Capitalism and the Factory System

Abridged article by Axel Leijonhufvud, in R. N. Langlois, ed., Economic as a Process:

Essays in the New Institutional Economics. New York: Cambridge University Press, 1986,
pp. 203-223.

Summary

 The organization of work has undergone several changes through various historical
periods
 The factory has emerged as the most significant icon for large-scale organization of
work and production
 Work in the factory is based on certain organizing principles that offers immense
economic benefits
 The factory also had social consequences leading to the emergence of the firm as the
icon of industrial and managerial capitalism

Introduction

Establishing a conceptual foundation of the function of ‘management’ requires a historical

review of transformation of work and the emergence of organization of production during
the industrial progress of human civilization. The use of management is intricately linked
with the two icons of organized production – the factory and the firm. While the factory is
signified by an ensemble of machines and workers collocated in one workplace, the firm is
signified by its "capitalistic" nature in the sense that capital hires labor rather than vice
versa.

Pre industrial work organization

The factory and the firm emerged in around the mid of 18th century during and after the
historical period of industrial revolution. Before the emergence of the factory, the mercantile
system, a form of capitalism also called as merchant capitalism, prevailed as the
predominant economic system and organized mode of production, comprising of
“entrepreneur” traders and "family firm" craft-shops. Traders were active in markets,
exchanging goods and commodities. The craft-shops were run by a master craftsman with a
couple of journeymen and apprentices and family helpers. The prevalent organization for
production, called as putting-out system, had the trader supply or "put out" raw materials
as well as tools and equipment for processing to crafts-men who usually worked at home.

For example, in the 14th century, Arsenal in Venice was one of the largest shipbuilding
centers of the world housing a large size of the labor-force concentrated within it. The
organization of shipbuilding at Arsenal was not that of a firm; instead, numerous craftsmen,
owning their own tools, and a few journeymen and apprentices, were engaged building and
outfitting of ships. Other examples of large workforces in one location before the industrial
revolution include woolen manufacturing workshops in England that existed in beginning
of the 16th century.

The Factory System.

The factory system transformed the mode of production and replaced the putting out
system. Prominent features of the factories were (a) a large number of workers collocated at
the same workplace and (b) a dominant role of fixed capital and machinery. Some
historians of the industrial revolution view that new technologies and machines were
responsible for the emergence of the factories. For example, early steam-engines, with their
low thermal efficiency, were very large and stationary. Consequently, to utilize steam-power,
one had to pull a large labor force under one roof and run the various machines by belt
drives. Such explanation suggested that new technologies demanded economies of scale that
led to large-scale factory production

An alternative explanation to the emergence of the factory was described by Adam Smith in
his book, Wealth of Nations, written much before the mechanized, steam powered, fixed-
capital-intensive factory system became established as the predominant modes of
production. In his work, Smith did not dwell much on machines as one of the "causes of
wealth." Instead, he made "division of labour" his focal theme. In fact, he treated the role
of machinery as important but secondary to "increasing division of labor" in his account of
economic progress.
In Smith's famous pin-making illustration of the benefits of division of labor, two modes of
organizing production were contrasted - "crafts production" and "factory production". In
Crafts production, each craftsman sequentially performs all the operations necessary to
make a pin. In Factory production, each worker specializes in one of these operations so
that "the important business of making a pin is, in this manner, divided into several distinct
operations which, in some manufactories, are all performed by distinct hands”.

Suppose, for illustration, that we have five craftsmen producing a product that requires five
successive operations. These must be undertaken in temporal sequence running from left to
right in Figure 1:

A1 A2 A3 A4 A5

B1 B2 B3 B4 B5

C1 C2 C3 C4 C5

D1 D2 D3 D4 D5

E1 E2 E3 E4 E5

Time

Figure 1

In the production arrangement shown, each artisan did all the operations to manufacture
the pins, working at his own pace. Workers differed in skill across the different operations
and hence although pins became produced, there was no standardization of output quality
and quantity. Suppose now the work was arranged differently as indicated in Figure 2:
 A1 B2 C3 D4 E5

A1 B2 C3 D4 E5

A1 B2 C3 D4 E5

A1 B2 C3 D4 E5

A1 B2 C3 D4 E5

Time

Figure 2

In the new production arrangement, workers who previously worked in parallel now worked
in series. Worker A now performed only operation 1, while worker B performed only
operation 2, and so on, for all units of output produced by the team. Note that there is no
change the engineering description of operations performed, no change in the tools used,
and no change the people involved. Therefore, we might expect no change in rate of output
as well. However, large increase in productivity, from improvements in both quality and
quantity, was achieved from this reorganization of the work.

The economies achieved by switching from crafts to factory production arose from division
of labor. In the first example, labor was entirely "undivided". The conversion was from
individual production to team production. There are three aspects to this that deserve
attention. First, specialization of labor in team production required standardization of
product. Under crafts production, the variance in skills and care of individual artisans led to
non-standard output. Second, serial production required coordination of activities in the
sense of time-phasing of the inputs of individual workers. Third, labor of individual
workers became complementary inputs. If one work-station on an assembly line became
unmanned, total product went to zero. In total, the improved from division of labor is
achieved through coordinated work.
However, apart from improved coordination, conversion from crafts to factory production
also presented other opportunities to economize on capital inputs differently. Firstly,
reorganization of production led to division of labor as well as creates possibilities for
mechanizing some stage of the process. Hence an increase in fixed capital took place. At the
same time, the switch in modes of production was capital-saving derived from the
opportunity to economize on goods-in-process inventories. Under craft production,
considerable time (and concentration) was lost in switching from one task to the next. A
master craftsman produced in batches performing operation 1 x n times, before moving on
to operation 2, and so on. If his "dexterity" at each task was equal to that of the specialized
factory worker, the factory's competitive edge lay in preventing such movement leading to
lower working-capital requirements. Economizing on goods-in-process was likely to have
been particularly important in the evolution from the putting out system to the factory
mode of production.

There was another vital aspect of economizing in the switch to factory production. It also
saved on human capital. No worker in the factory needed to possess all the skills required
to make a pin from beginning to end. Under crafts production, each individual had to
spend years of apprenticeship before becoming a "master pinmaker." In factory production,
the skills needed to perform one of the operations could be quickly learnt. The increased
productivity resulting from specialization on simple, narrowly defined tasks was the
advantage arising from increased division of labor.

Differentiation of Capital and Labor

The emergence of the factory led to important socio-economic changes. The process of
division of labor increased the functional differentiation between capital and labor with
social consequences. Although the factory operations by becoming mechanized tended to
become simple and standardized, the machines used therein were often extremely specialized
for doing just this one task or series of tasks. Vertical subdivision of production, therefore,
made machines functionally more specialized or "dedicated." As a consequence, a particular
machine had few alternative uses and was not easy to replace. This led to differentiation of
equipment, observed even in simple hand-tools. So as the different operations got
disconnected from each other, each fractional operation acquired a typical and peculiar
form with specific implements.
With labor, the impact was however different. The individual worker became a "detail
laborer," i.e., specialized in the sense that, when at work, he performed only one task. But
the task became increasingly an unskilled one. The worker, consequently, could be easily
replaced. Thus, increasing specialization had quite different implications for the competitive
position of capital and of labor

Emergence of the Firm

The factory system led to a form of capitalism, called as the industrial capitalism, which had
the “firm” as its symbol and signified by joint ownership of machines by several capitalists
through the instrument of “shares”. The firm hired the labor.

To understand the mechanism of the formation of the firm, assume that a number of
individuals came together for the purpose of producing a particular commodity. There were
no marked distinctions of wealth, power or status among these people. But, some of them
contributed their skills and labor, while others brought machines to the joint enterprise.
Together, they tried to take advantage of the economies of division of labor and so set up
production in the form of an assembly line.

The enterprise earned profit as the total sales-proceeds exceeded the costs of the inputs.
How would the profit be divided? Assume that all the inputs were strictly complementary.
So, if one machine was withdrawn from the assembly line, total output must fall to zero.
Also, if one worker went missing, the consequence was the same.

The division of profit now became a bargaining and hold-up problem. As far as bargaining
between capital and labor is concerned, it would seem that there were equal threats for both
the capitalist and the labor. With plenty of unskilled laborers, but few substitute for the
specialized machine, the capitalist could claim higher bargaining power and threaten to walk
away. However, the unskilled laborer had more alternative employment opportunities than
the machine. Therefore, even the laborer could threaten to walk away and easily find
another job leaving the machines idle. Each could threaten the other to withhold or “hold
up” their input so that the joint profit would go to zero.

One way to enhance bargaining power was by forming coalitions amongst interested
members. Two broad coalitions therefore resulted - the machine owners (capitalist) and the
operatives (labor). The coalition of capitalists became however stronger as they could
restrict movement of labor to other alternative employment. This became the foundation
for the emergence of the firm as the cartel of machine owners.

The joint stock form of the company, however, emerged from another bargaining situation.
Each capitalist or machine owner could threaten to reduce output and, therefore, the group
earnings to zero until a replacement for their machine could be found. Although the market
for specialized machines was thin and replacements – as well as alternative use were hard to
find, any agreement regarding the division of earnings amongst the machine owners were
extremely unstable. A contract for organization of production was needed that avoided the
complementarities between the highly specialized inputs of owners, or else, no owner would
have found it attractive to invest into the dedicated machines.

The solution was, therefore, to prevent individual capitalists from owning and controlling
specific machines. Instead, a legal entity of the "firm" was formed with members giving up
ownership of their machines in lieu of accepting "shares". Thus the entity of the firm
arrived with joint ownership of a vertically integrated assembly-line.