no third solution

Blogging about liberty, anarchy, economics and politics

Category Archives: Economic Theory

Democracy and the Right of Exit

August 19th, 2009

I believe “democracy” is fatally flawed. It’s a topic about which I’ve been meaning to write for some time. On that topic, William inquires

Explain to me again why corporations and cooperatives come to decisions through majoritarian democracy? …And I’ve been struggling to comprehend this for nearly a decade. Seriously. What on earth could be more arbitrary and totally irrelevant to the efficient management or allocation of resources?

Indeed. Unfortunately, today is not the time for me to write about democracy per se, but this comment by William renewed my interest in the matter, and set up a tangent for me to follow, if only briefly. It seems to me that the subtext of his question is, “Isn’t there a better way to do things?”[1], in which case William’s inquiry is really one of organizational theory, a topic on which I do not pretend to be an expert.

But for the topic at-hand; is participatory democracy in these circumstances really “arbitrary and totally irrelevant to the efficient management or allocation of resources”? I disagree, conditionally.

Where the right of exit is denied the individual, the majority exercises tyranny over the minority.

When people organize, voluntarily and in a co-operative manner, decisions must ultimately be made which impact the constituent pieces of the organization. And the rules by which future decisions will be made ought to be the product of an unanimous decision. This is an important condition, without which tyranny (in one form or another) is assumed to be the default. The contributors must start from a position of equality with regards to one another, and they must maintain the right of exit or secession.

Thereafter, being dissatisfied with the way an organization is being run, the way resources are being allocated or projects are being managed, individuals have several options:

  1. Propose a better solution that the organization adopts (unfortunately, via majoritarian democracy)
  2. Bail out of the organization, taking with you that which is yours

The “exit” option is the alternative: disassociate, and take along whatever knowledge and capital is proper. However, for any sort of organization (cooperative, collective, corporation, etc.) comprised of more than one individual and their attendant (but collectively held) properties, divestiture can be a difficult process[2].

Where the right of exit is tolerated, abiding by a “majority” decision is tantamount to unanimity.

In the real world, transaction costs are not zero, and abiding by a majority decision may in many instances simply be the path of least resistance; in some circumstances the actors may judge that even though they disagree with the “majority,” the process of divestiture affords no greater opportunity, in which cases they agree to abide by the majority decision..

Although I welcome alternatives and I am open to suggestions, it is simply the only thing other than tyranny, that 10,000 years of collective human ingenuity has been able to achieve. There is no guarantee that its product will be perfect, or efficient, or even satisfactory, but so long as the right of exit is permitted, I have no serious objections with cooperative democracy.

  1. Of course, one never need rely on squishy techniques like “democracy”, in the absence of collaboration, but since the question presumes the existence of a collaborative organization this alternative is not an option.
  2. I presume divestiture would be nearly impossible in certain circumstances, namely those in which the right to private property is not recognized, and therefore the dissatisfied individual has no recourse to the tyranny of the majority, in all of his daily affairs.

What is Profit?

July 11th, 2009

This question comes up from time to time, so I’ll answer as best I can.  I choose to use the definition in its pure, unadulterated form, a close approximation of which is given by Investopedia:

A financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses … needed to sustain the activity. [link]

This is quite close to the definition I recently used in Profit IS Justified by Entrepreneurial Risk: for any given interval, Profit equals Revenue less Expenditures. Incidentally, this is not that far off from Franc’s definition (you may recall that Franc vehemently disagreed with the position I took in the aforementioned post) given in a post about the Corporate profit motive, with which I agree at least somewhat [1] in spirit:

In a free society, where there is no exploitation, the profit you make on a given product is, in general, the material expression of how other people evaluate the worth of your product… individual profit [is] something we can understand and contend with in a free society.

You’d almost think he was channeling Mises.[2]  Although individuals may also experience “profits” by exploiting others (more on this, below), there is nothing either explicit or implicit in this definition about exploitation. Consequently, profit (or loss) is the end-result of all production, undertaken by anyone, within any socioeconomic framework.  Profit (or loss) is what remains after the bills are paid.  Therefore I conclude that exploitation is neither a necessary nor sufficient condition to bring about profit, and I reject the Trojan Horse definition, which smuggles the assumption that profit requires exploitation.

But what about the exploitation?  If your definition of “profit” includes this smuggled premise, in my opinion you are really describing an entirely different animal. I more closely associate the exploitative phenomena with economic rent (The Economist, for its faults, gives a very precise textbook definition):

[Economic rent] is a measure of market power: the difference between what a factor of production is paid and how much it would need to be paid to remain in its current use… In perfect competition, there are no economic rents, as new firms enter a market and compete until prices fall and all rent is eliminated.

I’ve alluded to this in the past.  The invaluable functions of the price system (which have no corollary in a non-market economy), are its ability to send signals [3] to the market.  By following profits and avoiding (or cutting) losses, the tendency of a free economy (one where competition is as atomistic as possible) is towards equilibrium, and the existence of profit is a fleeting disequilibrium which signals to individuals, “Not enough of X is being produced!”

For if enough were being produced, there would be no profits to be had, and if instead too much were being produced, there would be mounting losses.

Production will increase in those spheres where profit is to be gained, the increasingly available quantity of product in this market will drive prices down to a theoretical minimum or perhaps temporarily even lower. At this “equilibrium” price revenues are just enough to satisfy opportunity costs. Accordingly, the experiences of “profit” or “loss” are the calculus used to right the economy when it’s out-of-whack — to coordinate the infinite array of human desires with the finite array of resources at our disposal.

At the very least then, the exploitation theory of profit would need to assert that non-exploitative profit is a catalyst for economic rents, in other words, it would need to negate everything we understand about perfect competition and economic disequilibria, and most of price theory, to boot.

Why Profit?

The “evenly rotating economy”, one with neither profit nor loss, (in which all needs are omnisciently forecast, and all resources are allocated in precisely the right quantities, times, and places, such as to satisfy those needs at the precise moments of their realizations) does not exist.

If, under the above definitions of profit, rent and competition, you’re still asking yourself why anyone needs to profit, you might as well be asking yourself, “Why does anyone need to eat?”  As the purpose of eating is to sustain life, the purpose of production (whether it be for your own use or another’s) is profit. Eating permits us to live another day, while profit allows for that day to perhaps be more enjoyable than the previous.

  1. c.f. Mike Gogulski’s reply for an accurate summarization of my objections thereto.
  2. c.f. Mises 1949, p.299. “Production for profit is necessarily production for use, as profits can only be earned by providing consumers with those things they most urgently want to use.” — h/t QuebecoisLibre
  3. Prices convey information about the magnitude and intensity of any of the infinite array of human wants, desires, and needs, and about how to best allocate the finite resources at man’s disposal, which can in no other way be conveyed as quickly, as precisely or with as little effort.

Profit IS Justified By Entrepreneurial Risk

July 4th, 2009

In his most recent post, Profit is not justified by entrepreneurial risk, Francois Tremblay appears to be baiting the big-tent Libertarians into defending the current economic system, which they quite wrongly describe as a “free market”. Or maybe I’m just in a particularly polemic mood (it wouldn’t be the first time). I’m not a “Libertarian”, but I’ll bite, if only to clear the air.

I have probably said it before, but in case I have not, let me make myself abundantly clear: the problem is not teh evil “profit”.

In a freed market, the return to labor is profit, when workers produce and sell products, what they receive in exchange for their production is sales revenue, not wages. Any net income (over and above their expended outlays) resulting from these sales is profit, not wages. In a truly free market, we’re all entrepreneurs. The degrees of risk we each accept in exchange for certain returns, of course, will vary widely by individual case.

since the workers take just as much risk as the owners.

The argument that “the workers” take as much risk as the entrepreneurs —in a free market— is patently false. The workers don’t take anywhere near as much risk as the entrepreneurs. The workers receive income for their production even if the ultimate product turns out to be a dud and generates 0 revenue. On the other hand, the entrepreneurs bear nearly all of the risk that others are unwilling to undertake. We know this is true, because if “society” was willing to bear these risks at a lower premium than the entrepreneur, they would’ve already done so, and we wouldn’t be talking about entrepreneurs.

Workers have to contend with losing their jobs and taking a major hit while looking for another one,

Meanwhile, entrepreneurs have to contend with losing everything, property, belongings, family-life, reputation, credit, etc. On the other hand, up until the entrepreneur closes shop, and the employees are pink-slipped, the employees benefitted (in a rather ironic reversal of the zero-sum-game) from the receipt of wage income in gross excess of their contributions’ actual value to society which may in some extremes be 0 or negative.

while the rich owners benefit from lenient bankruptcy laws.

This is a clear-cut example of “poisoning the well”. First, the assumption that the entrepreneur is rich ex ante (or some other primitive accumulation nonsense), the corollary to which of course is the use of “rich” in pejorative [1]. Whatever. Furthermore, the assumption that lenient bankruptcy laws exist to the benefit of the entrepreneur is not really a slam-dunk, and is a statement to which I could offer at least one serious objection [1].

Profit, which in a freed market may accrue to the controlling interests of any factor of production (i.e., land, labor or capital) is indeed justified by entrepreneurial risk. In a freed market, anyone who undertakes any productive endeavor is an entrepreneur. Some may choose to take the relative security of “wage” labor in lieu of pure entrepreneurialism (i.e., the net of my revenue less expenses is my “profit”), but I submit that under these conditions, these individuals are no less entrepreneurs. The only distinction is that they prefer the relative security and stability of a certain type of employment, to other arrangements.

The problem is a disparity between “profit” and “wages”, the result of a perversely unfree market.


1. Of course we know from observation that many entrepreneurs were not rich by anyone’s definition, when they began their undertakings. And we also know from observation, that many entrepreneurs (the vast majority, really) ultimately fail, and never become “rich” enough to vilify. Even if the entrepreneur is “rich” to begin with, this descriptive fact alone says nothing about the legitimacy of his earned, acquired, or found position of wealth with regards to any other.

2. Since the counter-party in any bankruptcy filing consists of either another “rich” entrepreneur, or a banking cartel, it would seem that however lenient are the bankruptcy laws, they result in a total wash. (Unless it could be demonstrated that the bankruptcy laws also are detrimental to the non-entrepreneurs. Plausible? Perhaps. But this argument was put forth, and so I’m not contesting it.)

no third solution

Blogging about liberty, anarchy, economics and politics