Tuesday, May 24, 2011

Progress Yes, Equilibrium No!

Tim Harford (the undercover economist), writes, 21 May, (HERE):

‘A font of wisom on economies of scale’

‘Annoyingly, economies of scale are analytically inconvenient – if you want to build a textbook model of an industry with scale economies, the mathematics are messy – and yet Adam Smith’s famous example of the pin factory simply illustrated how fundamental economies of scale are to economic progress.’

Comment (not a criticism)
In practice, what actually happened in pin-making illustrates what happened across manufacturing in the nineteenth to twentieth centuries through the introduction of power-driven machinery which enabled fewer, not more, individual workers to complete the work of many men, and increase output substantially. In 1820, there were 11 pin factories in Gloucester employing 1,500 people, but by 1870, the pin industry in Gloucester was gone. By 1939, the number of pin manufacturers in the United Kingdom had shrunk to about 12, and by 1978 there were only 2, as a result of mergers, take-overs and firms leaving the trade (HERE).

Smith’s example of the constituent elements in the manufacture of the common labourer’s coat (WN I.i.11, 22–23) is probably significant than his more famous pin factory, but most readers do not turn the few extra pages to get to the more significant (for the 21st century) labourer’s coat example. The multiple instances of manufacturers simultaneously and serially improving the productivity of their production processes in response to the possibilities of the growing extent of their own markets constantly changes their supply chains forwards and backwards and increases the productivity of the entire set of producers along their supply chains. This happens among their customers and among their customers’ customers, most of whom have limited or no connections with each other.

Improvements in hand tools from an improved division of labour not only reduces the unit costs of making shears, say, for sheep shearing, but might also improve hammers for carpenters, and all manner of other metal tools for others to meet rising demand in their and ever more complex extended markets. As output rises in response to a growth in the extent of all the sub-markets, it separates the operations into more roundabout processes, adding to productivity across more than one industry (inputs into one industry may also be inputs into others).

The division of labour is not limited to one pin factory; it affects cumulatively all processes that use pins and nails, and, later, affects the productivity of nails and other attachments, plus changes in technology, materials, and processes. Thus, the ‘enlarging of the market for any one commodity, produced under conditions of increasing returns, generally has the net effect . . . of enlarging the market for other commodities’ (Young, Allyn (1928) (HERE).

Young gave interesting examples of the cumulative effect of these processes in the early printing industry that promoted producers of wood pulp, inks and their ingredients, metal type, technologies for producing illustrations, and the manufacturer of specialised tools and printing machines, plus suppliers to the printing trades and other industries (Young, 1928, 537).

He also advised that increasing returns are not ‘discerned adequately by observing the effects of variations in the size of an individual firm or of a particular industry’ because ‘the progressive division and specialisation of industries is an essential part of the process by which increasing returns are realised’ across ‘all industrial operations’ when ‘seen as an interrelated whole’. He identified increasing returns as dependent ‘upon the progressive division of labour, and the principal economies of the division of labour’, which cumulatively arise from ‘using labour in round-about or indirect ways’. Lastly, while Smith said ‘the division of labour depends upon the extent of the market’, the extent of the market ‘also depends upon the division of labour’, and in this ‘circumstance lay the possibility of economic progress, apart from the progress which comes as a result of the new knowledge’ (Young, 1928, 538; see also: Roger Sandilands HERE).

Smithian growth is an open, not closed, process driven by increasing, not diminishing, returns (Ricardo's error). The economy is not in a state of equilibrium (as 'proven' mathematically but nowhere has it applied; the mathematics are not just 'messy' - they are futile) because (in relatively free capitalist economies) many millions of individuals participate in it, normally without central control, quite independently of each other, with (for ‘better’ outcomes) few imposed constraints on imitation, innovation or invention, and without regulated setting of prices or costs and supervision of the process of their bargaining exchanges (attempts to impose such constraints normally have not been successful). Disequilibrium in an economy is endemic because there is plenty of scope for human error, for mistaken readings of market conditions, and for failures to innovate or adapt when maybe they should have, or possibly when they shouldn’t (as Adam Smith showed in relation to mercantile Britain). Interventions are also fraught with error for the same human proclivities to meddle to ‘improve’ outcomes.

It may be better to abandon theories of equilibrium in economics and the search for it, with the expectation of Nobel prizes for ‘proving’ it in theory (General Equilibrium), though clearly never finding it anywhere in practice.

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