A Thought (Requesting Feedback)

Esuric posted on Thu, Nov 25 2010 4:55 AM

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I just wanted to bounce some ideas off you guys and see what you think about a topic I’ve been thinking about for quite some time. The topic at hand deals with firm expansion, namely why economies of scale doesn’t yield a socialist economy where one firm has complete control over every single market. Now there are many well-known explanations, such as transaction costs, managerial diseconomies of scale, product differentiation, etc. Of course, there’s also the Austrian explanation, the calculation and coordination arguments, which explain why this final condition, namely the socialist economy, is entirely untenable. But the actual process, namely why the transition towards the socialist economy is inherently problematic, has always been somewhat vague to me. In other words, I understand why a socialist economy simply cannot exist for any extended period of time, but I don’t fully understand why the economy doesn’t naturally move towards this final state (at least, I can’t coherently articulate an argument with any degree of certainty) without referring to the explanations mentioned above (which are not characteristically Austrian).

My theory is basically a deduction from the works of Ludwig Lachmann who explains that each individual firm creates its own capital combination in an attempt to satisfy continuously changing consumer desires in an efficient manner, i.e., without squandering scarce resources. Additionally, the price mechanism attempts to coordinate all of the various capital combinations into a coherent capital structure, and profit/loss represents either failure and/or success in this endeavor. In other words, the price mechanism attempts to match expectations with reality, in a dynamic process of trial and error, by eliminating those firms that have failed to organize their capitals in inefficient ways. It, the firm, begins to create massive capital combinations that are disconnected from actual consumer preferences.

From this, it seems obvious that as firms (capital combinations at the micro level) expand, their capital combinations become larger and larger, therefore yielding relatively inelastic combinations that become increasingly difficult to adjust in the face of continuously changing consumer preferences and technological innovation (new technology, methods of production, etc). Since consumer preferences change at such a rapid rate, it would be seemingly impossible to calculate and forecast such changes for any extended period of time, making relatively smaller capital combinations (which are relatively elastic) relatively efficient (because they easier to adjust). In other words, new data continuously emerges, and entrepreneurs are expected to deal with such uncertainty and act accordingly. Economies of scale helps facilitate firm expansion in one direction, but the inelasticity of ever expanding capital combinations serves as a vital check, a counter-balancing force (along with the other explanations in the first paragraph) in the other direction.

Essentially, all firms are doomed in the very long-run. Small firms, in the short run, face a substantial disadvantage due the fact that larger firms are able to utilize economies of scale (they begin to absorb the smaller firms). But the larger firms, eventually, are forced to either sell-off entire blocks of capital (divisions) in order to remain in business, or will be unable to adjust at a fast enough pace, ultimately causing that firm to go out of business and lose access to their resources. And this is essentially what happens when firms go out of business (most obvious during recessions); car companies, for example, have to close down multiple factories and sell-off entire divisions in order to remain in business. I also believe that this theory fits in well with the Austrian theory of cycles.

Now it’s just a thought, which I haven't really thought through (for example, I would have to include changes in time preferences as well. Presumably, a higher time preference would make firm expansion relatively easier compared to a lower time preference), but what are your thoughts? Does this argument make sense? Have you heard this argument before? Do you think that the other explanations are sufficient?

Thanks in advance.