Myth and Metaphor in Orthodox Economics

This is Chapter 2 from: Ellerman, David. 1995. Intellectual Trespassing as a Way of Life: Essays in Philosophy, Economics, and Mathematics. Lanham MD: Rowman & Littlefield.

Discussion of the fundamental questions of political economy is today almost completely clouded and distorted by a number of basic myths and metaphors.  Deconstruction is necessary before constructive discussions can begin.  The myths and metaphors are concerned with basic conceptions about property and contract, not with prices and markets.  As layer upon layer of distortions are removed, new facts and new perspectives on old facts will emerge.  These facts have fairly direct normative implications, but the disagreements and controversies are about the facts, not about norms or prescriptions.

There is one myth that is so basic to the perception of the capitalist system in both the East and West that we call it the “Fundamental Myth” of the capitalist system.  That myth is the whole idea that a firm or enterprise is owned as a piece of property in the capitalist system.  This claim is, of course, sensitive to exactly how one defines “firm” or “enterprise.”  We define the “firm” as the legal party that is the residual claimant for some given productive or business activity—the legal party that owns the outputs and pays for the inputs of the activity.

If one always identifies the firm with a corporation, then a corporation is, of course, owned as a piece of property.  But a given corporation need not be the “firm” with respect to some given productive or business activity.  When a corporation does function as the residual claimant for a certain activity, then that is the result of the current pattern of contracts (e.g., the fact that the corporation hires in the labor instead of hiring out its capital).  If the pattern of contracts changed (e.g., when labor hires capital instead of vice versa), then the residual claimant in the productive activity changes, but the ownership of the corporation is still the same.  Thus the identity of the firm is determined by the contractual fact-pattern (principally, the direction of the hiring contracts—”Who hires what or whom?”) even though the ownership of corporations is determined by the distribution of property rights.  Firmhood is a creature of contract, not of property.

When a nonbankrupt corporation has customarily undertaken a given productive activity, then it is “unthinkable” to consider a change in residual claimancy through a mere change in the hiring contracts.  In addition to being “unthinkable,” there might be high barriers of transaction costs that would hinder rewriting and reversing the hiring contracts.  The corporation might also have monopoly ownership of certain of the inputs.  These mental and cost barriers conspire to give the customary contractual fact-pattern the appearance of a “property right”—the “ownership of the firm.”

The “discovery” of the contractual determination of firmhood (residual claimancy) opens up the question of property appropriation in production.  If not the “ownership of the firm,” then just what is it that gives one legal party rather than another the ownership of the produced outputs as well as the symmetrical set of liabilities for the used-up inputs?  The answer given by the institution of private property is quite simple; the legal party that bears the costs of the used-up inputs has the defensible legal claim on the produced outputs.

That is the way the institution of private property does operate, but how should it operate?  Of course, the legal party that bears the costs of the inputs should also own the outputs—but who should that party be?  The old labor theory of property, usually associated with John Locke, answers that people should legally appropriate the (positive and negative) fruits of their labor.  The people who work in the firm (the productive activity) are the people who jointly use up the inputs and produce the outputs so, by the labor theory of property, they are the people who should constitute the legal party that is the firm.  That is, by the labor theory of property, people should always be jointly self-employed in their firm (i.e., the firm should be “employee-owned,” to use a common but somewhat misleading terminology).

The labor theory of property, commonly thought to be the basis for private ownership, is thus at odds with the current system, which allows any legal party to make the contracts to be the residual claimant or firm.  But actually the conflict is only with one contract, the employment or hired labor contract.  The conflict is not with the system of property appropriation that imputes the outputs to the party that bore the costs.  The conflict is with the contract that allows any outside legal party to hire or rent the people working in a productive activity so that the outside party then appears as the legally responsible party.  Thus the employment contract is at odds with the labor principle of private-property appropriation.

The analysis therefore shifts to contracts.  The contract to hire or rent human beings is a free and voluntary contract, but should all free and voluntary contracts be allowed?  Liberalism often pretends that the answer is “Yes” but a moment’s thought reveals otherwise.  For instance, one free and voluntary contract that is legally forbidden is the self-enslavement contract that was legally valid in antebellum days.  The intellectual history of some arguments about the self-sale contract is traced in Chapter 3 “The Libertarian Case for Slavery.”  The individual contract to sell voting rights, and the collective contract to sell or forfeit the rights of self-determination (the pactum subjectionis) are other examples of contracts that might be free and voluntary but are not currently legally valid.

There is a simple example of an invalid contract, namely the contract to transfer responsibility for one’s actions to another person when those actions are criminous.  We use the intuition pump of the criminous employee wherein an employee who commits a crime at the behest of the employer is promoted by the legal authorities to the status of a partner with the employer.  It is easy to understand how a person is still de facto responsible for the results of his or her actions (i.e., for the fruits of his or her labor) in spite of the contract—at least when those actions are criminous.  But it is difficult to see how the factual status of one’s responsibility could change when the legal status of the actions is noncriminous (as in ordinary work performed by employees).  It is hard to see how employees can suddenly become instruments, tools, or robots in fact when their actions are lawful.  This is a simple restatement of an old argument about inalienable rights (called the “de facto theory of inalienability”) that dates back to the Enlightenment if not to the Reformation and before.  The argument was originally applied against the contract to sell all of one’s labor, the self-enslavement contract, but it applies as well to the contract to sell one’s labor piecemeal, the modern employer-employee contract [see Ellerman 1992].

Much of modern economic theory is a brilliantly executed piece of applied mathematics served up with a thick sauce of myths and metaphors.  But when this “sauce” is brushed away, much older and long-forgotten concepts reemerge, such as people’s claim to the fruits of their labor, naturally invalid contracts, and inalienable rights.

Click here to download this Chapter 2.