Managerial Capitalism

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A couple weeks ago this Blog focused on a central finding of the GEM Project’s research on the generalization of rational exchange from the marketplace to the workplace. The Second Industrial Revolution,  dating from the second half of the 19th century and featuring the advent of large bureaucratic firms, is a crucial dividing-line in the on-going evolution of macro instability.

The Project demonstrates that, in the new, soon to be dominant class of enterprises, wages cannot be rationally determined by the labor market alone. Labor pricing in large complex establishments has to be moved inside the firm, where the process becomes subject to objective functions, incentives, and constraints that differ from those found in the marketplace. Labor-management optimization in the workplace venue produces downward nominal wage inflexibility and chronic labor rents, microfounding causality from nominal demand disturbances to involuntary job loss, employment, output, income, and pure profit.

The methodological message is that understanding optimizing behavior within large bureaucratic firms is essential for understanding stabilization-relevant macroeconomics. That message surprises most macro theorists, justifying its frequent reiteration.

Modeling Managerial Capitalism

Alfred Chandler, a preeminent scholar of the Second Industrial Revolution, argued that American business history is usefully separated into two distinct phases: pre-1850 (prior to the SIR upheaval) and post-1850 (the revolution and its aftermath). His great insight is that the huge technological shift required the fundamental reorganization of the firm. His “new corporate forms” necessitated the creation of modern management.

From Chandler’s Visible Hand (1977, p.455): “The development of top management methods and procedures in the early managerial firms marked the culmination of an organizational revolution that had its beginnings in the 1850s with the railroads. The processes of production and distribution, the methods by which they were managed, the enterprises that administered them, and the resulting structure of industries and the economy itself – all were, by World War I, much closer to the ways of the 1970s than they were to those of the 1850s or even of the 1870s. A businessman of today would find himself at home in the business world of 1910, but the business world of 1840 would be a strange, archaic, and arcane place. So, too, the American businessman of 1840 would find the environment of fifteenth-century Italy more familiar than that of his own nation seventy years later.”

Chandler identifies the post-WWI period as developing the complex, bureaucratic processes and procedures that, on a best-practices learning curve, provided near-universal content to large-establishment behavior. The range of those systems, often replacing marketplace exchange, is unsurprisingly broad. Especially significant for macroeconomic theorists is what has become known as human-resource systems, a coherent set of administrative principles used globally to substitute for reliance on market pricing of labor services by large, specialized firms. Human-resources management is the economic process that original efficiency-wage theorists attempted, eventually successfully in the GEM Project, to formally model.

It should be noted here that the remarkable information processing and distribution revolution motivated by on-going computer-chip development has again sufficiently transformed efficient business practices to challenge the comprehension of managers of one or two generations ago. The modern revolution, however, has done little to compromise the significant substitution of managerial decision-making for competitive market exchange. Especially relevant, it has not pushed large-firm human-resource management and wage determination back to the marketplace. (Chapter 8)

The Great Fact

That nearly all global progress in living standards has occurred in a single burst that began in the middle-nineteenth century has been named the “Great Fact”. Trend productivity growth was transformed by specialization-based increasing returns associated with the spread of large, hierarchical firms. The organization of that now-ubiquitous class of enterprises was triggered by the development of railroad, steamship, telegraph and cable systems which decreased delivery times and uncertainties for large flows of goods through national and international economies. The wave of relatively uncomplex technological innovations exploiting the increased potential for high-volume, high-speed production motivated the Second Industrial Revolution. Again from Chandler et al. (1997, pp.12-13): “Entrepreneurs and firms pioneered in the commercialization of new capital-intensive technologies by making the investments and creating the new corporate forms required to fully exploit their profit-making potential.” The change was fundamental. As late as 1840, there were no middle managers in the United States.

That over the past two centuries an increasing and now dominating share of global GDP has been produced by large, bureaucratic firms is an essential piece of the “Great Fact”. Macro theorists, to their detriment, never got the message that now omnipresent large specialized establishments are home to optimizing activities that are fundamentally different from what occurs in small firms, making size distribution a necessary part of any model tasked to explain modern economies. The reorganization associated with the Second Industrial Revolution produced a new landscape of technological heterogeneities that had to be accommodated by market economies. Production processes that intensively exploit input specificities, creating complex combinations of scale, high productivity, market rents, workplace information asymmetries, job routinization, and the greatly enhanced value of voluntary labor cooperation, have had to coexist in the population of firms with enterprises that are much more simply organized.

Technological differences are especially consequential when interacting with the only conscious production factor. Employees are the input class capable of recognizing the latitude imperfect information provides for advancing their interests inside the firm. The formal economic method, once extended to rational price-mediated exchange in the workplace, helps explicate the post-SIR complications that reduce micro-coherent market-centric general-equilibrium modeling to a badly incomplete description of labor pricing and use. In short, much of the transformational economic behavior of the Second Industrial Revolution occurred inside large bureaucratic establishments, requiring close attention to “new corporate forms” and creating a companion activity set (workplace exchange) that must be modeled and integrated into the mainstream macro thinking. Generalized-exchange modeling accommodates critical disparities between large and small production establishments, providing economics an additional class of equilibrium, a rest period in the space of optimizing workplace decision rules.

Blog Type: Wonkish Saint Joseph, Michigan

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