Marx vs Coase: experimental evidence

Are firms efficient institutions for responding to uncertainty, as Coase thought? Or are they, as Marxists believe, means whereby capitalists exploit workers? A new paper by Ernst Fehr and colleagues provides experimental evidence.

They split subjects into principals and agents, and asked them to try to form either employment contracts or sales contracts. Under sales contracts, the agent performed a set task. Under employment contracts, the principal could assign the agent to one of three possible tasks; one of which paid well in one state of the work, one of which paid well in another, and a third which was inefficient in aggregate but very profitable for the principal.

This set-up highlights the difference between Marxian and Coasian theories of the firm. For Coasians, employment contracts are better because they allow the principal to respond to uncertainty by assigning workers to the more efficient task when that task cannot be identified in advance: as Coase said (pdf), "it seems improbable that a firm would emerge without rthe existence of uncertainty." But for Marxists, the danger is that they allow workers to be exploited - to be assigned to the third task.

Fehr and colleagues found that, in one-shot encounters where employment contracts were struck, 51% of principals exploited agents. "The Marxian idea that power can be used for exploitation is real" they conclude.

Why only 51%? It's because there's a norm of fairness which stops some principals exploiting workers. This norm is a two-edged sword. On the one hand, it promotes efficiency, as it encourages agents to enter into the more flexible employment contract rather than sales contracts in the belief they'll be treated fairly. On the other hand, though, this belief might prove mistaken - and so the fairness norm actually facilitates exploitation.

However, in repeated encounters, the prevalence of exploitation dropped to 21%. This is because employers wanted to build a reputation for fairness which they could use to encourage workers to stick to employment contracts.

Simple as it is, this gives us a framework to pose the question: under what conditions are we likely to have Coasian rather than Marxian firms?

One is where there's a strong norm of fairness. You can read the campaign for a living wage as an effort to build such a norm.

Another is where firms have a desire for a reputation as a "good" employer. This is more likely to be the case under conditions of near-full employment, where they have to compete for for workers.

A third is the existence of strong unions. Fehr and colleagues say:

To the extent to which reputational forces alone are insufficient for solving the employers’ moral hazard problem, labor unions and labor legislation can play an efficiency enhancing role by constraining the employers’ ability to assign the workers inefficient tasks.

This corroborates my suspicion that strong unions can be good for an economy.

There is, however, a fourth possibility - for workers to have an outside option such as welfare benefits that allow them to reject exploitative contracts.

The fact that many of capitalism's supporters reject this fourth course makes me suspect that what they are interested in is not so much efficient Coasian firms as the power of capital to exploit workers.

Comments

[Rlpkamath]

I'm surprised you don't list competitive labour markets as a reason for firms to be fair: i.e. if employees have options with other firms, they will leave for where they are treated better. I think this would be the explanation for capitalists who dislike the welfare state. They would argue that the welfare state imposes costs on employment which in turn make labour markets less efficient, particularly for clearing workers with low productivity. Am I missing something in your otherwise often quite excellent analysis?

[Luis Enrique]

would be interesting to expand the experiment to allow workers to exploit employers ... I'm thinking of bankers ripping off bank shareholders, but also I suppose organized labour can sometimes have sufficient bargaining power to achieve something that might called exploiting employers - if you think owners extracting the lion's share of the surplus and leaving workers with the minimum is exploitation, I think that implies the possibility of vice versa.

[I think a lot of capitalism's supporters also believe something like "people shouldn't be allowed to sponge off others because they don't want to work" - regardless of whether you think the belief makes sense, I reckon it explains why these supporters of capitalism oppose a more generous welfare state]

[gappy]

Your concept of "experimental evidence" is confused. This has nothing to do with experimental evidence of Coase vs. Marx, or at least, no more than ultimatum and dictator games. You are assuming that the experiment is capturing the essence of the principal-agent relationship in an industrial relationship setting, just because the contracts are labeled "sales" and "employment". It ignores relationship among multiple agents under the same principal, interactions between separate groups of principal and agents, etc. Most importantly, the experiment doesn't capture at all the essence of the coasian arguments explaining the existence of firms, transaction costs and uncertainty. All the experiment is telling you is that a) individuals don't behave strictly according utility theory; b) they do so more in one shot-games, or (perhaps) in end-game effects. You didn't need this experiment to know that, and these facts, whatever their explanations are, are orthogonal to the the problem at hand.

It's a sad state of affairs for Marxism when it gets to be mildly defended on such a basis.

[George Hallam]

Why only 51%?

To understand this you need to examine the way the word 'exploitation' is being used.

[chris]

@ rlpkamath - I didn't mention competitive labour markets because hitory shows that these almost never generate the full employment that gives workers a strong bargaining position:
http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2012/07/unemployment-a-brief-history.html
@ gappy - of course, the experiment leaves lots of things out. That's what experiments do. But it doesn't rule out uncertainty (the subjects face two uncertain states of the world) and transactions costs are embedded in the fact that the "sales contract" is inefficient if the wrong state occurs.
The fact that such a simple world generates exploitation is, surely support for Marx because it's improbable that the omitted factors would tend to eliminate exploitation.

[Thomas Bergbusch]

Fascinating stuff. It would be interesting to run the experiment again, to see how co-operatives treat agents (employees and contractors). My guess, following Bill Mitchell's evidence on Mondragon and other co-operatives, is that there would still be an exploitative tendency, albeit a much weaker one.

[nathan tankus]

This is nonsense that has nothing to do with Marx. Read his stuff on piece wages.

[Magpie]

While I congratulate the authors for their effort in dealing with this matter, I am afraid I have to agree with Nathan Tankus: their methodology appears to be dodgy.

The problem, it seems, arises because the word "exploitation" has one ordinary-language usage and a specifically Marxian usage. And both are different.

Think, for instance, of the distinction between "investment" in everyday sense and in the macroeconomic sense: they are not the same.

The authors seem to mean exploitation in the sense of deliberately taking advantage of a position of power to obtain an unethical benefit:

"ex·ploi·ta·tion
"n.
"2. Utilization of another person or group for selfish purposes: exploitation of unwary consumers."

For Marx, exploitation is more than that.

This is a quote from A Dictionary of Marxist Thought. 2nd Edition. Edited by Laurence Harris, V.G. Kiernan and Ralph Miliband. 1991:

"Capitalist production generates a surplus because capitalists buy workers' labour-power at a wage equal to its value, but being in control of production, extract labour greater than the equivalent of that wage. Marx differed from the classical political economists, who saw exploitation as arising from the unequal exchange of labour for the wage. For Marx, the distinction between labour and labour power allowed the latter to be sold at its value while the former created the surplus. Thus exploitation occurs in the capitalist mode of production behind the backs of the participants". (page 183-184, you can google it)

In other words, exploitation happens, whether capitalists and workers know it or not, even when every labour regulation in the book is respected to the letter. This is so, because labour is the source of all value.

At best, it seems to me (and I've just skimmed the paper), what the authors assessed was the tendency of capitalists to go the extra mile and take conscious advantage of that position of power. You know, to squeeze the last drop out of the orange.

Make no mistake, this seems to be a valuable contribution; but it is far from being the whole story.