Transformational Growth and the Business Cycle

Edward Nell

• Publisher: Routledge
• Year: 2005
• Print ISBN: 9780415862448
• eBook ISBN: 9781134752324
• Edition: 1
• Topic: Commerce
• Subtopic: Commerce Général

This book examines the concept of Transformational Growth from a number of different historical and geographical perspectives. Transformational Growth sees the economy as an evolving system in which the market selects and finances innovations, changing the character of costs and affecting the pattern of market adjustment. This creates the possibility that markets will work differently in particular historical periods.
This book explores market adjustments in two distinct historical periods, 1870-1914 and 1945-the present. The book focuses on six countries: USA, United Kingdom, Canada, Germany, Japan and Argentina. In all cases the earlier period, dominated by craft-based technologies, proves to be the one in which markets adjust through a weakly stabilising price mechanism. By contrast, in the later period, in all cases, with the exception of Argentina, there is no evidence of such a price mechanism, but in its place can be seen a multiplier-accelerator process which, arguably, reflects a change of technology to mass-production.

Part I
THE IDEA OF TRANSFORMATIONAL GROWTH

1
FROM CRAFT TO MASS PRODUCTION

The changing character of market adjustment

Edward J. Nell

Macroeconomics makes an occasional bow to history and institutions, noting their importance in understanding policy, particularly in connection with exogenous “shocks.” But the models advanced in most mainstream work, as well as those in contemporary “alternative” schools of thought, tend to be perfectly general. They are not considered specific to any one historical period. Economic behavior and the working of markets are treated as universal, essentially the same, aside from “imperfections,” in all times and places. Economics is grounded in rational choice, expressed most fully in general equilibrium price theory. Macroeconomics can then be derived from this by specifying any of a large number of imperfections or institutional barriers to the smooth adjustment of markets.

THEORIES AND ERAS

General equilibrium theory is abstract and non-empirical. But price theory does not have to take this form.¹ Ordinary textbook microeconomics—supply and demand—offers a strikingly detailed picture of the way markets work, from which a number of plausible empirical propositions can be derived. For example, this picture suggests that, when demand fluctuates, prices will fluctuate in the same direction, and the fluctuations will be greater the more inelastic the supply is. Movements in prices will therefore be positively correlated with movements in output. Real wages will be inversely related to employment and output. Increases in productivity will lead to lower prices. The picture has institutional implications as well: firms will grow to an optimal size and operate at that level indefinitely.

These empirical implications of ordinary price theory are seldom stressed, perhaps because they do not appear to be true of today's economy. Instead, price theory tends to be developed axiomatically, and is presented as an offshoot of a more general theory of rational choice. But this is to do microeconomics a disservice. It was originally formulated as a theory of the working of markets, and it deserves to be taken seriously as just that.

Old-fashioned macroeconomics, as presented in the textbooks of the 1950s, like the simplest models today, took prices as fixed, and examined quantity adjustments. These reflected the multiplier and the accelerator, or “capital stock adjustment” principle, and provided an account of market adjustment, which could be and was examined empirically in extensive studies.² These models also yielded policy implications.

Macroeconomic data suggest a great difference between the working of the economy in the era in which price theory was founded and its behavior later. In the late nineteenth century, when price theory developed, production was organized largely through family firms and family farms, and steam power was used to operate processes that still reflected traditional crafts. In the Keynesian era, production came to be organized by giant modern corporations running modern technologies on electric power and internal combustion (Tylecote, 1991; Perez, 1983, 1985; Solomou, 1986). The technologies are different and so are the institutions. As a result, it will be argued, so is the way the market works.

In the earlier period the market appeared to function in some respects, as would be expected from neoclassical theory, at least in Marshallian form. In the later period aspects of its working appear to be Keynesian, and the neoclassical elements have largely disappeared. In the earlier period there is some evidence to suggest that the market and the price mechanism responded in a stabilizing manner. Financial markets and the monetary system, however, tended to be unstable. The turning points of the business cycle appear to have been endogenous. In the later period, however, the stabilizing aspects of market adjustment appear to have vanished. Indeed, market responses appear to have exacerbated fluctuations, as would be expected from Keynesian theory and from early Keynesian accounts of the business cycle. The government, however, perhaps in conjunction with the financial system, has tended to provide a stabilizing influence.

An explanation for the differences between the eras can be suggested, which is supported by the record, namely that the prevalent technology in the earlier period prevented easy adjustment of output and employment. This, in effect, imposed a form of price flexibility, which can be shown to have had a moderately stabilizing influence. But technological innovation greatly increased the adaptability of production processes, so that by the later period, output and employment could be adjusted easily, and the resulting system can be shown to have been unstable in a Keynesian sense.

TWO SYSTEMS OF TECHNOLOGY AND GROWTH

Dynamic processes depend in part on the flexibility of production, which in turn rests on the kind of technology in use. And technology, in turn, developed as a result of learning induced by the characteristic problems encountered in operating the initial production system. An idealized contrast of early and later capitalism can be sketched: early capitalism consisted largely of family firms and family farms operating production technologies that depended on the presence and cooperation of skilled workers, working together. Such an economy tended to run at full capacity, unless seriously disrupted by business failures; product markets tended to clear through price adjustments. Employment remained fixed in the face of fluctuations in sales (short of the bankruptcy level); when output varied it was through changes in the productivity of labor. But this system created strong incentives to change the methods of production, in particular to increase the size of operations and to establish greater control over current costs, especially labor. Towards the end of the nineteenth century the methods of mass production were widely introduced, as we shall see, partly in response to pressures created by problems in the working of the earlier technology. Besides lowering costs the new methods provided a desired degree of flexibility; but their successful adoption depended on the simultaneous emergence of adequate finance and a mass market, since these new methods required large outlays of capital. The change to the new methods can be called “Transformational Growth,” for, once adopted, these innovations in technology changed the way the system worked, replacing price with multiplier adjustments and full utilization with normal excess capacity.

FIXED EMPLOYMENT TECHNOLOGY COMPARED WITH MASS PRODUCTION

The change from craft technology to scientific mass production has largely been examined from the perspective of total cost reduction (Maddison 1982). This is certainly a major factor, but the attention paid to it has perhaps led to the neglect of other dimensions. Indeed, economists have paid little attention to the actual characteristics of production technology. Output is normally considered to be a “function” of various “combinations” of the basic “factors”: land, labor and capital. The variations in the qualities and features of these are not considered, and neither is it explained exactly how they are “combined.” The often-cited “laws of returns” do not fit coherently together (Sraffa 1926). Everything is discussed at the highest imaginable level of abstraction and, in fact, the real object of the argument is to explain the distribution of income between rents, wages and profits on the basis of marginal productivity. The analysis of costs and their relation to prices is derivative. By contrast, the input-output approach tells us something about the technical relationships, since the various inputs for each unit output are clearly set forth, but there is still no consideration of how, exactly, these inputs are combined, or what varies with what.

Yet this is just what has to be considered if we are to explore the dimensions of flexibility. Craft production has often been praised for its greater flexibility, compared with mass production, because craftsmen could often adapt product design to the customer's specifications, but this is only one aspect of flexibility, and not the most important when the survival of the firm is in question. So let us turn to an aspect of technology that has largely been overlooked, namely the extent to which the process of production permits inputs or costs (and even output itself) to be varied so as to adapt to fluctuations in the state of demand.

Fluctuations in demand, of course, are endemic both in early and in developed capitalism. They are to be distinguished from permanent changes in demand, although it often may be difficult to tell which is which. Fluctuations may be quite temporary and local, temporary and global, long-term and local or global. There are seasonal fluctuations and variations reflecting local or temporary conditions, on the one hand, and those of the general business cycle on the other. They may be foreseen, or unforeseen; if foreseen, only the direction or their direction and magnitude may be correctly anticipated. But, even if they are fully and correctly anticipated, the realization may have dawned too late for anything to be done about it; or the duration of the fluctuation may be too short to be worthwhile adapting to. This does not depend only on the ability to anticipate the market; it also depends on the technology and organization of production, for it is production which has to be adapted.

Examples will help to indicate some of the ways in which businesses may try to adapt to variations in demand. If there is no refrigeration or method of storage, the whole current supply of fish and vegetables must be offered for sale, otherwise it will spoil. If demand has fallen, supply on the market cannot be reduced, so price will be forced down. Sometimes output cannot be varied; spring planting (and the weather) determines the harvest. If demand has dropped in the meantime, output cannot be changed, although grain can be stored, so supply could be changed, but at a cost. In a traditional blacksmith's shop the forge must be lit, and the apprentices must be on hand, whether much or little work is to be done. Energy and labor costs will be the same for quite a wide range of levels of daily output. Lighting the forge or, in steam-driven factories, building up a head of steam, is time-consuming and labor-intensive. Thus, faced with fluctuations in demand, the methods of production may or may not permit the supply offered to the market, the output produced, employment and energy costs to be varied pari passu. To the extent that all or any of these cannot be varied, excess or shortage of supply will exert pressure on prices. But employment is the key; if it cannot be varied then the largest part of current costs will be fixed, and output can be made variable only by changing productivity.

More precisely, if employment cannot be varied, it may not be worthwhile to vary output when demand falls; hence prices will be driven down. Yet, if employment does not change, money wages will not be much affected, so real wages will rise. Clearly, these characteristics of the technology can exercise significant influence.

However, the technological rigidities just noted do not necessarily translate in any straightforward way into corresponding economic inflexibilities, for there are at least two institutional forms that employment relations, based on craft technology, took in the past or can take nowadays (for example, in developing countries): first, there is the domestic system in which capitalists, often merchants, “put out” work, paying piece rates to craftsmen working in their own homes and using their own tools and equipment. Then there is the factory system, in which workers are assembled in central buildings, owned and equipped by the capitalist, to work under direct supervision. The latter has many significant advantages. It permits training and close supervision, with the establishment of work norms and both product and labor standards, thus providing quality control. Labor skills in general will be raised towards the level of the best-practice workers. Economies of scale will be realized, and machinery can be run off a central power source, such as steam or water. And it will eliminate the sometimes costly and bothersome travel to and fro for the delivery of materials and collection of finished work.

In each case the technology permits little adaptation to variations in demand. Current costs are the major portion of costs, and the greater part of current costs are real and fixed. But the domestic system puts this burden on the craftsmen and their households, whereas the factory system obliges the capitalist to assume it. As we shall see, the early factory operated as a (largely) fixed employment system, with little ability to run on short time or at less than normal capacity. But in the domestic system, when there was less work to be put out, the craftsmen, having to support their families and establishments, could ...

Table of contents

• Cover
• Half Title
• STUDIES IN TRANSFORMATIONAL GROWTH
• Full Title
• Copyright
• CONTENTS
• List of illustrations
• List of tables
• List of contributors
• Preface
• PART I The idea of Transformational Growth
• PART II Industrial history
• PART III Studies of stylized facts
• PART IV Implications for economic analysis
• References
• Index