Theories of the Employer: Risk, Control, and Innovation

Posted on Oct 30, 2024 in Economy

Item 2: The Employer

Historical Review

In the mid-nineteenth century (when economists were starting to follow and analyze the separable functions of capitalist and entrepreneur) the employer was conceptualized as:

A man whose ultimate goal is to make money.
The one who organizes and directs the combined factors of production for products sold in the market.
The confident and adventurous individual who assumes the “risk” securing a rent to the “undecided” or “shy”.
An “innovator”.
A man of action, practical, and with economic foresight.

During the twentieth century, three major theories were produced: Schumpeter, Knight, and Galbraith.

The Employer

The employer leads, controls, and is responsible for the activity of the company.
The employer may not be identified as a person; in most cases, it is a group (such as a management team or partners in a cooperative).
Their decisions determine the course of the long-term undertaking.

Businessman: Risk, Employer: Control, Entrepreneur: Innovation

The Theory of Risk: The Knight Employer

According to Knight, the company faces the future with two situations:

1. “At Risk”

When you know something about the future and, therefore, it is possible to quantify the cost of what there is to know.
The future can be “secured” with a given cost.
Example: the policies of insurance companies (because they make an estimate of the cost of the insured based on statistical data).

2. “Uncertainty”

When there is nothing known about the future.
For Knight, the authentic employer is making decisions under uncertainty.

The Technical Structure and the Theory of Power

The theory of techno-structure.
The theory posits that there is a separation between ownership and control (as in the case of a publicly traded company).
The separation of these two factors gives rise to two currents of Employer Identification:
- Businessman: Risk – is the owner (ends up becoming a mere investor).
- Entrepreneur: Control – is the manager who is leading the company (for Galbraith, the true entrepreneur).

Galbraith questioned what separates control from property.

The separation occurs because of the complexity and size of the firm.
Because of this, managers are hired based on their expertise – the venture entrepreneur delegates because they are not qualified to lead the company – and also, in larger companies with a high number of owners, this makes it difficult to conduct business efficiently, so they delegate to managers.
The company will be managed by these directors, who are technocrats applying their knowledge.
Science and technology, with which these managers have been trained, are what truly make the decisions (employers are simply executing the various theories).

Galbraith calls this set the technostructure.

The employer has very little leeway to make decisions (limited by technology and the law of the State).
The technostructure (set of science and technology) guides employers.
This approach of “joint” corporate uniformity leaves consumers (who, in turn, act independently) at a disadvantage compared with other companies.
To balance the forces between the bidders and the applicants, it would be necessary to create a power wielded by the latter to restore balance to the economic system.
Therefore, consumers should seek to act uniformly, creating a countervailing power (e.g., consumer associations).

The Theory of Schumpeter’s Innovating Entrepreneur

You need a word like “entrepreneur.”

But this business function carried other meanings: “innovative,” “business leader.”
What counts is not words but the recognition of the characteristic performance of the operator.

Reality never offered this feature in and of itself; there is no pure business function. It is a phenomenon that falls within the broader aspect of leadership. The employer must be compensated for the personal work that they have contributed to the direction of the company (the employer’s “wage” and the “employer’s benefit” – a residual income that is attributed to the result of the business). The entrepreneurial function need not be vested in an individual (especially in only one person): it addresses collective enterprises run by institutions or corporations.

Schumpeter’s argument is that if the economy is in a position of balance (between supply and demand), it does not change if the circumstances in which it exists do not change.
As soon as these vary, a new equilibrium point must be sought.
The company that has introduced this innovation is the one that is in a position of privilege until there is a new equilibrium.
When talking about innovation, Schumpeter refers not only to technological innovation but to anything that will push the company above its competitors (advertising, design, etc.).
This privileged position generates an income (and benefits) that is outstanding.
The remaining companies (in light of this success) adopt the innovation brought by the former.
Following this, the special benefit will be reduced (because there are more companies like it) until it is canceled by generating another equilibrium.
The employer is introducing innovation (not just the one at the front of the company) into the economic system through the company.
For Schumpeter, innovation means something new that can be both technological, like an invention, or organizational, like a new way to reward staff.
The one at the front of the employer company is only an entrepreneur when they risk something new and different from what other companies do.
While not innovating, they are acting as an employee.

Knight / Schumpeter

The theory of Schumpeter’s innovation and Knight’s theory of risk are quite similar in that any innovation creates a situation of uncertainty. But it does not always have to be so; because of uncertainty, there are some decisions where the decision is not an innovation.