Thorstein Veblen's critique of the American system of business

Thorstein Veblen was certainly a heterodox observer of modern capitalism. He was trained in the late nineteenth-century iteration of neoclassical economics, but he was more impressed by the irrationality of what he observed than the optimizing rationality that is postulated by the neoclassicals. He was also an intelligent observer and analyst of contemporary economic and sociological trends — not in theory but in the concrete forms that turn-of-the-century capitalism was taking in the United States and Europe. It is interesting, therefore, to examine his analysis of the business firm in The Theory of Business Enterprise, published in 1904. (I examined his critique of American universities in The Higher Learning in America in an earlier post.)

Here is how he describes his approach to the topic of American business:

In respect to its point of departure, the following inquiry into the nature, causes, utility, and further drift of business enterprise differs from other discussions of the same general range of facts. Any unfamiliar conclusions are due to this choice of a point of view, rather than to any peculiarity in the facts, articles of theory, or method of argument employed. The point of view is that given by the business man's work, -- the aims, motives, and means that condition current business traffic. This choice of a point of view is itself given by the current economic situation, in that the situation plainly is primarily a business situation. (Preface)

Veblen is sometimes credited with being one of the originators of institutional economics. This is due, in large part, to his effort to discover some of the institutional dynamics created for the modern industrial system by the incentives and constraints created for the owners and managers of firms.

One of the central impressions that emerges from reading The Theory of Business Enterprise is this: the modern American industrial economy is a coordinated system that requires many things to happen in sync with each other; but the owners of the components of this system often have strategic interests that lead them to take actions leading to de-synchronization and short-term crisis. There is a serious conflict of interest that exists between the interests of the owner and the needs of the system -- and the public's interests are primarily served by a smoothly functioning system. So owners are in conflict with the broader interests of the public.

So who is the primary actor, the "business man", in Veblen's account, and what are his or her motives?

The business man, especially the business man of wide and authoritative discretion, has become a controlling force in industry, because, through the mechanism of investments and markets, he controls the plants and processes, and these set the pace and determine the direction of movement for the rest. (Chap. 1)

The motive of business is pecuniary gain, the method is essentially purchase and sale. The aim and usual outcome is an accumulation of wealth. Men whose aim is not increase of possessions do not go into business, particularly not on an independent footing. (Chapter 3)So the owners and managers of businesses have a great deal of power in organizing and coordinating economic activity, and their goal is to maximize individual financial gain. Does this work to further the interests of society as a whole? Veblen does not adopt Adam Smith's notion that the pursuit of self-interest leads naturally to the expansion of the common good, and that the hidden hand guides this economy towards optimal outcomes and uses of available resources:

The outcome of this management of industrial affairs through pecuniary transactions, therefore, has been to dissociate the interests of those men who exercise the discretion from the interests of the community.... Broadly, this class of business men, in so far as they have no ulterior strategic ends to serve, have an interest in making the disturbances of the system large and frequent, since it is in the conjunctures of change that their gain emerges.... It is, as a business proposition, a matter of indifference to the man of large affairs whether the disturbances which his transactions set up in the industrial system help or hinder the system at large. (7%)

Here Veblen seems to be making an interesting and unorthodox point: that the strategic actions of the owners of capital in a modern economy are oriented towards disequilibrium as often as they are towards equilibrium. The comment seems uncannily apt with regard to the financial crisis of 2008.

The end of his endeavors is, not simply to effect an industrially advantageous consolidation, but to effect it under such circumstances of ownership as will give him control of large business forces or bring him the largest possible gain. (8%)

Veblen appears to have in mind the consolidations and strategic actions involved in the railroad industry at the turn of the century. But this comment also has resonance with respect to the past two decades of recent history in the software industry, with companies jockeying for advantage on the desktop of users for their operating systems and applications.

Another incentive that owners of industries have, according to Veblen, is to insulate themselves from competition -- to create partial or complete monopolies in the fields they occupy. And Veblen looks at advertising as one of the tools that businesses use to secure a partial monopoly.

The endeavor of all such enterprises that look to a permanent continuance of their business is to establish as much of a monopoly as may be. (12%)

So Veblen's organizing view of modern industry (circa 1900, anyway) is that it is dispositionally inclined towards being anti-competitive -- to finding means of sheltering its production methods and prices from competition from other firms.

In the end Veblen does not believe that these practices turn the balance sheet negative against this form of economic organization. But he believes that the wastefulness associated with these strategic efforts at short-term advantage with regard to competitors is only compensated for due to the pressure that this system creates on the direct producers -- workers, engineers, architects, and service providers -- to be as productive during their working hours as possible. Owners and managers have an incentive to destabilize their competitors; but they also have an interest in optimizing their own uses of resources.

While it is in the nature of things unavoidable that the management of industry by modern business methods should involve a large misdirection of effort and a very large waste of goods and services, it is also true that the aims and ideals to which this manner of economic life gives effect act forcibly to offset all this incidental futility. These pecuniary aims and ideals have a very great effect, for instance, in making men work hard and unremittingly, so that on this ground alone the business system probably compensates for any wastes involved in its working. There seems, therefore, to be no tenable ground for thinking that the working of the modern business system involves a curtailment of the community's livelihood. It makes up for its wastefulness by the added strain which it throws upon those engaged in the productive work. (14%)

One reason I particularly enjoy re-reading thinkers like Veblen is that they do a good job of challenging our current assumptions. Veblen was looking at a functioning economy with important similarities to our own, consisting of visibly distinct groups of actors (owners, engineers, workers, advertising execs, ...), and he was in a position to notice some of the dysfunctional features of this system that are still with us today but that are no longer so visible.

(Here is an earlier post about Charles Perrow's treatment of corporations during much the same time period; link.)