Exploitation through State Organizations

The state in a market socialist society would exercise some of the same eco­nomic functions that states in free enterprise systems exercise. For instance, it would provide for some goods and services such as defense and education through state-owned enterprises, and it would use Hscal and monetary pol­icy as instruments to try to achieve macro level goals for the economy.

In a market socialist system, these two functions of the state are interre­lated. It is because the state is the steward of society’s capital that it receives the capital usage fees from the cooperatives; those funds represent the returns to capital, and it is with them that the state controls new investment. Recall from chapter 2 that the motivation for state control of new investment is twofold. First, it subjects the rate and direction of economic development to collective decision making. The priorities for new investment do not just emerge as the unintended consequences of disparate plans and interests of groups and individuals, as they do in free enterprise systems; instead, those priorities are consciously and collectively chosen through the political process. Second, state control of new investment prevents or corrects for var­ious “social irrationalities” tossed up as unintended by-products of the oper­ation of market forces. Perhaps the most important of these is unemployment, but this category also includes externalities such as pollution, and specific undesirable patterns of investment and/or consumption. For example, if a region has been especially hard hit by unemployment, investment funds can be targeted to that area.

Despite the attractions from a socialist perspective of state stewardship of

society’s capital and state control of new investment, both of these features of a market socialist system create distinctive opportunities for exploitation. The purpose of this section is to investigate these opportunities. The discussion is focused narrowly on exploitation, omitting treatment of other problems, including some significant inefficiencies, occasioned by these features of a market socialist economic system. For example, unlike in a free enterprise system, where smaller firms are rarely audited, all smaller firms in a market socialist system would have to be audited. Compared to the free enterprise alternative, this is a significant inefficiency simply because of the substantial resources that would have to be committed to these audits on an ongoing basis.

Exploitation through the Valuation of Assets

The last subsection of chapter 6 discusses the ways in which cooperatives could exploit the providers of capital. This subsection discusses how exploita­tion might take place in the other direction. Because of the potential for exploitation by the cooperative, the state in its role as capital provider will have to audit the cooperatives on a regular basis. Many people think that the primary task of the auditor is to detect fraud and malfeasance on the part of corporate officers. But that is not the case. Perhaps the most important task the auditors must discharge in a market socialist system is to verify that the value of tangible and intangible assets has been properly maintained. And, of course, they must ascertain that the cooperative has maintained the quasi­rent value of the firm itself, the asset that accountants misleadingly call good will. All of this is important for the obvious reason that society wants to pre­vent the dissipation of the assets that it has entrusted to the workers in the cooperative. But it is also important because the total value of the firm is the figure on which the capital usage fee is calculated. The higher that figure is, the higher the capital usage fee will be.

The epistemological indeterminacy of the value of all these assets creates a devil’s playground in a market socialist system. Clearly, there is an inher­ent conflict of interest between the cooperatives and the state on this. For reasons discussed earlier, the cooperatives will tend to undervalue their assets. The auditors will have to act aggressively to protect the interests of society at large. How this would be played out is impossible to say without a more detailed specification of the relevant state institutions and their incen­tive structures. For example, if auditors were paid a commission on the value of the assets of the firms they audited, they would have a strong incen­tive to overvalue those assets. If they themselves were members of indepen­dent profit-making accounting cooperatives and were hired by the firms they audit, they would have an incentive to undervalue the assets.¹⁰ What­ever the incentives, however, it is fair to say that it would be truly astonish­ing if the auditors came up with an accurate valuation of the firms. Inde­pendent of the incentives implicit in the structure of the organizations of which they are members, the multiple Indeterminacies identified previously would make it much more likely that they would undervalue or overvalue the firms rather than assess them accurately.

This has important implications for exploitation: neither the state nor the cooperative has anywhere else to go if the other party is appropriating value from them. If the cooperative is siphoning value from the firm’s assets into the residuals that the auditors do not catch, then obviously the state will not be able to do anything about it. Moreover, even if the state discovers it, there may not be much that it can do. Penalties might cause the firm to go under or cause the workers to abandon the firm and go elsewhere. Also, whatever its legal authority, the state cannot easily strip the workers of their firm and turn it over to a new group of workers. Similarly, if the state has unwittingly (or perhaps wittingly, depending on what motivates the auditors) overvalued the cooperative’s assets and set the capital usage fee too high, the workers would likely have no real alternative but to turn over to the state what is, in effect, their residuals or the return on their labor. This is so for three reasons. First, getting a second opinion from another state auditing team would, in general, be too costly, and there are moral hazards in permitting firms to shop around for auditors. Second, it is likely that some of the quasi-rents asso­ciated with their labor really are appropriable because they will have devel­oped some firm-specific assets (knowledge and skills) that would be lost if they left. And it would likely be difficult to redeploy those assets because of the sluggish labor markets that characterize market socialism. Finally, even if these workers could go somewhere else, it may not matter. Depending on the incentive structure under which the auditors are working, these workers might well be facing essentially the same situation at their new jobs. It follows from all this that if the cooperatives are not exploiting the state, the chances are very good that the state is exploiting the membership of the cooperatives.

These observations would not count as a serious objection against market socialism if the same problem afflicted capitalist organizations.

Exploitation through State Control of New Investment

In general, those who favor market socialism have provided little detail about the institutional structures by or through which state control of new invest­ment would be exercised. The presumption that the state would be charac­terized by a high degree of participatory democracy tells us little about the details—or even the broad principles—of institutional design. Chapter 2 provides a rudimentary sketch of a way in which new investment might be controlled through the political process. It would be useful here to recall that sketch and augment it further. Suppose that the national legislature sets the capital usage fee, which determines the amount of funds that will be available for new investment. If, for example, it is set at 5 percent, then every firm must pay 5 percent of the value of the firm, as the latter has been determined by the auditors. The priorities for how these funds will be spent are also deter­mined through the political process. At the national level, those priorities might be expressed in very broad terms (e.g., so much for the tourist indus­try, so much to develop new sources of energy). Political authorities might also designate funds to certain regions, for example, to those areas suffering from high unemployment.

However, because the political process at this level can only produce gen­eral guidelines, there must be various planning agencies to implement invest­ment policy and priorities, presumably at different levels (e.g., national, regional, and local) of the society. These agencies receive their marching orders from the political process, but they themselves must determine the more specific guidelines to be followed in disbursing the funds. Lower-level planning authorities might make finer distinctions within the broad para­meters set by the national legislature, and they might get input from lower levels of government. Actual funds could be disbursed through state-owned (national, regional, or local) banks, which would evaluate proposals from existing firms and from groups of workers who want to start up new firms. These proposals would be evaluated for their fit with the investment plan for the economy, their contribution to sovling regional or local problems (e.g., pollution) that did not receive priority at higher levels of government, and their financial soundness. By accepting these funds, cooperatives agree to pay the capital usage fee on the assets they purchase with them.

This method of determining new investment creates substantial oppor­tunities for exploitation in a market socialist society that do not exist in a free enterprise system. To see what they are, notice that in a market socialist sys­tem, profitability is not the decisive or determinative criterion for new invest­ment decisions that it is in a free enterprise system. At every level, govern­mental organizations charged with formulating and implementing policy use multiple decision criteria to determine where and how investment funds should be channeled. This use of multiple decision criteria creates a number of distinct moral hazard problems.

Suppose, as seems reasonable, that one of the most important goals of the investment policy formulated by the legislature is to reduce or prevent unem­ployment. This creates a moral hazard problem of colossal proportions. In the last subsection of chapter 6, it was pointed out that the ultimate decision makers in a cooperative have an incentive to shift costs into the future and shift income from the future to the present. One thing that might constrain these forms of exploitation is the concern that the cooperative, to which these decision makers have ties of fraternity and sentiment, might go out of busi­ness if they go too far. However, if they believe that state authorities in con­trol of new investment would not let this happen, that constraint evaporates. This allows firms that have been poorly run to be bailed out at the expense of—and thus to exploit—society at large.

There is some empirical evidence that bears on this. In what used to be Yugoslavia, even when the state did not completely control new investment, it had some control of investment beyond what can be achieved by manipu­lating tax and fiscal policy. It also had responsibility for reducing unemploy­ment. It is perhaps not a coincidence that the state was used to bail out fail­ing firms. As Janos Kornai observes,

state money is regularly used to rescue consistently loss-making firms [doc­umented in an accompanying table].... A high proportion of consistently loss-making firms are not merely kept alive with state subsidies or soft cred­its; their capacity is increased further. There is only a loose relation between the firm’s past and future (expected) profitability and its investment, growth, and technical development. (1992, 490)

Kornai does not specifically address the question of whether there is a causal connection between the state’s responsibility for dealing with unemployment and the bailouts, but the evidence he offers is very suggestive, to say the least. Moreover, as Kornai notes, the problem of bailouts is further aggravated by elements of socialist ideology such as solidarity with those who are in eco­nomic difficulty or about to lose their jobs (p. 493). It seems reasonable to suppose that any economic system in which state control of new investment is conceived of, at least in part, as an instrument to deal with unemployment will face a serious moral hazard problem in this respect. The problem could not be avoided by simply passing a law whereby badly managed firms would not be bailed out, since the distinction between a badly managed firm and one that is the victim of circumstances beyond its control is inherently con­testable. In addition, as a practical matter, what counts as a badly managed firm and what counts as a bailout must be defined, and one could well imag­ine the lobbying effort that failing firms (as well as firms that might fail in the future) would mount when some subcommittee of the national legislature marked up that piece of legislation.

The problem just discussed is not limited to a system in which state con­trol of new investment is an instrument to deal with unemployment. The problem arises as long as any criterion other than profitability is used to determine new investment. Any firm in financial difficulty and in a position to appeal to these other criteria will have an obvious incentive to propose new investment that would cover up their mistakes or make up for risks that turned out badly. In other words, firms that have not managed their assets wisely can exploit society at large by appeal to these other criteria to keep them in business. For example, a failing chemical company can argue that it is best positioned to deal with the toxic waste problem it has created but only if it is lent the money it needs to expand production of its best-selling pesti­cide or to gear up a promising research project to create and market prod­ucts to deal with this problem. They might point out that if they do not get the money, they will be forced out of business, and the taxpayer will have to foot the bill anyway. By contrast, in a free enterprise system the state can go after the company’s equity owners, and as liability lawyers can attest, there is money to be found there. Indeed, the lack of an equity base in market social­ist cooperatives, coupled with free labor mobility, encourages firms to run risks they otherwise would not take. If and when those risks eventuate, the workers can move on; society as a whole loses the assets.

If the system were able to deal with the externalities and other “social irra­tionalities” in a satisfactory manner, socialists might regard the inevitable exploitation perpetrated by poorly run cooperatives as a reasonable price to pay. However, the morally hazardous aspect of the situation means that these problems are effectively encouraged by the system. The root of the problem is the fact of multiple decision criteria for new investment. If unemployment or pollution or any other social problem traceable to the operation of the market is supposed to be addressed through new investment controlled by the state, this creates incentives for people to do things that risk causing the very problems the system is supposed to address or prevent. In sum, the sys­tem is self-defeating, and it allows—and indeed encourages—firms that have run their operations badly to exploit society at large by getting bailed out by the infusion of new investment monies.

By contrast, in a free enterprise system, perceived profitability is the main determinant of new investment, and if a firm is failing, it is generally not able to force others to contribute capital to keep it in business. In the classical cap­italist firm, new investment that might rescue a firm comes from the savings of the classical capitalist or perhaps from money lent by friends and relatives. If the firm subsequently goes under, the classical capitalist has not exploited herself. But what about friends and relatives? Might not they be exploited under these circumstances? Perhaps. But on the other hand, maybe people who make loans to friends or relatives whose businesses are in trouble deserve whatever happens to them.

The ultimate decision makers in the open corporation are also not in a position to exploit those who provide capital for new investment because, with the exception of debt holders, they are the capital providers. Debt hold­ers are protected by the equity cushion of the firm, since in bankruptcy pro­ceedings debt holders are paid off before equity owners. In both types of organizations, equity owners, who have ultimate decision-making authority, are legally last in line to get paid and thus first in line to suffer whatever losses they are responsible for. In general, for debt holders, whatever losses they suffer merely represent the downside of the risk premium they receive; assuming that they bought debt instruments with their eyes open, those losses can hardly be termed exploitative. But what about the state as a source of cap­ital for firms that would otherwise fail?

It is true that in existing free enterprise systems, some firms have been judged “too big to fail” (e.g., the Chrysler Corporation a number of years ago), but this is “the exception that proves the rule” in two respects. First, these bailouts are not vices of the free enterprise system with no qualifying predicates. They are vices (or virtues, depending on one’s perspective) trace­able to the political system and are far from universal, especially by histori­cal standards. Second, bailouts by the state that occur because of the fear of unemployment are rare enough to create no appreciable moral hazard in the system. Whatever else can be said about the unhealthy relationship between government and business in existing free enterprise systems, those in charge of large private corporations have little reason to believe that the government will bail them out by investing taxpayers’ money in them if they do not man­age the assets they control wisely. In societies with a free enterprise system, there is a gulf between the economic and political system that would not— and indeed could not—exist in a market socialist system. Whatever problems this gulf occasions, one salutary consequence is that generally speaking, firms that do not meet the test of the marketplace do not get to exploit society at large by forcing the latter to invest more in them when they are in trouble.¹¹ The same cannot be said of publicly owned organizations.

This explains some of the ways in which the ultimate decision makers in fail­ing cooperatives can exploit the capital providers (i.e., society at large or the taxpayers) by manipulating the multiple decision criteria that are the inevitable accompaniment of planning. No special assumptions were made about the government agencies charged with implementing whatever plans were arrived at through the political process. One reason for that is that defenders of market socialism have not been very forthcoming about the nature or structure of the state organizations that they envision controlling new investment in a socialist economic system. Despite this paucity of detail, something can be said about the organizational structure of the public bureaucracies (namely, the planning agencies and banks) charged with imple­menting the will of the legislature about new investment.¹² This, in turn, per­mits an Identihcation of some additional distinctive opportunities for exploitation in a market socialist system.

In a series of articles, Terry Moe, a political scientist, has called attention to some systematic differences between economic organizations and their political counterparts, public bureaucracies (Moe 1989, 1990a, 1990b). Transactions cost analysis proceeds on the assumption that the structure of economic organizations is largely determined by considerations of (transac­tions cost) efficiency. Economic actors often consciously seek to arrive at effi­cient, mutually advantageous arrangements when they create a business organization, and even if they do not, competitive pressures tend to weed out inefficient structures. However, no such presumption of efficiency applies in the case of public bureaucracies. In the political arena, other fac­tors are determinative.

To see what they are, notice that one crucial difference between business organizations and public bureaucracies is that the creators of the former are the ultimate decision-making authorities for as long as they want to be and can sell their rights in the Rrm at any time. By contrast, in the case of public bureaucracies, the political lives of their creators—the politicians—are rela­tively short or at least of uncertain duration. The ultimate decision makers in business can undertake and execute (or have managers undertake and exe­cute on their behalf) plans and projects without worrying that someone else (notably their opponents or rivals) will usurp them in a few years and do something entirely different with the firm. This is a luxury that political actors do not have.

In a democracy, when a decision is made to create a public bureaucracy, there are winners and losers among the political actors. The latter did not want the organization created at all, or they wanted it to have a very differ­ent mandate. Even if one assumes that the winners had to make no compro­mises with the losers to get the agency created, the former must deal with the fact that their hold on political power is uncertain; their rivals may come to power in the next election or the one after that. In addition, the winning political actors have a specific agenda they want to advance through the agency. That is why the agency is created in the Rrst place. So they want to get their agenda enacted, but they may not be able to hold onto political power indefinitely. How will they design the agency to cope with the fact that their own political power may evaporate and reappear in the hands of their rivals?

Moe discusses a number of strategies they can and do use (Moe 1990b, 136-37). One that is especially important for present purposes is that in writ­ing the agency’s charter, they can put more emphasis on technical expertise and professionalism than is warranted. Professionals tend to be more resis­tant to political pressure, and they desire autonomy. Some autonomy is inevitable in any case, since political authorities can only give the agency gen­eral guidelines, which it must then interpret. However, not just any profes­sionals will do. Political actors need to find high-level bureaucrats who will “do the right thing” once they are in the agency. Professionals know this, so they strive hard to create reputations that will make them natural choices to staff the upper levels of new bureaucracies. If the right people are chosen, the agency can run itself and fulfill the desired goals of the political actors who created it without extensive political oversight. Additional methods by which the independence of the agency can be ensured include circumscrib­ing the authority of the political appointees who are sometimes nominally in charge of the agency, ensuring that agency decisions are immune from leg­islative veto, and preventing the agency from being subject to sunset provi­sions, which requires legislative reauthorization of the agency after a certain period of time.

Once the agency has been created, there is a new group of players on the scene, namely, the bureaucrats themselves. Whatever their ends or goals, the inherent uncertainty of the political environment creates problems for them, just as it does for the political actors who created the agency. The bureaucrats can deal with this problem in a number of different ways. One is to encour­age mutually beneficial exchanges with political actors and their supporters who can help or harm them, including groups who were originally hostile to the agency (Moe 1990b, 144). This strategy can only go so far, however, since the agency’s actions are bound to favor some interests at the expense of oth­ers; those who are harmed, or fear being harmed, have an interest in mobi­lizing political support to thwart or redirect the agency’s (and thus the bureaucrats’) agenda. So there is no way for the bureaucrats to eliminate the political uncertainty in their environment.

This motivates a second, complementary strategy—isolation. As Moe says: Bureaucrats... can promote further professionalization and more exten­sive reliance on civil service. They can formalize and judicialize their deci­sion procedures. They can base their decisions on technical expertise, operational experience, and precedent, thus making it “objective” and agency-centered. They can try to monopolize the information necessary for effective political oversight. These insulating strategies are designed, moveover, not simply to shield the agency from its political environment but also to shield it from the very appointees who are formally its in-house leaders, (1990b, 144-45)

In addition, as time goes on, bureaucrats develop agency-specific knowledge and skills, which makes them increasingly difficult to replace, at least at the wholesale level. Political actors of whatever persuasion are increasingly forced to deal with them. Political actors, including the agency’s creators, can fore­see some of this (though one should be careful not attribute omniscience to them) and will take steps, both in the initial phase and subsequently, to pre­vent these agencies from running amok. But the potential for significant principal-agent problems remains because of the dynamics of the politics of bureaucratic structure.

Let us consider how all this applies in a market socialist system to that part of the state concerned with the control of nearly all new investment for the economy. Various planning agencies would be created in an environment characterized by opposition and political uncertainty. After all, this takes place in the aftermath of the transition from a free enterprise system to a market socialist system, and presumably there would be many people around who would have been recently pried loose from their equity ownership in capi­talist firms. In the period of the transition, investment bankers, urban plan­ners, and (above all) economists would be developing their expertise and rep­utations so that they will be in a good position to be selected to staff the various banks and planning agencies that would be created to implement investment policy. Political actors on the winning side—the socialists—would obviously have an agenda to pursue. However deep and sincere their com­mitment to the democratic process, it is virtually certain that those who fight the political battles necessary to achieve victory for socialism will believe that society’s investment priorities under the old order were significantly out of line with what was and is in society’s best interests. (Concerns about the envi­ronment, for example, might be a major source of that conviction.) In light of this, they will seek out experts who share their particular vision about the direction the economy should take, and they will create bureaucratic struc­tures that insulate the relevant agencies from political meddling. As time goes on, the bureaucrats themselves become major players in the policy game and seek to protect and insulate their agencies from political interference in the manner indicated.

This insulation enhances the discretionary authority implicit in the mis­sion of the agencies and their relationship to the political process. This latter point warrants some elaboration. Because of the sheer size and complexity of modern market economies, the political process, at whatever level, can only produce general guidelines for economic planning, perhaps coupled with a few specific directives. These guidelines will have to be interpreted and applied by the relevant agencies. For example, the national legislature may decide that the nation should use more renewable sources of energy, but they may not know what investment policy best meets that objective. How much should go into research and development of new technologies? How much should production of existing modalities be stimulated? How are decisions on these questions affected by tax policy? These and a host of related ques­tions require highly specialized knowledge and expertise, and some of that knowledge and expertise is located in the planning bureaus. Another factor feeding into this discretionary authority for the agencies is that compromise

in the political process is often best achieved through vague or ambiguous language. It will be up to the agency to give form and substance to that lan­guage.....

For these reasons, some individuals in the planning agencies and the banks will have real discretionary authority to decide which investments—or which kinds Ofinvestments—best meet whatever guidelines emerge from the political process. So, if the national investment plan calls for $10 million of new investment in tourism in California, someone is going to have to decide what the boundaries of the tourist industry are, what the boundaries of Cali­fornia are (Does it include any firm whose headquarters are in California? How are headquarters to be defined? and so on).

What are the implications of all this for exploitation? To see what they are, notice that the considerable discretionary authority that the bureaucrats have, in conjunction with the politics of bureaucratic structure, together create truly significant and probably intractable monitoring problems for political authorities. After all, the nature of their tasks makes the bureaucrats difficult to monitor, the agencies themselves will have been deliberately designed to be difficult to monitor, and the bureaucrats have both the motive and meth­ods to exacerbate the monitoring problem. A further potential problem con­cerns the monitoring of the monitors. It is likely that the political authorities responsible for monitoring the bureaucracies (e.g., members of the legisla­ture) would themselves be difficult to monitor. Politicians are accountable to the voters (and taxpayers), but, as public choice theorists point out, it is often difficult and not cost-effective for citizens to monitor their elected officials, especially on the minutiae Oflegislative oversight of the bureaucracy.¹³ Peo­ple knowledgeable in the ways of government know all of this, at least after a fashion. This raises the adverse selection problem: What kind of person would volunteer for morally hazardous duty in the planning bureaucracy? What would be the likely result?

At the very least, the potential for corruption would appear to be signifi­cant. Socialists do not talk much about corruption in a socialist system, either because they believe it would not exist or because they believe it could not be worse than it is in a free enterprise system. The former is naive, and the lat­ter ignores the fact that the vulnerability of institutions to corruption is an important determinant of the actual level of corruption in any society.

The issue of outright corruption aside, the likelihood is high that the pub­lic organizations responsible for new investment decisions would develop an unhealthy symbiotic relationship with the cooperatives affected by their deci­sions. Cooperatives would, of course, have a strong incentive to mount lob­bying efforts at the agencies on behalf of their investment projects. A revolv­ing door between the cooperatives and the agencies would begin to spin. In short, a whole range of evils of the modern welfare state would be replicated in this new branch of government. The stakes in all this are very high: around 2 to 10 percent of the entire wealth of the nation would be up for grabs each year.

The revolving door problem is both important and particularly intractable. If the wall between the cooperative sector and the planning sector is so high that bureaucrats in the planning agencies are legally prohibited from selling their talents and abilities in the cooperative sector, the government risks an adverse selection problem: it will be able to attract only those who are not attractive to private industry (i.e., the cooperative sector). The alternative is to pay everyone in the planning bureaucracy a huge premium for working in the public sector, which would mean that the taxpayers would be forced to pay many of these bureaucrats far more than they are worth. In this way, the latter could exploit the taxpayers. On the other hand, if the wall between the two sectors is low (a more likely scenario), the bureaucrat’s incentive is rela­tively strong to act opportunistically and serve the interests of potential employers in the private sector instead of the public interest.

Another incentive for those in the agency to act opportunistically involves what might be called the private agenda problem. Bureaucrats in the plan­ning agencies, especially at the higher levels, are likely to have their own ideas about what the investment priorities should be for the economy as a whole or for their particular sector. Since they are poorly monitored, they will have the opportunity to steer a sector of the economy, more or less blatantly, in the direction they believe it should go. The revolving door and private agenda problems involve a misrepresentation of the inputs or outputs or both on the part of the bureaucrats in the agency, and so can be conceived of as forms of opportunism. In both these ways, bureaucrats can exploit the taxpayers who pay their salaries.

The harm done to the taxpayers in the form of exploitation by the bureaucrats would likely be relatively minor in comparison to the larger harms done to society as a result of these forms of opportunism. First, if the bureaucrats’ favoritism toward certain firms or industries temporarily props up cooperatives that eventually fail or if it bails out cooperatives that would otherwise fail, then society has had some of its capital stock dissipated, even though, in this case, the main exploiters are the members or the management of the failing cooperative, rather than the bureaucrats (the latter being sim­ply collaborators). Second, the bureaucrats’ private agenda may not serve the public interest. (Indeed, the same thing might be true of the politicians’ agenda.) This is not specifically a problem of exploitation, however, except to the extent that the outputs Ofbureaucrats are misrepresented. Finally (and again independent of the exploitation issue), it looks as if the idea of using political control of new investment as a way of giving expression to people’s collective preferences (not to mention dealing with the social irrationalities of the market) is truly utopian. Even assuming that some version of the democratic process best discovers what those collective preferences are,¹⁴ their implementation in a market socialist system requires the cooperation of people who have some (and perhaps a significant) penchant for opportunism and who work in very poorly monitored organizations.

To complete this discussion, it is necessary to examine briefly the extent to which analogous problems afflict capitalist organizations. One factor that complicates a comparative analysis on this point is that there is no organiza­tional equivalent to the planning agencies in the free enterprise system. New investment decisions are made “in-house,” although debt financing brings outsiders into the picture.¹⁵ However, there is a genuine issue here: just as bureaucrats in the agencies can exploit the capital providers (society at large) in a market socialist system through their decisions on new investment, so, too, it would seem that the decision makers in the open corporation (though not in the classical capitalist firm) could exploit the capital providers in their decisions about new investment.

Indeed, it might be argued that in the open corporation, profitability is not always the sole criterion for investment decisions. Other factors, which can be grouped under the heading of bias or favoritism, can play a role in management’s decisions about new investment. It certainly seems possible for equity owners to be exploited by managers insofar as these other factors are determinative of the investment decisions managers make. For example, if a firm launches an ambitious expansion program to satisfy the ego of its chief executive officer and not because of sound business reasons, the equity own­ers may have the quasi-rent value (or worse) of their assets dissipated. Busi­ness persons, just like bureaucrats, can have a private agenda and can use their power to their own strategic advantage.

This possibility for exploitation of the equity owners in the open corpo­ration cannot be denied, but the real issue here is the quality of monitoring and the damage control mechanisms; on both counts, the structure of the open corporation is markedly superior to the corresponding structures in a market socialist system. Recall from chapter 5 that one of the functions of the board of directors is to ratify major investment decisions. Sometimes, board members have significant residual claimant status (Demsetz 1988a), which gives them a strong incentive to protect the interests of the equity owners. Other monitoring instrumentalities include the ability of equity owners to sell their shares on the stock market. Securities analysts also have an interest in monitoring new investment decisions. Finally, there is the mar­ket for corporate control. In all these cases, there are people with a signifi­cant personal financial interest in accurately assessing and monitoring man­agerial decisions.

On the other hand, this is not the case in the corresponding political insti­tutions. Not only are the organizations inherently highly vulnerable to shirk­ing and other forms of opportunism, but the only true residual claimant is the taxpayer, and the only residuals for which the taxpayer is eligible are the negative ones. If the bureaucracy squanders money, either on itself or through bad investments, the taxpayer must pay up. If an investment is hugely successful, however, the cooperative reaps the residual gains. How to monitor large government bureaucracies has always been problematic, and it may not be cost-effective for a citizen to do it. An assumption to the effect that there would be widespread participation in the political process pro­duces the illusion that there is no monitoring problem because it presumes that decision makers are monitors and vice versa. But this ignores the com­plexities of modern life in which both decision making and monitoring require highly specialized knowledge and skills. Moreover, talk about partic­ipatory democracy obscures the question of institutional design.

The other major problem with state investment is the sheer size of the errors that can be made. Market socialist systems, unlike free enterprise sys­tems, would have “energy czars” and the like, who could squander social wealth on a grand scale. Only central planners and invading armies can put more social wealth to the torch. When these czars lose their heads and make bad decisions, everyone pays. Taxpayers, unlike equity owners, have unlim­ited liability.

This completes the comparative evaluation of free enterprise systems and the type of market socialist system outlined in chapter 2 on the question of exploitation. This evaluation was done through a comparison of the char­acteristic organizational forms of the two types of systems, namely, the clas­sical capitalist firm and the open corporation on the one hand and the worker cooperative (both small and large) and the associated state organi­zations on the other hand. The organizations of market socialism have proven to be consistently more vulnerable to exploitation than their free enterprise counterparts. Distinctive opportunities for exploitation were found in the structure of economic roles (residual claimant, ultimate deci­sion-making authority, capital provider, entrepreneur, monitor, economic planner, politician) that define market socialist organizations. Before final judgment can be passed, one potential complication must be addressed. Might not some forms of exploitation cancel out other forms of exploitation? For example, managers can exploit and be exploited by their fellow resid­ual claimants; cooperatives can exploit and be exploited by the state. If these forms of exploitation canceled each other out, the relative disadvantages of market socialism vis-a-vis a free enterprise system would disappear or at least diminish.

Though this possibility cannot be ruled out (and indeed would undoubt­edly occur in particular cases in real-world economic systems), there is some reason to believe that this canceling-out effect would not be a systematic phe­nomenon. The reason for this is that successful opportunistic behavior (which is what exploitation is) is necessarily deceptive and not anticipated. Indeed, it need not even be easily discoverable after the fact.¹⁶ This means that the distribution of income will tend to be skewed toward those who are more opportunistic and whose assets have well-protected or low quasi-rent values and away from those who are less opportunistic and whose assets have the highest quasi-rent values (e.g., workers with highly specialized skills and knowledge). There is no assurance the latter will be compensated in other ways. For example, workers with highly specialized knowledge and skills might be exploited by their unskilled coworkers; they may get some of the value of their contribution back if the firm’s management is especially slick in its dealings with the state’s auditors, though these managers are more likely to siphon their ill-gotten gains into their own pockets. (People who hire exceptionally vicious lawyers face a similar adverse selection problem.) On the other hand, if their management team is relatively nonopportunistic, then the skilled workers would lose out—not once but twice.

All that can be said at this level of abstraction has to do with the dynam­ics of adverse selection and moral hazard, since these systematically affect people’s penchant for opportunism. Given the comparative weaknesses of organizations of market socialism, one could predict that if market socialism replaced capitalism in a given society, there would be a tendency for workers with more highly specialized human capital and workers who are not given to opportunism to emigrate from the society. In short, there would be a brain drain and virtue drain, and those who remained would become more cyni­cal in response to the likely increase in exploitation throughout the econ­omy—hardly an encouraging prospect from a socialist (or indeed any other) perspective.

Though the just always prosper at the expense of the unjust, the really important question is, How much? It seems that the answer will depend cru­cially, though not exclusively, on the vulnerability of economic organizations to exploitation. I have tried to explain the vulnerabilities of market socialist organizations in such a way as to make it evident that there is no way to pre­vent the various forms of exploitation that have been identified, at least within the framework for a market socialist economy as it has been specified in this book. This raises an obvious question: Why this system? Or, more exactly, why this particular configuration of market socialist property rights? The answer to this question is to be found in the third section of chapter 2, which motivates each element of the system of property rights that has been the subject of this chapter and chapter 6. These motivations are to be found in a socialist vision of the good society—a vision that ultimately derives from a widely shared socialist critique of capitalism—and are summarized in Fig­ure 2.1.

At this point, it would be appropriate to locate the results of the discus­sion in chapters 5-7 in the framework of the larger capitalism/socialism dis­pute outlined in chapter 1. The primary aim of these chapters has been to give a limited criticism of a well-motivated type of socialism and a limited defense of a free enterprise system. Roughly, the argument has been that this type of market socialist economic system is more exploitative than free enter­prise systems. This is a comparative judgment about types of economic sys­tems pitched at a level of abstraction that transcends particular economic sys­tems. This means that there is no way to say how serious the problem would be in any particular society that has this type of market socialist system, since the extent of exploitation in any actually existing society depends on a whole host of factors, only one of which is the system of property rights in the means of production. Nevertheless, there is a substantial literature on the econom­ics of property rights which indicates that “property rights matter.”¹⁷ At the level of abstraction at which this discussion has been carried out, all that can be said with assurance is the legal prohibition on alternative organizational forms both permits and encourages forms of exploitative exchange that are precluded or minimized by the characteristic organizational forms found in free enterprise systems. Since the good society is defined in terms of what it is reasonable to hope for, and since it is reasonable to hope that a society would not permit persistent and avoidable exploitation (a form of injustice), it can be concluded that this type of market socialist system is not the eco­nomic system of the good society.

What remains to be determined is how much progress this conclusion represents in the capitalism/socialism dispute. The answer to this question depends on how well motivated this type of market socialist system is. This in turn depends in large measure on whether or not there are socialist alter­natives to the form of market socialism that has been under the microscope in this book—alternatives that do not have the defects that afflict the latter.

Indeed, one might wonder why other configurations of socialist property rights have not been considered, especially if a change in the system could eliminate or minimize some form of exploitation. Part of the answer to this question is that when discussing alternatives to a free enterprise system, it is extremely important to have a clearly specified alternative on the table that can be subjected to a thorough evaluation. For too much of the past century and a half, socialism has been like a three-year-old at the dentist’s office unwilling to sit still for a thorough examination. If different socialist alter­natives are to be discussed, they need to be specified and evaluated seriatim.

Still, it is legitimate to ask whether any other version of market socialism might realize the socialist vision of the good society. The first two sections of chapter 8 will systematically address this question by considering plausible alternatives to the version of market socialism that has been the main topic of this book. These alternatives are intended to deal with the organizational weaknesses identified in this chapter and the preceding one that make this form of market socialism so vulnerable to exploitation. The argument will be that each of these alternatives is either (1) also inferior to a free enterprise system on the question of exploitation, (2) unable to realize other social virtues that are part of the minimal socialist vision of the good society, or (3) not really a form of socialism. Chapter 8 will also explore the larger signifi­cance of this conclusion by connecting the conception of exploitation employed in this book to concerns about distributive justice and by recon­sidering the socialist vision of the good society.