Reinventing Capitalism

by eskokilpi

Economist Brian Arthur from the Santa Fe Institute argues that the ever increasing role of knowledge in value creation makes the foundations of economics badly outdated. Likewise, Peter Drucker predicted that “knowledge may come to occupy the place in the politics of the knowledge-based society which property and income occupied over the three centuries that we have come to call the age of capitalism.”

Luckily, an important and growing body of research and writing is exploring the theoretical nature of capital-centric enterprises. Although most of these efforts are still sketchy, they may well lead to normative implications concerning the allocation of claims and control rights in firms. If this happens, the new approaches may be very different from those principal-agent models that are the norm in capital-centric firms today.

In principal-agent models, employees are viewed as agents of the (managers of the) firm, and the managers of firms are viewed as agents of the shareholders. The only right management challenge is then to design the terms of the relationships in a way that will encourage the agents to behave in ways that benefit the principals.

The firm is viewed as a contracting mechanism between providers of financial capital (the principals) and managers (the agents). Principal-agent models are extremely influential in corporate governance and have in reality formed the basis of mainstream compensation structures.

As early as 1964 Gary Becker coined the term “human capital” to refer to the fact that many of the skills and knowledge required to do knowledge work could only be acquired if “some investment was made in time and resources”.

In his seminal work, Becker considered the implications of the fact that some of the knowledge and skills acquired by employees have a much higher value in some relationships than they do in others. The labor services of employees with specialized skills can thus no longer be modeled as undifferentiated, generic inputs, for which wages and quantity, the number of employees, and the number of hours of work, are determined. Once employees are understood to have specialized skills, it matters which employee does what tasks for what firm. With context-specific human capital, the productivity of a particular individual depends not just on being part of a firm, but on being part of a particular group of people engaged in a particular task.

More importantly, once acquired, knowledge and skills that are specialized are assets that are at risk following the very same logic as that by which financial assets are at risk.

Is human capital then conceptually the same as financial capital and should investors in firm specific human capital also be seen as principals? Should employees be shareholders? Should capitalism accordingly create a much larger number of capitalists?

According to the mainstream principal-agent view of the firm, a corporation is understood to be something apart from each of its participants. The nexus of investments view suggested here offers a view of corporations that stresses willing participation by both financial investors and human capital investors, and the ability of both parties to protect their interests. A firm is essentially about creating long-term contracts when short-term contracts are too bothersome. Reinventing capitalism is about renegotiating many of the things that we have too long taken for granted.

I believe that everybody will benefit, if, in the future, a larger number of workers think like owners and act like investors.

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Thank you Brian Arthur, Steve Denning, John Hagel, Umair Haque, Gary Becker, Margaret Blair, Ronald Coase, Oliver Williamson, Harold Demsetz, Oliver Hart and Jeff Gates

Background reading. Robert H. Frank in the Boston Globe.