Constitutional Enterprise

Volume 2 Number 2, June 1994

© 1994-1998, Richard L. Forschler, SeaTac, Washington. All rights reserved.

In This Issue

I had planned to use this issue of Constitutional Enterprise to further define the constitutional branch of the CE system. However, comments by readers of earlier issues revealed the need for some clarification before moving on.

Successful implementation of CE in existing businesses would require several significant changes. In this issue of Constitutional Enterprise I'll describe some of them in greater detail than previous issues, and explain why they are necessary. Topics I'll cover are:

Business Revolution—CE is a radical departure from traditional business systems. It requires vast changes in thinking and practice.

Internal Market System—At the heart of CE is an internal market system regulating production. Non market-based systems lack the measures necessary for efficiency.

The Role of Managers—CE cannot be implemented efficiently in an existing business without first eliminating the top-down authority structure. Such a structure is incompatible with the internal market system of CE.

Misplaced Confidence—We over-simplify the challenge of self-organizing systems if we think that success is assured simply by choosing the right leaders. Any person, good or bad, will achieve poor results in a flawed system. We must fix the system first, then secure good men and women.

Business Revolution

Business theorists are notorious for taking their own ideas too seriously and seeing within them the origins of revolutionary progress. They tend to discredit the theories of others and with utopian optimism ignore potential weaknesses in their own. They are usually fanatics. Why should I be any different?

CE has the potential for revolutionizing modern large businesses and bringing about quantum-level improvements in efficiency. Unfortunately, progress of this scale comes at a price. Compared to other popular business theories it requires a far more radical shift in both thinking and action.

While some benefits could be realized by implementing CE in a piecemeal fashion, the various systems are so interdependent they will not work efficiently in isolation. [1] The influence of some features are greater than others, and some are more visible than others, but they all must work in concert for maximum efficiency. For this reason CE cannot be adjusted to fit most existing businesses; instead, they must be completely rebuilt to accommodate it.

Perhaps the greatest obstacle to implementing CE is mental. Traditional concepts of top-down decision making, order, and organization must be replaced with philosophies of organic-like adaptation and self-organizing systems. People accustomed to long-range planning and command structures will have difficulty trusting anything else. Many will never be convinced until CE is proved in real-life applications. Meanwhile, the only way to allay their fear is the example of the free market in society, and most people have only a vague understanding of how the free market works.

Internal Market System

The most important difference between CE and traditional businesses is the presence of an internal market system. It's like the difference between the backward economy of the Soviet state and the dynamic economies of free countries. An internal market system is the engine of CE—the source of its power and efficiency.

While many different business structures exist today, most are organized like a series of mini-monopolies; each with a sole-supplier relationship to the other departments in the company. Each handles its own portion of the production process without any choice of who to deal with and how much it should cost. By contrast, in market-based firms each department buys from and sells to other departments, or if they so choose, other companies.

Understanding why a market-based approach promotes efficiency begins with understanding exchange value and competition. The exchange value of something is exactly what someone is willing to exchange for it. In the process of exchange people naturally strive to maximize the value they receive for a given price. If they can't make an equitable exchange with one source, they seek out another. If competing sources are available they usually choose the most efficient one. [2] Those of lesser efficiency must either improve, or change their line of work.

Without a system for exchanging products and services within a business it is difficult to measure the contribution individual departments make to the whole. Attempting to establish value using labor time based accounting systems is futile. Labor-based measures merely identify costs, not what someone is willing to pay. Inefficiency is camouflaged behind layers of internal departments, each providing their products to the next without any exchange taking place. Is it any wonder internal customers are not concerned about the efficiency of their internal suppliers when they are supplied with their products for free?

In addition to regulating goods and services a true market-based system regulates investment capital as well. Competition for the available reserves naturally channels capital to its most productive use.

Thus, in the CE approach, production is totally controlled by market forces. This concept strikes the traditionally minded as being risky. They usually feel that a management structure is necessary to maintain discipline. On the contrary, those departments which are poor at serving their customers, are disciplined by the market far more severely than any management hierarchy could do.

The Role of Managers

The most readily perceived difference between CE and traditional businesses is the lack of a top-down authority structure. No CEOs, directors, managers, or supervisors are necessary. Of the functions they would typically perform, many have been eliminated, and the rest are performed by either individual departments or elected representatives.

When designing the features of CE I did not begin with the goal of eliminating managers, but once the design was largely complete, there was simply no need for them. I do not mean to imply that managers are merely useless or even harmless. In fact, I discovered the conflicting roles held by them work against the efficient functioning of a business—their presence is harmful.

A top-down authority structure is poison to a business system. It focuses the goals of employees on the desires of management, in spite of the fact the business exists for its ability to serve a customer. To the extent there is no conflict between the desires of managers and customers the business is likely to do well. However, in the absence of an internal market system, such conflicts are the rule.

The best example of the myriad problems created by a large top-down control system is the Soviet experiment. For many years all production was directed by the Soviet government—all factories were owned by them and all decisions over the supply of goods were mandated from above. They assumed the needs of consumers could be guided by administrators. As a result, the consumers were subjected to shortages of needed goods and overages of unneeded ones. People stood in long lines to acquire goods of short supply, while other unwanted goods rotted in warehouses. Rationing became the way to deal with consumer demand. Time and again it was the black market that actually supplied the goods the people needed.

The Soviet system was management-driven instead of consumer-driven. It could not respond adequately to market demands because the consumer was isolated from production decisions—they could not duplicate the self-organizing character of the free market. Attempting to bring order to industry they institutionalized methods to suit existing conditions. Then when conditions changed, as they always do, the methods were inappropriate.

One of the major sources of inefficiency in a management-driven system is the psychological effects the hierarchy has upon its participants. As shown in Exhibit 1, below, management's authority to reward and punish is the primary influence over employee actions. It imposes fear where there should simply be a business relationship. By contrast, in a consumer-driven system, where employees do not receive conflicting signals, they simply serve customers.

Exhibit 1

A hierarchy naturally imposes downward pressure on subordinates to comply with the wishes of their superiors. Whether it is a Soviet government or a business hierarchy inefficiency is the rule when commands are imposed from above. It is the combined roles of lawgiver, judge, and executioner that causes the problem. Fear is the natural result when the same person issuing commands has the power to punish for non-compliance. Regarding governments, James Madison said it this way:

The accumulation of all powers, legislative, executive, and judiciary, in the same hands, whether of one or a few, or many, and whether hereditary, self-appointed, or elective, may justly be pronounced the very definition of tyranny. [3]

In a management-driven business each level of the hierarchy regularly imposes mandatory activities upon those below. Often with totally good intentions, and the best interests of their respective companies in mind, they study the business environment for potential ways to improve. Upon discovering new methods that have reportedly proved effective in other companies they take active steps to implement them in their own. Many of them contain excellent tools for increasing efficiency and quality. Programs such as MRP, Quality Circles, and Just in Time, have great potential; but, implementing them from the top-down continually ruins their effectiveness. No employee wants to be known as a person who doesn't support management goals. So rather than treating the programs as tools to improve service to the customers they are treated as ends in themselves. The needs of the customer gives way to showing compliance with management.

Today, technological, social, and economic change must be dealt with rapidly. Appropriate actions are possible only if people can freely give candid or dissenting opinions. An open environment is essential. But with a top-down reward structure each level is beholden to the hierarchy and strives to please those above. Facts, goals, and even morals are thrown out if they conflict with the agenda of the superior. In this environment, ideological correctness becomes essential.

Both in business and government, it becomes unwise to oppose the rulings from above. The way to get ahead is to please one's superiors. If the boss supports a program then all of his or her subordinates feel as though they must out-do their peers in showing compliance. They may even invent other projects for the sole purpose of demonstrating their enthusiasm for the favored goal. Steadily the poison seeps through the system until everyone in the hierarchy either sings the praises of the program or is removed to a less visible position. This produces a climate abounding in both implicit and explicit threats, not to mention, waste.

In both governments and businesses a system cannot be management-driven and consumer-driven at the same time. A management-driven system so radically distorts production activities it is incompatible with a consumer-driven system. CE is consumer-driven, and therefore totally incompatible with a management-driven top-down system to control production.

Misplaced Confidence

As some readers consider the foregoing section on managers many will undoubtedly believe the problems of hierarchy are simply "people problems," and propose training or replacing the managers as a solution. Instead of seeing inadequate systems they prefer to see inadequate persons. This highlights one of the next most significant changes in thought required by the CE ideology.

Choosing talented, honest, and sincere people is not a sufficient safeguard against abuse in a hierarchy. It is dangerous to trust anyone with unchecked authority, even those whom we believe possess integrity. History teaches us, by sad experience, that unchecked authority brings with it an almost irresistible temptation to exercise it. Often a person's whole outlook and personality changes when placed in a high position. In the words of Lord Acton, "Power tends to corrupt, and absolute power corrupts absolutely."

The whole purpose of checks and balances in a constitutional system is to prevent the abuse of authority. Thomas Jefferson wrote,

It would be a dangerous delusion were a confidence in the men of our choice to silence our fears for the safety of our rights....Confidence is everywhere the parent of despotism. Free government is founded in jealousy, and not in confidence; it is jealousy, and not confidence, which prescribes limited constitutions to bind down those whom we are obliged to trust with power....Our Constitution has accordingly fixed the limits to which, and no further, our confidence may go....
In questions of power, then, let no more be heard of confidence in man, but bind him down from mischief by the chains of the Constitution. [4]

Our confidence is misplaced when we trust good men and women to control a bad system. In fact, in a bad system it might be wiser to choose people who are lazy and incompetent. If you were chained to the oars of a galley ship, who would you rather have standing behind you with a whip: a sincere and energetic believer in the system, or a disinterested and lazy skeptic? We need to understand and institutionalize good systems before we seek out good people.

Many utopian socialist schemes relied upon similarly unrealistic views of human nature. Speaking about such schemes in his book Human Action, Ludwig von Mises stated:

    Speculative minds drew ambitious plans for a thorough reform and reconstruction of society....They did not search for the laws of social cooperation because they thought man could organize society as he pleased. If social conditions did not fulfill the wishes of the reformers, if their utopias proved unrealizable, the fault was seen in the moral failure of man. Social problems were considered ethical problems. What was needed in order to construct the ideal society, they thought, were good princes and virtuous citizens. With righteous men any utopia might be realized. [5]

In his insightful book, American Spirit, Lawrence Miller compared modern management problem solving techniques to a plot from an episode of The Lone Ranger. [6] Miller observed that our concept of problem solving is conditioned by decades of watching such programs. We have come to expect problems to be caused by villains and solved by heroes; heroes who can rush in, correctly discern the problem, save the helpless victims, and leave again, all inside a 30 minute episode.

When people assume this role of hero we have only ourselves to blame—we beg for heroes to save us. In the first issue of Constitutional Enterprise I stated:

Large organizations are not efficient under socialism because, in a system without consumer-driven prices, no measures exist to guide production. Without such measures the well-meaning participants work at cross-purposes with each other and lost opportunities become increasingly difficult to identify. While people in such a system may fervently desire greater prosperity, the injustice of the system itself becomes a demotivator. Frustration turns to resentment and suspicion. Someone, they feel, must be incompetent or selfish. Unable to see flaws in the overall system they search for villains and saviors. [7]

This describes a systems problem, not a people problem. We need to look beyond foolishness and wickedness to the systems that promote such behavior. Blaming individuals for systemic problems is easy, but fails to solve the underlying cause. We need to stop trying to solve problems by changing people, and discover ways to make foolishness and wickedness self-defeating. In such systems people will cease to behave irresponsibly because they are the first to suffer from their own actions.

In An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith states that a person engaging in commercial activity who—

...intends only his own gain, led by an invisible hand to promote an end which was no part of his intention....Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. [8]

What Adam Smith saw was the self-regulating nature of the free market, where individuals are responsible for their own support and their success depends upon their ability to serve customers. No one needs to guide production toward socially correct ends. For every person who becomes self-reliant there is one less who requires support by others. Foolish, wicked, and irresponsible actions result in natural penalties; wise, generous, and responsible actions result in natural rewards. There is no need to worry about greed and selfishness; the market will eventually filter-out any customer-negative actions. Individuals enrich others while traveling on the road to their own riches.

This is the purpose and central theme of the CE ideology—to create self-organizing systems where the actions of individuals spontaneously benefit the entire organization. The solution lies in creating and maintaining an environment, in which these systems can operate efficiently, without jeopardizing the systems themselves. But the real challenge is much deeper and more difficult to achieve—we must change our notions of order and organization. Both the problem and the solution lie within our minds.


  1. For an overview of the constitutional system, market system, and profit system see Constitutional Enterprise, Volume 2 Number 1, February 1994. Return

  2. Of course, many factors besides price can have a great influence on their decision to exchange—reliability, quality, delivery schedule, etc. Return

  3. See, Alexander Hamilton, James Madison, and John Jay, The Federalist Papers, originally published 1777–1788, (c) 1961, The New American Library, New York. Paper No 47, by Madison, p. 301. Return

  4. Thomas Jefferson wrote this passage as part of the Kentucky Resolutions of 1798. See The Real Thomas Jefferson, (c) 1983, The National Center for Constitutional Studies, Washington DC, pg. 200. Return

  5. Mises, Ludwig von, Human Action, 1949, Contemporary Books, Inc., Chicago, Illinois, 1963, p. 2. Return

  6. Miller, Lawrence M., American Spirit, Visions of a New Corporate Culture, (c) 1984 by Lawrence M. Miller, Warner Books, p. 43–46. Return

  7. See Constitutional Enterprise Volume 1 Number 1, July 1993, p. 3. Return

  8. Adam Smith, An Inquiry Into The Nature And Causes of The Wealth of Nations, 1776, Liberty Classics, Indianapolis, 1981, Volume I, p. 456. Return

In The Next Issue

The next issue of Constitutional Enterprise continues the discussion of socialism and capitalism and shows how businesses, in a capitalistic society, with capitalists in charge, can indeed contain a socialistic structure. The next issue also takes a flight of fancy, and considers what would have happened if CE could have been implemented 150 years ago.

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