Arnold Kling  

Notes for a Debate

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On the topic of corporate power. Open to the public. This Friday evening, January 21st. 7:30 PM. Washington Plaza Hotel, 10 Thomas Circle, in NW Washington DC. Frederick Hall.

My notes follow:

1. Thinking about organizations.

There are many different kinds of organizations in society. Governments, businesses, nonprofit businesses, charities, churches, clubs, criminal gangs, ...

The libertarian perspective is to divide these organizations into those that thrive on the basis of voluntary transactions and those that thrive on threats and intimidation. In general, governments and criminal gangs fall on the "bad" side of the line and corporations fall on the "good" side.

In contrast, I think many people think that certain organizations are inhabited by good spirits and others are inhabited by evil spirits. One particular viewpoint is that good spirits inhabit labor unions, the Democratic Party, crusading lawyers and regulators, etc., while bad spirits inhabit the Republican Party, fundamentalist churches, criminal gangs, and corporations.

I call this good-spirit, bad-spirit approach the enchanted way of thinking about society. If you are deep into the enchanted view, and you imagine that everyone else holds an enchanted view, then the only way you can explain libertarians is by telling yourself that they have a perverse enchantment: libertarians must believe that corporations are inhabited by good spirits, and government is inhabited by evil spirits.

But I prefer to think of myself as disenchanted. I do not believe that organizations are inhabited by spirits. Corporations are not inhabited by good spirits. If you think otherwise, just ask my wife what it's like dealing with health insurance companies. But government is not inhabited by good spirits, either. Just ask her what it's like trying on the behalf of her mother to deal with Medicare.

What makes corporations tolerable is competition. When a corporation treats me well and gives me what I want, I give thanks to its competitors.

I tend to give credit to unregulated competition rather than government rules. I do not believe in a wise-referee spirit that inhabits government regulatory agencies. Instead, I see those agencies as subject to capture by large, incumbent businesses. Most of the time, government regulation will thwart competition rather than promote it.

Overall, from the disenchanted perspective, there are no good spirits to protect us from greedy corporations. Instead, what protection we have--and it is far from perfect--comes from competition. I am in favor of any voluntary form of organization that enhances that protection. Consumer watchdog groups, organizations that track and report on the performance of businesses, etc.

2. Exit vs. Voice

In markets, consumers express their preferences through exit. If you do not like something, you do not buy it. If a company gives you lousy service, you stop using that company, and you tell your friends about the bad experience that you had.

Another way to express your preferences is through voice. You can complain, write a letter, and so on. But voice without the option to exit is futile. The health insurance company or the cable company can get away with lousy service because it is so difficult for the consumer to exit. Monopoly or near-monopoly diminishes the exit option, and the consumer suffers.

Nowhere is the exit option harder to exercise than with government. Are there policies that you would rather not support with your taxes? Too bad. Are there services you would rather get from another source? Take what the government gives you.

Government claims to be responsive to the voice option. We live in a democracy, so the government has to listen to "the people," right? Well, once you reflect for a while, you realize that the voice option is not terribly impressive. Notwithstanding the egalitarian myths, when it comes to exercising voice some or more equal than others. Much more.

3. Conclusion

When you encounter corporate power that you find frustrating, the best way to deal with it is usually exit. Occasionally, you come across a situation where you think that you can do more, such as form a consumer watchdog group or start a competing enterprise. Often, though, people want to counter corporate power with something more coercive, in the same class as criminal enterprises and governments. Libertarians see that as trying to address the wrong of corporate power with an even worse wrong.


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COMMENTS (11 to date)
Joel writes:

Your examples of competition acting as a check on corporations seem to center around how it forces them to treat their customers well. One obvious objection is that competition doesn't provide them any incentives not to (for example) secretly dump toxic waste in the river or (more generally) mistreat people who aren't their customers. You might want to think about addressing this.

That said, I agree almost wholeheartedly with what you've written.

david writes:

"Notwithstanding the egalitarian myths, when it comes to exercising voice some or more equal than others."

should be

"Notwithstanding egalitarian myths, when it comes to exercising voice, some are more equal than others."

If I were reading off notes like these, I'd trip at a sentence like this, so... hope you don't?

On the point: the left is typically much more enthusiastic about voice, yes. The left tries to fight organized power by organizing themselves, rather than trying to subject the organized power to competition sustained by... some other set of forces?

The implicit assumption in relying on competition as a social force is that competition is "enough" even in the absence of the usual coterie of microeconomic assumptions. And that nationalism or tribalism, even by other people, will be suppressed by competition (people display brand loyalty! In the crazy "this brand is part of my personal identity" sense, not just the reputational sense! And this is just for brands like Starbucks, what about brands like citizenship and so on?)

We who know some economics are less skeptical about competition than the hoi polloi, but not as usually optimistic as our kind host here...

MernaMoose writes:

Sounds like a good debate, if I lived close enough I might come and see it.

I pretty much agree with your notes but, there are problem areas that somehow get ignored too often in debates of this type.

One example is the fact that some segments of the economy are not going to operate like a free market, due to whatever reason. There's not enough real estate to have genuine competition in roads and streets. There's not enough capital (or is it, not enough customers?) in the world to fund competition amongst major utilities. Etc.

Many lefties I've met sense this, poke in the general direction, but are not able to articulate it very well.

So what do people do when both the market and the government have failed? The same thing they've always done -- live with it.


As I like to put it, the Left doesn't trust the Market and the Right doesn't trust the government. As a classical liberal I don't trust either of them, and believe that both should be given its appropriate level of shackling.

Capitalism is a lot like playing with fire. It is a force which can grant us great powers if we learn to harness it -- if it doesn't kill us along the way.

You could say the same thing about government. But when you put it this way, lefties will always claim they don't "trust" government any more than I do. After which they inevitably proceed to contradict themselves.

MichaelM writes:
There are many different kinds of organizations in society. Governments, businesses, nonprofit businesses, charities, churches, clubs, criminal gangs, ...

When discussing corporations (and meaning actual incorporated firms, as opposed to the lay meaning of the term 'corporation' as any large business), the relevant categories are the legal categories of sole proprietorships, partnerships, and corporations. Governments, businesses, nonprofits, charities, churches, and clubs can all fit into any one of these categories, depending on the nature of their ownership.

This is important because it casts an entirely different light on the debate. Proprietorships and partnerships are, in some sense, natural. In the eyes of the law (and, to the legal positivists amongst us, in the wider world), proprietorships and partnerships are human individuals or groups of human individuals. Corporations, on the other hand, are themselves a type of individual; not human, but artificial, purely legal ones. The common law recognizes proprietorships or partnerships formed by anybody, while precedent is that only corporations formed by the relevant state authority are recognized.

These qualities serve to qualify the differences between proprietorships/partnerships and corporations, but they don't tell us whether or not corporations are necessarily a good or bad thing. To do that, we need to look at more specific qualities of the corporate structure that proprietorships/partnerships can not share.

Four main properties define the modern corporation:

1. Limited liability. Beside the fact that partnerships have already been granted limited liability by legislatures, limited liability as a purely contractual relationship already existed long before the birth of the modern corporation. This form of limited liability was not 'costless' as the modern kind is (ignoring the fact that corporate taxes can be considered a price for limited liability), but instead there was a 'break' in the contract. In order to enjoy limited liability, you had to maintain anonymity as an investor. The company still paid dividends, but it could refuse to pay and you had no recourse without declaring yourself in court and giving up your anonymity and, thus, your limited liability.

Likewise, it's theoretically possible to see creditors agreeing to a contract where certain partners are considered limited partners for the purposes of the contractual relationship between that creditor and the firm in question.

2. The joint-stock structure. While corporations actually did innovate the joint-stock structure, it was easily replicable for partnerships and they did indeed replicate it as soon as the Bubble Act of 1720 outlawed any corporations not explicitly formed on the crown's authority.

3. Legal personality. This one is harder. Without legislative fiat, partnerships cannot get legal personality, rather they are an aggregate of the legal personalities of their partners. Proprietorships have legal personality, but they are natural legal personalities, in comparison to the artificial legal personalities of corporations. This one only ends up mattering in combination with...

4. Immortality. This is the one that, at least under current technological conditions, is absolutely impossible for either of the common law forms of organization. Proprietorships naturally disappear when their human proprietors experience their natural death. Partnerships technically pass whenever a change in the composition of partners occurs.

A person with any concern for social equality at all should be extremely suspicious of the last two properties. From the point of view of a classical liberal or libertarian, individual income inequality may be acceptable because it is, by necessity, temporary. Parents always imperfectly pass on their skills and qualities to their children, so the extreme productivity of high income individuals is a good trade-off for the socially damaging nature of income inequality. The advantages their children get are often the very seed of destruction for the wealth; children born into privilege often fail to pick up the skills necessary to maintain their privilege. Rockefeller's descendants are almost all middle income, for instance.

But things change when we start talking about immortal individuals. Natural personalities inevitably die and their talents dissipate through their family line. But artificial personalities can drag on, theoretically forever. I would argue this distinction can be important -- corporations have privileged access to long term credit simply because creditors don't need to worry about the corporation dropping dead. Now, this particular privilege isn't too relevant today, because unpredictable long run inflation makes it infeasible to emit long term bonds, but in a hypothetical environment where we have sound money, 100 year bonds are a perfectly reasonable expectation. In fact, 100 year bonds were being created in the 1920's, when the gold standard was still alive and kicking.

A host of other possible advantages come from the immortality of corporate personalities; one more is that creditors often do not pay attention to the change in the composition of shareholders in a corporation, while partnerships are required to inform their creditors and business relations of changes in the composition of their pool of partners, since technically the old partnership passes out of existence when new partners join or old partners leave.

I wanted to get this all out of the way because, as it seems to me, ignorance of these legal distinctions is incredibly widespread amongst all layers of society, including among lawyers. This distinction ends up being incredibly important. While I cannot justify it 100%, I personally believe that the existence of general incorporation laws is poison to a republic, in the same way the existence of slavery was poison to the Romans and almost poison to our own, without the heroic actions of millions of young Americans in the 1860's. In truth, corporations, like government, are like fire, to be used sparingly and with immense care. The fewer corporations a society has, the freer and better off it is. Modern economies, dominated as they are by corporations (less so here in America than in Europe), are un-free no matter how few regulations the state promulgates. In fact, a well-regulated corporate economy can make the society it inhabits freer than a less regulated one, just as long as the private economy is not intruded upon by statutory controls on the corporate, public one.

Dr. Kling, I hope you'll read this post and keep it in mind during your debate. In fact, I hope you'll take it as an impetus to do further research on the history and nature of the corporate form.

ed writes:

MichaelM, interesting comment! I'm always hearing vague criticisms of "corporations," but this is the first time I've seen a critique that actually engages with exactly what corporations actually are, or what exactly it is about them is supposedly bad.

That said, I don't think I agree with you. Please explain how we would be better off if nobody could form an ongoing organization with the "immortality" property. Would partnerships be able to produce, say, cars or computer chips or pharmaceuticals, or would we simply do without these things? And what about Duke University or the Sierra Club or the Red Cross or the Catholic Church or the United States Chess Federation? Would these things somehow work better as partnerships, or would we just be better off without them? Would we be more "free" if nobody could form or join such an organizations?

Please explain.

MernaMoose writes:

MichaelM,

Good post. I'm of a classical liberal bent and have always sensed something corrosive about corporations, but have never been able to clearly identify all the why's of it.

You have what may be a good start here, and it's interesting in any case. But I have to agree with ed, this problem still needs a lot more fleshing out. A thought or two:

Howard Hughes told congress where the bear goes in the woods. When was the last time you heard of a corporation doing the same? Rarely. When governments pass stupid laws, individuals object. But corporations tend to say "You want me to do what? Oh, well, okay...."

Because, in part at least, corporations are run by boards and comittees of employees, not individuals whose whole being is on the line. I see the corporate elite (VPs, CEOs etc) as being much like congressmen -- at the end of the day, they don't really end up having to take the full and direct consequences of their own decisions.

Howard Hughes could go bankrupt. The CEO of a corporation has a golden parachute. He'll make out even if he runs the company in the ditch.

Corporations end up being more or less extensions of government. My opinion but it would take a lot of explaining.

In the end, my biggest concern about corporations may be the concentration of power that they can come to wield. If you're into the idea of limited government on grounds of keeping its power in check, then I argue we should (in today's world) be equally concerned about keeping the power of corporations similarly in check.

I don't believe buying decisions alone are a sufficient check on corporate power. But then, voting alone has proven to be an insufficient check on politicians.

OTOH, international corporations are now far-flung enough that a one-man, Howard Hughes style empire seems beyond the capacities of one-man rule. And there is a genuine economic need (and benefit) from the accrual of economic resources that corporations represent.

I agree this is a worthwhile topic that needs further study. This issue has never been entirely clear to me.


Combine this with the fact that some dimensions of the economy will never be able to operate along true free market lines as I discuss above, and I think we've maybe got the two biggest avenues through which the free market is attacked by its opponents.

fundamentalist writes:

Mernamoose: “Capitalism is a lot like playing with fire. It is a force which can grant us great powers if we learn to harness it -- if it doesn't kill us along the way.”

You make capitalism something other than us. Capitalism is not an institution, like government or a force of nature, like lightning. Capitalism is us. Substitute us/we for capitalism and your sentence reads “We are a lot like playing with fire. We are a force which can grant us great powers if we learn to harness ourselves – if we don’t kill us.”

Capitalism isn’t just competition. Competition is one aspect, but capitalism requires the rule of law so that people don’t steal, cheat and murder. With the rule of law, protection of property rights and free markets, there is no reason for the state to build roads and give monopolies to utilities. Free people can work these things out themselves. Better protection for property rights would take care of all pollution problems except the ocean, where property rights are difficult to estbablish.

MichaelM, I don’t agree at all that corporations are unnatural. They’re no more unnatural than is giving limited liability to bond holders. The issue is control. Bond holders don’t control the operations of a company, so they aren’t held responsible for decisions made by management. The only difference with stock holders is that they aren’t guaranteed a return on their investment. Stock owners give up control of operations in exchange for limited liability, just as bond holders do.

BTW, churches are immortal, too. That doesn't make them evil.

Don writes:

Limited liability is just a pre-nup for the marriage of a firm's owners and creditors. There's nothing sinister about it. What's more, limited liability is not a benefit to the owners of a firm at the expense of creditors, as it increases the firm's cost of capital due to creditors' rational anticipation that there is a non-zero probability of default. Limited liability does provide a benefit to both owners and creditors in that it ex ante reduces the legal and transaction costs of dissolution.

MichaelM writes:

Hm, looks like this will have to go point by explanatory point. Allow me to just clarify that I hate doing point-by-points and that I'm not trying to refute what anyone is saying, but clarify my position.

Howard Hughes told congress...it would take a lot of explaining.

Believe it or not, you're actually more or less right. At least in modern economies, the corporate economy is, more or less, a way for states to borrow money cheaply. Rather, that's the primary reason they originally surfaced and why governments always keep them around and as healthy as possible. There's a reason the Federal Reserve System is tied directly into the largest incorporated banks which, for reasons purely of a transactions cost and network effect basis, also tend to lend to the largest incorporated businesses. It's all meant to prop up behemoths that, under more normal circumstances, would have trouble staying afloat when competing with more flexible unincorporated businesses.

Corporations are quite literally creatures of the state. Believe it or not, the primary distinguishing feature of a corporation -- artificial legal personality -- was introduced into Western legal systems by none other than Caesar Augustus himself, in order to ensure his own control (and the control of his office) over the Roman economy in preference to the private business associations that had existed during the Republic. In the Anglo-Saxon world, corporations began to show up during the late Tudor period/early Stuart period as a way for the Crown to quickly and cheaply gather capital for long-distance overseas trading missions. From thereon out they were almost always monopoly institutions designed to give the Crown privileged access to the capital available in London money markets.

The South Sea Bubble, and the surrounding scandal, is a good example of how the British Crown used corporations. The South Sea Company was incorporated in order to attempt to gather as much money to the Crown as possible, and the Crown did everything in its power to help it along. The Bubble Act of 1720 wasn't a measure to limit the excesses of corporate power in the British economy, as it is often portrayed, but rather an attempt to give the South Sea Company a monopoly on the corporate structure, to better privilege its access to capital.

A similar thing happened in France around the same time, with John Law's land banks.

The modern business corporation is sourced to early to middle 19th century America. Initially, corporations in America were no different from corporations elsewhere: They were statutory grants of monopoly over a particular area or object of business. The very first corporations were universities, many of them with holdover charters from Kings of Great Britain, which state legislatures assumed the responsibility for. The practice of incorporating monopoly firms spread to things like ports and major works of infrastructure that were subsidized by the state, such as canals. The key business that was incorporated, and the ultimate downfall of the monopoly corporation in the US, was banking.

Beginning in Massachusetts in the 1780's, states started creating their own 'national' (read: state, but for a time when the states were essentially their own nations) banks and then forbidding private banks from competing with the corporate state bank through limits or prohibitions on note issue. Competition was extremely slow to trickle in, as you needed to get a charter from the legislature to incorporate a bank, and the state legislature was usually stacked with allies of the existing corporate banks. There's a funny little tale of Aaron Burr's attempts to found a competing bank in New York state. The legislature was very friendly with Alexander Hamilton and his Bank of New York, and would never have granted Mr Burr a charter to found a bank with, so Mr Burr had to get creative. He petitioned the legislature for a charter to found a company to deliver water to New York City. When the charter was going through the legislature, he had one of his friends on the relevant committee insert a clause allowing the new company to issue bank notes, ostensibly to fund itself. The charter passed and Mr Burr got his water company. He actually did build an aqueduct into New York that was used for the next 40 years, but his primary business very quickly became banking, and for a short while he was the only competitor with Mr Hamilton's Bank of New York.

Mr Burr's Manhattan Company eventually became Chase-Manhattan Bank.

Anyway, this process continued in all the states for quite a few decades. The legislative chartering process was very obviously corrupt to everyone who understood what was going on. One common practice was to offer the right legislators discounted shares in a newly chartered bank in exchange for ensuring the charter went through. By the 1830's, the whole thing was unbearable to the people of the states with active banking industries (and especially in New York state). In the aftermath of President Jackson's war with Mr Biddle, the dissolution of the Second Bank of the United States, and the subsequent economic depression, New York adopted its 'free banking' laws, which allowed any individual or group of individuals with a minimum level of capital to apply to a particular office of the state government for a charter and the right to issue notes.

This breakdown in the legislative chartering process ended up being the death knell for the old style of monopoly corporation and the birth of the modern business corporation. General incorporation acts quickly followed in most states and, by the end of the 19th century, all you needed to do to incorporate a new firm was apply to the relevant state office and meet some small level of regulatory requirements. Other nations quickly adopted similar rules.

As you can see, corporations very much are an 'intervention' of state powers into the private economy. Their very existence gives the state a power over the economy that it wouldn't normally have. In fact, even before the New Deal and the Supreme Court's implementation of 'relaxed review' on property rights, state governments and the Federal government were able to get around prohibitions on actions dealing with human individuals by regulating their own 'creatures', the inhabitants of the corporate economy.

In the end, my biggest concern about corporations may be the concentration of power...there is a genuine economic need (and benefit) from the accrual of economic resources that corporations represent.

Indeed. Ideally, we really ought to not have business corporations at all, limiting incorporation to a very small, select number of explicitly public purposes. However, historically, corporations have served as an OK check on the runaway power of governments which were not entirely under democratic control (in the period when corporations were first rising in the US, we still did not have universal suffrage, with most limiting requirements being property requirements).

Some kind of reform that drastically lower the ratio of representative to constituent would be enough, I feel, to give people stronger control over their government such that we could do away with the corporate form in business and be better off for it. They're ultimately harmful to liberty in any given country simply because they serve as an easy repository of state largess in return for campaign funding, outright bribes, or whatever other corruption you might think of. Think about how much of an uproar there would have been had the 2008 bailouts gone to a privately owned banking partnership, rather than large corporate banks. I actually don't think they could possibly have passed had they been aimed at real human beings, rather than the artificial corporate beings they were given to.

Partnerships can indeed get huge: Standard Oil wasn't incorporated until long after its peak market share had passed. But they become huge because of their ability to deliver a quality product at a low price, and they pass as the individuals driving their success pass on. Corporations, on the other hand, have an inertia that comes with their sheer size and immortal staying power, not to mention their ability to seek out and hire officers whose talents can be replaced, and whom have a fiduciary duty to the corporation that isn't shared by junior partners or hired lackeys in a partnership.

Ultimately, I have a preference for a common law republic, a republic whose government(s) have the sole duty to pursue and uphold the common law, both in spirit and practice. Corporations are alien to the common law, historically only recognized when created by legislative fiat. Without that legislative fiat, there's no reason to expect the presence of an immortal, dominant corporate economy at all. You see, it's less about the worry that any one individual will use their position in the corporate structure to gain inordinate power or privilege (although that is always a danger), but rather that the very existence of corporations locks huge amounts of capital away from private individuals and, in part, creates the division between labor and capital, employee and employer, that drives all the anger and angst that is expressed in leftist critiques of capitalism such as socialism and modern 'liberalism'. Without this particular flaw, I see no reason to expect such horrid labor agitation as one sees in economies totally dominated by corporations such as in France.

MichaelM, I don’t agree at all that corporations are unnatural. They’re no more unnatural than is giving limited liability to bond holders. The issue is control. Bond holders don’t control the operations of a company, so they aren’t held responsible for decisions made by management. The only difference with stock holders is that they aren’t guaranteed a return on their investment. Stock owners give up control of operations in exchange for limited liability, just as bond holders do.

I use 'natural' in a particular sense here. Social arrangements that arise out of the common law are 'natural', and arrangements that can ONLY be achieved with statutes are 'unnatural'. I wish I could think up a better set of terms for this distinction, but right now, I can't.

BTW, churches are immortal, too. That doesn't make them evil.

Would you like to know a secret?

Churches are often corporations. The Catholic Church certainly is, as is the Anglican Church and many state churches throughout Europe.

Believe it or not, modern states are corporations as well. The US Constitution is nothing less than a corporate charter from a sovereign ("We the People") to a subject (The US Government). Any state which is not a monarchy is, by necessity, a corporation. Even some monarchies are based in the corporate form: The Crown of Great Britain is technically a corporation. Only the ancient kind of feudal monarchy is not a corporation.

ed writes:

MichaelM, this was much less interesting than your last comment (although still somewhat more interesting than the typical anti-corporation rant.)

Nice history lesson, but you have done nothing to explain how a modern society would work without corporations (of any kind!), and you haven't even attempted to answer the questions I posed. It's nice that YOU like the common law so much better than statutory law, but you haven't offered me a reason to share your view.

Their very existence gives the state a power over the economy that it wouldn't normally have.

This is a very strange claim. In the modern world, most everyplace that anyone would choose to live has corporations. The places without corporations (North Korea?) are generally not characterized by limited state power. Where are you getting your conception of how the state "normally" operates?

ed writes:

MichaelM, this was much less interesting than your last comment (although still somewhat more interesting than the typical anti-corporation rant.)

Nice history lesson, but you have done nothing to explain how a modern society would work without corporations (of any kind!), and you haven't even attempted to answer the questions I posed. It's nice that YOU like the common law so much better than statutory law, but you haven't offered me a reason to share your view.

Their very existence gives the state a power over the economy that it wouldn't normally have.

This is a very strange claim. In the modern world, most everyplace that anyone would choose to live has corporations. The places without corporations (North Korea?) are generally not characterized by limited state power. Where are you getting your conception of how the state "normally" operates?

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