Many people do not understand what capitalists do within capitalism. Some suggest they ought to be removed, as they are just parasites who tax the productive elements of society (e.g. workers)

(I)

It is said, for example, that capital income (rents, interest, dividends, capital gains) does not come from producing anything, but from owning. It’s not from matching capital with labor and such, because it’s entrepreneurs who do that. To a point, it would be workers (CEOs, HRs, etc) too.

Elon Musk, or Amancio Ortega, or Jeff Bezos are both workers and capitalists. As workers, what they do is to manage the companies they also partially or totally own as capitalists. It is easy to see how an assembly line worker, working hard for hours, adds value to the product. It is somewhat less easy to see how an engineer, looking at a screen, scribbling unreadable things in a piece of paper, and producing models in 3D to be later used in manufacturing, adds value. The engineer is not sweating, after all. Yet the engineer earns more than the assembly line worker. The reason is that the engineer is more productive. Or technically, that the marginal productivity of engineers is higher than that of assembly line workers, in part due to there being more of the latter than of the former.

CEOs appear to have expensive lunches with other highly paid workers, sit around doing nothing, and ordering people around. They don’t even need to do the research to take decisions: they have other people to do that for them. A CEO can be sometimes seen as someone who pushes Yes/No buttons in response to corporate needs. The thing is, that seemingly easy task is incredibly complex. A wrong answer can cost millions, or even bankrupt the company. A mistake an assembly line worker makes can be, usually, easily fixed, and there controls in the factory to ensure quality. Quality is relatively easy to measure against well defined standards. But if a CEO approves a decision to build a new factory in India instead of in Iran, or if she decides to increase dividends rather than investment, there is no one to say she was wrong. Those mistakes can take years to make themselves evident.

It is sometimes said that there exists real uncertainty (e.g. Knightian) in markets. One key human skill that will take time to be replicated by machines is to aggregate uncertain information to craft productive plans that are able to succeed even when facing such an uncertain world. Accordingly, markets reward CEOs in proportion to their massive importance.

You could, in theory, run a company without workers, purely using machinery. But you can’t escape the fact that someone has to decide what to do with that equipment. What to produce? When? How? How to price it? Those decisions are orders of magnitude more important than soldering, riveting, programming, or assembling anything. People who think otherwise are reasoning from either wrong intuitive economics, or from wrong economic theories of value.

But CEOs are workers, and this post is about capitalists.

(II)

So what do capitalists do?º

According to some people, they do not produce anything. They just happen to own stuff, and they get money because that stuff is scarce. It is said that capital income is unearned plunder, just from owning things, not adding value to anything, just taxing the economy. If this is so, an economy without capitalists would, perhaps, be better than an economy with them.

Let’s then assume that capitalists are removed from the economy. Now, a corporation that was previously controlled by some thousand tiny capitalists that each owned a few shares and some few big ones is left uncontrolled by them. A couple of things can happen now:

The CEO keeps acting as CEO, and becomes the new de-facto capitalist The company becomes a cooperative, and profits are distributed to workers by some mechanism. Now, workers become the new capitalists. Some society-wide entity receives the profits and does whatever some elected politician wants it do with it. This makes everyone a surrogate capitalist (a public bureau would be managing the money and profits). This entity would get a % of earnings from each corporation. The percentage would be set in such a way as to make sure whatever salaries are set by the company are adequate. In practise, the agency would have to calculate how much income generated by a corporation comes from labour, how much comes from entrepreneurial discovery, and how much comes from capital.

Option 3 is plagued with problems, and it supposes the end of capitalism, as there ceases to be a market for capital, and all the means of production become centrally owned. If you read economic history books about the Soviet Union, you know what to expect. We’ll explain the problems of this in more detail later on.

Option 1 is not what dislikers of capitalism have in mind, as it seemingly just keeps capitalists around, just reducing their number, and thus concentrating their power.

Option 2 is what they usually think of. But see that here you are not abolishing capitalism or capitalists. You are just forcing the capitalists of company X to be the workers of company X. You could still say that if, say, Apple is made into a cooperative, Apple’s workers are taking advantage of their position as owners of Apple, as they keep the profits to themselves rather than giving them away. They would be getting extra profits ‘just because’ they own Apple, in addition to the wages they make as workers.

(III)

Let’s look now at how worker-owned corporations work. Some examples are a few banks (like Crédit Agricole), Mondragon, John Lewis, The Cooperative Group. The largest right now is the relatively unknown Indian Farmers Fertiliser Cooperative Ltd.

Seemingly, then, there is nothing stopping worker-owned companies from spreading.

A brief literature review (Pencavel, 2012, Pérotin 2016,) highlights some problems for cooperatives, among which there is the ‘degeneration’ argument: coops will become capitalist enterprises. The original workers will just hire non-owner workers and in the long run, they will be able to stop working, living from profits alone. In Mondragon, for example, 10% of workers were non-owners in 1990. In 2007, 70% are in that situation. It is rare for a co-op to employ only and exclusively owner-workers.

Other argument is that equal division of revenues may provide weak work incentives. Managers can only stay as managers as long as workers approve of them, which may generate the short-term problems present in modern-day politics, and the company may increase its aggregate time preference (i.e. increase wages at the expense of investment). It is also said that co-ops will be slower to adopt innovations that may save labour, in an effort to keep every member employed.

Another argument is that if the firm is managed by a direct-democratic process, it may generate perverse incentives, similar to the ones described above. Whether this will be superior to a regular CEO-managed and shareholder-owned corporation will depend on the relative talent of CEOs and workers in managing companies. The democratic process may also introduce conflicts between heterogeneous preferences that are less salient in regular companies: the CEO has an overarching goal of maximising profits for shareholders, and profits are easy to measure. This goal is compatible with others (e.g. Corporate Social Responsability), nonetheless.

There are also arguments for worker ownership: If workers own the machines and equipment they use, they may care better for it, and perhaps there will be less need for supervision relative to a capitalist company.

Another argument is that profits will accrue to workers, so their effort becomes higher compensation in a more direct way, which is always a good incentive.

Some facts from the empirical literature:

Cooperatives tend to be larger than regular companies (greater median and average number of employees). This is partly because cooperatives are born larger than other companies (many companies start with just 1 or 2 employees, while cooperatives begin with 4 on average)

There are no obvious sectors where cooperatives are better than regular companies, or viceversa.

Cooperatives survive as long or longer than other firms, controlling for industry, starting wage, size, and year of creation.

Capital intensity (fixed assets per employee) is lower than in conventional firms, but there are some studies that show that this is not always the case.

Worker cooperatives are more productive, on average

Cooperatives tend to adjust pay, rather than employment, in response to demand shocks. That is, they hire and lay off less.

Some suggest (Schwartz, 2011) that the reason why cooperatives are not the predominant form of firm in the market is not because they are worse, but because their formation suffers from a collective action problem: individual workers do not know about worker cooperatives (they are rare) and how to set them up, and do not have the resources to start them on their own. Capitalists could be seen as market entrepreneurs who profit from solving the problem of bringing together resources.

However, the fact that, historically and for very long periods of time capitalist ownership has been the norm, suggest that it does have some advantages. If worker ownership is better overall, and given that technology tends to reduce transaction costs, and thus make collective action problems easier to solve, then we would expect worker cooperatives to become more prevalent in the future.

Finally, it can also be the case that there were cooperatives are more efficient, they appear, so that the social optimum of cooperatives is well below 100% of total firms. [1]

(IV)

The surprising effectiveness of worker cooperatives is not problematic for capitalism: instead of having shareholders, you have workers acting as capitalists. You still have capital markets, and varied ownership of capital goods. It does show that in some circumstances, expropriating shareholders and giving the ownership to workers may be a non-negative-sum game, at least from a static point of view, if those workers do a better job at controlling the firm than shareholders. But from a dynamic perspective, and economy where expropriation and redistribution towards workers is expected will work differently than one in which it doesn’t happen, so even if an individual case may seem economically efficient to expropriate, it may not be so in the long term. This discussion glosses over the ethical case for respecting private property, independent of efficiency, which I consider important.

Worker ownership would not, by itself, dispel the critique that there are people earning income without doing anything to earn it, ‘just from owning’. Workers in a hypothetical Apple co-op would get more profits than the equally hard working owners of Mondragon. People might think it is different because they would see that only people (workers) who do something visible are acquiring income, but it’s just that the roles of capitalist and worker are overlapping.

If worker ownership is not enough to end capitalism, one would have to turn to Option 3. Here you have the problem of there being just one ultimate power that decides over every capital allocation in the market. The Public Board of Investment would receive petitions from workers to give them resources to start new cooperatives, and it would decide who to give control power over capital to. There would be no stock market, but companies could post their value as their discounted expected future revenues. This would miss input from anyone who might want to change that figure. Apple might say that it’s worth a certain amount, but others can disagree in the stock market and short it. In the end, those with better prediction skills are rewarded in the stock market, which tends to ensure that information gets aggregated relatively efficiently.

You can imagine this as a world in which there is only equity-based venture capital (where the venture capitalists takes 100% equity), and the only venture capitalist is a Public Board.

Why would this underperform capitalism?

(V)

Basically, because the Board would not be challengeable. If one has an idea that has been rejected by the board, you can’t implement it, period. There is no other agent in the entire economy who can finance you.

So maybe can you fix this by having thousands of analysts, and each one of them can decide? If one rejects your proposal for funding, you can take it to another analyst of the Public Board and hope they accept it.

This takes the problem one step further. The analysts will have a budget allocation from the Public Board, which will be decided for them by a manager.

Okay, so let’s have lots of managers to distribute money!

But someone would have to assign money to the managers mow. Say, you have 1000 analysts, and 100 managers, so each manager gets 1/100 of the total money earned by the Public Board and uses it to hire/fire and reward its 10 analysts. But why 1/100 per manager? Why not give more to the more successful managers.

The system is then improved with an algorithm that rewards managers according to their success. But which criteria to use for the algorithm? Whoever designs it is again in the position of being the sole decisor for the whole economy.

The problem is not solvable the way I’m trying to solve it here. Yo really need separate capital ownership so that every piece of capital equipment can be potentially owned by everyone.This can be approximated adding epicycles to the basic market socialist model to make it more and more like capitalism. This discussion ignores incentive problems, and assumes everyone will be well behaved, but those problems would be there.

(VI)

Capitalists do three useful things: to refrain from consumption, and invest instead, to allocate capital, and to bear risk. Even in my market socialist example this still happens, only that the whole society is made a collective ‘capitalist’.

That is: First, you decide to set apart a fraction of your resources for future use. Then, you decide where to invest those resources in. Then, you benefit from the upside, or suffer from the downside of that decision.

Even something as simple as owning a pension or investment fund is a valuable activity. First, you are not consuming the money, so you are not demanding resources that others can use. Then, you are investing the money in a particular fund, so you are favouring those productive plans vs others in an economy. The money you invest goes to buy shares of a set of companies. So first, selling shareholders are rewarded for their past performance. Then, the performance of the value of those newly acquired shares will determine your future benefits and losses.

And also, the value of the shares themselves will serve for others to measure the performance of the company, which is useful when new shares are issued.

In capitalism, no one is rewarded ‘just for’ owning. I own a few books, and I’m not earning anything for them. Not even ownership of the means of production automatically generates rewards. You can buy an Airbus A380, park it in a field, and wait as much as you want, and you are not getting income from there anytime soon. The same goes for a landlord: a crumbling house in the middle of nowhere is almost worthless. A well furnished, nicely looking flat in the middle of London can cost a fortune.

Capitalists are rewarded for performing useful functions for the rest of the economy. And even marxists end up admitting this, as pointed out at the end of this talk. Key paragraphs:

Let us take, first of all, the words “proceeds of labor” in the sense of the product of labor; then the co-operative proceeds of labor are the total social product. From this must now be deducted: First, cover for replacement of the means of production used up. Second, additional portion for expansion of production. Third, reserve or insurance funds to provide against accidents, dislocations caused by natural calamities, etc. […] Before this is divided among the individuals, there has to be deducted again, from it: First, the general costs of administration not belonging to production…(Marx, 1875) It has often been contended that in the future society everyone will have the right to the full product of his labour. ‘What you have made by your labour, that you will receive.’ This is false. It would never be possible to realize it fully. Why not? For this reason, that if everyone were to receive the full product of his labour,there would never be any possibility of developing, expanding, and improving production. Part of the work done must always be devoted to the development and improvement of production. If we had to consume and to use up everything we have produced, then we could never produce machines, for these cannot be eaten or worn. But it is obvious that the bettering of life will go hand in hand with the extension and improvement of machinery. It is plain that more and more machines must continually be produced. Now this implies that part of the labour which has been incorporated in the machines will not be returned to the person who has done the work. It implies that no one can ever receive the full product of his labour. (Bukharin, 1920)

Someone will be dealing with the consumption/investment tradeoff, and someone will be choosing where to invest, and someone has to bear risk for those decisions. In communism, the entire society, as one entity, bears risk, and very indirectly, decides how much and where to invest. Aggregation of decisions happens via voting, or comittees. In capitalism, every person decides all of that for themselves, with the possibility of letting others take more fine grained decisions (e.g. invest on a pension fund, and then the fund picks companies). Aggregation of decisions work via prices, which, as we know from economics, convey signals far better.

So can you have an economy without capital and capitalists? Yes, you can, but worker-owned firms do not suffice. You have to socialize the entire capital stock. But the functions that capitalists perform will still be performed by someone, so those you cannot get rid of without consequences, for those functions are economically useful and necessary.

Further questions

What about the so called ‘sovereign wealth fund socialism’. That will only work within a market. Full market socialism will end like regular central planning socialism. How large can a SWF that invests on its own economy be? What do the empirical literature say about this?

EDIT: Meta-analysis that shows that worker-owned companies perform slightly better than non-worker-owned companies.

[1] I’m not very familiar with the literature on worker cooperatives, so my confidence in section III is not very high. I remember there were theoretical arguments why they are not prevalent, but the History of Economics is the story of how theoretical arguments fail and institutional innovations succeed. apparently, the key book on the matter is Dow’s Governing the Firm: Worker’s control in theory and practice., which I haven’t read.