be worth doing badly, because it’s worth doing.

The most ruthless Free-Market economics, the greatest attachment to price and incentive over command and control, the most thorough abandonment of hierarchy and oversight is more consistent with the Distributist vision than even that of the Anarcho-Capitalists. The giant corporations are holes in the market, they don’t use price coordination or free exchange internally, and as a consequence they are what we know them to be: Horrible things. We know that the Dilberts of the world are right about their own workplaces, not merely in terms of misery, but in terms of inefficiency and incompetence. Economies of scale, to the extent that they exist, provide efficiency merely so that the increased output can be absorbed in valueless activity that benefits only those with power within the organization.

I worked for a multimillion dollar corporation last year, at least it was capitalized in the millions according to its stock valuation. On the other hand, the company hadn’t posted a profit in eight quarters when I left. Reforms were more or less constant, but also more or less routine. The fact is that the profit motive didn’t exist for this capitalist enterprise; we consistently posted profits and dividends of zero for our shareholders, but we weren’t dead, because we sure as hell continued cutting huge paychecks to our executives. And who’s really in the driver’s seat, owners, or managers?

The specifics of how businesses in the modern economy really pay off are so perverse, and the profit obsession we constantly hear about is so sabotaged and unreal, that we have to doubt whether corporations believe in Free Markets at all. Shareholders do not generate returns on their investment by putting their money into businesses that generate revenue in excess of costs, they get returns by selling their stock once its price has risen. Dividend yield is such a laughably small part of “making money in the stock market” that investment strategies oriented towards dividends (indexed funds, for instance) are considered an unorthodox gamble. But the entire purpose, the only purpose, of investing and starting a business, was to generate dividends! Dividends are profits, dividends are the cash the consumers are spending, coming back to compensate the investor for putting his money into an enterprise that provides something for people. When investors ignore dividends, they ignore profits, and when profits are ignored (…ugh…do I really have to use this phrase?) social utility is lost.

A profit-oriented business in a Free Market is ever seeking to drive down costs and drive up the desirability of its products, so that more can be sold, or sold for more. Because the willingness of consumers to spend is a reflection of their subjective valuation of the product, the entrepreneur is being incentivized to find ways to serve the desires of the public. But because costs are also a price coordinated reflection of subjective valuation (ie it costs more to hire a man to clean out the inside of a mixer than to hire him to do a more pleasant job), he is also incentivized to minimize the undesired consequences of his actions. He is being paid more the better he produces things people want, while minimizing social costs as transmitted through the markets. In other words, if we can eliminate the socialization of costs and hold every man responsible for his specific actions (the very opposite of the social collective) then we have a perfect machine of incentive to produce what we desire, at maximum efficiency. That’s a market.

What we have instead is the people who steer these enterprises being paid for entirely unrelated, or distantly related outcomes. Stockholders want CEO’s that can boost stock prices, so that the portfolio value increases. Now, earnings can help with this, but it is the hardest way. A great CEO is one who is at the head of a multimillion dollar operation that hasn’t made a sale in months, is mired in lawsuits and revolving debt, propped up with bailouts, and is at its core a machine not for producing products, but for exploiting tax law, and he keeps the stock high with his confidence and his lobbying and his lies and his press releases. It’s the more amateurish management of small business that concerns itself with production processes, with satisfying consumer demand, with more than cursory understanding of costs, in fact, with everything that makes the market efficiency-seeking in the first place.

What I’m getting at here, as a Distributist, is that the benefits of the Free Market are captured more fully the more of a market it is (duh) and that it is more of a market the smaller the proportion of economic activity that is under command and control. All that would be totally accepted by any Free Market economist, where “command and control” is quietly assumed to mean “government”. But command and control is a system of organization, no more unique to government than are hierarchies or telephones. A lot of Austrian economists don’t care about command and control within private institutions (I suspect) because people voluntarily enter into those employment relations; i.e. their primary objection to the sort of command and control we see in North Korea is obviously a moral one, so similar strategies without the coercive element get a pass because they are not so immoral. But they are equally incompetent. The same ineptitude about allocating resources that is mocked in Soviet industry is constantly before my eyes within a corporation, because both are attempting the same thing. Both the Marxist revolution and the Managerial revolution were attempts to shut off the price mechanism’s aggregation of knowledge, and rely on a central planner. Sure, I can leave the corporation, that’s not the point here. The point is that the portion of real production that is carried out under the type of management that is today commonplace is deliberately blind and uncoordinated in the same way that Communist production is blind.

Now, there was one man of importance in the field (unlike me) who tackled the above problem, essentially asking why large firms or any firms exist at all. Ronald Coase, a genius, proposed that in the efficiency-seeking behavior of the market, if it happens in a particular case that command and control reveal themselves to be very efficient, then an institution of that type will have an advantage, and thus prevail. He referenced the transaction costs involved in negotiating and discovering proper prices from scratch, of risk and uncertainty about the performance of others, of negotiating sharp contracts or occasionally enforcing them, and of taxes. All these things can be evaded or reduced by a pre-assembled system of actors who do not use the price mechanism, but simply perform continuously according to set rules, as in a firm. Is he right, and Distributism wrong?

Consider this: The transaction costs which Coase refers to confer an advantage to any entity that does not have to bear them. If it costs an average of an extra 10% to find an initial price (a cost that will be borne in the form of some unfavorable negotiations at the beginning) then the entity that doesn’t engage in price-finding will have a 10% cost advantage over all others. As a practical matter, it is unlikely that this will translate into a 10% lower price; a fundamental cost advantage usually causes the business to undercut its competitors only as much as is necessary to win bids, and then disburse the rest of the savings as profits or bonuses. They might not even undercut at all, but instead absorb the whole cost savings for their own use, if price cutting doesn’t produce sufficient increase in sales to justify it. In any case, they have this negotiating and revenue advantage, and they will either expand their market share or others will imitate (if possible) until the innovation becomes the industry standard. This is essentially the process Coase was describing, of the efficiency advantages of firm-type organization showing themselves and being subsequently adopted. I’m tempted to argue about the validity of these efficiency advantages. For instance, I might say that the 10% savings enjoyed by not engaging in price finding could be realized in a theoretical static market, but if supply and demand for the good fluctuate as they always do due to outside forces, those measurable savings would be quickly erased by unmeasurable losses due to blind allocation. Price finding is a costly but necessary activity; avoiding it to cut costs is like installing a cardboard windshield to save money. However, I wouldn’t want to get into this debate with Coase or with anyone because first of all, there are unquestionably valid examples of transaction costs which firms wholly legitimately avoid, and secondly, because the answer will always be, “If large firms aren’t efficient, why do we see them succeeding in the market?”

But let’s look at the question from the opposite perspective. If firms gain their efficiency advantage because of transaction costs, then larger transaction costs will produce larger firms. But largeness has costs too. Enlarging the firm to a huge size does not pay off unless huge costs are avoided, because the costs of management scales up wildly for large operations, and waste gains more and more footholds. For evidence of the increasing costs of managing a growing corporation, I point you to the vast body of literature on business management, and the vast effort and thought that go into keeping one of these large entities in operation at all. Essentially then, the firms we see have found a balance, where the savings afforded by bigness are not overtaken by the costs of bigness itself, remembering that the savings from bigness come (in this theory) from transaction costs avoided. This balance determines optimal firm size, and in a competitive, free market, firms will tend toward optimal size. Any general increase in transaction costs will push this optimum size upward, making it harder for small firms to operate and easier for larger ones, while a decrease in transaction costs or an increase in management costs (perhaps due to an unfortunate intellectual fad) will influence firm size down by reducing the savings from transaction costs avoided.

How does this help my Distributist case? Enormously, actually. The corporate tax rate in this country is 35% flat (interestingly not a progressive rate like that for individuals…) meaning that if one man catches a fish, and sells it to another who guts and cleans it and sells it to another, who wholesales and delivers it to a restaurant, who sells it to a consumer, that fish has been taxed four times on income tax alone, because every transaction was a sale which translated directly into somebody’s income. I don’t know of any corporation that carries out these exact steps for fish, but if all the market actors except the consumer were part of the same legal fiction of a corporation, it would have been taxed once, at 35%…which is frankly an enormous amount even at only one hit. When it repeatedly hits the same item in vertical supply chain, such a tax inevitably consumes the majority of the value of the good or service. It’s pretty descriptive of the above to say that in the series of sales example, 18% of the fish caught makes it to the table. The other 82% of the value goes to taxes. The Wal-Mart type entity with its vertically integrated arrangement loses less than half of that. Is this anything like a real efficiency advantage? Is this the same sort of efficiency we’re referring to when we describe the rise of injection molding or CNC machining? Is greater satisfaction of demand generated out of lesser scarce inputs? No, vertical integration is simply a massively effective tax dodge. If firm size is determined by the balance between the rising costs of being big and the rising benefits of being big, then how does this tremendous artificial disadvantage to being small play? How does charging four small businesses more than double the taxes (per unit of output) charged to one corporate giant affect the outcome? Firm size is inflated. Firm size is laughably, incredibly, despicably inflated, when a vertically integrated chain of four steps is taxed at 35%, while a market-managed chain is taxed at 82%. And you didn’t think Coase’s theory would help the Distributist argument.

Two points I need to address before moving on: The Socialists will call this a case for progressive taxation of businesses, and well, as far as I’m concerned, there aren’t enough spittoons in the world for that view either. Heavy, complex tax codes inevitably produce injustice, I am not interested in the redistributing injustice among the public. The only way we will ever see anything like maximum efficiency in these arrangements is to go with the Ron Paul income tax: Reduce it to zero, replace it with nothing. Fiddling with the administration of the tax will only shift the injustices and distortions from one place to another, since we can’t know what optimum the market is seeking until the market finds it. And the Socialist who introduces progressive taxation for businesses runs immediately into the second point I need to address, and one that I know a lot of theorists will have been waiting for all through the Coase argument: Economies of Scale.

What happens when a larger system actually provides true efficiency gains, gains of the type we see in injection molding, etc? The rationale for even having a flat tax rate for business was almost certainly to avoid depriving the public of the benefits of large scale mass production. It would be argued that a factory can produce a thousand times the output of a workshop, from merely five hundred times the inputs, which is more or less the Henry Ford case. Progressive taxation in this case would have a destructive effect in the opposite direction, pushing firm size below optimum and causing the manufacturing process to be less productive for given inputs. Now, this does not alter the Coase argument in the slightest: If large firms have economies of scale and absurd tax advantages, their real efficiency will take them so far in enlarging the firm, and their false efficiency will take them still further. Given the tax issue, we know for a fact that firm size is inflated beyond optimum, even if optimum is expected to be very large. Only there is really something of an open question about economies of scale. There are management gurus out there pushing it hard as a basis for centralizing and standardizing work, of substituting huge singular plants for dispersed workshops, etc. And there are opposing management gurus like John Seddon and Tom Peters, discovering empirically that these methods are not fulfilling their promise. Now, nobody is proving that Henry Ford’s plant wasn’t productive; what Seddon asserts is something far more interesting: Essentially, that scale economy is not a general property of business, but merely a specific case of efficiency discovery by an intelligent manager. Some systems run better large, some small, some continuously, some on-demand. Seddon is most interested in comparing modern pursuit of economy of scale with the abandonment of that pursuit in the Toyota Production System under Taiichi Ohno (just read the whole article ffs there’s more wisdom in it than in a college education). To quote:

The secret of Ohno’s method was studying the work, as a system. His favorite word was ‘understanding’. He would turn in his grave if he knew that his system was being sold to managers as a set of ‘lean’ tools; he taught managers to find out what their real problems were, as they were often different from the ones they thought they had. The tools developed in the Toyota System were developed to solve the problems associated with designing a system to produce cars at the rate of demand. In service organizations we have different problems to solve.

What a revolutionary thought! Calling upon managers to comprehend what they manage, rather than embrace a general direction to enlarge and standardize whatever is put in front of them. I won’t give it all away, but essentially what Seddon presents is not the unreality of Economies of Scale, but the prevalence of the Superstition of Scale, and it is this superstition that guides lazy management and influences public policy to pursue enormity itself, whether it yields results or no. The tendency to attempt to realize economies of scale is far more universal than are the real gains. The massive call centers, the CRM software, the Lean Six Sigma seminars, the constant backfiring and unexpected cost overruns…But grave as these management errors may be, the influence on law is far more destructive. You see, when the vice president of operations goes off to a Lean Black Belt course (and writes off the weekend as a business expense) and comes back spouting bullshit about moving all design work out of the local jurisdictions to a central location where the variety of challenges can be more efficiently and obtusely ignored (you can tell I’ve been down this road can’t you…) there are consequences to let somebody know it’s a bad idea, if it is. If the engineers get out to their new office and immediately bottleneck the whole company with rework because of all the errors that are the obvious consequence of adding an obstacle to their perception of what they’re attempting to achieve…well somebody up at corporate may see the pileup, may see the fall in revenue, and if revenue happens to be important to this management team, that will be the end of this pursuit of the vice president’s pet mistake. In other words, where diseconomies of scale prevail (which Tom Peters, it seems, discovered to be a shockingly common case with organizations of people) a free market system at least repeatedly punishes those who pursue them, even if the error is made new every morning.

However, there is nothing to punish the tax code for favoring scale, both efficient and inefficient. We could go a century without correcting that error…well, we have, haven’t we? The income tax is a hundred years old, and we still find in it new abominations every day! The legislators and officials who decide how our property will be confiscated certainly don’t have even the understanding of production systems that the inept horde of middle managers do; somebody explained a little about Long Run Average Costs to them one time and it sounded pretty good and now Economies of Scale is a guiding principle of policy. Nevermind that policy affects everybody within the law’s reach, while Economies of Scale arise from highly specific phenomena within specific specialized trades, and may be nonexistent or reversed in the next industry or the next market or the next street. Why is a factory a tax write-off, but a payroll a taxable item? Because tax policy is guided by superstition not understanding. The superstition that says that a huge factory will always be more productive than a workshop, and a huge farm than a small one, or a thousand retail stores under a single name rather than separate names hits the truth sometimes, but its odds of hitting the truth are radically improved if small operations are taxed three or four times as much, while long distance inventory transportation is subsidized by the fuel taxes of the general public, etc. If the people who are setting policy think that the way to protect productivity is to protect scale, then the Superstition of Scale becomes a self-fulfilling prophesy.

Indeed, the tax write-offs for capital expenditures don’t just go against the Distributist desire for independent units, or the Free-Market principle of price coordination over command and control, it is a downright job-killing policy. If you’re trying to find the most efficient way to produce things using labor and equipment, any subsidy on the equipment skews the ultimate balance towards equipment-heavy, labor-light operations. The costs of the giant machines that substitute for the work of many are a real cost; machines need to justify themselves with output, not be superstitiously promoted beyond the market level of capitalization, which is exactly what the government does with its tax policy.

We don’t know what the correct firm size is because we have not allowed the market to seek it out. We have artificially inflated it. We don’t know what the most efficient level of capital equipment is, because we have subsidized it. What we do know is that because we have so massively rewarded vertical integration, and so thoroughly incentivized the concentration of massive capital equipment, is that both of these effects are radically beyond the market level. We can say, without even glancing at the “human” side of things, but based purely on the science of economics, “These firms are too large and the concentration of capital is too great.” That in a free market, firms would be radically smaller, and production would be less reliant on the million-dollar equipment that competitively excludes small scale production…only it is hardly competitive exclusion when large-scale production is subsidized by tax policy and artificially cheap debt. People always imagine Distributists (well, people who know of our existence…) as begging for artificial protections for the family farm, against the more productive corporate competitor. As it stands, I think I’m asking for more than we need, merely by asking for a level playing field. What we need to protect the quaint little shops and peasantries and small properties of the Distributist dream is a ruthless laissez-faire policy, because the government’s hand is always a hand of favoritism, and I think I’ve made some progress in showing that the existing favoritism leans awfully strongly in favor of the giants.

Aw hell, I didn’t even cover how regulation protects monopolies! That’s like as much of a problem as all the rest of this combined! Well, something for another blog…

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One thought on “The connection between Distributism and Libertarian economics

  1. Pingback: Labor intensity | waltherkoch

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