The Fundamental Institutions of Capitalism

Ernesto Screpanti

• Publisher: Routledge
• Year: 2001
• ISBN:
  9781134538683
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

The Fundamental Institutions of Capitalism presents a radical institutional approach to the analysis of capitalism. Ernesto Screpanti puts forward a number of provocative arguments that expose common ground in both neoclassical and Marxist orthodoxies. It will appeal to a broad audience of social scientists including advanced students and professio

1 The employment contract, transaction institutions and capitalism

Profit making and labour mobilisation

Mr Boss decides to set up a business to earn profits. To be precise, he decides to use workers to produce pins. The perfect world in which Mr Boss lives has certain peculiar characteristics. There are many workers who, to avoid unemployment, are eager to work for a wage. All individuals are self-interested but loyal, and nobody conceals information. Both Mr Boss and his workers are risk neutral. It is not difficult for anyone to collect the information necessary to take a personal decision, nor does anyone find the economic calculations complicated. All agreements are simple and there are no transaction costs. Furthermore, whatever the technique used to produce pins, the means of production and working skills are not tied to the production of pins and can be disinvested at any time without loss of value, apart from normal depreciation. Finally a criterion of valuation is in force, called ‘the principle of equivalence’, according to which the price of any commodity coincides with its production cost and the present value of its prospective yields. Mr Boss has a major problem: what kind of agreement should he propose to the workers to make them produce profits for him? He considers several options.

The first is to propose that they become partners in his firm. All the partners, including Mr Boss himself, are equal, all of them do the same work and have the same decision-making power. At the end of the production process the partners democratically share the value added (net of interest on capital),¹ and therefore they all earn an income proportional to their productivity. Mr Boss cannot earn any profit.

The second possibility is to give the workers a mandate: to work autonomously in Mr Boss’s factory, i.e. to work by preserving their decision-making power as far as labour activity is concerned. However, their decisions must pursue Mr Boss’s interests. Since the latter knows the workers are loyal, he has no doubt about their will to supply the efforts and intelligence necessary to reach his own ends. The workers will be paid fairly, so that their incomes will be proportional to the value of their services. Mr Boss will again be disillusioned: no profit will remain for him.

The third possibility is to ask the workers to sell him the specific labour services necessary for the production of pins. Mr Boss in this case knows all details of the labour process before stipulating the agreement and is able to define the exact labour services required of the workers. The latter will readily accept the agreement, since their services will be remunerated fairly, i.e. in accordance with the ‘human capital’ from which they originate. Also in this case Mr Boss will discover he can earn no profit, since the value added in production, net of interest and depreciation allowances, will coincide with the value of labour services.

The fourth possibility is to propose a sharecropping contract to the workers: they will take all production decisions and implement labour activity autonomously; at the end of the production process income will be divided into two parts, one for Mr Boss and one for the workers. It would appear that the former could earn some net profit with an agreement of this type, and this will in fact occur if his income share is greater than the interest on capital. But then the agreement will be considered unfair by the workers, since they will have supplied a production and decision-making activity and produced a value, of which only a part returns to themselves. However, in the special case in which the principle of equivalence is applied in defining income shares, the remuneration of Mr Boss will again be nil.

There is, finally, a fifth option: to propose to the workers an agreement by which they accept to give up their decision-making autonomy for a certain number of hours a day, during which they will perform labour activity under the command of Mr Boss. With this agreement there is no need for the workers to be informed beforehand about the labour activity they will be ordered to carry out in the production process. Nor will they be entitled to know it. Their activity during labour time will no longer be their action, since it will be a manifestation of Mr Boss’s will and a means for the realisation of his ends. Whatever income they are paid, there will be no way of linking it to the labour services, since these services belong to Mr Boss. What he will do during their labour time and with their labour activity is his own business and prerogative. Thus the workers’ remuneration does not take the form of the price of a commodity, nor does the value of the product of their activity take the form of a value produced by them. Wage is not the price of labour services, but a compensation for obedience. And there is no reason or possibility of appealing to the principle of equivalence to ask for the present value of labour pay to be equal to the ‘human capital’ embodied in the workers’ capacities.

It is possible therefore that Mr Boss succeeds in using labour activity to produce a net income, i.e. a surplus value, which is over and above the wage paid to the workers for their obedience. Note that surplus value includes interests and rents, besides profits. If Mr Boss aims at maximising his profits, he in fact works at maximising surplus value. Interests and rents are a cost to him, but are not determined by him. Therefore the only way for Mr. Boss to increase profits is to increase surplus value. The employer who controls the labour process is an exploiter who works in the interests of the whole capitalist class, including the rentiers.

The employment contract

Some kinds of contracts that can be used to mobilise labour

To bring out the moral of the story, let me now reformulate its message in a more rigorous form. The scene takes place in a very unreal world. The reader should have understood that the hypotheses describing this world have no descriptive pretensions. In fact they have two objectives.

First of all they sustain a counterfactual reasoning. All the assumptions used in recent neoinstitutionalist literature to account for the employment contract have been removed: bounded rationality, class differences in risk aversion, incompleteness and asymmetry of information, opportunism, costs of control, transaction costs, asset specificity. I want to show that even in this strange world there is good reason for resorting to the employment contract; none of those special assumptions is necessary for the existence of this kind of contract.

The second objective is more ambitious: to bring to light the rationale of the employment contract by showing its real nature. This is why the force of abstraction has been driven to such sidereal heights. The principle of equivalence, according to which the price of a commodity coincides with its cost of production and the present value of its future yields, is not in force in the capitalist world, even if it is in force in most economic theory.² Yet it has been assumed here. It is precisely at this level of abstraction that the real nature of the employment contract can be understood. In fact, since it is not a contract for the sale of a commodity, there is no possibility of applying the principle of equivalence to it.

It is easy to grasp the nature of the employment contract by comparing it to other kinds of contracts that can be used to mobilise work. Four of them are considered: partnership, agency, services, and sharecropping.³ There are two categories of subjects, B and L, who stipulate a contract at time t₀ to regulate the performance of a production activity to be completed at time t₁. The contracts establish that L will be paid an income w, the amount of which can be defined either at time t₀ or at time t₁, depending on the kind of contract. L will perform an operation, O_i, during the period of the production process, t₁–t₀. The various forms of contract differ in several characteristics, in particular: the object exchanged, the time at which w is decided, the time at which O_i is decided, the subject who decides O_i. Table 1.1 shows schematically the main characteristics of the five kinds of contract.

In the Partnership contract two or more subjects confer goods or services for the common exercise of an economic activity, with the aim of sharing its profits. There are many kinds of partnership, but here, for the sake of simplicity, I shall assume that capital is rented by all the partners in equal shares, and that labour services of the same value are contributed by all the partners. Thus profits are shared in equal parts. There is no difference between B and L. The object of transaction in this contractual form is the set of labour services contributed by the partners. The amount of labour contributions is decided ex ante, i.e. at the moment the contract is signed, t₀. The specific labour services, however, are decided during the production process, i.e. in the period t₁–t₀. All the partners have equal decisionmaking power. Finally remuneration is decided in time t₁, the moment of closing of the production process, when profits are distributed. This kind of arrangement cannot generate surplus value for anyone if the income shares coincide with the values of labour services contributed.

Table 1.1 Types of contracts that can be used to mobilise work

With the contract for services subject L undertakes to supply a service or a set of services for subject B without any bond of subordination. L takes an obligation to furnish a specific job and not to carry out a generic labour effort. Both the nature of the service and the remuneration are fixed at the time of stipulating the contract, t₀. The way the service is produced, though, is L’s business, and will be decided during the production process, in the period t₁–t₀. What matters is that, at the established term, L is able to deliver the result of labour activity. Also in this case neither of the subjects will earn a profit if the value of the service is equal to the income paid by B to L and coincides with the cost borne by L.

With the contract of agency the agent, L, takes a commitment to perform actions in the interest of the principal B. The agent preserves his personal autonomy, so that he himself decides the labour services during the production process. His compensation can be fixed at the moment of contract stipulation, but a part of it can be linked to economic performance and decided at the end of the production process. If the principle of equivalence is in force, compensation coincides with the value of the services. The residual income belongs to B, but it will coincide with the interest on capital.⁴

The sharecropping contract consists of an agreement between the owner, B, and the sharecropper, L, by which the latter performs the labour activity and the former supplies the means of production. Although the commodities to be produced can be decided by B at time t₀, the labour services are decided autonomously by L in the period t₁–t₀. Profits are shared by the two parties. Therefore, if the principle of equivalence is applied, the value of the labour services must coincide with the sharecropper’s share, in which case no net profits will accrue to B. Shares need not be fixed at 50 per cent, and in general the sharecropping scheme can be considered a prototype of a vast series of pay schemes in which the compensation of L is linked to the outcomes of labour activity: performance pay, group bonuses, payment by piece-work, sales commissions etc. In all these cases B will get no profits from L’s labour activity if the workers’ compensation coincide with their productivity.

The contract of employment and the capitalist firm

In the employment contract w is decided at time t₀, whilst O_i is decided in the period t₁–t₀. It is the employer who determines O_i, since the contract assigns him the prerogative of deciding autonomously on everything concerning the use of labour. This prerogative derives from the employees’ obligation to carry out labour activities under the command of the employer. In the contract of employment no labour services are exchanged, so that the employees do not need any information about them. The labour services may be known ex ante to the employer, but this is not a necessary condition. In reality, due to the constant drive to innovate the labour process, employers do not normally know ex ante the labour services they will order their employees to produce.

The contract of employment differs from all the other contracts as it does not entail the sale of a commodity. Even the partnership contract, insofar as the partners contribute labour services, takes the form of an agreement for the exchange of commodities, namely a multilateral agreement. Furthermore, the income earned by the workers with the other contracts is compensation for the production contribution brought by their services. This is not so with the contract of employment, in which the workers sell no services. What they actually sell is an obligation to obedience. With this obligation they give up their decision-making autonomy for a certain number of hours a day, and the employer acquires the power of command over them. The labour activity carried out after the contract stipulation is not an action of the workers, but takes the form of an action of the employer. As a consequence, the product obtained by this means belongs to the employer, so that there is no reason to link the workers’ remuneration to their productivity. Of course there is always a production contribution of labour activity, but this is not a worker’s contribution. Finally, precisely because the contract of employment is not a contract for the sale of a commodity, the workers’ remuneration does not take the form of the price of a commodity. Wage is not the price of a ‘labour commodity’ or ‘labour power’ or ‘labour services’. It is compensation for the renunciation of freedom.

The fact that the wage is not the price of labour services is a first condition for the exploitation of labour. Since the production contribution of labour activity does not relate to the worker, there is no way of reducing the wage to the value of labour services; and, since labour is not a commodity, there is no way of referring its value to a production cost. This implies that it is not possible to appeal to the principle of equivalence to determine the wage rate. And, if justification of the principle is sought via an appeal to perfect competition, it could be observed that the wage rate has never been strictly determined by the law of demand and supply – not even at the beginning of modern capitalism, as Adam Smith so well understood.

A second condition for the exploitation of labour occurs in the production process. Since employers have command over the workers, it is their right to direct and control labour activity in pursuing their own ends. And if their ends are reduced to the profit motive, the contract of employment gives them the social instrument for extracting surplus value from the use of labour. Labour services are produced by the employers’ actions, and their product belongs to them. Therefore, by directing labour activity the capitalists can produce a value which is over and above the compensation paid to the workers for their obedience. Note that all the other forms of contract can also be used to generate exploitation, but only insofar as market conditions enable the exploiter (who could be either B or L) to infringe the principle of equivalence. None of the other forms of contract generates the conditions for exploitation in production.

The capitalist firm is founded on the workers’ commitment to obedience and is an organisation based on a hierarchy of power whose purpose is to produce profits. The capitalist firm is a nexus of contracts of employment, the exact opposite of what the philosophers of the ‘nexus of contracts’ believe. To understand its rationale there is no need to know anything about the market, let alone its imperfections. It is not born out of any imperfection in mercantile exchange. The conditions for the existence of the capitalist firm are not generated by transaction costs, information asymmetries, or any other kind of market failure.

The theories that sustain the opposite view are in fact based on a misunderstanding about the forms of contract used to mobilise labour. To understand the rationale of the capitalist firm one must avoid confusing the employment contract with that of agency. With the latter, the agents preserve their decision-making autonomy: labour services are exchanged together with a mandate to define them during the production process. This kind of agreement is perfectly defined in the market sphere. But, if it works, in an economic context in which the agent is risk neutral like the principal, there is no way for either of them to extract profits from the labour process.

It is also necessary to avoid confusing the employment contract with the contract for services. Specific services are exchanged under the latter, and, if the market does not fail, they are paid their real value. When we ask a plumber to repair our wash basin we know the commodity we require and, if the market mechanism enforces the principle of equivalence, there is no way of extracting surplus value from the plumber’s work. The contract of employment is another thing, and must not be considered as an incomplete contract for services.⁵ Since it is not a contract for the sale of a commodity, it does not contribute to the market allocation of labour. The allocation of labour is defined in the labour process within a hierarchical structure. The rationale for this structure has nothing to do with market failures, transaction costs, uncertainty, complexity, technical change and so on: it is simply to be found in the profit motive. Note that the employment contract does not presuppose employees know ex ante the nature of the labour process. The contrac...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Tables
• Introduction
• 1 The Employment Contract, Transaction Institutions and Capitalism
• 2 Individuals, Culture and Behavioural Institutions
• 3 The State and Normative Institutions
• 4 Forms of Co-operation and Power
• 5 Production Governance Structures
• 6 Different Forms of Capitalism
• Conclusions
• References