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Freakonomics review part 2: The Heterodox Theory of the Criminal Firm

Ah, ya thought it was never coming �

Here is the first bit of the Freakonomics review; there is more to come, along the lines of this and this semi-related bits. But for now, I’m planning to take a bit of an excursion and write a little bit more about the “crime gang = corporation” idea. I want to show that there is no meaningful analogy between a crime gang and a capitalist corporation, and to develop an alternative theory of the remuneration structures that Levitt and Venkatesh observed, drawing on more heterodox/Marxist traditions. It’s partly a digression which interested me, and partly an attempt to show that there are always a zillion and one economic theories consistent with the data, particularly when the data are as partial as the raw material of Freakonomics.

The fundamental reason why a crime gang isn’t like a capitalist firm is that it doesn’t obey the fundamental principle of a capitalist firm, which is to accumulate capital. The crime syndicate described in Freakonomics sold drugs at a mark-up, and it presumably wanted to make more profit rather than less, but so did a merchant under feudalism. The defining characteristic of a capitalist enterprise is accumulation, not profit per se.

For people who are a bit familiar with the Marxist literature, this is quite an easy argument to make; a capitalist firm follows the cycle M-C-M’, but a criminal gang has to be in the cycle C-M-C’. For people who aren’t familiar with the Marxist literature, M stands for “money”, C stands for “commodity” and an apostrophe means “more”. In other words, the purpose of a capitalist is to produce more money, while the purpose of a crime gang is to produce more crime.

I sense I’m not convincing the unconverted. OK, look at it this way. The central feature of a capitalist economy is the good old “miracle of compounding”. When you make a profit from something, you reinvest that profit in your business so that your wealth grows at a compound rate. Even if your own firm has reached maximum scale, the rest of the capitalist economy is there to let you reinvest your surplus in order to produce more surplus. That’s the M-C-M’ cycle.

On the other hand, can a criminal gang really reinvest its profits? Not really. The physical means of production (guns, drugs inventory, etc) is not usually the constraint on a drug gang’s ability to expand. For any drug gang which isn’t basically a startup, the market will be more or less saturated in the territory it commands, so the only way to grow is to get more territory. While having some spare profits to reinvest is obviously a prerequisite for growing your territory, it’s clearly one of the least important parts of a difficult and complicated programming problem. I would say that to a first approximation, a criminal firm differs from a normal capitalist enterprise in that it cannot reinvest its profits and the entire surplus is consumed by the top management of the firm. I surmise that the actual consumption behaviour of criminals is at least weak evidence that I am right.

Obviously, the managers of a successful criminal enterprise can, if they launder them, invest their profits in the legitimate economy, but that is not the same thing. In particular, it appears to me as if there is no genuine accumulation in the criminal economy, no tendency toward monopoly and no likelihood of overproduction or underconsumption crises. Criminal gangs rise and fall due to non-economic factors.

For this reason, among others, I am not convinced that the inverted pyramid remuneration structure that Levitt and Venkatesh observed is particularly well explained as a “tournament”. As I mentioned in the first section of the Freakonomics review, the Disciples’ reward structure does not really fit very well with the objectives of a business that wanted to maximise return on sales. The soldiers were paid a flat wage, not a commission on sales, and advancement through the ranks tended to go to those individuals who demonstrated a combination of bravery, loyalty and psychopathic aggression. My sound knowledge of popular culture suggests to me that this is a common organisational feature of crime gangs; top-ranking crooks always like to claim that they are in it for the money, and that their best gangsters are the ones who can generate new profit opportunities, but a glance at the film “Goodfellas” (based on an autobiography) gives a more honest picture of what actually happens when a bunch of “guys like us” are put in charge of organising an actual capitalist enterprise.

I think that the actual stylised facts are better explained by something like the “conflict theory of the firm“, due to Bowles, Skilman, Devine and others. This puts the conflict between owners of an enterprise (who want as much profit as possible) and the workers (who want to expend as little effort, danger and inconvenience as possible for their wage) at the centre of the theory. Rather than a Coasian “nexus of contracts” between freely associating individuals, brought together to minimise transaction costs and maximise productive efficiency, a firm under the conflict theory is made up of a bunch of overlords at the top, a bunch of surly minions in the middle, and to resolve the conflict, a bunch of not-directly productive supervisors in the middle. Yes, as a matter of fact, the central college textbook for teaching this version of economics is the Dilbert Principle. JT in the gang studied was occupying the classic pointy-haired boss role; he wasn’t a businessman himself, but he was responsible for supervising a crew of soldiers.

I think that this theory actually explains a lot more of the organisational structure of the Disciples than Levitt’s tournament analogy. The soldiers were not, as a matter of fact, encouraged to believe that they could rise to the top of the gang and reap the rewards of an equity-owner. They were encouraged to stay within the confines of the gang whether or not they were actually performing in sales terms, and were incentivised to make their sales targets with beatings rather than commissions. Finally, the supervisor ranks were dominated by the loyal, the brave and the psychopathically violent. This wasn’t an entrepreneurial organisation; it was a hierarchy where the stupid were exploited by the evil, making use of the mindless. Which makes me think that perhaps a crime gang is rather more similar to a capitalist firm than I had previously thought, and that it is the neoclassical model of a capitalist firm which is the odd one out.

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