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Management of MNCt200813
Management of MNCt200813
Put very simply, efficiency is the process of getting more for less. … An economy
is efficient when it is impossible to get more output from existing resources.
Efficiency is what all economic systems strive for whether they are individuals,
organizations, or countries. …
The most common reasons for markets not achieving efficient coordination are
market power, imperfect information, increasing returns in production, and
externalities. When any of these conditions prevail, the market may be inefficient.
When people found that markets were inefficient in coordinating economic
activities, they often organized firms. Remember the functional component in the
definition of firms – they organize economic activity. (89, emphasis added)
Notice the ‘most common reasons for markets not achieving efficient coordination’ –
Market power – results from market structures and pricing decisions – the
more participants in a market, the lower the degree of market power
exercised by any party (Competition). If there are few sellers and
many buyers, the sellers are able to set prices at higher levels than
would have been the case if the were many sellers. Similarly, if there
is a single buyer of a resource, the buyer is able to dictate a lower
price than would have been the case with many buyers bidding for
the resources. [Incomplete markets]
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not of the same order as those that make for Diminishing Return :
and there are undoubtedly cases in which it is better to emphasize
this difference by describing causes rather than results, and
contrasting Economy of Organization with the Inelasticity of
Nature’s response to intensive cultivation. (Emphasis added)
3
arise “… from an increase in the scale of production of any kind of goods,
may be divided into two categories: -- “firstly those dependent on the
general development of the industry; and, secondly, those dependent on
the resources of the individual houses of business engaged in it , on their
organization and the efficiency of their management. We may call the
former external economies, and the latter internal economies. (Marshall,
221, emphasis in original) It was A.C. Pigou who seized upon the negative
externalities in his well known book, The Economics of Welfare (1920)
declaring it a ‘market failure’ requiring government intervention to protect
the third parties and it was Ronald Coase who pointed out that it was
simply a ‘transaction cost’ that, under the correct circumstances, could be
eliminated by negotiations. (“The Problem of Social Costs,” Journal of
Law and Economics, 1960)
4
and bottle, can and packaging materials suppliers – creating addition jobs
and household incomes for workers in Jacksonville. (Marshall, 279: and
Alfred Weber, 1909)
Similar results are associated with expected for consumption activities and their
uncompensated costs imposed and unrewarded benefits bestowed on third parties
as the result of consumption activities.
When viewed from the perspective of the nature, structure and cost of obtaining
information, and their consequences insights are gained regarding the allegations
of economic inefficiencies and the presumed need for government intrusion and
intervention into free markets. The economic inefficiencies allegedly associated
with incomplete markets (the exercise of market power), less than perfect
information, increasing returns, and externalities are society operating inside its
production possibility frontier. This represents levels of resource use (less than
full employment of resources) and production below the economy’s potential. The
combined effects of the situation are underproduction (un- or underemployed
resources and lower returns to the owners of ‘factors of production’) → increased
relative product scarcities (and associated higher prices for underproduced
goods) → reduced satisfaction of human needs and wants (lowered levels of
‘social welfare’) → need, according to A.C. Pigou, for government intervention
to correct the so-called ‘market failure,’ by stimulating consumer demand and
‘full resource employment,’ especially of labor – however ‘full employment’ is
defined.
Unemployed Resources
Problem: Problem:
á la A.C. Pigou á la R.H. Coase &
J.M. Buchanan
- “inefficient regulations’;
- “riddled with monopoly” - “when a command economy is
subject to arbitrary decrees
by inept bureaucrats”
5
Remember that Acs and Gerlowski have identified four basic factors responsible for the
failure of competitive markets:
- imperfect information
- existence of externalities
It is worth mentioning that a fifth factor that that contributes to the failure of both a free
market and the failure of government: ‘rent-seeking’ behaviors on the part of members
of special interest group in the private sector and government bureaucrats. At this
juncture it is appropriate to quote Acs and Gerlowski’s comments of ‘rent-seeking’:
The terms ‘rent’ and ‘quasi-rent’ may not be unfamiliar to many. The concept of
‘economic rent’ goes back to writings of David Ricardo [“Essay on the Influence of a
Low Price of Corn on the Profits of Stocks.”] According to Robert Formaini’s analysis of
Ricardo [“David Ricardo: Theory of Free International Trade,” Economic Insights, 9 (2);
@ www.dallasfed.org/research/ei/ei0402.html.] is revealing. He has noted that the Corn
Laws (1815):
Several things are at work here: First, less fertile land (lower productivity) had to be
pressed into agricultural production. The use of less fertile land under cultivation, created
a ‘surplus value’ on the more productive land, i.e., ‘economic rent’. Second, owners of
the most fertile land have a vested interest in maintaining agricultural commodity prices
6
high (self-serving, rent-seeking behavior). Third, provides a template for the same ‘rent-
seeking behaviors’ in contemporary American markets – in which ‘special-interest
groups’ (sugar cane and tobacco growers, steel and auto producers, textile manufacturers,
etc.) seek rents through government intervention in ‘free international markets’ and the
erection of trade barriers – tariffs, quotas, voluntary export restraints, and content
requirements). Trade restrictions benefit small, well organized and funded, special
interests at the expense of the consumer and results from collusion between these
special interests and government. Interestingly, Robert J. Carbaugh (International
Economics, 3rd Ed,) has concluded:
Many people view members of the bureaucracy as ‘self-less public servants.’ Such a
view strains credulity, since each and every individual, despite their protestations
otherwise, are in fact self-interested, pursuing the gratification of their own wants and
needs. Government failure is associated with ‘rent-seeking’ behavior (using the powers
of government to obtain that which has been denied to them through free competitive
markets) and the existence of inefficient regulations –
Consider the following quotations from Alan Greenspan’s paper: “Antitrust,” given at the
Antitrust Seminar of the National Association of Business Economists, Cleveland,
September, 1961; published by Nathaniel Branden Institute, New York, 1962. Re-
printed in Ayn Rand. 1967, Capitalism: The Unknown Ideal, 63-71.
7
There are several arresting points in this quotation: first, (i) there was once a
‘fear’ of ‘arbitrary power’ wielded by politicians; second, (ii) the Civil War was a
benchmark – ‘few’ attributed the abuse of power to the private sector [remember
that Karl Marx released the Communist Manifesto in February 1848, which was
followed by the outbreak of revolutions throughout Europe] … now the alleged
venality of the capitalist class was uncovered … and spread to the United States
(see: www.age-of-the-sage.org/ philosophy/ communist_ manifesto.html); third, it
was government workers that wielded the monopoly-legal power to coerce
individuals to obey their dictates [remember Lincoln’s actions against judges who
insisted on the ‘rule of law’ by placing them under house arrest … see: Thomas J.
DiLorenzo. 2006. Lincoln Unmasked: What You’re not Supposed to Know
About Dishonest Abe.]; and fourth, as noted by Adam Smith (1776): “…
businessmen had no such power…. (they) needed customers …. (have) to appeal
to their self-interest.”
Notice Greenspan’s words which have been emphasized – seemed, appeared, and
alleged – reflects his questioning of intent. He continues:
It was claimed then – as it is still claimed today – that business, if left free,
would necessarily develop into an institution vested with arbitrary power.
Is this assertion valid? Did the post-Civil War period give birth to a new
form of arbitrary power? Or did the government remain the source of such
power, with business merely providing a new avenue through which it could
be exercised? This is the crucial historical question.
The railroads developed in the East prior to the Civil War, in stiff
competition with one another as well as with the older forms of
transportation – barges, riverboats,, and wagons. By the 1860’s there
arose a political clamor demanding that the railroads move west and tie
California to the nation: national prestige was held to be at stake. But
the traffic volume outside of the populous East was insufficient to draw
commercial transportation westward. The potential profit did not warrant
the heavy cost of investment in transportation facilities. In the name of
8
‘public policy’ it was, therefore, decided to subsidize the railroads in their
move to the West. (64, emphasis added)
The contrast between the economic realities in the East and the West that
Greenspan has drawn is revealing – in the East there were ‘competitive forces’
that were lacking in the West [‘with one another’ and ‘older forms of
transportation’ (barges, riverboats, and wagons’)]. He then describes ‘a political
clamor’ – i.e., individuals who would benefit directly from the railroads (ranchers,
farmers and land-owners and political wanna’ be’s) – in a disgusting display of
‘rent-seeking’ behaviors – explaining the reasons that these ‘special interest
groups’ went to government to obtain the results that they wanted! The market
demand for transportation services – ‘traffic volume’ (manifest as ‘potential
profit’) in the West was insufficient to attract risk-taking, private sector
entrepreneurs to the westward expansion of the transportation system – the
railroads. The answer was expansion of government powers! In order to satisfy
the ‘needs’ and ‘wants’ of the ‘special interest groups’ in the West, (short-term
profits from the ability to tap into the eastern markets for meat and grain)
government intervention was necessary – the ‘subsidization of the railroads.’
Between 1863 and 1867, close to one hundred million acres of public lands
were granted to the railroads. Since these grants were made to individual
roads, no competing railroads could vie for traffic in the same area of the
West. Meanwhile, the alternative forms of competition (wagon, riverboats,
etc.) could not afford to challenge the railroads in the West. Thus, with the
aid of government, a segment of the railroad industry was able to ‘break
free’ from the competitive bounds which had prevailed in the East.
Notice the form of the subsidy – 100 million acres of public lands taken out of the public
domain and given to ‘special interests’ … alternating ‘square-mile blocks’ for each linear
mile of track laid … including subsurface mineral rights, including oil and natural gas!
Additionally, the lack of competition from other roads and other forms of transportation,
created what Edward H. Chamberlain referred to as a ‘spatial monopoly’:
9
His observations apply not just to retail establishments, but extend to other sectors of the
economy, see: Appendix D, “Urban Rent as a Monopoly Income,” 266-69.
The western railroads were true monopolies in the textbook sense of the
word. They could, and did, behave with an aura of arbitrary power. But
that power was not derived from a free market. It stemmed from govern-
ment subsidies and government restrictions. (65, emphasis added)
The source of the monopoly-power was NOT the forces of free-markets, but government
intervention, which had eliminated competitive interactions and supported the creation of
monopoly pricing. Greenspan continues:
That Act was not necessitated by the ‘evils’ of the free market. Like
subsequent legislation controlling business, the Act was an attempt to
remedy the economic distortions which prior government interventions
had created, but which were blamed on the free market. The Interstate
Commerce Act, in turn, produced new distortions in the structure
and finances of the railroads. Today, it is proposed that these
distortions be corrected by means of further subsidies. The railroads
are on the verge of final collapse, yet no one challenges the original
misdiagnosis to discover – and correct – the actual cause of their
illness.
Greenspan then proceeds to analyze the ‘trusts’ and the passage of the Sherman Act
(1890), beginning with Standard Oil:
What observes failed to grasp, however, was the fact that the control
by Standard Oil, at the turn of the century, of more than eighty percent
of the refining capacity made economic sense and accelerated the
growth of the American economy.
10
because they were the most efficient units in those industries which, being
relatively new, were too small to support more than one large company.
(65-6, emphasis added)
Greenspan’s observations may force us to consider the path of many ‘high technology’ industries
today – transistors/semiconductors, software, biotechnology, and information technologies – the
so-called ‘new economy’ industries. Here, once again, the ideas of ‘increasing returns’ and
‘technological lock-in,’ expressed by Kaldor, David and Arthur, along with ‘transaction costs’
developed by Coase find application.
It takes extraordinary skill to hold more than fifty percent of a large industry’s
market in a free economy. … The rare company which is able to retain its
share of the market year after year and decade after decade does so by means
of productive efficiency – and deserves praise, not condemnation.
The error of the nineteenth-century observers was that they restricted a wide
abstraction – competition – to a narrow set of particulars, to the ‘passive’
competition projected by their own interpretation of classical economics. As a
result, they concluded that the alleged ‘failure’ of this fictitious ‘passive
competition’ negated the entire theoretical structure of classical economics,
including the demonstration of the fact that laissez-faire is the most efficient
and productive of all possible systems. …. (67)
A ‘coercive monopoly’ is a business concern that can set its prices and
production policies independent of the market, with immunity from
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competition, from the law of supply and demand. …
The analysis is then extended to the aluminum industry of the United States – and ‘the
history of the Aluminum Company of America’ or ALCOA before the Second World War.
In this section, he notes:
Perhaps the most damning of Greenspan’s observations and social costs of antitrust
policies are saved for last, and includes a silly quote from the former Supreme Court
Judge:
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… No one will ever compute the price that all of us have paid for that Act
(Sherman) which, by including less effective use of capital, has kept our
standard of living lower than would otherwise have been possible. …..
Those who allege that the purpose of the antitrust laws is to protect
competition, enterprise, and efficiency need to be reminded of the
following quotation from Judge Learned Hand’s indictment of
ALCOA’s so-called monopolistic practices. (70)
ALCOA is being condemned for being too successful, too efficient, and
too good a competitor. Whatever damage the antitrust laws have done to
our economy, whatever distortions of the structure of the nation’s capital
they may have created, these are less disastrous than the fact that the
effective purpose, the hidden intent, and the actual practice of the anti-
trust laws in the United States have led to the condemnation of the pro-
ductive and efficient members of our society because they are productive
and efficient. (70-1, emphasis in the original)
So there you have it! Government as the ‘protector’ of the consumer and society from the
rapacious business community ultimately makes businesses less efficient by retarding
innovation, mal-allocates scarce resources, limits output, and drives prices higher than
they would have otherwise have been – absent the Interstate Commerce Act (1887) and
the Sherman Act (1890). One can only imagine the costs of other government
interventions into the free market on Americans’ standard of living.
Hopefully, the material abstracted from Alan Greenspan’s article, “Antitrust,” will
provide insights into the textbook issues championing business innovation (the
development of new products, the adoption of more efficient organizational structures,
and investment in new processes). It raises concern over the Government’s Sword of
Damocles that hangs over the heads of the of the entrepreneur – the risk of being savaged
by the very bureaucrats pursuing their own self-interest at the expense of the national
welfare that they have been charged to protect – for more on this issue, read: Formaini’s
description of James Buchanan’s contributions to ‘public choice’ economics at:
www.dallasfed.org/research/ei
13
Acs and Gerlowski, then call attention to differences between ‘resource-based’ industry
[the old economy or ‘rust-belt industry] and ‘knowledge-based’ segments of the economy
[the ‘new’ economy]. Examples of the former include – iron and steel, automobiles,
textiles, food processing, while the later includes: semiconductors, software, computers,
photo-voltaic, nanotechnologies, biotechnology, robotics. Firms in the former industries
tend to be labor and capital intensive and experience diminishing returns, while the latter
are characterized by ‘intellectual’ capital [protected by patents, copyrights, trademarks
(federal level) and trade secrets (state-level)] created by research and development
(R&D) activities – and tend to experience increasing returns. Several scholarly articles
may be referred to formulate an understanding of the nature, structure and attributes of
the so-called ‘new’ economy:
As noted previously, the following articles are significant in the interpretation of the
‘knowledge-based’ economy:
14
June 23, 159-60.
A.P. Carnavale. 1991. America and the New Economy. San Francisco: Jossey
Bass.
Thomas A. Stewart. 1997. Intellectual Capital: The New Wealth of
Organization. New York: Doubleday/Carraway Books.
It’s important to note that Alfred Marshall, devoted extensive material devoted to the
issue of ‘increasing returns’
It ‘fails’ in the Pigovian (A.C. Pigou. 1920. The Economics of Welfare) sense of the
term. Robert L. Formaini and Thomas F. Siems [“Ronald Coase – The Nature of Firms
and Their Costs,” Economic Insights, (Dallas Federal Reserve), 8 (3)] have reported what
Pigou had concluded, that:
Once it is explicitly acknowledged that all resources are scarce, any misallocation via ‘a
malfunction of the market mechanism’ reduces the total level of social welfare … less is
produced, prices are higher and consumers deprived of potential satisfaction of needs and
wants. Acs and Gerlowski, then point out:
15
IBM, GM – to create ones with less market power. Most traditional
textbooks [and University professors] take this approach. This book
takes a different tact. Since we are unlikely to replicate the competitive
model, we should concentrate on how to deal with [alleged] market
failure. For example, the information problem is at the heart of under-
standing how organizations function. (112, emphasis added)
One of the chief reasons for the need for organizational coordination, a la Coase’s “The
Nature of the Firm,” finds its roots in the division of labor (specialization of task), which
simultaneously, reduce production costs and increasing transaction costs! Clearly, the
attainment of efficient outcomes must involve tradeoffs.
An interesting take on this may be found in James M. Buchanan’s short, but penetrating
book: Property as a Guarantor of Liberty (1993). Buchanan provides an alternative
defense for the existence of private property – it is not simply justifiable on the basis of
economic efficiency (minimization of negative externalities), but the defense of private
property rights adds both to productivity improvements, but, perhaps more importantly,
also supports individual freedom (or liberty). He begins his argument with an analysis of
the Hobbesian jungle – where there is no separation of that which is ‘thine’ and what is
‘mine’. In such a state, the
Under such conditions, individuals would value security (of person and property)
sufficiently to voluntarily surrender:
Such trade-offs would not be made, if the individual expected to be worse off than before
the relinquishment of authority to the sovereign.
Quite often the starting point for an analysis of social relations is the so-called ‘tragic
commons’ (See: Garrett Hardin. 1968. “The Tragedy of the Commons,” Science, 162,
1243-8 – a very disturbing article justifying government fertility control, even by
draconian means), where land (or other value-generating resource) is held and used in
common is ultimately degraded as each individual seeks to use the land first and most
intensively (the maximization of individual self-interest, at the expense of the greater
whole or society). Each individual is governed by self-interest (the desire to maximize
that individual’s returns from his/her actions) and the quest to ‘capture’ as much value for
him/her own advantage as possible. This is as Adam Smith had described things in his
famous The Wealth of Nations (1776) ……………………….
16
The result of this unfettered competition for the use of the scarce resource (land) is ‘over-
use’ of the land … declining fertility, de-forestation, over-fishing or soil erosion. The
message is that ‘private choice is combined with common access,’ results in over
exploitation, e.g.:
This solution is beset by two problems – (i) minority views; and, (ii) the need for
enforcement of the collective will … there is always the temptation for the majority to
force its will on others and, ultimately, their willingness to employ coercion employing
some collective mechanism of enforcement. Yet, there is a simpler solution, one that does
not involve government – the establishment of well-defined private property rights that
are easily enforced and transferable.
17
The Hobbesian jungle places emphasis on the need for enforcement and protection of
private property rights [role of the sovereign (or government), enforcement of contracts].
This provides a “theory of legitimacy for a coercive political-legal order,” based on the
consent of the participants. This raises a thorny issue for the sovereign (or government):
What if the participants withdraw their consent? What happens to the ‘legitimacy for a
coercive political-legal order’? Is the sovereign or government, then induced to arbitrarily
exercise coercion? If it does, then is the sovereign or government acting illegitimately?
It seems that the socialists (or as Hayek and Mises refer to them – the ‘statists’) have a
better intuitive understanding of the nexus between enforceable private property rights
and the liberty of the individual property owner. This helps explain their willingness to
severely curtail and circumscribe ‘private property rights’, justifying it as being
undertaken in the ‘interest of the welfare of the social whole’. Perhaps, a more
reasonable, though unstated reason is that when the individual property owners have
their rights protected and enjoy liberty and freedom of use, the political class is always in
danger of their withdrawal of consent. It is in the interest of the political class to reduce
the sanctity of private property rights, limit the freedoms (liberties) that go along with
them, and increase individuals’ dependence upon the sovereign or government. Nowhere
has this been more clearly seen than in the former
Buchanan emphatically states that the partitioning of the commons involves the
establishment of “… well defined limits or boundaries…” by some initial agreement. It is
not enough for there to be ‘well-defined’ property rights, those rights must be enforceable
and exchangeable, in order for liberty (or freedom) of the individual to be assured! He
then goes on:
This initial agreement [contract between the sovereign and the property
owners or ‘participants’] establishes the law of property and defines
violations of this law to occur when [the limits or] boundaries are crossed.
(10)
Much of the legal framework has been codified in ‘common law,’ e.g., the ‘Law of
Capture’ applied to fluid resources – water, petroleum, and natural gas.
Buchanan continues by noting that initially, there are no advantages to be derived from
‘specialization of task’ or the ‘division of labor,’ except along age and sex lines—based
on the individual and the family-unit, which produces all ‘goods and services’ that are
needed by that unit – they are economically ‘self-sufficient’ units (autarchic), operating
independently of others. Individual autarchy (economic self-sufficiency) represents
maximal independence of the individual or family-unit and maximal efficiency of
resource use:
18
However, such independence has an obvious opportunity cost, the incremental value of
goods and services that could have been produced and would be available for consump-
tion through the miracle of division of labor (or specialization of task).
In the traditional simple circular flow model, the firm is typically represented as a box on
the right-hand side of the diagram. Inputs (factors of production, i.e., land, labor, capital
and entrepreneurship) flow into the firm from households (resource or factor owners),
while a compensatory flow of payments for the use of those resources (rents; salaries,
wages and other forms of labor compensations; returns on capital; and profits) flow from
the firm to the factor owners or households. The summation of all returns to factor
owners represents an ‘income estimation’ of GDP. Simultaneously, within the firm the
firm a transformation takes place, wherein the factor inputs are converted into semi-
finished or final goods and services. With the successes of firms pursuing ‘outsourcing,’
and increasing adoption of this ‘buy’ model by highly integrated firms, as opposed to ‘in-
house’ production components or ‘make’ approach, the number of specialized, sub-
contracting firms producing semi-finished components, can be expected to increase.
Within limits, this specialization results in increasing returns and economies of
production. The sum of all value of all producers of goods and services (as expressed by
the prices consumers pay) is the ‘Output’ method of expressing gross domestic product
(GDP). This should provide insight into the basic fact that there is an overlap between
microeconomics and macroeconomics – they are NOT separate and distinct, but, as Mises
and Hayek have noted, that there are ‘real-couplings’ through the existence of the
activities of the firm taking place through time – the short- and the long-run.
Perhaps a more innovative, as well as a more revealing approach to the economic issue of
production is to be found in what has come to be known as the Hayekian Triangle,
named after Frederick Hayek who developed the view in the 1930s. His approach must
be contrasted with the Keynesian model with its focus on the ‘short-run’. Hayek’s view
considered, what Roger Garrison refers to as, a ‘real coupling’ between the ‘short-run’
and the ‘long-run’. At the heart of the Hayekian view is a ‘capital theory’ –
Garrison continues:
Dating from the late 1920s, Hayek [“Das Intertemporale Gleichgewichtssystem der
Preise und die Bewegungen des Geldwertes,” 1928; and Prices and Production, 1935],
19
following the lead provided by Ludwig von Mises [The Theory of Money and Credit,
1912], infused the theory with monetaryconsiderations. He showed that credit policy
pursued by a central monetary authority can be the source of economy-wide
distortions in the intertemporal allocation of resources and hence an important
cause of business cycles. (4, emphasis added)
Oh, my! Notice what is being said and the implications …. ‘credit policy’ of the Federal
Reserve Bank … can ‘distort’ the inter-period allocation of resources [what von Mises
refers to as ‘malinvestment’, not simply ‘misinvestment’] and therefore is ‘an important
cause of business cycles.’ Hummm … the Fed is the cause of the very thing that it is
supposed to be preventing! This is expressed clearly by Garrison:
Hayek’s focus [1935] on a money-induced artificial boom reflects the fact that, as an
institutional matter and as an historical matter, money enters the economy through
credit markets. Hence, it impinges, in the first instance, on interest rates and affects
the intertemporal allocation of resources. (5, emphasis added)
There is a real coupling between the short run and the long run …. Identifying
the relative-price effects (and the corresponding quantity adjustments) of a
monetary disturbance, as compared with tracking the movements in macro-
economic aggregates that conceal those relative-price effects, gives us a superior
understanding of the nature of a cyclical variation in the economy and points the
way to a more thoroughgoing capital-based macroeconomics. (5, emphasis in
original)
Before returning to the nature of production and the Hayekian Triangle, several salient
realities must be pointed-out. First, the explicit recognition of the significance of ‘time’
[t-n → t0 → tn] and the ‘intertemporal allocation of resources’ in the analysis of
economic relationships, i.e., the ‘real’ coupling of short run and long run. This contrasts
starkly with Keynes’ driven focus on the short-run (“In the long run we’re all dead.”) and
the supposed preoccupation of classical economics with the long run (said to be the result
of devotion to Say’s Law – “Supply creates its own demand.”) Garrison argues that:
[W]e must guard ourselves against the popular fallacy of the drawing a sharp
line between short-run and long-run effects. What happens in the short run is
precisely the first stages of a chain of successive transformations which tend
to bring about long-run effects.
Additionally, according to Sean Corrigan (2002. “Say’s Law for Our Time,”
www.mises.org), Keynes’ model is based on the identity:
20
A careful review of the structure of the data in Table B-1 Gross Domestic Product, 1959-
2005; and Table B-2 Real Gross Domestic Product, 1959-2005 available in the
Economic Report of the President, confirms this observation:
where:
Corrigan continues:
Clearly, it is production that matters, for this is what ultimately lifts us out of
savagery. That this should be controversial shows how far we have fallen from
the good common sense of our forefathers.
For we can play Oliver Twist all we like, importunately holding up our plates
for more, but unless we offer something in return, we are unlikely to be able
to rely on our portion being replenished at will.
This simple observation sounds very much like a quote from Adam Smith (1776. An
Inquiry into the Nature and Causes of the Wealth of Nations ):
Clearly, production is important (it is the sources of goods and services and of the
incomes necessary to attract resources), additionally, production provides the means by
which ‘specialization’ can be accomplished – it is the source of the wherewithal of
households to purchase product outputs, rather than having to provide them for himself.
Adam Smith’s parable of pin-factory helps in understanding the efficiency improvements
of ‘division of labor’ and the concomitant decline in costs and product prices. (See:
www.divisionoflabour.com/archives/000006.php.)
The Hayekian Triangle lays out the structure of the production processes, explicitly –
from ‘early stages’ (extractive and refining processes and manufacturing) through the
‘late stages’ (distributing and retailing). [See below] This diagrammatic
OUTPUT
21
OF
CONSUMER
GOODS
EARLY LATE
STAGES STAGES
STAGES OF PRODUCTION
PRODUCTION TIME (t0 → tn)
framework and its labeling accentuate the intertemporal linkages [t-n → t0 → tn]
that are assumed away by traditional economic models – both macro – (Keynesian and
neo-Keynesian) and micro – (normatively exemplary perfectly competitive) models.
Garrison has noted:
Garrison observes:
Capital-based macroeconomics gives play to both the value dimension and the
time dimension of the structure of production. The relationship between the final,
or consumable, output of the production process and the production time that the
sequence of stages entails is represented graphically as the legs of a right triangle.
In its strictest interpretation, the structure of production is conceptualized as a
continuous-input/point-output process. The horizontal leg of the triangle represents
production time. The vertical leg measures the value of the consumable output of
the production process. Vertical distances from the time axis to the hypotenuse
represent the values of good-in-process. The value of a half-finished good, for
instance is systematically discounted relative to the finished good – and for two
reasons: (1) further inputs are yet to be added; and (2) the availability of the
finished good lies some distance in the future. Alternatively stated, the hypotenuse
represents value added (by time and factor input) on a continuous basis. (46)
Keep in mind that Gross Domestic Product (GDP) can be estimated in several ways – the
summation of values of all incomes (Households) and the summation of the values of all
final outputs or products (Firms). A third way of estimating GDP is the summation of all
Values Added, i.e., at each and every stage of production.
… the Hayekian triangle has a double interpretation. First, it can depict goods
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in process moving through time from the inception to the completion of the
production process. Second, it can represent the separate stages of production,
all of which exist in the present, each of which aims at consumption at different
points in the future…. The double labeling of the horizontal axis … is intended
to indicate the double interpretation: ‘Production Time’ connotes a time-
consuming process; ‘Stages of Production’ connotes the configuration of the
existing capital structure.
It might be noted that the Hayekian triangle serves as a compliment to Alfred Weber’s
theory of location (1909. Location of Industries) – wherein mining activities and
production of the of final product are separated by geographic space, this separation can
be overcome, but only at a cost (transportation costs), as well as, time (t0 → tn). The
output from mines must be processed then this product must be moved to new locations
for further processing and, ultimately fabricated into final products that must be
distributed to final consumers (or final demand). All of these activities cannot be
accomplished ‘instantaneously,’ both processing and transporting are time-intensive.
This explicit recognition of the importance of time permitted the Austrian School to
interpret:
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Clearly, adjustments in the economy are NEVER instantaneous, nor are they perfect.
Second, notice the FULL title of John Maynard Keynes’ well-known book: The General
Theory of Employment, Interest and Money – in it there is no mention of capital, but, as
put by Garrison, “… its shadow, interest, does.” Garrison notes that:
Classical economists saw the rate of interest, also known as the rate of profit,
as the price of capital. Keynes, who clearly rejected this view, was involved in
creating them or money was involved in facilitating their exchange. (6, emphasis
added)
But, perhaps more importantly, Keynes’ model is a “demand-dominated model,” one has
to ask: “What is the role of supply or production and its need for investment?” Garrison’s
full comments on Keynes and the so-called ‘general theory’ are:
It’s necessary to go back to basics – the factors of production are: land, labor, capital and
entrepreneurship … Notice how Alfred Marshall [Principles of Economics, 8th Ed., 1920]
has put it:
The agents of production are commonly classed as Land, Labour, and Capital.
By Land is meant the material and the forces which Nature gives freely for man’s
aid, in land and water, in air and light and heat. By Labour is meant the economic
work of man, whether with the hand or the head. By Capital is meant all stored-up
provision for the production of material goods, and for the attainment of those
benefits which are commonly reckoned as part of income. It is the main stock of
wealth regarded as an agent of production rather than as a direct source of
gratification.
Capital consists in great part of knowledge and organization : and of this some
part is private property and other part is not. Knowledge is our most powerful
engine of production; it enables us to subdue Nature and force her to satisfy our
wants. Organization aids knowledge; it has many forms, e.g. that of a single
business, that of various businesses in the same trade, that of various trades
relatively to one another, and that of the State providing security for all and help
for the many. (115)
Later in the book, in Book V, “General Relations of Demand, Supply and Value;” Chapter
III, ‘Equilibrium of Normal Demand and Supply,’ Marshall observes:
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… It is for instance often sufficient to take the supply price of the different kinds
of raw materials used in any manufacture as ultimate facts, without analyzing
these supply prices into the several elements of which they are composed;
otherwise indeed the analysis would never end. We may then arrange the things
that are required for making a commodity into whatever groups are convenient,
and call them its factors of production. Its expenses of production when any
given amount of it is produced are thus the supply prices of the corresponding
quantities of its factors of production. And the sum of these is the supply price
of that amount of commodity. (283)
Mises (1998) calls attention to the obvious, but all too often ignored production
relationships whenever there are MORE than, a single activity taking place:
Other things being equal, the more the production of a certain article increases,
the more factors of production must be withdrawn from other employments in
which they would have been used for the production of other articles …. (340)
Information
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Company) has suggested that perfect competition may be interpreted as a parable
[a short fictitious story that illustrates a moral attitude or religious principle],
since the conditions assumed for its fulfillment have never existed. Economists
then argue that it functions as a norm or yardstick by which markets are to be
evaluated. Hummm …. Frank Knight, while noting that virtually every business is
a partial monopoly, expressed amazement that: “… the theoretical treatment of
economics has related so exclusively to complete monopoly and perfect
competition.” (1921 Risk, Uncertainty and Profit, 193). Again, Acs and
Gerlowski, in their ‘Glossary,’ have defined Perfect Competition, as:
What then are these assumptions which have never existed? The key assumption
upon which perfectly competitive markets are based is that all parties to
transactions or exchanges have access to perfect information. Additionally:
The implications of perfect information and perfect competition are that there are
some mystical forces that impel markets toward an efficient equilibrium.
Imperfect Information – introduces the notion that it is impossible for market partici-
pants to have access to flawless information. It is not possible to foretell the future
or to fully anticipate the actions or re-actions of other market players. Imperfect
information involves several factors – information will always be incomplete and
less than totally accurate. Additionally, and perhaps even ore importantly from an
economic perspective, information is not costless to acquire. Acs and Gerlowski
have reported:
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The firm may not know exactly what the marginal products of its inputs are.
Further, attempts at estimating them may be flawed for a number of reasons.
Imperfect information regarding wage rates for labor (or rental rates for
capital) can also create problems leading to inefficiencies in production.
(110)
When one market participant has more and/or better information than other
participants, such ‘informational asymmetries,’ create the potential for
opportunism. According to Acs and Gerlowski:
Less than perfect information enables one or the other participant to a market
transaction to engage in ‘opportunistic behavior’. Once again, Acs and Gerlowski
have defined the concept:
Action taken when one party to an agreement acts in his or her own
selfish interests, even at the expense of other parties involved in the
agreement. (446)
Incomplete
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of ‘private information’. Information is never costless, it must be
acquired research, investigation (collection of ‘raw data’), processing
(organization and interpretation), and communication. Each of these
activities involve costs or the expenditure of scarce resources. Such
information is private when it is acquired by participants in the private
sector (members of businesses and households). These data are
protected by:
Copyrights
Patents
Trade Secrets
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