The Fundamental Myth

The Fundamental Myth Of Ownership of the Firm

David Ellerman

We are presenting an analysis of economic organization quite different from the perspective of the Great Debate between capitalism and socialism. The Great Debate has focused on whether workers should be rented privately for profit or should always be rented by the government and employed for the public good. The view that people should not be rented at all was not a topic in the classic capitalism/socialism debate.

We present an alternative analysis that juxtaposes employment in a private capitalist or government-owned firm to membership in a democratic firm. There are powerful barriers to this conceptual reconfiguration. There are fundamental but flawed presuppositions shared by both sides in the classic capitalism/socialism debate. Thus there has been little pressure to overthrow those common assumptions. But it is only by moving beyond the shared myths of the Great Debate that the ground can be cleared for a fresh start.

The Fundamental Myth is that the identity of the legal party undertaking a given production opportunity is determined by a property right called “ownership of the firm” or, in the Marxist tradition, “ownership of the means of production.”

Both sides to the Great Debate shared the assumption that “firmhood” (the identity of the firm) is determined by the “ownership of the firm.” The firm is a “piece of property.” The difference of opinion was over who should own that property. State socialists argued that only the government should own the firms, while capitalists defended the private ownership of firms. Today, that debate is replaced by the “privatization debate” [see Ellerman, Vahcic, and Petrin, 1991] over how best to establish private ownership of the firms.

But firmhood is not determined by a property right; it is determined by the pattern of contracts between factor suppliers. Being the firm is a contractual role, not a property right.

Here again, there are many ways to misinterpret the argument. The assertion is quite sensitive to the meaning of words and phrases such as “firm,” “company,” “corporation,” “means of production,” “capital,” and so forth. The word “firm” has a specific technical meaning in the assertion “There is no such property right as the ownership of the firm.” The assertion would be nonsense if by “firm” one meant “corporation” since clearly corporations are owned by their shareholders.

A Corporation is Not Necessarily a Firm

Corporations are owned; that is no myth. But corporate capital can be hired out just as labor and other factors can be hired in, so the corporation is not necessarily the firm (i.e., the party undertaking production) even with respect to its own plant and equipment. It is the pattern of those hiring contracts that determines who is the firm.

Consider a production process for manufacturing widgets. The process is currently being undertaken by a corporation, Widgets Unlimited, which owns the land, factory building, and machinery. Finance is borrowed from a bank, raw materials and subcomponents are purchased from suppliers, and labor services are purchased from the employees. By the “firm” we mean the legal party undertaking this widget production process. Widgets Unlimited is undoubtedly the firm in the example. But why? Because of the ownership of the corporation or because of the company’s contractual role of hiring (or already owning) the requisite inputs to the widget production process?

The question is easily answered by considering a rearrangement or reversal of the input contracts without any sale in Widgets Unlimited shares. Suppose the workers (including managers) get together, borrow the money, lease the production facilities for Widgets Unlimited, purchase the other inputs from the suppliers, and undertake the widget production process. Then the firm (= widget producer) changed hands from Widgets Unlimited to the new legal party of the associated workers without any sale of corporate shares. The Widgets Unlimited still own the same shares, but the corporation is no longer the firm (= the widget producer). It is a factor supplier to the firm. Thus the ownership of the corporation Widgets Unlimited was not the “ownership of the firm.”

Firmhood as a Contractual Role, Not a Property Right

There is no “ownership of the firm.” Being the firm (e.g., the widget producer) is a contractual role, not a property right. What is the contractual role that is equivalent to firmhood? It is being the party that has hired or already owned all the factor services used up in production so that party bears those costs and thus has the defensible claim on any appropriable products (e.g., widgets) produced in the process. That contractual role is called the role of the hiring party (since it hires the other factors) or the residual claimant (since it nets the value of the appropriable products minus the costs of the inputs).

In a private property free enterprise market economy, firmhood is determined by the outcome of the contest or conflict–the “hiring conflict”–over who hires what or whom in the factor markets. In abstract terms, if Capital (= the capital-owners) hires Labor (= the workers including the managers), then Capital is the firm. If Labor hires capital, then Labor is the firm. A contract reversal between Capital and Labor reverses who is the firm. There is no need for Labor to “buy the firm”; it suffices to rent the capital. And if some third party, an entrepreneur or the state, hires both the capital and the workers, that party is the firm.

The winner of the hiring conflict is the hiring party, the party which becomes the firm. If not already a corporation, the hiring party will organize the “spoils of victory” by forming a corporation which it owns. For example, if the widget workers successfully hired the other factors to undertake production, they would legally encapsulate their operation in a corporation of some type. If the workers lost the hiring conflict and remained employees, they would most likely not form a corporation. In a free market economy, one tends to find a one-to-one correlation between being the firm and ownership of a corporation just as there is a perfect correlation between winning an Olympic event and owning an Olympic gold medal. But it would be a mistake to think that someone won the event because they own a gold medal. The causality was the reverse.

Examples of Contract Reversals

A major oil company might own the facilities of a gas station but not operate the station as a business. The gas station facilities would be leased to an individual who would run the station as an independent operator. In other cases, an oil corporation might operate the station by hiring in the people to run it. Following the Mideastern oil crisis of a few years back, gas prices escalated and the profit potential of gas station operation increased. Some major oil companies which had previously leased out their stations decided to reverse the contracts and hire in the labor. The independent operators were notified that their leases would not be renewed when they expired. However, the oil company would be happy to hire them as employees to continue running the gas stations.

One independent operator in the Southwest staged a protest that made national television news. He barricaded himself into the station with a shotgun and issued statements to the press. He said the oil company was “stealing my business.” It couldn’t “just hire me”; it had to “buy me out.” The poor fellow had bought the myth; he thought he “owned the firm.” In fact, he only had the contractual role of being the firm, and more powerful market participants could change that contractual role when they pleased. The oil company correctly pointed out it didn’t need to “buy the firm” to take over the operation of the station; it only needed to hire in the labor.

In another example, the owner of a department store chain decided to endow his employees with “ownership.” But his shares were already locked into trusts for his family and heirs. Thus he set up another corporation which was 100% employee owned through an employee share ownership plan (ESOP). Then he leased all the fixed assets of his company and sold the inventory to the new employee owned company. All the employees switched over to the new corporation which also acquired the contractual right to do business under the original tradename. By these contractual rearrangements, the firm changed hands but the original corporation didn’t. The shares were still in the family trusts. The original corporation changed from being the firm (= the department store operation) to being a factor supplier to the firm.

Yet another example is the leasing movement in the Soviet Union and some other socialist countries [see Ellerman 1990]. Over a thousand state sector enterprises in the USSR have leased their fixed assets to be operated by the collectivity of workers from the original enterprise. The new legal entity with the workers as its members takes over the role of being the residual claimant (i.e., is the firm) even though the state still holds the ideological fetish of the “ownership of the means of production.” The contract reversals in both capitalist and socialist countries reveal the falsity of the common assumption that “being the firm” is part and parcel of the ownership of the means of production.

The Role of Bargaining Power

The argument that firmhood is determined by the contractual role does not assume that factor suppliers actually have enough market power to change the direction of the contracts. The argument is about the structure of the legal institutions. It makes no assumption whatever about the respective bargaining power of the market participants. That is entirely another question.

Typically large accumulations of capital have the market power to hire in labor whenever desired. Democratic worker ownership within capitalist society is often restricted to the nooks, crannies, and backwaters of the economy. The bargaining power of the capital-owning class includes the social power of having successfully indoctrinated workers and the workers’ trade union representatives that “their role” is to hire out labor, not to hire in capital and go into business. Thus the capital owners are the firm, but “being the firm” is not an attribute of capital. The accumulation of capital and the social conditioning give capital owners the power to win the hiring conflict (which Labor rarely contests) by hiring in labor and becoming the firm.

Having a position of market power is not itself a property right. Parties often lose positions of market dominance. This is the free play of market forces, not a violation or confiscation of property rights. Capital’s actual property rights (as opposed to imagined property rights) would not be violated if the capital owners lost the market power to hire in the other factors, and thus they had to hire out their capital in order to secure an economic return.

We are now in a position to appreciate the powerful ideological role of the ownership-of-the-firm myth. Capital owners quite naturally do not want their dominant social role as being the firms to be perceived as the result of mere market power which could well be otherwise without violating their “property rights.” They are accustomed to their contractual role as the firm so, like the dominant classes of the past, they see it as their right, their “ownership of the firm.” Capital is the firm because Capital “owns the firm.” Any change in Capital’s role as the firm would violate “sacred private property rights.”

The ownership-of-the-firm myth has a fundamental role in capitalist ideology; it transfigures a mere contractual role into a “sacred property right.” That, in turn, allows a most miraculous transformation of capitalism into the defender of the principles of private property. The natural basis for private property appropriation is labor. Yet the employment system is founded on denying people the right to the fruits of their labor by virtue of the employment contract. The ownership-of-the-firm myth allows the system founded on denying the labor basis for private property appropriation to present itself as the embodiment of private property.

The Symbiotic Role of Marxism

Since the firm-ownership myth can be exposed by a simple contract reversal argument, how has it been such a stable part of capitalist ideology? As if the social power of Capital was insufficient to vouchsafe the myth, Marx vastly increased its credibility by giving his imprimatur. In feudal times, the governance of people living on land was taken has an attribute of the ownership of that land. The landlord was Lord of the land. As Gierke put it, “Rulership and Ownership were blent” [1958, 88]. Marx mistakenly carried over that idea to capital. The command over the production process was taken as part of the bundle of capital ownership rights.

It is not because he is a leader of industry that a man is a capitalist; on the contrary, he is a leader
of industry because he is a capitalist. The leadership of industry is an attribute of capital, just as in
feudal times the functions of general and judge were attributes of landed property. [Marx 1977,
450-451]

Marx bought the myth.

Marx’s “ownership of the means of production,” indeed Marx’s notion of “capital,” involves the mythical “ownership of the firm.” By “capital” Marx did not simply mean financial or physical capital goods; he meant those goods used by wage labor in capitalist production. Outside of capitalist production, “capital” becomes just the “means of labor.”

In short,

Marx’s “capital” = “means of labor” + “contractual role of being the firm.”

If one wishes to use the word “capital” in that sense, then not all of what is included in “capital” can be owned. There is the ownership of the means of labor (financial and physical capital goods directly owned or indirectly owned through the legal shell of a corporation), but there is no “ownership” of the residual claimant’s contractual role of being the firm.

By agreeing that there is the ownership of “capital” (which includes being the firm), Marx swallowed the Fundamental Myth of capitalist ideology even though he took great pride and joy in exposing other aspects of capitalist mythology. It should be carefully noted that this analysis of the “ownership of the firm” is entirely descriptive; it is not normative. The point is not that the “ownership of the firm” should not exist; the point is that it does not exist. Marx accepted that the “private ownership of the firm” does exist as a part of the capitalist system, and he argued that it should not exist.

By accepting the Fundamental Myth as a point of fact, Marxism becomes the perfect symbiotic partner and the ideal foil for capitalist ideology. Then the battle could rage without touching on the shared but mistaken assumption about the nature of the capitalist system. Like Voltaire’s god, if Marxism didn’t exist, capitalism would have to invent something like it as an ideological foil. Autocrats find real or imagined bugbears to justify their power, and the same psychological dynamic operates in the realm of ideology.

Marxism, which in governments means Marxist-Leninism, has been the perfect foil for capitalism for other reasons as well. Perhaps another slavery analogy will illustrate the point. The present-day capitalism/socialism debate is analogous to a debate over slavery where the alternative proposed by the “abolitionists” was the public ownership of the slaves. That would be a debate with real stakes since the nationalization of the slave plantations would break the social power of the private slave-owners. But this “Great Debate” over the private or public ownership of the slaves would nevertheless miss the point; the real alternative is for the slaves to be free and self-determining. Similarly, the current Great Debate over whether workers should be privately or publicly rented misses the point; the real alternative is for people to be jointly working for themselves in democratic firms.

The Firm Ownership Myth in Democratic Theory

The argument for democratic worker ownership rests on two legs, democratic theory and property theory. Our purpose here is to foreshadow how the firm ownership myth has previously distorted both democratic theory and property theory by shutting off certain avenues of investigation and shunting the debate into irrelevant detours. The idea of applying democratic principles to the economic enterprise is hardly a new idea. What principles behind the capitalist firm must be changed in order to apply democratic principles? Where is the conflict? If “rulership and ownership are blent” in the capitalist firm, then replacing capitalist rulership with workplace democracy entails eliminating the capitalist “ownership of the firm.” Thus democracy is perceived to be at war with property rights in the capitalist firm.

Most modern political theorists ignore the question of applying democratic principles to the firm. They are intellectually placated by being told that the firm is “private” whereas democracy is “public.” The inalienable human rights at the foundation of our political democracy do not reach the “private sphere.” Those political theorists who take democratic principles seriously enough to apply them to the firm still tend to misinterpret property rights by accepting the firm ownership myth.

The owner of capital resources, or the agent who acts on behalf of the owner or a number of associated owners, controls and determines, in virtue of such ownership, the process of production and the action of the workers who are engaged in the process. In its unqualified form, capitalistic organization is a form of autocracy or absolutism. In practice it is never unqualified. . . We may call it … a limited absolutism, which naturally seeks to escape its limits, and on which (so long as it exists) combinations of workers will as naturally seek to impose new limits. [Barker 1967, 105-106, emphasis added]

The preeminent democratic theorist, Robert Dahl, presented essentially this analysis of democracy in conflict with the “ownership of the enterprise” in his otherwise excellent book Preface to Economic Democracy [1985]. In this conflict, Dahl holds that democratic principles should take precedence over property rights, and thus he develops the case for economic democracy.

That analysis takes a contractual role as a property right. The firm ownership myth includes the idea that the management rights (rulership) over the people using capital goods are part of the ownership of the capital. But those positive control rights over people are not included in capital ownership. The negative control rights to exclude other people from using the property are part of the property rights so we must digress on the distinction between positive and negative control rights.

Another person may not use one’s property without the owner’s consent. Thus ownership does give a right of negative control over other people’s actions, the right to withhold consent and thus to specify how they will not use the property. The owner can decide what others will not do with his or her property. But that is quite different from the right to control what others will do. They may have many other options not involving that property, and those property rights give the owner no control rights over which of those options the others will choose.

The right to tell others what not to do with one’s property is a negative control right. The right to tell others what to do is a positive control or management right. The negative control right over other’s activities is a part of property ownership, but the positive control right to tell others what to do is not a part of property ownership. How does one acquire the positive control right over another person’s behavior–the right to tell them what to do? The employment contract. Hire them.

If labor and land are to be mixed in productive work, there is no pre-existing property right which specifies whether the labor-owner or land-owner directly controls the process. Absent any contracts or agreements between the two parties, the land-owner’s negative control rights can make the worker into a trespasser if he tries to use the land without consent. But symmetrically, the worker can make the land-owner into a kidnapper if he tries to force the worker to work the fields without consent. Thus when the labor and land are mixed, there must be a hiring contract one way or the other to determine positive control of the process. If the worker rents the land, he manages the work process. If the land-owner hires the worker, the land-owner manages the work. In either case, it is the hiring party which controls the use of the commodities in the production process. In neither case does the prior ownership of one of the factors by itself give management rights over the production process mixing the factors.

Or consider a factory owner who issues orders to the people working in the factory. What is the legal basis for his positive control rights over the workers’ actions? Absent an employment contract, the ownership of the factory gives the factory owner the right to make the workers into trespassers by denying consent. It does not automatically make the workers into servants or employees; that requires the employment contract. The positive control rights over the workers are not an attribute of capital; the employer buys those rights in the employment contract.

Here again, many social theorists are mislead by hastily evoking that universal explanatory factor, “power relations.” The ownership of the factory may well give the factory owner the bargaining power to hire in labor. The sequence is:

factory ownership => bargaining power => positive control via employment contract.

Some theorists collapse the sequence and infer that factory ownership is “tantamount” to owning the positive control rights.

Returning to democratic theory, we find no structural conflict between democratic principles and the negative control rights which are part of private property ownership. In an economy run entirely on democratic principles, consent would of course be required as usual to use other people’s property. The alleged conflict between democracy and property is really a conflict between democracy and the employment relationship.

Democracy is at war with the renting of human beings, not with private property. In the mythical picture painted by capitalist ideology, private property rights are the center of the capitalist universe. Our analysis shows that the actual center of the capitalist universe is the employment contract. The economic application of democratic theory (and the labor theory of property) presented here is based on the Copernican paradigm shift to seeing capitalism as revolving around the employment contract instead of around the “private ownership of the means of production.”

The Firm Ownership Myth in Property Theory

The Fundamental Myth also distorted thought about property rights. It influenced not only the “answers” but the way in which questions were posed, or rather, ill-posed.

The basic property question about production is about the ownership of the product.

How is it that one legal party rather than another owns the outputs of a production process?

Where the firm ownership myth holds sway, the answer is simple; the “owner of the firm” owns the product. The product ownership rights are part of the ownership of the firm. That answer detours inquiry off in the direction of “How is the ownership of the firm acquired?” And the standard answer is that the owners bought it, inherited it, or started the firm from scratch. Even firms which were bought or inherited must have been previously created. And thus all questions about property ownership in products or firms are traced back to the initial creation of property rights.

The creation or initiation of a property right is called the appropriation of the property. Philosophical treatments of appropriation (e.g., John Locke’s treatment) are usually set in some rather mythical original state of nature when property was first privately appropriated from the common patrimony of Nature. There is also the symmetrical matter of terminating property rights, but that is ignored in the philosophical treatments which tend to be non-technical and elementary.

That is the conventional story which begins by holding that the ownership of the produced outputs is part of the “ownership of the firm.” But the “ownership of the firm” is a myth. In the previous example, the widgets produced by the same workers using the same machines and raw materials would be owned by another party if there had been a prior rearrangement of the hiring contracts. The product is owned by the party with the contractual role of the hiring party. So how did the hiring party get the ownership of the outputs? Did that party buy the outputs from a prior owner? No, there was no previous owner of the outputs. The hiring party is the first owner. In other words, the hiring party appropriated the outputs.

Thus the recognition that there is no “ownership of the firm” leads to the recognition that normal day-to-day production is a site of appropriation. That recognition changes the debate. It means traditional theories of appropriation such as the labor theory of property can be applied to normal production, not just to some original Lockean state of nature.

Why don’t the workers have the labor claim on the produced outputs (as well as the symmetrical claim against them for the used-up inputs)? The firm ownership myth is only the first line of defense. The real defense is the employment contract which puts the employees in a non-responsible position of a hired factor “employed” by the employer. But the labor theory of property is the property theoretic expression of the usual juridical canon of assigning legal responsibility in accordance with de facto responsibility. We shall see in an intuitive example of the criminous employee how de facto responsibility is not transferable and how the law only pretends that labor has been alienated (until a crime has been committed). Thus the capitalist appropriation of the product (including the liabilities for the used-up inputs) is based not on the “private ownership of the means of production” but upon the legal validation of an inherently invalid contract which pretends that human actions are transferable like the services of things.

The discussion here is a prelude to show how the recognition that the “ownership of the firm” is a myth opened up the intellectual space for the analysis of appropriation.

Summary

There is a “fundamental myth” accepted by both sides in the Great Debate between capitalism and socialism. The myth can be crudely stated as the belief that “being the firm” is part of the bundle of property rights referred to as “ownership of the means of production.” Any legal party that operates as a conventional capitalist firm actually plays two distinct roles:

·  the capital-owner role of owning the means of production (the capital assets such as the equipment and plant) used in the production process; and

·  the residual claimant role of bearing the costs of the inputs used up in the production process (e.g., the material inputs, the labor costs, and used-up services of the capital assets) and owning the producing outputs

The fundamental myth can now be stated in more precise terms as the myth that the residual claimant’s role is part of the property rights owned in the capital-owner’s role, i.e., part of the ownership of the means of production.

It is simple to show that the two roles of residual claimant and capital-owner can be separated without changing the ownership of the means of production. Rent out the capital assets. If the means of production such as the plant and equipment are leased out to another legal party, then the leasor retains the ownership of the means of production (the capital-owner role) but the leasee renting the assets would then have the residual claimant’s role for the production process using those capital assets. The leasee would then bear the costs of the used-up capital services (which are paid for in the lease payments) and the other input costs, and that part would own the produced outputs. Thus the residual claimant’s role is not part of the ownership of the means of production.

This “rent out the capital” argument is very easy to understand. But it is astonishing how difficult the argument is to understand when the capital-owner is a corporation. If an individual owns a machine, a “widget-maker,” then that ownership is independent of the residual claimant’s role in production using the widget-maker. The capital owner could hire in the workers to operate the widget-maker and to produce widgets–or the widget-maker could be hired out to some other party to produce widgets.

Now suppose the same individual incorporates a company and issues all the stock to himself in return for the widgetmaker. Instead of directly owning the widget-maker, he is the sole owner of a corporation that owns the widgetmaker. Clearly this legal repackaging changes nothing in the argument about separating capital ownership and residual claimancy. The corporation has the capital-owner’s role and–depending on the direction of the hiring contracts–may or may not have the residual claimant’s role in the production process using the widget-maker. The corporation (instead of the individual) could hire in workers to use the widget-maker to manufacture widgets, or the corporation could lease out the widget-maker to some other party. The process of incorporation does not miraculously trans-substantiate the ownership of a capital asset into the ownership of the (net) products produced using the capital asset.

The residual claimant’s role is a contractual role, not a property right. The identity of the “firm” (in the sense of the residual claimant) is determined by who hires what or whom in the markets for inputs. The “firm” is the legal party which hires or already owns all the inputs to be consumed in production and which bears those costs as the inputs are used up. Another party could take over that contractual role through contract reversals (e.g., Labor hiring capital) without having to “buy the firm.”

Traditional democratic theory and property theory have both been distorted by the uncritical acceptance of the fundamental myth that residual claimancy was a property right. There is in fact no structural conflict between private property rights in capital and democratic principles. The conflict is between the employment contract and democratic principles.

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