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Mises Explains Global Inflation and Global Firms

Tags Protectionism and Free TradeMoney and Banking

[This article is Part 4 of a series. See Part 1 and Part 2 and Part 3.]

Mises’s insight into the importance of Cantillon effects can be further extended to explain not only income and wealth inequalities among individuals (Part 2), or the reasons for the economic disparities among national economies around the globe (Part 3), but also some rather curious developments in global industrial organization over the last few decades.

The growth of cross-border business activities in the 21st century has been accompanied by organizational changes within companies that produce or trade internationally. These changes—concerning the size, corporate hierarchy, or financial decision-making of firms—, have been analyzed in detail in both the global management and the international trade literature. Firms have in fact become a rather common unit of analysis in international economics, especially “since the mid-1990s, [when] a large number of empirical studies provided a wealth of information about the important role that firms play in mediating countries’ imports and exports” (Bernard et al. 2007, 2).

The creation and development of firms that trade internationally, or that have branches in different countries is usually investigated in a framework centered on four elements: “organizational formation through internalization of some transactions, strong reliance on alternative governance structures to access resources, establishment of foreign location advantages, and control over unique resources” (Oviatt and McDougall 1994, 45). And yet, “despite this resurgence [of the theory of the firm], there is still little connection between the entrepreneurship literature and the literature on the firm, both in academia and in management practice” (Foss and Klein 2012, ix). More importantly, as entrepreneurship is generally linked to small enterprises—and less with international corporations, or export-import activities—it remains dissociated from the study of international investments, and of international firms. The latter, in turn, remains dissociated from the study of international monetary systems and their impact on international enterprise growth and formation. Therefore, these studies omit to discuss the relationship between monetary policies, and firms’ features and financial behavior in global markets.

Nevertheless, the international firm can be understood as an entrepreneurial phenomenon within international markets, and because entrepreneurial judgment is action calculated in monetary terms, the prerequisite for the creation and development of international enterprise is the existence of money and money prices that can make heterogeneous resources commensurable, and input and output comparable. Only with the help of monetary calculation can entrepreneurs make rational decisions concerning the organization, size, compartmentalization, geographical location, and financial decisions of the firm. Consequently, all decisions taken by a firm on international markets (to trade, to invest, to be born globally, to do green field investments, to merge with or acquire another company, to license or wholly own its subsidiaries, or to slice up production stages across countries) are indelibly tied to the entrepreneurial judgment of an individual or group of individuals, and the result of their entrepreneurial decisions.

Calculated entrepreneurial action in terms of money prices in international markets represents thus the basis for trade, production, and global financial phenomena. Because of this, monetary expansion impacts the organization of firms in two important ways.

On the one hand, because the boundaries of the firm are determined by economic calculation, falsification of the latter can affect decision about the outlook, structure, and size of the firm as a whole. As Foss and Klein explain, “the limits to firm size can be understood as a special case of the arguments offered by Mises and Hayek about the impossibility of rational economic planning under socialism” (2012, 181). In other words, “these ultimate limits are set on the relative size of the firm by the necessity for markets to exist in every factor, in order to make it possible for the firm to calculate its profits and losses” (Rothbard 2009, 536). Furthermore, the structure, boundaries, and the internal organization of firms—both for small companies, as well as international enterprises—respond to changes in entrepreneurial judgment, which in turn is sensitive to changes in the interest rate. On the other hand, entrepreneurial judgment is also sensitive to the structure of incentives, such that monetary expansion and government intervention can promote unsustainable firm growth or unsustainable start-up businesses, discourage innovation or bias entrepreneurs’ financial decisions toward debt and promote financialization—as we shall see more in Part 5.

In the case of firm size and firm boundaries, empirical studies show that international trade is populated in an overwhelming proportion by large firms, which are more likely to be successful on global markets than smaller firms. According to the U.S. Bureau of Economic Analysis and Eurostat data, large firms in the US, UK, Germany, and France comprised around 80% of the total value of their countries’ imports and exports in 2012-2013, the rest being shared between small and medium enterprises. Over the last decades, the SME share in trade has in fact diminished, although SMEs have increased in absolute numbers over the same period. Further disaggregation of the data reveals, however, an even more important bias: the growth in the number of SMEs was led in great part by micro and small firms, while medium-sized business have almost disappeared in most countries, from both domestic and international activities. As a result, international trade is “hourglass-shaped” (Feldman and Klofsten 2000, 632), comprising mainly very small and very large companies, while medium-sized firms appear to be only a transitional point in enterprise growth.

Common explanations for this bias in favor of large firms emphasize the latter’s competitive advantages: large firms command most of international trade because they are better and quicker at identifying international opportunities, have more resources than smaller firms, more bargaining power with local government authorities, and better access to capital markets. However, as there is nothing that would suggest medium-size firms as an unviable business model, such an anomalous distribution of transactions by firm size cannot be entirely justified as a natural tendency of the market economy. These explanations cover only partially the bias in favor of large firms, and do not clarify the reason for the disappearing ‘middle’ market.

A better explanation is that the distortion of economic calculation via monetary expansion brings about this hourglass distribution of firm size in international trade. This explanation is first corroborated by the ‘odd’ behavior of existing middle market companies. Approximately 31% of mid-sized firms in Germany, for example, are owned by a family, and a further 40% by some combination of private equity and family, while only 14% are traded on a stock market ( The Economist 2012 ). As an oasis in the middle of a debt desert, medium-sized firms from most countries prefer to finance their business from retained profits rather than borrowing or from the stock market, and do not wish to make use of public trade finance to internationalize. Their reluctance to resort to debt might explain why they lack the ‘financial edge’ to penetrate global markets, but also why they were, as a group, less affected by the recent financial crisis.


The overwhelming majority of starting companies, however, rely heavily on external finance—out of which almost half is bank credit, as shown in Figure A (data from Beck et al. 2008)—even from the beginning of their activities. This is due to the fact that loanable funds markets are the easiest to access source of capital, as well as the most plentiful.

During financial booms, this dependence of firms on bank finance is only strengthened, because working capital is cheap and asset bubbles provide entrepreneurs with better collateral to access more credit. But the easier entrepreneurs obtain funding for their projects, the more inclined they are to expand the firm and to extend their “resource bundles” (Foss and Klein 2012)—i.e. to acquire complementary resources, integrate additional lines of production, or simply develop existing activities. Consequently, bank loans, inter-firm credit, and other external finance from domestic and foreign sources, allow many companies, during periods of monetary expansion, to grow rapidly and to a greater extent than otherwise. Banks also support the growth of firms that would not have otherwise qualified for (trade) finance, which can provide little collateral and whose growth prospects appear viable to investors only because of the artificially lower interest rates. These developments, together with capitalist-entrepreneurs’ search to diversify their growing asset portfolios and foreign investments, further strengthens the participation of such companies on international markets.

Similarly important to a firm’s international decisions are the potential changes in the geographical distribution of global commercial networks. Many firms, as they grow, are incited to internationalize by policy pressure and by the credit lines offered by chambers of commerce, industrial associations, banks, or other export-promoting government agencies (as we shall see in more detail in Part 6). As a result, they also become more integrated in international production chains, and begin to export to more distant foreign markets. On an unhampered market, such integration would be genuine, and thus highly beneficial to the international division of labor. In the present monetary system, however, firms seek these commercial relationships in pursuit of short-term gains, or due to an understatement of the risk of their transactions. The growth of such firms and global production chains, therefore, is not authentic, and their long-term survival becomes dependent on the continuation of monetary expansion.

The expansion of bank credit, and implicitly that of trade finance, also leads to a decrease in innovation. Many businesses are discouraged from incremental innovation, such as cost cutting or improving features of existing products, because cheap finance lessens the pressure of competition, and provides a financial edge that can, for a longer or shorter time, substitute an otherwise necessary managerial or innovative edge. Other businesses are encouraged to invest in radical innovation, through which they create new products and new markets for their products—and promote, as seen before, an increase in the extensive margin of trade. Nonetheless, if their innovativeness is in fact reckless decision-making, their projects turn out to be just costly experiments.

Even so, when innovation is encouraged, this is likely to happen in existing, large firms, and to be denied to smaller companies, due to the way in which innovation and financing programs are set up by the national chambers of commerce, industrial associations, banks, or other government agencies. According to OECD statistics (OECD 2013), data from 2005 to 2010 shows that only 700 firms accounted for close to half of the world's total research and development expenditure, while less than 10%, on average, of total patent applications in OECD countries over the same period were filed by firms younger than 5 years. These figures support what Hülsmann (2008, 181) argues, that

“any new product and any thoroughgoing innovation in business organization is a threat for banks, because they are already more or less heavily invested in established companies, which produce the old products and use the old forms of organization. They have therefore every incentive to either prevent the innovation by declining to finance it, or to communicate the new ideas to their partners in the business world.”

The infusion of new technology contributes to the growth of some firms more than others, further reflecting the unevenness of Cantillon effects, i.e. of the social and economic changes following monetary expansion: FDI technological spillovers are concentrated, because of the features of the business cycle, into the higher stages of production, benefitting these sectors in a different proportion than otherwise prescribed by the market. On the other hand, trade barriers and patent laws divert and limit the transfer of technology and know-how, and again disproportionately favor firms in some countries more than others, at odds with the pattern of technology transfer on a free market.

In conclusion, between the small firms that cannot grow or innovate — but which, in number, increase every year as a result of government programs for SME start-up — and the large firms whose activities grow faster than otherwise, one finds the explanation for the otherwise puzzling absence of the middle market in international trade.


Contact Carmen Elena Dorobăț

Dr. Carmen Elena Dorobăț is a Fellow of the Mises Institute and Senior Lecturer (Associate Professor) at Manchester Metropolitan Business School in the United Kingdom. 

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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