Misconceptions of power: from Alchian and Demsetz to Bowles and Gintis.

Author:Palermo, Giulio


In this paper, I critically discuss the debate on power within mainstream economics. In that debate, apparently opposite conceptions have been developed, spanning from the ultra-liberal view of Armen Alchian and Harold Demsetz to the radical approach of Samuel Bowles and Herbert Gintis, and including more moderate positions developed within transaction-costs economics, propertyrights theory, and within part of the (old) institutional school. My thesis, however, is that the acceptance of neoclassical methodology (and its implicit ontology) that these approaches have in common leads them to the same conception of power as being an exception to perfect Walrasian competition. (1)

In the first part of the paper, I review the debate and single out the common methodological and ontological traits of these theoretical approaches to power. In the second part, I criticise this general conception by pointing out its theoretical contradictions and the mystified view of capitalist relations that it incorporates.

  1. The debate on power within mainstream economics

    The debate on power in modern economic literature starts formally in the 1970s in the domain of the theory of the firm, with the contrasting contributions of Stephen Marglin (1974, 1975) on the one hand, and Alchian and Demsetz (1972) on the other. The former argues that power relations play a decisive role in the organisation of the firm; the latter contend that formal authority within the firm is only an appearance that hides a reality of perfect reciprocal freedom. Ronald Coase's (1937) paper on the nature of the firm, however, forms part of the background to the debate. In that paper, Coase explicitly sets the mechanisms of authority and command within the firm against the market price mechanism as alternative modes of coordination.

  2. 1. Coase's starting point

    Coase's paper, let us remember, is not about the nature of capitalist power relations, but rather deals with the nature of the firm in capitalism. Such a problem may appear trivial, for the firm is an integral part of the capitalist system and therefore, one might argue, the nature of the firm and of other institutions of capitalism can be understood by analysing the historical origin and developments of capitalism.

    This problem, however, is anything but trivial if placed in the context of neoclassical economics--a context in which economic restitutions are seen as universal and everlasting, just like the economic problem they solve: the allocation of scarce resources. In neoclassical economics, the firm and the market are just two alternative allocative mechanisms. The problem, however, is that in the general equilibrium model, coordination between isolated individuals both in the sphere of production and in that of consumption takes place entirely within the market, which makes all other institutions economically redundant--the story told in order to describe the general equilibrium model sometimes makes reference to the firm and to other institutions (such as the family), but analytically, they are superfluous add-ons. This leaves the internal relations of the firm undetermined. As Paul Samuelson (1957: 894) put it, 'in a perfectly competitive model, it really doesn't matter who hires whom; so let labor hire capital'.

    The general equilibrium model, like any theoretical model, is defined by a decision-making context (DMC) and an organisational structure (os).The former defines the features of the world in which agents of the model live and interact; the latter defines the relations between them and the way in which they interact. The DMC of the Walrasian model is characterised by perfect information, full rationality and zero transaction costs. In this paper, I will refer to it as the 'perfect' DMC. The os is a completely decentralised one, based on market relations and perfect competition.

    Starting from the fact that the firm is redundant within the Walrasian model, Coase raises his scientific questions: Why do hierarchies exist in the market system? Where do power relations within the firm come from? These questions can be approached in many ways. Coase's method consisted in exploring the reasons why authority and direction can be economically superior to market relations in a context of positive transaction costs. Methodologically, Coase thus rejects the perfect DMC, and investigates how OSs with some degree of centralisation might perform better than the Walrasian one. (2) Within this logic, Coase's explanation of the nature of the firm insists on the existence within the firm of a relation of formal authority that is absent in the market. In one way or another, thus, Coase introduces a form of power into the neoclassical model and uses it to analytically characterise the firm as an institution that is qualitatively distinct from the market. If power is the ability to condition the behaviour of other individuals, then authority is the strongest form of power, for it implies that one subject orders and the other obeys. In terms of decision-making theory, A's authority over B is expressed by A's ability to restrict B's decision-making to just one option. (3)

    Theoretically, the introduction of authority as a specific coordination mechanism operating within the firm solves the problem raised (that of the nature of the firm); but on the other hand, it cracks the harmonious vision of interpersonal relations provided by the general equilibrium model. From the viewpoint of the liberal doctrine (which is at the origin of neoclassical economics), the problem is thus to reconstruct a harmonious vision of spontaneous (and possibly Pareto-efficient) interactions in a context in which there exists, alongside the competitive mechanism of the market, a mechanism of command working within the firm.

    Some forty years after its publication, Coase's paper has become the starting point of a new research programme which aims at explaining all the institutions of capitalism and their internal power relations. This research programme is developed in particular by the 'new institutional economics' school of thought and has, in my interpretation of that school, developed along two distinct lines. In the first approach, Coase's intuition has been developed by a denial of the existence of real authority relations within the firm, and by the explanation of the mechanism of command as a specific form of competition. The main exponents of this line of research are Alchian and Demsetz. In the second, the costs and benefits of competition and command have been analysed systematically in the attempt to determine virtues and vices of markets and hierarchies. Oliver Williamson's transaction-costs economics and the property-rights theory of Stanford Grossman, Oliver Hart and John Moore are the main contributors to this line. (4) Outside the sphere of new institutional economics, research on power and the institutions of capitalism has been developed in particular by exponents of radical political economics such as Bowles and Gintis, and by exponents of the institutional school, such as Victor Goldberg. In the pages that follow, I discuss these theoretical positions and examine the reasons why acceptance of neoclassical methodology (and its underlying ontology) engenders a narrow conception of power, viewing it as an alternative mode of interaction with respect to Walrasian competition.

    1.2. The contractual approach of Alchian and Demsetz

    The idea that capitalism is characterised by the absence of any substantial power relations between individuals has been vigorously defended by Alchian and Demsetz (1972). Their paper is one of the most cited contributions on the subject of interpersonal relations occurring within the firm, and has become the starting point of a new approach to the study of capitalist institutions. In their 'property rights approach', they explicitly deny the existence of any form of power or authority even in those contexts in which, according to many, they are clearly manifest.

    Alchian and Demsetz consider production within the firm to be the result of the cooperation of individuals belonging to a team. The essential feature of team production is the impossibility of determining the relative contribution of each component of the team to final production, which makes it difficult (1) to fix an efficient level of remuneration for each of the different work activities, and (2) to prevent negligent and free-riding behaviours within the team (also see Alchian, 1987). Such difficulties raise a problem of monitoring. From the assumption that the benefits of monitoring (an increase in overall productivity) are greater than its costs (the wages of the monitor), it follows that there is an incentive to est-ablish a monitor. The monitor, however, has no real power over the other members of the team, since he is subject to the same discipline imposed by market competition, in the sense that he would be replaced if another member of the team were to offer the same monitoring activity at a lower price. In this way, Alchian and Demsetz bring all the relations within the firm back to market relations and, in their discussion of the boss-worker relation, show that hierarchy within the firm is only apparent. This is how they discuss the boss-worker relation.

    It is common to see the firm characterized by the power to settle issues by fiat, by authority, or by disciplinary action superior to that available in the conventional market. This is delusion. The firm does not own all its inputs. It has no power of fiat, no authority, no disciplinary action any different in the slightest degree from ordinary market contracting between any two people. I can 'punish' you only by withholding future business or by seeking redress in the courts for any failure to honor our exchange agreement. That is exactly all that any employer can do. He can fire or sue, just as I can fire my grocer by stopping purchases from him or sue him for delivering faulty...

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