Exploration of the research questions

Human economic activities are expressed mainly through material changes that occur as a result of production, distribution, exchange, and consumption. These changes are not the same as natural or seasonal material transformations such as spring blossoms or an autumn harvest. Human economic activities are artificial and collective. A purely personal activity, even if productive, is only a survival activity and not an economic activity. The fundamental objective of economic activities is to maximize interests. For each individual, this idea can be expressed as utility maximization. For firms, maximizing interests implies maximizing profits while, for governments, interest maximization implies maximizing social welfare. Under the premise that each economic agent seeks an individual’s own interests, the group and social nature of economic activities manifests as interest distribution among people. Such distribution includes the division of production cooperation, distribution of cooperative income, and transactions between economic agents. Distribution is the most important of the four factors of economic activities: production, distribution, exchange, and consumption. Distribution determines exchange, consumption, and production. For a firm, whether distribution is reasonable will affect the inputs of every production factor and fully display their efficiency. Therefore, the equity of interest distribution is the necessary condition for maximizing interests. Distribution plays a central role in economic activities whereby it determines whether the related activities can be conducted and affects the outcomes. Among economic agents, the structure of interest distribution relies on the structure of power. Following is a discussion on the formation of distribution systems and methods from three aspects: firms, the market, and government.

10 Introduction Firms

According to interpretations of new institutional economics, a firm is an economic organization composed of a series of contracts. A firm offers a way to transact that is characterized by collaborative production and common benefit. Consequently, business contracts represent the interest distribution structure for various production factors. All types of contracts are directly or indirectly related to interests; if a contract is not concerned with interests, it arguably should not be considered a contract. Moreover, the formation of enterprise contracts is the result of long-term games among all factors. The bargaining chips include the demand-supply relation in factor markets, the specific properties of each factor, and the significance of factors in terms of collaborative production. During contract negotiation, individuals who control scarce resources have market influence and power. Thus, these individuals dominate negotiations and ultimately benefit from the terms of the contract. Since the contest among factors determines the distribution and ownership of residual claims and control, for the non-Pareto state, there always exists the situation where one side initiates adjustments to the contract to further their interests. All parties have no consensus about the decision-making rights that are ambiguous or not addressed; thus, the parties engage in continuous negotiations for their own interests. Improper control and claim allocations are adjusted until the structure of power matches that of the interests. Of course, there are no absolute criteria for what is reasonable. The process is reasonable so long as every agent participating in the economic activity accepts it, and the accepted production relation and distribution structure becomes institutional. If the power structure changes between factors, new institutions will replace the old, and the interest distribution structure will change accordingly. That is, because the change in the power structure of the production factors requires corresponding adjustment in the interest distribution structure, the enterprise contract will change, and the driving force behind the contract change comes from the change in the power structure. The latest development in modern corporate theories emphasizes the idea that firms are not only a combination of contracts of free transactions but also a set of power relations (Cui, 2004).

The market

Traditional market economic theory states that price, the invisible hand, adjusts all economic activities continuously, which eventually optimally allocates resources. Price itself reflects one type of interest distribution relation. What determines such distribution, or, effectively, the equilibrium price? Some consider the answer to be the demand-supply relationship of goods. However, is this really so? In a perfect monopolistic market, the demand- supply relationship is only a tool to calculate the possible relative quantities of demand at different price levels. The price depends on the level that will embody the company’s strategic goals or maximize firm values. Therefore, in such a market structure, price is not determined by demand-supply relations but by monopolistic power over the market, which is the economic power that an entity possesses. In an oligopolistic market, price is not determined by the demand-supply relationship either. All tangible and intangible strategic alliances and price agreements, such as Cartels or Konzern, are the result of games between oligopolists using their economic power. The greater the control over the market, the more likely the oligopolists are to set favorable prices. In a monopolistic-competitive market, the reason that firms strive to weed out old and bring in new products and technologies is to gain a monopoly over a certain function of similar goods through product differentiation and then win initiatives in pricing so that profits or values are maximized. Therefore, in a monopolistic competitive market, it is not supply and demand that determines prices, it is manufacturer’s control over certain functional characteristics of goods. In a perfect competitive market, due to the quantity of demand and supply between individual buyers and sellers only account for a small part of the market share. Particularly, all commodities of similar products have no difference in quality, and each individual firm can only be the market price taker without any control over the price. Only in this case can price be determined by the market demand-supply relation. This does not mean that the economic power of agents has no role in setting prices, only that the influence of their power is reciprocal.

Market mechanisms are not merely the equilibrium between demand and supply. Market mechanisms embody the relationship of interest distribution either on the demand or supply side or between the two sides regarding the transaction surplus. Changes in market price are the focus of both demand and supply in the fight for interests, which represent the contest of power. Power is determined by whether the maximum amount of obedience can be obtained at minimum cost. If buyers have strong demand but no alternatives, firms can obtain more obedience at minimal cost, which, in turn, controls consumers. Market competition eases the expansion of firm’s power, and consumers resist this power by establishing cooperatives or purchasing associations. If the initial state between producers and consumers is given; that is, either consumer’s information is passed on to producers through price, or producers induce consumers through commercial advertisements, the interest distribution structure between demand and supply—price—will be determined to a large extent by the struggle for consumers among producers. Contests between firms are everywhere— price wars, brand wars, function and technology innovations, management and production efficiencies, negotiations for alliances, and breakdowns in negotiations. The strength of an enterprise in the market relative to other enterprises depends on economic power; it is not the case that the relationship between supply and demand determines an enterprise’s market share and return. The power relation is the most obvious in oligopolistic markets. Any oligopolist’s action will result in another’s reaction. The inter-dependence of oligopolists’ strategies is the interactive relation between oligopolists. Such relations determine the structure of market share. It must be true that market distribution structure conforms with the power structure among oligopolists; otherwise, agreements would not be implemented. Even in a monopolistic industry, firms must expend some rents to contest against potential rivals. Such rents include costs to maintain advanced technology, patents on innovation, and rents to persuade government to support monopolistic behavior and to accept or consent tacitly to the monopolistic price. The aim of such expenditures is to maintain monopolistic position and to prevent new firms from entering the market. Of course, monopolist power is reflected in the monopolist’s complete control over the industry and forced acceptance by consumers and workers. Marx (1911) once predicted that human labor would not generate fortunes in a direct way after technology is extensively applied to production; therefore, the function of working time is no longer a measurement of the values of fortune. Since there is no single objective criterion to measure the contributions of production factors, naturally, prices, wages, and interest rates lose the objective of market fairness and become the outcome of power relations. Therefore, the market is not really operated by price, the invisible hand, but by power, a hand sometimes visible or invisible. Full competition can control economic power although any economic agent hopes to restrict or avoid competition.

Government

The main economic function of government is to achieve social equity and maximize social welfare through a series of fiscal and financial policies and the implementation of related legislations and regulations, which is also the redistribution of interests. How are such policies and rules made? For example, what categories of taxes should be designed; what tax rates should be set; on whom are the limited fiscal revenues to be spent; and how much should be spent? Such questions are resolved directly by administrative power. However, the decision-making process should consider ways to help maximize social wealth and welfare, how economic entities will react, and the actions they might take. It is clear that the outcome results from games between the administrative and economic powers. As another example, anti-trust and pollution prevention laws are made by government to respond to market failure, the essence of which is an economic power that is out of control. To prevent the power from losing control, government intervention and coercion is necessary. However, it is inevitable that government adjustment and control will be influenced by different interest groups. This influence allows advantaged groups, who possess strong economic and political power due to substantial public resources, to influence government decisions directly and indirectly and make policies and regulations that benefit their own interests. In contrast, disadvantaged groups under long-term containment do not have representatives to fight for their interests in law making, regulation.

and policy creation. It is a general belief that the process toward market- orientation and liberalization will bring improvements in efficiency and economic development while administrative regulatory behavior mitigates the distribution disparity among different income levels. These two dynamics are complementary. However, market liberalization does not necessarily promote economic development. On the other hand, centralized monopoly of power may result in unequal income distribution. Both administrative regulation and market competition are institutional forms of production and the distribution of social wealth. In the economic transition process, individuals reject market penalties and often resort to government for protection. Government is more willing to act as the savior. Consequently, government monopoly in institutional design is increasingly common. It is necessary for the rulers and the ruled to reach agreement on power and responsibility or agreement of rights and obligations. Such contracts stipulate what the government must do and the power to which it is entitled. In the meantime, it is more important to stipulate what government must not do and what rights cannot be taken away from the ruled. Such contract arrangements define constitutionalism. Under constitutional principles, unconditional power is illegitimate. People have the right to effectively restrain and supervise power.

To summarize, because economic activities are collective, interests are obtained through distribution. The emergence of interest distribution mechanisms is, in turn, the result of power games. The distribution and the power systems are identical, and the pattern of power determines the pattern of distribution while the power structure is determined by the scarcity, importance, and substitutability of resources that economic agents control. To attain full utilization and optimal resource allocation to maximize social interests and welfare, it is fundamental to realize power reciprocity among different economic agents at the same hierarchy level and the ensure symmetry between power and responsibility for the same economic agent.

Traditional economic theory has sufficiently shown that perfect competition is the ideal state for realizing optimal allocation of resources even though it is not realistic. The essence of a perfect competitive market is power equality among economic agents, which means each individual economic agent has no dominant role in market transactions. Keynesian theory has illustrated that the necessary and sufficient condition for full employment and full utilization of resources is that goods markets, labor markets, and monetary markets are simultaneously in equilibrium. The essence of such equilibrium is that the overall influence and effects are equal for all input factors. Once the control and influence power of an economic agent or a group of agents has changed substantially, the initial equilibrium will be broken causing disequilibrium and gradual attainment of a new equilibrium. Only when power reciprocity is realized, which means general equilibrium under perfect competition, can full utilization and the optimal allocation of resources be achieved simultaneously. Although such reciprocity and balance are almost impossible, the objective is perpetually pursued.

The optimization of social benefits and welfare requires a certain mechanism to induce resource movement and allocation. For economic agents, only when power is reciprocal and power and responsibility are symmetrical can social wealth be guaranteed to continuously increase and to be distributed fairly. The essence of the principal-agent problem is not the asymmetry between agent’s power and interests, it is agents’ absolute power over firms’ management and no explicit obligation of success or failure of business management, which represents asymmetry between power and responsibility. For the same economic agent, its power and responsibility must be clarified. In other words, the economic agent must understand in advance what they can and cannot do and the corresponding rewards and punishment. If there is only power and no corresponding responsibility, that power will be unrestricted power, or infinite power. If there is only responsibility and no power, then responsibilities cannot be guaranteed and bear results. Therefore, the micro-foundation of enhancing corporate value and realizing full utilization and optimal resource allocation is that an economic agent has symmetry between power and responsibility.

The social justice problem that people have been pursuing is, in essence, the pursuit of a power mode with two-way effects; in other words, the equity problem. This is so because in the mode of one-way effects, one party’s claims on interests cannot be expressed or even mentioned if they are to be realized. For example, the arable land in China’s rural areas was wantonly occupied, and the peasants did not receive a reasonable subsidy. This is not a market problem since the marginal returns after changing the purpose of arable land are much higher than retaining the land for agricultural usage even after deducting rent-seeking returns for administrative agencies. It is neither a land property rights problem, since the Constitution clearly stipulates that land is owned by the state or the collective (peasants who contract the land are entitled after 50 years of farming the land), nor a principal-agent problem since agents in the grass-roots cadres are not elected by peasants. The source of the problem lies in a hidden power imbalance. The property rights institution without protection from power means nothing. The latent rules in a society become the basis of decisions by economic agents even if they are not documented in written regulations or recognized by laws due to the support of power. In land transactions, the real owners, and the individual who creates benefits, have virtually no opportunity to express opinions. They have neither the power nor the ability to influence the allocation of land. Therefore, the transactions are, inevitably, a one-way process of transferring interests, which is a transfer from the disadvantaged to the advantaged.

The structure of this book is as follows. Chapter 2 defines power and the historical basis of the economic power paradigm. Chapter 3 analyzes how control rights are distributed among members of a firm and the sources of these rights based on economic power. Chapter 4 discusses the formation of price under the power game among market subjects. In Chapters 5-7, we investigate transaction prices in goods markets, financial markets, and labor markets. Chapters 8 and 9 focus on government intervention and the optimal allocation of production factors, respectively. Chapter 10 presents the nature of institutions and the dynamic mechanisms of institutional change from the perspective of power. The final chapter addresses some limitations that we encountered and suggests directions for future research on economic power.

Notes

• 1 There is a certain correlation between a particular means to exert power and the source of a particular power but it’s not exclusive. For example, organizations can exert the conditioned power externally but the condign power internal^'. A nation as an organization can use all of the three kinds of power. The means of the exertion and the source of the power exerted are interlaced.
• 2 D. Acemoglu is professor in the economics department of M.I.T. He’s made valuable contributions in various areas. Especially, his work in institutional and political economics has been innovative and influential in the related areas. He was awarded in 2005 the John Bates Clark for his work. The medal is often called the junior Nobel Prize.