The Invisible Handcuffs of Capitalism: How Market Tyranny Stifles the Economy by Stunting Workers (14 page)

Leibenstein appealed to one of the three conventional effects of monopoly that Harberger dismissed—that monopolies misallocate resources. However, X-efficiency cut two ways for conventional economists. To begin with, it showed a weakness in Harberger’s contention that monopolies do not reduce welfare: even if increased prices might do little harm, monopolies reduce productive efficiency. Leibenstein reminded economists that the “misallocation of resources,” which Harberger mentioned at the beginning of his article, included resources used in production.

Economists did not need Leibenstein to teach them about the harm done by monopoly. A core concept of economics is that competitive pressures are the key to efficient production. Monopolistic power offers protection from competition. In the splendid words of John R. Hicks, “The best of all monopoly profits is a quiet life.”
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While economists were unlikely to welcome Mundell’s nightmare of economists sinking into irrelevancy, Leibenstein’s assertion of dissimilar efficiencies had even more uncomfortable implications. Virtually all schools of economics, ranging from monetarist to Keynesian, build their models and theories upon the assumption that both firms and businesses maximize.

Yet, Leibenstein’s claim of dissimilar productive efficiencies implied that many firms—not just monopolies or oligopolies—do not
maximize. Identical firms should produce identical outputs. In this sense, the concept of X-efficiency undermined one of the central assumptions of academic economics, threatening a fate worse than irrelevancy.

Leibenstein was an unlikely rebel. He had resigned from Berkeley after being repulsed by the campus turmoil of the 1960s. He did not intend to openly challenge conventional economics, but he made the mistake of making things difficult for economists who want to be able to reduce everything to simple equations. At the same time, he inadvertently opened the door to questions of work, workers, and working conditions.

Leibenstein’s article unleashed a volley of criticism. A retrospective on his work noted:

Between 1969 and 1980, the article was the third most frequently cited in the Social Science Citation Index. However … much of this citation derived from attempts to explain X-efficiency theory away: it was under almost constant attack from much of the mainstream of the profession over that same dozen years.
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On December 18, 2009, JSTOR registered 1,351 references to X-efficiency, including 884 since 1980, suggesting a continuing interest in the subject. Why then should an article, describing a well-known phenomenon, raise a firestorm among economists?

Stigler’s Reprimand

Leibenstein’s harshest critic was none other than George Stigler, who always stood ready to bully anybody who dared to stray too far from the conventional wisdom. Leibenstein was not immune from this treatment, which came in a caustically titled article, “The Xistence of X-Efficiency.”

From one perspective, Stigler’s vehemence in attacking X-efficiency is puzzling, because Leibenstein’s article lent support to the
proposition that barriers to competition—barriers that most economists abhor, such as monopolistic practices or regulation—can be wasteful. Stigler himself was a constant critic of regulation and hardly a defender of monopoly.

Stigler’s main point was that these differential efficiencies were an illusion. The different firms were producing different mixes of products for sale and other non-marketed outputs, “including leisure and health.”
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Stigler did not mean the leisure and health of the workers, but that of their employers.

Stigler was undoubtedly correct that CEOs do often take actions that trade off firm profitability for their own personal utility. Contemporary research has shown that corporations underperform when their CEOs excel in golf and that the cost of corporate jets is higher when CEOs belong to country clubs far from their headquarters.
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Such behavior raises two questions. First, how do actions that raise managerial utility square with the idea that capitalism maximizes either output or total utility? After all, the consequences of such actions do not differ from embezzlement. Second, if the subjective side of work were relevant for employers, such considerations would be relevant for workers.

Granting that leisure can be part of output, even if that leisure is only for the employers, goes a long way toward accepting the basic thesis of this book. Quickly, after inadvertently opening the door to consideration of work, workers, and working conditions, Stigler tried to slam that door shut by concluding his paper with a warning:

Unless one is prepared to take the mighty methodological leap into the unknown that a nonmaximizing theory requires, waste is not a useful economic concept. Waste is error within the framework of modern economic analysis, and it will not become a useful concept until we have a theory of error.
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In short, Stigler declared that unless economists can wrestle waste into a simple mathematical box, economists must not take such a “mighty methodological leap.” Leibenstein’s sin was to suggest a line
of research that would require economists to look into the way that things are produced rather than confining themselves to the transactional side of the market.

Four years after Leibenstein’s death, Arnold Harberger gave his presidential address to the American Economic Association on the subject of economic growth. Harberger began by downplaying the marginal perspective that was the centerpiece of his 1954 article: “Many, maybe even most, economists expected that increments of output would be explained by increments of inputs, but when we took our best shot we found that traditional inputs typically fell far short of explaining the observed output growth.”
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Harberger gave numerous examples of the sort of productive improvements that fall through the usual net of economic analysis, many based on his experience in Latin America. In his most telling case, he wrote:

I recall going through a clothing plant in Central America, where the owner informed me of a 20-percent reduction in real costs, following upon his installation of background music that played as the seamstresses worked.
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Harberger suggested two different metaphors for economic growth—yeast and mushrooms: “Yeast causes bread to expand very evenly, like a balloon being filled with air, while mushrooms have the habit of popping up, almost overnight, in a fashion that is not easy to predict.”
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Harberger must have understood as clearly as Stigler that conventional economics is not particularly useful in hunting mushrooms, such as finding the kind of music that might make the seamstresses work harder. Yet, as Harberger realized, such unquantifiable innovations can be very productive.

The rest of Harberger’s article ignored mushrooms, retreating to a conventional analysis of the yeast-like bunching of technical change within particular industries. He blamed the poor performance of the lagging industries on an inability to perceive potential cost savings together with a nod to the damage done by inflation, bad regulation,
and protectionism. However, he never showed any interest in why these problems should vary among firms.

In the end, Harberger was no more prepared than Stigler to deal with work, workers, and working conditions. Interestingly, while debates about the arcane subject of X-efficiency might seem complex, in the world of team sports, people commonly speak of players’ intangibles, which are something like their X-efficiency. The idea is that despite unimpressive outward appearances and statistical records, some athletes have these inexplicable intangibles. For example, in the statistics-obsessed world of baseball, Leo Durocher, a famed manager, explained why Eddie Stanky was his favorite player. Durocher told a reporter, “He can’t hit; he can’t run; he can’t field; he can’t throw. He can’t do a goddam thing, Frank—but beat you.”
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Other, outwardly very impressive players are described as poison, meaning that their effect on others is destructive.

A Twisted Reflection of Working Conditions

A third potential intrusion of work, workers, and working conditions emanated from a young University of Chicago graduate student, Richard Thaler, eight years after Leibenstein’s article. Unlike the hostile reaction to Jevons and Leibenstein, the discipline actually embraced this analysis.

Today, Thaler is perhaps the world’s best-known behavioral economist. Here is how he explained his own work:

I am not your usual sort of economist. I practice what has come to be called behavioral economics. We behavioralists differ from our more traditional brethren in the way we characterize agents in the economy. Traditional economics is based on imaginary creatures sometimes referred to as “Homo economicus.”… Real people have trouble balancing their checkbooks, much less calculating how much they need to save for retirement; they sometimes binge on food, drink or high-definition televisions…. Behavioral economics is the study of Humans in markets.
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Thaler did not begin as a behavioralist. In 1974, he published a Ph.D. dissertation at the University of Chicago that found a correlation between wage rates and the probability of dying on the job and then published his results in an article with his advisor, Sherwin Rosen.
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Based on this correlation and assuming the higher wages were a reward for accepting the risk of death, he proposed one could assume that workers were communicating through their transactions on the job market how much they thought their lives were worth. Thaler estimated that workers were demanding $200 a year (in 1967 dollars) for each 1-in-1,000 chance of dying.

This method is seriously biased downward because poor people, especially immigrants, with few alternatives, are more likely to accept low-wage, dangerous jobs. For example, a government report on workplace deaths concluded, “During 1992–2006 … the death rate for Hispanic workers was consistently higher than the rate for all U.S. workers, and the proportion of deaths among foreign-born Hispanic workers increased over time.”
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A different kind of study would arrive at a very different result. If, for example, economists had the capacity to plumb the minds of students who are about to graduate with MBAs from elite universities, they could investigate how much more the students would expect from hypothetical investment banking jobs with an annual 1 percent chance of workplace fatality. If such a study were somehow possible, the value of a “statistical life” would certainly be higher than estimates for a pool of potential applicants for jobs as farmworkers.

Thaler quickly realized the weakness of his results. His friends told him they would never accept anything less than $1 million in return for increasing their chances of dying by 0.1 percent. Paradoxically, the same friends would not be willing to sacrifice any income to reduce the probability of dying on the job.
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This apparent inconsistency soon left Thaler disenchanted with his work, but his recognition that economics’ central assumption of rationality was flawed moved him in the direction of behavioral economics.

Although Thaler lost confidence in his work, he was almost alone in this respect. Instead, his work resonated with the objectives of
opponents of regulation, including business interests and their armies of lobbyists, who along with a number of conservative think tanks and some conservative economists, tirelessly work to weaken regulations.
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One of the major strategies of the anti-regulators is to argue that the benefits of regulations are less than their costs.

To make that point in the case of regulations to protect human lives, anti-regulators want to find ways to diminish the importance of any deaths that regulations might prevent. To meet this need, economists constructed an influential literature to measure the value of a “statistical life.”

Most people resist putting a monetary value on human life, but Thaler’s idea of a “statistical life” had a twofold benefit: it gave a human life a lowball value and put scientific gloss on the anti-regulators’ arguments. Once the idea of assigning a monetary value is accepted, anti-regulators could work to create even lower estimates, further minimizing the consequences of workplace fatalities, as well as deaths from consumer products.

Government agencies embraced this technique.
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This practice is only one part of a three-pronged strategy, which also includes overestimating the costs of regulation and suggesting that money spent on regulation would do far more good in other areas, such as vaccinating children. For example, in pushing this third prong of anti-regulatory rhetoric, John D. Graham, a fervent opponent of regulation, who became President George W. Bush’s head of the Office of Management and Budget’s Office of Information and Regulatory Affairs, even went so far as to claim that spending money on regulations instead of vaccinating children is tantamount to “statistical murder.”
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Ironically, I know of no case when the anti-regulators came out in support of any program to actually vaccinate children, perhaps preferring to be able to recycle vaccination as a straw man to wield against all regulation.

The example of a statistical life illustrates the opportunistic ways that economists avoid looking into questions regarding work, workers, and working conditions, except where they can cherry-pick some useful results.

Thaler’s career is interesting in this regard. Much like David Card, Thaler paid a price for straying from the mainstream fold. His thesis advisor, the same Sherwin Rosen who refused to take Krueger’s work seriously, loved the dissertation but expressed deep disappointment that Thaler’s later work in behavioral economics wasted his career on trivialities. Another University of Chicago professor, Merton Miller, the Nobel Laureate who was so critical of the work of Card and Krueger, refused to talk with Thaler.