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Tuesday, April 16, 2019


Which brings us to the third and most problematic of the sources of accounting ambiguity, joint production, for that is precisely what is at stake when it comes time to allocate the cost of the space in which the two divisions carry out their productive activities.  Speaking generally, joint production is the use of a factor input to produce two distinct salable outputs.  In this case, the input is the company’s building and the outputs are cardboard and boxes.  An oil refinery usually generates an entire array of products from its processing of crude, as does a slaughterhouse from its transformation of beef on the hoof into an assortment of meat products, hides, and other outputs.  It is not too much to say that in a modern corporation, joint production is the rule rather than the exception.

            The accountant, in preparing an annual report of a firm, is called upon to allocate the cost of the inputs that are used jointly in the production process.  As Thomas demonstrates, there is no neutral pattern of allocations that can determine how much of the cost of such a factor is to be allocated or imputed to each unit of the several outputs in whose production process it is employed.  The problems are manifold, as should by now be obvious.  Thomas cites as one example an attempt to distinguish the cost of a building in which are carried out production processes having multiple outputs from the cost of the land on which it is built.  The problem is that tearing down the building would so significantly alter the land values in the neighborhood in which the factory is located that the sale price of the cleared land would in no way reflect the cost to be allocated among the several outputs. 

            Well, enough is enough.  Even these remarks, which might be characterized as accounting lite, are more than any sensible layman would want to read.  Why does all this matter to someone like myself who is trying to assess Marx’s analysis of the transition from capitalism to socialism? 

Perhaps the best way to begin is with the classic essay by Ludwig von Mises entitled “Economic Calculation in the Socialist Commonwealth.”  First published in the original German version in 1920, and included in an English version in Friedrich von Hayek’s widely read 1935 collection of essays, Collectivist Economic Planning, von Mises’ essay is generally thought to be a devastating dismantling of the socialist penchant for central planning.  His thesis, in a nutshell, is that since the free market does the best possible job of pricing factor inputs, through the interplay of individual decisions to buy or sell, the very most that socialist planners could do, in the ideal case, would be to mimic the operations of the market.  Since in the real world they have no hope of achieving that ideal, collectivist planning will always be inferior to free market competition as a way of deciding how most efficiently to employ scarce resources.  Thus, contrary to the expectation of Marx and his followers, socialist planning can never improve on the unplanned outcome of the marketplace, but will fall disastrously short of that standard, producing wastage, bottlenecks, shortages of necessary productive inputs and calamitous failures to meet consumer demand.  In the jargon of modern economists, unfettered capitalism will tend to put an economy on its production possibility frontier, while socialist planning will consign an economy to a position well below and to the left of that desirable location.

The first thing to be said is that in 1920, von Mises was dead right, and I think it is a fair guess that Marx, had he been alive, would have agreed.  Von Mises was of course looking at the fledgling Bolshevik government that had just seized power in Russia, ostensibly in the name of Marx and communism.  Russia was then still a late feudal economy with a tiny nascent capitalist sector pretty much confined to a few cities west of the Urals.  The social relations of capitalist production had scarcely begun to grow in the womb of feudalism, and nothing remotely resembling socialist relations of production could be discerned anywhere in Russia’s economy.  The Bolsheviks were well aware of this fact, and engaged in a lively – ultimately bloody – discussion about whether it was theoretically possible to “skip a stage” and go directly from late feudalism to socialism.  Marx knew that the answer was no, and so, I suspect, did they, but when one has unexpectedly taken control of a vast nation at considerable personal risk, it would have seemed unnecessarily doctrinaire to turn the state over to whatever capitalists one could find and wait patiently for the slow evolution of new social relationships to run its course.  Not surprisingly, what emerged in Russia, and later in the even vaster peasant society of China, bore no resemblance at all to what Marx had in mind when he spoke of socialism growing in the womb of capitalism.

So von Mises was certainly right with regard to the world he was looking at in 1920.  The market clearly did a better job of allocating scarce capital resources than any group of planners could, even though Russia numbered among its intelligentsia some of the best economists in the world.  [Indeed, it is said that some years later when the young Wassily Leontief took his brilliant new technique of linear programming to the Soviet Commissars and offered it as a tool for sophisticated central planning, they dismissed his offer on the bizarre grounds that since Marx only used addition, subtraction, multiplication, and division, Stalin had decreed that his planners must do likewise.  Leontief eventually moved to Harvard, where his theoretical innovation assisted corporate planners to manage their capitalist empires.  Many years later, he was awarded the Nobel Prize in economics.]

But von Mises was fundamentally wrong in his conception of the question under debate.  Marx did not think that socialists could do a better job than capitalists of running a capitalist economy.  Marx had only the greatest admiration for the explosive efficiency of capitalism.  No one has ever penned more effusive panegyrics to capitalism than Marx.  What Marx said was that inevitably, ineluctably, socialist relations of production would develop within capitalism, devised and advanced by capitalists, not by socialist moles burrowing into the heart of enemy territory in an effort to undermine their fortresses.

If market forces were adequate to the task of making rational allocations of scarce resources, there would be no internal impetus for the evolution of new ways of organizing production.  But as we have seen, in a large modern corporation, the play of the market does not of itself resolve questions of allocation, resource use, and profitability.  Capitalists do not develop internal planning models of economic decision making because they have been seduced away from the faith of their fathers by tenured radicals on effete Eastern campuses who have never met a payroll.  They develop new modes of corporate decision making because their accountants and financial experts cannot tell them, in a neutral, objective fashion, which of the available alternatives will be most profitable.  Our cardboard C. E. O., struggling to decide which of his division managers has made the most significant contribution to the firm’s profits, must somehow resolve the disagreement between the two over the proper allocation of the fixed costs of the building in which their production takes place, and over the proper amounts to be charged against the box division’s accounts when it draws its raw materials from the stocks produced by the cardboard division.

Once the firm’s president becomes persuaded by his accountant’s argument, he realizes that the disagreements between his division managers will have to be worked out politically – they will either have to be negotiated, or else he will have to decide them by an exercise of sovereign authority.

            In either case, what has happened, even in this very elementary case, is that a decision originally made for the firm by the market, and then made for the firm by an accountant, now has been transformed into a political decision to be made essentially by some form of political mechanism.  In short, economic calculation has been replaced by political planning.

            No doubt, none of the actors in this miniature drama would consider it in the slightest appropriate for what is usually called the political system to get involved in deciding how fixed costs are to be allocated in the cardboard carton firm. But though there might be many other reasons for keeping the city, the states, or the federal government out of the process, the principal and most plausible reason has evaporated, namely that the decision, being economic in nature, is best made by the impartial working of market forces. The fact of the matter is that the decision isn’t simply economic – it is not actually an objective scientific decision at all. It is a political decision, required in order to resolve a conflict between the incompatible ambitions of the two division managers, one of whom is seeking to hold his job against the threat of replacement, the other of whom is trying to advance her career by demonstrating her ability to run a division profitably.

            The situation we have analyzed in this hypothetical small firm is reproduced throughout the modern capitalist corporate world, with complications, elaborations, and variations that cannot even be hinted at in our example. A major multinational corporation, as has often been remarked, is better compared to a state than an entrepreneurial firm.  Contained within it are huge bureaucratic systems and sub-systems in whose hallways and meeting rooms men and women live their entire working lives.  The processes by which corporate-wide calculations of profitability are made involve considerations of tax codes, local ordinances, international trade, exchange rates, inflation rates and regional differential development patterns that are substantially indistinguishable from the corresponding considerations weighed by economic planners in centralized national economies.

            The running of such a corporation requires systems of data acquisition and retrieval entirely beyond the capabilities of the eighteenth and nineteenth century capitalist firms on whose behavior the original models of capitalism were based. To manage such information systems, and thereby to coordinate the decisions, the purchasing and shipping patterns, the product development time-tables, and the promotional campaigns of the many divisions of the firm require an extremely high level of literacy – both linguistic and computer – on the part of lower and middle level, as well as upper level, employees.  Until it is possible to get reliable answers quickly to questions about employee levels, warehouse inventories, price shifts, exchange rates and capital availability, those charged with the central planning of the corporation cannot even begin to carry out their tasks.

            Nothing resembling this level of information flow, and consequent decision implementation, existed in the early capitalist firms, not even in those that grew to great size in the nineteenth century.  The importation into capitalist industrial organization of the model of military command and control was due at least as much to the sheer unavailability of any alternative way of managing and coordinating the behavior of large numbers of people as to the ideological affinity of the early industrial magnates for militaristic modes of organization.

            In short, when Marx talks about socialism, he has in mind an economy whose stage of development of technology and organization is so far advanced that national planning is technically possible.  Such a stage exhibits both a certain level of technology of production, of data generation and retrieval, and of communication, and also a corresponding level of knowledge and skill on the part of workers at every level, not merely at the top.  Although Marx failed to foresee the digital computer, it is not far-fetched to say that his conception of socialism presupposed it, or something equivalent.

            Marx expected, for sound reasons, that the technology of production, communication, and management required for the central planning and control of an entire economy would develop first within capitalist firms, in direct response to the pressures of competition and the demands of profitability.  And so they have.  An immediate consequence of this process is the transformation of economic calculations into political decisions, within the firm.  Thus, if by socialism we mean the rationally coordinated planning of an entire national economy in such a way as to transform the major economic choices of the society into political choices, responsive to the will of the people, then it is true that socialism has been growing within the womb of capitalism, or at least that the technical preconditions for socialism can be seen to be developing there.

            The economic systems established in the Soviet Union, in Eastern Europe, in the People’s Republic of China, and in a number of other nations self-described as “socialist,” were not in any usable sense examples of socialism.  This description must be denied them not because of the character of their political systems, but quite simply because they did not exhibit either the stage of development of productive forces or the level of development of, and rationalization of, relations of production pre-requisite for what Marx meant by “socialism.” An economy cannot, with the best will and the strongest ruling party in the world, move directly from a feudal or early capitalist economic organization to socialism. The reason has nothing whatever to do with piety, ideology, or the inexorable march of history, and has everything to do with the impossibility of planning food production rationally when you cannot even find out with any precision how many acres are under cultivation, or what the pattern of crop yields is from county to county, and when your work force is computer-illiterate.

            Note, by the way, that the development of efficient techniques of central planning within a modern capitalist corporation is advanced, not impeded, by the ambition, acquisitiveness, and egocentricity of the workers and managers.  Switching over to a planning system in our carton factory does not require the development of socialist consciousness. It requires only that the objective structure of the firm make policy-neutral calculations of profitability theoretically impossible, as in fact they are once the second division of the firm starts to operate. Somewhat more to the point, the coherent management of large modern firms does not require that the capitalist mentality so often credited with the rise of modern capitalism be somehow transcended. The same men [and recently women] who manage the great corporations would, if they were suddenly to find themselves running small firms in a classically competitive environment, adopt precisely the calculations of profitability traditionally conceived as determined for them by the free market. They do not do so when managing large corporations simply because it is technically impossible to do so.

            What, then, is the fundamental difference between socialism and capitalism at its most advanced, rationalized, and centralized?  Under socialism, economic decisions would be treated [I use the subjunctive because there does not yet exist a socialist society] as collective political decisions, to be made democratically on the basis of the aggregated will of the entire people. In a capitalist society, decisions are taken privately, within the firm, in response only to the interests, the will, or the pressures of those who occupy positions of power within the firm.

            The issues available for decision are not at all comparable in the two systems. A socialist society will be presented with choices among economy-wide investment policies or systematic wage policies that simply do not come within anyone’s ambit of decision in a capitalist economy.  This, of course, is the principal source of the greater rationality of a socialist economy.  But the mechanisms for the acquisition and management of information, and the consequent management of economic activity, will have been developed and tested within the capitalist firm – within the womb of the old society.


Unknown said...

Great to see you presenting this work again, Professor Wolff. I recently came across the (new) book below and thought of your paper. It's on my list to read, though I can't yet vouch for its quality. But I thought you and others might be interested:
The People's Republic of Walmart: How the World's Biggest Corporations are Laying the Foundation for Socialism:


Dean said...

"In either case, what has happened, even in this very elementary case, is that a decision originally made for the firm by the market, and then made for the firm by an accountant, now has been transformed into a political decision to be made essentially by some form of political mechanism. In short, economic calculation has been replaced by political planning."

*This* answers my questions! Thank you.

Nick Drew said...

" ... because there does not yet exist a socialist society" is a pretty good let-out clause: but "Under socialism, economic decisions would be treated ... as collective political decisions, to be made democratically on the basis of the aggregated will of the entire people is fairly utopian. Indeed, it's circular (because presumably, if a society isn't achieving this wondrous mode of decision-making well, hey! - it's not socialist!)

Logical sniping aside, I take it you've never worked in industry or commerce? Of course there is politics in large firms - and not just because some perfect scheme of accountancy adjudication "can't exist". (You haven't even mentioned internal transfer-pricing, which is generally a much more keenly-fought battle than allocation of overheads.) There's politics because ... there are people!

You portray the large enterprise as though, through a 'political' process, a single accounting principle will have been settled upon, ultimately by fiat (and it necessarily hurts some and helps others). But here's the reality:

- things are much more fluid and dynamic than the stasis you conjure: accountancy rulings (for internal purposes, as well as for tax etc) change all the time. Someone's up, someone's down in the power stakes. And one division is facing a price war in its market sector this year, and needs all the help it can get. Another division is deliberately being killed off. Yet another is nurturing an embryonic technology and needs to be as lightly burdened as possible. And a fourth needs to show bigger margins to impress the Street. And next year ... it's all different again

- firms don't exist in isolation (unlike 'socialist' governments), but in a marketplace (unless they've achieved monopoly, that perfect - but transient - triumph of the belief in the 'efficiency' of central planning, or so they will argue). Decisions on allocation of overheads, transfer-pricing etc will be made in the context of what the other firms are doing, as viewed through various lenses such as: fashion / fad; 'best practices'; ways of getting an advantage over the competition; what the analysts write; what the banks think - etc etc

- in all this, there are plenty of Darwinian processes at work. Do something that turns out to be clever (by calculation, or good luck, or whatever) and you'll thrive a little more. And the converse. Capitalism benefits from experimentation, trial-&-error, random mutations and the rest. Diversity allows mutation & experimentation with fairly limted societal risk

- finally, on the 'hurt-or-help' issue: it's a rare state of affairs when the relative fortunes of two 'competing' divisions are made or broken by an accounting decision alone (though it could happen that way). Mostly, some division is already thriving / on the way up, and another is already stagnating / on the way down; and it'll make no real difference to their respective fates. And there are a lot more than two divisions. And it's all swirling around (see above). And they'll mostly be happy to have a decisive accounting judgement made and, ideally, enforced consistently; and then get on with more pressing issues.

See, life is much messier and less theory-driven than you leftists can ever imagine! Recall what the good Brian Leiter says: “Marx misjudged the smarts of the capitalist class”. He also theorised too much: rarely a good thing.

Roger Ablin said...

Minor comment - I'm not sure that Leontief developed linear programming. I believe the correct Soviet pioneer was Leonid Kantorovich, the only Soviet intellectual to be awarded the faux Nobel in Economics.

Your analysis seems similar to that of Hilferding, who anticipated wrongly a forthcoming transformation. A lot of your analysis is similar to that of conventional economics and economic history - Coase's work and Chandler's famous The Visible Hand.

Anonymous said...

You're electing to miss the point completely. You cardboard factory could have the most advance super computers but still not be as good as the aggregated price mechanisms in determining the productivity. In your example when the CEO is faced with the question of which division manger yielded more he doesn't need to go the "political sphere" he can simply look at the aggregated amount of revenues that contracts pertaining to each division produced.

In addition, your socialism is always in the future, we may quite realistically doubt the assertion that we will ever reach the epistemic requirements from workers and managers to move to 'true socialism'