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Table of contents :
About the Book
Contents
Chapter 1: Introduction to the Jurisprudence of Property and Contract
1.1 Introduction
1.2 The Conventional Neglect of the Question of Appropriation
1.3 The Fundamental Myth
1.4 The `Invisible Hand´ in the Property System
1.5 Normative Theory of Appropriation and Transfers of Property
1.5.1 Applying the Juridical Principle of Imputation to All Intentional Human Activities
1.5.2 Rights-Based Normative Economics
1.6 The Fundamental Theorem for the Property Mechanism
1.7 Description of Production in the Employment System
1.7.1 The Facts of the Case
1.7.2 How Does the Description of Employment Square with the Fundamental Theorem?
References
Chapter 2: Mathematical Introduction to the Jurisprudence of Property and Contract
2.1 From Numbers to Vectors of Numbers
2.2 Graphs
2.3 The Contractual Mechanism
2.4 Analysis of Breaches and Externalities
2.5 ``Appropriation Is the Boundary of Contract´´
2.6 Responsible Actions and Factual Transfers
2.7 Fundamental Theorem of Property Theory
2.8 Intuitive Summary of Basic Ideas: A Water Meter Example
2.9 Intuitive Summary of Basic Ideas: Accounting Examples
2.10 Application to the Human Rental Firm
2.11 Appendix: The Mathematical Development Using General Vectors
2.11.1 Node and Arc Assignments
2.11.2 Divergence Operator
2.11.3 Cuts
2.11.4 The Covering Relation
2.11.5 The Contractual Mechanism
2.11.6 Analysis of Breaches and Externalities
2.11.7 An Exchange Example
2.11.8 Appropriation Is the Boundary of Contract
2.11.9 Responsible Actions and Factual Transfers
2.11.10 Fundamental Theorem of Property Theory
2.11.11 Application to the Human Rental Firm
2.11.12 The Equivalence Between the Two Mathematical Formulations
References
Chapter 3: The Property Fallacy in Capital Theory and Corporate Finance Theory
3.1 The Appropriation of Produced Assets and Liabilities
3.2 The Property Fallacy in Capital Theory
3.3 The Property Fallacy in Corporate Finance Theory
3.4 Property Interpretation of the Book-Plus-Profits Formula
3.5 Future Whole Products as ``Goodwill´´
References
Chapter 4: The Arrow-Debreu Model
4.1 Introduction
4.2 The Modeling Error in the Arrow-Debreu Model
4.3 Separating Corporations from Firms Utilizing Production Sets
4.4 Production as Arbitrage Between Input and Output Markets
4.5 Endgames to Defend the AD Model
4.5.1 Defining Away the Problem with Owner-Specified Outputs
4.5.2 Hidden-Factor Ploys
References
Chapter 5: Marginal Productivity Theory
5.1 What Is the Frame of Discussion?
5.2 Heterodox Criticism of MP Theory
5.3 Isn´t the Distribution of Wealth and Income the `Real´ Problem?
5.4 The Fork in the Road for the `Labor Theory´
5.5 The Question of Appropriation Again
5.6 The Pons Asinorum of Property Theory
5.7 The Descriptive Question of Appropriation
5.8 The Normative Question of Appropriation
5.9 The Juridical Principle of Imputation
5.10 On the Theory of Marginal Productivity
5.10.1 The Metaphor: Treating the Productive Services of Things Like the Responsible Actions of Persons
5.10.2 The Mistake: No Division of Actual Property Rights to the Product
5.10.3 The Miracle: Each Factor´s Immaculate Production of Its Marginal Product
5.11 Conclusions About MP Theory
5.12 Mathematical Appendix on Vectorial MP Theory
References
Chapter 6: Marxism as the Ultimate `Capitalist Tool´
6.1 Introduction
6.2 Marx´s Labor Theory of Value
6.3 Marx and Marxism´s Huge Favors for the Human Rental System
6.3.1 Huge Favor (1) ``Capitalism Is Based on Private Property Rights´´
6.3.2 Huge Favor (2) ``The Basic Question Is: Consent Versus Coercion´´
6.3.3 Huge Favor (3) ``Value Theory Is the Intellectual Battleground to Analyze Capitalism´´
6.3.4 Huge Favor (4) ``Inalienable Rights!? Nonsense on Stilts!´´
6.3.5 Huge Favor (5) ``Democracy Is Only Relevant in The Public Sphere; Capitalist Enterprises Are Private´´
6.3.6 Huge Favor (6) Marxism as the Leftwing Ideology of One-Party Autocracy
References
Chapter 7: The Logical Fallacy in Cost-Benefit Analysis and Law and Economics
7.1 Introduction
7.2 The Same-Yardstick Fallacy and Definitional Statements
7.3 An Example of the Fallacy in the Law and Economics Literature
7.4 The Analysis with a Non-Involved Numeraire
References
Chapter 8: Jurisprudence and the Corporate Governance Debate
8.1 Introduction
8.2 Two Types of Rights: Property Rights and Personal Rights
8.3 Corporations and Cooperatives
8.4 Stakeholder Governance
8.5 What About Shareholder Democracy?
8.6 Concluding Remarks
References
Chapter 9: Invalidity of Personhood Alienation Contracts
9.1 Introduction to Rights-Based Normative Economics
9.2 Examples of Injustice as Non-Correspondence
9.3 Example 1: The Coverture Marriage Contract
9.4 Example 2: The Voluntary Slavery or Perpetual Servitude Contract
9.5 Example 3: Pactum Subjectionis
9.6 De Facto Inalienability
9.7 Employment Contract as the Human Rental Contract
9.8 Example 4: The Human Rental Contract
9.9 Frank Knight as an `Exceptional´ Classical Liberal Thinker
9.10 Classical Liberal Jurisprudence and the Abolition of Certain Voluntary Contracts
9.11 The Democratic Alternative
9.12 Concluding Remarks on the Inalienability of Responsible Agency
References
Chapter 10: Concluding Remarks About Jurisprudence and Neoclassical Economics
10.1 What Is Really Wrong Descriptively?
10.2 What Is Really Wrong Normatively?
References
Index
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David Ellerman

Putting Jurisprudence Back Into Economics What is Really Wrong With Today’s Neoclassical Theory

Putting Jurisprudence Back Into Economics

David Ellerman

Putting Jurisprudence Back Into Economics What is Really Wrong With Today’s Neoclassical Theory

David Ellerman Faculty of Social Sciences University of Ljubljana Ljubljana, Slovenia

ISBN 978-3-030-76095-3 ISBN 978-3-030-76096-0 https://doi.org/10.1007/978-3-030-76096-0

(eBook)

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG. The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

To Warren Samuels And, of course, to Vlasta

About the Book

For over a century, the basic jurisprudence of the system of property and contract that underlies the market has been squeezed out of—or incorporated only in metaphorical terms in—neoclassical economic theory. Neoclassical microeconomic theory is not only the basis for the high prestige of neoclassical theory, but it also provides a sophisticated ideological defense for the current economic system based on the hiring, renting, employing, or leasing of persons, the employment system. Most critiques of neoclassical microeconomic theory, orthodox or heterodox, conservative or progressive, also ignore the underlying jurisprudence and are instead based on criticizing the theory as being abstract and idealized, not descriptive of economic realities. For instance, neoclassical microeconomic theory focuses on the perfectly competitive model when the reality falls far short of that model. Such empirical criticism is not our purpose here. Our purpose is to spell out what is ‘really wrong’ with the theory both descriptively (i.e. conceptual, not empirical, mistakes) and normatively. The criticism is based on questions of normative and positive jurisprudence and on neoclassical theory’s sins of omission and commission concerning the underlying system of property and contract, not the system of market prices.

vii

Contents

1

2

Introduction to the Jurisprudence of Property and Contract . . . . . 1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 The Conventional Neglect of the Question of Appropriation . . . 1.3 The Fundamental Myth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4 The ‘Invisible Hand’ in the Property System . . . . . . . . . . . . . . . 1.5 Normative Theory of Appropriation and Transfers of Property . . . 1.5.1 Applying the Juridical Principle of Imputation to All Intentional Human Activities . . . . . . . . . . . . . . . . . . . 1.5.2 Rights-Based Normative Economics . . . . . . . . . . . . . 1.6 The Fundamental Theorem for the Property Mechanism . . . . . . 1.7 Description of Production in the Employment System . . . . . . . . 1.7.1 The Facts of the Case . . . . . . . . . . . . . . . . . . . . . . . . 1.7.2 How Does the Description of Employment Square with the Fundamental Theorem? . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mathematical Introduction to the Jurisprudence of Property and Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 From Numbers to Vectors of Numbers . . . . . . . . . . . . . . . . . . 2.2 Graphs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 The Contractual Mechanism . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 Analysis of Breaches and Externalities . . . . . . . . . . . . . . . . . . 2.5 “Appropriation Is the Boundary of Contract” . . . . . . . . . . . . . 2.6 Responsible Actions and Factual Transfers . . . . . . . . . . . . . . . 2.7 Fundamental Theorem of Property Theory . . . . . . . . . . . . . . . 2.8 Intuitive Summary of Basic Ideas: A Water Meter Example . . . 2.9 Intuitive Summary of Basic Ideas: Accounting Examples . . . . . 2.10 Application to the Human Rental Firm . . . . . . . . . . . . . . . . . . 2.11 Appendix: The Mathematical Development Using General Vectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1 1 3 5 7 9 9 11 13 15 15 19 23

. . . . . . . . . . .

27 27 28 32 33 35 36 38 38 39 41

.

45 ix

x

Contents

2.11.1 2.11.2 2.11.3 2.11.4 2.11.5 2.11.6 2.11.7 2.11.8 2.11.9 2.11.10 2.11.11 2.11.12

Node and Arc Assignments . . . . . . . . . . . . . . . . . . . Divergence Operator . . . . . . . . . . . . . . . . . . . . . . . . Cuts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Covering Relation . . . . . . . . . . . . . . . . . . . . . . The Contractual Mechanism . . . . . . . . . . . . . . . . . . Analysis of Breaches and Externalities . . . . . . . . . . . An Exchange Example . . . . . . . . . . . . . . . . . . . . . . Appropriation Is the Boundary of Contract . . . . . . . . Responsible Actions and Factual Transfers . . . . . . . . Fundamental Theorem of Property Theory . . . . . . . . Application to the Human Rental Firm . . . . . . . . . . . The Equivalence Between the Two Mathematical Formulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

4

5

. . . . . . . . . . .

45 46 46 47 48 49 52 54 54 56 57

. .

59 61

. . . . . . .

63 63 66 71 72 73 75

The Arrow-Debreu Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 The Modeling Error in the Arrow-Debreu Model . . . . . . . . . . . 4.3 Separating Corporations from Firms Utilizing Production Sets . . . 4.4 Production as Arbitrage Between Input and Output Markets . . . . 4.5 Endgames to Defend the AD Model . . . . . . . . . . . . . . . . . . . . . 4.5.1 Defining Away the Problem with Owner-Specified Outputs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5.2 Hidden-Factor Ploys . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

77 77 78 79 83 84

Marginal Productivity Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1 What Is the Frame of Discussion? . . . . . . . . . . . . . . . . . . . . . 5.2 Heterodox Criticism of MP Theory . . . . . . . . . . . . . . . . . . . . 5.3 Isn’t the Distribution of Wealth and Income the ‘Real’ Problem? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.4 The Fork in the Road for the ‘Labor Theory’ . . . . . . . . . . . . . 5.5 The Question of Appropriation Again . . . . . . . . . . . . . . . . . . . 5.6 The Pons Asinorum of Property Theory . . . . . . . . . . . . . . . . . 5.7 The Descriptive Question of Appropriation . . . . . . . . . . . . . . . 5.8 The Normative Question of Appropriation . . . . . . . . . . . . . . . 5.9 The Juridical Principle of Imputation . . . . . . . . . . . . . . . . . . .

89 89 90

The Property Fallacy in Capital Theory and Corporate Finance Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 The Appropriation of Produced Assets and Liabilities . . . . . . . 3.2 The Property Fallacy in Capital Theory . . . . . . . . . . . . . . . . . 3.3 The Property Fallacy in Corporate Finance Theory . . . . . . . . . 3.4 Property Interpretation of the Book-Plus-Profits Formula . . . . . 3.5 Future Whole Products as “Goodwill” . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . .

84 85 87

. 92 . 95 . 96 . 97 . 100 . 101 . 102

Contents

xi

5.10

On the Theory of Marginal Productivity . . . . . . . . . . . . . . . . . . 5.10.1 The Metaphor: Treating the Productive Services of Things Like the Responsible Actions of Persons . . . . . 5.10.2 The Mistake: No Division of Actual Property Rights to the Product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.10.3 The Miracle: Each Factor’s Immaculate Production of Its Marginal Product . . . . . . . . . . . . . . . . . . . . . . . 5.11 Conclusions About MP Theory . . . . . . . . . . . . . . . . . . . . . . . . 5.12 Mathematical Appendix on Vectorial MP Theory . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6

7

8

Marxism as the Ultimate ‘Capitalist Tool’ . . . . . . . . . . . . . . . . . . . . 6.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2 Marx’s Labor Theory of Value . . . . . . . . . . . . . . . . . . . . . . . . . 6.3 Marx and Marxism’s Huge Favors for the Human Rental System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.1 Huge Favor (1) “Capitalism Is Based on Private Property Rights” . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.2 Huge Favor (2) “The Basic Question Is: Consent Versus Coercion” . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.3 Huge Favor (3) “Value Theory Is the Intellectual Battleground to Analyze Capitalism” . . . . . . . . . . . . . 6.3.4 Huge Favor (4) “Inalienable Rights!? Nonsense on Stilts!” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.5 Huge Favor (5) “Democracy Is Only Relevant in The Public Sphere; Capitalist Enterprises Are Private” . . . . 6.3.6 Huge Favor (6) Marxism as the Leftwing Ideology of One-Party Autocracy . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Logical Fallacy in Cost-Benefit Analysis and Law & Economics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.2 The Same-Yardstick Fallacy and Definitional Statements . . . . . 7.3 An Example of the Fallacy in the Law & Economics Literature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.4 The Analysis with a Non-Involved Numeraire . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Jurisprudence and the Corporate Governance Debate . . . . . . . . . 8.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.2 Two Types of Rights: Property Rights and Personal Rights . . . 8.3 Corporations and Cooperatives . . . . . . . . . . . . . . . . . . . . . . . 8.4 Stakeholder Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.5 What About Shareholder Democracy? . . . . . . . . . . . . . . . . . . 8.6 Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

106 106 109 111 112 114 116 119 119 120 122 122 123 124 124 125 127 128

. 131 . 131 . 133 . 134 . 136 . 139 . . . . . . . .

141 141 142 143 145 147 149 151

xii

9

10

Contents

Invalidity of Personhood Alienation Contracts . . . . . . . . . . . . . . . 9.1 Introduction to Rights-Based Normative Economics . . . . . . . . 9.2 Examples of Injustice as Non-Correspondence . . . . . . . . . . . . 9.3 Example 1: The Coverture Marriage Contract . . . . . . . . . . . . . 9.4 Example 2: The Voluntary Slavery or Perpetual Servitude Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.5 Example 3: Pactum Subjectionis . . . . . . . . . . . . . . . . . . . . . . 9.6 De Facto Inalienability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.7 Employment Contract as the Human Rental Contract . . . . . . . . 9.8 Example 4: The Human Rental Contract . . . . . . . . . . . . . . . . . 9.9 Frank Knight as an ‘Exceptional’ Classical Liberal Thinker . . . 9.10 Classical Liberal Jurisprudence and the Abolition of Certain Voluntary Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.11 The Democratic Alternative . . . . . . . . . . . . . . . . . . . . . . . . . . 9.12 Concluding Remarks on the Inalienability of Responsible Agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Concluding Remarks About Jurisprudence and Neoclassical Economics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.1 What Is Really Wrong Descriptively? . . . . . . . . . . . . . . . . . . . 10.2 What Is Really Wrong Normatively? . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . .

153 153 154 155

. . . . . .

157 160 162 164 165 168

. 170 . 172 . 173 . 175 . . . .

177 177 179 182

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183

Chapter 1

Introduction to the Jurisprudence of Property and Contract

Abstract This chapter treats (informally) the sins of omission and commission about property rights and contracts in neoclassical microeconomic theory. The analysis is developed at both the descriptive and normative levels, and then the Fundamental Theory of Property Theory connects the two levels. That theorem is the property theoretic counterpart of the price theoretic theorem that a competitive equilibrium, under certain assumptions, is Pareto optimal. The property theoretic version states that when the market mechanism operates with no property externalities (no thefts or conversions of property) and no breaches of contracts, then the appropriation of newly created assets and liabilities by market participants (producers and consumers) satisfies the juridical principle of imputation of legal responsibility in accordance with factual responsibility.

1.1

Introduction

The purpose of this book is to present an integrated jurisprudential critique of neoclassical economic theory. In terms of the division between micro- and macroeconomic theory, it is the microeconomic theory that is unified, that has the greatest scientific prestige, and also provides the most ‘scientific’ ideological foundation for the current economic system. Separating the science from the ideology is part of our task. The word “theory” is important. Almost all the orthodox or heterodox critiques of neoclassical economics are based on pointing out the rather obvious, if not completely trite, fact that the idealized microeconomic theories are not descriptive of reality—so our purpose is not to reiterate that refrain. Our purpose is also not to point out “what’s wrong in [macro] economics” after the crisis of 2007–2008 (Skidelsky 2020). In contrast, our purpose is to point out what is “really wrong” with today’s neoclassical microeconomic theory—hereafter referred to as just “neoclassical theory.” On the descriptive side, our focus is on conceptual mistakes in the theory, which are even clearer due to the idealized nature of the theory. By far the most philosophically sophisticated and thorough defender of the standard theory was Frank H. Knight, and he emphasized the conceptual nature of © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_1

1

2

1 Introduction to the Jurisprudence of Property and Contract

the perfectly competitive model, and criticized the confusion of taking it as a description of actual behavior. Economic theory is not a descriptive, or an explanatory, science of reality. Within wide limits, it can be said that historical changes do not affect economic theory at all. It deals with ideal concepts which are probably as universal for rational thought as those of ordinary geometry. (Knight 1969, p. 277) The fact that description of ideal behaviour in part explains actual behaviour operates as a source of confusion; the notion that economics is a science explanatory of actual behaviour is the most important single confusion in the methodology of the science. (Ibid., p. 279)

Now the most sophisticated model of competitive equilibrium is the ArrowDebreu model (Arrow and Debreu 1954), so we have a chapter devoted to show how it conceptually fails to model even the idealized competitive private property market economy. Roughly speaking, neoclassical economics is part ideology and part social science (including much applied mathematics of constrained optimization). It is almost a tautology that a good part of any social “science” is devoted to fundamentally justify an idealized form of the social system in which it is embedded—as well as to offer some searching and heartfelt criticisms of how the actual system does not live up to the idealized version. Our focus is conceptual criticism of the idealized model, not on its empirical shortcomings. When emphasizing this professional role of conventional economic theory to justify the idealized system (e.g., the perfectly competitive model of a private property market economy with the employment relation), we will capitalize it as “Economics.” In addition to our deepest-thinking antagonist, Frank Knight, our quotes will tend to be from Paul Samuelson or other winners of the Nobel Prize in Economics. What is the source of this conceptual criticism? In a word, it is “jurisprudence.” John Stuart Mill (1970 [1848]) was the last major political economist who considered the study of property rights as an integral part of economic theory. Since his time, the marginalist revolution reshaped conventional economic theory to focus on the theory of markets and prices to the detriment of any serious descriptive or normative theory about the underlying system of property and contract—as if the theories applied to different worlds. Hence it should be no surprise that the conceptual criticisms in this book have to do with the descriptive and normative misconceptions about property and contracts that are deeply embedded ideology in neoclassical Economics, not to mention in the broader society. The focus on the jurisprudential mistakes, both descriptive and normative, means that this book is not a scattershot critique or ‘lawyer’s list’ of complaints about neoclassical microeconomic theory. It is an integrated critique of certain basic errors that nevertheless surface again and again in neoclassical theory. We begin with an analysis of property and contracts in a private property market economy. The property system underlies the price system. There is no market without an underlying system of property and contracts. From Adam Smith onward, economics has analyzed the idea of an invisible hand mechanism in the price system. But

1.2 The Conventional Neglect of the Question of Appropriation

3

Fig. 1.1 Life cycle of a property right

underlying the price system, there is a more basic system of private property rights. When the system of property rights is analyzed in its own right, it turns out that there is also an invisible hand mechanism in the property system. It governs the legal initiation and termination of property rights in an on-going market economy (as opposed, say, to some one-time usually ‘mythical’ appropriation in a ‘state of nature’ or private appropriation of common property). Property theory includes a description of that property mechanism, the underlying normative analysis, the fundamental theorem for the property system, and the application to the current private property market economy all of which are the topics of this chapter.

1.2

The Conventional Neglect of the Question of Appropriation

Property and the legal rights to property have a life cycle; they are created, transferred, and eventually terminated. Market contracts transfer property rights but what is the institution for the legal creation and termination of property rights? In ordinary economic activity, property rights are being constantly created in production and they are constantly being terminated in consumption as well as in production activities (inputs consumed in production) as indicated in Fig. 1.1.1 Neoclassical economics is essentially a theory of markets since markets are where property rights are transferred but not created or terminated. It is a remarkable fact—which itself calls for explanation—that the sparse literature on the so-called “economics of property rights” does not even formulate the question about the mechanism for the initiation and termination of property rights in these normal activities. For example, that question is ignored:

1

Like in standard Economics texts, our focus is on commodities, rivalrous and excludable private goods, that are produced and consumed as a part of deliberate human activity—even though in the distant past there may have been endowments of unproduced goods. Intellectual property rights in non-rivalrous knowledge try to fit it into the rivalrous paradigm but the special aspects of property in knowledge are not our topic.

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• in the “economics of property rights” (e.g., Furubotn and Pejovich 1974), • in the “property rights approach” to the firm (e.g., Hart and Moore 1990), • in the Putterman and Kroszner anthology (1996) of papers on the “economic” nature of the firm, • in the “property rights” literature of the new institutional economics (e.g., Furubotn and Richter 1998), and • in the law and economics literature (e.g., Cooter and Ulen 2004; Miceli 1999). Before turning to an explanation, we could simplify the terminology about the eventual termination of property rights by referring to the legal termination of a property right as the legal assignment or appropriation2 of the liability for that property: termination of an asset ¼ appropriation of the liability (for the asset).

Algebraically this is the familiar idea that “subtracting a plus quantity” is the same thing as “adding a minus quantity.” Hereafter, we will describe the termination of the right to a used-up or consumed asset (subtracting a plus quantity like an asset) as the appropriation of the liability for the using-up or consumption of the assets (adding a minus quantity like a liability). Hence the question before us is the mechanism for the appropriation of the assets and liabilities created in normal production and consumption activities.3 Appropriation is usually neglected in normal production and consumption since discussions of property creation tend to be restricted in the philosophical literature to a rather mythical state of nature (e.g., Locke 1960) or original position, or, in the economic literature, to the “appropriation” of unclaimed or commonly owned natural goods (e.g., Cooter and Ulen 2004). This ignores the everyday matters of production and consumption of commodities where property rights are created and terminated “on the fly.” For instance, Harold Demsetz (1967) considers how private property in land with fur-bearing animals was established as a result of the growth of the fur trade. John Umbeck (1981) considers how rights to gold deposits were created during the 1848 California gold rush on land recently ceded from Mexico. Yoram Barzel (1989) considers how the common property rights to minerals under The termination of rights was an original meaning of “expropriation.” “This word (expropriation) primarily denotes a voluntary surrender of rights or claims; the act of divesting oneself of that which was previously claimed as one’s own, or renouncing it. In this sense, it is the opposite of ‘appropriation’. A meaning has been attached to the term, imported from foreign jurisprudence, which makes it synonymous with the exercise of the power of eminent domain, ....” (Black 1968, p. 692, entry under “Expropriation”) Since “expropriation” now has this acquired meaning, we will treat the “expropriation (termination) of rights to the assets +X” as the “appropriation of the liabilities X.” 3 The stocks and flows of value in normal production can be described using double-entry accounting. By formulating the double-entry system mathematically, the system can be extended to multidimensional non-negative vectors to describe the stocks and flows of property rights in production—including the vector of property rights flows (input liabilities and output assets) here called the “whole product.” (Ellerman 1982 or Chap. 6 in 1995 or 2014) This is developed in the next chapter. 2

1.3 The Fundamental Myth

5

the North Sea were privatized but ignores the assignment of initial rights in normal production (e.g., in Barzel’s Chap. 5, “The formation of rights”). On the negative side, the law and economics literature looks extensively at the assignment of liabilities in the legal trials that may follow the destruction of property in torts or crimes. But there is no attention to the mechanism for assigning the liabilities for the production inputs and consumption goods that are used up or consumed in normal production and consumption activities where legal trials are clearly not the mechanism for liability assignment. What is the everyday mechanism for the assignment of liabilities?

1.3

The Fundamental Myth

There is a reason—albeit a mistaken one—for not formulating the question of appropriation in production. It is rather commonly thought that the product rights are “attached to” or are “part and parcel of” some pre-existing property right such as the ownership of a capital asset, a production set, or, simply, the firm. This idea in various forms is so ubiquitous that it might be termed the fundamental myth about the private property system. It is the lodestone that sets so many compasses wrong in neoclassical Economics. For instance, the simplest version of this fundamental myth is the assumption that the bundle of rights that constitute ownership of a capital asset includes “a right of ownership-over-the-asset’s-products, or jus fruendi” (Montias 1976, p. 116), the “right of usufruct (which) entitles the holder to the ‘fruits’ or ‘produce’ derived from an asset” (Furubotn and Richter 1998, p. 79), or simply “the right to the products of the asset” (Putterman 1996, p. 361). To see that the product rights are not part of capital ownership, one only has to consider the result of renting out the capital employed in production. The party who hired in the capital and paid for all the other used-up inputs would have the legally defensible first claim on the produced output, not the owner of the capital asset to whom the rent was being paid as one of the input costs. It should be further noted that the ideas of an “asset’s product,” the “‘produce’ derived from an asset,” or “the products of the asset” have a quaint nineteenth century flavor prior to the development of the reasoning associated with marginal productivity (MP) theory. It is the interdependence of productivities of land, labor, and capital that makes the distribution of income a complex topic. Suppose that you were in charge of determining the income distribution of a country. If land had by itself produced so much, and labor had by itself produced so much, and machinery had by itself produced the rest, distribution would be easy. Moreover, under supply and demand, if each factor produced a certain amount by itself, it could enjoy the undivided fruits of its own work. (Samuelson and Nordhaus 2010, p. 234)

The survival of these pre-marginalist notions of an “asset’s product,” the “products of an asset,” or the “‘produce’ derived from an asset”—even in the neoclassical

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‘new institutional economics’ (Furubotn and Richter 1998), is a testament to the pervasiveness of the fundamental myth and the lack of serious analysis of property rights in neoclassical Economics as a whole. Another more recent version of the fundamental myth is to take the “asset” as being a production opportunity as described by a production function or a production set (see the chapter on the Arrow-Debreu model). Entrepreneurs are “bidding for ownership of the firms” and become the “owners of the productive opportunity” (Hirshleifer 1970, pp. 124–125). A proprietor may sell “the rights to the transformation function” or “his rights to the venture” (Fama and Jensen 1996, p. 341) to another proprietor. The entrepreneur is the “owner of a production function” (Haavelmo 1960, p. 210). Hence the technological relationship between inputs and outputs is reified as a form of property in Economics identified with “the firm.” In addition to buying or already owning all the inputs to production (including technical knowledge), the employer now has to also get “ownership” of the “production function”! The simple hypothecation of an analytical concept (“production function” or “production set”) in neoclassical Economics as a real existing property right is another testament to the lack of serious analysis. Perhaps the primary source of the fundamental myth is the confusion between owning a corporation and “owning” the productive opportunity that a corporation may or may not undertake depending on its contracts. The line of reasoning is: A corporation is an owned asset [true]4 and a corporation owns “its products” [true by definition] so there is no need for some mechanism to account for the ownership of the product—it’s all part of the ownership of the corporation.

It is only a tautology to say that a corporation owns “its products”; the question is how did the products produced in a certain productive opportunity become “its products.” In a private property market economy, all factors of production and even whole factories are rentable, and it is the pattern and direction of those hiring contracts that determine who owns the product. There is even a historical example that cuts like a lighthouse beam across the sea of obscurity in neoclassical Economics. Not only is it routine for buildings, office space, and machines to be rented out, there is even a historical example of a whole factory being rented out. In the early 1950s, the Studebaker-Packard Corporation had the Packard bodies produced in a Detroit Conner Avenue plant of the Briggs Manufacturing Company. After the founder died, all twelve of the U.S. Briggs plants were sold to the Chrysler Corporation in 1953. “The Conner Ave. plant that had been building all of Packard’s bodies was leased to Packard to avoid any conflict of interest.” (Theobald 2004) Then the Studebaker-Packard Corporation would hold the management rights and product rights for the operation of the factory owned by the Chrysler Corporation. The simple fact is that the shareholders’ ownership of a corporation is the indirect ownership of the corporate assets (e.g., the Conner Ave. factory). Whether or not the 4 To see how the idea of a corporation would change with the abolition of the employment contract, see Ellerman (2020), Chap. 4 in Ellerman (2021), or the Chap. 8 on corporations herein.

1.4 The ‘Invisible Hand’ in the Property System

7

company owns the products produced using some of those assets depends on whether the company hires or leases out those assets to some other party (who would then appropriate the product) or the company hires in a complementary set of inputs to undertake the production opportunity itself. The legal party who ends up appropriating (i.e., having the defensible claim on) the produced assets is the party, often called the “residual claimant,” who was the contractual nexus of hiring or already owning all the inputs used up in production (and who then “swallowed” those input-liabilities rather than reselling the inputs). Since that party undertaking production, the residual claimant, is determined by who was the nexus of the hiring contracts (who hires or already owns what or whom), the rights to the product are not part of some prior bundle of rights to a capital asset or to a corporation. In other words, residual claimancy is contractually determined in a market economy; it is not legally determined by some “product rights” supposedly attached to some alreadyowned asset. The fundamental myth also leads to fallacies in capital theory and corporate finance theory (which are analyzed in Chap. 3). The grip of the fundamental myth in one form or another seems to account for the failure to formulate the concept of a mechanism for the appropriation of the assets and liabilities that are created in normal production activities.

1.4

The ‘Invisible Hand’ in the Property System

Neoclassical economic theory has worked to elucidate the invisible hand mechanism embodied in the price system that, in theory, guides property rights to an efficient allocation. The life-cycle of property rights includes not only transfers in the market but the initiation and termination of the property rights. The market also embodies an invisible hand mechanism that governs the initiation and termination of property rights—but the very idea of this mechanism has been neglected due to the many forms of the fundamental myth that the product rights are already included in pre-existing capital asset rights. To “see” an invisible hand, it is helpful to look at the corresponding visible hand and then to see what happens in the absence of the visible hand. When does the ‘visible hand’ of the legal system intervene in the marketplace? The prime example is a trial to assign the legal liability for property that has been destroyed by a legal party other than the owner. Such a trial also illustrates the underlying juridical norm that we will use in the fundamental theorem about the invisible hand property mechanism. That norm is the responsibility or juridical imputation principle: assign the de jure or legal responsibility to the person or persons who were actually de facto responsible for destroying the property.

Thus, there are two questions; the descriptive one and the normative one. What is the description of the invisible hand mechanism in the property system, and when does it operates correctly according to the juridical imputation principle? That

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question is answered by the Fundamental Theorem of Property Theory—treated informally in this chapter and formally in the next chapter. The invisible hand mechanism for the legal assignment of initial and terminal rights comes into play when there is no explicit trial—when the visible hand of the legal authorities does not intervene and when it thus, in effect, renders the laissez faire judgment of “let it be.” Using the Smithian metaphor, we might even conceptualize “non-action” on the part of the legal authorities as the ruling of the “Invisible Judge” who always rules “let it be.” In the tradition of Ronald Coase (1960), there has been an emphasis on a legal system defining clear property rights. Property rights are defined as much by the inaction of the legal system as by its actions. When sparks from a passing locomotive burn the crop growing in a farmer’s field and the Invisible Judge rules “let it be” (i.e., the legal authorities for whatever reason allow no action), then at least the right to take that specific action was, in effect, established on the part of the railroad and the liabilities for the damaged crops were, in effect, assigned to the farmer who might have chosen to plant crops close to the railroad. There are two types of contracts where the role of the Invisible Judge is particularly important, namely, the first and the last transfer contracts in the life-cycle of a commodity. When a newly produced commodity is first sold and the Invisible Judge lets it be, then the first property right was, in effect, assigned to or appropriated by the first seller. And when a purchased commodity is subsequently consumed, used up, or destroyed and the Invisible Judge lets it be, then the liability was, in effect, assigned to or appropriated by the last buyer. Thus, we have the laissez-faire property assignments governing the first and last contracts in the life-cycle of commodities: Market invisible hand mechanism of appropriation: The property rights (or liabilities) to newly produced (respectively, finally used-up) commodities are assigned to or appropriated by the first seller (respectively, last buyer) of the commodities.

The application to normal consumption is straightforward. When a commodity is consumed and the Invisible Judge lets it be, then the liability for the using up or consumption of the commodity is in effect imputed to the last buyer. It is the application of the market mechanism of appropriation is to normal production activities that is more controversial. Abstractly considered, one legal party purchases (or already owns from past purchases or activities) all the “inputs” (e.g., raw materials, intermediate goods, and labor services considered as another input commodity) to be used up in the production process. When those inputs are used up and new products or outputs are produced, then the last buyer of the inputs is in a legally defensible position to be the first seller of the outputs unless the legal authorities would intervene to overturn both sets of contracts. Hence when no such intervention takes place—as in normal production—then that one legal party in effect legally appropriates a bundle of legal rights and liabilities, the input-liabilities and the output-assets, which might be called the “whole product”—but is usually called the “production vector” or “input-output vector.” That is a description of how the invisible hand or invisible judge system of appropriation works. As in

1.5 Normative Theory of Appropriation and Transfers of Property

9

descriptions about how the price system works, the next question is “what are its normative properties?”. Just as neoclassical economics addresses the question of under what conditions does the price system operate efficiently, so the theory of property must consider when the invisible hand of the property system operates correctly.

1.5 1.5.1

Normative Theory of Appropriation and Transfers of Property Applying the Juridical Principle of Imputation to All Intentional Human Activities

The fundamental theorem for the competitive price mechanism proves a correspondence between the descriptive or positive notion of a competitive equilibrium and the normative notion of Pareto efficiency. The fundamental theorem for the market mechanism of property appropriation has the same logical form of a correspondence between a descriptive situation and a normative principle of appropriation. The normative principle of appropriation is just the ordinary juridical imputation principle:5 assign de jure (or legal) responsibility in accordance with de facto (or factual) responsibility—applied to normal production and consumption instead of being applied by visible judges to torts and crimes. This is the modern treatment of what historically was called the labor or natural rights theory of property—the basic idea that people have a natural right to own the positive fruits of their labor (and symmetrically a natural obligation to bear the negative fruits of their labor) (Hodgskin 1973 [1832]; Menger 1899; Schlatter 1951; the “labor theory of right” in Brockway 1995; Ellerman 1992 or 2021). Since this principle is already used in the interventions of the visible hand of the law, i.e., legal trials, it is natural to see under what conditions the invisible hand mechanism of the property system actually follows the same principle. That question is answered by the Fundamental Theorem of Property Theory. The imputation principle assigns de jure responsibility in terms of the de facto or factual responsibility of persons. In conventional normative economics, the Paretian criterion only involves the preferences of persons and ignores the “revealed preferences” of lower animals and things. Similarly, the normative theory of appropriation of assets and liabilities is only applied to the responsible actions of persons, not to the behaviors or services of the lower animals or things. Regardless of the causal

“(This) is itself a principle about natural responsibility, and so, as a guide for adjudication, unites adjudication and private morality and permits the claim that a decision in a hard case, assigning responsibility to some party, simply recognizes that party’s moral responsibility.” (Dworkin 1985, p. 288).

5

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efficacy of a thing’s services, the juridical imputation principle is never applied to the services of non-persons. Any science of economics (redefined to include the underlying system of property and contract along with the underlying juridical principles) needs to recognize a metaphor for what it is. There is an old literary metaphor (a version of the pathetic fallacy) where natural forces are pictured as being “responsible” for certain consequences. Economists sometimes indulge these picturesque images as when an asset is imagined as ‘cooperating’ with persons in the production of a product or when natural forces and human actions are coupled together as if both were de facto responsible. “Together, the man and shovel can dig my cellar” and “land and labor together produce the corn harvest” (Samuelson 1976, pp. 536–537). However, since the demise of primitive animism as a legal theory (e.g., after the trials of child-killing pigs during the Middle Ages), the law has only recognized persons as being capable of being responsible. The responsibility for the results of using tools or assets is imputed back through the things to the human users. For instance, a description without the pathetic fallacy would be that a man is responsible both for using up the services of a shovel and for thereby digging a cellar (note the positive and negative side of responsibility)—or that labor uses up the services of land in the production of the corn harvest (again the negative using-up of land services to produce the positive corn harvest). Modern jurisprudence has always been clear that the responsibility principle applies only to persons (of normal capacity). The statement that an individual is zurechnungfähig (“responsible”) means that a sanction can be inflicted upon him if he commits a delict. The statement that an individual is unzurechnungfähig (“irresponsible”)—because, for instance, he is a child or insane— means that a sanction cannot be inflicted upon him if he commits a delict. . . . The idea of imputation (Zurechnung) as the specific connection of the delict with the sanction is implied in the juristic judgment that an individual is, or is not, legally responsible (zurechnungfähig) for his behavior. (Kelsen 1971, p. 327)

Regardless of their causal efficacy (e.g., marginal physical productivity), physical assets and animals are, a fortiori, unzurechnungsfähig—regardless of the crude analogical attempts in neoclassical Economics to interpret the juridical responsibility principle as “the ethical proposition that an individual deserves what is produced by the resources he owns.” (Friedman 1962, p. 196). There is certain ambivalence, if not incoherence, in neoclassical Economics about the treatment of human preferences on the one hand and the human actions that express those preferences on the other hand. Human preferences are singled out over the revealed preferences of animals for special treatment in normative definition of individual welfare and Pareto optimality. Yet the standard practice in neoclassical economics (including the Austrian variants) is to list the services of things and animals alongside responsible human actions in an undifferentiated list of “inputs” in a production function y ¼ f(x1, . . ., xn). Any prosecutor who hauled the instruments of a crime into court along with the alleged perpetrator and charged them all with the crime might be considered as having taken too many Economics courses. In any case, the responsibility principle in jurisprudence singles out persons as being the sole source of responsibility (both positive and negative), and that is the legal theory modeled here.

1.5 Normative Theory of Appropriation and Transfers of Property

11

In connection with the Paretian criterion of efficiency, there is another problem with neoclassical theory that might be mentioned. One attempt to go beyond the Paretian criterion is to use the Kaldor-Hicks criterion (a potential Pareto improvement where the gainers could but don’t necessarily compensate the losers) to modernize the Marshall-Pigou tradition of welfare economics. A proposed social change satisfying the KH criterion is parsed into an increase in a monetized social pie (“social wealth”) and a redistribution of the pie. The welfare economist can supposedly recommend the increase in “social wealth” as an increase in “efficiency” while the redistributive part of the change is a separate question of “equity” outside of the bailiwick of the professional Economist. This methodology is the basis for the standard economic treatment of the law (Chicago wealth-maximization school of Law & Economics) and for cost-benefit analysis. However, the Kaldor-Hicks criterion rests on a logical fallacy that is explained in the chapter of the Kaldor-Hicks Principle herein. The less traveled road beyond the Paretian criterion is a rights-based jurisprudential theory that takes seriously the incommensurability of persons, that eschews any notion of a given collective social welfare, and that recognizes the de facto or factual responsibility of persons as opposed to things. The normative property theory developed here uses the “Paretian” methodology—by basing the normativelyrelevant notion of legal responsibility on the de facto human responsibility just as the normatively-relevant notion of individual welfare is based on human preferences (not the ‘revealed preferences’ of animals or things)—to take the rights-based path.

1.5.2

Rights-Based Normative Economics

The other part of the life-cycle of property rights is the transfer between legal parties. The same methodology yields the obvious solution, the principle of consent. The legally permitted transfers in property rights of a person are to be those that have the subjective permission or consent of the owner. “Consent is the moral component that distinguishes valid from invalid transfers of alienable rights.” (Barnett 1986, p. 270). Property theory as modeled here is about the appropriation and transfers of property in production and consumption in an on-going market economy. The theory is silent on any initial endowment of property rights that is, in any case, long lost in the mists of the past. The Lockean idea that one should appropriate the fruits of one’s labor applied to the commons is an application of the responsibility principle. But one’s labor also had the negative fruits of using up some portion of the commons and the same principle implies that one ought to hold that liability (which Locke tried to finesse by assuming that as much and as good is left for others). The question of endowment is about to whom that liability for using up the fruits of nature should be owed. Is it “society” as organized in the state? Is it some version of past, present, and future humanity? The normative theory given here does not delve into the initial endowment; it simply assumes an endowment so that we may model the appropriations and transfers in the normal production and consumption activities of an on-going private property market economy.

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There are exactly two ways that a transfer might go wrong: (1) if a property transfer was made without any voluntary contract, which will be called a “property externality” (e.g., a theft or conversion of property), or (2) if a contract was not fulfilled by the actual transfers, namely, a breach of contract. In this simple model of the property system, the legal system has two normative tasks: (a) to implement the responsibility principle in the production and consumption internal activities of the parties, and (b) to implement the consent and no-breach principles in external transfers between parties. The responsibility principle is concerned with the internal activities of the parties whereas the transfer contracts deal with the external relationships between parties. But in a market system, the two tasks are related. The key result, the fundamental theorem, is that if the legal authorities just ensure that the contractual machinery works correctly in the external market relationships between parties—no property externalities and no breaches— then the market mechanism of appropriation will indeed satisfy the responsibility principle in the internal activities of the parties. That is the ‘natural system’ of property and contract. By the fundamental theorem, the two tasks of a legal system become one. Hence the legal authorities only need to intervene when the external property transfers between the parties go wrong, and do not need to monitor the internal activities of the parties (surely an important attribute of a well-functioning private property market system). In the early days of political economy, e.g., in the days of David Hume and Adam Smith, such jurisprudential considerations were part of the analysis. The conditions on transfers—no externalities and no breaches—will be called “Hume’s conditions” because of his emphasis on “transference by consent, and of the performance of promises.” (Hume 1978 [1739], Book III, Part II, Section VI, p. 526).6 Adam Smith later had the same two conditions on the voluntary transference of property. To this there are two things necessary: I, the will of the proprieter or transferrer, distinctly signified, that the thing should be transferred to the transferré; and II, tradition, that is, that (the) thing the property of which is transferred should be put into the power of him to whom it is transferred. (Smith 1982, p. 71)

The responsibility principle concerning appropriation will be called the “Lockean principle.”7 The fundamental theorem then takes the form: “Hume (and Smith) implies Locke.”

6 The closest Hume came to recognizing the legal appropriation of the output assets in production was his notion of accession: “We acquire the property of objects by accession, when they are connected in an intimate manner with objects that are already our property, and at the same time are inferior to them. Thus the fruits of our garden, the offspring of our cattle, and the work of our slaves, are all of them esteem'd our property, even before possession.” (Hume 1978, Book III, Part II, Section III, p. 509) He did not explicitly recognize the algebraically symmetric appropriation of liabilities, nor examine the consequence of property being rented out. 7 This historical tag is not intended as an explication of Locke’s thought. Indeed, I have argued elsewhere (Ellerman 1992) that Locke’s theory was quite ambiguous and that he should not be considered a “Lockean” in the sense of adhering to the responsibility principle. On that topic, see also the excellent analysis of C. B. Macpherson (1962).

1.6 The Fundamental Theorem for the Property Mechanism

1.6

13

The Fundamental Theorem for the Property Mechanism

The correctness theorem for the market mechanism of appropriation shows that if the market contractual mechanism works correctly (no breaches and no externalities), then the invisible hand or laissez faire mechanism of imputation operates correctly in terms of the responsibility principle. It is important to be more explicit about certain underlying assumptions in standard economic models. Each party has a certain set of commodities (goods and services) within the party’s possession and control which we might call the party’s possessions. In the one-period individual consumption problem of maximizing utility U(x1, . . ., xn) subject to a budget constraint p1x1 + . . . + pnxn ¼ B, there are several (often implicit) assumptions that relate the xi’s that occur in the utility function to those that occur in the budget constraint. If five pounds of meat are purchased but then accidentally spoil and are thrown away, then the meat will appear in the budget constraint but not in the utility function representing consumption. Or there might be vicarious consumption of commodities in some other party’s possession that would not appear in the budget constraint. Both these possibilities are ruled out in the efficiency or correctness theorem for the price mechanism (i.e., that a competitive equilibrium is Pareto efficient), and we must make similar (no-accident and no-vicarious consumption) assumptions about the property mechanism. There is thus a set of assumptions that relates the party’s de facto responsible actions to the internal changes8 in a party’s possessions. Just as it is conventionally assumed that consumer goods do not accidentally spoil or get destroyed but are deliberately consumed, so we must rule out accidents (like spoilage or other unintended destruction) by assuming that the internal changes in a party’s possessions are made by the party’s de facto responsible actions. And the analogy of “no vicarious consumption” is the locality or no-action-at-a-distance principle that de facto responsible action can only operate on commodities in the party’s possession or control (i.e., responsibility implies causality).9 By these no-accident and locality assumptions, the positive and negative results of a party’s de facto responsible actions are equal to the internal changes in the party’s possessions. We could abbreviate this as: de facto responsibility ¼ internal changes in possessions.

Now we turn to the legal system’s task of enforcing the rules about the external changes, the changes due to transfers with other parties. In the consumption example, the purchased xi’s that appear in the budget constraint might not be delivered (a breached purchase contract), and there might be some commodities “delivered” from another party which were not purchased as in an externality (e.g., a theft or 8 These “internal changes” are sometimes thought of as “trades with Nature” as opposed to trades with other parties. 9 This is why alibis are important in establishing who is not de facto responsible for a crime.

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conversion). The enforcement of Hume’s no-breach and no-externality conditions means that the external changes in each party’s factual possessions are precisely those made by the legal contracts with other parties. When the same commodity is bought and sold by a party (and transferred in and out), then it nets out so the external changes (always in net terms) in a party’s possessions are those indicated by the firstsale and last-purchase contracts. We could abbreviate the enforcement of the no-breach and no-externality rules as: external changes in possessions ¼ first-sale and last-purchase contracts.

We previously saw that in the market mechanism of appropriation, the Invisible Judge imputes legal responsibility according to the first-sale and last-purchase contracts. We could abbreviate this mechanism as: legal responsibility ¼ first-sale and last-purchase contracts.

To complete the theorem, it only remains to note the mathematical result that: “internal changes in possessions ¼ external changes in possessions.” In graph theory, this is the “divergence principle” (Rockafellar 1984, p. 55) which is the discrete version of the fundamental theorem of calculus. For an intuitive picture, think of an incompressible fluid flowing into and out of a closed region in the plane. Fluid is also coming out of sources inside the region with a sink counting as a negative source. The divergence principle is that the net amount flowing out across the boundary of the regions (external changes) equals the net amount flowing out of the sources within the region (internal changes): external changes in possession ¼ internal changes in possessions.

We may put the assumptions, conditions, and mathematics together to have the: Fundamental Theorem of Property Theory (“Hume implies Locke”): If there are no breaches and no externalities in the market contractual transfers, then the market mechanism of appropriation imputes legal responsibility in accordance with de facto responsibility, i.e., operates correctly in terms of the responsibility principle. Informal proof: Legal responsibility ¼ first-sale and last-purchase contracts ¼ external changes in possessions ¼ internal changes in possessions ¼

(by the market mechanism of appropriation) (by the no-externality and no-breach assumptions) (by divergence principle) (by no-accident and locality assumptions)

de facto responsibility.10 QED Enforce the contractual rules between the parties and then the Invisible Judge will make the right imputations to the parties. In the contrapositive form (Not-Locke

10

The proof is formalized using vector flows on graphs in the next chapter.

1.7 Description of Production in the Employment System

15

implies Not-Hume), the theorem states that if there was a misimputation by the Invisible Judge, then it would have to show up publicly as a property externality or a breached contract. This is the property-theoretic refutation of Marx’s charge that there could be injustice in the “hidden abode of production” while the sphere of exchange “is in fact a very Eden of the innate rights of man” (Marx 1990, Book I, Chap. VI, p. 280). Marx’s cleverness ran afoul of the cunning of the divergence principle that connects the “hidden abode of production” to the sphere of exchange.11

1.7 1.7.1

Description of Production in the Employment System The Facts of the Case

In view of the connection between transfers between parties (contracts) and the internal activities of the parties (e.g., production), analysis, we begin in the ‘abode of production’ and then move to the ‘sphere of exchange.’ 11

This book is dedicated to the late Warren Samuels who has written on the relationship between this theory of property and previous writings. Samuels was a strong supporter of this modern treatment of property theory and, before his death, he sent me a draft paper (Samuels 2007) (never published to my knowledge) raising the question of precursors and particularly the relation to Marx’s treatment of property. Here are a few excerpts from his second and, to my knowledge, last draft. This article is concerned with two interrelated issues: first, the relation of the ideas on the theory of property of David Ellerman to the relevant ideas of Karl Marx and, second, the nature of precursor status, specifically, whether, as it turns out, Marx, a foremost 19th century critic of property, was a precursor of Ellerman, arguably the foremost contemporary theoretician of property. (p. 1) . . . Thus we have two stories, one by Marx centering on the creation of surplus value and the other by Ellerman centering on the appropriation of final output by the hiring party to the employment contract. Literally, Marx’s earlier story could be called the precursor and Ellerman’s later story that which acknowledges Marx’s to be a precursor. Ellerman’s story of appropriation is not derived from Marx’s story of surplus value; nor does Marx’s account necessarily lead to Ellerman’s. Both deal with labor and capital but do so in quite different ways. The precursor status arises not inevitably with Marx but with certain accounts and interpretations of Marx’s story which seem to make them precursors of Ellerman’s story. (pp. 7–8) . . . David Ellerman’s theory of appropriation seems clearly to be the foremost and most tightly reasoned theory of the production, use, and disposition of final output. . . .Surely, Ellerman’s theory is the only theory that examines in detail wherein the law of property is and is not specifically involved and that specifies explicitly the total output of the firm, rather than surplus value, as the object of control and disposition. (p. 26) In response to Samuels’ first draft of the paper, I wrote a long email arguing that Marx was not a precursor to the modern natural rights or labor theory of property, a role that should be assigned to the classical laborists or so-called “Ricardian socialists” (e.g., Hodgskin and Proudhon). The points made in that email are expanded upon and incorporated in Chap. 6 on Marx herein.

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Consider a productive opportunity represented by the production function Q ¼ f (K, L) where: • K represents all the non-labor inputs used up during the time period (i.e., the flow of capital services, not the stocks of capital assets) in the productive opportunity, and • L represents all the intentional human actions performed by all who work in the enterprise, managerial (entrepreneurial or not) and non-managerial workers). The basic argument is that in performing the intentional actions L, the people working in the enterprise are de facto responsible for using up the inputs K and for producing the outputs Q. By the responsibility principle, they should jointly be the legal appropriators of the input-liabilities K and the produced assets +Q. These are the underlying facts about de facto or factual responsibility and about the application of the responsibility principle regardless of the legal or institutional superstructure. The people working in the enterprise, by performing the actions L, produce the positive and negative results (Q, K, 0) which might be called Labor’s product. It is customary in neoclassical Economics to conceptualize the performance of these human actions as the “producing” of the labor services L which are then sold and “used up” in production by the employer. Then the overall results of production would be represented as the whole product (Q, K, L). In neoclassical economics, this vector is called the “production vector” or “input-output vector” (Quirk and Saposnik 1968, p. 27) but for historical reasons, we will use the “whole product” terminology.12 Using that representation, Labor’s product can be parsed into two parts: Labor’ s product ¼ ðQ, K, 0Þ ¼ ð0, 0, LÞ þ ðQ, K, LÞ ¼ labor commodity þ whole product Now we view the facts of the case under the institutional structure of production based on the employer-employee contract—which is the contract for the renting, hiring, or employing of persons.13 Under the human rental system, Labor (the people working in an enterprise), as the first seller of L, is recognized as initially owning (0, 0, L). However, the employer (who we may or may not be the owner of the assets yielding the capital services K) is in the contractual position of the last buyer of all We have used the “whole product” phrase to recognize the tradition summarized by Carl Menger’s jurisprudential brother Anton Menger (1899). 13 In the words of the preeminent neoclassical economists, Paul Samuelson: “One can even say that wages are the rentals paid for the use of a man’s personal services for a day or a week or a year. This may seem a strange use of terms, but on second thought, one recognizes that every agreement to hire labor is really for some limited period of time. By outright purchase, you might avoid ever renting any kind of land. But in our society, labor is one of the few productive factors that cannot legally be bought outright. Labor can only be rented, and the wage rate is really a rental.” (Samuelson 1976, p. 569) Marx’s name for the system, “capitalism,” was actually a misnomer based on the fundamental myth, so we will refer to the “human rental system.” 12

1.7 Description of Production in the Employment System

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Table 1.1 Responsibility principle violation under the employment system Labor de facto responsible for Labor legally appropriates Labor responsible for but does not appropriate

(Q, K, 0) (0, 0, L ) (Q, K, 0) (0, 0, L ) ¼(Q, K, L )

¼ Labor’s product ¼ labor commodity ¼ whole product.

the inputs (K as well as L) and thus as the defensible claimant on the product Q. Thus, the employer, in sum, legally appropriates the whole product (Q, K, L ).14 This is summarized in the Table 1.1. The notion of “imputation” was introduced into economics by the jurisprudentially-trained Austrian economist Friedrich von Wieser in his treatment of marginal productivity theory at the end of the nineteenth century. Things as well as human actions are causally efficacious at the margin so Wieser metaphorically used the notion of “imputation” according to marginal productivity which Wieser thought of as “economic responsibility.” But he was well aware that this “economic” notion was not the same as the legal or moral notion of imputation which could only apply to human actions. The judge,. . ., who, in his narrowly-defined task, is only concerned with the legal imputation, confines himself to the discovery of the legally responsible factor,–that person, in fact, who is threatened with the legal punishment. On him will rightly be laid the whole burden of the consequences, although he could never by himself alone–without instruments and all the other conditions–have committed the crime. The imputation takes for granted physical causality.. . . The expression “this man has done it” does not mean “this man alone has done it,” but “this man alone, among all the active causes and factors, is legally responsible for the deed.” In the division of the return from production, we have to deal similarly. . .with. . .an imputation, – save that it is from the economic, not the judicial point of view. (Wieser 1930 [1889], pp. 76–79)

The task of property theory is the opposite—to deal with an imputation, save that it is from the usual juridical, not the “Economic,” point of view. Unless neoclassical Economics is to apply to some other world than the legal system applies to, it is the

14 This provides the modern reconstruction of the old slogan: “Labour’s claim to the whole product” put forward by the classical laborists such as Thomas Hodgskin and William Thompson. For the history of that school, see Anton Menger (1899) and particularly the Introduction by Foxwell (1899) as well as Lowenthal (1972) and Stark (1943). Although the classical laborists would not expect some other party to pay the costs of production in a cooperative or labor-managed enterprise, they were not always clear that the negative product (0, K, L ) must always be included along with the positive product (Q, 0, 0) in making “Labour’s claim to the whole product” (Q, 0, 0) + (0,  K, L ) ¼ (Q, K, L ). The negative part of the “fruits of one’s labor” was probably as hard for them to conceptualize as it is for so many today. The labor theory of property is even caricatured as holding that once the employer has paid for all the inputs, then the workers should appropriate all the outputs. It seems hard for some to even understand that the question is who should appropriate the whole product or production vector including the liabilities in the first place.

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original, normal, and non-metaphorical jurisprudential notions of imputation and responsibility that are used in normative property theory. One of the astonishing feats, or, rather, feints of neoclassical Economics is the learned ignorance of the fact that while all the inputs are causally efficacious, only human action (“labor”) can be de facto responsible and that the responsibility for using productive instruments is imputed back through the instruments to the human users. The basic reasons for the professional blindness are not hard to fathom; today’s unnatural system of property and contract based on the renting of human beings, the “employment system,” legally treats labor services as if they were “nonresponsible” (outside of crimes) and transferable like the services of things. When called in for jury duty concerning a murder committed with a gun, a professional economist presumably would not ask “Why isn’t the gun being put on trial since it was certainly efficacious in committing the murder?”—but in their ‘professional’ role of justifying the human rental system, the difference between the responsible actions of persons and the ‘productive’ (i.e., causally efficacious) services of things is a perfect example of “learned ignorance.” That is why “productive” is one of the favorite words in the apologetics for the human rental system (e.g., Frank Knight); it smudges the difference between the responsible actions of persons and the causally efficacious but non-responsible services of things.15 The property theoretic question is not about the price-theoretic notion of “distributive shares”; it is about who appropriates the whole product in the first place. Moving beyond the “deep” metaphors of neoclassical theory (see the chapter on marginal productivity theory) to the “shallow” legal facts, the whole product (positive plus negative products) is in fact legally appropriated by one legal party, the party who stands between the input suppliers and output demanders, and who pays for all the inputs and sells all the outputs of production. This reconceptualization of production changes the focus of normative questions from the value-theoretic “distributive shares” questions to the basic property-theoretic and pre-distributive question of “Who is to be the whole product appropriator?”. Since the whole product appropriator is usually called the “firm” in the going-concern sense, the basic question is not the relative size of “distributive shares” but “Who is to be the firm in the first place?” (e.g., Capital, Labor, the State, Knight’s ‘Entrepreneur’, the shareholders, etc.). That is the fundamental question, not the relative shares in the distributive pie in some as-if ‘partnership’ between the input suppliers and the employer. Since Labor is responsible for producing (Q, K, 0) but only appropriates (0, 0, L ) in the employment system, Labor is responsible for but does not appropriate the difference which is the whole product:

15 The factual responsibility for the murder is imputed, as it were, back through the gun to the person. Guns do not commit murders. Nevertheless, a murderer is more causally efficacious or ‘productive’ in committing murders using a gun than without it—see Chap. 5 herein on marginal productivity theory.

1.7 Description of Production in the Employment System

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ðQ, K, 0Þ  ð0, 0, LÞ ¼ ðQ, K, LÞ: The legal party who has the contractual role of being the last buyer of all the inputs consumed in production would “swallow” the input liabilities K and L and thus would have the legally defensible claim on the outputs Q. In this manner, the employer would legally appropriate the whole product (Q, K, L ) independently of owning the assets yielding the K services and independently of any de facto responsible actions—which would, in any case, be included in L in the case of a working employer. Since Labor was de facto responsible for the whole product, the responsibility principle was violated by the employer’s appropriation of the whole product.

1.7.2

How Does the Description of Employment Square with the Fundamental Theorem?

Since “Not-Locke implies Not-Hume,” the violation of the responsibility principle in production under the employment relation means that there must have been some violation of the no-externality or no-breach conditions in the sphere of exchange. It is the no-breach condition that is violated by the employment contract. The basic fact that connects the contractual mechanism and the imputation mechanism is that things can, in fact, be transferred from the factual possession and control of one party to another. That is the transfer that Hume and Smith described. Person A might rent a van (i.e., sell some of the van’s services) to another person B. To fulfill the contract, the van would be factually transferred from A to B so that B can then use the van (i.e., use up the van services) independently of A and be solely de facto responsible for the results obtained by using up the services of the van. The contractual mechanism functions correctly when legal title to those services stays coordinated with the factual possession and use of the services. Then the legal imputation of the Invisible Judge to B for using up the van’s services according to the last-buyer contract will be in accordance with de facto responsibility of B for the use of those services. But this mechanism breaks down when person A (an “employee”) tries to rent themselves (i.e., sells their own labor) to person B (the “employer”). There is no voluntary action to fulfill an employment contract so that the employer can “employ” the employee and be solely de facto responsible for the “employment” of those services. In Adam Smith’s characterization of voluntary transference, “(the) thing the property of which is transferred should be put into the power of him to whom it is transferred” (Smith 1982, p. 71) does not apply when the “property” being sold is the responsible human actions of the employees. What actually happens to voluntarily “fulfill” the employment contract is that the employee agrees to co-operate with the employer in a certain activity. But there is no voluntary transfer of de facto

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responsibility. Both the employee and the working employer16 are jointly de facto responsible for the fruits of their joint activity. The employee’s responsible agency is inherently inalienable.17 When the legal authorities accept (N.B.: “accept” in the laissez faire sense of taking no action) the de facto responsible co-operation (labelled as “obedience”) of the employee as “fulfilling” the labor contract for the sale of labor services from the employee to the employer, then the Invisible Judge mistakenly imputes all the legal responsibility to the employer for the using up of the “input” labor and other factor services and for producing the positive products of their joint activity. The legal authorities take no explicit or public action to declare that the employees are “non-responsible” or to declare that the employer is solely de facto responsible for the positive and negative product of the joint activity. And that is just the point; an Invisible Hand mechanism works by non-action. The mis-imputation of the Invisible Judge is based simply on the legal authorities not rejecting the employees’ responsible co-operation as “fulfilling” the legal transfer so that there seems to be no breach to give grounds for intervention. The underlying facts of workers’ de facto responsibility are not controversial. This is easily seen by considering the “intuition pump” (Dennett 2014) of the hired criminal, i.e., the rather different reaction of the legal authorities when the employer and employee, or “master and servant” in the old-speak of agency law, co-operate together in the commission of a crime. The Invisible Judge becomes a visible judge, and the servant in work becomes the partner in crime. All who participate in a crime with a guilty intent are liable to punishment. A master and servant who so participate in a crime are liable criminally, not because they are master and servant, but because they jointly carried out a criminal venture and are both criminous. (Batt 1967, p. 612)

When the venture being “jointly carried out” is non-criminous, the workers do not suddenly become non-persons or automatons being “employed” by the employer. The facts about de facto responsible co-operation remain the same. It is the reaction of the legal system that changes when no legal wrong is recognized. Then there is no call for a visible judge to intervene in the marketplace, so the Invisible Judge takes over and rules “let it be.” That is how the contractual fact-pattern mis-imputes the whole product to the employer. That is the basic trick in the human rental system— which incidentally has no direct connection to prices or values. Of course, a contract involving a crime is null and void. But the worker is not de facto responsible for the crime because he made an illegal contract. The employee is This is assuming that the employer is a natural person. When the “employer” is an absenteeowned corporation and thus the actual work is employees cooperating with employees, then there is fiction piled on top of fiction. Economists and jurisprudents of the far future will probably be astounded that their counterparts today could be so devoted to their assigned social roles as to take the absentee-owned corporation so seriously as a legitimate institution. For more analysis of corporations, see the chapter on corporations herein. 17 See the Chap. 9 herein on inalienable rights for the further development of that part of the analysis. 16

1.7 Description of Production in the Employment System

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de facto responsible because the employee, together with the employer, committed the crime (not because of the illegal status of the contract between them). The meaning of “immobility” depends on the “space” being considered. In trade theory, land and its services are immobile factors in geographical space. People and capital, in contrast, move about in geographical or physical space. But when it is said, for example, that a house was transferred into the possession of the buyer, then the house is transferred in what we might call “possession space” while it stays immobile in physical space. It is people who are the fixed coordinates in possession space; people and their services cannot be transferred in possession space.18 When people move in physical space to occupy a house or a factory, then it is the house or factory that move in possession space to the people using it. The fact that human action is never factually transferred between persons was noted by Marshall as the “second peculiarity” that the seller of labor “must deliver it himself” (Marshall 1961, p. 566), i.e., labor is immobile in possession space of persons. Instead of the factual transfer of labor services between parties, there is only de facto responsible co-operation. In terms of the contractual machinery, the employment contract is impossible to actually fulfill with the transfer of responsible actions from the seller (employee) to the buyer (employer). Thus, the employment contract systematically violates Hume’s conditions by being inherently breached. In what might be taken as a fraud on an institutional scale, “an institutional robbery—a legally established violation of the principle on which property is supposed to rest” (Clark 1899, p. 9), the responsible co-operation of the “employees” is taken by the legal authorities as “fulfilling” (i.e., not breaching) the labor contract which allows the employer to take the contractual position of the whole product appropriator. That is the basic “institutional robbery” in the employment system of renting human beings. It has nothing whatever to do with prices, values, wages, exploitation (e.g., being under-paid or over-worked), bad working conditions, dominating (Roberts 2017) or oppressive (Anderson 2017) employers, bathroom breaks (Linder and Nygaard 1998), or the rest of the usual litany of heterodox criticism of neoclassical Economics (e.g., Keen 2011). One of the key connections to bring the pieces of the puzzle together was the realization that the “fruits of one’s labor” principle from labor theory of property was the positive application of the normal juridical principle of responsibility typically applied to the negative side of appropriation, the imputation of liabilities. Independently of Ellerman (1980, 1985, 1992), this connection has been noted by a legal scholar: [T]he libertarian entitlement thesis, to the effect that persons are entitled to retain the fruits of their labor, and the libertarian thesis about outcome-responsibility, to the effect that persons are responsible for the harms that they cause, are two sides of the same coin. ... The basis of

18 This applies only to the voluntary actions of people. A person can be physically coerced and thus not be de facto responsible for the results of that coercion but our concern is with normal voluntary actions. Here again, Marx went down a completely different road by arguing that wage labor was ‘socially coerced.’

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1 Introduction to the Jurisprudence of Property and Contract this unity is the idea that people “own” the effects, both good and bad, that causally flow from their actions. (Perry 1997, p. 352)

Actually, the connection was, in effect, made over a century ago in orthodox apologetics. John Bates Clark (1899) constructed an interpretation of marginal productivity theory using metaphorical Lockean language that became part of orthodoxy. When a workman leaves the mill, carrying his pay in his pocket, the civil law guarantees to him what he thus takes away; but before he leaves the mill he is the rightful owner of a part of the wealth that the day’s industry has brought forth. Does the economic law which, in some way that he does not understand, determines what his pay shall be, make it to correspond with the amount of his portion of the day’s product, or does it force him to leave some of his rightful share behind him? A plan of living that should force men to leave in their employer’s hands anything that by right of creation is theirs, would be an institutional robbery - a legally established violation of the principle on which property is supposed to rest. (Clark 1899, pp. 8–9)

Or more recently, “The basic postulate on which the argument rests is the ethical proposition that an individual deserves what is produced by the resources he owns.” (Friedman 1962, p. 196) Wieser (1930 (1889)) constructed a metaphorical interpretation MP theory using the language of imputation and the responsibility principle. Since both schemes build metaphorical interpretations of the same MP theory (where all inputs are treated as “responsible”), the connection between Lockean entitlement (Clark) and juridical imputation (Wieser) was there all along in orthodox apologetics. Since the contract for renting people is impossible to fulfill, it is invalid for the same reasons that a voluntary self-sale contract (to essentially take on the full-time role of a non-responsible instrument) is already recognized as being invalid. The flaw is not in the laissez-faire mechanism of appropriation in the private property market economy; the flaw is in the institutional fraud of the legal system validating the person-rental contract and accepting the inherently co-responsible (non-criminous) actions of the employees as “fulfilling” the contract. Clearly this analysis of the employment contract has nothing to do with the size of the wage payment (which was never mentioned) so it is totally independent of exploitation theories of the neoclassical variety (paying less than the value of the marginal productivity of labor) or the Marxian variety. If the modest “neo-abolitionist” proposal (Ellerman 2015, 2021) were accepted that the contract for the renting of human beings be recognized as invalid and be abolished, then production could only be organized on the basis of the people working in production (jointly) hiring or already owning the capital and other inputs they use in production.19 Then the Invisible Judge would correctly impute the legal One of the first questions asked is: “What about public employment?” Government jobs need to be analyzed to see if they involve the use of the public power, such as the policing power or authority to tax, or they are just conventional work not involving any discretionary use of public authority. If a person’s job involves the use of public powers, then their inalienable rights of selfgovernment are still there but can only be exercised as a part of the democratic polity that delegated

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responsibility to the de facto responsible party—so that is the natural system of liberty and private property. The legal members of the firm as a legal party would be the people working in the firm.20 Such a firm is a democratic firm, and the private property market economy of such firms is an economic or workplace democracy.21 The interesting implication is that, notwithstanding two centuries of economic theorizing and apologetics, the current system is not the “natural system of private property and free (and non-fraudulent) contract” any more than would be an even more ‘free-market’ private property system where longer-term voluntary contracts in human capital (e.g., self-sale or voluntary slavery contracts) were legally valid. The natural system of private property and contract is the one where the self-employed proprietorship and family farm generalize to democratic firms of any size where people are jointly still working for themselves as the principals in the business.

References Anderson, E. (2017). Private Government: How Employers Rule Our Lives (and Why We Don’t Talk About it). Princeton NJ: Princeton University Press. Arrow, K. J., & Debreu, G. (1954). Existence of an Equilibrium for a Competitive Economy. Econometrica, 22, 265–290. Barnett, R. (1986). A Consent Theory of Contract. Columbia Law Review, 86(2), 269–321. Barzel, Y. (1989). Economic Analysis of Property Rights. New York: Cambridge University Press. Batt, F. (1967). The Law of Master and Servant (5th ed.). London: Pitman. Black, H. C. (1968). Black’s Law Dictionary. St. Paul: West Publishing. Brockway, G. P. (1995). The End of Economic Man: Principles of Any Future Economics (3rd ed.). New York: W. W. Norton. Clark, J. B. (1899). The Distribution of Wealth. New York: Macmillan. Coase, R. (1960). The Problem of Social Cost. Journal of Law and Economics, 3, 1–44. Cooter, R., & Ulen, T. (2004). Law and Economics (4th ed.). Boston: Pearson Addison-Wesley. Dahl, R. (1985). Preface to Economic Democracy. Berkeley: University of California Press.

those public powers to them. Take away the right to use coercion, the uniform, badge, and gun from the police, and one essentially has private security guards who could be self-governing in a private democratic firm. Jobs that do not involve any public powers (e.g., construction work or ‘paperpushing’ jobs) could be organized in democratic firms contracting with the government. The “monstrous hybrid” (Jacobs 1992) is a private firm (democratic or not) exercising discretionary public powers like a private prison system. 20 It was noted previously that when employer and employees engage in a crime and the legal authorities intervene to explicitly make the imputation in accordance with the responsibility principle, then the “business” is in effect reconstituted as a “partnership” of all the people involved. Since the facts about de facto responsibility are unchanged when the business is non-criminous, it might be said that the people working in an enterprise should always be “treated as criminals” by setting aside the employment contract and legally reconstituting the non-criminous business as a ‘partnership’ in the sense of a democratic firm. 21 See, for example, Dahl 1985. The best examples today are probably the Mondragon industrial cooperatives in the Basque region of Spain (see Oakeshott 1978, 2000; Ellerman 1984; Lutz 1999; Whyte and Whyte 1991). Employee stock ownership plans (ESOPs) and codetermination arrangements are steps in the same direction.

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Demsetz, H. (1967). Toward a Theory of Property Rights. American Economic Review, 57(May 1967), 347–359. Dennett, D. C. (2014). Intuition Pumps and Other Tools for Thinking. New York: W. W. Norton & Company. Dworkin, R. (1985). A Matter of Principle. Cambridge: Harvard University Press. Ellerman, D. (1980). Property Theory and Orthodox Economics. In E. J. Nell (Ed.), Growth, Profits and Property: Essays in the Revival of Political Economy (pp. 250–263). Cambridge: Cambridge University Press. Ellerman, D. (1982). Economics, Accounting, and Property Theory. Lexington MA: D.C. Heath. Ellerman, D. (1984). The Mondragon Cooperative Movement Case No. 1-384-270. Boston: Harvard Business School. Ellerman, D. (1985). On the Labor Theory of Property. Philosophical Forum, XVI(Summer 1985), 293–326. Ellerman, D. (1992). Property & Contract in Economics: The Case for Economic Democracy. Cambridge MA: Blackwell. Ellerman, D. (1995). Intellectual Trespassing as a Way of Life: Essays in Philosophy, Economics, and Mathematics. Lanham MD: Rowman & Littlefield. Ellerman, D. (2014). On Double-Entry Bookkeeping: The Mathematical Treatment. Accounting Education: An International Journal, 23(5 (Oct.)), 483–501. Ellerman, D. (2015). On the Renting of Persons: The Neo-Abolitionist Case Against Today’s Peculiar Institution. Economic Thought, 4(1), 1–20. Ellerman, D. (2020). Fallacies of Corporate Analysis. Challenge, 1–23. https://doi.org/10.1080/ 05775132.2020.1723289 Ellerman, D. (2021). Neo-Abolitionism: Abolishing Human Rentals in Favor of Workplace Democracy. Cham, Switzerland: SpringerNature. https://doi.org/10.1007/978-3-030-62676-1 Fama, E., & Jensen, M. (1996). Organizational Forms and Investment Decisions. In L. Putterman & R. Kroszner (Eds.), The Economic Nature of the Firm (2nd edition., pp. 336–344). Cambridge: Cambridge University Press. Foxwell, H. S. (1899). Introduction. In A. Menger (Ed.), The Right to the Whole Produce of Labour (pp. v–cx). London: MacMillan. Friedman, M. (1962). Price Theory. Chicago: Aldine. Furubotn, E., & Pejovich, S. (Eds.). (1974). The Economics of Property Rights. Cambridge: Ballinger Publishing Company. Furubotn, E., & Richter, R. (1998). Institutions and Economic Theory: The Contributions of the New Institutional Economics. Ann Arbor: University of Michigan. Haavelmo, T. (1960). A Study in the Theory of Investment. Chicago: University of Chicago Press. Hart, O., & Moore, J. (1990). Property Rights and the Nature of the Firm. Journal of Political Economy, 98, 1119–59. Hirshleifer, J. (1970). Investment, Interest, and Capital. Englewood Cliffs: Prentice-Hall. Hodgskin, T. (1973). The Natural and Artificial Right of Property Contrasted. Clifton NJ: Augustus M. Kelley. Hume, D. (1978). A Treatise of Human Nature (2nd ed.). Oxford: Oxford University Press. Jacobs, J. (1992). Systems of Survival: A Dialogue on the Moral Foundations of Commerce and Politics. New York: Vintage Books. Keen, S. (2011). Debunking Economics—Revised and Expanded Edition: The Naked Emperor Dethroned? London: Zed Books. Kelsen, H. (1971). What is Justice? Justice, Law, and Politics in the Mirror of Science Collected Essays by Hans Kelsen. Berkeley: University of California Press. Knight, F. H. (1969). The Ethics of Competition and other essays. Freeport NY: Books for Libraries Press. Linder, M., & Nygaard, I. (1998). Void Where Prohibited: Rest Breaks and the Right to Urinate on Company Time. Ithaca NY: Cornell University Press. Locke, J. 1960 (1690). Two Treatises on Government. New York: New American Library.

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Lowenthal, E. (1972). The Ricardian Socialists. Clifton NJ: Augustus Kelly. Lutz, M. (1999). Economics for the Common Good. London: Routledge. Macpherson, C. B. (1962). The Political Theory of Possessive Individualism: Hobbes to Locke. Oxford: Oxford University Press. Marshall, A. (1961). Principles of Economics (9th ed.). London: MacMillan and Company. Marx, K. (1990). Capital (Vol. I). (B. Fowkes, Trans.). London: Penguin Classics. Menger, A. (1899). The Right to the Whole Produce of Labour: The Origin and Development of the Theory of Labour’s Claim to the Whole Product of Industry. (M. E. Tanner, Trans.). London: Macmillan and Co. Miceli, T. J. (1999). Property. In J. Backhaus (Ed.), The Elgar Companion to Law and Economics (pp. 121–35). Cheltenham UK: Edward Elgar. Mill, J. S. 1970 (1848). Principles of Political Economy. Harmondsworth: Penguin Books. Montias, J. M. (1976). The Structure of Economic Systems. New Haven: Yale University Press. Oakeshott, R. (1978). The Case for Workers’ Co-ops. London: Routledge and Kegan Paul. Oakeshott, R. (2000). Jobs and Fairness: The Logic and Experience of Employee Ownership. Norwich UK: Michael Russell. Perry, S. (1997). Libertarianism, Entitlement, and Responsibility. Philosophy & Public Affairs, 26 (4 Fall), 351–96. Putterman, L. (1996). Ownership and the nature of the firm. In L. Putterman & R. Kroszner (Eds.), The Economic Nature of the Firm (pp. 361–369). Cambridge: Cambridge University Press. Putterman, L., & Kroszner, R. S. (Eds.). (1996). The Economic Nature of the Firm. Cambridge: Cambridge University Press. Quirk, J., & Saposnik, R. (1968). Introduction to General Equilibrium Theory and Welfare Economics. New York: McGraw-Hill. Roberts, W. C. (2017). Marx’s Inferno: The Political Theory of Capital. Princeton NJ: Princeton University Press. Rockafellar, R. T. (1984). Network Flows and Monotropic Optimization. New York: John Wiley & Sons. Samuels, W. (2007). On Precursors in the History of Economic Ideas: Is Karl Marx a Precursor of David Ellerman? Unpublished draft. Samuelson, P. A. (1976). Economics (10th ed.). New York: McGraw-Hill. Samuelson, P. A., & Nordhaus, W. (2010). Economics (19th ed.). New York: McGraw-Hill/Irwin. Schlatter, R. (1951). Private Property: The History of an Idea. New Brunswick: Rutgers University Press. Skidelsky, R. (2020). What’s Wrong with Economics. New Haven: Yale University Press. Smith, A. (1982). Lectures on Jurisprudence. (R. L. Meek, D. D. Raphael, & P. G. Stein, Eds.). Indianapolis: Liberty Fund. Stark, W. (1943). The Ideal Foundations of Economic Thought. London: Routledge and Kegan Paul. Theobald, M. (2004). Briggs Mfg. Co. Coachbuilt. http://www.coachbuilt.com/bui/b/briggs/briggs. htm. Accessed 4 January 2021. Umbeck, J. (1981). Might Makes Right: A Theory of the Formation and Initial Distribution of Property Rights. Economic Inquiry, 19(1), 38–59. Whyte, W. F., & Whyte, K. K. (1991). Making Mondragon (2nd revised.). Ithaca: ILR Press. Wieser, F. von. 1930 (1889). Natural Value. (C. A. Malloch, Trans.). New York: G.E. Stechert and Company.

Chapter 2

Mathematical Introduction to the Jurisprudence of Property and Contract

Abstract This chapter develops the formal mathematical treatment of the theory of property rights and contracts in both the descriptive and normative dimensions. The mathematical framework is in terms of vector flows on graphs, but there are two equivalent alternative treatments depending on whether the vectors are all non-negative or are general real vectors with both positive and negative components. The treatment within the body of the chapter uses non-negative vectors and thus it dovetails with (but does not assume) double-entry bookkeeping using vectors. The treatment using general vectors is given in the Appendix. In both cases, the goal is the mathematical treatment of the Fundamental Theorem of Property Theory.

2.1

From Numbers to Vectors of Numbers

There are c commodities (including money as a commodity). A c-dimensional vector (‘c-vector’) is a list X ¼ (x1, . . ., xc) of real numbers as its components xi, i.e., a member of the vector space ℝc. The usual inequality between c-vectors, Y  X holds if yi  xi for i ¼ 1,. . .,c. A vector X is non-negative if 0  X where 0 in this context is the zero vector (all components are 0). The set of non-negative vector is ℝcþ , the non-negative orthant of ℝc. In formalizing the jurisprudential mathematics of property and contracts, there is a choice of using only non-negative c-vectors or to use general c-vectors with positive and negative components. The treatment in the body of this chapter will use non-negative vectors and the equivalent treatment using general vectors will be given in the Appendix. For over five centuries, double-entry bookkeeping has been used to describe the stocks and flows of scalar notions of value within and between parties. There are no negative numbers in double-entry bookkeeping, only ordered pairs (“T-accounts”) [d // c] of non-negative numbers c and d where the left-hand side entry is called the debit entry and the right-hand side is the credit entry. In earlier work decades ago, double-entry bookkeeping was mathematically formulated and then generalized from d and c being single numbers (‘scalars’) to multidimensional vectors to describe the stocks and flows of physical quantities that © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_2

27

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Fig. 2.1 A Directed Graph

underlie conventional value accounting using only scalars (see Ellerman 1982, 1986, or 2014). The key idea in the mathematical formulation and generalization of double-entry accounting was that the “T-accounts” were the ordered pairs in the group of differences construction which extends the monoid of non-negative numbers which have no additive inverses, to an additive group with additive inverses. For instance, the natural numbers 0, 1, 2, . . . are not closed under subtraction. In the group of differences construction, the natural numbers are represented as the ordered pairs [0 // 0], [0 // 1], [0 // 2],. . . and then their additive inverses (i.e., . . ., 2, 1, 0) are represented by . . ., [2 // 0], [1 // 0], [0 // 0]. All the entries in the T-accounts are non-negative but it is mathematically equivalent to the positive and negative integers, i.e., . . ., 2, 1, 0, 1, 2, . . . . The general rule is that two T-accounts are equal if their cross-sum are equal. That is:   ½d==c ¼ d’ ==c’ if and only if d þ c’ ¼ c þ d ’ : The same ordered-pairs construction is used in the multiplicative group of fractions to extend the multiplicative monoid of positive natural numbers to the positive rationals (fractions) which include multiplicative inverses (division) and where the ordered pairs are written vertically as fractions. Two fractions are equal if 0 their cross-multiples are equal, i.e., dc ¼ dc 0 if and only if cd0 ¼ dc0. Double-entry bookkeeping is mathematically formulated and extended to c dimensions by using (horizontally written) ordered pairs or T-accounts where the debit and credit entries are non-negative c-vectors. Property theory is developed in the Appendix using that machinery of general c-vectors. The additive group of T-accounts of non-negative c-vectors is isomorphic to the additive group of ℝc so property theory can be developed using either formalism.

2.2

Graphs

A directed graph G, as shown in Fig. 2.1, is given by two sets: A ¼ (a1, . . ., ae), the arcs or edges, and N ¼ (n1, . . ., nv), the nodes or vertices, and a function which assigns to each aj in A, an ordered pair (ni, ni’) in N  N where i 6¼ i’ which could be written as aj ~ (ni, ni’) and interpreted as being a directed arc from ni to ni’. We may assume at most one directed arc between two nodes and no loops at a node. These directed graphs will be used in the Appendix in connection with general c-vectors.

2.2 Graphs

29

Fig. 2.2 A Bi-Directed Graph

Fig. 2.3 Disjoint vectors

In our current treatment using only non-negative c-vectors, we need the notion of a bi-directed graph, as shown in Fig. 2.2, where there are two opposite arrows between nodes. For bi-directed graphs, it is best to identify the arcs simply by the ordered pair of nodes, so (ni, ni0 ) is the arc directed from ni to ni’ and (ni0 , ni) is the arc from ni’ to ni. Since there are no loops at the nodes, the set Δ of self-pairs (ni, ni) is subtracted out of the set N  N or all ordered pairs so the set of arcs is A ⊆ N  N  Δ of arcs (where we assume that if (ni, ni0 ) is in A then (ni0 , ni) is also). An arc assignment or flow x : A ! ℝcþ is an assignment of non-negative vectors x (ni, ni0 ) to each arc in a bi-directed graph. In this context, it is interpreted as a property flow along the arc from one legal party to another, the parties being represented by the nodes. Two non-negative vectors d and c are said to be disjoint (see Fig. 2.3) if the minimum is the zero vector, min(d, c) ¼ 0. Disjointness means that one or both of the corresponding components, di or ci, are zero for i ¼ 1,. . .,c. There is no need to represent the same property going both ways along a pair of opposite direction arcs between two nodes in the given time period. Hence we may assume, without loss of generality, that all arc assignments give disjoint vector flows along those opposite arcs, i.e., that x(ni, ni0 ) is disjoint to x(ni0 , ni). A vector T-account is a pair (d,c) of non-negative vectors in ℝcþ  ℝcþ . The pair could also be written as [d//c] as in multi-dimensional double-entry accounting. Two T-accounts [d//c] and [d0//c0] are equal if their cross-sums are equal, i.e., d + c0 ¼ d0 + c. A T-account [d//c] is said to be in reduced form if d and c are disjoint. A T-account can always be put into reduced form by subtracting off the minimum from each pair of corresponding components: ½ð. . . , d i  min ðd i , ci Þ, . . .Þ==ð. . . , ci  min ðdi , ci Þ, . . .Þ: A node assignment y : N ! ℝcþ  ℝcþ is an assignment of a T-account y (ni) ¼ [d//c] to each node ni that is interpreted as the outflow from the node. We may assume, without loss of generality, that d and c are disjoint so the T-account is in reduced form, In the previous pair of arcs between nodes ni and ni’, the outflow at the node ni is the vectorial T-account [(0, 7, 0)//(5, 0, 2)] and the outflow from these arcs at the other node ni’ would be the opposite T-account [(5, 0, 2)//(0, 7, 0)].

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Fig. 2.4 Divergence at a node

The divergence at a node ni, div(x)i (as illustrated in Fig. 2.4) from a property flow x would be the sum of all the outflow T-accounts from the arcs incident to the node where T-accounts add by adding corresponding entries. In the above example: ½ð0, 7, 0Þ==ð5, 0, 2Þ þ½ð8, 2, 0Þ==ð0, 0, 5Þ ¼ ½ð8, 9, 0Þ==ð5, 0, 7Þ ¼ ½ð3, 9, 0Þ==ð0, 0, 7Þ: The equality of the last two T-accounts is because the cross-sums are both (8,9,7), and the T-account [(3, 9, 0)//(0, 0, 7)] is in reduced form. The divergence div(x) of the arc-assignment x is the node assignment divðxÞ : N ! ℝcþ  ℝcþ that assigns div(x)i to node ni. Double-entry bookkeeping comes into play if we were to further analyze what happens inside each party’s activities to generate a net outflow (see Ellerman 1982), but that will not be necessary for our purposes here. The flow along an arc appears once positively and once negatively at the two nodes so if we add the divergences at all the nodes it must be the zero T-account: X all nodes ni

divðxÞi ¼ ½ð0, . . . , 0Þ==ð0, . . . , 0Þ

Total divergence principle: For any set S of nodes and its complement N  S, a cut [S, N  S] is the set of arc-pairs between nodes ni in S and nodes ni’ in N  S. The arcs going from S to N  S are the forward arcs and the arcs in the reverse direction are the backward arcs. The flow across the cut from an arc assignment x is the T-account with the credit entry as the sum of the flows on the forward arcs and the debit entry as the sum of the flows on the backward arcs, and then put in reduced form. Divergence Principle: Given a cut [S, N  S] and a flow (arc assignment) x, the sum of the divergences for the nodes in S is equal to the flow across the cut. The proof is simply that all the flows between nodes in S will cancel out so the remaining divergence from the nodes in S is for the arcs across the cut whose sum is the flow across the cut. For the sake of simplicity, we will represent the divergence principle with an example using scalar flows. On any opposing pair of arrows between two nodes, the flows are disjoint so one of the scalar flows is 0 and that arrow is deleted in the

2.2 Graphs

31

Fig. 2.5 Divergence Principle

following diagram, so all the flows represented are positive. The divergences at each node are the net outflows represented as a T-account. The sum of the divergences for the nodes in S, as illustrated in Fig. 2.5, is: ½9==0 þ ½0==10 þ ½0==2 ¼ ½9==12 ¼ ½0==3 and the flow across the cut is 5 + 2  4 ¼ 3 which as a T-account is [0//3]. The divergence principle is rather ubiquitous1 and it underlies the invisible hand mechanism of imputation. The general idea is that we are interested in the unobservable sources and sinks at the nodes in a region (i.e., legal party’s’ internal production or consumption activities) but we can only make certain observations about what goes through the border of the region (i.e., the contracts and factual transfers between the legal parties). Under certain conditions, a mechanism based on what happens at the border of the region can be lead, as if by an “invisible hand,” to be “correct” about the net sources within the region in view of the divergence principle. In the property theoretic application, under certain standard assumptions, if the legal and factual transfers agree across the border of any region, then the legal and factual net sources agree within the region by the divergence principle. A real vector can always be decomposed into the difference of two non-negative vectors. Given two vectors X ¼ (x1,. . .,xc) and Y ¼ (y1,. . .,yc) in ℝc, let max(X,Y)

1 The one dimensional version is the Fundamental Theorem of Calculus and the n-dimensional versions in the calculus of differential forms include the classical theorems of Green, Gauss, and Stokes (see the Divergence Theorem in Fleming 1977). For example, consider a one-dimensional “tube” from point a to point b along the x-axis with the amount of the flow in the tube at point x is given by F(x). At each point between a and b, there is a flow source of strength F0(x) ¼ dF/dx so by the divergence principle, the sum (integral) of all the sources within the region or interval from a to b Rb is equal to the out-flow minus the in-flow to the tube: a F 0 ðxÞdx ¼ F ðbÞ  F ðaÞ:

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be the vector with the maximum of xi and yi as its ith component. The minimum min (X,Y) would be similarly defined. The positive part of X is: Xþ ¼ max ðX, 0Þ, the maximum of X and the zero vector. The negative part of X is: X ¼ max ðX, 0Þ ¼ ðXÞþ : For a T-account [d//c] in reduced form, the positive part is [d//c]+ ¼ c and the negative part is [d//c] ¼ d. Both the positive and negative parts of X are non-negative (note the abuse of language in calling the non-negative vector X the “negative part” of X). Every vector X can be represented as the difference of the positive and negative parts, which is called the “Jordan decomposition”: X ¼ Xþ  X : For instance, if X ¼ (2, 3), then X+ ¼ (2, 0), X ¼ (0, 3), and X ¼ (2, 0)  (0, 3). Given two c-vectors X and Y, the standard vector inequality relation Y  X holds between the vectors if the inequality holds component-wise, i.e., Yi  Xi for i ¼ 1,. . .,c. For instance, 0  X and 0  X+. Similarly, for two T-accounts, [d0// c0]  [d//c] is defined as d0  d and c0  c. The definitions of positive and negative parts and the inequality extend immediately to node and arc assignments by applying the definitions to all the vectors assigned to the nodes or arcs.

2.3

The Contractual Mechanism

Let FT : A ! ℝcþ be an assignment of non-negative vectors to the arcs which represents the transfer in the de facto control of the commodity vectors between the parties represented by the nodes. This is the transfer that Adam Smith referred to as “that (the) thing the property of which is transferred should be put into the power of him to whom it is transferred.” (Smith 1982, p. 71) Thus FT represents the factual transfers of possession and control of the commodities between the parties. Let LT : A ! ℝcþ represent the transfers in legal property rights between the parties which are assumed to be mutually voluntary contracts. Thus, LT represents the legal transfers recognized by the property system. The factual transfers not covered by voluntary contracts are called (property) externalities (e.g., thefts, conversions, or any transfers of property not covered by consent or contract). The legal contracts unfulfilled by factual transfers are called breaches.

2.4 Analysis of Breaches and Externalities

33

In the price system, the “law of supply and demand” operates as a negative feedback mechanism to push competitive prices towards an equilibrium, i.e., excess supply leads to a lower price and excess demand leads to a higher price. In the property system, there is also a negative feedback mechanism to enforce a matching between legal and factual transfers, a mechanism that is taken for granted in price theory. The mechanism is simply that either sort of mismatch between factual and legal transfers is sufficient occasion for a visible judge to intervene to overrule the asit-were imputations of the Invisible Judge.2 When one party’s property is factually transferred to another party without any covering voluntary contract (e.g., a conversion or theft of property), then those are grounds for a legal intervention, e.g., a damage suit. When there is a legally recognized transfer of ownership but no fulfillment by the factual delivery of the property, then those are also grounds for a legal intervention, e.g., a suit for breach of contract. In both cases, considerations of transactions costs may prevent the aggrieved party from using the legal enforcement mechanism, but the principle of the negative feedback mechanism is clear. The idea is not simply to enforce damages or fulfillment but to apply penalties to make the costs of breaches or externalities rather forbidding. Penalties are not prices; penalties function not to guide the allocation of resources but to enforce constraints.3 The negative feedback of the contractual mechanism works to eliminate breaches and externalities. Our model does not deal with the ‘dynamics’ of the contractual mechanism but with the normative properties of the ‘equilibrium’ or matching of legal and factual transfers.

2.4

Analysis of Breaches and Externalities

Since any differences between legal transfers LT and factual transfers FT are to be accounted for as breaches or externalities, the initial impulse would be to define externalities as the difference FT–LT and breaches as the opposite difference LT– FT. But the difference X–Y of two non-negative vectors is not necessarily non-negative, so we define the arc assignment EXT for externalities and BRE breaches using the positive part of the differences:

2 There is no need to formally model this negative feedback mechanism since we are not concerned here with the trajectory to, uniqueness, or stability of an “equilibrium,” a contractual matching, only with the normative properties of a matching. 3 In computational algorithms, there are prices to guide allocation and there are penalties (which differ by orders of magnitude)—as in the “penalty method” in linear programming—to enforce constraints (e.g., the difference between the payment in a parking meter and a parking fine for unmetered use of a parking space). In theoretical maximization problems, constraints can be represented by infinite costs attached to the points that do not satisfy the constraints, see Rockafellar (1984).

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2 Mathematical Introduction to the Jurisprudence of Property and Contract

Fig. 2.6 Factual transfers between Alice and Bob

Fig. 2.7 Legal transfers between Alice and Bob

EXT ¼ ½FT  LT þ BRE ¼ ½LT  FT þ : For instance, let us consider commodity vectors that are three-dimensional and, the factual transfers between the parties ni and ni’, named Alice and Bob, are as follows in Fig. 2.6. Furthermore, the legal transfers are as follows in Fig. 2.7: Then the property externalities between these two parties are: EXT ðni , ni0 Þ ¼ ½FT ðni , ni0 Þ  LT ðni , ni0 Þþ ¼ ½ð5, 0, 2Þ  ð3, 0, 0Þþ ¼ ð2, 0, 2Þ EXT ðni0 , ni Þ ¼ ½FT ðni0 , ni Þ  LT ðni0 , ni Þþ ¼ ½ð0, 7, 0Þ  ð0, 9, 3Þþ ¼ ð0, 2, 3Þþ ¼ ð0, 0, 0Þ: And the breaches are: BRE ðni , ni0 Þ ¼ ½LT ðni , ni0 Þ  FT ðni , ni0 Þþ ¼ ½ð3, 0, 0Þ  ð5, 0, 2Þþ ¼ ð2, 0, 2Þþ ¼ ð0, 0, 0Þ BRE ðni0 , ni Þ ¼ ½LT ðni0 , ni Þ  FT ðni0 , ni Þþ ¼ ½ð0, 9, 3Þ  ð0, 7, 0Þþ ¼ ð0, 2, 3Þ: Thus Bob ‘converted’ (i.e., took outside of any contract) 2 units of the 1st commodity and 2 units of the 3rd commodity from the Alice, and Bob also breached contracts to transfer 2 units of the 2nd commodity (note that 7 units were fulfilled) and 3 units of the third commodity to Alice. For any vectors, the following three conditions are equivalent: X  Y, ½X  Yþ ¼ 0, and min ðX, Y Þ ¼ X: The minimum min(X, Y) of two non-negative vectors is their overlap. Each vector can be represented as the sum of the positive part of their difference plus their overlap:

2.5 “Appropriation Is the Boundary of Contract”

35

Table 2.1 Type I & II error table for mismatches between factual and legal transfers

X ¼ ½X  Yþ þ min ðX, YÞ Y ¼ ½Y  Xþ þ min ðX, YÞ: In general, whenever two quantities are to match, then there could be two types of errors which, depending on the context, could be overcount/undercount errors, error of omission/commission, or type I/II errors as in Statistics. Hence a Type I/II error table can be adapted from Statistics to show the comparison between legal and factual transfers between parties—as illustrated in Table 2.1. The two types of mismatches are the property externalities EXT ¼ [FT  LT]+ where property has been factually transferred without consent or contract and the breaches BRE ¼ [LT  FT]+ where a legal transfer has not been fulfilled by a factual transfer. The sum of the column under factual transfers is FT ¼ [FT  LT]+ + min (FT, LT) and the sum of the row for legal transfers is LT ¼ [LT  FT]+ + min (FT, LT). The two types of injustice are the BRE and EXT entries on the anti-diagonal, and the two cases without injustice are the two diagonal entries, min(FT,LT), the part of the factual transfers covered by legal transfers which equals the part of the legal transfers fulfilled by factual transfers, and, of course, the case where there are no transfers either way.

2.5

“Appropriation Is the Boundary of Contract”

Each arc assignment of transfers T determines the node assignment div(T) of net outflows at the nodes. The simple model considered here is a one-period flow model so no explicit account is taken of stocks accumulating at the nodes.4 A legal system would determine a node assignment LA : N ! ℝcþ  ℝcþ (as in “legal appropriation”) where the credit entry of the T-account at each node would 4 In effect, any stock (e.g., inventory) carry-over at the end of a period is treated as being used up and then reproduced at the beginning of the next period.

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represent the assets legally appropriated by the party during that period and the debit entry would similarly represent liabilities legally appropriated by the party. In the language of imputation or assigning of legal responsibility, LA represents at each node the assets and liabilities legally imputed to that party during the time period. The simple market or laissez faire mechanism of appropriation was previously described informally. The idea was that in the chain of buying and selling of a commodity (the life-cycle of the commodity), there would be a first seller and a last buyer. If the legal authorities did not intervene, then we might figuratively say that the “Invisible Judge” imputed the initial ownership of the commodity to the first seller and the legal liability for using up the commodity (the “terminal” ownership) to the last buyer. Since the arc assignment LT represents the legal transfers or contracts, the credit entry in the T-account div(LT) of the divergence at the node represents precisely the node assignment of first-sold commodities at each node. If the legal authorities do not intervene, then those commodities would be laissez faire imputed to those parties by the “Invisible Judge” so they would be included in the positive components of LA. Similarly, the debit entry of the T-account div(LT) of the divergence at the node represents the last-purchased commodities at the nodes, so without any legal intervention, those liabilities would be legally imputed by the Invisible Judge to the party. Hence the imputations of the Invisible Judge are: LA ¼ divðLT Þ: Market mechanism of appropriation: Since the divergence of an arc assignment is also called its “boundary” (also denoted ∂x, e.g., Aigner 1979, p. 358; Giblin 1977, p. 27 with the opposite sign convention), we can say that “legal appropriation is the boundary of contracts.” There might be other methods of legally assigning assets and liabilities, e.g., when legal authorities intervene ex post to, in effect, write or rewrite contracts or to assign private rights that are not transferred by contract. But we are modeling the case where the visible judges do not intervene; only the market mechanism operates.

2.6

Responsible Actions and Factual Transfers

When people carry out intentional actions, then they are de facto responsible for the results of those actions. Let RA : N ! ℝcþ  ℝcþ (as in “responsible actions”) be the node assignment representing in terms of net commodities the ex post de facto responsible actions of the party at each node.5 The credit entries in RA at each node represent commodities net produced (including being removed from stocks The phrase “ex post” is used here to emphasize that we are not considering a person’s “responsibilities” in an organizational role, or whether or not a person acted “responsibly” to fulfill their

5

2.6 Responsible Actions and Factual Transfers

37

carried over from the prior period) while the debit entries represent commodities net consumed or used up (or inventoried to stocks carried into the next period). The divergence principle tells us that the debit entries in div(FT) at a node are delivered to the party at that node, but the commodities in those debit entries might be used up or destroyed in accidents. The no-accidents assumption is that RA  div (FT), i.e., whatever is delivered to the party is intentionally (not accidentally) used up or consumed. And similarly, a positive accident or windfall might account for some commodities being transferred away without being intentionally credited by the party, and that is also ruled out by the no-accidents assumption, i.e., RA+  div (FT)+. Hence we have:6 divðFTÞ ¼ ½divðFTÞ ==divðFTÞþ   ½RA ==RAþ  ¼ RA Noaccidents assumption: But can a party be de facto responsible for consuming or producing commodities in another party’s possession? That is ruled out by the no-action-at-a-distance (in possession space) assumption. The basic fact is that for a party to be de facto responsible for consuming or using up a commodity, then the commodity must have been in the de facto possession and control of the party and must have gone out of possession but not by transfer to another party. The consumer is the last possessor, i.e., RA  div (FT). Applied to production, the no-action-at-a-distance principle implies that the credit entries in RA that a party was de facto responsible for producing in net terms during the time period must be first de facto possessed by the party and thus de facto transferred away from the possession of the party during the time period,7 i.e., must be included in the credit entry in div(FT) at the node. The producer is the first possessor, i.e., RA+  div (FT)+. Hence we have: divðFTÞ ¼ ½divðFTÞ ==divðFTÞþ   ½RA ==RAþ  ¼ RA Noactionatadistance assumption: Hence the no-accidents assumption div(FT)  RA and the no-action-at-a-distance assumption div(FT)  RA imply that:

role. See Hart (1968, p. 211) for an example of the many ways the word “responsibility” can be used and abused. 6 Recall that, for two T-accounts, [d0//c0]  [d//c] is defined as d0  d and c0  c. 7 With no accumulation of stock at the nodes, the commodity flow that is produced is either consumed or transferred away during the period so that which is produced in net terms is transferred away.

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divðFT Þ ¼ RA:

2.7

Fundamental Theorem of Property Theory

Finally, the juridical principle of assigning legal responsibility in accordance with de facto responsibility can now be stated in more formal terms: RA ¼ LA Juridical Principle of Imputation: To focus on the effects of responsible action, we make the no-accidents assumptions and to make explicit the nature of possession, we make the no-action-at-adistance assumption. The main theorem in the jurisprudence of property and contract then gives the conditions under which the market mechanism of appropriation satisfies the juridical principle of imputation. Fundamental Theorem If there are no (property) externalities and no breaches in the transfers between parties in the marketplace, then the market mechanism of appropriation satisfies the juridical principle of imputation. Proof If EXT ¼ 0 ¼ BRE then FT ¼ LT so RA ¼ div (FT) ¼ div (LT) ¼ LA.

2.8

Intuitive Summary of Basic Ideas: A Water Meter Example

Mathematically the fundamental theorem is essentially an application of the divergence principle, i.e., equality of two flows along the arcs implies equality of the net outflows (the divergence) at the nodes. In view of the application to fluid flow, we could refer to this application of the divergence principle as the “water meter principle.” We are interested to arrive at a correct measure of the water used up by a household user. The divergence principle is a mathematical truth that will equate the amount of water being used up in the sink to the amount flowing in across the border of the region (here we think in terms of sinks and inflows instead of sources and outflows). Hence instead of intrusively trying to measure the water used up in the user’s sinks, a water system might use a water meter to measure the inflow across the border between the user and the rest of the water system. The actual inflow to the user from the system plays the role of the factual transfers and the water registered by the system as being legally transferred to the user is given by the reading on the water meter. If the user has some secret pipes into the system water bypassing the meter, that is an “externality,” a theft of water from the system. When the meter registers a

2.9 Intuitive Summary of Basic Ideas: Accounting Examples

39

flow without any actual flow to the user, then that is a “breach.” If the user does not bypass the meter to tap into the system (which includes getting flow when the meter is broken) and the meter does not register an incorrect flow, then there is a matching between the legal and factual flows across the border. The negative divergence of the legal transfers gives the water liabilities imputed to the user, i.e., the measured net inflow. How does that compare to the water that the user is de facto responsible for using up? The no-action-at-a-distance assumption says that the user could not somehow be de facto responsible for using up system water without it being factually transferred to the user. The no-accidents assumption essentially brackets aside any accidental loss or windfall gain (i.e., rainfall catchment) of water outside the water system (e.g., in exchanges with nature outside the property system). Then the user is de facto responsible for all and only what happens within the border of the household. Those assumptions imply that the system water the user is de facto responsible for using up is equal by the divergence principle to the water that factually arrived through the water pipes from the water system. If the latter is correctly registered by the water meter (the matching between legal and factual transfers), then the market imputation of water liability to the user is correct in terms of the responsibility principle.8 This example may seem a long-winded and pedantic explanation of a simple water meter, but it illustrates the general principle behind the market mechanism of imputation and the fundamental theorem. The example is not a metaphor but a particularly simple and lucid special case of the mechanism. With the matching at the public border, the Invisible Judge makes an imputation about private (inside the border) water use that is correct in terms of the responsibility principle.9

2.9

Intuitive Summary of Basic Ideas: Accounting Examples

The general logic relating legal and factual flows is ubiquitous in accounting so it might help to motivate the fundamental theorem by looking at such mundane applications. The two levels of analysis, legal transfers and factual transfers are reflected in accounting in the distinction between the booked stocks and flows of resources and physical stocks and flows (as in doing a “physical inventory”). The whole system of legal property rights could be seen as a society’s way of assigning resources to individuals on “society’s books” (although books of record are not usually kept unless the property is to be taxed, e.g., land cadasters). However,

The stock-flow identity (Beginning stock – Ending stock ¼ Outflow – Inflow) is also an example of the divergence principle and is even used as an imputation mechanism when the observed change in the stocks in a hotel minibar is used to assign the liabilities for the unobserved usage. 9 The example also illustrates that property theory deals entirely in quantity terms. The price charged for the liability for using up so many units of water was never mentioned. 8

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2 Mathematical Introduction to the Jurisprudence of Property and Contract

accounting books are routinely kept for business enterprises (again taxation provides a motivation), so the same issues of relating the books to the underlying physical realities will occur within enterprises. The general logic can be illustrated using the divergence principle in its simplest form, the stock-flow equation: beginning stock—ending stock ¼ inflow—outflow. Accounting typically keeps track of three terms in the equation and then calculates the fourth. Suppose we start with a beginning booked stock level in a merchandise inventory (assumed equal to the physical beginning stock level) which could be zero and we record the booked inflows (purchases of merchandise items). Then there are two choices of method according to which of the two remaining items to determine (outflows or ending stock) and then the other is inferred or imputed by the equation. In the periodic inventory method, the ending stock is determined by a physical inventory (e.g., monthly) and the outflow (“Cost of goods sold”) is determined by the equation (see any accounting text). In the perpetual inventory method, the outflows (inventory changes due to sales) are booked, and the ending stock level is then inferred by the stock-flow equation (physical inventories are still taken but not as often). One can then consider the conditions under which these inferences or imputations will be correct. Whenever two things “A” and “B” are supposed to agree, match, or ‘correspond,’ then there are two types of error: the “A and not B” error and the “B and not A” error. In the periodic inventory method, we use the stock-flow equation (i.e., divergence principle in its simplest form) as follows: Booked beginning stock ð¼ actual beginning stockÞ þBooked purchases Booked ending stock ð¼ actual ending stockÞ ¼ Booked Cost of goods sold: The two types of possible errors are the physical inflows or outflows that were not booked (slippages, thefts, or, in property theory, “externalities”) and the booked inflows or outflows that were not physically realized (non-deliveries or, in property theory, “breaches”). Suppose five widgets of merchandise stock was purchased but not delivered (a booked non-inflow) and the accounting system did not intervene to take account of the non-delivery. Then since the five widgets would not be there in the ending inventory, their cost would be misimputed to “Cost of goods sold.” Another case would be inventory theft (a non-booked outflow). Again, the cost of those items would be misimputed to the “Cost of goods sold.” There is also the internal matter of “accidents” where goods are damaged or spoiled and can no longer be sold. These costs are also imputed to the “Cost of goods sold” (in the above calculation). There is then a “fundamental theorem” for the periodic inventory method which states that if there are no booked non-flows (no breaches) and no non-booked flows (no externalities), then the actual cost of goods sold is covered by the imputed “Cost

2.10

Application to the Human Rental Firm

41

Fig. 2.8 Dramatis Personae

of goods sold” (any difference being the cost of goods internally wasted by accidents instead of being sold). If we additionally assume no accidents, then the imputed “Cost of goods sold” would be exactly correct. Since the “Cost of goods sold” is inferred or imputed in the periodic inventory method and is not directly recorded in a ledger account by the accounting system, we could use (or over-use) the “invisible hand” metaphor to say that it is recorded by the “invisible accountant.” The “fundamental theorem” for the periodic inventory method then states the conditions under which the “invisible accountant” makes the correct imputation of costs. A similar exercise could be carried out for the perpetual inventory method. Another example is in “balancing a checkbook.” There are transfers in and out recorded in one’s checkbook (“booked”) and additions and subtractions from the bank balance (“banked”). The two errors that needed to be taken into account in order to balance the checkbook are the “booked but not banked” transactions (e.g., checks not cashed) and the “banked but not booked” transactions (e.g., bank charges or interest payments in an interest-bearing account not recorded in one’s checkbook).

2.10

Application to the Human Rental Firm

In this simple illustrative model of the employment system in Fig. 2.8, there are three parties: • Labor consisting of all the people who work in a specific production opportunity, • Employer who we assume also supplies the non-labor inputs and who are assumed to have the role of the last buyer of inputs, and • Market which represents all the other activities (e.g., consumption by people). The production operation during one time period is the standard one where Q represents the outputs, K represents all the non-labor inputs including capital services, and L represents the work performed by the people included in the party Labor (including managers and working capital-suppliers qua workers). The consumption activities of the people in the parties Labor and Employer are not represented as part of their functions in Labor and Employer. The unit prices are

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2 Mathematical Introduction to the Jurisprudence of Property and Contract

Fig. 2.9 Legal transfers for human rental firm

p, r, and w so pQ is the revenue, rK is the non-labor cost, and wL is the labor cost.10 Four-dimensional vectors will now be used with money as the fourth component: ðOutputs, Non  labor Inputs, Labor, MoneyÞ: The whole product (Q, K, L, 0) ¼ (Q, 0, 0, 0)  (0, K, L, 0) is the difference of two non-negative vectors (its positive and negative parts) has the profits π ¼ pQrKwL as its value. Since money is neither created nor destroyed (at least when there are no accidents), it requires some special treatment. Since consumption or other uses of the involved money is not represented in the activities of the model, we will treat the money being carried over to the next period as the use of the money (as if that uses up the money for this period and then it is created in the next period). The legal transfers (voluntary contracts) can be described first in Fig. 2.9. In the employment contract, Labor voluntarily sells the labor services L to the Employer in return for the wages wL. The Employer will be represented as directly supplying its endowed non-labor inputs K, paying for the labor, and selling the outputs Q to the Market for pQ. Those are the basic voluntary contractual transactions. The parties’ net outflows (first sale minus last purchase contracts) can be computed from the transfers. The legal appropriation of each party is equal to its net out-transfers. The legal net outflow of the Employer is LAE ¼ DivðLT ÞE ¼ ½ð0, 0, L, pQÞ==ðQ, 0, 0, wLÞ: By being the last-buyer of L and first-seller of Q contracts, the Employer legally appropriates in quantity terms [(0, 0, L, 0]//(Q, 0, 0, 0] which could be parsed as the whole product (as a T-account) plus the capital services (the latter being endowed to the Employer): ½ð0, 0, L, 0==ðQ, 0, 0, 0 ¼ ½ð0, K, L, 0Þ==ðQ, 0, 0, 0Þ þ ½ð0, K, 0, 0Þ==ð0, 0, 0, 0Þ: The legal net outflow of Labor is

10

In this property theoretic analysis, the prices have no role other than showing how much money needs to be transferred in a market exchange.

2.10

Application to the Human Rental Firm

43

Fig. 2.10 Factual transfers for human rental firm

LAL ¼ DivðLT ÞL ¼ ½ð0, 0, 0, wLÞ==ð0, 0, L, 0Þ indicating that Labor legally appropriates in quantity terms (as first seller) only the labor services L. The factual transfers are different as shown in Fig. 2.10. A person cannot voluntarily transfer his or her own de facto responsible actions to another person; labor is de facto nontransferable. The non-labor inputs K are de facto transferred11 to Labor (all the people working in the firm), and then Labor consumes them in the production process. Labor produces the outputs Q which are represented as being transferred to Capital to be sold to the Market in return for the revenue pQ.12 The factual net outflow of Labor is: DivðFT ÞL ¼ ½ð0, K, 0, wLÞ==ðQ, 0, 0, 0Þ indicating that Labor produces and transfers away what was called Labor’s product (Q,K,0,0) in Chapter 1 which is the sum of the whole product (Q,K,L,0) and the labor services (0,0,L,0), or in terms of T-accounts: ½ð0, K, 0, 0Þ==ðQ, 0, 0, 0Þ ¼ ½ð0, K, L, 0Þ==ðQ, 0, 0, 0Þ þ ½ð0, 0, 0, 0Þ==ð0, 0, L, 0Þ: Labor’ s product ¼ Whole product þ Labor services: The factual net outflow of the Employer is: divðFT ÞE ¼ ½ð0, 0, 0, pQÞ==ð0, K, 0, wLÞ ¼ ½ð0, 0, 0, pQ  wLÞ==ð0, K, 0, 0Þ ¼ ½ð0, 0, 0, rK þ πÞ==ð0, K, 0, 0Þ

11

Recall that transfers in possession are not to be confused with movement in physical space, particularly when real estate or land is concerned. When the workers and managers go to the workplace in physical space, that is the transfer of the capital services and other non-labor inputs K into the possession of Labor. 12 The representation of the members of the Employer as actually playing this intermediary role in the sale of the product may seem implausible for absentee shareholders but it is less implausible for a working employer who, by definition, wears two hats (as part of Labor and as the Employer).

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2 Mathematical Introduction to the Jurisprudence of Property and Contract

Fig. 2.11 Legal ¼ Factual transfers in the democratic firm

which indicates the endowed capital services K being transferred to Labor. The Employer is pictured as getting Q and transferring it to the Market (so the Q nets out). The Employer gets pQ from the Market, pays wL to Labor, and thus receives in net terms, pQ–wL ¼ rK+π which is the value of the K transferred away plus the value π of the appropriated whole product (Q,–K,–L,0). Now we can compute the factual-legal mismatches in outflows at the parties. There is no mismatch between legal and factual transfer between the Employer and the Market. On the arc from Labor to the Employer, we have: EXTðLabor, EmployerÞ ¼ fFT  LTgþ ¼ fðQ, 0, 0, 0Þ  ð0, 0, L, 0Þgþ ¼ ðQ, 0, 0, 0Þ EXTðEmployer, LaborÞ ¼ fFT  LTgþ ¼ f0, K, 0, wLÞ  ð0, 0, 0, wLÞgþ ¼ ð0, K, 0, 0Þ: And BRE ðLabor, Employer Þ ¼ fLT  FT gþ ¼ fð0, 0, L, 0Þ  ðQ, 0, 0, 0Þgþ ¼ ð0, 0, L, 0Þ BRE ðEmployer, Labor Þ ¼ fLT  FT gþ ¼ fð0, 0, 0, wLÞ  ð0, K, 0, wLÞgþ ¼ ð0, 0, 0, 0Þ: Thus EXT, the property transfers not covered by contract, are the transference of Labor’s product (Q,K,0,0) from Labor to the Employer, and BRE, the breach in the contract between Labor and the Employer is (0,0,L,0), the non-transference of responsible agency from Labor to the Employer. In the democratic firm, the legal party, Labor, consisting of the people working in the firm, rents the capital (i.e., buys the capital services) and buys the other non-labor inputs from the K-owner (née “the Employer”) rather than the K-owner renting those people. In this case, the legal and factual transfers are the same as shown in Fig. 2.11. Hence EXT ¼ 0 ¼ BRE on all the arcs. By the fundamental theorem of the property system, in the democratic firm, people legally appropriate (in quantity terms) the positive and negatives fruits of their labor, Labor’s product (Q, K,0,0). Using the language of the Scottish Enlightenment, the theorem shows that in the “natural system of liberty” there is a connection between the contracts that connect

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Appendix: The Mathematical Development Using General Vectors

45

parties and their own internal activities. If the legal authorities can enforce Hume’s no-breach and no-property-externality conditions, then the invisible hand mechanism of imputation—the Invisible Judge—will assign legal responsibility in accordance with de facto responsibility. Taking the normal juridical principle of imputation as the modern explication of the Lockean “fruits of one’s labor” principle of property appropriation, then the theorem shows that when Hume’s contractual mechanism works correctly, the Lockean principle will be automatically satisfied.

2.11

Appendix: The Mathematical Development Using General Vectors

When using general vectors (as opposed to non-negative vectors) we do not need bi-directed graphs or T-accounts, but the appropriate ordering relation on general vectors is not the usual one. We recall that a directed graph G, as shown in Fig. 2.12, is given by two sets: A ¼ (a1, . . ., ae), the arcs or edges, and N ¼ (n1, . . ., nv), the nodes or vertices, and a function which assigns to each aj in A, an ordered pair (ni, ni’) in N  N where i 6¼ i’ which could be written as aj ~ (ni,ni’) and interpreted as being a directed arc from ni to ni’. We may assume at most one directed arc between two nodes and no loops at a node.

2.11.1 Node and Arc Assignments An assignment x: A! ℝc of real c-dimensional vectors to each arc is an arc assignment or flow and the value x(aj) is the flow through arc aj. When c ¼ 1, x is a scalar flow. In general, there are c different commodities. With vector-valued flows, x(aj) would be a property vector in the commodity space ℝc. The positive components of x(aj) represent the flows or transfers in the direction of the arc aj and the negative components represents transfers in the opposite direction. An assignment y: N! ℝc of real c-vectors to each node is a node assignment where yi ¼ y(ni) would also be an c-vector in the vector-valued case. The sign convention is that the positive components in y(ni) represent an outflow (i.e., the node as source) and the negative components as an inflow (i.e., the node as a sink). Fig. 2.12 A directed graph

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2 Mathematical Introduction to the Jurisprudence of Property and Contract

2.11.2 Divergence Operator Given a vector flow (vector-valued arc assignment) x: A! ℝc, we compute at a node ni , divðxÞi ¼

X ni !

xj 

X !ni

xj

where “ni!” means that the arc aj is directed outward from node ni and “!ni” has the opposite meaning so div(x)i gives the net outflow at node ni from the flow x. The node assignment div(x): N! ℝc is the divergence of the flow x. If the vector (3, 2, 3, 0) was transferred out of a node and (2, 6, 0, 1) was transferred into the node, then the net out-transfer, net outflow, or divergence is: (3, 2, 3, 0)  (2, 6, 0, 1) ¼ (1, 8, 3, 1) as shown in Fig. 2.13. If we then add all the divergences of x over all nodes, then the flow on an arc will add in once positively and once negatively so the sum is the zero vector 0. P Total Divergence Principle For any flow x, divðxÞi ¼ 0. all ni

2.11.3 Cuts For any set of nodes S and its set complement SC, let [S, SC]+ ¼ { arcs aj : aj ~ (ni,ni’) where ni is in S and ni’ is in SC} [S, SC]– ¼ { arcs aj : aj ~ (ni’,ni) where ni is in S and ni’ is in SC}. Any signed set of arcs of this form is a cut in G, with the arcs in [S, SC]+ called the forward arcs and the arcs in [S, SC]– the backward arcs. The definition includes the empty cut where we may take S ¼ ∅ or S ¼ N. The reverse of a cut is the same set of arcs with the orientations reversed and it is obtained by reversing the role of S and its complement. Given a cut Q ¼ [S, SC] and a vector or scalar flow x, the flow of x across Q is the sum of the flow xj on the forward arcs subtracting the flow xj on the backward arcs. Given a set of nodes S and a flow x, let div(x)S be the sum of the divergences div(x)I for nodes ni in S. Then we have the fundamental result: Fig. 2.13 Divergence at a node

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47

Fig. 2.14 Illustration of the Divergence Principle (scalar flows). Outflow across border of S ¼ 5 (2)  4 ¼ 3 ¼ 10 + 2  9 ¼ Sum of divergences in S; Outflow across border of SC ¼ 5 2 + 4 ¼ 3 ¼ 1 + 3 2 5 ¼ Sum of divergences in SC

Divergence Principle Given vector-flow x and a cut Q ¼ [S, SC], then the flow of x across the cut Q is div(x)S. The proof is simple. In adding up the divergences for the nodes in S, all the flows on the arcs with both nodes in S will cancel out (total divergence principle applied to S). The only remaining arcs connected to nodes in S are the ones with the other node in SC, and the forward ones will count positively in div(x)S and the backward ones negatively—which yields the flow across the cut—as shown in Fig. 2.14. Since the cut Q separates S and its complement SC ¼ N  S, the net flow out of S is the negative of the net flow out of the complement SC, so the sum of the divergences in S and in SC, i.e., the sum of all the divergences, is 0, which is the total divergence principle again.

2.11.4 The Covering Relation To formulate the property theoretic concepts using general vector flows on graphs, we will need a less familiar ordering relation so that we might say, for instance, that the factual transfers were “covered” by the legal transfers (no externalities). This “covering” relation is not the usual component-wise ordering on real-valued vectors. The vectors assigned to an arc represent flows both in the direction of the arrow (positive components) and in the opposite direction (negative components). Yet the direction of the arrow is, in a sense, an arbitrary sign convention. A covering relation (e.g., factual transfers are “covered” by contracts) should be ‘stable’ under reversals in the direction of the arrow. For instance, if (apples, nuts) ¼ (2,6) were the factual transfers from party A to B and (3,8) were the legal transfers, then we would say that the factual transfers were “covered” by the legal transfers. The directionindependent statement is that the legal transfers were larger than or equal to the factual transfers in each direction. Yet (2, 6) ⩽ (3, 8) in the usual vector ordering.

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Hence we will define a new “covering” partial ordering on the real vectors to capture this property of the ordering being stable under reversal in the direction of the arrows. There are also operations of “difference” and “intersection” that are related to the covering ordering in the usual way. The covering ordering ° is defined using the usual ordering on the positive and negative parts of the vectors: X°Y if X  Y and Xþ  Yþ ðread Y covers XÞ The covering relation on real c-vectors is a partial ordering in the sense that it is reflexive (X covers X), transitive (if Y covers X and Z covers Y, then Z covers X), and anti-symmetric (if X covers Y and Y covers X, then X ¼ Y). It might be noted that the zero vector is a minimal element in the covering ordering. If X and Y are compatible in the sense that xi and yi are both non-negative or both non-positive, then X and Y are in the same (non-negative) orthant of ℝc. Then Y ° X is equivalent to X and Y being compatible and |X|  |Y|, i.e., |xi|  |yi| for all i. Thus, the covering ordering is the absolute value ordering on compatible vectors. Also X ° Y if and only if X and Y are in the same orthant and Y–X is in that same orthant. Note that the covering ordering is preserved under reversal of sign, i.e., X°Y if and only if  X°  Y whereas the usual inequality is reversed under sign reversal. If X ¼ (2, 6) and Y ¼ (3, 8) then X ° Y but Y is not greater than or equal to X (i.e., X  Y does not hold). All these definitions and results extend immediately to arc and node assignments by applying them to each vector assigned to the arcs or nodes.

2.11.5 The Contractual Mechanism Let FT:A! ℝc be an assignment of vectors to the arcs which represents the transfer in the de facto control of the commodity vectors between the parties represented by the nodes. Thus, FT represents the factual transfers of possession and control of the commodities between the parties. Let LT:A! ℝc represent the transfers in legal property rights between the parties which are assumed to be mutually voluntary contracts. Thus, LT represents the legal transfers recognized by the property system. The factual transfers not covered by voluntary contracts are called (property) externalities (e.g., thefts, conversions, or any transfers of property not covered by consent or contract). The legal contracts unfulfilled by factual transfers are called breaches.

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Appendix: The Mathematical Development Using General Vectors

49

2.11.6 Analysis of Breaches and Externalities Since any differences between legal transfers LT and factual transfers FT are to be accounted for as breaches or externalities, the initial impulse would be to define externalities as the difference [FT  LT]+ and breaches as the opposite difference [LT  FT]+. However, that would be thinking as if all vectors were non-negative. We define the covering difference, denoted X Ø Y, as follows. Definition For any X and Y, X Ø Y ¼ [X+  Y+]+  [X  Y]+ (read: “the X not covered by Y”). Given the arc assignments LT and FT, the externality arc assignment EXT and the breach arc assignment BRE are defined using the covering differences. þ

Definition : EXT ¼ FTØLT ¼ ½FT þ  LT þ   ½FT   LT  þ þ

Definition : BRE ¼ LTØFT ¼ ½LT þ  FT þ   ½LT   FT  þ : For instance, let us consider commodity vectors that are three-dimensional and, on arc aj oriented from party ni to ni’, FT(aj) ¼ (5, 7, 2) and LT(aj) ¼ (3, 9, 3) as shown in Fig. 2.15. Then EXTðaj Þ ¼ ½ð5, 0, 2Þ  ð3, 0, 0Þþ  ½ð0, 7, 0Þ  ð0, 9, 3Þþ ¼ ð2, 0, 2Þþ  ð0, 2, 3Þþ ¼ ð2, 0, 2Þ and similarly, BRE(aj) ¼ (0, 2, 3) as shown in Fig. 2.16. Thus Bob ‘converted’ (i.e., took outside of any contract) 2 units of the 1st commodity and 2 units of the 3rd commodity from Alice, and Bob also breached contracts to transfer 2 units of the 2nd commodity (note that 7 units were fulfilled) and 3 units of the third commodity to Alice. It is sometimes useful to apply a Venn diagram heuristic to think about vectors. For instance, we might picture X and Y as “sets” and then XØY is the X not covered by Y and YØX is the Y not covered by X as shown in Fig. 2.17.

Fig. 2.15 Factual and legal transfer between Alice and Bob

Fig. 2.16 Externalities and breaches between Alice and Bob

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Fig. 2.17 Venn diagram analogy

Fig. 2.18 Vector Illustration of Parsing X ¼ X Ø Y + X \ Y and Y¼YØX+X\Y

The diagram suggests that the “overlap” of two general vectors could be defined covering intersection of general vectors X and Y, written X\Y, which is defined as follows. Definition

X \ Y ¼ min ðX þ , Y þ Þ  min ðX  , Y  Þ:

The Venn diagram heuristic would then suggest the: Lemma X ¼ XØY þ X \ Y and Y ¼ YØX þ X \ Y Proof It should first be noted that the corresponding relationship holds on non-negative vectors, i.e., for non-negative X and Y, X ¼ [X  Y]+ + min (X, Y). This is easy to verify component-wise because for any i, if min(X, Y)i ¼ yi then yi  xi so xi  yi ¼ [xi  yi]+ and thus xi  [xi  yi]+ ¼ xi  [xi  yi] ¼ yi, i.e., X  [X  Y]+ ¼ min (X, Y) holds for each i. If min(X, Y)i ¼ xi , [xi  yi]+ ¼ 0 so xi  [xi  yi]+ ¼ xi, i.e., X  [X  Y]+ ¼ min (X, Y) holds for each i. Applying this to the positive and negative parts (which are always non-negative), we have for general X and Y, X \ Y þ XØY þ

¼ min ðX þ , Y þ Þ  min ðX  , Y  Þ þ ½X þ  Y þ   ½X   Y  þ þ

¼ min ðX þ , Y þ Þ þ ½X þ  Y þ   ½ min ðX  , Y  Þ þ ½X   Y  þ  ¼ Xþ  X ¼ X and similarly for Y. Example To graphically illustrate the parsing of X and Y into their common part and their non-covered part, we take a two-dimensional example as given in Fig. 2.18 with X ¼ (2,5) and Y ¼ (7,3).

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Table 2.2 Type I & II error table for factual and legal mismatches

The vectors covered by any given vector (i.e., below it in the covering ordering) are the vectors in the rectangle formed by the given vector and the origin. The greatest point (in the covering ordering) where the two “inner rectangles” for two vectors intersect is the greatest lower bound or intersection of the two vectors, i.e., X \ Y ¼ (2, 3) in the above example. If nowhere else, the inner rectangles will intersect at the origin which is a lower bound on all vectors in the covering ordering, i.e., is covered by all vectors. One ‘expects’ to find a certain relationship between an ordering relation, a difference operation, and an intersection operation. For example, for non-negative vectors, we have: X  Y iff [X  Y]+ ¼ 0 iff min(X, Y) ¼ X. It is easily verified that these relationships also hold for the covering ordering. That is, the following conditions are equivalent. 1. X ° Y; 2. X Ø Y ¼ 0; 3. X \ Y ¼ X. Verbally, Y covers X if and only if none of X is not covered by Y if and only if the greatest lower bound of X and Y is X. Since the covering relation is a partial ordering, we have that: X ¼ Y if XØY ¼ 0 and YØX ¼ 0: In the property theoretic case, there is a contractual matching (FT ¼ LT) if and only if there are no breaches, BRE ¼ LT Ø FT ¼ 0, and no externalities, EXT ¼ FT Ø LT ¼ 0. In general, whenever two quantities are to match, then there could be two types of errors which, depending on the context, could be overcount/undercount errors, error of omission/commission, or type I/II errors as in Statistics. Hence a Type I/II error table can be adapted as in Table 2.2 to show the comparison between legal and factual transfers between parties. The two types of mismatches are the property externalities EXT ¼ FT Ø LT where property has been factually transferred without

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consent or contract and the breaches BRE ¼ LT Ø FT where a legal transfer has not been fulfilled by a factual transfer. The sum of the column under factual transfers is FT \ LT + FT Ø LT ¼ FT and the sum of the row for legal transfers is FT \ LT + LT Ø FT ¼ LT. The two types of injustice are the BRE and EXT entries on the anti-diagonal, and the two cases without injustice are the two diagonal entries, FT \ LT, the part of the factual transfers covered by legal transfers which equals the part of the legal transfers fulfilled by factual transfers, and, of course, the case where there are no transfers either way.

2.11.7 An Exchange Example Consider the simplest case of two parties, 1 (Alice) and 2 (Bob), and the transfers between them. As a graph, there are two nodes and one arc, which we take as oriented from Alice to Bob. The factual and legal transfers are arc assignments so we can take FT and LT as the transfer on the one arc. There are two commodities, (apples, nuts), in the vectors. Alice has created at least 40 nuts and Bob at least 22 apples. The agreed-up legal transfer is LT ¼ (20, 40), i.e., Alice sells 40 nuts in exchange for 20 apples from Bob. But suppose that Alice reneged on the factual delivery of one nut and grabbed an extra two apples. Then the factual transfers across the border from Alice to Bob would be FT ¼ (22, 39). Then the “property flow box” diagram (like the property version of an exchange illustrated in an Edgeworth box diagram) would be as in Fig. 2.19. Since the Invisible Judge imputes legal responsibility according to the role of being the first seller and last buyer, then Alice was the first seller of (0,40) and the last buyer of (20,0), and the complementary party Bob had the opposite contractual role. Thus, if there was no over-ruling intervention of a visible judge and the imputations of the Invisible Judge were thus in effect “sustained,” then Alice would in effect receive the legal imputation of (20,40) and Bob would be imputed the negative of that vector. Technically, there is only one arc incident to each node, so:

Fig. 2.19 Property flow box

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53

divðLTÞAlice ¼ ð20, 40Þ ¼ LAðAliceÞ, divðLTÞBob ¼ ð20, 40Þ ¼ LAðBobÞ: But those vectors disagree with vectors representing the de facto responsible actions of the parties. Under the assumptions no action at a distance and no accidents, divðFTÞAlice ¼ ð22, 39Þ ¼ RAðAliceÞ, divðFTÞBob ¼ ð22, 39Þ ¼ RAðBobÞ: The property externalities (factual transfer not covered by consent and contract) are: þ

EXT ¼ FTØLT ¼ ½FTþ  LTþ   ½FT  LT þ ¼ ½ð0, 39Þ  ð0, 40Þþ  ½ð22, 0Þ  ð20, 0Þþ ¼ ð0, 0Þ  ð2, 0Þ ¼ ð2, 0Þ: The legal transfers not fulfilled by factual transfers are the breaches: þ

BRE ¼ LTØFT ¼ ½LTþ  FTþ   ½LT  FT þ ¼ ½ð0, 40Þ  ð0, 39Þþ  ½ð20, 0Þ  ð22, 0Þþ ¼ ð0, 1Þ  ð0, 0Þ ¼ ð0, 1Þ: This formally reproduces the fact that there were 2 apples transferred from Bob to Alice without the cover of a contract and the factual delivery of nuts from Alice to Bob fell one short of the legal contract. The part of the factual transfers covered by contract which equals the part of the contracts actually fulfilled is: FT \ LT ¼ min ðFTþ , LTþ Þ  min ðFT , LT Þ ¼ min ½ð0, 39Þ, ð0, 40  min ½ð22, 0Þ, ð20, 0Þ ¼ ð0, 39Þ  ð20, 0Þ ¼ ð20, 39Þ: Note that: FTØLT þ FT \ LT ¼ ð2, 0Þ þ ð20, 39Þ ¼ ð22, 39Þ ¼ FT LTØFT þ FT \ LT ¼ ð0, 1Þ þ ð20, 39Þ ¼ ð20, 40Þ ¼ LT: Internally, the responsibility mismatch is that Alice consumed (2,0) but did not receive that last-buyer imputation for those liabilities, while Bob was in the opposite position of having lost two apples (2,0) but did not receive that first-seller imputation from the Invisible Judge. Moreover, Alice received the first-seller imputation for the asset (0,1) but did not deliver it while Bob received the last-buyer imputation of the liability for that nut but did not consume it. The responsibility mismatch RA 

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LA ¼ (2,1) for Alice (and the opposite for Bob) was reflected in the property externality and the breach EXT + BRE ¼ (2,1) in the transfers from Alice to Bob.

2.11.8 Appropriation Is the Boundary of Contract Each arc assignment of transfers T determines the node assignment div(T) of net outflows at the nodes. Since the arc assignment LT represents the legal transfers or contracts, the positive components div(LT)+ of the divergence represent precisely the node assignment of first-sold commodities at each node. If the legal authorities do not intervene, then those commodities would be laissez faire imputed to those parties by the “Invisible Judge” so they would be included in the positive components of LA, i.e., divðLTÞþ  LAþ : Similarly, the negative components div(LT)– of the divergence represent the lastpurchased commodities at the nodes, so without any legal intervention, those liabilities would be legally imputed by the Invisible Judge to those parties, i.e., divðLTÞ  LA : Thus, using the covering ordering, the operation of the market or laissez faire mechanism of appropriation covers the first-sales/last-purchases of the parties: divðLTÞ°LA There might be other methods of legally assigning assets and liabilities, e.g., when legal authorities intervene ex post to, in effect, write or rewrite contracts or to assign private rights that are not transferred by contract. If we assume that only market appropriation takes place, then whatever is legally appropriated is covered by the last-buyer/first-seller method, i.e., LA ° div(LT), then we can conclude that: LA ¼ divðLTÞ: Appropriation is the boundary of contract:

2.11.9 Responsible Actions and Factual Transfers When people carry out intentional actions, then they are de facto responsible for the results of those actions. Let RA:N! ℝc (as in “responsible actions”) be the node

2.11

Appendix: The Mathematical Development Using General Vectors

55

assignment representing in terms of net commodities the ex post de facto responsible actions of the parties. The sign conventions for RA were chosen so that the positive components represented commodities net produced (including being removed from stocks carried over from the prior period) while the negative components represented commodities net consumed or used up (or inventoried to stocks carried into the next period). Hence RA would be a node assignment with the positive (resp. negative) components at each node representing the assets (resp. liabilities) for which the party represented by the node is de facto responsible. The basic fact is that for a party to be de facto responsible for consuming or using up a commodity, then the commodity must have been in the de facto possession and control of the party and must have gone out of possession but not by transfer to another party. The consumer is the last possessor. There is no “action at a distance” (in possession space). Since transfers in de facto possession and control are represented by the arc assignment FT, this fact means that any commodities RA– for which a party was de facto responsible for consuming in net terms must have been de facto transferred to the party during the period, i.e., must be included in div (FT)–. Hence the fact that “the consumer is the last possessor” is expressed mathematically as: RA  divðFTÞ : Applied to production, the no-action-at-a-distance principle implies that the commodities RA+ that a party was de facto responsible for producing in net terms during the time period must be first de facto possessed by the party and thus de facto transferred away from the possession of the party during the time period,13 i.e., must be included in div(FT)+. The producer is the first possessor. Hence the fact that “the producer is the first possessor” is expressed as: RAþ  divðFTÞþ : Using the covering relation, we have the: RA°divðFTÞ Noactionatadistance principle: Using a simplistic dichotomy between deliberate actions and accidents, the “gap” between the net results of responsible actions RA (“fruits of the labor” of the parties) and the net factual outflows div(FT) would be the commodities represented in div (FT) which were net creations or destructions that were not intended, namely net

With no accumulation of stock at the nodes, the commodity flow that is produced is either consumed or transferred away during the period so that which is produced in net terms is transferred away. 13

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2 Mathematical Introduction to the Jurisprudence of Property and Contract

accidents (including “positive accidents” or windfalls). Accidents would be ruled out by assuming that whatever happened at the nodes, happened deliberately: divðFTÞ°RA Noaccidents assumption: Hence the no-action-at-a-distance assumption and the no-accidents assumption imply: RA ¼ divðFT Þ: Finally, the jurisprudential principle of assigning legal responsibility, whenever possible, in accordance with de facto responsibility can now be stated in more formal terms using the covering ordering: RA ¼ LA Responsibility principle:

2.11.10

Fundamental Theorem of Property Theory

Under the assumptions of no-action-at-a-distance and no-accidents, the fundamental theorem is straightforward. Fundamental Theorem If there are no (property) externalities and no breaches in the transfers between parties in the marketplace, then the market mechanism of appropriation satisfies the juridical principle of imputation. Proof If EXT ¼ 0 ¼ BRE then FT ¼ LT so RA ¼ div (FT) ¼ div (LT) ¼ LA. To develop the connection with the divergence principle, the fundamental theorem can be restated in a local form focusing on the interface or border between one party and all other parties. The divergence principle can be illustrated with a “property box diagram” (essentially a simple property version of the Edgeworth box diagram). Consider any party S and its interface with all the other parties which we can group together as the complementary party SC (“everyone else”). Each party has certain production and consumption activities and there are transfers across the interface or border between S and SC as shown in Fig. 2.20. In property theory, we are interested in the unobserved sources and sinks within a region, but the contractual mechanism only applies to what goes through the border of the region (legal and factual transfers). Under certain conditions, a mechanism based on what happens at the border of the region (appropriation defined as the boundary of contracts) can be led, as if by an “invisible hand” (the divergence

2.11

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57

Fig. 2.20 Divergence Principle. Net “divergence” of Party S ¼ (9,2,6) ¼ Net outflow across border from S to other parties

Fig. 2.21 Dramatis Personae

principle), to be “correct” about the net sources within the region. The local form of the fundamental theorem states if there are no externalities or breaches then the legal and factual transfers agree (LT ¼ FT) across the border of any party so the factual net sources RA ¼ div(FT) must equal the legal net sources LA ¼ div(LT) within the party.

2.11.11

Application to the Human Rental Firm

The legal parties are the same as before but there are only single arcs between the parties and the vectors are general vectors as shown in Fig. 2.21. The legal transfers (voluntary contracts) can be described first. In the employment contract, Labor voluntarily sells the labor services L to the Employer in return for the wages wL. The Employer will be represented as directly supplying its endowed non-labor inputs K, paying for the labor, and selling the outputs Q to the Market for pQ. Those are the basic voluntary contractual transactions in Fig. 2.22. The parties’ net outflows (first sale minus last purchase contracts) can be computed from the transfers. The legal appropriation of each party is equal to its net out-transfers. The legal net outflow of the Employer is LAE ¼ DivðLTÞE ¼ ðQ, 0, 0, pQÞ  ð0, 0, L, wLÞ ¼ ðQ, 0, L, pQ þ wLÞ: By being the last-buyer of L and first-seller of Q contracts, the Employer legally appropriates in quantity term (Q,0,L,0) which could be parsed as the whole

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Fig. 2.22 Legal Transfers for the human rental firm

Fig. 2.23 Factual Transfers for the human rental firm

product (Q,K,L,0) plus the capital services (0,K,0,0), the latter being endowed to the Employer. The legal net outflow of Labor is LAL ¼ DivðLTÞL ¼ ð0, 0, L, wLÞ indicating that Labor legally appropriates (as first seller) only the labor services L. The factual transfers are different as indicated in Fig. 2.23. The factual net outflow of Labor is: DivðFTÞL ¼ ðQ, K, 0, wLÞ indicating that Labor produces and transfers away Labor’s product (Q,K,0,0) which is the sum of the whole product (Q,K,L,0) and the labor services (0,0, L,0). The factual net outflow of the Employer is: divðFTÞE ¼ ðQ, 0, 0, pQÞ  ðQ, K, 0, wLÞ ¼ ð0, K, 0, pQ þ wLÞ ¼ ð0, K, 0, rK  πÞ which indicates the endowed capital services K being transferred to Labor. The Employer is pictured as getting Q and transferring it to the Market (so the Q nets out). The Employer gets pQ from the Market, pays wL to Labor, and thus receives in net terms, pQwL ¼ rK + π which is the value of the K transferred away plus the value π of the appropriated whole product (Q,K,L,0).

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59

Fig. 2.24 Legal ¼ Factual transfers in the democratic firm

Now we can compute the factual-legal mismatches in outflows at the parties. There is no mismatch between legal and factual transfer between the Employer and the Market. But on the arc from Labor to the Employer, we have: þ

EXT ¼ FTØLT ¼ ½FTþ  LTþ   ½FT  LT þ ¼ ½ðQ, 0, 0, 0Þ  ð0, 0, L, 0Þþ  ½ð0, K, 0, wLÞ  ð0, 0, 0, wLÞþ ¼ ðQ,  K, 0, 0Þ: And þ

BRE ¼ LTØFT ¼ ½LTþ  FTþ   ½LT  FT þ ¼ ½ð0, 0, L, 0Þ  ðQ, 0, 0, 0Þþ  ½ð0, 0, 0, wLÞ  ð0, K, 0, wLÞþ ¼ ð0, 0, L, 0Þ: Thus EXT, the property transfers not covered by contract, are the transference of Labor’s product (Q,K,0,0) from Labor to the Employer, and BRE, the breach in the contract between Labor and the Employer is (0,0,L,0), the non-transference of responsible agency from Labor to the Employer. In the democratic firm, the legal party, Labor, consisting of the people working in the firm, rents the capital (i.e., buys the capital services) and buys the other non-labor inputs from the K-owner (née “the Employer”) rather than the K-owner renting those people. In this case, the legal and factual transfers are the same as in Fig. 2.24. Hence EXT ¼ 0 ¼ BRE on all the arcs. By the fundamental theorem of the property system, in the democratic firm, people legally appropriate the positive and negatives fruits of their labor, Labor’s product (Q, K,0,0).

2.11.12

The Equivalence Between the Two Mathematical Formulations

Since the covering ordering and other definitions using general vectors are less familiar, we need to show how to go back and forth between the two formulations. Recall that each general c-vector x can be parsed into two disjoint non-negative vectors x+ ¼ max(x,0) and x ¼ max(x,0) such that x ¼ x+  x (the Jordan

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Fig. 2.25 Transfer using general vectors

Fig. 2.26 Same transfers using non-negative vectors

decomposition). A vector flow x ¼ (5, 7,2) on a directed arc in the treatment using general c-vectors is given in Fig. 2.25. The same flows could be replaced by two opposite directed arcs each with a non-negative flow as in Fig. 2.26 where x(ni, ni0 ) ¼ x(aj)+ and (ni0 , ni) ¼ x(aj) are disjoint. Thus, we have a way to translate arc assignments between the two treatments using general c-vectors and non-negative c-vectors. Where aj~(ni, ni0 ) and x : A!Rc is an arc assignment using general c-vectors, then x(ni, ni0 ) ¼ x(aj)+ and x(ni0 , ni) ¼ x (aj) is the corresponding arc assignment using non-negative c-vectors. And given a non-negative arc assignment, then x(aj) ¼ x(ni, ni0 )  x(ni0 , ni) which is the difference of two disjoint vectors. It is important to note that for the difference of two disjoint non-negative vectors c and d: ½c  dþ ¼ c and ½c  d ¼ d: We need to particularly check that analysis of externalities and breaches is the same in both treatments. The non-negative vector treatment of EXT ¼ [FT  LT]+ gives the assignments: EXTðni , ni0 Þ ¼ ½FTðni , ni0 Þ  LTðni , ni0 Þþ EXT ðni0 , ni Þ ¼ ½FT ðni0 , ni Þ  LT ðni0 , ni Þþ so the corresponding assignment to aj is: EXT ðni , ni0 Þ  EXT ðni0 , ni Þ ¼ ½FT ðni , ni0 Þ  LT ðni , ni0 Þþ  ½FT ðni0 , ni Þ  LT ðni0 , ni Þþ : But FT(aj) ¼ FT(ni, ni0 )  FT(ni0 , ni) is the difference between to non-negative disjoint c-vectors so FT(aj)+ ¼ FT(ni, ni0 ) and FT(aj) ¼ FT(ni0 , ni). The unusuallooking definition of EXT for the general c-vectors is:

References

61 þ

EXTða j Þ ¼ ½FTða j Þþ  LTða j Þþ   ½FTða j Þ  LTða j Þ þ ¼ ½FT ðni , ni0 Þ  LT ðni , ni0 Þþ  ½FT ðni0 , ni Þ  LT ðni0 , ni Þþ so the two definitions are equivalent. The equivalence proof for the two ways to define BRE goes the same way with the roles of FT and LT reversed.

References Aigner, M. (1979). Combinatorial Theory. New York: Springer-Verlag. Ellerman, D. (1982). Economics, Accounting, and Property Theory. Lexington MA: D.C. Heath. Ellerman, D. (1986). Double Entry Multidimensional Accounting. Omega, 14(1 January), 13–22. Ellerman, D. (2014). On Double-Entry Bookkeeping: The Mathematical Treatment. Accounting Education: An International Journal, 23(5 (Oct.)), 483–501. Fleming, W. (1977). Functions of Several Variables. New York: Springer-Verlag. Giblin, P. (1977). Graphs, Surfaces and Homology. London: Chapman and Hall. Hart, H. L. A. (1968). Punishment and Responsibility: Essays in the Philosophy of Law. New York: Oxford University Press. Rockafellar, R. T. (1984). Network Flows and Monotropic Optimization. New York: John Wiley & Sons. Smith, A. (1982). Lectures on Jurisprudence. (R. L. Meek, D. D. Raphael, & P. G. Stein, Eds.). Indianapolis: Liberty Fund.

Chapter 3

The Property Fallacy in Capital Theory and Corporate Finance Theory

Abstract The Fundamental Myth, that the rights to the (whole) product of production (and the management rights) in a productive opportunity are part and parcel of the ownership of capital (the “means of production”) was introduced and explained in Chap. 1. In this chapter, it is shown how the Fundamental Myth is baked into the simple formulas for the valuation of capital assets used actively (i.e., by hiring in a complementary set of inputs and then selling the produced outputs) as well as into the sophisticated formulas of Miller and Modigliani in corporate finance theory.

3.1

The Appropriation of Produced Assets and Liabilities

Property theory brings into sharp relief a largely neglected aspect of production, the appropriation of the assets and liabilities created in the production process. The legal appropriation of those assets and liabilities is not determined by the ownership of the corporation undertaking the production process as a going concern. It is determined by the contractual fact-pattern (e.g., who hires what or whom) of the contracts made in the marketplace between legal parties, corporations or not. Since contractual factpatterns are not owned, the determination of who is to be the firm in the goingconcern sense is not determined by the prior ownership of corporations or capital assets. It is a contribution to clear thinking to use different names for what is owned and what is not. The conventional corporation is owned by its common shareholders. If we use the word “firm” to designate the market-determined legal party undertaking a production process as a going-concern, then there is no ‘ownership’ of the firm.1 In the previous Chap. 1 on property theory, we outlined the actual legal mechanism of appropriation. In the normal day-to-day activities of production and consumption, commodities are consumed as inputs to production or as consumer goods—all purchased through marketplace contracts. The owner of the goods loses the goods but not by transfer to another party. The goods have been used up 1

The author has been making this distinction and point since the mid-1970’s (Ellerman 1975) and the French legal scholar, Jean-Philippe Robé, has independently made the same distinction (Robé 2011). © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_3

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and consumed with the knowledge and intent of the owner of the goods, so that party has no legally defensible claim against another party for compensation against the loss. That is the original legal meaning of “expropriation” (Black 1968), the voluntary legal expropriation of those goods, or, equivalently, the voluntary legal appropriation of the liabilities for those goods. Since no explicit legal imputation or assignment of the liabilities for those goods was involved, we have termed this a laissez faire appropriation of the liabilities. If the goods had been consumed, used up, or destroyed in circumstances against the consent of the owner, then the owner would presumedly have a plausible claim against some other party for compensation. Legal proceedings involving a visible judge could be commenced that could overturn the laissez faire solution and reassign the liability to the other party. In production, new goods, commodities, or assets are produced. Under normal circumstances, a party has already voluntarily appropriated the liabilities for the matching inputs that were used to produce outputs. Hence, in the absence of any reassignment of the input liabilities, that party would have the legally defensible claim on the produced outputs. Since no explicit legal assignment is involved, we have termed this the laissez-faire appropriation of those assets. In this manner, a party laissez-faire appropriates the assets and liabilities produced in production. The list or ‘vector’ of assets and liabilities is normally called the “production vector” or “input-output vector” but for historical reasons I will call it the “whole product.” Having borne the costs of the inputs used up in production, that party is the last legal owner of the inputs. In a market economy, that party, the wholeproduct appropriator, is not always the prior owner of some specific input which could have been rented out. Usually owners of capital hire labor, but workers can borrow or hire capital and an entrepreneur could hire both the labor and capital. The whole-product appropriator is determined by the direction of the hiring contracts, by who hires what or whom. Whichever party hires all the inputs (and does not resell them) will bear those costs as the inputs are consumed in production and thus will appropriate the whole product. The whole-product appropriator (or, in value terms, the residual or profit claimant) is that last legal owner of the consumed inputs; that is, the hiring party. Being the hiring party, and thus the whole-product appropriator, is a contractual role. It is not the ownership of some specific asset owned by a corporation or the performance of any specific service. Moreover, it is a return in terms of property, not simply a value return. In the textbook model of perfectly competitive equilibrium with zero profits, there are no pure or economic profits, so the net value of the whole product is zero. This does not mean that the hiring party gets nothing. The hiring party gets no net value in that pinpoint instance but still gets the whole product in terms of property in addition to the discretionary management rights over the production process. Moreover, the property mechanism of laissez faire appropriation operates regardless of whether the price mechanism is in equilibrium or disequilibrium and regardless of whether the markets are competitive or noncompetitive. There is a widespread tendency, especially in Economics, to “explain” any income as the return to some factor. The whole product is not a return to some factor. It is of no avail to postulate hidden or implicit factors. At best, some hidden

3.1 The Appropriation of Produced Assets and Liabilities

65

factor might be competitively priced so that the profits would be exactly zero when the factor is taken into account. Hidden factors don’t change the structure of property rights involved in production. The whole product, even if of zero value, still accrues to the contractual role of being the hiring party.2 The explanation that profit is a return to risk bearing is quite tautologous when risk bearing means bearing the costs (appropriating the negative product). Of course, the party that appropriates the negative product (the negative liabilities listed in the whole product) also appropriates the positive product (the positive entries) and thus nets the profits. But why in the first place did that party, rather than some other, appropriate the negative product and thus the whole product? That party did so only by being the last owner of the inputs. The inputs might have changed hands several times. But it is the party whose name is on the input contracts when the inputs are consumed in production (and thus are not resold) who will bear, or swallow, the costs of the inputs rather than pass the costs on. Having one’s name on the contracts is a contractual role. Economic resources have two types of uses, the so-called active use and the passive use. A resource is used passively when it is sold or rented out in return for some market price or rental. A resource is used actively when, instead of being evaluated directly on the market, it is used up in production, usually along with other resources. Then the liabilities for the used-up resources and the rights to any produced assets are appropriated. Thus, appropriation is involved in the active use, not in the passive use of resources. Difficulties arise in the conventional treatment of the active case, since conventional economics tends to ignore appropriation by attributing the appropriation to the “ownership of the corporation” which in that instance made the necessary market contracts to legally appropriate the liabilities and assets created in the productive process. The economic return in the active case is not just the value of the original resource but the extra value of the appropriated property. But the mistake is that the total return in the active case is typically imputed only to the original resource, as if the ownership of the appropriated property were already included in ownership of the original resource (the fundamental myth)—which could be a capital good or a whole corporation viewed as just a big machine. Property that is appropriated cannot be previously owned; otherwise it could not be appropriated. The extra value of the appropriated property (for example, the whole product) is not a return to the original resource—which could have been hired out under a different set of contracts. In the context of the laissez faire appropriation mechanism, it is a return to the contractual role of being the last legal owner of the used-up resources.3

2 The same holds for the determination of who has the power or managerial rights over the work process so Bo Rothstein refers to it as the “contract theory of the power” (Rothstein 2021, p. 10). 3 An early treatment of this argument was in Ellerman (1986).

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3.2

The Property Fallacy in Capital Theory

One way to neglect appropriation is to construe the right to the whole product as if it were part of a preexistent property right, e.g., the ownership of a capital assets or a corporation in neoclassical theory or the “ownership of the means of production” in Marxist theory. This fallacy common to neoclassical and Marxist economics is the “fundamental myth.” This practice is part of the Marxist view of the so-called “capitalist” economic system where the preexistent property right is the “ownership of the means of production.” In a society where labor legally can hire capital, the right of capital owners to command labor cannot logically be founded on the idea of property rights. The right of capital to command labor is thus not based on any property right, as both Marxists and libertarians have argued. Rather, it is based on the legal construction of the rental contract, in this case the employment contract. (Rothstein 1992, p. 116)

This is also a common practice in capital theory, where the preexistent right is the ownership of a capital asset or a corporation. For example, in Paul Samuelson’s treatment of capital theory, he assumes not only that future property (for example, the stream of future whole products) has a present value but that it has a present owner. All potential income must be capitalized. That is to say, we start with institutional property rights. Each income account “belongs” to some “person.” (Samuelson 1937, p. 477; reprinted in Samuelson 1966, p. 169)

Consider a simple example of a capital asset. The asset had a market cost of C, yielded K units of capital services per year for n years (no maintenance), and then had a salvage value of S. Capital services have a market value of R per unit and the interest rate is r. Under competitive conditions, arbitrage between buy and lease markets would enforce equality between the present values of the outlays to obtain the same stream of real services K, K,. . .,K through buying and leasing: C

S ¼ RKaðn, r Þ ð1 þ r Þn

where: aðn, r Þ ¼

1 1 1 þ þ ... þ ð1 þ r Þ ð1 þ r Þ2 ð1 þ r Þn

is the present value of an ordinary annuity of one. Hence the market value of the capital asset C is the discounted present value of the rentals plus the scrap value:

3.2 The Property Fallacy in Capital Theory

C ¼ RKaðn, r Þ þ

67

S : ð1 þ r Þn

Consider a simple production possibility where K units of capital services combined with L units of labor yield Q units of output each year. Let W be the wage rate and P the unit price of output, all payments being made at the end of the period. Hence the economic profit each period is: π ¼ PQ  RK  WL: One of the basic concepts of capital theory is the notion of the capitalized value of an asset. The definition is usually stated in a rather general fashion; owning the asset yields a future income stream and the discounted present value of the income stream is the capitalized value of the asset. But there are quite different ways in which owning an asset can yield an income stream, the active and the passive uses of capital. The capitalized-value concept is unproblematic if the income stream is simply the passive stream of net rentals plus the scrap value. The capitalized value of that stream is, under competitive conditions, just the market value C of the asset. Bonds and annuities provide similar examples of income streams generated by renting out or loaning out capital assets; that is, by the passive use of capital. Property appropriated in the future can have a present capitalized value (which could be zero) but it cannot have a present owner beyond the reach of present enforceable contracts. The future contracts involved in the active use of capital have not yet been made, and there is no present property right to enforce those contracts. In contrast, the future coupons in a bond do have a present owner, the owner of the bond, and the future rentals if a capital asset is rented out have a present owner, the owner of the asset. Both those passive uses of capital do not involve the appropriation of property in the future. The basic fallacy involved in conventional capital theory is to assign or impute the whole products appropriated in the active use of a capital asset in a production process to the capital asset itself. Capital theory would be somewhat less controversial if it stuck to such examples of hired-out capital. However, the capitalized-value definition is also applied to the quite different active case where, instead of hiring out the capital, labor is hired in along with other inputs, a product is produced and sold, and the net proceeds are all ‘imputed’ to the capital assets. In the example above, the owner of the capital asset could hire L units of labor and produce Q units of output each year for n years. This action would yield net proceeds of PQ  WL each year plus the scrap value of S the last year. The present discounted value of this income stream is: V ¼ ðPQ  WLÞaðn, r Þ þ

S : ð1 þ r Þn

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This present value is then called the capitalized value of the capital asset as if to impute the net proceeds to the capital asset. The economic profits were π each year so the present value of the profit stream is: V 0 ¼ πaðn, r Þ: The net proceeds PQ – WL ¼ RK + π can be analyzed as the implicit rental RK plus the profits π. Hence the capitalized value can be analyzed into two parts: V ¼ RKaðn, r Þ þ

S þ πaðn, r Þ ¼ C þ V 0 : ð1 þ r Þn

Thus, the capitalized value V is the market value of the asset C plus the present value V0 of the future profits. The profits π are the market value of the whole product so V0 is the present value of the whole products appropriated each of the n years. Value is the value of property, and the property whose value is V consists of the capital asset plus the stream of whole products appropriated each year. Hence, strictly speaking, it is fallacious to label V as the capitalized value of the capital asset by itself. When the profits are imputed to the capital asset by calling V the “capitalized value of the capital asset,” then the role of appropriation is overlooked. One might then think that by purchasing the asset, or the means of production, one is thereby purchasing the outputs and the net proceeds—so there is no need to appropriate the outputs. When a man buys an investment or capital-asset, he purchases the right to the series of prospective returns, which he expects to obtain from selling its output, after deducting the running expenses of obtaining that output, during the life of the asset. (Keynes 1936, p. 135)

But in fact, one thereby purchases only the asset. Any further return will depend on one’s contracts. If one rents out the asset and sells the scrap, then one receives only the rental-plus-scrap income stream. If, instead, one hires in labor, bears the costs of the used-up labor and capital services, and then claims and sells the outputs, then one receives the net proceeds mentioned by Keynes. In each case, one owned the asset. The difference was in the subsequent contracts. By making the contracts so that one was the hiring party, one could additionally appropriate the whole product each time period with its positive or negative value. The capitalized value V is the return to the asset C plus the return V0 to the contractual role that allows one to appropriate the stream of whole products. Another example of assigning the whole product to the capital asset is involved in the notions of marginal efficiency or net productivity of capital. We have seen how competitive arbitrage will enforce the equation:

3.2 The Property Fallacy in Capital Theory

69

C ¼ RKaðn, r Þ þ

S : ð1 þ r Þn

In other words, the interest rate r will discount the rental-plus-scrap income stream back to the market cost C of the asset. Since: V ¼ RKaðn, r Þ þ

S þ πaðn, r Þ ð1 þ r Þn

the interest rate r discounts the rental-plus-scrap and profit streams back to the value V ¼ C + V0. If the profits are positive, then V is larger than C. Some higher discount rate r0 would be necessary to discount the rental-plus-scrap and profit streams back to C, since the assumed interest rate r discounts them back to V. Such a rate r0, which satisfies the equation: C ¼ RKaðn, r 0 Þ þ

S þ πaðn, r 0 Þ: ð1 þ r 0 Þn

is sometimes called an internal rate of return or an average rate of return over cost. However, the rate r0 is also presented as the yield rate of the capital asset and then it is called the marginal efficiency of capital (Keynes 1936, p. 135) or the net productivity of capital (Samuelson 1976, p. 600). This usage presents the profit stream as if it were part of the return to owning the capital asset when in fact it is the return to having the additional contractual role of being the hiring party and appropriating the future whole products. Yet another method of imputing the whole product and its value, the profits, to capital is the quasi-rent doctrine. In a genuinely competitive model, all factors including the services of plant and equipment would have a competitively determined price. Capital assets would have a competitive rental such as RK in the example. In the example, the so-called quasi rent would be PQ  WL ¼ RK + π. The quasi-rent doctrine is another example of the ‘professional’ penchant in neoclassical Economics to fallaciously impute the profits to capital. For instance, the value of the appropriated whole product, the profit, is added to the machines competitive rental, and the result, RK + π ¼ PQ  WL, is dubbed the “quasi-rent earned by the machine” (Stonier and Hague 1973, p. 328). There is a pattern here. Capital has a passive use and an active use (at least when all other factors can be rented or purchased). Thus, capital theory will always have a pair of concepts associated with capital, one concept derived for the passive case and one concept for the active case. The value concept associated with the active case includes the concept for the passive case plus the value of the whole product (the profit) that is appropriated by the capital owner in the active case. Thus, a capital asset has a market cost (passive) and a so-called ‘capitalized value’ (active). A physical capital good has a marginal productivity (passive) and a so-called ‘net productivity’ (active). Financial capital has a marginal rate of return over cost

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(passive) and a so-called ‘average rate of return over cost’ or ‘marginal efficiency’ (active). And a capital asset has a market rental (passive) and a so-called ‘quasi-rent’ (active). The difference between the passive and active case is the appropriation of the whole product, which is the return to a contractual role, not a return to the capital itself. But conventional capital theory neglects appropriation and fallaciously imputes the whole product and its value, the profits, to capital in all those various ways—all examples of the fundamental myth completely embedded in neoclassical Economics. One traditional way to hide the neglect of the entire question of the appropriation of the whole product is to argue that it doesn’t matter, for the purposes of price theory, if attention is restricted to pin-point special case of zero-profit perfectly competitive equilibrium. Remember that in a perfectly competitive market it really doesn’t matter who hires whom: so have labor hire “capital”. (Samuelson 1957, p. 894; reprinted in Samuelson 1966, p. 351) [U]nder constant returns to scale and statical conditions of certainty, it is immaterial which factor hires which Labor as much hires capital goods and land as capital hires labor and land. (Samuelson 1967, p. 114)

When the capital-theoretic assignment of the whole products to the capital assets is challenged, the all-too-typical response is also that it really doesn’t matter because in the pinpoint hypothetical special case of perfectly competitive equilibrium, the pure profits are zero. In that instance, Samuelson can claim to have demonstrated that “equality of capitalized value and reproduction cost” (Samuelson 1961, p. 42; reprinted in Samuelson 1966, p. 309); that is, V ¼ C. Similarly, a prominent capital theorist shows that the competitive “equilibrium price of a one-year-old machine in terms of ‘costs’” is equal to the “present discounted value of the future net output which a one-year-old machine can produce.” (Burmeister 1974, p. 443). Any such justification of the capital-theoretic imputations that must assume perfectly competitive equilibrium with zero profits is on rather thin ice. And even then, there is no property-theoretic explanation: it is simply a moot point from the price-theoretic viewpoint since the whole products have zero value in that razor-thin special case. Moreover, the capital-theoretic definitions of capitalized value or net productivity are by no means restricted to the zero-profits competitive model. When Samuelson asserts that “capital goods have a ‘net’ productivity” (1976, p. 661) (while the other factors have only a marginal productivity), there is no limitation to competitive equilibrium. The capital-theoretic definitions are used throughout the literature on capital budgeting and finance theory—which is hardly restricted to competitive equilibrium. It is ultimately of no avail always to retreat ostrich-like to the special case of zero-profit perfectly competitive equilibrium whenever the fallacious imputation of the whole products to capital is challenged. The real problem (aside from the obvious ideological bias) is that the consideration of appropriation carries Economics beyond the neoclassical conceptual orbit of price theory into the domain of property theory and jurisprudence.

3.3 The Property Fallacy in Corporate Finance Theory

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Samuelson’s dictum that the cash value of a doctrine is in its vulgarization applies not only to Marxism but to the fallacious imputations of capital theory. For instance, in a book entitled The Capitalist Manifesto, one reads the vulgarization: The essence of property in productive wealth is the right to receive its product. (Kelso and Adler 1958, p. 210)

The return to property is its rental or selling price. The product, that is, the whole product, must be appropriated and the identity of the whole product appropriator is determined by who hires what or whom in the marketplace, not by “property in productive wealth.” Historians of economic thought can sort out the question of priority. Is capitalist ideology a vulgarization of capital theory or are the imputation fallacies of capital theory an attempt to rationalize capitalist ideology?

3.3

The Property Fallacy in Corporate Finance Theory

In our discussion of capital theory, we considered how the economic profits produced using a capital asset are added into the capitalized value of the asset as if the right to the whole product was part and parcel of the ownership right to the capital asset. In the influential work of Economics Nobel-laurates Merton H. Miller and Franco Modigliani in finance theory, this capitalized-value definition is applied to a corporation itself. Consider now the so-called discounted cash flow approach familiar in discussions of capital budgeting. There, in valuing any specific machine we discount at the market rate of interest the stream of cash receipts generated by the machine; plus any scrap or terminal value of the machine; and minus the stream of cash outlays for direct labor, materials, repairs, and capital additions. The same approach, of course, can also be applied to the firm as a whole which may be thought of in this context as simply a large, composite machine. (Miller and Modigliani 1961. p. 415).

Miller and Modigliani showed that, under perfectly competitive conditions, the capitalized value of a corporation is independent of the corporation’s policy on dividends versus retained earnings. They proved the dividend irrelevance thesis by developing formulas for the value of a corporation that are the same regardless of the dividend decision. Our interest is less in the dividend irrelevance thesis than in analyzing the capitalized-value definition to discern the underlying property rights. Miller and Modigliani (1961) present four distinct but equivalent approaches to the capitalized value of a corporation: 1. 2. 3. 4.

the discounted-cash-flow approach, the current-earnings-plus-future-investment-opportunities approach, the stream-of-dividends approach, and the stream-of-earnings approach.

All these approaches yield the same capitalized value, but none of them allow one to readily analyze the underlying property rights so as to separate the property

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actually owned by the corporation from the property that the corporation is assumed to appropriate in the future. This job is performed by a fifth equivalent approach, the net-book-value-plus-future-economic-profits approach or, in short, the book-plusprofits approach. We saw in the simple capital-theory example how the capitalized value V could be split into the value C of the asset itself plus the value V0 of the future whole products that could be appropriated. The fifth approach simply extends this analysis to the corporation itself. The mathematical proofs of the equivalence between the book-plus-profits formula and the four Miller-Modigliani approaches have been given elsewhere (Ellerman 1982, Chapter 12).

3.4

Property Interpretation of the Book-Plus-Profits Formula

The book-plus-profits formula extends the capital-theoretic formula V ¼ C + V0 to a corporation as a capital asset. The book-plus-profits formula is important because it, unlike the other formulas used by Miller and Modigliani, allows one to discern the status of the property rights underlying the formula for the value of a corporation. Our treatment of the book-plus-profits formula illustrates a methodological principle used to derive property-theoretic results. One is ultimately interested in results that hold in the real world; that is, in a non-competitive disequilibrium situation fraught with uncertainty. Yet the most highly developed models in economic theory are for competitive equilibrium. Yet the framework of property theory is quite independent of any assumptions about competition, equilibrium, and uncertainty. The functioning of the laissez faire property mechanism does not require the price mechanism to be in equilibrium. The property mechanism depends on contracts, and contracts are made even in markets that are in constant flux and disequilibrium. Hence we have taken a different expository approach: derive property-theoretic results in a familiar context (for example, a competitive model), and then generalize them by showing that they do not depend on any of the particular assumptions of the special case. Value is the value of property. The book-plus-profits formula shows that the property whose value is the so-called “value of the corporation” is: (l) the property in assets and liabilities whose value is the net book value, and (2) the property in the future whole products whose present value is the discounted sum of the future economic profits. The total assets and liabilities of the company are indeed existent property rights and obligations of the corporation. However, the future whole products must be appropriated according to future contracts so there is no present property right, held by the corporation or any other party, to those future bundles of rights and obligations. We have assumed that the corporation will make the required contracts to be in a position to appropriate the whole products. We could also make the contrary assumption and derive that the value of the corporation was only the

3.5 Future Whole Products as “Goodwill”

73

value of the total assets and liabilities; that is, the net book value, since the whole products would then go elsewhere, e.g., the Conner Ave. example. The point is not whether the assumption is correct. The point is that it is a matter of the future contracts not of the present property rights. A corporation still owns just its assets and owes its liabilities, and may or may not appropriate the future whole products depending on its contracts. The relaxation of the idealized assumptions certainly will affect the behavior of the market participants. Uncertainty about the future coupled with risk aversion may lead a party to avoid the role of the hiring party. Noncompetitive market power may help ensure that another party can take on the contractual role of being the hiring party. But such market power is not a property right. If competition materializes that neutralizes the market power of a once dominant corporation, that does not violate a property right of the corporation. In the general noncompetitive disequilibrium situation, each corporation still owns only its total assets and liabilities. The whole product will be appropriated by the party who emerges as the hiring party from the market process; that is, the hiring conflict over who hires what or whom.

3.5

Future Whole Products as “Goodwill”

“Goodwill” is traditionally defined as the difference between the capitalized value of corporate assets and the net book value. By the book-plus-profits formula, the goodwill is the discounted present value of the future economic profits (Edey 1962). The actual property, whose value is the goodwill, is the series of future whole products. The nature and treatment of goodwill has been a perennial problem area in accounting—and for good reason. The peculiarities of appropriation emerge in accounting under the guise of goodwill. The property analysis allows us to see what goodwill is, what it is not, and how it should be treated in accounting. Since the word “goodwill” is often used loosely, we must first be clear that our treatment will only deal with goodwill as the difference between the capitalized and book value—and not with a fluffy notion of “goodwill” in some psychological sense. We will not be concerned with it in the sense of the consumer’s favorable disposition since that does not represent a property right at all. There might be situations where a corporation used a novel and patentable invention or idea in its production that, however, was never actually patented and shown as a balance-sheet item. If the corporate assets were hired out, then such inventions, ideas, or industrial secrets would probably be patented or otherwise secured and then entered on the balance sheet. We must assume that all such appropriable proprietary items have been duly claimed and reported on the balance sheet—so that the balance sheet accounts accurately reflect the corporation’s present property rights and obligations. Since goodwill is the present value of quite tangible but future whole products, it is not the value of some present mysterious intangible asset. It is the value of the whole-product vectors that may be appropriated in the future. The appropriation of

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the whole product is the return to a contractual role, in this case, the future contracts to be made by customers and suppliers. The corporation has no present property right to force the future customers and suppliers to make the contracts assumed in the future projections. Hence, there cannot exist any present property right to the future whole products whose present value is the goodwill. In other words, a corporation does not own what is called its “goodwill.” An economist, Sidney S. Alexander, applied this mistaken capitalized-valueof-the-asset definitions of capital theory to a corporation itself (as did Miller and Modigliani). The Neverlose Manufacturing Company is engaged in the manufacture of gadgets. At the beginning of 19x5, it was expected that throughout all future time the company would manufacture a hundred thousand gadgets a year and sell them for $100,000 at a total cost of $90,000 including all charges, so affording an annual profit and an annual dividend of $10,000 indefinitely into the future. The current long-term interest rate is 5 percent, and so the value of the equity in the company is $200,000, the present value of $10,000 a year indefinitely into the future. (Alexander 1962, p. 140)

He goes on to argue that the income of the corporation should be measured by the changes in this capitalized value instead of the changes in the usual net book value. However, this argument misses a crucial point. Any notion of income should presumably be related to the changes in the value of the corporation’s rights (not just some expectations). Since the corporation has no present property right to the future whole products, their present value, the goodwill, is not part of the value of the corporation’s present rights. Hence, changes in goodwill should not enter into income. The point is not that the appropriation of future whole products is uncertain and thus the point is unchanged by assumptions about conditions of certainty. It is always instructive to compare the future stream of whole products with the future income stream attached to a bond. The payments on a bond are, of course, uncertain since the issuer might default and declare bankruptcy. The owner of the bond has a legal right to the bond payments against the issuer. Hence there may be wishful thinking but there is no fallacy involved in valuing the bond at the present value of the bond payments. Future whole products are appropriated or not depending on the contractual fact-pattern with consumers and suppliers, so there can be no present right to them. To present their discounted value, the goodwill, as part of the value of one’s present rights is not just speculation in the face of uncertainty; it is a mistake. Goodwill is at best the value of the property that a party expects to appropriate in the future. The bond owner does not just expect to ‘appropriate’ the future bond payments since the owner already has the legal property right to those payments. Accountants have quite rightly resisted the arguments, made by some economists such as Alexander, for recording changes in goodwill as income and for recording unpurchased goodwill as an asset. In neither case are there any present property rights to be accounted for. However, it is conventional to record, as an asset, any purchased goodwill. This is reminiscent of the story of the country bumpkin who goes to New York and is sold the Brooklyn Bridge. He could enter the Brooklyn Bridge as a purchased asset on his balance sheet. The point is that the seller of

References

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goodwill, like the seller of the Brooklyn Bridge, has no such property right to sell. Ordinarily, when goodwill is “purchased” the buyer is paying the seller to withdraw from the field and turn over his less than perfectly competitive market position to the buyer. The buyer is then in a better competitive position to appropriate the future whole products which have the goodwill as their present value. The buyer is not purchasing any enforceable present property right, tangible or intangible; otherwise, there would be no reason to term it ‘goodwill.’ Capital expended to purchase a non-right should not be recorded as an asset; it should be recorded as a debit to equity. In the AICPA Accounting Research Study No. 10, Accounting for Goodwill, George Catlett and Norman Olson have (courageously) argued for this treatment of purchased goodwill. The amount assigned to purchased goodwill represents a disbursement of existing resources, or of proceeds of stock issued to effect the business combination, in anticipation of future earnings. The expenditure should be accounted for as a reduction of stockholders’ equity. (Catlett and Olson 1968, p. 106)

The debit to shareholders’ equity would then be cancelled if and when the anticipated future whole products were appropriated, priced out as profit, and recorded in equity.

References Alexander, S. S. (1962). Income Measurement in a Dynamic Economy. In W. T. Baxter & S. Davidson (Eds.), Studies in Accounting Theory (pp. 126–200). Homewood: Irwin. Black, H. C. (1968). Black’s Law Dictionary. St. Paul: West Publishing. Burmeister, E. (1974). Neo-Austrian and Alternative Approaches to Capital Theory. Journal of Economic Literature, XII, 413–456. Catlett, G., & Olson, N. (1968). ARS No.10: Accounting for Goodwill. New York: American Institute of Certified Public Accountants. Edey, H. C. (1962). Business Valuation, Goodwill and the Super-Profit Method. In W. T. Baxter & S. Davidson (Eds.), Studies in Accounting Theory (pp. 201–217). Homewood: Irwin. Ellerman, D. (1975). The “Ownership of the Firm” is a Myth. Administration and Society, 7 (1 May), 27–42. Ellerman, D. (1982). Economics, Accounting, and Property Theory. Lexington MA: D.C. Heath. Ellerman, D. (1986). Property Appropriation and Economic Theory. In P. Mirowski (Ed.), Reconstruction in Economic Theory (pp. 41–92). Boston: Kluwer-Nijhoff. Kelso, L., & Adler, M. (1958). The Capitalist Manifesto. New York: Random House. Keynes, J. M. (1936). The General Theory of Employment, Interest, and Money. New York: Harcourt, Brace & World. Miller, M. H., & Modigliani, F. (1961). Dividend Policy, Growth, and the Valuation of Shares. The Journal of Business, 34(October 1961), 411–433. Robé, J.-P. (2011). The Legal Structure of the Firm. Accounting, Economics, and Law, 1(1), Article 5. https://doi.org/10.2202/2152-2820.1001 Rothstein, B. (1992). Social Justice and State Capacity. Politics & Society, 20(1 March), 101–126. Rothstein, B. (2021). Why No Economic Democracy in Sweden? A Counterfactual Approach (No. 12) (pp. 1–20). SocialEurope.eu. https://www.socialeurope.eu/wp-content/uploads/2021/ 02/re_no_12_Why_No_Economic_Democracy_in_Sweden.pdf

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Samuelson, P. (1966). The Collected Scientific Papers of Paul A. Samuelson Vol. I. (J. Stiglitz, Ed.). Cambridge: MIT Press. Samuelson, P. A. (1937). Some Aspects of The Pure Theory of Capital. Quarterly Journal of Economics, LI(May 1937), 469–496. Samuelson, P. A. (1957). Wages and Interest: A Modern Dissection of Marxian Economic Models. American Economic Review, XLVII(6), 884–912. Samuelson, P. A. (1961). The Evaluation of “Social Income”: Capital Formation and Wealth. In F. A. Lutz & D. C. Hague (Eds.), The Theory of Capital (pp. 32–57). London: Macmillan. Samuelson, P. A. (1967). The Monopolistic Competition Revolution. In R. E. Kuenne (Ed.), Monopolistic Competition Theory: Studies in Impact (pp. 105–138). New York: John Wiley and Sons. Samuelson, P. A. (1976). Economics (10th ed.). New York: McGraw-Hill. Stonier, A. W., & Hague, D. C. (1973). A Textbook in Economic Theory (4th ed.). New York: Wiley.

Chapter 4

The Arrow-Debreu Model

Abstract The Arrow-Debreu model of competitive general equilibrium and more recent variants are the highpoints of neoclassical microeconomic theory. They are usually criticized as being unrealistic but the analysis in this chapter is not based on that common criticism. Precisely because the Arrow-Debreu model is so idealized, it is easy to pinpoint the conceptual error in the assumption that production sets are “owned” by given legal parties (assumed to be corporations). In an idealized competitive market, any proposed equilibrium with positive pure profits in any productive opportunity would be immediately undercut by arbitrageurs offering slightly higher prices to input sellers and slightly lower prices to output buyers— so such a competitive equilibrium with positive pure profits is, pace Arrow and Debreu, impossible. As was consistently and correctly argued for decades by Lionel McKenzie, a competitive equilibrium is only possible in the pinpoint special case with constant returns to scale in all productive opportunities and zero pure profits. This realization also undercuts crucial assumptions in microeconomic modelling, e.g., the assumption that it is somehow “given” that a resource-owner is a resourcesupplier rather than a demander for a complementary set of inputs needed to undertake production. This indeterminacy is traced back to the assumption that all that is needed to undertake production (e.g., the human actions of the people carrying out the productive activity) is available as commodities in the marketplace. If everything is marketable, then firmhood is indeterminate and can only be ignored (in price theory) in the rather special case of universal constant returns to scale.

4.1

Introduction

It is now rather commonplace, if not somewhat passé, to criticize the Arrow-Debreu (AD) model (Arrow and Debreu 1954) on empirical grounds. At every turn, the AD model makes some unrealistic, if not fantastic, assumptions in order to round out the logical structure of the model. The common view is that the AD model represents an idealized model of a market economy but that the real-world economy is unfortunately different. But we will not join in this empirical criticism of the AD model. Our point is that the AD model contains a fundamental structural error even as an © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_4

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idealized model of a “frictionless” market economy. The model simply gets the basic logic of a private property market economy wrong—when all inputs are marketable.

4.2

The Modeling Error in the Arrow-Debreu Model

Not surprisingly, the error is in the modeling of property rights—in the notion of the “ownership of the firm.” As discussed in the previous chapters, one needs to separate the corporation (which does have owners) from the legal party making the necessary market contracts to undertake a production opportunity as a going concern. One way to make the distinction is to call the contractually determined party undertaking production as the “firm” as opposed to the “corporation.”1 In the terms of that distinction, the identity of the “firm” is determined by the contractual fact-pattern in the marketplace, by who hires what or whom. Hence with that usage there is no “ownership of the firm” since no legal party “owns” the contractual behavior of potential contractual counterparties such as suppliers and customers. The modeling error is to confound the real ownership of a corporation with the non-ownership of the contractual fact-pattern of being the firm as a going concern. This modeling error appears in the AD model because they allow constant or decreasing returns to scale. With decreasing returns to scale, positive pure profits (the market value of the appropriated production vectors or whole products) would supposedly appear in equilibrium and these profits must be assigned to economic agents. Arrow and Debreu employ the notion of the “ownership of the firm” to close that logical gap and to assign the profits to the “shareholders.” If they had assumed constant returns to scale throughout, then equilibrium profits would be zero, as in model of Lionel McKenzie (1954), so the assignment of profits to individuals can be finessed (rather than erroneously addressed by confusing “corporations” with “firms”). The two models differ in their implications for income distribution. The Arrow-Debreu model creates a category of pure profits which are distributed to the owners of the firm; it is not assumed that the owners are necessarily the entrepreneurs or managers. ... In the McKenzie model, on the other hand, the firm makes no pure profits (since it operates at constant returns); the equivalent of profits appears in the form of payments for the use of entrepreneurial resources, but there is no residual category of owners who receive profits without rendering either capital or entrepreneurial services. (Arrow 1971, p. 70)

The modeling error in the AD model is easy to state but apparently difficult to understand. In a private property market economy, there is no such property right as the ownership of a production set (set of technically feasible production opportunities) or a production function. For instance, in the production function Q ¼ F(K, L ), there is the ownership of the capital services K, of the labor services L, and of the 1 Robé (2011) and (Ellerman 1975) both make the same distinction and argue that there is no “ownership of the (contractually-determined) firm.”

4.3 Separating Corporations from Firms Utilizing Production Sets

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outputs Q, but there is no ownership of the production function F. There is, however, an ownership form in a (modern) market economy, namely the ownership of a corporation, which Arrow and Debreu confuse with the ownership of a production set or function.

4.3

Separating Corporations from Firms Utilizing Production Sets

It is easy to logically separate ownership of a corporation from “ownership of a production function.” Suppose we consider a production process using a specific set of capital goods that provide the capital services K. When the labor L is applied along with K, the outputs Q ¼ F(K, L ) can be produced. We assume, for the sake of argument, that the capital goods are owned by a certain ABC Inc. which is owned by given shareholders. Since we are considering a production process using specific capital goods owned by a specific ABC Corporation, we are giving the AD model every benefit of the doubt to show that the corporation has “ownership of the production function.” Does ABC Inc. “own” the production possibilities described in the production function F in the sense that it must own the output of the production process of the labor services using ABC’s capital goods to produce Q ? No—ABC does not necessarily own Q. The argument is painfully simple, and it is captured in the old saw that “capital can hire labor or labor can hire capital.” In other words, the ownership of the stock of capital goods used in production does not automatically yield ownership of the product produced using those capital goods if the stock of capital goods was rented, hired, or leased out to some other party (of course, at the parametrically given competitive rental rate). If the capital goods were rented to another party, then the capital services K would be sold to that other party, say to a corporation XYZ Inc. (owned by some other party). Then XYZ would have to purchase (or already own) the other complementary inputs to production (such as the labor services L ) in order to lay a clear property claim on the outputs Q. In that case, XYZ would appropriate the ownership of the outputs Q after paying for the inputs K and L, and thus XYZ would receive the net profit from the production function Q ¼ F(K, L ). Yet the ownership of the ABC corporation did not change; it is still in the hands of the same shareholders. Thus, the ownership of the corporation is not the ownership of the production function. If the identification fails in the case of a production process using specified corporate-owned capital goods, then it fails, a fortiori, with a more abstractly specified production function. If by “ownership of a production function” one simply means blueprints and other technical knowledge, then such intellectual property is routinely bought and sold as an input in a production opportunity. The initial ownership of the produced Q is assigned in a different way. Nothing comes out of nothing. In order to produce Q, inputs K and L (including other inputs

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in a more complex case) had to be consumed in production. Whatever legal party has the ownership of the used-up inputs (that led to the production of Q) had the clear and incontestable legal claim on Q. That is the legal mechanism of appropriation discussed previously. But the ownership of the K and L used up in production is determined by the pattern of input contracts, not by the ownership of a corporation. It is determined by whether capital hires labor, labor hires capital, or some third-party (e.g., Frank Knight’s entrepreneur) hires both, i.e., by who hires what or whom. If we use the word “firm” to designate that legal party who is the residual claimant in the sense of getting the ownership of Q by being the last legal owner of the used-up inputs K and L in a going-concern, then there is no such thing as the “ownership of the firm.” Firmhood (residual claimancy) is determined by the direction of the input market contracts, not by the ownership of the corporation which might supply one of the inputs (implicitly or explicitly) to the firm. As a corollary, the whole notion, one version of the fundamental myth, is false that the ownership of the product and management rights over production are part and parcel of the ownership of the capital goods or “means of production” involved in the production opportunity. When capital goods are rented out, then the owner of the capital still owns the capital but is not the owner of the produced outputs Q nor the holder of the management rights. Buildings, office space, and machines are routinely rented out. The historical example to make the point is the Chrysler Corporation leasing out the Detroit Conner Avenue plant (which they purchased from Briggs Manufacturing) to the StudebakerPackard Corporation. No amount of assigning shares in the two corporations to individuals (which the AD model does) determines who undertakes the production process in the Conner Avenue plant since that is determined by the pattern of market contracts with is hardly given in the initial assumptions of resource ownership. In spite of the logical argument and factual examples, most economists and legal theorists seem unwilling to draw out the implications of capital being as rentable as people. “How can Chrysler Corporation not hold the management rights or rights to the products of its own factory?” Of course, conventional economists can understand that capital can be rented out, but they find no convenience in drawing out the consequences. They prefer to lazily assume the fundamental myth which serves as the pons asinorum of property theory (Ellerman 1992). For them, it is a bridge too far. Marx popularized the capital-based phraseology of “capitalist” and “capitalism.” To understand Marx’s concept of the “rights of capital” embodied in the “ownership of the means of production” that crystallized in the Marxist version of the fundamental myth, one must go back to the medieval notion of dominion based on the ownership of land. What today we might call the “landlord” was then the Lord of the land exercising both political/juridical control over the people living on the land and the rights to the fruits of their labor. As the legal historian, Frederic Maitland (18501906), put it: “ownership blends with lordship, rulership, sovereignty in the vague medieval dominium. . . .” (Maitland 1960, p. 174). Or as the German legal scholar,

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Fig. 4.1 Circular Flow Diagram: Indeterminacy of Who Hires What or Whom

Otto von Gierke (1841–1921), put it simply: “Rulership and Ownership were blent.” (von Gierke 1958, p. 88).2 It is this medieval notion of dominion associated with the ownership of land or ‘landism’ that Marx carried over to the ownership of capital is his conception of ‘capitalism.’ 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 1990, Book I, Chap. 13, pp. 450–451)

But this is a colossal blunder if it is meant as a description of property rights—as opposed to bargaining power. Of course, “capital” has the bargaining power particularly in the usual description of a “competitive market” where “collusion in constraint of trade” is forbidden on the part of labor-suppliers and labor-demanders. The typical “labor-demander” is a corporation wherein hundreds, thousands, or millions of capital-owners (i.e., the shareholders) are allowed to bargain as one legal party. Then in the “majestic equality” of neoclassical theory, the laborsuppliers (individual workers) and labor-demanders (individual corporations) are alike forbidden to collude together in labor unions or in corporate cartels to gain non-competitive bargaining power. The imagery of neoclassical theory gets worse—even prior to considering the property fallacy of the fundamental myth. The conventional circular flow picture assumes that firmhood is determined prior to market activity. The resource owners are lined up on one side and the “firms” are supposedly lined up on the other side of the input markets. But this is not the case in a free enterprise market economy as indicated in Fig. 4.1. It is not legally predetermined that an input owner is a supplier of inputs rather than a demander of a complementary set of inputs needed to undertake production. In particular, it is not legally predetermined that a capital owner (corporate or not) is a labor demander rather than a capital supplier. Prior to the market contracts,

2 As Tom Malleson observes, “The idea that legitimate decision-making power over other people can stem from property ownership is a feudal anachronism that we need to outgrow.” (Malleson 2014, p. 45) For this and further analysis of the “rights of capital” in the context of corporations, see Ellerman (2020) or the chapter on corporations herein.

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corporations are just input owners. Any resource owner, corporate or otherwise, may aspire to be a “firm” in the technical sense of a going-concern by attempting to purchase the complete set of inputs to a productive opportunity. It is a free market economy! Prior to market contracts, legal parties are not associated with production sets, so input demand and output supply schedules are not even well-defined. In other words, the determination of who is to be the “firm” is not exogenous to the marketplace; it is a market-endogenous determination. This adds a new degree of freedom (who is to be the firm as a going-concern?) to the model which can only be ignored in the pinpoint special case of constant returns and zero economic profits when it doesn’t matter (at least for price theory) who is the firm. This new degree of freedom wreaks havoc with the standard microeconomics textbooks. The indeterminacy in the standard supply-and-demand models (outside of the constant returns case) does not extend to the usual pure exchange economy of consumption goods (e.g., Newman 1965) because it is assumed that the last-buyer of commodities is the actual consumer. But we could imagine that the concept of “employing” another human being could be extended from production to consumption. Instead of the employer paying the employee to carry out a productive activity, the employer would be paid by the (consumptive) employee to employ them to consume some commodities.3 Then even the activity of consuming commodities would become marketable so that would introduce the same indeterminacy as in the case of productive employment. The owner of some consumer goods would then be indeterminate between selling the goods on the market (as in the usual pure exchange models) or selling the “consumptive experience” of employing a consumptive-employee to consume the goods. In the latter case, the employer is the legal ‘consumer’ of the consumed goods (by the usual market mechanism of appropriation) just as in the productive case, the employer is legally the so-called ‘producer’ of the produced goods. Except in the special case where the two activities have the same net return, the given endowment of consumer goods (and budgets) would leave the market indeterminate. The indeterminacy is due—as in the case of productive employment—to ‘everything’ being on the market, even the (de facto inalienable) human activities of production and consumption. From the normative point of view, the exact same critique applies to consumptive employment as to productive employment. By the juridical principle of imputation, the consumer should be liable for what they use up and own their by-products they produce (be the by-products of positive or negative value). And that de facto responsible human agency exercised in consumption is just as inalienable as that exercised in production. Returning to the usual renting of people to engage in productive activities, the fundamental myth implies that the very designation of the human rental system as

3

The closest to a real-world model of a consumptive employment relation is probably a cruise ship where the passengers pay the cruise company to ‘employ’ them to consume the “cruise” as well as the food, drinks, and facilities of the cruise ship.

4.4 Production as Arbitrage Between Input and Output Markets

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“capitalism” is a misnomer. This is even recognized by one of the more profound defenders of “the system,” Frank Knight, who also traced the misconception back to Marx. Karl Marx, who in so many respects is more classical than the classicals themselves, had abundant historical justification for calling, i.e., miscalling—the modern economic order “capitalism.” Ricardo and his followers certainly thought of the system as centering around the employment and control of labor by the capitalist. In theory, this is of course diametrically wrong. The entrepreneur employs and directs both labor and capital (the latter including land), and laborer and capitalist play the same passive role, over against the active one of the entrepreneur. . . .The superficial observer is typically confused by the ambiguity of the concept of ownership. The owner of an enterprise may not own any of the property employed in it; and further reflection will show that the same item of property may in different senses be owned entirely, or in widely overlapping degrees, by a considerable number of proprietors. (Knight 1956, p. 68, fn. 40)

Because of the precision of the mathematics, the property theoretic error can be pin-pointed in the Arrow-Debreu model. Shareholders do indeed own corporations, but corporations do not own production sets. There is no problem in assuming that the ith consumer owns “a contractual claim to the share aij of the profit of the jth production unit (Arrow and Debreu 1954, p. 270) where “production unit” is a corporation. The problem is in the assumption that for “each production unit j, there is a set Yj of possible production plans” (Ibid., p. 267) where no other party, aside from the jth corporation, can utilize those production possibilities. In a private enterprise market economy, there is no such property right as the “ownership” of production sets of feasible production vectors (whole product vectors). In the Arrow-Debreu model each consumer/resource-owner is endowed prior to any market exchanges with a certain set of resources and with shares in corporations. But, prior to any market activity, ownership of corporate shares (e.g., the shares in Chrysler Inc.) is only an indirect form of ownership of resources, the corporate resources (e.g., the Conner Ave. factory purchased from Briggs Manufacturing Inc.). It is the subsequent contracts in input markets (e.g., leasing the Conner Ave. plant to Studebaker-Packard Inc.) which will determine whether a corporation, like any other resource-owner, successfully exploits a production opportunity by purchasing the requisite complementary inputs and appropriating the produced outputs—or whether those resources are sold or rented to another party. That is the logic of free markets, and that is the logic that the AD model gets wrong.

4.4

Production as Arbitrage Between Input and Output Markets

We might call the question of “who hires what or whom” the “hiring conflict” since in the context of prices that yielded positive pure profits, it is a game theoretically indeterminate conflict over who will receive those positive profits. Any proposed set of contracts that yielded one party positive profits could be upset by anyone else

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offering the input suppliers slightly more so that a slightly smaller level of positive profits would remain. This can be modeled by the dollar-division game where a dollar is given to three people and they can divide it in any way so long as a majority agree to the division. But no division can be a solution (technically, the ‘core’ is empty) since any one party can propose another division to benefit that person and one other person. In the idealized frictionless world of Arrow and Debreu, such a transaction is perfectly possible, and, indeed, production is a form of arbitrage between input markets and output markets (buy low on input markets and sell high on output markets). Since the proposed set of contracts yielding positive profits could be upset by another party willing to accept a slightly lower level of pure profits, there can be no competitive equilibrium with positive pure profits. Thus, we have reached what, pace Arrow and Debreu, should be an unsurprising result—there can be no competitive equilibrium in the presence of profitable arbitrage possibilities. How do Arrow and Debreu manage to prove otherwise? The math is fine. They simply don’t allow anyone else to demand the other inputs except the corporation that is “identified” with the production set. But as the trivial possibility of hiring out corporate capital assets reveals (e.g., in the Chrysler example), there is no “identification” between corporations and production sets (or production functions). Firmhood is determined within the marketplace by the pattern of who hires what or whom, and is not determined by the given initial distribution of corporate ownership. The basic property theoretic modeling error in the AD model is the assumption that corporations “own” production sets and that leads to the mismodeling of how idealized competitive markets operate. This result restores the symmetry between the different returns to scale. There can be no competitive equilibrium with increasing returns to scale because no one wants to be the firm (due to negative profits), and, symmetrically, there can be no competitive equilibrium with decreasing returns to scale because everyone wants to be the firm (due to positive profits). As Lionel McKenzie had consistently and correctly argued from the beginning and reiterated in his Presidential Address to the Econometric Society (McKenzie 1981), there can only be a competitive equilibrium under constant returns to scale (where profits are zero and firmhood is indeterminate).

4.5 4.5.1

Endgames to Defend the AD Model Defining Away the Problem with Owner-Specified Outputs

There are a number of “endgames” that are used to try to defend the fundamental myth that corporations “own” production opportunities (rather than just owning some of the inputs to the opportunities). One strategy is simply to verbally define

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the output as being that owned by the corporation, so this blocks some other party from owning that output by simply rearranging the input contracts. In our example, we showed that ABC Corporation owned Q because it owned the used-up inputs, the capital services K and the labor services L, and if any other party by a rearrangement of the input contracts owned K and L then that party would own Q without having to buy ABC Corporation. But a common reply to this argument by lay and professional economists is that the ownership of “ABC’s output Q ” is part of the ownership of ABC Corporation, so some other party would have to buy ABC to get the ownership of ABC’s Q. But this formulation already assumes that Q is defined as “ABC’s output” and thus it begs the real questions as to how Q got to be ABC’s output as opposed to some other party’s output—a question which is answered by looking at which party owned the input services used up in the production of Q, i.e., by considering who rents what or whom in the marketplace. The auto bodies coming off the assembly line in the Conner Avenue factory owned by Chrysler were not “Chrysler’s output Q” since the factory was leased to Studebaker-Packard. Similarly, one could beg the price-theoretic question of how price is determined by incorporating price in the specification of a commodity. One does need any price theory to determine the price of a “$2 chunk of cheddar cheese.” But one does need some theory of price to determine how this chunk of cheddar cheese (specified otherwise than by price) has a $2 price. In a similar manner, one doesn’t need any property theory to determine who owns the “Briggs auto bodies” that roll out one end of a production building owned and operated by Briggs, but one does need to reconsider the owner of the auto bodies (sans Briggs specification) that roll out of the same production building when owned by Chrysler—and leased to and operated by Studebaker-Packard.

4.5.2

Hidden-Factor Ploys

Another common ploy (more favored by academic than lay economists) to salvage “ownership of production functions” is to build some privately-owned factors into the “shape” of the production function or set. Since these factors are not shown in the notation of the production function or set, one cannot represent in such a model the possibility of some other party renting that factor. Hence one can supposedly say the owner of the hidden factor “owns” the production function. This seems to introduce the methodological innovation of “proof by bad notation.” But this is not a joke. It was the ploy used explicitly by Arrow and Hahn (1971) in their treatment of the AD model. McKenzie (1981, 2002), Koopmans (1957, p. 65), and others have interpreted the Arrow-Debreu model as assigning production sets to specific parties by postulating “hidden factors” owned by the parties. But this compromises the model in a number of ways (see Ellerman 1982, Chapter 13; or McKenzie 1981). Firstly, there are no non-market-able privately owned input services, and Arrow and Debreu have identified none. Some hidden factors which might be used to supposedly justify

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decreasing returns are not privately owned, e.g., publicly-owned (congested) roads or unowned natural factors (the atmosphere). The existence of unowned or publiclyowned factors does not account for the assignment of production sets to specific parties. Arbitragers also have access to those public factors so they could defeat any proposed equilibrium with positive pure profits. Arrow and Hahn try to replace “not market-able” with “not market-ed.” But it is incoherent to simply assume that “not all inputs are, in fact, marketed” (Arrow and Hahn 1971, p. 61) when the production sets are first being specified. For any vector y, let yM and yP be the vectors formed by considering only the marketed and private components, respectively. For the firm, assume that the private components are given:. . . From the viewpoint of the study of markets, only the vector yM is relevant. (Arrow and Hahn 1971, p. 61)

Arrow and Hahn then restrict the production vectors to their “marketed” components and leave the “private” components implicit in the shape of the production sets (all prior to the determination of any equilibrium prices!). But whether an input is marketed or held for private uses will depend on the equilibrium configuration of prices—which are hardly known or assumed when production sets are first being specified. The Arrow-Hahn tactic is not only methodologically incoherent; it could be inconsistent with the other assumptions. As Edwin Burmeister has pointed out: [A) formulation which assumes that certain markets do not exist is incomplete and, more importantly, it may be inconsistent with profit maximization. (Burmeister 1974, pp. 414–415)

The modeling error is easy for neoclassical Economists to see if it is made by some supposed opponents to neoclassical Economics. Suppose an economic reform was in the past instituted in the Soviet Union where some inputs were traded on free markets with factory managers instructed to maximize profits, but certain other inputs (e.g., capital goods and other “means of production”) were designated as “not marketed” and were not exposed to market forces (see previous Arrow and Hahn quote). Neoclassical economists would be very quick to point out that if some factors were hidden from exposure to scarcity-reflecting market prices, then there could no assurance that the factors would be efficiently allocated. Any “efficiency theorem” the Soviet economists might derive would be bogus due to the existence of the non-marketed hidden factors that are not exposed to market signals. Unfortunately, neoclassical Economists suddenly display professional timidity or a learned ignorance of this critical but rather elementary insight when Arrow and Hahn use the same tactic (p. 61) and then claim to prove their equally bogus “efficiency theorem” for their model (p. 110). In reviewing a book about Nicholas Kaldor, Frank Hahn (of Arrow and Hahn 1971) seems to have had second thoughts. [Kaldor insisted] that perfectly competitive general equilibrium only made sense under constant returns. To economists brought up on Arrow-Debreu this seems plainly wrong. Constant returns are not assumed. (Hahn 1988, p. 1746)

References

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Citing modern work by McKenzie and others that does not assume the identity of firms to be given prior to market activity, Hahn concludes that Kaldor was “substantially right” (Hahn p. 1746). So, McKenzie was also right all along that when all factors are exposed to market forces and are rentable or publicly available, then there can be no equilibrium except under constant returns to scale and zero profits. In McKenzie’s book on general equilibrium theory (2002), he presents both his model and the Arrow-Debreu model. For his model, he presents production possibilities as convex cones of activities (i.e., constant return to scale) where “In the economy of activities the individual firms are suppressed.” (McKenzie 2002, p. 197). When presenting the AD model, McKenzie interprets it as using the hidden non-marketed factor ploy that was quite explicit in the Arrow-Hahn book (1971). In the present discussion we will take the diametrically opposed view that the firms are fundamental to production and each firm owns a technology or a possible production set Yf that is given. The firm trades in the goods that are used in production or that issue from production but not in the things that determine the possible production set which it owns. The set of firms, f ¼ 1, . . ., F, is also given. This approach to the competitive economy was taken by Arrow and Debreu in their classic article (1954). (McKenzie 2002, p. 197)

In spite of McKenzie’s earlier remarks on the AD model (1981) and his private remarks to the author, “Actually I have directly challenged the Arrow-Debreu paradigm in my papers subsequent to the 1954 piece” (McKenzie 1984), he only focused on the mathematics in his book (2002). He left unmentioned the point that there is no ownership of production sets in a private property market economy where all factors (hidden or not) are marketable or publicly available. That would require a little legal or jurisprudential reasoning about what is owned and what is not owned. For instance, there is no “ownership” of the “production set” that economists might associate with the former-Briggs Conner Ave. factory owned by Chrysler and leased to Studebaker-Packard. There is the ownership of the factory, but the exploitation of the production possibilities associated with the factory was determined endogenously in the marketplace. But since Arrow and Debreu used their jerry-rigged model to supposedly prove the existence of competitive equilibrium in the general case of non-increasing returns to scale and positive pure profits, they were “sainted” with Nobel Prizes in Economics—while McKenzie (who correctly restricted his model to constant returns) was passed over for the Nobel Prize.4

References Arrow, K. J. (1971). The Firm in General Equilibrium Theory. In R. Marris & A. Woods (Eds.), The Corporate Economy. Cambridge: Harvard University Press.

4 For an in-depth analysis of the interrelationships between Arrow, Debreu, and McKenzie (without pointing out the conceptual error in Arrow and Debreu), see Düppe and Weintraub (2014).

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Arrow, K. J., & Debreu, G. (1954). Existence of an Equilibrium for a Competitive Economy. Econometrica, 22, 265–290. Arrow, K. J., & Hahn, F. H. (1971). General Competitive Analysis. San Francisco: Holden-Day. Burmeister, E. (1974). Neo-Austrian and alternative approaches to capital theory. Journal of Economic Literature, XII, 413–456. Düppe, T., & Weintraub, E. R. (2014). Finding Equilibrium: Arrow, Debreu, McKenzie and the Problem of Scientific Credit. Princeton NJ: Princeton University Press. Ellerman, D. (1975). The “Ownership of the Firm” is a Myth. Administration and Society, 7 (1 May), 27–42. Ellerman, D. (1982). Economics, Accounting, and Property Theory. Lexington MA: D.C. Heath. Ellerman, D. (1992). Property & Contract in Economics: The Case for Economic Democracy. Cambridge MA: Blackwell. Ellerman, D. (2020). Fallacies of Corporate Analysis. Challenge, 1–23. https://doi.org/10.1080/ 05775132.2020.1723289 Gierke, O. von. (1958). Political Theories of the Middle Age. (F. W. Maitland, Trans.). Boston: Beacon Press. Hahn, F. (1988). Review of Nicholas Kaldor, By Anthony Thirlwall. Journal of Economic Literature, XXVI(Dec.), 1746–1747. Knight, F. H. (1956). On the History and Method of Economics. Chicago: Phoenix Books. Koopmans, T. C. (1957). Three Essays on The State of Economic Science. New York: McGrawHill. Maitland, Frederic W. (1960). Frederic William Maitland: Historian. (R. L. Schuyler, Ed.). Berkeley: University of California Press. Malleson, T. (2014). After Occupy: Economic Democracy for the 21st Century. New York: Oxford. Marx, K. (1990). Capital (Vol. I). (B. Fowkes, Trans.). London: Penguin Classics. McKenzie, L. (1954). On Equilibrium in Graham’s Model of World Trade and Other Competitive Systems. Econometrica, 22(April 1954), 147–161. McKenzie, L. (1981). The Classical Theorem on Existence of Competitive Equilibrium. Econometrica, 49(July 1981), 819–841. McKenzie, L. (1984, July 26). Letter from Lionel McKenzie to David Ellerman. McKenzie, L. (2002). Classical General Equilibrium Theory. Cambridge MA: MIT Press. Newman, P. (1965). The Theory of Exchange. Englewood Cliffs NJ: Prentice-Hall. Robé, J.-P. (2011). The Legal Structure of the Firm. Accounting, Economics, and Law, 1(1), Article 5. https://doi.org/10.2202/2152-2820.1001

Chapter 5

Marginal Productivity Theory

Abstract Neoclassical economic theory pays indirect homage to the imputation principle of jurisprudence by giving a metaphorical interpretation of the factor payments according to marginal productivity (MP) in competitive equilibrium so that “each factor gets what it produces.” This chapter does not make the usual criticism for MP theory being unrealistic, hard to measure, involving idealized informational assumptions, and the like. Again, the real problems lie largely at the level of jurisprudence. Instead of the employer, employees, and input suppliers being in some sort of metaphorical partnership, each getting a share of the product, the actual property rights are that the employer legally appropriates 100% of the assets and liabilities created in production (so the employees qua employees get 0% of that production vector like the other mere suppliers of inputs). The metaphorical MP theory also treats all causally efficacious (or ‘productive’) factors as if they were responsible agents like persons, but the actual juridical principle only imputes legal responsibility to persons as was repeatedly pointed out by the legally-trained Austrian Friedrich von Wieser in the late nineteenth century. And the usual scalar notion of marginal productivity suggests an immaculate or ‘virgin-birth’ notion of production where each unit of a factor produces its marginal product without the use of other factors.

5.1

What Is the Frame of Discussion?

In neoclassical microeconomics, the competitive model is what Kant called a “regulative ideal.” It is the ideal state always to be approximated better and better. Neoclassical normative discussion is typically framed in terms of the competitive ideal. The key importance of marginal productivity (MP) theory lies in the understanding that the competitive private property market system would allocate to “each according to what he and the instruments he owns produces” (Friedman 1962, pp. 161–162). Hence the labor question is usually framed in the competitive model: is a worker being paid “according to what he. . . produces”—or is labor being ‘robbed’ in some sense?

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_5

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The point of essentially all critiques is that the actual economy falls so far short of the competitive ideal (Piketty 2014; Stiglitz 2012; Galbraith 2012; Keen 2011; Rawls 1999; Thurow 1975; etc.). That sort of critique at least implicitly accepts the framing provided by the competitive ideal and laments how the real economy falls short. The critique outlined in this chapter reframes the labor question as being about property instead of pay. It shows the jurisprudential flaws even the competitive ideal of distribution to labor according to marginal productivity—as opposed to most criticism about how the actual economy falls short of the competitive paradigm. The theory used to critique MP theory (as an implied normative theory of distribution) is the usual juridical principle of imputation (impute legal responsibility according to de facto responsibility) applied to questions of property appropriation. This is the modern treatment of what historically was called the labor or natural rights theory of property—the basic idea that people have a natural right to own the positive fruits of their labor (and symmetrically a natural obligation to bear the negative fruits of their labor) (Hodgskin 1973 [1832]; Menger 1899; Schlatter 1951; the “labor theory of right” in 1 Brockway 1995; Ellerman 1992, 2021, or Chap. 1 on property theory herein). By trying to show that the competitive ideal satisfies the principle of giving to each what it produces, neoclassical Economics pays silent homage to the natural rights theory of property. Unfortunately for neoclassical theory, the imputation is only metaphorical in MP theory; one could as well analyze a slave plantation according to whether or not it falls short of allocating the real income (in terms of food, clothing, and shelter) to the slaves according to their marginal productivity— which some economists do (Fogel and Engerman 1974) while other economists squabble about the empirical facts of the matter (David et al. 1976). The real question is about rights, not real income. The same critique also reframes the labor question about the employment contract. The point has nothing to do with the size of wages, benefits, or working conditions. The point is that the whole idea of renting human beings, i.e., selling responsible human actions, is invalid due to the factual inalienability of responsible human agency.

5.2

Heterodox Criticism of MP Theory

Much, if not all, of heterodox ‘criticism’ of MP theory stays at least implicitly within the framing of the competitive paradigm as the ideal by pointing out all the ways in which the actual economy falls short of the competitive model:

1

Although George Brockway was a small-e economist in intellectual terms, he did not make his living as a professional Economist so he could be an apostate in the Church of Human Rentals with his labor theory of right.

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• markets in general and labor markets in particular are far from competitive; • information imperfections abound which undercut the informational assumptions behind the competitive model; • there are great difficulties in actually measuring “marginal productivity” at the firm level; • most economic decision-making is not governed by the rational maximization of the neoclassical theory; and • all of this adds up to an economy suffused with non-competitive rents and rentseeking behavior. And even the competitive market paradigm does not address all the prior non-market violence, theft, and conquest behind the historical initial distribution of property. But, it will be asked, “What about Marx’s labor theory of value and exploitation?” It didn’t just attack the competitive shortcomings of the actual economy. Firstly, it should be noted that MP theory provides a neoclassical theory of exploitation which also purports to show, under certain non-competitive conditions, that workers would be underpaid according to their marginal product. Marx’s theory was developed long before MP theory, but it also purported to show, under certain conditions, that labor would be “paid below its value.” It will be seen later that the labour expended during the so-called normal day is paid below its value, so that the overtime is simply a capitalist trick to extort more surplus labour. In any case, this would remain true of overtime even if the labour-power expended during the normal working day were paid for at its full value. (Marx 1990. Book I, Chap. X, Sec. 3, p. 357 fn. 40)

But, outside the dwindling band of the faithful, Marx’s labor theory of value and exploitation has long been discredited (and rightly so)—in addition to being superficial since it was not even a critique of the institution of wage labor per se, but only a critique of labor being “paid below its value”.2 There always seems to be some need to further beat the dead horse of Marx’s labor theory of value and exploitation (see Ellerman 1983, 1992, the Chap. 6 on Marx herein).3 As Albert Hirschman wisely observed, Marx’s “works exhibit a simple juxtaposition of scientific apparatus and moralistic invective, wholly unversöhnt [i.e., unresolved]” (Quoted in: Adelman 2013, p. 570). In fact, it has gotten so bad that Marxism has become a “capitalist tool” in the sense that the main ‘supporters’ these days (in the sense of keeping the Marxist theory ‘in play’) of Marx’s labor theory are the neoclassical Economists who

2

The point is about Marx’s theory that wages are too damn low, not his personal views. Of course, he was personally against the institution of wage labor, at least in its private form. The point is that he only brought a value theory to a property-theoretic fight, so it would have still been ineffectual even if it was a good value theory. 3 It seems that many on the Left only support the Marxist analysis of exploitation for reasons of identity and posture; it serves as their “badge of Red courage” to establish their credibility as being against “The System.” For academic Marxists, this is compounded by their ‘telephone-sex theory of radicalism’; talking the deal is the deal.

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want to pretend that Marxist economics is the only real alternative to neoclassical theory—in the same sense that “Soviet Communism” was long promoted as the only real alternative to the present human rental system. Then they can knock down the Marxist strawman and declare “There Is No Alternative” to neoclassical Economics.

5.3

Isn’t the Distribution of Wealth and Income the ‘Real’ Problem?

In progressive circles (e.g., Stiglitz 2012; Galbraith 2012; Piketty 2014), “the problem” has been framed in terms of the obscene mal-distribution of wealth and income which are only the symptoms of the human rental system. And the proposed redistributive reforms (e.g., changes in income, wealth, and estate taxes, increased minimum wages, income caps, and universal basic incomes) have all stuck to that framing of the question. One could apply the same framing to the previous system of owned workers. There was a similar, if not more extreme, mal-distribution of wealth, income, and political power in the institution of slavery where workers were involuntarily owned rather than voluntarily rented. Yet, it should be obvious to modern eyes that redistributions (perhaps a universal basic income) in favor of the slaves (surely a good thing), while leaving the institution of owning workers intact, would not address the root of the problem. The system of slavery was eventually abolished in favor of the system we have today which differs in two important respects: (1) the workers are only rented,4 hired, leased, or employed (i.e., the employer/master only buys some, but not all, of employee’s labor); and (2) the rental relationship between employer and employee is voluntary. Today, the root of the problem is the whole institution for the voluntary renting of human beings, the employment system itself, not the terms or completeness of the contract or the accumulated consequences in the form of the mal-distribution of income and wealth.

4 The word “rented” is used deliberately even though American English prefers to say that cars are rented but people are hired. In the UK, rental cars are called “hire cars.” Indeed, the system of borrowing money or renting things is called the “loan and hire” system in English law (Baty 1918) as in the phrase “hire-purchase” applied to things. In any case, the underlying economic relationship (buying the services of a productive factor instead of the ownership of the factor) is the same no matter what it is called. Moreover, this is not a matter of controversy. “The commodity that is traded in the labor market is labor services, or hours of labor. The corresponding price is the wage per hour. We can think of the wage per hour as the price at which the firm rents the services of a worker, or the rental rate for labor. We do not have asset prices in the labor market because workers cannot be bought or sold in modern societies; they can only be rented. (In a society with slavery, the asset price would be the price of a slave.)” (Fischer et al. 1988, p. 323; or nearly identical passage in: Begg et al. 1997, p. 201).

5.3 Isn’t the Distribution of Wealth and Income the ‘Real’ Problem?

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What is the orthodox defense of the institution of voluntarily renting human beings? It has several layers. The first layer of defense is that the employment contract is voluntary, and that is correct; it is voluntary by any normal juridical standards.5 That defense is supposed to remove the employment relation out of the category of possibly being per se invalid—so any remaining questions can only be about the terms and conditions of the contract. Here again, it may be helpful to repose the question about the prior system of owning all of a worker’s labor. What if that system was based on a voluntary contract? Conventional intellectual history has long displayed a studied ignorance of the fact that the sophisticated arguments for that peculiar institution were indeed based on seeing the incidence of contract from Roman Law down to Antebellum America.6 The real argument for the abolition of the voluntary purchase of all a worker’s labor was the theory of inalienable rights that descends from the Reformation (i.e., inalienability of conscience) and Enlightenment (principally, Baruch Spinoza and Francis Hutcheson) down to the present in the Abolitionist and Democratic Movements (Ellerman 1992, 2015, 2021, or the chapter herein on inalienable rights). The “problem” in the historical remembrance of that inalienable rights critique of the

5

At a more fundamental level than the neoclassical framing of the competitive paradigm is the older classical liberal framing in terms of consent-versus-coercion. There has long been a fashionable posture on the Left to simply escalate one’s conception of involuntariness so that the labor contract, if not most contracts, would be ‘involuntary’ and ‘coercive.’ But by any real-world standards (leaving aside cultural posturing), a collectively-bargained employment contract is “more” voluntary than the usual contract of adhesion between an individual consumer and a supermarket. Moreover, that involuntariness-critique of the wage-labor contract shows the superficiality of much of the Left that is unable to get beyond the classical liberal “consent-versus-coercion” framing to figure out what could be inherently wrong with a voluntary contract—or, at least, to learn about the inalienable rights theory hammered out in the Abolitionist and Democratic Movements which answers that question (see the Chap. 9 on inalienability herein). 6 For instance, Rev. Samuel Seabury (1969 [1861]) gave a classical implicit-contract defense of slavery in 1861. Another standard defense was that slaves were prisoners of war who had the tough choice between death or being sold into slavery, and voluntarily chose slavery. For instance, John Locke seems to have justified slavery in the American colonies by interpreting the status of slaves as “captives” in wars inside Africa who took that plea bargain and who were then sold into the Atlantic slave trade (viz. Laslett notes on §24, 325–326 in: Locke 1960). But modern liberal scholars of pro-slavery thought can’t seem to find any of the contractarian defenses. Eric McKitrick (1963) collects essays of fifteen pro-slavery writers; Harvard University’s former President, Drew Gilpin Faust (1981), collects essays from seven pro-slavery writers; and Paul Finkelman (2003) collects seventeen excerpts from pro-slavery writings. But none of them include a single writer who argued to allow slavery on a contractual basis such as Seabury—not to mention Grotius, Pufendorf, Locke, Blackstone, Montesquieu, and a host of Scholastics such as Jean Gerson, Luis de Molina, and Francisco Suarez (on the Scholastics, see Tuck 1979). If a contractual relationship to buy all of a person’s labor was morally wrong in spite of being voluntary, then the current economic system based on the voluntary contract for the short-term renting of other people might be put in moral jeopardy. Hence ‘responsible’ intellectual historians of pro-slavery thought just cannot go there; the long history of contractual arguments for lifetime servitude is to them like a sealed chapter in intellectual history.

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voluntary contract to sell all of one’s labor at once (the factual inalienability of human agency) is that it clearly also applies to the current system of piecemeal selling of labor—so that critique must go down the memory hole of liberal intellectual history. But from the viewpoint of the Economics profession, the jurisprudential history of inalienable rights in the Abolitionist and Democratic Movements is all outside their bailiwick. They have developed a tight mathematically formulated theoretical structure, the competitive paradigm, and they are sticking to that story. In spite of all the heterodox critique of the empirical applicability of the competitive model, neoclassical economists are clear that it was never intended as an empirical model. Perhaps the most philosophically sophisticated of the orthodox defenders is Frank Knight who was quite clear on the point. The competitive model is not intended to be descriptive; it is postulated as the ideal or paradigm around which to frame and limit the normative discussion, e.g., are workers paid the value of their marginal product as in the competitive model or not? Even the most slavish neoclassical (or Austrian) defender of the faith is well aware that human rental markets are not perfectly competitive. Yet most progressive or heterodox critics of marginal productivity theory, e.g., Lester Thurow (1975), John Rawls (1999), and Steve Keen (Chapter 6, 2011) in addition to Stiglitz and Piketty, do not mount any criticism of the distributive ideal of marginal productivity in the functional distribution of income but only focus on applicability issues such as the non-competitiveness and informational “imperfections” of labor markets, measurement difficulties, rents based on market power, and the background mal-distribution of wealth—all of which were long ago acknowledged by sophisticated defenders of the system of human rentals such as Knight. The most important conventional philosopher of justice, John Rawls, is a good example to illustrate the point. He spent his whole adult life philosophizing about justice while living in a society based on the renting of human beings. Yet he never even considered that the human rental contract might be inherently problematic. Far from criticizing marginal productivity theory from the viewpoint of “people getting the fruits of their labor,” Rawls identified the two theories! Accepting the marginal productivity theory of distribution, each factor of production receives an income according to how much it adds to output (assuming private property in the means of production). In this sense, a worker is paid the full value of the results of his labor, no more and no less. Offhand this strikes us as fair. It appeals to a traditional idea of the natural right of property in the fruits of our labor. Therefore to some writers the precept of contribution has seemed satisfactory as a principle of justice. (Rawls 1999, p. 271)

Then he went on to only quibble about the empirical background conditions. The marginal product of labor depends upon supply and demand. What an individual contributes by his work varies with the demand of firms for his skills, and this in turn varies with the demand for the products of firms. An individual’s contribution is also affected by how many offer similar talents. There is no presumption, then, that following the precept of contribution leads to a just outcome unless the underlying market forces, and the availability of opportunities which they reflect, are appropriately regulated. (Rawls 1999, p. 271 [emphasis added])

5.4 The Fork in the Road for the ‘Labor Theory’

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Fig. 5.1 The Fork in the Road: How to Develop the “Labor Theory”

Indeed, how can one criticize the ideal of paying rented human beings the value of their marginal product—of course, with “underlying market forces (being) appropriately regulated”? Isn’t that, as Rawls suggests, the very idea of a “natural right of property in the fruits of our labor” or reaping what you sow? As Knight argued, the competitive system satisfies: justice by the principle of equality in relations of reciprocity, giving each the product contributed to the total by its own performance (“what a man soweth that shall he also reap”). (Knight 1956, p. 292)

Otherwise, as John Bates Clark pointed out: A plan of living that should force men to leave in their employer’s hands anything that by right of creation is theirs, would be an institutional robbery—a legally established violation of the principle on which property is supposed to rest. (Clark 1899, pp. 8–9)

5.4

The Fork in the Road for the ‘Labor Theory’

It takes a theory to kill a theory, so to criticize the MP theory as a normative ideal applied to labor, it takes an alternative theory about labor—that is as unknown to most heterodox and progressive critics as to orthodox defenders of the faith. One must go outside the usual orbit of ‘economic’ concepts covered in neoclassical, Austrian, or even most heterodox economics, and, indeed, one has to go back to the first half of the nineteenth century and take the other fork in the road—as indicated in Fig. 5.1—that leads to the jurisprudential principle of imputing responsibility, which includes the property-theoretic treatment of appropriation. The upper fork represents that small band of economic radicals who between 1820 and 1840 put forth the claim of labor to the whole product of industry (Blaug 1958, p. 140)

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including Thomas Hodgskin in 1832 [1973], William Thompson in 1824 [1963], John Francis Bray in 1839 [1968] , Pierre-Joseph Proudhon in 1840 [1970], and the other so-called “Ricardian socialists” (although they were neither) or classical laborists. They tried to develop the inchoate in-the-air “labor theory” into a labor theory of property (Menger 1899) rather than a labor theory of value. In the history of economic ideas, these early attempts to develop a labor theory of property were largely overshadowed by Karl Marx’s monumental attempt to develop a labor theory of value—which stayed within the framing of value theory and whose eventual failure has made it the favorite foil of neoclassical Economics (see Chap. 6 herein). It might be noted that the critique of the labor theory of value has become such a part of the DNA of neoclassical Economics that Economists cannot even “hear” about the labor theory of property without automatically assuming one is talking about some labor theory of value. What you are probably trying to say is that “Only labor produces value, and thus all value should go to labor.” Yes, we have heard all that before, so let us tell you why that value theory is completely discredited.

The orthodox fathom-line seems too short to plumb the topic of property theory. Hence no orthodox text, to the author’s knowledge, even discusses the modern treatment of the labor theory of property—which has nothing to do with value or price theory. Instead, the thoroughly discredited labor theory of value is the designated foil in the ‘science’ of Economics.

5.5

The Question of Appropriation Again

Before delving into MP theory per se, we need to review the jurisprudential theory that MP theory tries to metaphorically finesse: the juridical principle of imputation or modern labor theory of property. To understand the modern labor theory of property, there is many ‘misconceptions’—“ideological dreck” may be a better phrase—that needs to be first cleared away. Firstly, property appropriation applies to the initiation and termination of property rights, not the exchange of property rights. One cannot see the answer to the question if one has not even formulated the question. The labor theory of property is also normative theory that applies to the creation and termination of property rights (i.e., appropriation) in normal production (and consumption) activities.7 There is also a descriptive theory of property as to how property rights are created and terminated in a private property market economy. The flows of property rights should always be described in an algebraically symmetric manner reflecting both assets and liabilities. In a common stylized picture of production (see Fig. 5.2), the input services, say K and L, are used up and the 7

Our focus is on commodities, rivalrous and excludable private goods that are produced and consumed as a part of deliberate human activity. The brunt of intellectual property rights to non-rivalrous knowledge is to force them into that commodity model.

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Fig. 5.2 Assets and liabilities created in production

outputs Q are produced. Note that K stands for the services (not the stock) of capital assets. The assets Q are created so one property-theoretic question is: “Who is to own those assets?” The services K and L (including intermediate goods) are used up so another property-theoretic question is: “Who is to owe those liabilities?” The two questions together are: “Who is to legally appropriate the assets and liabilities (Q, K, L ), the whole product, created in a productive opportunity?” It is a remarkable fact—which itself calls for explanation—that economic theory, orthodox or heterodox, does not even formulate the question about the initiation and termination of property rights in these normal activities of production. One reason for the neglect is that discussions of property tend to be restricted to a mythical state of nature (e.g., Locke 1960 [1690]) or to the appropriation of unclaimed or commonly owned natural goods (e.g., Umbeck 1981; Barzel 1989) rather than the everyday matters of production where property rights are constantly created and terminated. On the liability side, the Law & Economics literature looks extensively at the assignment of liabilities in the legal trials that may follow the accidental destruction of property (e.g., Calabresi 1970).8 But what is the mechanism for assigning the liabilities for the normal deliberate using-up of inputs in production (or consumption)?

5.6

The Pons Asinorum of Property Theory

The most basic reason why the question of appropriation in production apparently cannot be raised is the “fundamental myth” that is largely swallowed whole by both the Left and Right. The fundamental myth is the idea that the rights to the product (and the discretionary management rights over production) are part and parcel of 8 See Chap. 7 below for the logical fallacy involved in the Kaldor-Hicks principle at the foundation of wealth maximization law and economics.

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“the ownership of the means of production” (to use the Marxian phrase) or part of the ownership rights to some capital asset including a corporation as a capital asset. There is no need to raise the question of appropriation, i.e., who should own the assets and owe the liabilities created in production, since it is all supposedly part of the already-existing ownership of “capital” or “ownership of the firm.” The idea goes back to the medieval notion of “dominium” or ownership of land as including the governance rights over the people living on and working the land as well as to the fruits of their labor. One of Marx’s most basic blunders was to carry over this idea by substituting capital for land. Marx’s blunder has been a staple of socialist thought ever since. It is astonishing that a hundred years of socialist thought have not confronted the basic capitalist idea—that owners of capital have the right of command in the relations of production. The idea behind nationalization, wage earner funds, and the like is in fact fundamentally the same idea as that on which capitalism is based, namely, that ownership of capital should give owners the right to command in the production process (be they democratically elected politicians, state bureaucrats/planners, workers’ representatives, or union officials). Indeed, this is a nice example of what Antonio Gramsci called bourgeois ideological hegemony. (Rothstein 1992, p. 118)

This view is also standard today in neoclassical Economics, e.g., the rights of authority at the firm level are defined by the ownership of assets, tangible (machines or money) or intangible (goodwill or reputation). (Holmstrom and Tirole 1989, p. 123)

In addition to swallowing the fundamental myth whole (and ignoring the role of the employer-employee contract in determining the “rights of authority at the firm level,” the cavalier inclusion of “goodwill” in “the ownership of assets” by two winners of the Nobel Prize in Economics is all too typical of the superficial treatment of property rights in the neoclassical Economics literature.9 It is conceptually trivial to see that in the current market system, the product and governance rights are not part and parcel of the ownership of capital. Human beings are not the only rentable inputs in the current system; capital may also be rented. The party who hired in the capital and paid for all the other used-up inputs would have the legally defensible first claim on the produced output, not the owner of the capital asset. The fundamental myth often hides behind misconceptions about corporations: “Are you saying a corporation’s ownership of its product is a myth?” Of course, a corporation owns “its product” (by definition of “its product”) but what determines whether or not the product produced using, say, a corporation’s factory building is “its product”? For instance, must the Chrysler Corporation own the car-bodies that rolled off the assembly line in the factory owned by Chrysler? If Chrysler at one point leased its Conner Avenue plant to another automobile company such as Studebaker-Packard, it is easy to see that the answer is actually “No.” Those car-bodies would be owned by the other company who was making the lease 9 As pointed out in Chap. 3, even accountants (Catlett and Olson 1968) understand that it is problematic to treat goodwill under “the ownership of assets.”

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payments and paying for all the other inputs in production and who thus would have the defensible claim on the produced car-bodies. Neoclassical economists, Nobel laureates or not, should at least be able to cross the pons asinorum by understanding those conceptual implications of capital goods also being rentable like persons. The grip of the fundamental myth in one form or another seems to account for the failure to even formulate the question of the appropriation of the assets and liabilities that are created in normal production activities. The professional defenders of the human rental system are only too happy to accept Marx’s Gift, the fundamental-myth characterization of the system as being based on the “private ownership of capital” and thus also the misnomer of calling the human rental system “capitalism.” The common understanding in Marxist and well as non-Marxist theories of the relation between power in the production process and market economy has no logical underpinning. ... Contrary to Marxian thoughts, it is the nature of the hiring contract, not the market economy as such, that entails power in a market-based production process. (Rothstein 2011, 208 fn. 3)

Or much earlier: It is astonishing that a hundred years of socialist thought have not confronted the basic capitalist idea—that owners of capital have the right of command in the relations of production. The idea behind nationalization, wage earner funds, and the like is in fact fundamentally the same idea as that on which capitalism is based, namely, that ownership of capital should give owners the right to command in the production process (be they democratically elected politicians, state bureaucrats/planners, workers’ representatives, or union officials). (Rothstein 1992, p. 118)

Frank Knight, a deeper thinker on these matters than most apologists, was quite clear on “capitalism” being a misnomer and that the employer may not be the owner of the capital. The “confused” myth about the “ownership” of the means of production is not part of the actual legal system where capital goods are just as rentable as people. But it is part of neoclassical capital theory and corporate finance theory (see Chap. 3 herein) and is apparently accepted or perhaps not even noticed by the heterodox Cambridge ‘critics’ of capital theory who only criticize orthodox capital theory because of aggregate notions of capital, reswitching, and all that.10 So far our task has just been to clear away the ideological dreck (symbiotically shared by the Right and Left) so that the descriptive and normative question of appropriation in production can be clearly formulated. If we use the highly stylized description of a productive opportunity given by a production function Q ¼ F(K, L ), then the list or vector of assets and liabilities created in productive opportunity is (Q, K, L ). 10

The Cambridge Capital Controversy (Harcourt 1972) between some orthodox economists of Cambridge MA and some heterodox economists of Cambridge UK had mainly to do with the problems with using short-cut aggregate concepts of capital. These problems were resolved theoretically by the full-blown heterogeneous capital goods model of the Cambridge MA school (Samuelson and Solow 1956). Of course, neither Cambridge considered the fundamental-mythbased flaws considered here.

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• The descriptive question of appropriation is: “How is it that one legal party rather than another ends up legally appropriating (Q, K, L) ?” • The normative question of appropriation is: “What legal party ought to legally appropriate (Q, K, L ) ?”

5.7

The Descriptive Question of Appropriation

The descriptive question is easily answered from our previous discussion. The previously described laissez-faire or market mechanism accounts for the actual assignment of the liabilities and assets created in production in a private property market economy. One legal party purchases (or already owns) all the inputs necessary for a productive opportunity and instead of reselling those inputs or expecting to be reimbursed for those used-up inputs, that party shoulders, swallows, or absorbs those liabilities when the inputs are consumed in production. That is the legal appropriation of the negative product, the liabilities incurred in production. Then having borne all the costs involved in the productive opportunity, that same legal party has the legally defensible claim on the produced outputs which are typically sold. Thus, in terms of property rights and liabilities, one legal party appropriates 100% of the input-liabilities (0, K, L ) as well as 100% of the output-assets (Q, 0, 0) which sum to the whole product (Q, K, L ). In property terms, there are no “distributive shares”; that is only a value-theoretic metaphor. The 100% appropriation of the input-liabilities and output-assets by one legal party is a simple legal fact. Since the distributive shares picture has conquered the Economics profession “like the Inquisition conquered Spain” (a Keynes quip in another context), one will search in vain through the modern economics texts to find that simple legal fact even mentioned. One might say that not one Economist in 10,000 understands the private property system, but you meet him every day praising “the private property system” (a Samuelson quip in another context). One has to go back to economics texts prior to the marginalist revolution to find such a simple statement about the actual property rights. Being equally, however, the owner of the labour, so purchased, as the owner of the slave is of that of the slave, the produce, which is the result of this labour, combined with his capital, is all equally his own. In the state of society, in which we at present exist, it is in these circumstances that almost all production is effected: the capitalist is the owner of both instruments of production: and the whole of the produce is his. (Mill [James] 1826, Chapter I, section II)

Outside of the ‘science of Economics’ one can find a few souls who are willing and able to describe the actual, as opposed to the metaphorical, property rights involved in production in the human rental system. Here, for example, is a statement by an economic sociologist a century ago. Under the factory system, the factory, raw materials, and finished product belong to the capitalist. The laborer at no time owns any part of what is passing through his hands or under his eye. Never can he say, “This product, when finished, will be mine, and my rewards will

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depend on how successfully I can dispose of it.” There is much theoretic discussion to the “right of labor to the whole product” and much querying as to how much of the product belongs to the laborer. These questions never bother the manufacturer or his employee. They both know that, in actual fact, all of the product belongs to the capitalist, and none to the laborer. The latter has sold his labor, and has a right to the stipulated payment therefor. His claims stop there. He has no more ground for assuming a part ownership in the product than has the man who sold the raw materials, or the land on which the factory stands. (Fairchild 1916, pp. 65–66).

Setting aside the normative questions for a moment, one may search in vain through the entire corpus of modern Economics to find such a plain statement of the “actual fact” that the employer bears 100% of the liabilities for the used-up inputs and owns 100% of the produced outputs—with the employees having 0% of both. Indeed, an Economics Nobel laureate could say (with false humility) to me in private correspondence, “Needless to say, the ‘legal’ aspects of all this are beyond me”—as if he could not figure out that one legal party pays off 100% of the input liabilities and owns 100% of the produced outputs (i.e., legally appropriates the whole product) and could only conceptualize the problem in his further words as “ways of imputing output to inputs”, i.e., the distributive shares metaphor.11 Such is the mental apartheid of the well-trained and finely-tuned Nobel-quality neoclassical mind. Neoclassical Economics, by focusing only on ‘economic’ aspects, has created well-rounded ‘scientific’ story (see any neoclassical text) that defines the field of real “Economics” and the professional community of Economists. Supposedly, all else is sociology. Why venture off into jurisprudential topics such as the underlying system of property and contract unless those matters can be reduced to Economics, e.g., as in Law & Economics based on wealth-maximization (shown to rest on a logical fallacy in Chap. 7 below)?

5.8

The Normative Question of Appropriation

First we need to recall some terminology. The list of input-liabilities and outputassets (Q, K, L ), that is called the “production plan” (Varian 1992, p. 2) or “input-output vector” in modern neoclassical texts, can be identified with the notion of the whole product (which is composed of the negative product (0, K, L ) plus

Hence the progressive and heterodox economics literature always addresses the “distribution of income” in the firm which does not even make the distinction between “who is the firm” and “who is only a rented input.” Similarly, in spite of the use of the whole product ¼ production vector in the production sets of modern neoclassical economics, there is zero discussion of its appropriation in the whole literature since it is supposed to be part and parcel of the ownership of corporations (i.e., the corporate version of the Fundamental Myth)—as if Economists could not understand the implications of capital assets being rented out, even whole factories as in the Conner Avenue example—in which case the whole product does not go to the corporation owning the capital asset. Conceptual counterarguments and even actual counterexamples are to be ignored in the defense of cherished ‘truths’.

11

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the positive product (Q, 0, 0)) that was used in the old slogan of “Labour’s claim to the whole product” highlighted by Carl Menger’s jurisprudentially-trained brother, Anton Menger (1899). It is true that this labor’s-right-to-the-whole-product tradition put the emphasis on the positive product. But since they could hardly expect some other party to pay their production costs, we will interpret their notion of “whole product” in modern terms as the usual production vector that also includes the negative product, the input-liabilities as the negative entries. If Economics could get beyond the metaphorical “division of the product” to face the actual legal fact that one party appropriates the whole product, then it could formulate the normative question of appropriation: “Who ought to appropriate the whole product in any given productive opportunity?” That party, the whole product appropriator, is rightly labeled the “firm” (in the going-concern sense of being the firm instead of “owning” the firm). Hence we have the prior: • Question of Predistribution:12 “Who ought to be the firm—in the first place?” as opposed to the usual; • Question of Distribution: “What should be the firm’s distributive shares?” The traditional possible answers to the Question of Predistribution are: Capital (the owners of the “means of production”), Labor (the legal party consisting of all who work in the enterprise), the State (as in present or past Marxian socialism), or perhaps just any entrepreneurial party who employs all the necessary inputs, bears those costs, and then claims and sells the outputs.

5.9

The Juridical Principle of Imputation

The other less-traveled fork in the “labor-theory” road is the labor theory of property that answered the normative Question of Predistribution with “Labor’s right to the whole product.” The key insight that distinguishes the modern treatment of that old theory is that it is simply the property-theoretic application of the usual: Juridical Principle of Imputation: assign legal responsibility in accordance with factual responsibility.

The principle is so basic and obvious that it is usually not even stated explicitly. For instance, in a jury trial, the jury is charged with making the official decision about whether or not the defendant is factually responsible as charged—and then the legal system, without further question, assigns or imputes the legal responsibility accordingly. The imputation principle applies in the first instance to deliberate

12 The phrase “predistribution” is due to Jacob Hacker (2011) but it was Branko Milanovic who suggested the application to worker ownership. For instance, legislation to increase worker ownership through Employee Stock Ownership Plans (ESOPs) or worker cooperatives is predistributive while raising taxes on the 1% is redistributive.

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human actions (not the accidents focused on in the law and economics literature), and the most deliberate of all human activities is production where the deliberate human actions are called “labor” (in the broad sense of all who work in an enterprise).13 That is why the old labor theory of property is, in modern terms, just the property-theoretic application of the juridical imputation principle. In factual terms, all who work in a productive opportunity (regardless of their legal role of employer or employee) are jointly de facto responsible for using-up the inputs and thus, by the imputation principle, they constitute the legal party who should owe those legal liabilities. And by those same deliberate human actions, they produce the outputs and thus, by the same imputation principle, they should the legal party who should legally own those assets. Thus, the application of the conventional (i.e., ‘bourgeois’ in the Marxist sense) principle of imputation to production provides the juridical basis for the old claim of “Labor’s right to the whole product”—to the positive and negative fruits of their joint labor. But what about the employment contract? The employees voluntarily sold their labor services to the employer. Here the analysis makes contact with the theory of inalienable rights that provided the basis for the abolition of a voluntary contract for selling labor by the lifetime. In a contract to sell or rent out a material instrument such as a wrench or a truck, the owner of the instrument can factually fulfill the contract by turning over the use of the instrument to the buyer or renter so that party can be factually responsible for using it and for whatever is thereby produced. The services of a thing are factually alienable. But the same transfer to fulfill the contract is not factually possible when a person voluntarily sells or rents out themselves. Responsible human agency is factually inalienable. Hence the contract to rent persons, like the voluntary contract to buy persons, is inherently breached and is thus inherently invalid. To pretend that responsible human agency can be transferred from one person to another is a legalized fraud carried out on an institutional scale in our current economic system, i.e., “a barefaced though legalised robbery” (Bray 1968 [1839], p. 50). One of the founders of Swedish social democracy, Ernst Wigforss, made the point long ago that the labor contract is invalid because it bogusly pretends that labor can be factually transferred like a commodity to be purchased and sold—and that this is the core of whole labor question. The remarkable passage is in the 1923 report of the Wigforss Commission on Industrial Democracy. There has not been any dearth of attempts to squeeze the labor contract entirely into the shape of an ordinary purchase-and-sale agreement. The worker sells his or her labor power and the employer pays an agreed price. What more could the worker demand, and how could he or she claim a part in the governance of the company? It has already been pointed out that the determination of the price can necessitate a consensual agreement on how the firm is

13

Note that the juridical imputation principle is about the past-oriented assignment of legal responsibility (positive and negative) for the results of people’s deliberate de facto responsible actions (e.g., as in a legal trial), and has nothing to do with future-oriented “assignment of responsibilities” in organizational roles. See Hart (1968, p. 211) or Ellerman (1992, pp. 86–87) for the many ways the R-word “responsibility” is used and abused.

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managed. But, above all, from a labor perspective the invalidity of the particular contract structure lies in its blindness to the fact that the labor power that the worker sells cannot like other commodities be separated from the living worker. This means that control over labor power must include control over the worker himself or herself. Here perhaps we meet the core of the whole modern labor question, and the way the problem is treated, and the perspectives from which it is judged, are what decide the character of the solutions. (Wigforss 1923, p. 28 [translated by Patrik Witkowsky])

At most, a person can and typically does voluntarily agree to obey the instructions of the employer, but then, in factual terms, they each share some of the de facto responsibility for the results of their joint actions. But if no crime has been committed, then the legal authorities do not intervene to hold a trial and explicitly apply the juridical imputation principle by assigning legal responsibility in accordance with that joint de facto responsibility. Instead, the legal system just counts obeying the employer as “fulfilling” the labor contract—even though there has been no factual transfer of responsible human actions (“labor services”) unlike the case of the factual transfer of the services of things like a wrench or truck. And then, as we saw in the description of the market mechanism of appropriation, one legal party (the employer) paid for all the input services (e.g., the services of the rented wrenches, trucks, and persons) so that party absorbs those liabilities and thus has the defensible legal claim on the produced outputs. Thus, the employment system inherently violates the juridical principle of imputation since one party is factually responsible for the whole product (the party consisting of all who work in the enterprise) while another party legally appropriates the whole product (the legal party playing the role of the employer). The employees in an employment firm have zero legal claims against them (qua employees) for the input-liabilities (they are only one of the parties to whom the wage-liability is owed) and they have zero legal claims (qua employees) on the output-assets—which is exactly the legal role of a rented thing. As usual, Frank Knight expresses it best: It is characteristic of the enterprise organization that labor is directed by its employer, not its owner, in a way analogous to material equipment. Certainly there is in this respect no sharp difference between a free laborer and a horse, not to mention a slave, who would, of course, be property. (Knight 1965, p. 126)

This can be illustrated using our “priceless” example. All who work in a production opportunity (“Labor” including managers) are de facto responsible for using up the inputs K to produce the outputs Q, which is summarized as Labor’s product (Q, K, 0). But Labor (qua Labor) only legally appropriates and sells (0, 0, L) in the employment system. Labor is de facto responsible for but does not appropriate the difference which is the “institutional robbery” of the whole product: ðQ, K, 0Þ  ð0, 0, LÞ ¼ ðQ, K, LÞ: Since no prices or values were mentioned in the analysis, it should be “intuitively obvious to the most casual observer” (an MIT student slogan) that the labor theory of value is not involved. It is also easy to see why neoclassical Economists are so

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addicted to the picture of the employees as metaphorical “partners” getting their distributive share of the product! They in effect say: As scientific economists, we don’t look at the superficial legalistic assignation or imputation of property rights and liabilities in an employment firm; instead we focus our attention on the deeper question of labor’s share of the product—which is justified in the ideal competitive case by the theory of marginal productivity.14

In the same manner, one could see the value of the product of a slave plantation as being split between the masters and slaves, the as-if partners in the enterprise. The masters get a certain part of the plantation’s income as do the slaves (in the form of food, clothing, and shelter). Rather than considering the ‘superficial’ legalistic rights, the distributive shares picture focuses on ‘deep’ question of the relative size of the real income shares so that morally-sensitive and progressive commentators in Antebellum times could promote an increased share of the plantation’s income going to the slaves. Or perhaps a universal basic income. There have even been rather pathetic contemporary debates within Economics (Fogel and Engerman 1974; David et al. 1976) about the ‘deep’ question of whether or not the slaves in effect received the value of their marginal productivity. To wrap up the review of the labor theory of property, it might be noted that perhaps the biggest analytical and moral idiocy of Marxism is its attack on the idea of private property. Far from implying the abolition of private property, the labor theory of property might paraphrase Gandhi15 to say: It would be a good idea to have a real private property market economy based on the principle of people legally appropriating the (positive and negative) fruits of their labor. Instead, we have now the property-as-theft (Proudhon) system based on the fraudulent and inherently invalid contract for the renting of human beings—whereby the employer can legally appropriate the positive and negative fruits of the labor of the people working in the enterprise by renting them.

Hence the neo-abolitionist call (Ellerman 2015 or 2021) for the abolition of the contract to rent, hire, lease, or employ human beings in favor of companies being reconstituted as democratic organizations whose members are the people working in the enterprise (Ellerman 1990b). But orthodox economists will respond: Please, we’re economists; we can’t talk about property rights and contracts or some so-called “juridical principle of imputation.” Needless to say, the ‘legal’ or jurisprudential aspects of all this are not even part of Economics. That’s a completely different faculty on the campus. So, let’s talk about Economics. What you probably mean to say is that workers produce more value than they are paid—and we largely agree with you since markets are far short of the competitive ideal as is correctly pointed out by progressive economists such as Stiglitz, Piketty, Galbraith, Thurow, and Keen as well as by leading progressive philosophers such as

14 At least, when the actual facts are considered as superficial, while metaphorical shares in the product are considered as deep, then one doesn’t have to ask if science or ideology is riding in the saddle. 15 The perhaps apocryphal quote attributed to Gandhi is that when asked “What do you think of Western civilization?”, he replied “I think it would be a good idea.”

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Rawls. But in the ideal competitive case, workers are paid the value of their marginal product so workers then “reap what they sow.” Hence let’s talk about making markets more competitive so workers will really be paid the full value of their marginal product, and then your concerns about justice—which we, of course, share—will be satisfied.16

Hence we turn finally to marginal productivity theory itself.

5.10

On the Theory of Marginal Productivity

Although economists may feign ignorance of the juridical principle of imputation, they have used, explicitly or implicitly, a metaphorical version of precisely that principle in marginal productivity theory ever since the marginalist revolution at the beginning of the twentieth century. As Milton Friedman put it, “To each according to what he and the instruments he owns produces.” (1962, pp. 161–162), or as Frank Knight put it, “what a man soweth that shall he also reap” (1956, p. 292). Hence it turns out that Economists know about the imputation principle after all and they even pay homage to it—at least to a metaphorical version of it. However, this attempted application of the imputation principle is based on: • a metaphor, • a mistake, and • a miracle.

5.10.1 The Metaphor: Treating the Productive Services of Things Like the Responsible Actions of Persons The first and foremost problem is the neglect of the difference between responsible human actions and the non-responsible but causally efficacious (i.e., productive) services of things like a wrench, machine, or truck. It is so much more ‘scientific’ to treat all causally efficacious ‘inputs’ as being symmetrical without differentiation. This blind-spot does not differentiate orthodox from heterodox economics; heterodox economists have just as much trouble finding the R-word. This fundamental distinction between persons and things in terms of responsibility and imputation has 16

The point is that neoclassical economists face a genuine quandary at this point. Should they argue that rented workers are actually non-responsible instruments ‘employed’ by the employer—unless they commit crimes? Should they argue that people should not appropriate the fruits of their labor? The solution taken is the obvious one; just ignore all those ‘non-economic’ questions about property and contract. No standard text addresses them. Work within the framing of the “problem of distribution” shared by the ‘serious’ progressive economists. And when it comes to ‘taking on the real opposition,’ find the nearest surviving Marxist to play the useful fool and give them a lecture on the problems in the labor theory of value and exploitation. Robert Solow’s review (Solow 2006) of Duncan Foley’s book, Adam’s Fallacy (Foley 2006) is an excellent example of this genre.

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long been part of standard jurisprudence—but is virtually unheard of in orthodox or heterodox economics. A person is the subject whose actions are susceptible to imputation. . . . A thing is something that is not susceptible to imputation. (Kant 1965 [1797], pp. 24–25)

Marx could not find the R-word from bourgeois jurisprudence (or from Kant), and (after Wieser) Economists cannot find the R-word or in their pathetic attempts to find some reasonable interpretation of Marx. Marx emphasized that labor is not the only useful factor of production. However, he did argue that it is the only useful factor of production contributed by human society. In this sense he considered it necessary to define all value and, therefore, all surplus value (profit, interest, and rent) as something that is produced by labor. (Baumol and Blinder 1982, p. 775) The point of the value theory may than be summed up as follows: goods are indeed produced by labor and natural resources together. But the relevant social source of production is labor, not an inanimate “land.” (Baumol 1974, p. 59)

Since they could not find the R-word that differentiates labor from natural resources, they might just as well point out that labor is the only “source of production” provided by featherless bipeds. One form of the failure to differentiate responsible human actions and the non-responsible services of things is to simply treat both as causally effective productive services. As usual, Knight says it best. We have insisted that the word “produce” in the sense of the specific (i.e., marginal) productivity theory of distribution, is used in precisely the same way as the word “cause” in scientific discourse in general. (Knight 1965, p. 178)

For “labor” we should now say “productive resources.” (Knight 1956, p. 8) How Knight loved the word “productive” that blurred the difference between the responsible actions of persons and the non-responsible but useful services of things. Knight goes on to describe the distribution problem in those terms. Goods are typically produced by the co-operation of various kinds of productive services, and the special problem of distribution, in modern terms, is that of the division of this joint product among the different kinds of co-operating productive services and agents. (Knight 1956, p. 21) There is an old literary metaphor (a version of the pathetic fallacy) where natural forces are pictured in an animistic way as being “responsible” for certain consequences. Instead of Knight’s down-grading responsible human actions to being just like the causally efficacious “productive services” of things, some economists use the opposite tactic as when an asset’s services, natural forces, and human actions are all coupled together as if all were de facto responsible agents.17

17 It is interesting that orthodox economics always treat human actions and the services of things both as being only “productive services” or both as being “responsible agents.” Economists seem to instinctively know that recognizing any fundamental difference between responsible human actions and the causally efficacious services of things in production can only lead to them having ‘trouble’

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However, since the demise of primitive animism, the law has only recognized persons as being responsible agents. If orthodox economists, such as Knight, were on jury duty for a murder trial, they would probably drop their learned ignorance of the difference between the responsible actions of persons and the causally efficacious services of things. They would probably not wonder—or, at least, not out loud—how to make the “division” of the joint responsibility “among the different kinds of co-operating productive services and agents.” They might even understand that the responsibility for the murder is imputed back through any gun or other weapon to the person using those instruments. The legally-trained Austrian economist, Friedrich von Wieser, could find the R-word. As soon as the judge has established the causal nexus and the presumption of sanity, he is bound to attribute the entire result to the accused. This is true even though he may know very well that the accused could never have accomplished it alone without instruments and without the peculiar contributing circumstances. . . . A decree of this sort is not in the least illogical. It does not purport to be a proposition concerning the causal nexus. It does not say that the perpetrator alone did commit, or could have committed, the deed without the aid of tools or the other persons of whom he made use. It says that among the many contributing factors the perpetrator is the only responsible agent. He is the only one whom the judge can punish in order to carry out the intention of the law and to satisfy the end of punishment. (von Wieser 1927, p. 115)

In spite of the relative commonplace of the legal assignment of liabilities in a damage suit, economists (orthodox or heterodox) seem to be particularly baffled by the negative components in the whole product vector and the corresponding assignment of the input-liabilities as the bearing of costs. They seem to find it particularly difficult to understand the negative side of responsibility, e.g., the man is responsible for using the services of the shovel or the land, or, as Wieser put it, the imputation “does not say that the perpetrator alone did commit, or could have committed, the deed without the aid of tools or the other persons of whom he made use. It says that among the many contributing factors the perpetrator is the only responsible agent.” There is a common pose that orthodox economists are scientifically judging the existing human rental system according to some normative principles. But the apologetic role of Economics suggests the opposite direction of causality. Normative principles are judged according to whether or not they align with the role of orthodox Economics in giving a “scientific account” of the existing or perhaps an idealized human rental system. For instance, Wieser summarizes the essentials of the labor theory of property (juridical imputation principle) critique of the employment system–“Land and capital have no merit that they bring forth fruit; they are dead tools in the hand of man; and the man is responsible for the use he makes of them.” (von Wieser 1930, p. 79) But Wieser’s correct description of the juridical principle of imputation fell like

or apostasy as clerics in the Church of Human Rentals and collectively in fulfilling the profession’s role in Church apologetics. The juridically-trained Wieser is the exception that proofs the rule.

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seeds in a desert—even for Wieser himself. The juridical principle gives Wieser no second thoughts about the system of renting human beings; it only shows that the usual moral or legal notions of imputation obviously do not apply! They must apply to some other world than the world of Economics. It would be a reductio ad absurdum to apply the usual moral/legal notion of imputation to production since it conflicts with the institution of renting human beings in the free market free enterprise system! The social role of Economics in the human rental system demands a new notion of “economic imputation” in accordance with another new notion of “economic responsibility.” In the division of the return from production, we have to deal similarly . . . with an imputation, – save that it is from the economic, not the judicial point of view. (von Wieser 1930, p. 76) THE ECONOMICALLY RESPONSIBLE FACTORS (header on p. 77)

By defining “economic responsibility” in terms of the animistic version of marginal productivity, Wieser and later orthodox economists can finally draw the conclusion demanded by their professional vocation: to show that the competitive human rental system “economically” imputes the product in accordance with “economic” responsibility. But one should not think that orthodox Economists are intellectual hirelings just because they ignore the usual legal or moral principle of imputation (as if the legal profession and the Economics profession were dealing with different worlds); they can be quite critical of the non-competitive aspects of the actual economy when rented workers are not paid rentals according to their “economic responsibility.” Now the metaphorical imputation and the metaphorical responsibility can take in each other’s laundry. Thus, we arrive at one of the highpoints of neoclassical Economics: trying to justify a metaphorical imputation/division of the product with a metaphorical notion of responsibility. In contrast, the modern treatment of the labor theory of property (i.e., based on the juridical imputation principle) deals with the imputation of the “return from production” precisely from the moral, legal, or “judicial point of view.”

5.10.2 The Mistake: No Division of Actual Property Rights to the Product Now the riddle of the Sphinx—how to allocate among two (or more) cooperating factors the total product they jointly produce—can be solved by use of the marginal-product concept. (Samuelson 1976, p. 541)

But it’s the wrong riddle of the Sphinx. The simple mistake involved in this interpretation of MP theory is that it does not deal with the actual appropriations addressed in the Question of Predistribution: “Who is to be the whole product

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appropriator—in the first place?”18 There is no property-theoretic riddle since in an enterprise, one legal party, typically the employer, legally appropriates the: ðQ, K, LÞ ¼ ðQ, 0, 0Þ þ ð0, K, LÞ: Whole product ¼ Positive product þ Negative product: There is no actual division of the property rights to the product. Although Nobel laureate Robert Solow proclaimed: “Après moi, la sociologie” (Solow 1967, p. 119), it might be again noted that avant Solow, an economic sociologist correctly explained: [The employer and his employee] both know that, in actual fact, all of the product belongs to the capitalist, and none to the laborer. The latter has sold his labor, and has a right to the stipulated payment therefor. His claims stop there. He has no more ground for assuming a part ownership in the product than has the man who sold the raw materials, or the land on which the factory stands. (Fairchild 1916, p. 66)

In order to address that question about the actual appropriation of the assets and liabilities created in production, one needs a theory of property, whereas marginal productivity theory is actually only a theory of the derived demand for inputs.19 Mathematical economists are normally quite keen to see duality—except when it comes to seeing that there is a ‘dual metaphor’ to the metaphorical imputation of the product to the factors of production. Instead of metaphorically picturing all the inputs as ‘responsible’ agents producing the positive product, one could metaphorically picture the outputs as ‘responsible’ agents using up the inputs (i.e., producing the negative product). Instead of imputing to each input “what it produces,” impute or charge to each output “what it uses up.” That is, in addition to saying that “an individual deserves what is produced by the resources he owns” (Friedman 1976, p. 199), one might say “an individual deserves the liabilities produced by the outputs he owns.” In value terms, each buyer of a unit of the output should be charged its marginal cost and, indeed in competitive equilibrium, the price of the output is equal to marginal cost (P ¼ MC). This dual metaphor is faulty for the same reasons as the original metaphor. Outputs are not responsible for using up the inputs; the people who work in the firm are the ones who perform the responsible human actions that use up the inputs in the process of producing the outputs. And the legal liabilities for the used-up inputs

18 Much ink has been spilt by Knight (1965) and others on the near-tautology that the party who “bears the risks” (i.e., appropriates the negative product) should also appropriate the positive product. Of course, one party appropriates the whole product (i.e., both the positive and negative products). The real question is: who is to be that one party? 19 The juridical principle of imputation provides no normative critique of treating genuine commodities (i.e., things) as things. Maximizing an objective function requires valuing things at their marginal contribution to the objective as indicated by the Lagrange multipliers in the mathematics of constrained optimization (Ellerman 1984, 1990a) or Chap. 10 “Finding the Markets in the Math: Arbitrage and Optimization Theory” in Ellerman (1995).

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are not actually assigned to the purchasers of the outputs. By the market mechanism of appropriation, those liabilities are laissez-faire appropriated by the last owner of the used-up inputs—all of which is a technical way of saying the costs lay where they fall (i.e., where the ‘Invisible Judge’ lets them lie) unless a court reassigns them. The last-owner of the inputs thereby gets the legally defensible claim on the appropriable outputs which, in turn, are sold to the output buyers. The dual metaphors only duel with each other; the facts about legal imputation lie elsewhere. The actual non-metaphorical legal facts are that there is one legal party who stands between the input suppliers and the output buyers, and that one party legally appropriates the whole product, i.e., both the input-liabilities and the output-assets.

5.10.3 The Miracle: Each Factor’s Immaculate Production of Its Marginal Product The whole picture of each unit of a factor producing its marginal product is implausible in the first place since production requires other inputs! Each (marginal) unit of the labor L cannot “immaculately” produce ex nihilo its virgin-birth marginal product MPL ¼ ΔQ ΔL of so-many widgets without using up some other services of capital and other intermediate goods summarized in K. There is no ‘immaculate conception’ and ‘virgin birth’ of marginal products—except perhaps as a dogma in the Church of Human Rentals. What technically counts as the marginal product of labor? Given an increase in labor of ΔL, the usual mathematical computation of the marginal product of labor ΔQ/ΔL involves a shift to a slightly more labor-intensive production process so that ΔQ extra product is produced with no change in the other factors, i.e., ΔK ¼ 0. But that nominal shift in general would violate the cost-minimization assumption that requires expansion along the least-cost expansion path. Thus the ΔL would typically require an increase in the other inputs K in order to produce some extra output ΔQ at minimum costs. Hence in place of the usual scalar notion of MPL, the neoclassical assumptions themselves require a vector notion of marginal product to account for those changes in the other inputs necessary to stay on the least-cost expansion path. Hence the vector marginal whole product of the extra labor ΔL would be a vector MWPL ¼ (ΔQ, ΔK, 0). And since labor is the only de facto responsible factor, the total labor L would be de facto responsible for the sum (or integral in technical terms) of the vectorial marginal products of labor from 0 to L (see the appendix for an example) which is exactly what we previous termed:20

20

The mathematics of vectorial marginal productivity theory was worked out a quarter century ago in this chapter entitled “Are Marginal Products Created Ex Nihilo?” of Ellerman (1995). See the Appendix for an example.

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Labor’ s product ¼ ðQ, K, 0Þ: Of course, the same mathematical calculations can be made for the causally efficacious but non-responsible inputs K, but since non-responsible things do not qualify for juridical imputation, that calculation has no normative significance. That is obviously a very off-putting asymmetry for ‘scientific’ economists to recognize as a relevant distinction between persons and things. Thus, redoing the MP theory taking account of the non-metaphorical fact that in terms of legal or moral imputation “no one but the labourer could be named,” we are taken right back to the property-theoretic application of the juridical principle of imputation, historically known as the “labor theory of property.” This raises the question of why doesn’t neoclassical economics follow out its own assumptions by using the vector marginal products taken along the least-cost expansion path instead of the notional (immaculate) marginal products off that path? On this matter, is it science or ideology that is ‘in the saddle’? The answer seems to be that only the immaculate or ‘virgin birth’ marginal products gives the “distribution of the product” or “distributive shares” picture (with the “exhaustion of the product” under constant returns to scale)—which can then be combined with the pseudo-application of the imputation principle to show that the competitive employment system satisfies “the ethical proposition that an individual deserves what is produced by the resources he owns.” (Friedman 1976, p. 199)

5.11

Conclusions About MP Theory

If the modest neo-abolitionist proposal (Ellerman 2015 or 2021) was accepted that the contract for the renting of human beings be recognized as invalid and abolished, then production could only be organized on the basis of the people working in a firm (jointly) hiring or already owning the capital and other inputs they use in production. Then the laissez-faire market mechanism of appropriation would correctly impute the legal responsibility to the de facto responsible party. Or as Justice Louis D. Brandeis put it: Hence no remedy can be hopeful which does devolve upon the workers participation in responsibility for the conduct of business; and their aim should be the eventual assumption of full responsibility—as in co-operative enterprises. This participation in and eventual control of industry is likewise an essential of obtaining justice in distributing the fruits of industry. (Brandeis 1934, p. 270)

The legal members of the firm as a legal party would be the people working in the firm. As the Conservative thinker, Lord Eustace Percy (1887–1958), put it: Here is the most urgent challenge to political invention ever offered to the jurist and the statesman. The human association which in fact produces and distributes wealth, the association of workmen, managers, technicians and directors, is not an association recognised by the law. The association which the law does recognise—the association of

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Conclusions About MP Theory

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shareholders, creditors and directors—is incapable of production and is not expected by the law to perform these functions. We have to give law to the real association, and to withdraw meaningless privilege from the imaginary one. (Percy 1944, p. 38; quoted in: Goyder 1961, p. 57)

Such a firm is a democratic firm, and the private property market economy of such firms is an economic democracy.21 The interesting implication is that, notwithstanding over two centuries of economic theorizing, the current system is not the “natural system of private property and contract” any more than would be a private property system where longer-term voluntary contracts in human capital (e.g., self-sale or voluntary slavery contracts) were legally valid.22 The natural system of private property and (non-fraudulent) contracts is one where the owner-operated proprietorship and the family farm generalize to democratic firms of any size where people are jointly working for themselves.23 Moreover, the system of economic democracy finally resolves the long-standing conflict between being a citizen whose inalienable rights are recognized in the political sphere and being a rented “employee” in the workplace. As the visionary corporate leader (founder of RCA, President and Chairman of General Electric, and Time Magazine Man of the Year for 1929), Owen D. Young (1874–1962), put it: Perhaps some day we may be able to organize the human beings engaged in a particular undertaking so that they truly will be the employer buying capital as a commodity in the market at the lowest price.24. . . If that is realized, the human beings will then be entitled to all the profits over the cost of capital. I hope the day may come when these great business organizations will truly belong to the men who are giving their lives and their efforts to them, I care not in what capacity. Then they will use capital truly as a tool and they will be all interested in working it to the highest economic advantage. . . . Then we shall dispose, once 21 See, for example, Robert Dahl (1985) and particularly the “Sketch of an Alternative” (p. 91). The best examples today are probably the Mondragon industrial cooperatives in the Basque region of Spain (see Oakeshott 1978, 2000; Whyte and Whyte 1991). Employee stock ownership plans (ESOPs) and codetermination arrangements are steps in the same direction. 22 Actually, the orthodox “fundamental theorem” that a competitive equilibrium is Pareto optimal must assume full futures markets in all commodities including labor so that theorem actually assumes long-term contracts in human capital. This is, of course, not stated in any elementary or advanced economics text but in an apparent outburst of clarity and honesty, an orthodox economist did state this in no less a forum than Congressional testimony. “Now it is time to state the conditions under which private property and free contract will lead to an optimal allocation of resources.... The institution of private property and free contract as we know it is modified to permit individuals to sell or mortgage their persons in return for present and/or future benefits.” (Christ 1975, p. 334) 23 The legal appropriation of the output-assets and input-liabilities is, of course, not done individually but jointly in the democratic company as the “human association which in fact produces and distributes wealth” (Percy 1944, p. 38) How the net value-added is allocated between the members is part of what has to be democratically decided by the members of the company (Ellerman 1990b)—not unlike the way a democratic polity has to decide how the joint net liabilities of the government are allocated between the citizens as taxes. 24 Justice Brandeis had the same ideal. “In a democratic community we naturally long for that condition where labor will hire capital, instead of capital hiring labor.” (Brandeis 1995, pp. 103–104).

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and for all, of the charge that in industry organizations are autocratic and not democratic. Then we shall have all the opportunities for a cultural wage which the business can provide. Then, in a word, men will be as free in cooperative undertakings and subject only to the same limitations and chances as men in individual businesses. Then we shall have no hired men. (Young 1927, p. 392)

Yes, then we shall have no rented people.

5.12

Mathematical Appendix on Vectorial MP Theory

The treatment of MP theory using vectorial marginal products will be illustrated using the Cobb-Douglas production function Q ¼ AKaLb with the unit prices of K and L being r and w respectively. The vectorial marginal products are derived by taking derivatives along the least cost expansion path. To fill in the details, the firstorder conditions for cost-minimization are in this case:       r= aAK a1 Lb ¼ w= bAK a Lb1 or  a b1   a1 b  AK L = AK L ¼ ðK=LÞ ¼ ððawÞ=ðbr ÞÞ: Hence the conditions that hold along the least-cost expansion path are: ðK=LÞ ¼ ððawÞ=ðbr ÞÞ: The whole product WPL ¼ (Q, K, 0) of the responsible factor L (also called the “Labor’s product”) can then be stated directly as a function of L using K ¼ ((aw)/ (br))L:   WPL ¼ ðQðLÞ, K ðLÞ, 0Þ ¼ AðððawLÞ=ðbr ÞÞÞa Lb , ððawÞ=ðbr ÞÞL, 0   ¼ AðððawÞ=ðbr ÞÞÞa Laþb , ððawÞ=ðbr ÞÞL, 0 : Taking the derivative with respect to L gives the marginal whole product of the responsible factor labor:   MWPL ¼ ða þ bÞAðððawÞ=ðbr ÞÞÞa Laþb1 , ððawÞ=ðbr ÞÞ, 0 : Since labor is the only responsible factor, one can compute its total responsibility for the positive and negative results of production by “adding up” or integrating its marginal whole product from 0 to L.

5.12

Mathematical Appendix on Vectorial MP Theory

Z

L 0

Z MWPL dl ¼ 

L

115

 ða þ bÞAðððawÞ=ðbr ÞÞÞa laþb1 , ððawÞ=ðbr ÞÞ, 0 dl

0

 L AðððawÞ=ðbr ÞÞÞa laþb o , ½ððawÞ=ðbr ÞÞlLo , 0



 AðððawÞ=ðbr ÞÞÞa Laþb , ððawÞ=ðbr ÞÞL, 0     ¼ AððK=LÞÞa Laþb , ðK=LÞL, 0 ¼ AK a Lb , K, 0 ¼ ðQ, K, 0Þ ¼ WPL : Adding-Up Theorem for Marginal Vectorial Product of Labor Thus, the adding-up of the marginal vectorial product of labor gives the Labor’s Product WPL ¼ (Q, K, 0). Hence getting the mathematics right (integrating the marginal vector product of labor along the least-cost expansion path) or just using straightforward jurisprudential reasoning, the fact is that the persons working in the enterprise start with the things (0, K, 0) and by performing the responsible actions L transform it into the things (Q, 0, 0), so those people are factually responsible for the difference: (Q, 0, 0)  (0, K, 0) ¼ (Q, K, 0). As previously noted, the same mathematical calculations can be made for the causally efficacious but non-responsible inputs K (e.g., capital), but since non-responsible things do not qualify for actual (as opposed to metaphorical) imputation, that calculation has no juridical significance. Orthodox MP theory metaphorically represents each factor as producing a certain share of the product Q, as if each input could produce some part of the product without using up some of the other factors. Then under the additional assumption of constant returns to scale (a + b ¼ 1 in this case), it proves the “Adding Up” or “Exhaustion of the Product Theorem” that the shares add up to the entire output Q. In the case at hand, the shares are: KMPK ¼ K ðð∂QÞ=ð∂K ÞÞ ¼ KaAK a1 Lb ¼ aQ and LMPL ¼ Lðð∂QÞ=ð∂LÞÞ ¼ LbAK a Lb1 ¼ bQ: Hence the sum of the shares is: KMPK þ LMPL ¼ ða þ bÞQ which equals Q under the assumption of constant returns, a + b ¼ 1.25 Continuing with the Cobb-Douglas example with prices P ¼ ( p, r, w), we will have at profit maximization both pMPL ¼ w and P  MWPL ¼ w so we might

25

It might be noted that the Adding-Up Theorem for marginal vector products makes no assumption about returns to scale. It is just the Fundamental Theorem of Calculus that the integral between two limits of the derivative of a function is the difference between the function’s values at the two limits.

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compute both functions on the left-hand side to compare them. The scalar MP of labor is MPL ¼ bQ/L so as a function of L, pMPL ¼ pbAðððawÞ=ðbr ÞÞÞa Laþb1 : In the vectorial case, we have: P  MWPL ¼ pða þ bÞAðððawÞ=ðbr ÞÞÞa Laþb1  r ðððawÞ=ðbr ÞÞÞ   ¼ ðða þ bÞ=bÞ pbAðððawÞ=ðbr ÞÞÞa Laþb1  ððawÞ=bÞ ¼ ðða þ bÞ=bÞpbAððK=LÞÞa Laþb1  ððawÞ=bÞ ¼ ðða þ bÞ=bÞpMPL  ððawÞ=bÞ ¼ ða=bÞ½pMPL  w þ pMPL : Thus, we finally have: P  MWPL ¼ ða=bÞ½pMPL  w þ pMPL The two functions are not the same. But when pMPL ¼ w, then P  MWPL ¼ w and when P  MWPL ¼ w, then pMPL ¼ w, so the two marginal conditions for profit maximization, one using the ‘virgin-birth’ MPL and the other using the vectorial MWPL, are equivalent. This illustrates from the mathematical point of view how MP theory could just as well be presented using the vectorial marginal products. But then that would sacrifice the metaphorical “distribution of the product” story that is so appealing in Economics in its professional role of justifying the human rental system.

References Adelman, J. (2013). Worldly Philosopher: The Odyssey of Albert O. Hirschman. Princeton NJ: Princeton University Press. Barzel, Y. (1989). Economic Analysis of Property Rights. New York: Cambridge University Press. Baty, T. (1918). Loan and Hire: Notes on the English Law on Lending and Hiring. London: Sweet and Maxwell. Baumol, W. (1974). The Transformation of Values: What Marx “Really” Meant (An Interpretation). Journal of Economic Literature, XII(March 1974), 51–62. Baumol, W., & Blinder, A. (1982). Economics (2nd ed.). New York: Harcourt Brace Jovanovich. Begg, D., Fischer, S., & Dornbusch, R. (1997). Economics (Fifth Ed.). London: McGraw-Hill Co. Blaug, M. (1958). Ricardian Economics. New Haven: Yale University Press. Brandeis, L. D. (1934). The Curse of Bigness. New York: Viking. Brandeis, L. D. (1995). Brandeis on Democracy. (P. Strum, Ed.). Lawrence KS: University Press of Kansas. Bray, J. F. (1968 [1839]). Labour’s Wrongs and Labour’s Remedy. London: Frank Cass & Col Ltd. Brockway, G. P. (1995). The End of Economic Man: Principles of Any Future Economics (3rd ed.). New York: W. W. Norton.

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Knight, F. H. (1956). On the History and Method of Economics. Chicago: Phoenix Books. Knight, F. H. (1965). Risk, Uncertainty and Profit. New York: Harper Torchbooks. Locke, J. (1960). Two Treatises on Government. New York: New American Library. Marx, K. (1990). Capital (Vol. I). (B. Fowkes, Trans.). London: Penguin Classics. McKitrick, E. (1963). Slavery Defended: the views of the Old South. Englewood Cliffs NJ: PrenticeHall. Menger, A. (1899). The Right to the Whole Produce of Labour: The Origin and Development of the Theory of Labour’s Claim to the Whole Product of Industry. (M. E. Tanner, Trans.). London: Macmillan and Co. Mill, J. (1826). Elements of Political Economy (3rd ed.). London: Baldwin, Cradock, and Joy. Oakeshott, R. (1978). The Case for Workers’ Co-ops. London: Routledge and Kegan Paul. Oakeshott, R. (2000). Jobs and Fairness: The Logic and Experience of Employee Ownership. Norwich UK: Michael Russell. Percy, E. (1944). The Unknown State: 16th Riddell Memorial Lectures. London: Oxford University Press. Piketty, T. (2014). Capital in the Twenty-First Century. (A. Goldhammer, Trans.). Cambridge MA: Harvard University Press. Proudhon, P.-J. (1970). What is Property?: An Inquiry into the Principle of Right and of Government. New York: Dover. Rawls, J. (1999). A Theory of Justice (Revised Ed.). Cambridge MA: Belknap Press. Rothstein, B. (1992). Social Justice and State Capacity. Politics & Society, 20(1 March), 101–126. Rothstein, B. (2011). The Quality of Government: Corruption, Social Trust, and Inequality in International Perspective. Chicago: University of Chicago Press. Samuelson, P. A. (1976). Economics (10th ed.). New York: McGraw-Hill. Samuelson, P. A., & Solow, R. M. (1956). A Complete Capital Model involving Heterogeneous Capital Goods. Quarterly Journal of Economics, 70(4 Nov.), 537–562. Schlatter, R. (1951). Private Property: The History of an Idea. New Brunswick: Rutgers University Press. Seabury, S. (1969). American Slavery Justified by the Law of Nature. Miami: Mnemosyne Publishing Company. http://www.nines.org/print_exhibit/276 Solow, R. M. (1967). A Rejoiner. The Public Interest, 0(9), 118–9. Solow, R. M. (2006, November 16). How to Understand the Economy. A review of Adam’s Fallacy: A Guide to Economic Theology, by Duncan K. Foley. New York Review of Books, 53(18). Stiglitz, J. (2012). The Price of Inequality: How Today’s Divided Society Endangers Our Future. New York: W.W. Norton. Thompson, W. (1963). An Inquiry into the Principles of the Distribution of Wealth. New York: Augustus Kelly. Thurow, L. (1975). Generating Inequality: Mechanisms of Distribution in the U.S. Economy. New York: Basic Books. Tuck, R. (1979). Natural Rights Theories. Cambridge: Cambridge University Press. Umbeck, J. (1981). Might Makes Right: A Theory of the Formation and Initial Distribution of Property Rights. Economic Inquiry, 19(1), 38–59. Varian, H. (1992). Microeconomic Analysis (3rd ed.). New York: W.W. Norton. Whyte, W. F., & Whyte, K. K. (1991). Making Mondragon (2nd revised.). Ithaca: ILR Press. Wieser, F. von. (1927). Social Economics. (A. F. Hinrichs, Trans.). New York: Adelphi. Wieser, F. von. (1930). Natural Value. (C. A. Malloch, Trans.). New York: G.E. Stechert and Company. Wigforss, E. (1923). Den industriella demokratiens problem 1. Stockholm: A.-B. Hasse W. Tullbergs boktryckeri. Young, O. D. (1927). Dedication Address. Harvard Business Review, V(4 July), 385–394.

Chapter 6

Marxism as the Ultimate ‘Capitalist Tool’

Abstract The system of (involuntarily or voluntarily) owning workers was abolished in the mid-nineteenth century, but it was replaced by the system of voluntarily renting, hiring, or employing workers. That system of renting human beings lasted far beyond its institutional ‘shelf-life’ in the twentieth century due to the perception that ‘The Alternative’ was the Marx-inspired system of socialism or communism based on state employment. In that sense, Marxian socialism was the silent helper to the (private) human rental system, the ultimate capitalist tool. This chapter goes over the intellectual and other deficits of Marxism (e.g., the labor theory of value) and gives at least six ‘huge favors’ that Marxism did for the human rental system.

6.1

Introduction

An all-important part of the framing of the ideological defense of ‘The System’ is to be able to specify ‘The Alternative.’ Once the dichotomous narrative is widely shared, then an expose of the flaws in ‘The Alternative’ is as good as a defense of ‘The System.’ For the private human rental system, ‘The Alternative’ is the system of public human rentals where most every worker is an employee of some level of government. Historically, the ideology of the public human rental system (where employees work for the ‘public good’ instead of ‘private greed’) was Marxism. And when Marxism was thoroughly discredited in the late twentieth century in both the East and West, then the dichotomous narrative must conclude that “There Is No Alternative” (TINA) to the private human rental system. The Great Debate in the twentieth century between the system of private or public human rentals is all too reminiscent of the Peloponnesian War between Athens, which had privately owned slaves, and Sparta, which had publicly owned slaves (the helots). A society where slavery was abolished was not an alternative. Similarly, the Great Debate about whether people could be privately employed or should always be publicly employed, left out the real alternative of abolishing the human rental relation altogether in favor of all organizations being democratic associations.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_6

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An economic democracy is a private property market economy where the contract to rent people (the employment relation) is abolished, where the democratic principle is applied to the workplace so that the legal members of each firm are the people who work in it, and where the assets and liabilities produced in the firms are thus privately appropriated by the people who create them in accordance with the standard principle of imputing legal responsibility in accordance with de facto responsibility (i.e., the modern treatment of the labor theory of property) (see Ellerman 1992 or Chap. 1 on property theory herein). The purpose of this chapter is to outline the role of Marx and Marxism in sustaining the misframing of the Great Debate, i.e., in maintaining the idea that ‘The Alternative’ to the private human rental system was the system of public employment. In conventional terms, of course using the fundamental myth in terms of the ‘ownership of the means of production,’ this is: the classical distinction between firms with privately-owned production means and firms with publicly-owned production means. In this case one will have capitalism on the one hand and two or more forms of socialism on the other. . . . (Jossa and Cuomo 1997, p. 113).

The purpose is also to analyze Marx’s labor theory of value and exploitation, not other aspects of Marx’s opus such as his extensive development of Sismondi’s notions of proletarians and class-struggle (Lutz 1999). We might begin with the connection, if any, between Marx’s value theory and the modern treatment of the labor theory of property as the application to production of the standard juridical principle of imputing legal responsibility in accordance with de facto responsibility.

6.2

Marx’s Labor Theory of Value

Any discussion of the natural rights or labor theory of property (LTP) is absolute anathema in neoclassical economics. And for good reason since there has never been any other plausible legitimizing principle for private property appropriation than people getting the fruits of the labor—which is why neoclassical Economics pays metaphorical homage to that principle in marginal productivity theory. One might say: “There is no alternative legitimizing principle.” Since the employees jointly in a human rental firm legally appropriate 0% of the positive and negative fruits of their labor (and are only one of the external parties to whom the liability for the used-up “labor services” is owed), such ‘superficial’ legal facts are simply not discussed or even mentioned in Economics as it is currently delimited. Hence any mention of a “labor theory” is automatically pigeon-holed as the Marxian labor theory of value (LTV), and then discussed on that basis. Having Marxism as ‘The Alternative’ is thus an important part of the defense of the (private) human rental system. It even allows that system where 100% of the positive and negative fruits of the labor of the employees is legally appropriated by the employer to parade about as “The Private Property System”—and Marxism even obligingly attacks private property and generally treats “private” as a swearword.

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From the side of Marxism, many Marxists seem to have adopted Marxism as a sort of counter-identity, a badge of Red courage, signifying that one is against “The System.” Anyone who was a Marxist largely for identity reasons could hardly bring themselves to talk, like Proudhon, in terms of purging the private property system (or rather the “property is theft” system) of injustice by abolishing the employment relation to create a genuine private property market economy of democratic firms. That sounds so “bourgeois” and for identity-Marxists, how something “sounds” is rather important. And there are those who want a market economy of private democratic firms, perhaps a labor-managed market economy (Vanek 1977), but they still (unlike Vanek) want to call it “socialism.” It is hard to take seriously those who say they seek a new world—but can’t even find a new word. Some Marxists correctly deny any real connection between Marx’s labor theory of value and the labor theory of property. None of this, by the way, implies that Marx intended the labor theory of value as a theory of property rights, a la Locke or even Proudhon. (Shaikh 1977, p. 121)

Other Marxists catch a glimpse getting beyond LTV by dropping “value” from the theory. And it is this fairly obvious truth which, I contend, lies at the heart of the Marxist charge of exploitation. The real basis of that charge is not that workers produce value, but that they produce what has it. (Cohen 1981, p. 219)

If it is a “fairly obvious truth” that the “labor theory of value” is not really about value, then there might be some other “labor theory” to consider. But G. A. Cohen was not able to find that other labor theory—which, in any case, would not deliver the sine qua non of Marxist socialism, the “social” appropriation of the product of industry. Hence Cohen goes on to argue that all the inputs are “socially produced” and thus appropriation must take place at the “social” level. Cohen did not understand that the direct implication of his “fairly obvious truth” is that the inputs in one enterprise are what the workers produce in a supplier enterprise. For instance, the drill presses used to produce the product in one enterprise are the products produced not by “society” but by the people working in a drill press enterprise. And the appropriate notion of “product” that the people in an enterprise produce is the whole product (i.e., the production vector of output-assets and input-liabilities) which includes not only the output-assets but also the liabilities for the inputs they use up, e.g., the liabilities for using up the services of the drill presses to be satisfied by buying or leasing the drill presses. The most sophisticated attempt to revive the LTV was the whole episode with matrix-Marxism by the Morishima School (1973), and it only made precise the idea that LTV was really just a sophisticated ‘interest grumble’ (Ellerman 1983) and had no connection to LTP. The most direct precursors to the LTP were the “small band” (Blaug 1958, p. 140) of classical laborists (or so-called “Ricardian socialists” although they were neither Ricardians nor socialists) such as Thomas Hodgskin (1973 [1832]), William Thompson (1963 [1824]), John Francis Bray (1968 [1839]), and Pierre-Joseph Proudhon

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(1970 [1840]). However, they were blown off the conventional intellectual map by the monumental work of Marx who took the discourse in a rather different direction (barely related to the LTP).

6.3

Marx and Marxism’s Huge Favors for the Human Rental System

It is rather hard to coherently defend the economic system based on the renting of people, the employment system, once the questions are correctly framed, not in terms of “private ownership of the means of production,” but in terms of: • the employment contract to rent human beings that pretends responsible agency can be alienated, • the violation of democratic principles in the workplace, and • the violation of the standard responsibility principle in the appropriation of property in production based on the employment contract. Apologetics does not even try to address these questions but rather uses a different framing of the questions. The most remarkable aspect of the Great Debate about the system is that Marx accepted the apologetics’ misframing of the questions and then took the other side of the false-dichotomies. Thus, Marx and Marxism have somewhat inadvertently become an essential part of the apologetics for the human rental system by agreeing to the bogus framing of the issues. Here are the major examples of huge favors Marxism does for the apologetics of the Church of Human Rentals.

6.3.1

Huge Favor (1) “Capitalism Is Based on Private Property Rights”

Perhaps Marx’s biggest blunder was his promotion of the fundamental myth that the ownership of capital goods, i.e., the “means of production,” includes the rights to the product and to the management of a production process using that capital (instead of being determined by “who hires what or whom” in the marketplace). This blunder led to his condemnation of the “private ownership of the means of production.” That, in turn, has allowed the defenders of the human rental system to strut upon the ideological stage as the “defenders of private property” when in fact they are defending the private system that allows the employer to appropriate 100% of the positive and negative fruits of the labor of the rented people working in the enterprise. That is a historical absurdity on the order of slavery apologists parading as the defenders of human rights. But that symbiotic relationship between Marxists

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and human rental apologists continues since the fundamental myth is one thing they both agree on.

6.3.2

Huge Favor (2) “The Basic Question Is: Consent Versus Coercion”

Conventional classical liberalism represents the basic question in the judgment of social institutions as “consent versus coercion.” If that is the basic question, then the employment contract clearly passes muster; one has to dig deeper into the analysis of the contract to rent persons as opposed to things to see the real problems in the contract. But that deeper analysis enters into the Reformation and Enlightenment theory of inalienable rights which bypassed Marx—even in his (mis)reading of Hegel’s far-reaching critique of the voluntary slavery contract (see below). Hence Marx implicitly accepted the consent-versus-coercion framing and took the opposite side by arguing that wage-labor was ‘socially involuntary.’ Workers, born without ownership of the means of production, are ‘forced’ to rent themselves out to an employer, and similarly, consumers, born without ownership of a farm, are forced to buy their food from a grocery store or farmers’ market. Yet a collectively bargained employment contract is certainly more voluntary than the contracts of adhesion the consumer accepts at the supermarket. Marx’s ploy is mirrored today in many progressives (not necessarily Marxists) who play the intellectual parlor-game of escalating their notion of coercion until the institutions they want to criticize can be seen as ‘involuntary’ by their high standards. This parlor-game or exercise is particularly useful for Economists and conventional classical liberals who have no notion of inalienable rights (e.g., Frank Knight) but who want to fit into their ambient society by accounting for the abolished contracts of the past, e.g., lifetime or long-term master servant relations, indentured servitude, or coverture marriage contracts. Economists might first proffer ‘economic’ arguments about transaction costs or inefficiency. But since such arguments are rather weak to account for the abolition of certain contracts, rather than offering a smorgasbord of other options, Economists and conventional classical liberals will fall back on the ploy of redefining ‘coercion’ to suit their needs; “How could you even think that those contracts were ‘really’ voluntary!?” Instead of playing “consent versus coercion” games, the deeper point is that no amount of consent can turn the employee into a non-responsible thing to legitimate the system where the employer legally appropriates 100% of the fruits—as always, positive and negative fruits—of the employees’ labor. What employees in fact do is consent to obey the employer or the employer’s agents—which hardly gets them offthe-hook from being de facto co-responsible partners when the enterprise is criminal rather than legal. That is one example why it is so important to keep even the simplest jurisprudential consideration out of Economics. And that critique of the human rental contract on the basis of the de facto inalienability of responsible

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personhood has nothing whatever to do with whether or not the labor was “paid for at its full value” (Marx 1990. Book I, Chap. X, Sec. 3, p. 357, fn. 40) or paid for at the value of the marginal productivity of labor—which brings us to Marx’s next ‘huge favor.’

6.3.3

Huge Favor (3) “Value Theory Is the Intellectual Battleground to Analyze Capitalism”

A labor theory of value and a labor theory of property both appear in Locke’s writings and also, to a lesser extent, in Adam Smith’s work. Classical economics left the status of ‘the labor theory’ in a somewhat inchoate state. Hence it was a rather fateful decision by Marx to try to develop a labor theory of value, and to ignore or disparage the budding but somewhat inchoate labor theory of property being developed by Proudhon, Hodgskin, and other classical laborists. Neoclassical economics really started with the marginalist revolution at the end of the nineteenth century which developed a sophisticated theory of value—that could even be exemplified in the applied mathematics of constrained optimization (Ellerman 1984, 1990, and Chap. 10 in 1995). After that, neoclassical theorists (Samuelson 1971; Baumol 1974) were delighted to do battle with ‘the Alternative’ of Marxian value theory once it was cast in an appropriate mathematical form by the school of matrix Marxism (Morishima 1973). Then it became clear that the Marxian theory of value and exploitation was little more than a disguised Aristotelian interest grumble (treating time as a free good so a positive rate of interest, renamed the “profit rate,” was ‘exploitative’) and was not even particularly related to labor at all. By reproducing for corn or iron or coal, all the striking results that Marx derived concerning for labor, we have, it seems to me, raised questions about the foundations of Marx’s critique of capitalism and classical political economy. (Wolff 1984, p. 172)

6.3.4

Huge Favor (4) “Inalienable Rights!? Nonsense on Stilts!”

One of Marx’s major sins of omission was to ignore or disparage the whole theory of inalienable rights that descends from the Reformation and Radical Enlightenment. The best place to “see” that theory was in the critique of a voluntary slavery contract (e.g., Hegel) or the critique of the intolerance of secular or religious authorities (e.g., Spinoza and Hutcheson). Georg Hegel gave one of the clearest critiques of a voluntary slavery contract in philosophy (Hegel 1967, Sections 57–66) and as a post-Hegelian, Marx was surely familiar with it. Since Hegel’s critique had nothing to do with the tenure of the contract, it clearly also applied against the short-term human rental contract—which

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Hegel did not explicitly point out. In fact, quite the opposite. Perhaps out of fear of Prussian censors, Hegel walked back the argument with a bit of metaphysical mumbo-jumbo to say that it did not apply to wage-labor—as if responsible personhood could be voluntarily alienated for “a limited time” but not for a longer time. I may make over to another the use for a limited time, of my particular bodily and mental aptitudes and capabilities; because, in consequence of this restriction, they are impressed with a character of alienation with regard to me as a whole. But by the alienation of all my labour-time and the whole of my work, I should be converting the substance itself, in other words, my general activity and reality, my person, into the property of another. (Ibid., § 67)1

The remarkable fact is that Marx never alluded to Hegel’s inalienable rights argument and instead quoted precisely Hegel’s walk-back as if it were an accurate description of the employment relation (Marx 1990, Book I, Chap. VI, fn. 3, p. 272). Moreover, Marx explicitly disparaged the whole tradition of natural, innate, or inalienable rights by adopting the mystery-revealing posture (beloved by a type of continental philosopher) of exposing the ‘true nature’ of wage-labor “in the hidden abode of production” while the sphere of exchange “is in fact a very Eden of the innate rights of man” (Marx 1990, Book I, Chap. VI, p. 280). But as we showed in chapters one and two, this tactic runs afoul of the divergence principle that connects the sphere of exchange and the “hidden abode of production.” By the fundamental theorem of property theory, any misappropriation in the “hidden abode of production” implies a theft or breach in the sphere of exchange—in this case the breach of the labor contract in that responsible human agency is never transferred from the employees to the employer. In exchange for the wage, the employees can only give obedience which, as we have seen (e.g., in the case of the hired criminal), maintains their de facto co-responsibility with the (working) employer for the results of the enterprise.

6.3.5

Huge Favor (5) “Democracy Is Only Relevant in The Public Sphere; Capitalist Enterprises Are Private”

Once human rights are legally recognized, there is often the ‘pushback’ that the rights only apply in the public sphere, not in the private sphere, e.g., a man’s house is his private ‘castle’ where patriarchy rules no matter what rights of women are publicly recognized. In about the middle of the nineteenth century, the rule of political democracy became the widely accepted norm among the Western 1

In case the purpose of Hegel’s backpedaling was not clear, one of the original editors added an explanation culled from Hegel’s lectures: “The distinction here explained is that between a slave and a modern domestic servant or day-labourer.” (Hegel 1967, p. 241) It seems that those who commit crimes for hire have not yet discovered how to factually “make over to another the use for a limited time, of my particular bodily and mental aptitudes and capabilities.” According to the apologetics in the Church of Human Rentals, it is only employees whose actions are legal who perform that miracle.

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industrialized countries. But that immediately created the prophylactic need for the human rental system to quarantine that democratic germ in the public sphere and to argue that it ‘clearly’ did not apply in the private sphere of economic firms where ‘the rights of private property’ (i.e., the fundamental myth) prevail. But the deeper argument for the inalienable right to self-governance had nothing to do with the distinction between the public and private sphere. It was based on the de facto inalienability of human responsibility and decision-making—facts about nature of the humans who inhabit both spheres. That factual inalienability was the basis for the critique of the long tradition of trying to justify forms of autocracy based on implicit or explicit constitutions or social contracts (pactum subjectionis) to alienate any rights to self-governance to the sovereign. Again, the basic issue was not the conventional consent-versus-coercion dichotomy, but the dichotomy between contracts of alienation versus contracts of delegation. As James M. Buchanan, in the tradition of democratic classical liberalism, put it: [T]he legitimacy of social-organizational structures is to be judged against the voluntary agreement of those who are to live or are living under the arrangements that are judged. The central premise of individuals as sovereigns does allow for delegation of decision-making authority to agents, so long as it remains understood that individuals remain as principals. The premise denies legitimacy to all social-organizational arrangements that negate the role of individuals as either sovereigns or as principals. (Buchanan 1999, p. 288)

Public versus private has nothing to do with it; the argument applies to any “social-organizational structures”. But Marxism, at least rhetorically, and many modern democratic socialists still take the public-private distinction as the fundamental frame in which to analyze these questions of workplace governance. Is the private workplace really ‘analogous’ to the public government? Also there is the democratic socialist argument that economic firms, or at least the “commanding heights,” can only become “democratic” when they are publicly owned in a political democracy. Of course, private firms, like private individuals, need to be regulated but the socialist argument is that large private firms are inherently ‘social’ so they should be not only government regulated but government owned. A private workplace democracy is just ruled out as long as “private” is treated as a swear-word. Today much of the democratic left is still hopelessly confused on this point. It is a commonplace in some parts of the left that the flaw in state socialism was that the state was too big, bureaucratic, and distant; municipal socialism or “community control” would be the solution—all as if there was something wrong with a democratic workplace being private (e.g., the Mondragon worker cooperatives) and not part of the government at any level. That is the same strain of thought that considers the community that wields “the public power” (i.e., the community of citizens represented by government at some level) as “The Community,” and all other communities (e.g., the people working together in a firm) as just private interest groups. No attempt is made to justify how the public power bestows such a metaphysical moral status on “The Community”; it is just the public-private framing at work again. It is a basic failing of Marxism and the democratic socialist tradition not to realize that the basic arguments against the

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human rental system and in favor of workplace democracy have (like the arguments about women’s rights) nothing to do with the public-private distinction—which was called up for ideological duty to protect the private economic autocracies from the democratic political revolutions of the mid-nineteenth century.

6.3.6

Huge Favor (6) Marxism as the Leftwing Ideology of One-Party Autocracy

There is another way that Marxism has been detrimental to democracy particularly in the political sphere. One common argument against democratic firms is that if they are so good (in whatever way), then how come there are so few of them? The assumed premise seems to be that somehow the economy is seeded with an equal number of democratic firms and human rental firms so the human rental firms must out compete the democratic firms and that is why there are so few of the latter. But the reality is that the legal form of a company is determined by its founders; it does not fall out of the sky in one form or the other. And the founder or small group of founders face the “founder’s decision” whether to build up the company with all new workers coming in as member/partners in a democratic enterprise or to have the new workers come in as employees. And it is in that situation that the human rental firm ‘outcompetes’ the democratic firm in delivering economic returns and autocratic authority to the founders. In that situation, the founders would need very strong moral motivation to choose the democratic option, e.g., in the Mondragon cooperatives. Marxism comes in when we consider the political version of the founder’s decision. When a revolutionary leader or small group of such leaders overthrow the previous system of government, they face the similar founder’s decision about the new form of government. Should it be a (multi-party) democratic system where they might be eventually voted out of power or should it be some system of autocracy where, barring another revolution, they would remain in power indefinitely? Unfortunately, over the course of history, it is clear that the autocratic form ‘outcompetes’ the democratic form in both the economic and political arena, i.e., that the political founders almost always choose a non-democratic system (e.g., fascist or communist) that will perpetuate their power. And throughout the twentieth century, with the exception of a few fascist dictators, Marxism has provided the main legitimizing rationale for the non-democratic choice. Again, the founder or founders need very strong moral motivation to choose the democratic option. Even after the American Revolution, members of the officer’s corps of the Revolutionary Army formed the Society of the Cincinnati that essentially wanted to install George Washington as the new monarch and themselves as the new aristocracy. Only Washington’s strong commitment to civic republicanism put a stop to that effort so the new United States was formed as a multiparty political democracy.

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The role of Marxism in providing the convenient rationale for almost all (or all) leftwing revolutionary governments to be one-party autocracies throughout the twentieth century has done another huge favor for the human rental system. The very system that denies democratic citizenship in the workplace, by legally treating the workforce as subjects within the scope of the human rental contract, is allowed to parade upon the world stage as the great supporters of the democratic ideal. In the middle of the nineteenth century, John Stuart Mill argued that if society continued to progress, then it would end up with the system of workplace democracy with labor hiring capital instead of the reverse. Yet after a century and three-quarters, the topic of workplace democracy is hardly, if at all, on the public agenda. What happened in the intervening years to derail Mill’s prophecy? In short, it was Marx, Lenin, and the Russian Revolution to create Soviet Communism as “the alternative” in practice and Marxism as “the alternative” in theory. That history of Marxism ended in tragedy; today it only survives as the farce of serving as the foil for human rental apologetics. For at least the above six reasons, Marx and Marxism have done huge favors for the human rental system. For over a century, apologetics has been given a ‘free ride’ pretending that Marxist socialism/communism was the only alternative to the private rentals of human beings. In that sense, Marx and Marxism have become the ultimate ‘capitalist tools.’2

References Baumol, W. (1974). The Transformation of Values: What Marx “Really” Meant (An Interpretation). Journal of Economic Literature, XII(March 1974), 51–62. Blaug, M. (1958). Ricardian Economics. New Haven: Yale University Press. Bray, J. F. (1968 [1839]). Labour’s Wrongs and Labour’s Remedy. London: Frank Cass & Col Ltd. Buchanan, J. M. (1999). The Logical Foundations of Constitutional Liberty: The Collected Works of James M. Buchanan Vol. 1. Indianapolis: Liberty Fund. Cohen, G. A. (1981). The Labour Theory of Value and the Concept of Exploitation. In I. Steedman & P. Sweezy (Eds.), The Value Controversy (pp. 202–223). London: Verso. Ellerman, D. (1983). Marxian Exploitation Theory: A Brief Exposition, Analysis and Critique. Philosophical Forum, XIV(Spring-Summer 1983), 315–333. Ellerman, D. (1984). Arbitrage Theory: A Mathematical Introduction. Society for Industrial and Applied Mathematics (SIAM) Review, 26(April), 241–61. Ellerman, D. (1990). An Arbitrage Interpretation of Classical Optimization. Metroeconomica, 41 (3 Oct.), 259–76. Ellerman, D. (1992). Property & Contract in Economics: The Case for Economic Democracy. Cambridge MA: Blackwell. Ellerman, D. (1995). Intellectual Trespassing as a Way of Life: Essays in Philosophy, Economics, and Mathematics. Lanham MD: Rowman & Littlefield.

This emphasis on academic Marxists serving as “capitalist tools” should not be taken to imply that they are actually “subsidized by the CIA”—although that may just reflect poorly on the subtlety of the CIA. For more on Marxism, see Ellerman (1983, 1992, 2010).

2

References

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Ellerman, D. (2010). Marxism as a Capitalist Tool. Journal of Socio-Economics, 39(6 December), 696–700. https://doi.org/10.1016/j.socec.2010.06.008 Hegel, G. W. F. (1967). Hegel’s Philosophy of Right. (T. M. Knox, Trans.). New York: Oxford University Press. Hodgskin, T. (1973). The Natural and Artificial Right of Property Contrasted. Clifton NJ: Augustus M. Kelley. Jossa, B., & Cuomo, G. (1997). The Economic Theory of Socialism and the Labour-managed Firm: Markets, Socialism, and Labour Management. Cheltenham UK: Edward Elgar. Lutz, M. (1999). Economics for the Common Good. London: Routledge. Marx, K. (1990). Capital (Vol. I). (B. Fowkes, Trans.). London: Penguin Classics. Morishima, M. (1973). Marx’s Economics: A Dual Theory of Value and Growth. Cambridge: Cambridge University Press. Proudhon, P.-J. (1970). What is Property?: An Inquiry into the Principle of Right and of Government. New York: Dover. Samuelson, P. A. (1971). Understanding the Marxian Notion of Exploitation: A Summary of the So-Called Transformation Problem Between Marxian Values and Competitive Prices. Journal of Economic Literature, IX(2), 399–431. Shaikh, A. (1977). Marx’s Theory of Value and the “Transformation Problem.” In J. Schwartz (Ed.), The Subtle Anatomy of Capitalism (pp. 106–139). Santa Monica: Goodyear. Thompson, W. (1963). An Inquiry into the Principles of the Distribution of Wealth. New York: Augustus Kelly. Vanek, J. (1977). The Labor-Managed Economy. Ithaca: Cornell University Press. Wolff, R. P. (1984). Understanding Marx. Princeton: Princeton University Press.

Chapter 7

The Logical Fallacy in Cost-Benefit Analysis and Law & Economics

Abstract Cost-benefit analysis and wealth-maximization Law & Economics are both based on the Kaldor-Hicks (KH) principle that was developed to bypass the usual notion of a Pareto superior change. In this chapter, the KH principle is shown to be based on a logical fallacy that, in a different context, Paul Samuelson illustrated as the ‘same-yardstick fallacy.’ The same-yardstick fallacy is illustrated here using the primary pedagogical example in David D. Friedman’s Law & Economics primer, Law’s Order: What Economics has to do with Law and why it matters. When the applications of cost-benefit analysis or Law & Economics are reformulated so they don’t involve the same-yardstick fallacy, then the KH principle just collapses back to the notion of Pareto superior change that the KH principle was designed to avoid. Thus the attempt of Law & Economics to put some alleged jurisprudence back into economics is shown to rest on a logical fallacy.

7.1

Introduction

The professional Economists in service to the human rental system have wisely eschewed actual principles of jurisprudence such as the juridical principle of imputation. That principle immediately casts doubt on the employer’s legal appropriation of 100% of the assets and liabilities created in an enterprise of rented human beings. But let us set aside for the moment the problems in the legitimacy of ownership and assume a set of people who legitimately own their property. By the principle of consent, any proposed change in their property would require their consent—indeed, the unanimous consent of all those whose legitimate property is affected. In actual fact, the proposed change may improve a person’s situation according to their own preferences, but they still might withhold consent due to some bargaining strategy. Hence economics may abstract away from the problems of individual bargaining to characterize a proposed change in property as a Pareto superior change if it improves some people’s individual welfare by their own account while leaving others indifferent and no affected person worse off. The Wicksell-Buchanan school of public choice emphasized this unanimity rule (Buchanan 1999).

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_7

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The supporters of the unanimity or Pareto criterion were well aware of its stringency, but they held that in the context of public choice it was the task of democratic process to debate and ‘log-roll’ until the resulting proposal was Pareto superior or ‘effectively so’ (a concession to practicality). But that did not satisfy the technocratic desire for some social decision-making criterion that could be applied without the messy, time-consuming, and ‘impractical’ process of democratic debate and compromise. The general equilibrium presentation of welfare theory emphasizes the shortcomings of the Pareto criterion as a guide to policy analysis and policy decisions. The compensation criterion, or Potential Pareto Improvement Criterion, of Kaldor and Hicks is then considered as a more promising approach to making public policy decisions. (Just et al. 2004, p. xv)

The most widely adopted social decision-making criterion of that technocratic character is cost-benefit analysis (CBA, sometimes called “benefit-cost analysis”). The theoretical basis for CBA in Economics is the Kaldor-Hicks principle (Hicks 1939; Kaldor 1939). CBA utilizes an alternative decision rule with somewhat less conceptual appeal, but much greater feasibility, than the actual Pareto efficiency rule. It is based on what is known as the Kaldor-Hicks criterion: a policy should be adopted if and only if those who will gain could fully compensate those who will lose and still be better off. (Boardman et al. 2011, p. 32)

The basic idea is to parse each proposed Pareto superior change into: • the “efficiency” part, the proposed changes that will benefit some people (the ‘gainers’) so that they can in theory compensate the ‘losers’ and still be better off, and • the “equity” part which consists of the compensation payments that, if actually made, would make the whole change into a Pareto superior change. The purpose of considering hypothetical redistributions is to try and separate the efficiency and equity aspects of the policy change under consideration. It is argued that whether or not the redistribution is actually carried out is an important but separate decision. The mere fact that is it possible to create potential Pareto improving redistribution possibilities is enough to rank one state above another on efficiency grounds. (Boadway and Bruce 1984, p. 97)

The ‘trick’ is then to say that Economists, in their professional service to non-democratic decision-making, can in “good conscience” recommend to implement the efficiency part of the proposed change and leave the equity part to politicians, philosophers, and other less ‘scientific’ practitioners. But to the extent that distributive justice can be shown to be the proper business of some other branch of government or policy instrument. . ., it is possible to set distributive considerations to one side and use the Kaldor-Hicks approach with a good conscience. This assumes, . . ., that efficiency in the Kaldor-Hicks sense—making the pie larger without worrying about how the relative size of the slices changes—is a social value. (Posner 2001, pp. 318–319)

An important aspect of the argument is, as we will see, that the size of the pie (often called “social wealth”) is measured in the same numeraire goods, typically

7.2 The Same-Yardstick Fallacy and Definitional Statements

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money, that are used in the potential compensation payments from the gainers to the losers. Cost-benefit analysis is now by far the most widely used technocratic decisionmaking rule. It is not only routinely used in Economics (Stokey and Zeckhauser 1978; Ray 1984; Just et al. 2004), but it is the basis for the attempt to address legal and even jurisprudential questions in the wealth-maximization “Law & Economics” movement (Posner 1972) that has swept through the American law schools like ‘syphilis in Hawaii.’ But there is a vaccine against this plague. That is, the Kaldor-Hicks attempt to bypass the unanimity or Pareto superior criterion is based on a logical fallacy. It is our purpose in this chapter to explain this fallacy.

7.2

The Same-Yardstick Fallacy and Definitional Statements

The name of the fallacy is due to Paul Samuelson. In an article (Samuelson 1979), he develops the idea of a consumer’s utility function measured in terms of money and then notes that the marginal utility of money would then be constant at one. That is an example of a definitional statement that essentially restates a definition. Samuelson cautions against inferring that the marginal utility of money is always constant and equal to one. The reason the marginal utility of money is constant in this (definitional) case is that “a yardstick cannot change in terms of itself” (Samuelson 1979, p. 1264). It is as if one wanted to check if a yardstick had changed and might not be a yard long, so one marked off the length of the yardstick on a table, and then turned around and measured it using the same yardstick to erroneously conclude that it was indeed still a yard long. That is the same-yardstick fallacy. There are many examples of erroneous arguments based on the same-yardstick fallacy that involve using a definitional statement as if it were an empirically meaningful statement that was not just true-by-definition. • Consider the argument between Galileo and the Church about the Earth moving. Suppose the Vatican astronomers has plotted the motions of the Earth and Sun using geocentric coordinates. Then they could triumphantly show that the Sun moves but the Earth did not move (when plotted in geocentric coordinates)! Hence Galileo was wrong and the Church was right about the Earth not moving. • Or consider the argument that there was no inflation during the twentieth century (or any time period) by considering what a dollar would buy at different points in time. At the beginning of the twentieth century a dollar would buy a dollar’s worth of goods (e.g., a dollar chunk of cheddar cheese), and, lo and behold, it would also buy a dollar’s worth of goods at the end of the century. Since a dollar would buy the same amount of goods over the time period (a “dollar’s worth of goods”), there was no inflation.

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• The price of gold never changes since the gold-price (in terms of ounces of gold) of an ounce of gold is always constant at 1 whereas the gold-price of a dollar is often changing. • The price of a dollar never changes since the dollar-price of a dollar is always constant at 1 whereas the dollar-price of gold is often changing. • The same-yardstick fallacy can also be used to show that any commodity, e.g., an apple, has the same value to all consumers. Taking apples as the numeraire, an apple would be worth the same amount, one apple, to any two people such as John and Mary. • A restatement of the previous fallacy is that a transfer of the numeraire between two parties does not change social wealth measured in terms of the same numeraire. For instance, transferring an apple from Mary to John would not change the size of the social pie—if it was an apple pie.

7.3

An Example of the Fallacy in the Law & Economics Literature

The definitional statement in the Kaldor-Hicks principle and in Law & Economics is the statement that the ‘equity’ part, the compensation payments from the gainers to the losers made in terms of the numeraire do not change social wealth measured in the same numeraire. Economists and cost-benefit analysts assert this tautology as if it were a substantive statement about “social wealth” or “value.” For instance, “pure transfers of funds among households, firms and governments should themselves have no effect on project benefits and costs.” (Boadway 2001, p. 35) Or again: It should be emphasized that pure transfers of purchasing power from one household or firm to another per se should be typically attributed no value. (Boadway 2001, p. 30; see also Boadway 2020, Chap. 3)

Elaborate attention is paid in the literature to (general equilibrium) effects of making the changes and paying the compensation if any (Boadway 1974 or 2006; Drèze and Stern 1987; Blackorby and Donaldson 1990) without even noticing the vacuous nature of definitional statement that transfers in the numeraire does not affect the size of pie measured in the same numeraire. Unfortunately, most of the criticism of the KH principle from non-economists and some economists is to plea for the distributional importance of the ‘equity’ part of the parsing (Nussbaum 2001; Richardson 2001) without questioning the meaningfulness of the parsing itself. But the parsing itself is contingent on the choice of numeraire. The following example is taken from David D. Friedman’s popular textbook in Law & Economics (Friedman 2000). It involves a possible Pareto superior exchange of an apple and money between John and Mary. By flipping the numeraire from money to apples, the parsing between the ‘efficiency’ and ‘equity’ part reverses itself. Then the usual ‘scientific’ recommendation of the ‘efficiency’ part is also reversed so the KH principle breaks down in incoherence.

7.3 An Example of the Fallacy in the Law & Economics Literature

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Fig. 7.1 Parsing of Pareto superior change into efficiency and equity parts with dollar numeraire

Fig. 7.2 Parsing of Pareto superior change into efficiency and equity parts with apples as numeraire

Mary has an apple which she values at $0.50 while John values an apple at $1.00. There could be a Pareto superior exchange of the apple for, say, $0.75. In one description of the situation, the ‘efficiency’ part (i.e., the ‘project’ in project evaluation or CBA) is the transfer of the apple from Mary to John, while the ‘equity’ part is the payment of the compensation (say, $0.75) from John to Mary as shown in Fig. 7.1. Friedman uses the example to illustrate how the apple transfer increases social wealth (measured in the numeraire of money) but not the compensation payment as a mere transfer in the numeraire. It would still be an improvement, and by the same amount, if John stole the apple—price zero—or if Mary lost it and John found it. Mary is fifty cents worse off, John is a dollar better off, net gain fifty cents. All of these represent the same efficient allocation of the apple: to John, who values it more than Mary. They differ in the associated distribution of income: how much money John and Mary each end up with. Since we are measuring value in dollars it is easy to confuse “gaining value” with “getting money.” But consider our example. The total amount of money never changes; we are simply shifting it from one person to another. The total quantity of goods never changes either, since we are cutting off our analysis after John gets the apple but before he eats it. Yet total value increases by fifty cents. It increases because the same apple is worth more to John than to Mary. Shifting money around does not change total value. One dollar is worth the same number of dollars to everyone: one. (Friedman 2000, p. 20)

Now we can redescribe the exact same potential Pareto improvement but taking apples as the numeraire. This does not mean just converting between apples and money at some given exchange rate. It means going back to Mary and John’s evaluations and restating them in the new numeraire. Mary valued the apple at $0.50 so it means she values $0.75 at 1.5 apples while John valued the apple at $1 so he values the $0.75 at ¾ apple. Since Mary values the $0.75 at 1½ apples while John only at ¾ apple, it would clearly increase social wealth measured in apples to transfer the $0.75 from John to Mary—as shown in Fig. 7.2. That is the social wealth increasing or ‘efficiency’ part of the Pareto improvement. But social wealth is the same if the apple is transferred from Mary to John or not, so scientific Economists may leave that question of equity to politicians, ethicists, philosophers, and the like. We leave it to the reader to reword the quote from David Friedman to conclude with

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the definitional statement: “One apple is worth the same number of apples to everyone: one.” Economists in their professional capacity can recommend in “good conscience” that the $0.75 be transferred from John to Mary, but the recommendation of the apple transfer is a matter for less ‘scientific analysis’ on the part of politicians or philosophers. Yet nothing has changed in the potential Pareto improvement of the exchange; the exact same situation was only redescribed with the flipped numeraire. In this manner, the whole Kaldor-Hicks attempt to short-cut the unanimity or Paretian principle falls apart in incoherence. Of course, actual projects in CBA or laws in Law & Economics are much more complex but there is no difference in principle. David Friedman was ironically correct in using the John and Mary example to illustrate the KH principle at the root of Law & Economics and CBA.

7.4

The Analysis with a Non-Involved Numeraire

In the earlier example of the same-yardstick fallacy, the exact same relative motions of the Earth and Sun in the flipped heliocentric coordinates would yield the opposite conclusion that the Earth moves but not the Sun. The same-yardstick fallacy about the motion of the Earth and Sun is only avoided by using a coordinate system based on, say, the center of gravity of the Milky Way, not centered on the Earth or Sun. Similarly, one won’t get much insight into the total motions of the prices of gold and dollars by just consulting prices stated in dollars or ounces of gold; one needs to consult their prices in terms of some third unit such as Euros. In exactly the same manner, the same yardstick fallacy in the John and Mary example is only avoided by choosing a numeraire not involved in the potential Pareto improvement. To show this in the John and Mary example, let’s take any commodity as numeraire that is a positive good for both parties such as, say, nuts.  Then rate of substitution of nuts per apple dN dA M is only constrained by  Mary’s   d$  dN  d$   and similarly John’s rate of substitution dN dA M dN M ¼ dA dA J is constrained by M  d$  dN  d$  dA J dN J ¼ dA J . To be more general, consider a proposed Pareto (strictly) superior exchange that Δ$ where ΔA apples were made both parties better off and took place at the ratio ΔA transferred from Mary to John and Δ$ dollars were transferred from John to Mary. Since it made both parties better off we have in general:   d$  Δ$ d$  < < , dAM ΔA dAJ indicating that the transfer of the apple from Mary to John will increase the size of the dollar-pie since John values the apple more than Mary in terms of dollars. And taking apples as the numeraire, we have the inverted ratios:

7.4 The Analysis with a Non-Involved Numeraire

137

  dA ΔA dA <  ,  < d$ J Δ$ d$ M indicating that the transfer of Δ$ from John to Mary will increase the size of the apple-pie since Mary values the Δ$ more than John in terms of apples. Now that we have a non-involved numeraire in nuts, we can calculate the increase in the size of the nut-pie from both transfers. The change from the transfer of ΔA apples from Mary to John is:  ΔN A ¼

   dN  dN     ΔA dA J dA M

and the change from the transfer of the Δ$ dollars from John to Mary is: 

   dN  dN  ΔN $ ¼    Δ$: d$ M d$ J Hence the total change in the size of the nut-pie from both changes is: 

       dN  dN  dN  dN  ΔN ¼    ΔA þ    Δ$ dA J dA M d$ M d$ J     dN  dN  dN  dN  ¼  ΔA   Δ$ þ  Δ$   ΔA: dA J dA M d$ J d$ M    d$    d$  dN  dN  dA   Now dN dA J dN J ¼ dA J so d$  ¼ dA J d$  so the change for John is: J

J

       dN  dN  dA dN  dA  ΔA    Δ$ ¼  ΔA   Δ$ > 0 dA J dA J d$ J dA J d$ J   ΔA which is positive since dA d$ J < Δ$ and nuts are a positive good for John.   d$       ¼ d$ so dN  ¼ d$ dN  so the change Similarly, for Mary, we have: dN dA M dN M dA M dA M dA M d$ M

for Mary is:        dN  d$  dN  dN  d$   Δ$    ΔA ¼  Δ$   ΔA > 0 dA M d$ M dA M d$ M d$ M  d$  Δ$ which is positive since dA < ΔA and nuts are a positive good for Mary. M There is no indication that the increase in the size of a pie is coming from either transfer by itself since we are using a non-involved numeraire. If, however, we recalculate the changes resulting from both transfers using one of the involved commodities as the numeraire, then a certain cancellation takes place

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due to the definitional fact that transfers in the numeraire don’t change the size of the pie in terms of that numeraire. Taking dollars as numeraire, the total change in dollars due to both transfers is:        d$  d$  d$ d$   ΔA þ Δ$ dAJ dAM d$M d$J       d$  d$  d$    ΔA þ ½1  1Δ$ ¼  ΔA, dA M dAJ dAM 

Δ$ ¼  d$  ¼ dAJ 

so that it appears as if the whole increase is due to the apple transfer. Since the apple transfer only benefited John, it appears that the dollar  i to Mary didn’t show h  transfer d$ d$ up as an increase in social wealth. The fact that d$  d$ ¼ 0, i.e., the dollarM

J

price of a dollar is always 1 for anyone, is the algebraic version of the definitional statement that a transfer in the numeraire does not change social wealth measured in the same numeraire. It is true regardless of any marginal rates of substitution for Mary or John; it is a tautology or true-by-definition statement. The inference that only the apple transfer increases social wealth, while the dollar transfer from John to Mary does not, is the same-yardstick fallacy—just as the conclusion that the Sun moves but not the Earth (due to the plotting of motions in geocentric coordinates) commits that fallacy. And taking apples as the numeraire, we calculate the change in apples due to both transfers: 

       dA dA dA dA ΔA ¼    ΔA þ    Δ$ dA J dA M d$ M d$ J         dA dA dA dA ¼ ½1  1ΔA þ    Δ$ ¼    Δ$, d$ M d$ J d$ M d$ J so that it appears as if the whole increase is due to the Δ$ transfer. Then it appears that the dollar transfer that benefited Mary showed up as an increase in social wealth but the apple transfer to John did not affect social wealth. The inference that only the dollar transfer increases social wealth, while the apple transfer from Mary to John does not, again commits the same-yardstick fallacy. It is only when we calculate the total change in social wealth using a non-involved numeraire that we avoid the same-yardstick fallacy. Then both John and Mary benefit in terms of social wealth when measured in terms of a non-involved numeraire. But then we are back to the Pareto superior criterion. The whole Kaldor-Hicks detour of the Economics profession through wealth maximization Law & Economics and cost-benefit analysis—both based on the Kaldor-Hicks principle—was only an exercise in being misled by the same-yardstick fallacy. When we avoid the fallacy by evaluating social wealth using a non-involved numeraire, then we see that both the gains to John and the gains to Mary in the

References

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potential Pareto improvement show up as improvements in social wealth—so we are back to the Pareto criterion.1

References Blackorby, C., & Donaldson, D. (1990). A Review Article: The Case against the Use of the Sum of Compensating Variations in Cost-Benefit Analysis. Canadian Journal of Economics, 23 (3 August), 471–94. Boadway, R. (1974). The Welfare Foundations of Cost-Benefit Analysis. Economic Journal, 84 (336), 926–39. Boadway, R. (2001). The Economic Evaluation of Projects. http://qed.econ.queensu.ca/pub/faculty/ flatters/courses/rwb_ben-cost_rev.pdf Accessed 5 January 2021. Boadway, R. (2006). Principles of Cost-Benefit Analysis. Public Policy Review, 2, 1–44. Boadway, R. (2020). Economic Evaluation of Projects. In A. Shah (Ed.), Policy, Program and Project Evaluation (p. Chap. 3). Cham, Switzerland: Springer International. Boadway, R., & Bruce, N. (1984). Welfare Economics. Oxford: Basil Blackwell. Boardman, A. E., Greenberg, D. H., Vining, A. R., & Weimer, D. L. (2011). Cost-Benefit Analysis: Concepts and Practice 4th Ed. Upper Saddle River NJ: Pearson Education. Buchanan, J. M. (1999). The Logical Foundations of Constitutional Liberty: The Collected Works of James M. Buchanan Vol. 1. Indianapolis: Liberty Fund. Drèze, J., & Stern, N. (1987). The Theory of Cost-Benefit Analysis. In A. Auerbach & M. Feldstein (Eds.), Handbook of Public Economics Vol. II (pp. 909–89). Amsterdam: North-Holland. Ellerman, D. (2009). Numeraire Illusion: The Final Demise of the Kaldor-Hicks Principle. In M. D. White (Ed.), Theoretical Foundations of Law and Economics (pp. 96–118). New York: Cambridge University Press. https://www.worldcat.org/title/theoretical-foundations-of-law-andeconomics/oclc/723451182&referer¼brief_results Ellerman, D. (2014). On a Fallacy in the Kaldor-Hicks Efficiency-Equity Analysis. Constitutional Political Economy, 25(2 June), 125–136. Ellerman, D. (2020). The Uses of Diversity: Essays in Polycentricity. Lanham MD: Lexington Books. https://1lib.eu/book/5624307/3d7828 Friedman, D. D. (2000). Law’s Order: What Economics has to do with Law and why it matters. Princeton: Princeton University Press. Hicks, J. R. (1939). The Foundations of Welfare Economics. Economic Journal, 49(196), 696–712. Hicks, J. R. (1975). The Scope and Status of Welfare Economics. Oxford Economic Papers, 27(3), 307–26. Just, R., Hueth, D., & Schmitz, A. (2004). The Welfare Economics of Public Policy: A Practical Approach to Project and Policy Evaluation. Cheltenham UK: Edward Elgar Publishing. Kaldor, N. (1939). Welfare Propositions of Economics and Interpersonal Comparisons of Utility. Economic Journal, 49(195), 549–52. Nussbaum, M. (2001). The Costs of Tragedy: Some Moral Limits of Cost-Benefit Analysis. In M. D. Adler & E. A. Posner (Eds.), Cost-Benefit Analysis: Legal, Economic, and Philosophical Perspectives (pp. 169–200). Chicago: University of Chicago Press.

1 See Ellerman (2009, 2014, or Chapter 9 in 2020) for more on how this analysis affects neoclassical theory, e.g., consumer and producer surpluses or even the whole non-catallactic Marshall-Pigou view of Economics as being naturally divided into the production and the distribution of social wealth (Hicks 1975). As Kaldor put it: “This argument lends justification to the procedure, adopted by Professor Pigou in The Economics of Welfare (1960), of dividing ‘welfare economics’ into two parts: the first relating to production, and the second to distribution.” (Kaldor 1939, p. 551).

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Pigou, A. C. (1960). The Economics of Welfare 4th ed. London: Macmillan. Posner, R. (1972). Economic Analysis of Law. Boston: Little, Brown and Company. Posner, R. (2001). Cost-Benefit Analysis: Definition, Justification, and Comment on Conference Papers. In M. D. Adler & E. A. Posner (Eds.), Cost-Benefit Analysis: Legal, Economic, and Philosophical Perspectives (pp. 317–41). Chicago: University of Chicago Press. Ray, A. (1984). Cost-Benefit Analysis: Issues and Methodologies. Baltimore: Johns Hopkins University Press for the World Bank. Richardson, H. S. (2001). The Stupidity of the Cost-Benefit Standard. In M. D. Adler & E. A. Posner (Eds.), Cost-Benefit Analysis: Legal, Economic, and Philosophical Perspectives (pp. 135–167). Chicago: University of Chicago Press. Samuelson, P. A. (1979). Complementarity: An essay on the 40th anniversary of the Hicks–Allen revolution in demand theory. Journal of Economic Literature, 12(4), 1255–1289. Stokey, E., & Zeckhauser, R. (1978). A Primer for Policy Analysis. New York: W.W. Norton.

Chapter 8

Jurisprudence and the Corporate Governance Debate

Abstract Many of the controversial questions raised by the reintroduction of jurisprudential considerations into economics are also raised in the legal debates about corporations and corporate governance. Hence this chapter delves into the debates about corporations to show how the same issues reemerge in that context.

8.1

Introduction

Many of the themes investigated in the analysis of neoclassical economic theory, e.g., “Who is to be the firm?”, are also central to the debate about corporations and corporate governance. Hence we also need to apply some of the analysis to that debate. It is useful to start with the startlingly clear moral insight of Lord Eustace Percy: The human association which in fact produces and distributes wealth, the association of workmen, managers, technicians and directors, is not an association recognised by the law. The association which the law does recognise—the association of shareholders, creditors and directors—is incapable of production and is not expected by the law to perform these functions. We have to give law to the real association, and to withdraw meaningless privilege from the imaginary one. (Percy 1944, p. 38)

Our analysis has constantly examined the correspondence or lack thereof between the legal superstructure and the underlying facts about human intentionality and responsibility. Percy immediately points out the factual truth that the de facto “association which in fact produced and distributes wealth” is not even recognized by the law. And on the legal side, the association that is recognized, typically a corporation, is “not expected by the law to perform these functions” of producing and distributing wealth—even though the legal ‘picture’ is that the corporation does precisely that. Hence the whole jurisprudence of corporate law seems to take place in a sort of fantasyland of the legal imagination. It is part of our task to point out this whole cloth of fictions, this ‘mobile army of metaphors’, while also showing what legal institution allowed the original concept of the corporation to wander so far from its legitimate roots. That original conception goes back to Roman and medieval law. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_8

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In the Roman law model of a corporation all power resided in the community and was delegated to an official who acted on behalf of the community. . . . In the normal doctrine of Roman private corporation law, the agent's powers were not only derivative, but revocable and subject to modification. He represented the community as its delegate, its syndic. When this model was applied directly to large-scale political society it yielded a pure republicanism in which the chief magistrate could always be deposed by the will of the people. (Tierney 1982, p.26)

In the Roman and medieval law, the universitas or corporation was a group of people, the members, carrying out some activity together “that possessed a juridical personality distinct from that of its particular members.” (Ibid., p. 19) In the first place, the corporative structures of medieval society are again significant. We are dealing with a time when, all over Europe, separated individuals were in real life coming together, swearing oaths to one another, covenanting together to form new societies, sometimes political societies - all those universitates, guilds, colleges, communes that we noticed earlier - and were deliberately shaping constitutional structures for their new societies. For civil and canon lawyers one distinction between a universitas and a mere crowd of individuals consisted precisely in the fact that the universitas, but not the individuals, could create a ruling official, having ordinary jurisdiction over the community. (Ibid., p. 36)

How did we get from the original idea of a corporation as the legal embodiment of a group of people actually engaged in some joint human activity to today’s notion of a piece of property that can be routinely bought and sold in toto or piecemeal in shares on public markets and whose ‘members’ (the absentee shareholders) are not even expected to participate in the joint activity that “produces and distributes wealth”?

8.2

Two Types of Rights: Property Rights and Personal Rights

One helpful distinction is between the type of rights that a person holds because they play a certain functional role, like the voting rights in a municipality attached to citizens having the functional role of residing in the city, and ordinary property rights which one may hold without having to play a certain functional role. Let us call the rights attached to a functional role, personal rights, to distinguish them from property rights. It makes no sense to have personal rights being bought and sold since the buyer might not have the necessary functional role, and if a would-be buyer had the necessary role, then they don’t need to buy the rights. Since a person cannot play a functional role after they die, the inheritability of rights is the litmus test to distinguish personal from property rights. The heirs of a voter in a democracy do not inherit the voting rights of the deceased, but the heirs of a corporate shareholder do inherit the stock and its voting rights as alienable pieces of property.

8.3 Corporations and Cooperatives

8.3

143

Corporations and Cooperatives

The modern notion of a cooperative can be seen as an attempt to resurrect the original notion of a corporation based on the members carrying out some joint activity where that member-activity or functional role is usually called their patronage in the cooperative. A co-operative is an autonomous association of persons united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprise. (International Cooperative Alliance 2015, p. ii)

Like the original notion of a corporation, the modern notion of a cooperative has also suffered considerable degeneration—even though membership rights are typically1 not marketable property rights. Consider the common example of a consumer cooperative. What is the joint activity carried out by the consumer-members? It is not consumption as one might have in a kibbutz or commune. Their ‘patronage’ is just shopping in the store. However, their membership rights are to govern not just their ‘shopping’ but the operation of the store as a food distribution business. The joint human activity in a food distribution business is carried out by the employees of the ‘cooperative’, not the members. In a few consumer cooperatives, there is a pathetic work requirement such as to have a member hand out cheese samples once a month. In an upscale NY consumer cooperative, members were scandalized by learning that some members had their servants or nannies perform their work requirement—without even realizing that they stand in the same relation (i.e., collectively as the employer) with the rented people who do the real work of the food store. The agricultural marketing cooperatives are much bigger businesses that are similarly degenerated when the ‘family farms’ are agribusiness corporations using hired labor and the processing plants are similarly all run by rented people. Worker cooperatives, as in the Mondragon cooperatives (Whyte and Whyte 1991; Oakeshott 2000), seem to be the only remaining productive cooperatives where the cooperative is legally the “human association which in fact produces and distributes wealth. . .”. This critique of “cooperatives” based on hired labor is hardly new. In the early days of neoclassical economics, William Stanley Jevons advocated for industrial partnerships and referenced an 1870 critique of the usual form of cooperatives even at that time.

1

There have been poorly structured worker cooperatives, like the old plywood cooperatives of the US Northwest that had membership shares (carrying the personal rights of membership) which also carried the members’ property rights to their share of the retained earnings. A retiring member had to sell their share to recoup their part of the retained earnings. But replacement workers could rarely afford to pay out the retiree’s retirement income from the firm so shares were sold to outsiders who thus became “members” too, and new workers became just employees. See Ellerman (1990) for more analysis. Spain’s Sociedades Laborales (SLs) have a similarly poor structure (i.e., one instrument, the membership share, carrying both personal rights and property rights) but they are not considered cooperatives at all.

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The [industrial] partnership scheme is, I believe, by far the truest form of co-operation. We have heard a great deal of co-operation lately, until we may well be tired of the name; but I agree with Mr. Briggs* in thinking that many of the institutions said to be co-operative really lack the fundamental principle, that those who work shall share. If a co-operative retail store employ shopmen, buyers, and managers, receiving fixed and usually low salaries, superintended by unpaid directors, I can only say that it embodies all the principles of dissolution; it has all the evils of a joint-stock company without many advantages. (Jevons 1883, p. 141)

The Yale University legal scholar, Henry Hansmann, has extensively analyzed the connection between cooperatives and corporations. He has even espoused the theory that all corporations “are cooperatives” (Hansmann 2013) but with different patronage definitions. The shareholders in a conventional corporation are the legal members2 and Hansmann takes “supplying capital” as the patronage requirement in the conventional corporation which can then be described as a “capital suppliers cooperative.” The members of the capital cooperative each lend the firm a given sum of money, which the firm uses to purchase the equipment and other assets it needs to operate (say, to manufacture widgets—or cheese). The firm pays the members a fixed interest rate on their loans, set low enough so that there is a reasonable likelihood that the firm will have net earnings after paying this interest and all other expenses. The firm’s net earnings are then distributed pro rata among its members according to the amount they lent, with the distributions taking place currently, as dividends, or on liquidation. Similarly, voting rights are apportioned among members in proportion to the amount they have lent to the firm. To supplement the capital that it obtains from its members, the firm may borrow money from lenders who are not members but who simply receive a fixed rate of interest (which may be different from the fixed rate paid to members) without sharing in profits or control. (Hansmann 1996, p.14)

Furthermore, Hansmann asserts that this is “precisely the structure that underlies the typical business corporation” (Ibid., p. 14). But this characterization of the typical corporation does not stand up to scrutiny. Yes, a person who buys shares from a corporation does supply capital to the company but there are many of other ways to obtain shares—even if we grant the assumption, for the sake of argument, that buying second-hand shares on the market is the ‘indirect’ supplying of capital to the company. One can obtain shares as a bonus for good work in a company or as a hiring bonus. One can acquire shares as a gift or as an inheritance. Even the founders and organizers of a corporation can obtain shares without supplying capital (aside perhaps from some legally required and nominal par value). One can obtain shares for any of the reasons that one can obtain any property right. Moreover, Hansmann himself says otherwise. Ownership of a firm need not, and frequently does not, attach to investment of capital. Indeed, contrary to some popular perceptions and even to some more sophisticated organizational theory, ownership of the firm need have nothing to do with ownership of capital, whether physical or financial. (Ibid., p. 15)

“In general, the shareholders are the members of the company and the terms ‘shareholders’ and ‘members’ may be used interchangeably.” (Hannigan 2012, p. 304).

2

8.4 Stakeholder Governance

145

But this leaves open the question of the connection between cooperatives where, in theory, membership is a personal right attached to patronizing the business of the cooperative, and corporations where membership is a property right available to any and all without playing any qualifying role of patronage. The answer is that the conventional corporation is the limiting form of a cooperative where the patronage requirement goes to zero. With no patronage requirement whatsoever, the membership rights become free-floating property rights that can be owned by anyone. This thesis: conventional corporation ¼ zeropatronage cooperative also accounts for the universality of the conventional corporation. If such a legal form did not exist, it would soon be invented as long as the actual joint human activity of the corporation (in its original conception) can be carried out by non-members (i.e., employees). The whole debate about who “owns the corporation”3 is ill-posed since it is the membership rights that are owned as property rights by the shareholders. Whether or not one interprets that ownership of membership rights as the “ownership of the corporation” is only of linguistic and ideological interest—but it contributes to a lot of loose thinking in the corporate governance debate. Since a corporation is by design a separate legal entity from the members, the members do not own the corporate assets as their personal assets and do not owe the corporate liabilities as their personal liabilities. But some scholars imagine that the idea of the member/ shareholders as “owning the corporation” is based on the erroneous notion that they somehow directly own the corporate assets, and then conclude that the shareholders do not “own the corporation,” e.g., Robé (2011), Stout (2012), or Ciepley (2019). Such is the bewitchment of language in ill-posed questions.

8.4

Stakeholder Governance

Another focal point of the corporate governance debate is the notion of stakeholder governance of a corporation where a “stakeholder” is loosely defined as anyone affected by the corporation. This notion could be traced back to the Roman law notion: “Quod omnes tangit ab omnibus approbetur (‘What touches all is to be approved by all’)” (Tierney 1982, p. 21). In more recent times, Robert Dahl has discussed a similar affected interests principle: “Everyone who is affected by the decisions of a government should have the right to participate in that government.” (Dahl 1990, p. 49) Some form of the affected interests principle is often used to argue for stakeholder governance (Robé 2011; Harrison et al. 2019).

3

See Chassagnon and Hollandts (2014) for a review of the literature on who “owns the corporation.”

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To analyze this as an argument for ‘stakeholder governance,’ we need to distinguish between two very different types of control or governance rights: 1. Negative decision-constraining control rights: this is the right to constrain by not consenting to the actions of others, corporate or not, that affect one’s person or property. Government regulations also have that effect of constraining what a corporation can do. 2. Positive decision-making control rights: this is the right to participate in the making of a decision, e.g., by electing representatives on to the board of a corporation. Vague stakeholder arguments that having one’s interests affected by a corporation should qualify one to have some ‘control over the corporation’ need to be clearer about the difference between negative and positive control rights. If a cell phone provider changes the design, capabilities, and pricing of their cell phone, that affects the interests of people all over the world already owning that company’s phones and potential customers. Typically, the consumer exercises a negative control right by not buying the corporation’s product. There may be many instances where the consumer’s negative control rights seem insufficient and inadequate, e.g., through corporate capture of regulatory agencies so that regulations are not enforced or are otherwise gutted or abolished. But that clearly calls for government reform, not for stakeholders to have some sort of direct positive control right over a corporation. Moreover, it is hard to see, as a practical matter, how any such positive control right could even be organized and exercised or how it could outweigh the other interests, e.g., shareholders, in corporate governance. Nothing would be worse for certain stakeholders than to neglect their negative control rights for the positive control rights to be a minority member of corporate boards along with the other stakeholders such as employees, local community members, consumers, suppliers, representatives of ethnic groups, and environmentalists. Each minority would be quickly steamrollered by coalitions of management (representing themselves first, shareholders second, and their fiduciary duty to “society” a distant third) and other minority interest groups—so that they might finally understand that their true power was in negative control rights and regulations which need to be vastly improved. Throughout most of the twentieth century, following Berle and Means 1932 book, The Modern Corporation and Private Property, there has been a debate about de jure shareholder governance versus de facto managerial governance. Some managerialists espoused what sounded like a stakeholder notion of governance. Since the large corporations affected so many social interests, the managers should be seen as a new type of professional mandated to consider all social (i.e., stakeholder) interests (Berle 1959). But as we have seen, the membership rights in a corporation have become property rights, so stakeholder governance or some type of social-managerialism was seen as an attack on the private property rights of shareholders—even though there were strong collective actions problems for the scattered shareholders to actually organize and control management using their voting rights. This debate came to some sort of a climax in the 1990’s when some legal scholars rather prematurely announced the “end of history” (Hansmann and Kraakman 2001)

8.5 What About Shareholder Democracy?

147

for the corporate governance debate with managers finally swearing fealty to shareholder governance. But the reality was quite different. Despite managers’ previous verbal commitments (“Mission Statements”) to the interests of stakeholders (genuine or not), the reality of their commitments became evident by the evolution of CEO and other managerial compensation, e.g., an around 300 ratio between top and bottom compensation in many corporations (Mishel and Wolfe 2019). What had changed is that managers had learned how to achieve their sky-rocketing compensation with a number of schemes, such as stock options, virtual equity, and share appreciation rights, that were nominally coordinated with shareholder interests. By manipulating stock value through stock buybacks (Lazonick and Shin 2020), managers could take advantage of their window of opportunity to further their interests and many transient shareholders’ equally short-term interests to the detriment of the reinvestment to secure the long-term prospects of the companies. Hence the readiness of managers to swear fealty to shareholder governance. Now the pendulum may appear to swing a little bit in the other direction since some managers have grander self-images than just the hired hands of the shareholders (Business Roundtable 2019)—although that proved rather empty corporate happy-talk once the Covid-19 epidemic started (Goodman 2020).

8.5

What About Shareholder Democracy?

One reason for the seemingly never-ending debate about corporate governance is the lack of any serious legitimating principles on either side. By what principle should stakeholders have any positive decision-making rights in a corporation (as opposed to their legitimate but sometimes ineffective negative control rights)—even if it could be effectively organized and would outweigh shareholders’ interests? By what principle should the managers of large publicly-traded corporations be empowered to pursue whatever they see as social interests—all without any actual accountability mechanisms? By being accountable to everyone, they would be actually account to no one but themselves. Speaking of principles, what about democracy? Shouldn’t the ideal be shareholder democracy—no matter how impractical it might seem for the shareholders to actually organize together? If one can have political democracy in large nation-states with all the similar problems of organizing voters, why not shareholder democracy at least as an ideal in a corporation? One problem with the idea of (absentee) shareholder democracy is its impracticality. As pointed out some time ago, by an antitrust law professor: “The only cohesive, workable, and effective constituency within view is the corporation's work force.” (Flynn 1973, p. 106). The real problem is more basic. Democracy is based on the idea of a people’s selfgovernance, not just going through some procedures of nominating and voting on the members of a government. For example, if Russia went through all the process of

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nominating and having the Russian people vote on the government members, it would not be a democratic if it was the government of Poland that was being elected, not the government of Russia. In the usual fantasyland of corporate jurisprudence, there seems to be little recognition that the core value of democratic government cannot even apply in principle to the conventional corporation. The people governed or managed by the board and officials of a corporation are not the (absentee) shareholders but the people working in the company. Harvard law professor, Abram Chayes (1922–2000) was one of the few to have the insight and courage to state the obvious. The analogy between state and corporation has been congenial to American lawmakers, legislative and judicial. The shareholders were the electorate, the directors the legislature, enacting general policies and committing them to the officers for execution. . . . Shareholder democracy, so-called, is misconceived because the shareholders are not the governed of the corporation whose consent must be sought. . . . Among the groups now conceived as outside the charmed circle of corporate membership, but which ought to be brought inside it, the most important and readily identifiable is its work-force. (Chayes 1966, pp. 39–41)

Other law professors just ignore the point about who is “the governed of the corporation” and just consider the voting franchise as the key to ‘democracy’ no matter who has the franchise. Yet in fact there is democracy in the typical investor-owned firm; it is just that the investors of capital do the voting rather than the workers. Converting to worker ownership means not only enfranchising the workers but also disenfranchising the firm’s investors while continuing to deny the franchise to the firm's consumers. (Hansmann 1996, p. 43)

This is akin to saying that the American Revolution enfranchised the Americans while disenfranchising the English and continuing to deny the franchise to the French in the government of the Americans. It may be a puzzle to scholars in a time not yet born how so many of today’s political scientists and legal scholars have lost sight of the idea of democratic selfgovernance in the organizations where most adults spend much of their waking hours. Robert A. Dahl (1915–2014) was a remarkable exception among political scientists. In giving his “Sketch of an alternative,” he made no use or mention of the affected interests principle. He argued for: a system of economic enterprises collectively owned and democratically governed by all the people who work in them. By democratically governed, I mean that within each enterprise decision making would be designed so far as possible to satisfy the criteria for the democratic process that I described in the preceding chapter, and thereby to achieve political equality and the protection of primary political rights within the firm. One crucially important feature of self governing enterprises, then, is that they satisfy the criterion of voting equality; hence each person employed in an enterprise is entitled to one and only one vote. Systems of this kind have been called workers’ cooperatives or examples of selfmanagement or industrial democracy; but I prefer the term self-governing enterprises. (Dahl 1985, p. 91)

8.6 Concluding Remarks

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In the world of jurisprudents, Justice Louis D. Brandeis (1856–1941) seems to be the clear exception to the rule. The civilized world today believes that in the industrial world self-government is impossible; that we must adhere to the system which we have known as the monarchical system, the system of master and servant, or, as now more politely called, employer and employee. It rests with this century and perhaps with America to prove that as we have in the political world shown what self-government can do, we are to pursue the same lines in the industrial world. (Brandeis 1934, p. 35)

But these answers seem beyond the pale for almost all ‘responsible’ legal, economic, and political thinkers, so the kabuki theater of the ‘corporate governance debate’ will continue.

8.6

Concluding Remarks

The original and ancient idea of a corporation is a group of natural persons engaged in certain joint activities “that possessed a juridical personality distinct from that of its particular members.” (Tierney 1982, p. 19) That original conception of the corporation is recalled in Davis (1961), Raymond (1966), and in Abram Chayes’ Introduction in the Davis book. We can here perhaps note a final irony, at least. The concept of the corporation began for us with groups of men related to each other by the place they lived in and the things they did. The monastery, the town, the guild, the university, all described by Davis, were only peripherally concerned with what its members owned in common as members. The subsequent history of the corporate concept can be seen as a process by which it became progressively more formal and abstract. In particular the associative elements were refined out of it. In law it became a rubric for expressing a complicated network of relations of people to things rather than among persons. The aggregated material resources rather than the grouping of persons became the feature of the corporation. (Chayes 1961, p. xix)

Originally corporations such as the guilds were incorporated associations of people carrying a certain activity or type of work, and they had to be qualified to do so. Before the joint-stock company, the guild and the regulated company had been the organizational forms relied on in England for ordering major economic activities. ... Admission to practice was generally restricted to those who had successfully completed the requirements of an apprenticeship. Besides economic affairs, the guilds served as a primary focus for their members’ social and religious lives. Some also provided welfare benefits, such as sickness, unemployment and burial insurance. (Baskins and Miranti 1997, p. 58)

But even some intermediary corporations still required some qualifications. The regulated companies that followed the guilds and were precursors of the joint-stock companies were, on the other hand, royally chartered associations of independent merchants who collectively enjoyed a monopoly of trade with particular foreign markets. These companies appeared in England in the thirteenth century and like the guilds, required prospective members to complete the terms of an apprenticeship. (Ibid., p. 58)

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However, the process of taking the limit as the qualifications for ownership finally went to zero and that created the joint-stock company. Finally, share ownership provided an opportunity to invest capital without the need to participate in the business management, as was the case of partnerships and regulated companies. (Ibid, pp. 60–61)

How could this happen? How could a company carry out its activities if the owners have no qualifications? There was another institution that allowed this evolution of the idea of a corporation from the corporate embodiment of a group of people engaged in a joint activity to the concept of a piece of property, with the “associative elements” squeezed out, so that it could be owned by anyone and routinely bought and sold. It is the institution of employing, hiring, renting, or leasing of persons that allowed the separation between doing the work of the corporation and being an owner of the corporation as a piece of property. In that sense, the entire idea of an absentee-owned corporation is a ‘wholly-owned subsidiary’ of the legal institution of renting people. Contrary to much popular analysis, it is not “the corporation” that is the problem but the underlying employment relation. If cotton farms were incorporated in the Antebellum South, it should have been clear that the problem was not the legal form of the plantation but the underlying relationship of the lifetime servitude of the people doing the work of the farm. When a recent occupant of the American White House suggested buying Greenland, pundits were “shocked, just shocked” at the suggestion that “it’s just a real estate deal,” and yet the same commentators do not bat an eye at the daily business of buying and selling communities of work that have legally been reduced to “aggregated material resources.” It’s just an asset deal. It is an interesting aspect of the entire corporate governance debate that so many legal, political, and economic thinkers have completely lost sight of the idea of democratic self-governance that they otherwise whole-heartedly support in residence-based communities. Aside of some free market libertarians,4 there is no corresponding ‘municipal governance debate’ about whether cities or towns should be governed by the people residing in them or whether municipalities should have shareholders owning shares freely traded on public markets to achieve optimal efficiency. It is only because of this professionally prudent forgetting of democratic ideals applied to the workplace that the whole question of corporate governance and purpose is “up for debate” in the first place.5

4 See the discussions of charter cities (Mallaby 2010), startup cities (Freiman 2013, 2014), shareholder states (Cowen 2014), or seastead cities (Quirk and Friedman 2017). 5 For more analysis of the corporate governance debate, see Ellerman (2020 or Chapter 4.3 in 2021).

References

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References Baskin, J. B., & Miranti Jr., P. J. (1997). A History of Corporate Finance. Cambridge UK: Cambridge University Press. Berle, A. A. (1959). Power Without Property: A New Development in American Political Economy. New York: Harcourt Brace & Co. Berle, A., & Means, G. (1932). The Modern Corporation and Private Property. New York: MacMillan Company. Brandeis, L. D. (1934). The Curse of Bigness. New York: Viking. Business Roundtable. (2019, August 19). Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans.’ Business Roundtable. https:// www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-topromote-an-economy-that-serves-all-americans. Accessed 5 November 2019 Chassagnon, V., & Hollandts, X. (2014). Who are the owners of the firm: shareholders, employees or no one? Journal of Institutional Economics, 10(1 March), 47–69. https://doi.org/10.1017/ S1744137413000301 Chayes, A. (1961). Introduction. In Corporations (pp. i–xix). New York: Capricorn Books. Chayes, A. (1966). The Modern Corporation and the Rule of Law. In E. S. Mason (Ed.), The Corporation in Modern Society. New York: Atheneum. Ciepley, D. (2019, Spring). Wayward Leviathans: How America’s corporations lost their public purpose. Hedgehog Review. https://hedgehogreview.com/issues/animals-and-us/articles/way ward-leviathans Accessed 11 January 2021. Cowen, T. (2014, July 24). Anarchy Unbound. Marginal Revolution. http://marginalrevolution. com/marginalrevolution/2014/07/anarchy-unbound.html Dahl, R. (1985). Preface to Economic Democracy. Berkeley: University of California Press. Dahl, R. A. (1990). After the Revolution?: Authority in a Good Society Revised Ed. New Haven: Yale University Press. Davis, J. P. (1961). Corporations. New York: Capricorn Books. Ellerman, D. (1990). The Democratic Worker-Owned Firm. London: Unwin-Hyman Academic. Ellerman, D. (2020). Fallacies of Corporate Analysis. Challenge, 1–23. https://doi.org/10.1080/ 05775132.2020.1723289 Ellerman, D. (2021). Neo-Abolitionism: Abolishing Human Rentals in Favor of Workplace Democracy. Cham, Switzerland: Springer Nature. https://doi.org/10.1007/978-3-030-62676-1 Flynn, J. J. (1973). Corporate Democracy: Nice Work if You Can Get It. In R. Nader & M. J. Green (Eds.), Corporate Power in America (pp. 94–110). New York: Grossman Publishers. Freiman, C. (2013). Cosmopolitanism Within Borders: On Behalf of Charter Cities. Journal of Applied Philosophy, 30(1), 40–52. Freiman, C. (2014). Vote Markets. Australasian Journal of Philosophy, 92(4), 759–774. Goodman, P. S. (2020, April 13). Big business pledged gentler capitalism. It’s not happening in pandemic. New York Times. Hannigan, B. (2012). Company Law 3rd Ed. Oxford UK: Oxford University Press. Hansmann, H. (1996). The Ownership of Enterprise. Cambridge: Harvard University Press. Hansmann, H. (2013). All firms are cooperatives—and so are governments. Journal of Entrepreneurial and Organizational Diversity, 2(2), 1–10. https://doi.org/10.5947/jeod.2013.007 Hansmann, H., & Kraakman, R. (2001). The End of History for Corporate Law. Georgetown Law Journal, 89, 439–468. Harrison, J. S., Barney, J. B., Freeman, R. E., & Phillips, R. A. (Eds.). (2019). The Cambridge Handbook of Stakeholder Theory. Cambridge UK: Cambridge University Press. International Co-operative Alliance. (2015). Guidance Notes on the Cooperative Principles. Brussels: International Co-operative Alliance. https://www.ica.coop/sites/default/files/publicationfiles/ica-guidance-notes-en-310629900.pdf Jevons, W. S. (1883). Methods of Social Reform. London: Macmillan & Co.

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Lazonick, W., & Shin, J.-S. (2020). Predatory Value Extraction: How the Looting of the Business Corporation Became the US Norm and How Sustainable Prosperity Can Be Restored. New York: Oxford University Press. Mallaby, S. (2010). The Politically Incorrect Way to Ending Poverty. The Atlantic Monthly, (July). https://www.theatlantic.com/magazine/archive/2010/07/the-politically-incorrect-guide-to-end ing-poverty/308134/. Accessed 11 January 2021. Mishel, L., & Wolfe, J. (2019). CEO compensation has grown 940% since 1978 (No. 171191) (p. 21). Washington D.C.: Economic Policy Institute. https://files.epi.org/pdf/171191.pdf Oakeshott, R. (2000). Jobs and Fairness: The Logic and Experience of Employee Ownership. Norwich UK: Michael Russell. Percy, E. (1944). The Unknown State: 16th Riddell Memorial Lectures. London: Oxford University Press. Quirk, J., & Friedman, P. (2017). Seasteading: How Floating Nations Will Restore the Environment, Enrich the Poor, Cure the Sick, and Liberate Humanity from Politicians. New York: Free Press. Raymond, R. L. (1966). The Genesis of the Corporation. In Corporations: Selected Essays reprinted from the Harvard Law Review (pp. 1–16). Cambridge MA: Harvard Law Review Association. Robé, J.-P. (2011). The Legal Structure of the Firm. Accounting, Economics, and Law, 1(1), Article 5. https://doi.org/10.2202/2152-2820.1001 Stout, L. (2012). The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public. San Francisco: Berrett-Koehler Publishers. Tierney, B. (1982). Religion, Law, and the Growth of Constitutional Thought 1150-1650. Cambridge UK: Cambridge University Press. Whyte, W. F., & Whyte, K. K. (1991). Making Mondragon (2nd revised.). Ithaca: ILR Press.

Chapter 9

Invalidity of Personhood Alienation Contracts

Abstract Since the middle of the nineteenth century, three types of voluntary contracts, a lifetime master-servant contract, the coverture marriage contract, and the non-democratic constitution (pactum subjectionis) have all been abolished in the advanced democratic countries. Yet conventional classical liberalism and neoclassical economics offer no serious grounds for abolishing a genuinely voluntary contract—as opposed to suggesting various reforms and regulations or alternative voluntary contracts. However, there is a deeper tradition, which might be called “democratic or Enlightenment classical liberalism,” that historically developed a theory of inalienable rights in the Abolitionist, Democratic, and Feminist Movements that accounted for the abolition of those contracts. The ‘problem’ is that when that deeper theory of inalienable rights is recovered and reformulated in modern terms, then it clearly applies also to the human rental or employment contract that is the basis of the current economic system. This chapter describes the recovery and reformulation of that deeper theory of inalienable rights implying the invalidity of personhood alienation contracts.

9.1

Introduction to Rights-Based Normative Economics

There are three historical theories that when expressed in modern form converge on the abolition of the renting of persons in favor of workplace democracy: (1) the labor or natural rights theory of property, (2) inalienable rights theory, and (3) democratic theory (Ellerman 2021). The theory of property was developed in the Chap. 1 which touched on the connection with the inalienability of responsible human actions (‘labor’). In particular, the Fundamental Theorem of Property Theory showed that if there was a violation of the labor theory of property in production, then there would have to be a violation of the basic norms of contract (i.e., the no theft and no breach conditions) in the sphere of exchange. The employer’s sole legal appropriation of the whole product produced by the de facto responsible cooperation of all the people working in an enterprise (employees and working employer) violates people’s rights to the fruits of their labor (i.e., the juridical principle of imputation applied to production). The corresponding © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_9

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contractual violation is the no-breach condition; responsible human action is not in fact transferred from employees to the employer, unlike the services of things purchased by the employer. This chapter goes into more depth about that inalienability of responsible agency. It is a longer story since the theory of inalienability was actually developed much earlier and only needed to be recovered and reformulated in clear modern terms. Hence this chapter has more intellectual history than earlier chapters. Moreover, the abolition of the human rental contract follows the historical abolition (in democratic countries) of three other contracts: the voluntary slavery (or perpetual servitude) contract, the undemocratic constitution or pactum subjectionis, and the coverture marriage contract. But how does that square with the prevailing philosophy of conventional classical liberalism? Would conventional—as opposed to democratic or Enlightenment—classical liberal jurisprudence ever imply the abolition of a mutually voluntary contract between consenting adults—as opposed to promoting other voluntary alternatives? We may lament that a person would be so desperate to make certain contracts (like selling a kidney) and desire to paternalistically outlaw such contracts. On strictly classical liberal or libertarian grounds, the non-paternalistic response is to expand the range of choices and opportunities so that no one would be desperate enough to make such extreme contracts. So, again, the question is: are there (non-paternalistic) grounds in conventional classical liberalism to abolish any mutually voluntary contract between consenting adults—as opposed to promoting a smorgasbord of alternatives? This and related questions of justice will be approached by applying what might be called the correspondence theory of justice, namely the principle that justice in legal institutions lies in correspondence with the facts of human intentionality and responsibility. We have already encountered the property theoretic version of this principle, namely the labor or natural rights theory of property as the propertyapplication of the juridical principle of imputation: assign legal responsibility according to de facto responsibility.

9.2

Examples of Injustice as Non-Correspondence

We might start by considering the simplest examples of an injustice in jurisprudence, namely the non-correspondence between the legal assignments and the facts of intentional or responsible human action. There are two ‘canonical’ examples that can be illustrated by adapting the Type I and Type II error tables from Statistics that classify the correspondences and non-correspondences between hypotheses and facts: 1. False negative: When a factually guilty person is not legally convicted of the crime—like Type I error in statistics when a factually true hypothesis is not accepted (i.e., is rejected);

9.3 Example 1: The Coverture Marriage Contract

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Table 9.1 Type I and Type II Injustices

2. False positive: When a factually innocent person is legally convicted of the crime—like Type II error in statistics when a false hypothesis is not rejected (i.e., is accepted). These two types of injustice can be illustrated Table 9.1. The basic underlying juridical principle of imputation that is violated in these injustices is: Impute legal responsibility according to factual responsibility.

Can a contract involve a similar factual-legal mismatch to make it unjust?

9.3

Example 1: The Coverture Marriage Contract

The classic description of the coverture contract was by William Blackstone in his Commentaries. By marriage, the husband and wife are one person in law: that is, the very being or legal existence of the woman is suspended during the marriage, or at least is incorporated and consolidated into that of the husband; under whose wing, protection, and cover, she performs everything; and is therefore called in our law-French, a feme covert, and is said to be under the protection and influence of her husband, her baron, or lord; and her condition during her marriage is called her coverture. (Blackstone 1959 [1765], the section on husband and wife)

By the coverture marriage contract, the independent legal personality of the wife was extinguished. The feme covert was a legal dependent under the guardianship of her lord and baron husband. To understand the argument for the abolition of coverture (as opposed to promoting many other marriage alternatives), consider where modern, liberal, and democratic societies do have a legal relationship of dependency and guardianship. In each case, there is a factual requirement of incapacity, such as children of minority age, which needs to be certified in order to apply to adults:

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• Insanity or mental disability in adults; or • Senility (e.g., advanced dementia or Alzheimer’s disease). The coverture marriage contract established this sort of legal dependency and guardianship for adults where: • there was no factual requirement of impairment or incapacity; • where satisfying such a factual requirement was not required to ‘fulfill’ the contract; • becoming factually incapacitated is not the sort of thing a person can voluntarily do to ‘fulfill’ a contract; and • thus, the traditional Law substituted another notion of ‘fulfilling’ the contract, namely, obey your “Lord and Baron” husband. In short, the coverture contract was a legalized Type I injustice or ‘fraud’ on an institutional scale, i.e., establishing legal incapacity where there is no corresponding factual incapacity. To get a better sense of the legalized fraud, suppose, for the sake of argument, there was some voluntary act by which a person could turn themselves temporarily into a person of diminished capacity. Then one might lament that anyone would want or need to make such a contract (like selling a kidney), but at least that contract would not be a legalized fraud—since the factual performance would (we assume) fulfill the factual requirements in the eyes of the law for adult incapacity and dependency. The order of the argument should be noted. The premise of the argument is not that the legal right to personhood is inalienable; that is the conclusion. The premise is that the condition of personhood is de facto or factually inalienable, and thus the legal contract to legally alienable personhood can only be a legalized fraud. The same pattern: “factual inalienability of aspects of personhood” ought to imply “legal inalienability of aspects of personhood”—is followed in all the inalienability arguments. Moreover, the description of the Type I injustice as an institutional or legalized ‘fraud’ does not imply anything about the subjective intent of the legislators who codified the coverture contract or the subjective intent of the individual “Lord and Baron” husbands. The analysis is of the legal institution, not individual actors. The legislators of the time may or may not have considered women to be factually incapacitated, but the argument for the Type I mismatch is independent of their subjective intent. The Type I & II error table can be used, as in Table 9.2, to illustrate the mismatches between legal and factual capacity where the coverture contract involved the Type I error. The point is that the coverture marriage contract should be abolished by the standards of classical liberal jurisprudence (and has been in the liberal democracies) not because it was involuntary, but because it was a Type I mismatch and thus institutionally fraudulent. In a fraud, the legal contract says A but the factual performance to ‘fulfill’ the contract is not A but some B. The voluntary performance

9.4 Example 2: The Voluntary Slavery or Perpetual Servitude Contract

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Table 9.2 Type I & II mismatches of factual and legal dependency

on the part of the feme covert is obedience (¼ B), not voluntarily turning oneself into a factually incapacitated adult (¼ A). But the legal contract then enforces of the consequences of A. That’s an institutionalized fiction, i.e., a legalized fraud. It is obvious that this analysis has nothing whatever to do with pragmatic, consequentialist, or utilitarian considerations such as the treatment of the wife by her husband, the size of the allowance given by the husband to wife, abusive relationships, or the legislative intent of the coverture laws. Since the woman is just as much a de facto capacitated adult as before voluntarily agreeing to the contract (the Type I error), the coverture contract was essentially an institutional fraud sponsored by the legal system in patriarchal society that allowed the reduction of married women to the status of legal dependents to parade in the form of a voluntary contract.

9.4

Example 2: The Voluntary Slavery or Perpetual Servitude Contract

Similar arguments were made by abolitionists against the voluntary self-sale contract. A voluntary contract for a person to take on the legal status of a non-person or thing cannot be factually fulfilled by any voluntary act—just as the feme covert does not voluntarily convert herself into a factually incapacitated dependent. Hence the legal system substitutes the same factual performance in order to count as ‘fulfilling’ the contract; obey your master, e.g., in the Bible, Eph. 6:5, Titus 2:9, 1 Peter 2:18, Col. 3:22. Thus, a voluntary slavery contract had the same sort of fraudulent mismatch; the contract made one a legal non-person but the factual performance that counted to ‘fulfill’ the contract was only voluntary obedience by a de facto person. Since the factual performance did not, in fact, fulfill a contract to alienate one’s personhood, the contract was again a legalized fraud. The early Scottish abolitionist and legal

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scholar, George Wallace, juxtaposed the factual and legal status of the slave to argue for the invalidity of any slavery contract. Men and their liberty are not in commercio; they are not either saleable or purchaseable. For these reasons, every one of those unfortunate men, who are pretended to be slaves, has a right to be declared free, for he never lost his liberty; he could not lose it; his prince had no power to dispose of him. Of course, the sale was ipso jure void. This right he carries about with him, and is entitled every where to get it declared. As soon, therefore, as he comes into a country, in which the judges are not forgetful of their own humanity, it is their duty to remember that he is a man, and to declare him to be free. (Wallace 1760, pp. 95–96)

Any legal system that validated such a contract was still fully aware of the fraudulent Type I mismatch, e.g., whenever the ‘non-person’ committed a crime. As one Antebellum Alabama judge explained: the slaves are rational beings, they are capable of committing crimes; and in reference to acts which are crimes, are regarded as persons. Because they are slaves, they are . . . incapable of performing civil acts, and, in reference to all such, they are things, not persons. (Catterall 1926, p. 247)

The institutional fraud was plain to all who would see it. Forthright modern libertarians, such as Harvard’s Robert Nozick (at least the young Nozick), have not seen any reason to abolish a voluntary slavery contract between consenting adults. The comparable question about an individual is whether a free system will allow him to sell himself into slavery. I believe that it would. (Nozick 1974, p. 331)

Robert Nozick was not the only classical-liberal/libertarian who thought that the legal system should legalize and enforce any contract to alienate personhood. More recently, three oddly-self-labeled “left” libertarians have logically developed the idea that one’s self is owned like a piece of (alienable) property and have carried the idea to its logical conclusion of condoning a voluntary slavery contract. But left-libertarians affirm, in contrast with most other liberal egalitarians, the extensive alienability of rights of self-ownership, encompassing, for example, the right to sell oneself into onerous servitude or even permanent slavery. (Vallentyne et al. 2005, p. 212)

They continue to emphasize the point in a footnote. Of course, many will view the right to sell oneself into slavery as highly implausible. We believe, however, that the affirmation of this right of transfer is more in keeping with our status as autonomous, rational choosers than its denial. To whom would a duty not to sell oneself into slavery be owed? (Ibid., p. 212, fn. 21)1

1 They go on to give their references where they individually argue for voluntary slavery contracts: Vallentyne (2000); Steiner (1994, pp. 232–233); and Otsuka (2003, pp. 126–127). The three authors should be congratulated on following out the logical consequences of their theory (about ownership of the self as a piece of somehow de facto alienable property) instead of the more conventional libertarian or classical liberal posture of ignoring the question or just adopting a conventional opinion without any supporting theory. The notion of “theory” is often used so loosely in the literature on political science, jurisprudence, and philosophy that any personal opinion of a writer (e.g., Rawls) is usually construed as following from whatever “theory” they might espouse.

9.4 Example 2: The Voluntary Slavery or Perpetual Servitude Contract

159

The answer to their rhetorical question is that there is no duty to not act like a slave or even a dog if anyone should so desire. The theory of inalienability is about what contracts the legal system should or should not validate, not about slavish, dog-like, or “capitalist acts between consenting adults” (Nozick’s phrase).2 They, of course, never consider the fact that voluntarily becoming a de facto non-person to fulfill the legal status resulting from such a contract is not factually possible for “autonomous, rational choosers.” This acceptance of a civilized voluntary slavery contract was standard in historical conventional classical liberalism. Frank Knight pointed out that the foundations of classical liberalism, as he saw it, were laid well before Adam Smith. Interestingly enough, the political and legal theory had been stated in a series of classics, well in advance of the formulation of the economic theory by Smith. The leading names are, of course, Locke, Montesquieu, and Blackstone. (Knight 1947, p. 27, fn. 4)

All three of these classical writers indeed had a notion of “inalienable rights” but it was more a rhetorical flourish than a serious theory since they would only rule out a slavery contract where the master had the right to kill the slave. All three writers then ‘turned around’ and acknowledged that this rather faux notion of “inalienable rights” would not apply against a civilized voluntary slavery contract that had some rights on both sides. Here are the three pertinent quotes. For, if once Compact enter between them, and make an agreement for a limited Power on the one side, and Obedience on the other, the State of War and Slavery ceases, as long as the Compact endures. . . . I confess, we find among the Jews, as well as other Nations, that Men did sell themselves; but, ‘tis plain, this was only to Drudgery, not to Slavery. For, it is evident, the Person sold was not under an Absolute, Arbitrary, Despotical Power. (Locke 1960, Second Treatise, §24) This is the true and rational origin of that mild law of slavery which obtains in some countries; and mild it ought to be, as founded on the free choice a man makes of a master, for his own benefit; which forms a mutual convention between two parties. (Montesquieu 1912 [1748], Vol. I, Bk. XV, Chap. V) Yet, with regard to any right which the master may have lawfully acquired to the perpetual service of John or Thomas, this will remain exactly in the same state as before: for this is no more than the same state of subjection for life, which every apprentice submits to for the space of seven years, or sometimes for a longer term. (Blackstone 1959 [1765], section on “Master and Servant”)

A libertarian can take a piece of paper and write out a “contract” to be his neighbor’s “dog” so long as he is taken for a morning walk and gets a nice piece of meat for dinner. No law enforcement officer will show up to coerce the libertarian to stop sleeping in the dog-house, to take off the dog collar, and to stop drinking out of the toilet. The libertarian’s “yelps for liberty” are not in that sense constrained by the theory of inalienable rights. But they should not expect the legal system to validate and enforce any such ‘contracts’ to be a slave, a feme covert, a dog, or the like. For instance, if the neighbor decided to deliberately “put down his dog,” the legal system would rightly find him factually and then legally responsible for murder, not just animal abuse.

2

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Table 9.3 Type I & II mismatches of factual and legal status as a person

But we have seen that there are deeper classical liberal grounds to abolish the voluntary slavery contract because it was a Type I injustice or institutional fraud by validating a contract that applied the de jure role of a non-person to de facto persons.3 Here again, this analysis, illustrated in Table 9.3, of the voluntary slavery contract has nothing whatever to do with the consideration for the contract, the slave’s real income (food, clothing, and shelter), how harshly the slave is treated, or other such considerations—not to mention any master’s license to kill the slave. The argument has nothing to do with the legislators’ subjective “intent to commit fraud” when they validated voluntary slavery contracts4 nor with the subjective intent of the masters in such contracts.

9.5

Example 3: Pactum Subjectionis

The third example of a contract to alienate some aspect of people’s personhood is the collective governance contract of a non-democratic constitution or pactum subjectionis by which people would voluntarily give up their legal status as citizens to become subjects of some sovereign. [A]s Rousseau shrewdly observed, Pufendorf had argued that a man might alienate his liberty just as he transferred his property by contract; and Grotius had said that since

3 See George H. Smith (1997 or 2013) who independently developed precisely this critique of the voluntary slavery contract. 4 For instance, legislation was passed in Virginia in 1856 entitled “An Act Providing for the Voluntary Enslavement of the Free Negroes of the Commonwealth” (Link 2003, p. 158) or in Louisiana in 1859 “which would enable free persons of color to voluntarily select masters and become slaves for life” (Sterkx 1972, p. 149). See also the section on “Voluntary Enslavement” in (Morris 1996, pp. 31–36).

9.5 Example 3: Pactum Subjectionis

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individuals could alienate their liberty by becoming slaves, a whole people could do the same, and become the subjects of a king. (Davis 1966, p. 413)

Since those were, by assumption, voluntary social contracts, democratic theory had to go beyond the simplistic idea of democracy as “government with the consent of the governed”5 and differentiate those voluntary pacts of subjection from democratic constitutions. The difference was in the theory of inalienability. The idea of natural rights could be used to defend either absolutist or liberal theories of government; the outcome of the argument turned on the theory of alienability that an author adopted. The question at issue was whether the members of a community could or actually did alienate all their rights in the act of constituting a government. If they did so they would have instituted an absolutist regime. Liberal theorists therefore argued that individuals retained some rights even after a government had been constituted. In the later debates Pufendorf’s argument leaned more to absolutism, Locke’s more to liberalism. (Tierney 1997, pp. 182–183)

As the legal scholar, Otto von Gierke put it: This dispute also reaches far back into the Middle Ages. It first took a strictly juristic form in the dispute . . . as to the legal nature of the ancient ‘translatio imperii’ from the Roman people to the Princeps. One school explained this as a definitive and irrevocable alienation of power, the other as a mere concession of its use and exercise. . . . On the one hand from the people’s abdication the most absolute sovereignty of the prince might be deduced,. . . On the other hand the assumption of a mere ‘concessio imperii’ led to the doctrine of popular sovereignty. (von Gierke 1966, pp. 93–94)

Or as the American constitutional scholar, Edward S. Corwin said: During the Middle Ages the question was much debated whether the lex regia effected an absolute alienation (translatio) of the legislative power to the Emperor, or was a revocable delegation (cessio). The champions of popular sovereignty at the end of this period, like Marsiglio of Padua in his Defensor Pacis, took the latter view. (Corwin 1955, p. 4)

Contrary to Sir Henry Maine, from the viewpoint of democratic theory, “the movement of the progressive societies” has not been a movement “from Status to Contract” (Maine 1972, p. 100) but the movement from contracts of alienation to contracts of delegation.

5 For instance, the U.S. Government’s Report of the Commission on Unalienable Rights stated the conventional view that “classical liberalism put at the front and center of politics the moral premise that human beings are by nature free and equal, which strengthened the political conviction that legitimate government derives from the consent of the governed.” (Glendon et al. 2020, p. 8). This ignores the whole tradition dating at least from Roman law and up to Harvard’s Robert Nozick of modern times of basing non-democratic government “on consent of the governed” which was the historical basis for the Democratic Movement to develop the theory of inalienable rights in the first place.

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De Facto Inalienability

The doctrine that a person cannot, in fact, alienate their decision-making powers and responsible agency to factually fulfill an alienation contract has its roots in the Reformation doctrine of the inalienability of conscience. Here “conscience” means one’s basic beliefs. No matter what one is told to believe by the priest or Pope, it is always inexorably one’s own decision. As Martin Luther put it: Furthermore, every man is responsible for his own faith, and he must see it for himself that he believes rightly. As little as another can go to hell or heaven for me, so little can he believe or disbelieve for me; and as little as he can open or shut heaven or hell for me, so little can he drive me to faith or unbelief. (Luther 1942 [1523], p. 316)

The inalienability of one’s decisions about one’s beliefs was summarized by Ernest Cassirer as the actual “central principle of Protestantism” (Cassirer 1963a, p. 117): “No one can believe for another.” Roger Williams (1603–1683) was an early and clear advocate of the inalienability of conscience in America. As the modern editor of Williams’ works on religious liberty put it: “Williams believed it absurd to suggest that persons could ‘will or entrust such a power to the civil magistrate to compel their souls and consciences’ to conform to convention or a government mandate, for conscientious conviction is by definition an inalienable experience over which no third party can assume control.” (Davis 2008, p. 25) This principle was then transformed in the Radical Enlightenment (Spinoza) and the Scottish Enlightenment (Francis Hutcheson) into the doctrine of inalienability based on one’s personhood. Few have seen these connections as clearly as Staughton Lynd in his Intellectual Origins of American Radicalism. When commenting on Hutcheson’s theory, Lynd noted that when “rights were termed ‘unalienable’ in this sense, it did not mean that they could not be transferred without consent, but that their nature made them untransferrable.” (Lynd 1969, p. 45) The crucial link was to go from the de facto inalienable liberty of conscience to a theory of inalienable rights based on the same idea. “Like the mind’s quest for religious truth from which it was derived, self-determination was not a claim to ownership which might be both acquired and surrendered, but an inextricable aspect of the activity of being human.” (Lynd 1969, pp. 56–57) Since “being human’ or personhood was not something that could be factually alienated to ‘fulfill’ a contract, any such legal contract to alienate aspects of “being human” is naturally invalid. And then “Jefferson took his division of rights into alienable and unalienable from Hutcheson, who made the distinction popular and important” (Wills 1979, p. 213). Hutcheson provided the alternative language to describe a right where the contract to alienate the right was inherently invalid—the language of inalienable rights. Although the appeal to inalienable rights first arose in the context of religious freedom, it was quickly extended to spheres other than religion, as we find in Jefferson’s appeal to the inalienable rights of “Life, Liberty and the pursuit of Happiness.” This was one of the most significant developments in the history of libertarian thought. (Smith 2017, pp. 118–119)

9.6 De Facto Inalienability

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As noted by George H. Smith (1997 and 2013), this notion of rights inalienable due to invalid contracts to alienate aspects of personhood, was indeed an important development in the history of classical liberal (or libertarian) thought since it accounted for the abolition of certain voluntary contracts. Ernst Cassirer provides a good summary of this argument that rules out the non-democratic pactum subjectionis not because it was involuntary but because it fraudulently assumed the alienation (as opposed to delegation) of the decision-making powers that are inalienably part of people’s personhood. There is, at least, one right that cannot be ceded or abandoned: the right to personality. Arguing upon this principle the most influential writers on politics in the seventeenth century rejected the conclusions drawn by Hobbes. They charged the great logician with a contradiction in terms. If a man could give up his personality he would cease being a moral being. He would become a lifeless thing—and how could such a thing obligate itself—how could it make a promise or enter into a social contract? This fundamental right, the right to personality, includes in a sense all the others. . . . There is no pactum subjectionis, no act of submission by which man can give up the state of free agent and enslave himself. For by such an act of renunciation he would give up that very character which constitutes his nature and essence: he would lose his humanity. (Cassirer 1963b, p. 175)

Moreover, the classical liberal economist/philosopher, James M. Buchanan, arrived at the same conclusion that a classical liberal social order would only allow a constitution of delegation. First, Buchanan makes the standard point about the necessity of consent. The justificatory foundation for a liberal social order lies, in my understanding, in the normative premise that individuals are the ultimate sovereigns in matters of social organization, that individuals are the beings who are entitled to choose the organizationalinstitutional structures under which they will live. In accordance with this premise, the legitimacy of social-organizational structures is to be judged against the voluntary agreement of those who are to live or are living under the arrangements that are judged. (Buchanan 1999, p. 288)

Then he moves to a deeper level in classical liberalism and requires that in addition to being a “sovereign” in the marketplace, people may at most enter into delegative contracts where they are the principals. The central premise of individuals as sovereigns does allow for delegation of decisionmaking authority to agents, so long as it remains understood that individuals remain as principals. The premise denies legitimacy to all social-organizational arrangements that negate the role of individuals as either sovereigns or as principals. (Ibid.)

Thus, Buchanan is in the long line of democratic (as opposed to conventional) classical liberal theorists who exclude the constitutions of alienation (pactum subjectionis) in favor of democratic constitutions where the governors have the role of agents and representatives of the people as principals. Here again, this analysis and criticism of the non-democratic governance contracts of alienation have nothing whatever to do with whether the sovereign is a “good king,” the material conditions of the subjects, or other consequentialist considerations.

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9 Invalidity of Personhood Alienation Contracts

Employment Contract as the Human Rental Contract

Before considering the employer-employee contract as the fourth example, it might be helpful to recall the conceptual nature of the contract. The employer-employee relationship is usually described by various euphemisms such as hiring, employing, giving a job to, and so forth. But from the economic viewpoint, it is the renting of a person essentially similar to renting a car (called `hire-cars’ in the UK) or an apartment—in the sense of buying the flow of services rather than the entity providing the services. The ‘Standard Reply’ is “But they are not the same! Giving a job to someone is not the same as renting a car or an apartment.” Of course, the details are not the same—like renting a car is not “the same” as renting an apartment. The point is that renting a person, car, or apartment is buying the flow of services of an entity instead of buying the entity itself—and in that more abstract sense, renting a person, a car, or an apartment are the same.6 While this ‘renting’ terminology is nonstandard when applied to persons, it is in fact not even controversial. As the foremost neoclassical economist and first American Economics Nobel winner, Paul Samuelson, put it: Since slavery was abolished, human earning power is forbidden by law to be capitalized. A man is not even free to sell himself: he must rent himself at a wage. (Samuelson 1976, p. 52 [his italics])

Other prominent economists agree: Strictly speaking, the hourly wage is the rental payment that firms pay to hire an hour of labour. There is no asset price for the durable physical asset called a ‘worker’ because modern societies do not allow slavery, the institution by which firms actually own workers. (Begg et al. 1997, p. 201)

The human rental system we have today differs from involuntary slavery in two fundamental respects: • The system today is based on a voluntary contract, the employer-employee contract; and • The contract is only to sell a limited amount of one’s labor, not the whole of one’s labor.

There is a related linguistic dodge that might be mentioned, namely the talk of “renting services.” But the rented entity has to be returned to the owner after the time period of the contract, and the services of a car (car-days), apartment (apartment-months), or person (person hours) are used up and cannot be returned. When an entity is rented, then the flow of services of the entity are purchased or bought, not “rented.” 6

9.8 Example 4: The Human Rental Contract

9.8

165

Example 4: The Human Rental Contract

Things, as opposed to persons, cannot be responsible for anything. Only persons can be responsible for anything, be it a crime or not. This distinction is perfectly standard in jurisprudence (liberal or otherwise). As Immanuel Kant put it: “A person is the subject whose actions are susceptible to imputation. . . . A thing is something that is not susceptible to imputation.” (Kant 1965, pp. 24–25). The modern jurist, Hans Kelsen, describes the associated norm of imputation. Since the connection between delict and sanction is established by a prescription or a permission-a “norm”-the science of law describes its object by propositions in which the delict is connected with the sanction by the copula “ought.” I have suggested designating this connection “imputation.” This term is the English translation of the German Zurechnung. The statement that an individual is zurechnungsfiihig (“responsible”) means that a sanction can be inflicted upon him if he commits a delict. The statement that an individual is unzurechnungsfiihig (“irresponsible”) -because, for instance, he is a child or insane-means that a sanction cannot be inflicted upon him if he commits a delict. . . . The idea of imputation (Zurechnung) as the specific connection of the delict with the sanction is implied in the juristic judgment that an individual is, or is not, legally responsible (zurechnungsfiihig) for his behavior. (Kelsen 1971, p. 327)

The juridically trained Austrian economist, Friedrich von Wieser, noted this difference between persons and things in 1889: The judge . . . who. . . confines himself to the discovery of the legally responsible factor— that person, in fact, who is threatened with the legal punishment. On him will rightly be laid the whole burden of the consequences, although he could never by himself alone—without instruments and all the other conditions—have committed the crime. The imputation takes for granted physical causality. (von Wieser 1930 [1889], p. 76)

Wieser restates the point in economic terms: If it is the moral imputation that is in question, then certainly no one but the labourer could be named. Land and capital have no merit that they bring forth fruit; they are dead tools in the hand of man; and the man is responsible for the use he makes of them. (Ibid., p. 79)

So, what are the facts about responsibility in a firm? The facts are that all the people who work in an enterprise, employees and working employers, are jointly de facto responsible for both: • the negative results, i.e., using up the inputs, and • the positive results, i.e., producing the outputs of the firm. But the legal system tells a different story. The employees (qua employees) jointly: • owe zero percent, 0%, of the liabilities for the used-up inputs; and • own zero percent, 0%, of the produced outputs of the enterprise.7 These are the actual property rights and obligations involved in the conventional firm. Unfortunately, most economists and philosophers use a “distributive shares” metaphor as if the employer and employees (or, for that matter, the master and slaves in a plantation) are in some sort of 7

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This is precisely the legal position of rented things, i.e., “dead tools in the hand” of the employer. Since those legal aspects are “intuitively obvious to the most casual observer,” it is no surprise that an Economics Nobel laureate could say in private correspondence: “Needless to say, the ‘legal’ aspects of all this are beyond me.” Thus, the human rental contract operates as if that human responsibility can be alienated and transferred to the employer who thus should have 100% of the legal responsibility for the positive and negative product, the assets and liabilities created in production. In modern economics, the list or ‘vector’ of those assets and liabilities created in a productive opportunity is called the “production vector” or “input-output vector” but for historical reasons, we call it the whole product since it lists the ‘whole’ results of production, both positive and negative. But an employee cannot voluntarily alienate their responsible agency to fulfill the human rental contract—just as the feme covert or voluntary slave could voluntarily take on the factual status to fulfill their contracts. Hence the legal system substitutes another factual performance to count as ‘fulfilling’ the human rental contract, namely obey your employer. All people can do voluntarily is to, say, obey another’s orders to do this or that, which means they are inextricably factually co-responsible for the results. Again, the fraud is out in the open for all who would see it—in the criminal case. A standard British law-book on the employer-employee relation notes: All who participate in a crime with a guilty intent are liable to punishment. A master and servant who so participate in a crime are liable criminally, not because they are master and servant, but because they jointly carried out a criminal venture and are both criminous. (Batt 1967, p. 612)

The obvious question is what happens in fact when the employer and employees “jointly carried out a [non-]criminal venture”? Do the employees suddenly turn factually into machines being “employed” by the all-responsible employer? No, the factually inalienable co-responsibility of the employees is the same as in the “criminal venture.” It is the response of the Law that changes. No crime has been committed so no need to hold a trial to assign the legal responsibility in accordance with the factual responsibility. The employer assumes and pays off the input liabilities and then has a 100% claim on the produced outputs, and the employees thus have 0% of the negative and positive fruits of their labor—in violation of the property theoretic version of the juridical principle of imputation, the labor or natural rights theory of property (Schlatter 1951). Since there is no actual transfer of responsible human agency from the laborseller to the labor-buyer, the whole contract to buy-and-sell labor, i.e., to rent persons, is a legalized fraud on an institutional scale, and thus should be abolished

partnership where they each get their “share” of the results. Then attention is focused on whether or not the metaphorical shares were ‘fair’ or not, e.g., Rawls (1971, p. 308). See any Economics text for that discussion about ordinary firms, and see Fogel and Engerman (1974), David et al. (1976), and with a recent survey Hilt (2020) for that analysis of slave plantations.

9.8 Example 4: The Human Rental Contract

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along with the self-sale contract and coverture marriage contract on classical liberal grounds. Here again, this analysis and critique of the employment contract have nothing whatever to do with ‘exploitative’ wage rates (in either a Marxist or neoclassical sense), the working conditions, the employees’ feelings of being dominated (in a civic republican sense), alienated (in a Marxist or other psychological or humanist sense), or other consequentialist considerations. For instance, Karl Marx’s labor theory of value and exploitation, setting aside all its other problems (see the Chap. 6 on Marx), would be only a critique of low wages, not a critique of the human rental system itself. Marx himself let this fact slip out in his claim that there would be exploitation in overtime pay “even if the labour-power expended during the normal working day were paid for at its full value.” (Marx 1990. Book I, Chap. X, Sec. 3, p. 357 fn. 40). Thus, the supposed critique is of the labor not being “paid for at its full value,” not of the employment system itself.8 Marx brought a value-theoretic knife to a gun fight about contracts and property rights. Ernst Wigforss, one of the founders of Swedish social democracy, argued for the inalienability-invalidity of the human rental contract in 1923. There has not been any shortage of attempts to squeeze the labor contract entirely into the shape of an ordinary purchase-and-sale agreement. The worker sells his or her labor power and the employer pays an agreed price. . . .But, above all, from a labor perspective the invalidity of the particular contract structure lies in its blindness to the fact that the labor power that the worker sells cannot like other commodities be separated from the living worker. ... Here we perhaps meet the core of the whole modern labor question,. . . . (Wigforss 1923, p. 28)

Indeed, the core of the labor question, so completely avoided in the earnest discussions about inequality (Blanchard and Rodrik 2021) by neoclassical economists, is the whole application of the notion of renting, hiring, or leasing applied to persons. The very idea is as unthinkable as questioning the application of buying and selling persons was to the leading thinkers of the eighteenth century. The modern political theorist, Carole Pateman, makes the same point in her 1988 book about the coverture contract writ large as “The Sexual Contract”: “The answer to the question of how property in the person can be contracted out is that no such procedure is possible. Labour power, capacities or services, cannot be separated from the person of the worker like pieces of property.” (Pateman 1988, p. 150)9 The moral philosopher, Elizabeth Anderson, makes a similar point. This makes it seem as if the workplace is a continuation of arm’s-length market transactions, as if the labor contract were no different from a purchase from Smith’s butcher, baker, or brewer. ...But the butcher, baker, and brewer remain independent from their customers after

8 Of course, Marx was completely against the (private) employment system personally, but the discussion is about his theory, not his personal opinions. The reach of his opinions often exceeded the grasp of his theories. 9 This analysis is further developed in the context of the modern discussion of “self-ownership” in Pateman (2002).

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selling their goods. In the employment contract, by contrast, the workers cannot separate themselves from the labor they have sold; in purchasing command over labor, employers purchase command over people. (Anderson 2017, p. 57)

A thing, like a tool, a beast of burden, a truck, or an apartment can be factually transferred to the use or employment of another person to factually fulfill a rental contract. A prominent classical liberal law professor, Randy Barnett, correctly asserted that some factual transfers cannot be made. If rights are enforceable claims to control resources in the world and contracts are enforceable transfers of these rights, it is reasonable to conclude that a right to control a resource cannot be transferred where the control of the resource itself cannot in fact be transferred. Suppose that A consented to transfer partial or complete control of his body to B. Absent some physiological change in A (caused, perhaps, by voluntarily and knowingly ingesting some special drug or undergoing psychosurgery) there is no way for such a commitment to be carried out. . . . What is my house or car could equally well be your house or car. But bodies are different from other kinds of things. What is my body cannot in any literal sense be made your body. Because there is no obstacle to transferring control of a house or car (of the sort that is unavoidably presented when one attempts to transfer control over one’s body), there is no obstacle to transferring the right to control a house or car. But if control cannot be transferred, then it is hard to see how a right to control can be transferred. (Barnett 1986, pp. 188–189)

Responsible human action, i.e., labor, cannot be separated or factually transferred or alienated from the “employed” person—unlike the services of anything that is rented out, e.g., a tool, a mule, a truck, or an apartment.

9.9

Frank Knight as an ‘Exceptional’ Classical Liberal Thinker

Most ‘responsible’ social scientists and legal scholars ‘tippy-toe’ around the mismatch between labor services as factually responsible human actions and their legal role as merely causally efficacious productive services like those of capital or land. But Frank Knight was a noteworthy exception; he was by far the most deepthinking and outspoken of the defenders of the human rental system. He knew that he had to collapse any relevant distinction between factually responsible human labor and the causally efficacious or productive services of things so that: “For ‘labor’ we should now say ‘productive resources’.” (Knight 1956, p. 8). In a deeper analysis, the error in the whole classical position ... roots in the special character and role assigned to labor. More generally still, it consists in confusing conceptual analysis with ethical evaluation. From the former standpoint, labor and capital instruments, including land, are all alike, simply productive resources. (Knight 1956, p. 87, fn. 70) To conclude this brief discussion of the productive services, we may merely notice the invalidity of . . . commonly assumed grounds of distinction between labor and property services. . . . It is characteristic of the enterprise organization that labor is directed by its employer, not its owner, in a way analogous to material equipment. Certainly there is in this

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respect no sharp difference between a free laborer and a horse, not to mention a slave, who would, of course, be property. (Knight 1965, p. 126)

And if all the employees in an enterprise are just supplying services like the productive services of things, then the only human actions responsible for the positive and negative results of the enterprise are the actions of the employer/ entrepreneur. Under the enterprise system, a special social class, the business men, direct economic activity; they are in the strict sense the producers, while the great mass of the population merely furnish them with productive services, placing their persons and their property at the disposal of this class; the entrepreneurs also guarantee to those who furnish productive services a fixed remuneration. (Knight 1965, p. 271)

We have seen how the inherent invalidity of a personhood alienation contract, like a voluntary slavery contract, can also be expressed as the inalienability of the rights such contracts would legally alienate. As if to anticipate the inalienability argument for human rentals, Frank Knight continually criticized the notion of “inalienable rights” as not allowing workers to hypothecate or mortgage their future labor in order to obtain present resources. The peculiar weakness of the position of one who owns earning power only in the form of personal capacities is, somewhat paradoxically, a consequence of the guarantee of personal freedom, general in modern nations, but logically not a part of the property system; in fact, it is a limitation on the ownership of one’s own person. Because of such “inalienable rights” a man cannot “capitalize” his earning power because a contract to deliver labour in the future will not be enforced. (Knight 1947, p. 26, fn. 3)

Since the “inalienable rights” restrictions on selling or collateralizing future labor are “logically not a part of the property system” in the human rental economy, those restrictions must be set aside for the idealized competitive model of the human rental system to achieve allocative efficiency; otherwise there might willing buyers and sellers of future labor who would be forbidden to make a mutually beneficial transaction. As another conventional economist put it in Congressional testimony: Now it is time to state the conditions under which private property and free contract will lead to an optimal allocation of resources. . . The institution of private property and free contract as we know it is modified to permit individuals to sell or mortgage their persons in return for present and/or future benefits. (Christ 1975, p. 334)

And to consistently round-out his argument, Knight must give an alternative rationale for the abolition of slavery than “inalienable rights.” The abolition of slavery or property in human beings rests on the fact that slaves do not work as effectively as free men, and it turns out to be cheaper to pay men for their services and leave their private lives under their own control than it is to maintain them and force them to labor. (Knight, 1965, p. 320)

Thus, Knight argues that slavery was abolished because it was cheaper to rent workers rather than own them. Aside from the rather dubious historical argument (not to mention the idea that the American Civil War was fought over the question of efficiency), inefficiency is not a reason to abolish slavery, but only to ensure that

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more efficient labor contracts are available to out-compete slavery in the free market of conventional classical liberalism.

9.10

Classical Liberal Jurisprudence and the Abolition of Certain Voluntary Contracts

We now have seen four examples of Type I mismatches and institutionally fraudulent contracts that legally alienated certain factually inalienable aspects of one’s personhood and thus should all be abolished on democratic or Enlightenment classical liberal grounds: • • • •

the voluntary slavery or self-sale contract; the coverture marriage contract; the pactum subjectionis; and the human rental or self-rental contract. Hence, we can abstract the common features:

• All the contracts put a normal capacitated adult into the legal role of a person of diminished or no capacity (within the scope of the contract); • All the contracts are not factually fulfilled by the person voluntarily becoming a person of diminished or no capacity; • All the historical contracts hence substituted another voluntary performance that would count as ‘fulfilling’ the contract to alienate aspects of personhood, namely the promise10 to; – obey your master, – obey your husband, – obey your ruler, and – obey your employer. All the contracts were the institutional basis for a legalized fraud; legally treating a normal capacitated person as a person of diminished or no capacity within the scope of the contract. The critique is not of the persons who, for whatever reason, accepted such contracts and ‘fulfilled’ them by their promised voluntary obedience. The critique is of any legal system that accepts such personhood- or personalalienation contracts as legally valid. A bedrock principle of classical liberal jurisprudence is that contracts must be voluntary and non-fraudulent,11 namely maintaining the correspondence between the legal transfers and the factual transfers.

10 The argument is not that one should not or cannot promise to obey; the argument is that such a promise does not turn one into a person of diminished or no capacity (within the scope of the contract). 11 This might be contrasted with the usual left-wing criticism that just escalates one’s notion of “voluntariness” until the contracts one wants to criticize are seen as “involuntary.”

9.10

Classical Liberal Jurisprudence and the Abolition of Certain Voluntary. . .

171

It seems to be important to note that the inalienability critique of human rentals is about the institution, not about individual acts. Upon first hearing the neo-abolitionist critique, one common response is to defend some individual act, not the institution (i.e., the employment contract)—such as: “After Uncle Ralph died, Aunt Louise hired the neighbor’s boy to mow the lawn with Ralph’s lawnmower. Are you saying she is a bad person?” No, the theory of inalienability does not say that Aunt Louise is a bad person; it says that any legal institution validating and enforcing a contract to legally alienate aspects of personhood that are de facto inalienable is an institutionalized injustice.12 But the analysis here is that the personhood alienation contract may well be voluntary (i.e., in the obedience ‘fulfillment’ sense) but such contracts are Type I mismatches and thus objectively fraudulent. Does this juridical theory of inalienability have an explanatory or clarifying power? The theory implies the: • abolition of the voluntary slavery contract; • abolition of the pactum subjectionis as a basis for political government; and • abolition of the coverture marriage contract. In the last two centuries, the most important social changes in the Western industrialized countries have been: • the abolition of slavery, involuntary and voluntary (nineteenth century); • the acceptance of democracy as the only legitimate form of government (nineteenth century); and • the abolition of the coverture marriage contract and other advances in the Women’s Movement (e.g., married women’s property acts in the nineteenth and early twentieth centuries). It is intellectually convenient to nod in agreement when a theory implies the abolition of institutions that have already been abolished. One of the more amusing aspects of arguing these questions today is philosophers, economists, and legal theorists defending the human rental system from a normative basis that is so weak that it does rule out any of the three historically abolished contracts. They find consequentialist arguments against those already abolished institutions to be ‘convincing’ but find arguments against human rentals to be ‘not convincing’—since the employment relation (apparently unlike those abolished institutions) can always be better regulated and reformed. How very convenient for one’s self-image and career! That is why conventional thought has a vested interest in the superficial intellectual history that does not delve too far into the abolitionist arguments that descend Another standard libertarian “defense” of the human rental contract does not even connect to the issue. “What could possibly be wrong with a contract that says ‘You do this, I do that, and here is how we split the proceeds.’?” Nothing is wrong since that is such a general description of a partnership contract that it has none of the peculiarities of the human rental contract which is not a partnership contract (except metaphorically).

12

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from the Reformation and Enlightenment in the Abolitionist, Democratic, and Feminist Movements. Hence conventional thinkers get nowhere near the old abolitionist arguments that once modernized and understood imply the abolition of the human rental or employment contract. That social change is far from being carried out, and what professional social scientist wants to jeopardize their career or wants to be a marginalized pariah like the abolitionists in the Antebellum era? It was hard enough to be an abolitionist in the North, but being an abolitionist in the Antebellum South would have been a sure way to be “tarred, feathered, and ridden out of town on a rail”—at the very least. When any theory implies the abolition of a bedrock institution in the ambient society, then the people born, raised, and building their careers in that society will consider the institution as natural and, of course, legitimate, and thus such any abolitionist (or neo-abolitionist) theory will be considered a reductio ad absurdum.

9.11

The Democratic Alternative

The alternative to the human rental system (Ellerman 1990, 1992, 2021) is: • • • • •

genuine system of private property (people getting the fruits of their labor); genuine system of non-fraudulent market contracts; everyone is a member of the democratic enterprise where they work; people are jointly working for and governing themselves in the workplace; and jointly appropriating the positive and negative fruits of their labor.

With remarkable courage and clarity, the Tory thinker, Lord Eustace Percy, put the fundamental task as follows: Here is the most urgent challenge to political invention ever offered to the jurist and the statesman. The human association which in fact produces and distributes wealth, the association of workmen, managers, technicians and directors, is not an association recognised by the law. The association which the law does recognise—the association of shareholders, creditors and directors—is incapable of production and is not expected by the law to perform these functions. We have to give law to the real association, and to withdraw meaningless privilege from the imaginary one. (Percy 1944, p. 38)

Note that Percy’s two associations correspond precisely to the: 1. Type I association that factually “produces and distributes wealth” but is not even “recognised by the law” and 2. Type II association which “the law does recognise” is factually “incapable of production and is not expected by the law to perform these functions” as illustrated in Table 9.4. The same conclusions were arrived at by one of America’s greatest jurisprudential thinkers, Justice Louis D. Brandeis. The civilized world today believes that in the industrial world self-government is impossible; that we must adhere to the system which we have known as the monarchical system, the system of master and servant, or, as now more politely called, employer and employee. It

9.12

Concluding Remarks on the Inalienability of Responsible Agency

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Table 9.4 Type I & II mismatches between legal and factual responsibility for the whole product of an enterprise

rests with this century and perhaps with America to prove that as we have in the political world shown what self-government can do, we are to pursue the same lines in the industrial world. (Brandeis 1934, p. 35) Must not this mean that the American who is brought up with the idea of political liberty must surrender what every citizen deems far more important, his industrial liberty? Can this contradiction—our grand political liberty and this industrial slavery—long coexist? Either political liberty will be extinguished or industrial liberty must be restored. (Ibid., p. 39) In my judgement, we are going through the following stages: We already have had industrial despotism. With the recognition of the unions, this is changing into a constitutional monarchy, with well-defined limitations placed about the employer's formerly autocratic power. Next comes profit-sharing. This, however, is to be only a transitional, half-way stage. Following upon it will come the sharing of responsibility, as well as of profits. The eventual outcome promises to be full-grown industrial democracy. (Ibid., p. 47)

9.12

Concluding Remarks on the Inalienability of Responsible Agency

The ‘problem’ in conventional classical liberal philosophy, economics, and jurisprudence is well illustrated by the case of James M. Buchanan. Consider, for example, the previous quote by the Nobel-prize-winning economist where he “denies legitimacy to all social-organizational arrangements that negate the role of individuals either as sovereigns or as principals.” (Buchanan 1999, p. 288) The phrase “all social-organizational arrangements” certainly includes the employment relation. But no one thinks that the employees are the principals and the employer is the agent, delegate, or representative of the employees in the employer-employee relation. The employment contract is an alienation contract, a pactum subjectionis, within the scope of the contract. Unlike Frank Knight, who better understood what he ‘had’ to do (e.g., identify responsible human action with the causally efficacious or ‘productive’ services of things), Buchanan and most other classical liberal

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scholars seem blithely unaware of the problem. Buchanan did not even notice in the economics system where he lived his whole life and in which he received the Economics Nobel Prize, that the employees are not the principals in the most common “social-organizational arrangements”; nor did he ever cast any doubt on the human rental relationship. It is just beyond the orbit of serious, not to mention prudent, consideration. Economists routinely ignore such arguments: “Such jurisprudential considerations are not part of Economics”—as if the current academic division of labor provided grounds for a normative defense of the system. Insofar as the topic is ‘seriously’ addressed, the usual dodge is to picture the employee only as the principal and sole proprietor in the business of selling their own labor services like a “resource-owner” might sell the services of an apartment or truck one owned—or just as the perpetual servant or coverture wife was the principal and sole proprietor in the business of selling larger chunks of their personhood. The willful neglect of the worker-qua-employee in favor of only considering the worker-qua-labor-seller was singled out for ridicule by the philosopher Elizabeth Anderson. The result is a kind of political hemiagnosia: like those patients who cannot perceive one-half of their bodies, a large class of libertarian-leaning thinkers and politicians, with considerable public following, cannot perceive half of the economy: they cannot perceive the half that takes place beyond the market, after the employment contract is accepted. (Anderson 2017, pp. 57–58)

Aside from providing some amusement to future scholars, these ‘arguments’ just ignore the whole inalienability analysis that is the root of the critique of those contracts to legally alienate aspects of personhood (e.g., responsibility and decision-making). The protest “But that’s not Economics” highlights why jurisprudence needs to be reintroduced into today’s Economics. Nevertheless, that factual inalienability critique is the basis for abolishing the historical personhood-alienation contracts. Those arguments are just ignored by the rather contrived but standard Economics picture of the owners of human resources being the principal and soleproprietor in the business of legally alienating aspects of one’s personhood. The philosophy of conventional classical liberalism historically developed, in part, as a defense of the system of private property and market contracts of which the employment contract has always been an integral part—even though that contract: • violates the non-fraudulent condition by putting the factually co-responsible employees into the legal position of non-responsible instruments; • violates the normative basis for private property appropriation since the employees legally appropriate 0% of the positive and negative fruits of their labor, and • violates the restriction to delegative contracts since the employment contract is a collective contract to alienate the employees’ self-governing rights to the employer within the scope of the employment. That form of classical liberalism seemed dedicated to the proposition that applying the market concept of buying and selling should not now to be applied to persons—which represents progress from the views of the founders such as Locke, Blackstone, and Montesquieu—but that there is no inherent problem (indeed, not

References

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even any discussion) about applying the concept of renting, hiring, employing, or leasing to persons. Hence, it is a considerable ‘problem’ for conventional classical liberalism if its own deeper principles, which implied the abolition of the voluntary slavery contract, the coverture marriage contract, and the social contract of a non-democratic constitution, also imply the abolition of the employment contract.

References Anderson, E. (2017). Private Government: How Employers Rule Our Lives (and Why We Don’t Talk About it). Princeton NJ: Princeton University Press. Barnett, R. (1986). Contract remedies and inalienable rights. Social Philosophy & Policy, 4(1), 179–202. Batt, F. (1967). The Law of Master and Servant (5th ed.). London: Pitman. Begg, D., Fischer, S., & Dornbusch, R. (1997). Economics (Fifth Ed.). London: McGraw-Hill Co. Blackstone, W. (1959). Ehrlich’s Blackstone. (J. W. Ehrlich, Ed.). New York: Capricorn Books. Blanchard, O., & Rodrik, D. (Eds.). (2021). Combatting Inequality: Rethinking Government’s Role. Cambridge: MIT Press. Brandeis, L. D. (1934). The Curse of Bigness. New York: Viking. Buchanan, J. M. (1999). The Logical Foundations of Constitutional Liberty: The Collected Works of James M. Buchanan Vol. 1. Indianapolis: Liberty Fund. Cassirer, E. (1963a). The Myth of the State. New Haven: Yale University Press. Cassirer, E. (1963b). The Question of Jean Jacques Rousseau. (P. Gay, Trans.). Bloomington: Indiana University Press. Catterall, H. T. (1926). Judicial Cases Concerning Slavery and the Negro (Vol. III). Washington, DC: Carnegie Institute. Christ, C. F. (1975). The Competitive Market and Optimal Allocative Efficiency. In J. Elliott & J. Cownie (Eds.), Competing Philosophies in American Political Economics (pp. 332–338). Pacific Palisades, CA: Goodyear. Corwin, E. S. (1955). The “Higher Law” Background of American Constitutional Law. Ithaca: Cornell University Press. David, P. A., Gutman, H. G., Sutch, R., Temin, P., & Wright, G. (1976). Reckoning with Slavery. New York: Oxford University Press. Davis, D. B. (1966). The Problem of Slavery in Western Culture. Ithaca: Cornell University Press. Davis, J. C. (2008). Introduction: Roger Williams and the Birth of an American Ideal. In On Religious Liberty: Selections from the Works of Roger Williams (pp. 1–45). Cambridge: Belknap Press. Ellerman, D. (1990). The Democratic Worker-Owned Firm. London: Unwin-Hyman Academic. Ellerman, D. (1992). Property & Contract in Economics: The Case for Economic Democracy. Cambridge MA: Blackwell. Ellerman, D. (2021). Neo-abolitionism: Abolishing human rentals in favor of workplace democracy. Cham, Switzerland: SpringerNature. https://doi.org/10.1007/978-3-030-62676-1 Fogel, R. W., & Engerman, S. L. (1974). Time on the Cross. Boston: Little, Brown and Company. Gierke, O. von. (1966). The Development of Political Theory. (B. Freyd, Trans.). New York: Howard Fertig. Glendon, M. A. et al. (2020). Report of the Commission on Unalienable Rights (p. 64). United States Department of State. https://www.state.gov/wp-content/uploads/2020/08/Report-of-theCommission-on-Unalienable-Rights.pdf Hilt, E. (2020). Revisiting Time on the Cross After 45 Years: The Slavery Debates and the New Economic History. Capitalism: A Journal of History and Economics, 1(2), 456–483. doi:https:// doi.org/10.1353/cap.2020.0000.

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Kant, I. (1965). The Metaphysical Elements of Justice: Part I of The Metaphysics of Morals. (J. Ladd, Trans.). Indianapolis: Bobbs-Merrill. Kelsen, H. (1971). What is Justice? Justice, Law, and Politics in the Mirror of Science Collected Essays by Hans Kelsen. Berkeley: University of California Press. Knight, F. H. (1947). Freedom and Reform. New York: Harper & Row. Knight, F. H. (1956). On the History and Method of Economics. Chicago: Phoenix Books. Knight, F. H. (1965). The Economic Organization. New York: Harper Torchbooks. Link, W. A. (2003). Roots of Secession: Slavery and Politics in Antebellum Virginia. Chapel Hill: University of North Carolina Press. Locke, J. (1960). Two Treatises on Government. New York: New American Library. Luther, M. (1942). Concerning Secular Authority. In F. W. Coker (Ed.), Readings in Political Philosophy (pp. 306–329). New York: Macmillan. Lynd, S. (1969). Intellectual Origins of American Radicalism. New York: Vintage Books. Maine, H. (1972). Ancient Law. London: Dent. Marx, K. (1990). Capital (Vol. I). (B. Fowkes, Trans.). London: Penguin Classics. Montesquieu, B. de. (1912). The Spirit of the Laws. (T. Nugent, Trans.). New York: Appleton. Morris, T. D. (1996). Southern Slavery and the Law, 1619-1860. Chapel Hill: University of North Carolina Press. Nozick, R. (1974). Anarchy, State, and Utopia. New York: Basic Books. Otsuka, M. (2003). Libertarianism without Inequality. Oxford: Oxford University Press. Pateman, C. (1988). The Sexual Contract. Stanford: Stanford University Press. https://books. google.com/books?isbn¼074568033X Pateman, C. (2002). Self-Ownership and Property in the Person: Democratization and a Tale of Two Concepts. Journal of Political Philosophy, 10(1), 20–53. https://doi.org/10.1111/14679760.00141e Percy, E. (1944). The Unknown State: 16th Riddell Memorial Lectures. London: Oxford University Press. Rawls, J. (1971). A Theory of Justice. Cambridge: Harvard University Press. Samuelson, P. A. (1976). Economics (10th ed.). New York: McGraw-Hill. Schlatter, R. (1951). Private Property: The History of an Idea. New Brunswick: Rutgers University Press. Smith, G. H. (1997). Inalienable Rights? Liberty, 10(6), 51–56. Smith, G. H. (2013). The System of Liberty: Themes in the History of Classical Liberalism. New York: Cato Institute, Cambridge University Press. Smith, G. H. (2017). The American Revolution and the Declaration of Independence: The Essays of George H. Smith. Washington D.C.: Cato Institute. Steiner, H. (1994). An Essay on Rights. Oxford: Blackwell. Sterkx, H. E. (1972). The Free Negro in Ante-Bellum Louisiana. Cranbury, N.J.: Associated University Presses. Tierney, B. (1997). The Idea of Natural Rights: Studies on Natural Rights, Natural Law, and Church Law 1150-1625. Grand Rapids: William B. Eerdmans Publishing. Vallentyne, P. (2000). Introduction: Left Libertarianism-- A Primer. In P. Vallentyne & H. Steiner (Eds.), Left Libertarianism and its Critics: The Contemporary Debate (pp. 1–20). New York: Palgrave Macmillan. Vallentyne, P., Steiner, H., & Otsuka, M. (2005). Why Left-Libertarianism Is Not Incoherent, Indeterminate, or Irrelevant: A Reply to Fried. Philosophy & Public Affairs, 33(2 Spring), 201–15. Wallace, G. (1760). A System of the Principles of the Law of Scotland. Vol. I. Edinburgh. Wieser, F. von. (1930). Natural Value. (C. A. Malloch, Trans.). New York: G.E. Stechert and Company. Wigforss, E. (1923). Den industriella demokratiens problem 1. Stockholm: A.-B. Hasse W. Tullbergs boktryckeri. Wills, G. (1979). Inventing America. New York: Vintage Books. Barnett, R. (1986). Contract Remedies and Inalienable Rights. Social Philosophy & Policy, 4(1), 179–202.

Chapter 10

Concluding Remarks About Jurisprudence and Neoclassical Economics

Abstract This last chapter is devoted to a general description of the descriptive and normative points of jurisprudence that arise when those points are introduced into today’s neoclassical microeconomic theory. These points are contrasted with the usual orthodox or heterodox criticisms of neoclassical economics as being unrealistic since the actual economy falls far short of the neoclassical regulative ideal of a fully competitive market economy based on the renting of human beings.

10.1

What Is Really Wrong Descriptively?

Almost all heterodox criticism of neoclassical economic theory focuses on the abstraction, idealizations, and unrealistic nature of the theory. This book eschews all such criticisms and focuses on “what is really wrong” with neoclassical theory, namely its neglect of basic jurisprudential considerations such as: • the responsible agency of persons as opposed to things, • the juridical principle of imputation, and • the inalienability of de facto responsibility (e.g., as in the hired criminal example). The fault is not in the price system. The problem descriptively and normatively lies in the underlying system of property and contract. Descriptively, neoclassical theory ignores the birth and death of property rights (i.e., the legal appropriation of assets and liabilities) in production and consumption activities. One major reason for ignoring appropriation in normal production is what we have termed the “fundamental myth” that product rights are already part and parcel of the ownership of the means of production so there is no new ownership to be established for the products in production. It is already there in the ownership of the underlying capital assets. Even though embedded in orthodox and much heterodox (e.g., Marxian) theory, the fundamental myth is easily defeated by just noting the case where the capital assets are rented out to some other party undertaking production. Then the product produced using those assets is not appropriated by the asset owner but by the residual claimant in the going-concern enterprise using the rented asset. Hence the identity of the firm in the going-concern sense is determined © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0_10

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by the market-endogenous question of who hires what or whom, not by the prior “ownership of the means of production.” It should not be too much to ask Economists to understand these facts about how markets operate. Even this simple point is sufficient to show the basic conceptual flaw in the goldstandard of the Arrow-Debreu model since it purported to show the existence of a competitive equilibrium with positive pure profits by claiming that “production sets” are “owned” by corporations. “The Arrow-Debreu model creates a category of pure profits which are distributed to the owners of the firm; it is not assumed that the owners are necessarily the entrepreneurs or managers.” (Arrow 1971, p. 70) But there are no such property rights in a private property market economy, idealized or not. And it precisely because of the idealized nature of the model that arbitragers could take over production by offering slightly higher prices to input-suppliers and/or slightly lower prices to output demanders until the positive profits were arbitraged away. Hence competitive equilibrium is only possible with zero pure profits as was argued consistently and correctly by other general equilibrium theorists such as Lionel McKenzie. Thus “what is really wrong” with the Arrow-Debreu model is not that it is idealized but that it structurally fails to model even an idealized private property competitive market economy. Neoclassical economic theory is really a theory of markets and prices, not a theory of property and contract. From Adam Smith onward, there was the conception of the invisible-hand or laissez faire market system. That culminated in the Fundamental Theorem of the Price System that a competitive equilibrium (a descriptive notion) is Pareto optimal (a normative notion). But it is little, if at all, noticed that there is also a laissez faire system concerning the underlying property rights that are basic to any market system. The legal authorities may intervene for a ‘visible’ judge to assign assets and liabilities in a trial. But the appropriation of assets and liabilities takes place all the time in normal production and consumption activities without any intervention of a visible judge. There is also an ‘Invisible Judge’ or laissez faire market system for the appropriation of assets and liabilities. And there is also a Fundamental Theorem for the market mechanism of property appropriation that describes the conditions under which the ‘invisible judge’ system (a descriptive notion) works correctly in terms of the usual norms of imputation of legal responsibility (a normative notion). Some of the chapters were not directly on the points about property and contract but were on closely related issues. Chapter 6 was on the how the failures of Marx and Marxism played into the hands of the apologetics for the human rental system so that Marxism has become the ultimate ‘capitalist tool.’ Chapter 7 was not about juridical points ignored by Economics but about a logical fallacy that is the basis for the attempt by neoclassical economics labelled “Law & Economics” to redo parts of jurisprudence based on the Kaldor-Hicks principle and wealth maximization. And Chap. 8 analyzed how the same issues of property and contract and democratic theory arise in the context of the corporate governance debate.

10.2

10.2

What Is Really Wrong Normatively?

179

What Is Really Wrong Normatively?

On the normative side, the problems in neoclassical theory and related orthodox (e.g., Austrian) theory are much deeper and more fundamental. The root problem is the lack of any basic distinction in neoclassical or Austrian (except Wieser) theory or even in most progressive heterodox theory between the responsible actions of persons and the causally efficacious services of things. Orthodox normative economics, e.g., “welfare economics,” distinguishes persons from the lower animals and things by only counting the preferences of persons, not the ‘revealed preferences’ of animals or things, in the normative notion of a Pareto improvement or Pareto optimality. But when it comes to the actions of persons (“labor”) versus the services of things, they are both only counted as being causally efficacious (“productive”) input services. Technically, the selling of the services of an entity (human or not) is the renting of the entity itself. Renting an apartment for a month or a car for a day is the buying of the services of an apartment-month or a car-day. And renting a person for an hour is the buying of a person-hour. Normal American usage talks about hiring a person but renting a car, but in the UK, rental cars are called “hire cars.”1 The human rental language is used here to constantly remind the reader that even though the whole system of owning workers (involuntarily or voluntarily) has been abolished, it does not mean that there is nothing intrinsically wrong with voluntarily renting workers instead. At some point in the far future, social scientists may well wonder how their counterparts today, who agree that the notion of selling should not be applied to persons, could seemingly without second thought think that the notion of renting could be applied to persons. It is a testament to the ‘Happy Consciousness’ instilled by the ambient society that the economically correct characterization of the employment contract as the renting of persons is a ‘surprise’ to most social scientists, not to mention ordinary people. It is something most people never thought of in that way—as if propagandainduced false consciousness only occurred in totalitarian communist or fascist societies. So many Economists and other social scientists see themselves as flying freely in the vast space of intellectual endeavors. But in fact, they fly within a glass corridor equipped to signal a warning whenever they get too near the transparent walls that guide the intellectual trajectory of ‘safe,’ ‘sane,’ and ‘serious’ social scientists.

1 The law of “loan and hire” (Baty 1918) in the UK is about the hiring of things. And as our profound and honest antagonist, Frank H. Knight put it: “. . .in a free society the larger part of the productive capacity employed (as matters stand today in a typical Western nation) consists of the services of human beings themselves, who are not bought and sold but only, as it were, leased.” (Knight 1936, p. 438). When a person is rented out by their (separate) owner in a system (involuntary) slavery (as opposed to the current system of people voluntarily renting themselves out), then all the linguistic variations are customarily used, e.g., in “the practice of ‘hiring out,’ ‘renting,’ or the ‘leasing’ of slave labor. . .”. (Hulse 2010, p. 504).

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The normative theory of property theory presented here is not anything new or unorthodox; it is just the usual ‘bourgeois’ juridical principle of imputation (“Assign legal responsibility according to de facto responsibility”) applied to the matter of appropriating assets and liabilities. It is the modern rendition of the old idea of people having the right to the (positive and negative) fruits of their labor, i.e., the labor or natural rights theory of property. Neoclassical marginal productivity theory pays homage to that principle by applying it metaphorically in the marginal productivity pricing of all input services under competitive conditions (ignoring any difference between the responsible actions of persons and the mechanical services of things). Each productive factor economically gets what it is economically responsible for producing. In that manner, neoclassical theory tries to normatively justify a metaphorical division of the product between the different factors of production. This is one of the high points of neoclassical Economics; paying silent homage to the juridical principle of imputation to justify a metaphorical division of the product using a metaphorical notion of responsibility. At least neoclassical Economics had the right idea by invoking the juridical principle of imputation. But the relevant non-metaphorical notion of responsibility is the usual legal or moral one wherein persons are the only responsible agents, not an invented notion of “economic responsibility” that applies to all causally efficacious services of persons and things. And the relevant non-metaphorical division of the product is that the employer appropriates 100% of the liabilities and assets created in production while the employees and other rented factors appropriate 0% of those liabilities and assets. Thus, the actual picture is that the juridical principle of imputation is completely violated in production based on renting the persons working in the enterprise. The irony is that the human rental system (a.k.a. “capitalism”) is not the natural system of private property implementing the principle of people getting the fruits of their labor; it is only ‘a’ system of private property as was the system of chattel slavery. It was only because “The Alternative” was considered to be some form of socialism/communism (public human rentals) that the (private) human rental system could even plausibly strike that historical posture. The Fundamental Theorem for the property system says that if the system of contracts works correctly (the no-thefts/externalities and no-breaches conditions), then the Invisible Judge will correctly assign the assets and liabilities created in production according to the juridical principle of imputation. The problem is not in the invisible judge of the laissez-faire system of legal appropriation, some form of which must work in any private property market economy. Since we have just noted that the juridical principle is violated in a human rental firm, that means the contractual conditions (no-theft or no-breach) must also be violated. It is the no-breach condition that is violated since the responsible human actions of the employees cannot be de facto transferred to the possession and control of the employer so that the employer with have the sole de facto responsibility for the results of production. The employees can at most agree to co-operate with any working employers but that means the employees along with the working employer are jointly de facto responsible for the positive and negative results of their joint activity.

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What Is Really Wrong Normatively?

181

This is all perfectly clear when employer and employee cooperate together to commit a crime, and employees do not turn into de facto robots or “talking instruments of production” when their actions are non-criminous. Of course, the legal authorities react differently in the two cases, but that does not change the facts about de facto responsible agency. A visible judge intervenes and correctly applies the juridical imputation principle to hold both employer and employees legally responsible. But when no crime is committed, the same co-responsible actions of the employees are taken to ‘fulfill’ the contract for the ‘transfer’ of ‘labor services’ from employees to employer so the employer can legally appropriate 100% of the positive and negative results of production. That is the basic ‘trick’ in the human rental system. The development of new theory may be driven by the critique of an existing system—as Adam Smith’s economics was driven by his critique of mercantilism. It is nevertheless a matter of some historical regret that the restoration of basic jurisprudence to economics (or political economy)—even when formulated in mathematical terms—is accompanied by the critique of the whole system of renting human beings. This will unfortunately retard the incorporation of even the most elementary jurisprudential points, e.g., distinguishing the responsible actions of persons from the ‘productive’ services of things, into today’s Economics. Such points have been foreshadowed in the literature, e.g., in the work of the juridically-trained Friedrich von Wieser, but they have understandably been excluded by the social function of ‘Economics’ in the human rental system. Many orthodox Economists will instinctively resist this neo-abolitionist critique of the human rental system, not because they are hell-bent in favor of human rentals, but they cannot discredit their profession and lifetime’s work by acknowledging that they somehow missed the inherent violation of people’s inalienable rights throughout their whole career. They may even think that workplace democracy is a fine thing but will steadfastly resist the argument that there is anything inherently wrong in the institution of free and voluntary employment contracts to rent, hire, employ, or lease human beings. As Upton Sinclair might have said, it is futile to try to get a person to understand something when their professional standing and self-image depend on not understanding it. Max Planck (1950) famously said that even a science as rigorous as physics only advances funeral by funeral—which is true many times over in the social sciences and particularly in the arrogant ‘science’ of Economics. On the brighter side, if history is any guide, then as with the original Abolitionist Movement, the reality and the supporting ideology of human rentals will eventually change in the direction of neo-abolitionism, but that process will take many decades—if not longer. This normative critique of human rentals in production is not even particularly new. It is largely just a modern treatment of the old labor or natural rights theory of property and the notion of inalienable rights that descends from the Reformation and Enlightenment in the Abolitionist, Democratic, and more recently Feminist Movements that argued for the abolition of even voluntary slavery contracts, the autocratic pactum subjectionis, and the coverture marriage contracts. The extent to which any of this seems new is largely due to the complete misframing of the relevant questions

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due to Marx, Lenin, and the Russian Revolution—that has ossified politicaleconomic debate for over a century. The recent Great Debate was over whether workers may be rented in the pursuit of private greed or should they only be rented for the ‘public good.’ Now that “socialism” (in the meaning of governmental ownership indelibly stamped on the word in the twentieth century) has at long last died, it is time to say “good riddance” to the dichotomous choice between public or private human rentals. Now that the Abolitionist Movement succeeded long ago in the abolition of the voluntary as well as involuntary ownership of workers and now that the dead end of socialism/communism is in the dustbin of history, it is time to consider the neoabolitionist call (Ellerman 2021) for the abolition of the whole private or public system of hiring, employing, renting, or leasing workers in favor of every enterprise being a workplace democracy.

References Arrow, K. J. (1971). The Firm in General Equilibrium Theory. In R. Marris & A. Woods (Eds.), The Corporate Economy. Cambridge: Harvard University Press. Baty, T. (1918). Loan and Hire: Notes on the English Law on Lending and Hiring. London: Sweet and Maxwell. Ellerman, D. (2021). Neo-Abolitionism: Abolishing Human Rentals in Favor of Workplace Democracy. Cham, Switzerland: SpringerNature. https://doi.org/10.1007/978-3-030-62676-1 Hulse, T. (2010). Military Slave Rentals, the Construction of Army Fortifications, and the Navy Yard in Pensacola, Florida, 1824-1863. The Florida Historical Quarterly, 88(4 Spring), 497–539. Knight, F. H. (1936). The Quantity of Capital and the Rate of Interest: I. Journal of Political Economy, 44(4), 433–63. Planck, M. (1950). Scientific Autobiography and Other Papers. (F. Gaynor, Trans.). London: Williams & Norgate.

Index

A Active use, 65 Anderson, E., 167, 174 Appropriation, 4, 63, 65, 96, 177 Arrow-Debreu model, 2, 77, 83, 178 Arrow, K., 78, 85, 87

B Badge of Red courage, 121 Barnett, R., 11, 168 Basic trick, 20, 181 Batt, F., 166 Berle, A., 146 Bi-directed graph, 29 Blackstone, W., 155, 159 Boadway, R., 134 Book-plus-profits valuation, 72 Brandeis, L.D., 112, 149, 172 Bray, J.F., 96, 103 Breaches, 32, 33, 35, 40, 48, 51 Breach of contract, 12 Brockway, G., 9, 90 Buchanan, J.M., 126, 163, 173

C Cambridge Capital Controversy, 99 Capitalism, 16 Capitalized value of the capital asset, 68 Cassirer, E., 162, 163 Charter cities, 150 Chayes, A., 148 Christ, C.F., 113, 169

Ciepley, D., 145 Clark, J.B., 22, 95 Classical laborists, 96, 121 Codetermination, 23 Cohen, G.A., 121 Conner Ave. plant, 6, 73, 80, 83, 85, 87, 98 Consumption employment, 82 Contractual defense of slavery, 93 Conventional classical liberalism, 123, 154, 159, 170, 173–175 Cooperative, 143 Corporate governance, 141, 149, 178 Corwin, E.S., 161 Cost-benefit analysis, 11, 132, 138 Covering ordering, 48 Coverture marriage contract, 154–157, 170

D Dahl, R., 113, 145 Davis, D.B., 161 Debreu, G., 78, 87 Democratic classical liberalism, 154, 160, 163, 170 Democratic firm, 44, 59, 113 Directed graph, 28, 45 Disjoint vectors, 29 Divergence, 30, 46 Divergence principle, 14, 15, 30, 31, 47–49, 125 Dog contract, 159 Dollar-division game, 84 Dominium, 80, 98 Double-entry bookkeeping, 27, 28

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 D. Ellerman, Putting Jurisprudence Back Into Economics, https://doi.org/10.1007/978-3-030-76096-0

183

184 E Economic democracy, 120 Economic profits, 64, 67, 68, 72 Economics of property rights, 3 Efficiency/equity parsing, 132 Employee stock ownership plans (ESOPs), 113 Enlightenment, 93, 123, 124, 172

F Factual responsibility, 11, 13, 14, 16, 20, 23, 54 Fairchild, H., 101, 110 Fischer, S., 92, 164 Flynn, J., 147 Founder’s decision, 127 Friedman, D.D., 134 Friedman, M., 89, 106, 110, 112 Fundamental myth, 5, 65, 66, 81, 99, 120, 122, 177 Fundamental theorem, 12, 56, 59, 178 Fundamental theorem of calculus, 31

G Galbraith, J., 90, 92 Gierke, O. von, 81, 161 Glass corridor metaphor, 179 Goodwill, 73–75 Group of differences construction, 28 Guilds, 149

H Hacker, J., 102 Hahn, F., 85, 86 Hansmann, H., 144 Happy Consciousness, 179 Hart, H.L.A., 37, 103 Hegel, G., 124 Hegel’s walk-back, 125 Heterodox criticism, 90 Heterodox economics, 106 Hicks, J., 132 Hiring party, 64 Hirschman, A., 91 Hodgskin, T., 96 Human rental contract, 92, 123, 154 Human rental firm, 41–45, 57–59 Human rental system, 16, 18, 99, 119 Hume, D., 12 Hutcheson, F., 93, 162

Index I Inalienability of de facto responsibility, 20, 153, 177 Inalienable rights, 93, 103, 159 Indeterminacy of firmhood, 82 Institutional robbery, 21 Invisible hand mechanism, 2, 7, 20 Invisible Judge, 8, 20, 36, 53, 54, 111, 178

J Juridical imputation principle, 7, 9, 17, 38, 96, 102, 104, 109, 112, 131, 153–155, 166, 177, 180, 181

K Kaldor-Hicks principle, 11, 132, 178 Kaldor, N., 132 Kant, I., 107, 165 Keen, S., 90, 94 Kelsen, H., 165 Keynes, J.M., 68, 69 Knight, F.H., 1, 83, 94, 95, 99, 104, 106, 107, 159, 168–170

L Labor’s product, 16, 17, 43, 104, 115 Labor theory of property, 9, 21, 90, 96, 103, 112, 120, 166, 180, 181 Labor theory of value and exploitation, 91, 120, 167 Law & Economics, 11, 97, 133, 134, 138, 178 Lazonick, W., 147 Legalized fraud, 21, 22, 103, 156 Legal responsibility, 11, 14, 20, 22 Lifetime servitude contract, 23, 113, 124, 154, 157–160, 169, 170 Locke, J., 4, 11, 12, 97, 159 Luther, M., 162 Lynd, S., 162

M Macpherson, C.B., 12 Maine, H., 161 Maitland, F., 80 Marginal efficiency of capital, 69 Marginal productivity theory, 22, 89, 106, 180 Market mechanism of appropriation, 8

Index Marshall-Pigou view of Economics, 11, 139 Marsiglio of Padua, 161 Marxism, 119 Marx, K., 80, 83, 91, 96, 98, 99, 120, 167, 182 Master and servant, 20 Mathematics of constrained optimization, 124 McKenzie, L., 78, 84, 87, 178 Means, G., 146 Menger, A., 96, 102 Milanovic, B., 102 Miller, M.H., 71 Mill, J., 100 Mill, J.S., 2, 128 Modigliani, F., 71 Mondragon, 23, 113, 126, 143 Montesquieu, B. de, 159 Morishima, M., 121

N Natural system of private property and contract, 12, 44, 113, 180 Negative decision-constraining control rights, 146 Negative product, 17 Neo-abolitionism, 22, 105, 112, 172, 181, 182 Net productivity of capital, 68–70 New institutional economics, 6 No-breach condition, 19, 154, 180 Nozick, R., 158

O Oakeshott, R., 23, 113, 143 Otsuka, M., 158

P Pactum subjectionis, 154, 160–161, 163, 170 Pareto efficiency, 9, 10, 13, 113, 179 Pareto superior, 131 Passive use, 65 Pateman, C., 167 Pathetic fallacy, 10, 107 Patronage, 143 Percy, E., 112, 141, 172 Personal rights, 142 Piketty, T., 90, 92, 94 Planck, M., 181 Pons asinorum, 80, 99 Positive decision-making control rights, 146 Positive product, 17 Posner, R., 132

185 Present value of an ordinary annuity of one, 66 Production vector, 8, 16, 64, 166 Property externalities, 12, 32, 33, 35, 40, 48, 51 Proudhon, P.-J., 96 Public employment, 22

Q Quasi rent, 69 Question of Distribution, 102 Question of Predistribution, 102, 109

R Rawls, J., 94, 95 Reformation, 93 Reformation doctrine of the inalienability of conscience, 162 Residual claimant, 7 Responsible agency of persons, 177 Robé, J.-P., 78, 145 Rockafellar, R.T., 33 Role responsibilities, 36 Roman and medieval law, 142 Rothstein, B., 98, 99

S Same-yardstick fallacy, 133 Samuelson, P., 66, 69, 70, 109, 133, 164 Samuels, W., 15 Schlatter, R., 166 Scottish Enlightenment, 44, 162 Seabury, S., 93 Seastead cities, 150 Shareholder democracy, 147 Shareholder states, 150 Smith, A., 2, 12 Smith, G.H., 163 Smorgasbord, 154 Sociedades Laborales (SLs), 143 Solow, R., 110 Spinoza, B., 93, 162 Startup cities, 150 Steiner, H., 158 Stiglitz, J., 90, 92, 94 Stock-flow identity, 39 Stout, L., 145

T T-accounts, 28 Thompson, W., 96

186 Thurow, L., 94 Tierney, B., 142, 161 Two types of injustice, 35, 52 Type I/II error table, 35, 51, 154, 156, 160, 172

V Vallentyne, P., 158 Vector T-account, 29 Vectorial marginal products, 114, 116 Virgin-birth marginal products, 111, 112, 116 Visible hand, 7, 9

W Wallace, G. (abolitionist), 158 Washington, G., 127 Whole product, 8, 16–18, 42, 44, 58, 64, 78, 97, 166

Index Whyte, K.K., 113, 143 Whyte, W.F., 113, 143 Wicksell-Buchanan school of public choice, 131 Wieser, F. von, 22, 108, 165, 181 Wigforss, E., 103, 167 Williams, R., 162 Wills, G., 162 Witkowsky, P., 104 Wolff, R.P., 124 Workplace democracy, 23, 182

Y Young, O.D., 113

Z Zero-patronage cooperative, 145