Adam Smith’s neoclassical theory of the firm
The neoclassical firm has several characteristics:
-The firm enjoys perfect information
-It operates at full efficiency (At the lowest point of the marginal cost curve)
-It is a price taker and not able to influence the market significantly
-Technology is exogenous (Can be obtained at almost no cost)
-The contribution of economic actors within the firm is not relevant
The neoclassical firm operates in a highly competitive environment and is usually represented by a small or medium sized company. (price taker)
Almost perfect examples for such a firm are for example early British metal-working firms. The growth of these firms stopped at the lowest point in the marginal cost curve so there was a limit to their size.
Later, Joseph Schumpeter challenged the neoclassical view of the firm. He focused on two things which he called ‘competitive habit’ and disequilibrium among firms. Competitive habit is how the company ‘behaves’ under competition in a disequilibrium.
Peter Drucker examined in 1946 that big business could be understood by looking at the technological foundations, the human effort that goes into it and the social impact it has.
Chandler said that technology has significant impact on the entrepreneurs choices and decisions and therefore forms the organization.
Edith Penrose believed that growth is explained by ‘the ability of the firm to exploit its physical and human capabilities’. She also takes organizational learning into account.
Winter and Nelson believed that a firm builds up routines to avoid uncertainty because the managers suffer from bounded rationality.
In the 1970’s 1980’s the agency theory was first describes. It describes contrasting interests of managers who focus on growth of the company or sometimes their personal benefit and shareholders of the company who have claims on the residual cash. (Their dividends)
Also the transaction cost theory came up which described that if the markets are inefficient some transactions have to be internalized within the company.
The last part of this chapter is explained in detail in the following chapters.
Entrepreneurship involves the individual or joint capacity to create something new which has a positive economic impact. Especially Schumpeter called the entrepreneur a ‘hero’ and believed that he was among the most important actors in an economy and also focused on the technological innovation aspect of entrepreneurship. Marxists and Adam Smith did not believe that there is significant impact of an entrepreneur. The entrepreneur himself doesn’t need to be a business owner but can also be single person participating in the economy. The way most other scientists see the entrepreneur is a middle-way between Schumpeter and Smith. He does have an impact on the economy but it is not as big as Schumpeter describes it.
Different waves of entrepreneurship came with the different industrial revolutions. For example, during the First Industrial Revolution many entrepreneurs could be found in the textile industry.
Entrepreneurs usually make high level decision and create a framework in which managers can operate. He has to create staff and perfect the hierarchy in an organization. Managers are in general more specialized in their field but do not have the ability to create this framework. (Chandler)
There is a very large variety of different definitions of the entrepreneur depending on the different scientists who investigated the issue and the concept is not completely clear. Quantifying the factor entrepreneurship like social scientists tried, did also not work and produced only odd results.
Pre-industrial Europe was not a homogenous construct because it was separated into states that were quite different from each other. Most of the GDP was caused by agriculture of the countries. (Around 80-90%)
The workforce was not mobile and there was hardly any urbanization in Europe and the distribution of income was uneven. (The farmers received nearly nothing)
A bit later in time there were new discoveries and revolutions in agriculture which later led to the First Industrial Revolution
A revolution both in trade and institutions within the state is considered an industrial revolution.
The ‘putting out system’
The putting out system is based on a company going to a rural area where the labor force is cheap and not mobile. The workers are employed in manufacturing work from home with their own equipment. Mostly this system was used in the textile industry since almost everybody had weaving equipment at home. Workers in this industry were also not specialized in their task.
One person is controlling this kind of production, either the master or a merchant entrepreneur
-flexible ( model adjusts to demand quickly by firing workers)
Later on there were also craft works that had much more specialization in their tasks such as leatherworks or copper smiths. The activities of those crafting employees were much more focused on adding value to the product and usually the shops were located near the end customers who were mostly rich people, the army or the government. Most craft shops used the master – apprentice system in which the master passed his knowledge to an apprentice who could then open a shop himself. Usually Craft shops belonged to a guild.
Guilds were important economic institutions at that time because they controlled the supply of skilled labor through the master-apprentice system they implemented. Guild usually tried to maintain high prices for their products by only giving the market a few skilled workers at once. They were conservative in general and did not facilitate the use of innovations.
They also settled differences among their members and colluded in order to set the prices to their benefit and resembled in general a monopoly that wants high prices (by collusion) and low output of products. (by limiting skilled labor supply).
The craft shops that were in a guild were small and their workers were relatively independent compared with the putting out system as long as they implemented the guilds policy.
Big scale business pre-industrial Europe
‘Manufactories’ existed. The word is a mix between factory + manufacturing
A manufactory was characterized by having many workers under one roof that still produced simple product like textiles in batches.
Most workers came to the factory only some worked from home. How many employees worked from home was determined by the nature of the business.
(E.g. Many textile workers worked at home as they had weaving equipment, but almost all workers harvesting coal or iron were at their workplace because nobody has a coal mine at home)
This system was in several industries therefore only a complement to the already existing putting out model.
The period from 1789 to 1914 is considered the ‘long 19th century'. Europe grew constantly and fast at around 1.2-1.3% per year per country
Britain gains a leadership role around 1840 even though it did not grow faster, but its income comes not so much from agriculture but more from manufacturing which was on the rise at that time. Britain therefore also had a different employment structure.
Other European countries slowly followed that trend, but many Mediterranean states stayed with agriculture as most important income stream. Soon after the countries specialized in several industries due to factor endowments and technology a stable Europe was created.
Britain’s advantages: Steam engine, cheap energy (water), intellectual climate, good distribution network, many big innovations due to working copyright law.
Later: machinery export in high tech sector (heavy machinery)
Due to those advantages of Britain soon an entrepreneurial class emerged in society which founded several new businesses.
In this first industrial revolution companies are rather small with around 12 people on average. Financing comes mainly from the entrepreneurs own funds and from the funds of partners. The control over the firm is entirely in the entrepreneurs’ hands, he manages every activity of the company alone.
A problem at that time was that all the new innovations mostly only focused on certain parts of production processes which could create bottlenecks and inefficiencies in other parts. This is known as ‘Innovation plague’.
Companies often clustered in industrial areas, often this resulted in a lack of coordination between the production stages, however by clustering innovations spread extremely fast in these areas. (Adam Smith ---> Technology is exogenous)
Sales networks were soon established which led to higher transaction costs because they had to be managed somehow. Often the transaction costs tried to be reduced by employing the own family as supervisors who will work for very low wages.
Merchants were used as long-distance mediators for companies because they already had existing networks. Often cooperating with a merchant led to conflict between the producer and the merchant because the merchant was not willing to make exclusive contracts with one producer but had several relationships with producers at once.
Financing for these activities consisted of everything you could get ---> Mostly your own or family funds and bank loans. Compared to the second industrial revolution starting a business was rather cheap.
So what’s new after first industrial revolution?
-Many workers under one roof, big factories
-High specialization! (Only one task per worker mostly)
-Clear lines between production and consumption (Workers are all inside factory, don’t work at home anymore)
---> Also there is a bigger market now
The employee does not own the machinery he works with anymore as it was in the putting out model. Now they come to the factory to work in their highly mechanized jobs. (Production through new machines) Industrial areas were therefore founded around water because of the cheap energy access.
Macro level change after first industrial revolution
-Growth rates of countries rose
Micro level changes
Fixed working hours and long travel distances to the job led to unhappy workers. It was simply not fun to work in a factory for 8 hours doing only one task.
Paternalism means that the boss takes care of his employees better and provides them with acceptable working condition. Often whole villages including sleep rooms and all necessary supply were built for the workers so they could live there with their family. (The job itself was still pretty bad though) Paternalism proved to be very effective in improving the relationship with the workers. The employees mostly dependent on the goodwill of their boss since there were no labor unions or guilds.
Schumpeter about the factory system: It is a big success, many new jobs are created and products become cheaper. The economy grows and ‘creative destruction will drive the old techniques away’. (In reality it was a slower change than he expected)
Marxists about factory system: The proletariat (working class) has very different needs
than the bourgeoisie. The factory bosses profit heavily by reducing costs through machinery but make their products still expensive. The proletariat will be unable to buy industrial goods because of their low wages. This could that would lead to a big crisis!
In the end both perspectives were somehow right: A growing economy took place but also there were conflicts in society. In general the factory bosses could control quality and output much better through factories.
The economy grows more and more, markets get bigger and new technology emerged such as the telegraph and fossil energy( from 1850 on). This led to the creation of the first really big businesses.
Railway systems are a driver of industrialization in the USA. In addition, the invention of the steamship plays a big role in enlarging the domestic market by reaching out to more distant towns and villages. The train has three major advantages: Speed, reliability and regularity.
In the Second half of the 19th century (from 1850 on) huge amounts of capital were needed to finance the railways, therefore the first investment banks were founded! Stock trade, speculating and buying of call and put options were fine-tuned and enhanced. Lots of capital from Europe goes to USA to build railways.
Railway (sometimes also telegraph) companies became extremely big and needed management, especially in USA where the companies where scattered across the country. USA therefore has the first professional managers and becomes a trendsetter for management innovation.
In big American firms managers should have little or no shares at all because ownership and management are supposed to be separated for the first time to avoid giving the managers full power over the company.
Also within management there are line and staff. Line management is responsible for revenue creation such as movements of trains and services while staff management is a revenue consumer but needed to keep the business alive. (Such as accounting)
The railway sector in general was oligopolistic and competitive and the relationship between worker and management at that time was quite okay, even though there were no unions yet.
The business know-how from railways also goes to other sectors via spillovers:
Carnegie strategy:
Because of new transportation by trains and better telecommunication some sectors of the economy transformed. New sales vendors and department stores with fixed prices and inventory came up. They had low margins but high turnover because there were regular supply deliveries by train now. Also mail-ordering of goods and retail chains became popular in America.
The highest impact of new technology could be observed on the manufacturing industry. Germany, Britain, and the US account for 2/3 of world industrial production by themselves.
The Second industrial revolution
What is it? It means the interconnection between innovations from different industries.
For example distillation originally comes from the chemical industry but spread to alcoholic beverage industry, sugar production and oil production and was soon used widely. The same happened to many other technologies. The results were lower per unit cost and therefore increased economies of scale and extremely fast innovation in many sectors.
The higher the degree of mechanization in a sector the higher was the impact of the second industrial revolution in general. Industries like metallurgy or packaging benefitted heavily while jobs with high degrees of manpower like textiles or leatherworks did not. Therefore, no giant plants existed in high-manpower industries as the jobs could not be mechanized.
The books also lists three major investment types because only investment in machinery was not enough to make good profit:
Investments in Distribution: Previous distribution can’t handle mass production products. Therefore integrate vertically (Both upstream and downstream), needs investment. First ones to do that: Sewing machine companies
Investments in Production: Take advantage of production capacity and throughput by investing in it
Investments in Management: Due to the new complexity, e.g. vertical integration, marketing, bookkeeping and organizing more and better middle-managers were needed. Invest in that.
The typical internal structure of a company was characterized by having decision makers (top management), middle management and small business unit managers. The power within the organization was slowly shared within the hierarchy.
New competition in many sectors had to deal with the first movers and their advantages. Markets sometimes became saturated with products and new companies dealt with it in different ways. They looked for new markets, developed FSA’s or integrated vertically to avoid competition.
Differences between countries after the Second industrial Revolution
Major factors for comparison: Market characteristics, governmental regulation of competition, social attitude towards big business and the cultural resources available for corporations.
USA
In America the normal business was a mix between being controlled by managers and family, the size of the firms became much bigger ---> America about to become first country of mass consumption!
Too much supply for too less demand. Smaller businesses and merchants want antitrust laws and regulations to save their businesses. (Around 1880) In 1911 there was a success of those groups when some companies were broken up by the law.
President Woodrow Wilson creates the Federal Trading Commission in 1914 and brings the ‘Clayton Antitrust act’ through congress
This lead to the American Paradox: Antitrust laws were supposed to limit corporation growth and unfairness to small businesses by prohibiting price-fixing and cartel agreements. When firms could not use these illegal tools anymore there was a large wave of merging between firms. (which was legal) This lead to even bigger companies with more power over the market. (Most sectors were oligopolistic)
Between 1880 and 1920, trade unions, political parties, lobbies and other professional associations were founded. American tendency of middle-class towards systematic control and efficiency.
Advantage for the rise of big businesses was also the educational system with business schools for managers and technical/engineering schools like the MIT. (Massachusetts Institute of Technology)
Germany
Favorable public opinion towards big businesses. Owners of a company had more influence than in the US. However, less involvement of family members in the business.
On the German market cartels played a much more crucial role, they were most common on markets unlike in the US.
Germany did not make use of the Second Industrial Revolution in all markets. The market for ‘consumer goods’ did not produce large companies with economies of scale advantages. Therefore this market was served by firms from Great Britain.
Banks were much more important in Germany than in the US since the most important markets in Germany (Electrical machinery, engineering and chemicals) were very capital intensive, so banks had to decide which companies to give credits to giving them much power in the economy. Banks were often shareholders in those companies. By the end of the twentieth century this effect decreased as the companies in these sectors made enough money to sustain themselves.
Germany served both its domestic market and foreign markets with chemicals, machinery etc. The USA mostly concentrated on their domestic market only.
The biggest sectors in Germany were dominated by cartels, however they did not have a negative impact on the economy as a whole by decreasing its efficiency.
Higher education was much better developed in Germany than in the US or Great Britain which lead to innovation and well-educated managers.
The big companies coexisted with many small- to medium sized companies that served different market niches, resistance against the big businesses was not as strong as in the US.
Great Britain
Different from the other two, many big businesses were in the sector of consumer goods. (Where they normally shouldn’t be. Remember from previous chapters that emergence of big companies in the second industrial revolution depends on if the sectors needs much manpower or not. Normally consumer goods need much manpower)
Many big businesses were family businesses (Unlike in the USA or Germany)
Scientists still argue whether this was the cause that British large companies were in total less effective than German or American ones. In addition, Britain continued to export many products from the first revolution such as textiles. They did not make use of the new innovations from the second revolution because the demand on their domestic market was low.
Britain did not have any antitrust policies and there was also a wave of merging companies like in the US, but much smaller in size. However, the result of the merging wave was quite different: In the US firms mostly merged into one new company with central hierarchical management. In Britain the firms legally merged into one company but in reality they stayed as they were before, with different independent management structures in place.
The bosses of each company would meet only to discuss price settings etc. Typically they were also not grouped into one big building like in the US but scattered across an area.
Education was not aligned with market needs. For example: 1,100 students in total were enrolled in engineering programs in Britain when the country desperately needed engineers to build machinery for mass production. At the same time Germany had 16,000 students in engineering, providing a big advantage in this sector.
Latecomers in industrialization: France, Japan, Italy, Russia
Government plays a crucial role for the latecomers because they have to prove themselves against the already industrialized countries. The government not only regulates competition but also gives subsidies uses protectionism and commissions to get economic growth.
In non-latecomer countries growth reasons were always economical (Simply making profit) For the latecomers there is also strategic growth. (e.g. subsidies in sectors that make no profit but give the country long-term advantages and benefits)
(Only some short notes on them as they don’t seem to be so important)
France
France caught up rather quickly by investing in new technologies, electricity, chemicals etc.
Almost all large companies owned and controlled by families.
Russia
Government has a crucial role with giving away large subsidies and using tariffs to protect the economy.
Especially the steel and machinery industry became big, the rest did not catch up to the industries of other states.
In general, the markets were oligopolistic with cartels.
Japan
First non-western nation to become a major player in the world economy later on.
The government subsidized heavily and even founded own companies that were later turned over to private businessmen. Japan wanted to industrialize in all sectors fast.
Wealthy families control a diversified industrial group, a so-called ‘Zaibatsu’. Often Zaibatsus were concentrated in shipping, finance and international trade.
During this first industrialization phase Japan was not as efficient as other countries but it opened the way for the extreme growth of the country later on.
Italy
The industrialization went quite normal in Italy, but they could not create really large businesses.
- Increases in firm size!
- Trend towards management with technical capabilities!
Before World War I there were two different organizational forms for large American Firms, the Unitary form (U-Form) and the Multidivisional form (M-Form).
The U-Form existed before the M-form and was the most common used form in business. In the U-Form the management of a company and the board of directors are one and the same, they were unified (---> Unitary form). Therefore the authority within the company is highly centralized within the U-form.
The last chapter said that there was a wave of merging firms in the US, which now had a lot of resources, both managerial and capital, at their disposal. The firms soon diversified their products and product lines became and more complex, which lead to a problem with the old U-form. Because of the increased number of product lines managers needed more time to supervise their products. However, in the U-shape the board of directors equals the managers, who now had no time left so that no well-thought out strategic decisions could be made.
Because of this problem the M-form (Multidivisional) was created. In this form there is a board of directors whose only purpose it is to oversee all departments of the company, make strategic decisions and allocates resources to them. Now the companies could diversify their product range better since the board of directors could manage the process more efficiently.
The managerial capitalism problem:
When more and more professionally managed companies came up that offered shares on the stock market, ownership was separated from control over the company (You could own the company through shares but not control it / Principal agent problems).
‘Berle and Means’ wrote a paper in 1930 about the relationship between owners and managers and concluded that an organization should not only benefit the owners or managers but also the community as a whole.
They said that the battle for control between management and owners would also concern the stakeholders such as employees, suppliers, distributors and end clients. (The whole community in the widest sense)
Another scientist, Walter Rathenau came to a similar conclusion several years earlier in Germany. He concluded that the interests of the firm should be aligned with the society as a whole.
World War I brought the world the end of the ‘first globalization’. Because of the conflicts internationalization of companies decreased heavily.
WWI also slowed the spreading of the managerial corporation in Europe down. In addition, the European market was now smaller than the American one. Europe and America concentrated their efforts on national trade because of WWI, however, America had the advantage of a bigger national market than Europe. (Also the population grew significantly in America and stagnated in Europe) Other disadvantages of Europe were an economic crisis, dictatorships and an unfavorable climate to change.
Therefore, the managerial corporation arrived slower in Europe
World War I fragmented Europe into very isolated small state-economies, while America did not have that problem
Many companies lost foreign subsidiaries, almost no foreign direct investment after the war (Great Britain is an exception, tried to continue its FDI)
Between the two world wars the presence of cartels in Europe was especially high. People wanted to reduce economic uncertainty and cartels provided more stability on the market so they spread quickly throughout Europe
Governments became more interventionist between wars. They intervened in the market to help the national economy survive the decreased domestic demand caused by the war. (Extreme example is Italy, where the state subsidized and bought lots of companies)
Financing between the wars was mainly a mixture between borrowing from banks and using the stock market.
Between wars, Europe had much more worker-unions than America which lead to more worker-participation in management decision, but also to a slightly lower productivity of European factories and assembly lines. While managers in the USA where properly trained, Europe relied on training them on the job and learning by doing. Often managers in Europe were skilled blue-collar workers that had no special managerial training.
European companies often did not separate ownership and control (Managerial corporation arrived slow)
They were less diversified
Power was less concentrated than in America (Worker-unions)
In total, the normal European corporation was smaller than the American equivalent. They used an H-form shape of business. (Holding corporation)
Japan was almost completely isolated from international trade, then a change in the government happened in 1868 aristocrats, samurai and oligarchs took over the government from the former ‘emperor’. This is known as the Meiji-Revolution (sometimes also Meiji restoration)
The goal of the new government was to catch up with the rest of the world. They encouraged abandoning tradition hindering economic progress and imported systems from the rest of the world such as the banking system from Germany, the managerial corporation from America or the judicial system from France. At the same time they invested heavily into infrastructure and education to make Japan fit for competition.
The government set up state owned enterprises that did not make profit at first to encourage other entrepreneurs in the country to invest into factories etc. When they made profit they were sold to private investors to stimulate the economy. (End of 1880). Between 1870 and 1880 (Around the first industrial revolution) Japan had factories producing the typical first industrial revolution products like textiles, glass and metalwork similar to other countries.
When the state owned companies were sold Zaibatsus (financial groups) were formed. Mitsubishi for example first owned a shipping company then it bought a mining company from the state to have coal supply for their ships and finally it bought steel mills to manufacture more ships. Most of the activities in a Zaibatsu were interrelated.
Zaibatsus have less control than the American M-shape businesses and more control than the European H-shape businesses. Zaibatsus could become extremely big with hundreds of subsidiaries in different industries. They usually had a ‘house-bank’ providing them with credits and finance.
Zaibatsus were important for Japanese growth but they were not the only growth factor, small and medium sized companies were also important. (--->Dualism)
Zaibatsus were highly diversified and usually led by one family who founded it. The family itself gave up control to a variety of managers that controlled the company for them. Zaibatsus often offered workers from the countryside education and welfare programs to keep up the morale in the factories.(---> Paternalism)
-The Zaibatsus also profited from the wars since capital intensive goods were needed and they controlled industries such as ship-building
-Before WWII Japan increasingly focused on reverse-engineering of western products to have access to technology.
At the beginning of World War II big businesses were characterized by three things:
1) Involvement of conflicting actors with different interests, such as managers, shareholders, stakeholders and the government.
2) Existence of a complex organizational structure
3) Important role of Research and Development within the company
Research and development became much more important since now there were many capital-intensive industries in all countries, which had to develop new complex products and better processes to produce. R&D gained importance from 1920 until the end of WWII. R&D became a strategic asset for companies.
-Firms often had their own R&D departments that had contact with universities and professors. R&D happened in both universities and private companies.
-If there was an R&D project it was divided into separate elements. Each element was worked on by a group of experts in their field.
-The innovations that were created by this wave of innovation had a positive spillover effect on the manufacturing sector as a whole.
The most efficient system of national innovation was owned by the US. They relied on private R&D by companies in combination with R&D from universities.
-When the war finally started the manufacturing sector had heavy demand in all industries. The result was a shortage in raw materials so new substitutes and alternatives had to be found. R&D spendings increased drastically during that period not only in manufacturing but also military technology. (radar technology, jet engines)
The third industrial revolution focused on three business clusters. (The book does not give an exact date but its set in the more ‘modern age’)
Communication
Communications drastically changed through mass distribution of computers, better telecommunication networks and the internet in general.
Transportation
The Second World War produced innovations such as the jet engine and new materials such as Plexiglas which changed the transportation sector.
Physical materials
The invention of the atomic bomb showed the potential energy from nuclear energy which revolutionized the energy sector. Also biotechnology was invented.
Also important were the invention of the semiconductor and the integrated circuit. They were used in almost every electrical invention at that time and are considered a ‘General Purpose Technology’.
These major innovations ‘decreased the distance’ between countries through faster delivery of goods and better communication, therefore between 1975 and 2000 there was a second wave of globalization. (Remember: The first one ended with WWI)
More products were traded, the overall trade volume increased and there was more foreign direct investment worldwide. This time is also called ‘era of shrinking space’.
In general the big businesses were reinforced by the new technologies and they expanded their activities through new subsidiaries and FDI globally. They became more decentralized because they operated in more countries at once
After the Second World War America’s economy was superior to almost all other economies in the world. America won the war and had mass production of products in place that was not possible for the after-war troubled Europe at that time. Research and Development was well established and America also had a well-developed infrastructure. Firms were used to being successful on the market in general.
However, in 1960 the American economy was surprised by the quick recovery of Europe and the emergence of Japan at the same time. All of the sudden there was extremely strong competition on the markets and America did not know how to react to that. This triggered another wave of merger and acquisitions on the American market. In many cases firms merged even though they had nothing in common. (Structurally and regarding products) So the merger and acquisition wave was more of a panic-reaction than planned strategy of the firms which aimed at diversifying the product range to avoid the competition in the previous core business.
This development led to the emergence of conglomerates. Conglomerates are firms that operate in unrelated sectors at the same time. Many manufacturing firms like steel producer diversified their business into different sectors such as insurance or finance after 1960. Conglomerates have also been founded directly after the war but the competition situation in 1960 made them much more widespread.
Advantages of conglomerates:
Ability to raise capital at low cost
Reduction of risk through product diversification
Could afford costly management experts, which small firms couldn’t
Conglomerates were beneficial at first but weakened the long-term position of firms. Management was incapable of managing completely different companies with completely different products efficiently. The Decline of conglomerates started in the 1970’s and firms restructured themselves, most returned to their core business. ‘De-conglomeration’ means splitting the conglomerate into the different sub-firms and parts and to sell them separately. This happened on the American market in 1980 and was quite popular at that time.
In total, America had some trouble in the second half of the 20th century but managed to get to a position that was optimistic at around 2000 again.
- At first: October revolution 1917, Tsar Empire falls apart, new government is in charge.
- Marx and Engels idea of communism ---> a class-less society where production is shared, not traded
- Lenin tried to make Russia fully communistic by first declaring socialism (The pre-form of communism)
- Later, in 1921 Lenin introduces the ‘new economic policy’ a mix between socialism and capitalism. (State keeps most of the production but allows producers to sell the rest)
Large firms were governed by a trust created by the government who could make strategic use of them for the countries benefit.
Downsides of trusts:
They kept around 80% of the profits from firms for the government, only 20% could be reinvested into new projects
Trusts quickly lost their marketing function and only cared about the production of goods, not sales.
After Lenin, Stalin reached power and converted all farms into collectives owned by the state. His vision was to industrialize and build up the military to economically beat the west. Instead of the ‘market’ Russia now had ‘the plan’. (Gosplan in Russian)
The plan was made by the government and dictated quantities-produced, prices, salaries and basically the whole economy. The state was organized like one huge corporation with several departments that took care of their specific function within the plan. The ‘state-corporation’ was led by the government which acted as top management, the different sectors such as agriculture or metalwork were only used as production facilities for the state and were under the control of the Gosplan. In the actual firms there was only one level of management that reported directly to the government.
This kind of organization was a big advantage and a leap forward for the country, however it was completely unbalanced and not sustainable.
After Stalin’s death the country experimented with ‘production associations’. Similar firms were merged to produce in a more efficient way with less waste during the production. Now Russia had big companies that resulted from merging several small ones. The big companies still had almost no influence on salaries or hiring and firing employees due to the Gosplan.
The west had several strategies for firms like differentiation, economies of scale or personalized products. Russia had only one strategy: Big companies with economies of scale. They were good at production but poor at marketing. Also there was almost no innovation in the big firms because the risk was higher than in small firms to innovate.
The Russian Gosplan proved efficient when the country needed to be flexible such as in the war with Nazi-Germany but extremely inefficient during normal conditions. Today it would be unrealistic to use such a plan in the economy.
- After WWII the USA officially prohibited Zaibatsus in Japan as they were considered to be hindering the ‘economic democratization’ of the country. After Japan regained independence in the next decades and abolished that law in 1952, similar groups emerged within the country. This time they were called Keiretsus. A Keiretsu could have two forms.
---> Horizontal Keiretsu (Kynyuu Keiretsu)
Many firms work together as a group and cross-hold shares of each other and the majority of shares always stayed inside the group which made it hard to take them over.
--->Vertical Keiretsu (Kigyoo Keiretsu)
One or two very large manufacturing companies are the head of the Keiretsu. They group together with many different suppliers to buy their semi-finished goods and raw material. Between the suppliers there is intense competition to build a good relationship with the manufacturer even though they are in the same Keiretsu.
In general about Keiretsus:
The management of a Keiretsu is quite informal since the bosses of the separate companies meet several times a year and make decisions within this ‘club of managers’. Also, Keiretsus mostly had house-banks (or main-banks) which are both creditors and shareholders and had direct influence on decisions.
Keiretsus offered the employees ‘lifetime employment’. When there was no job for an employee in one company anymore because of downsizing or a crisis he was transferred to another company from the group. Worker morale was therefore high and important for the Japanese success on the market.
Keiretsus did surprisingly not lead to much price collusion but improved efficiency and competitiveness of the involved firms.
The Japanese state played a crucial role in modernizing several sectors of the economy, a good example of that is the steel industry. The Japanese ministry of International Trade and Industry (MITI) used protectionism and isolated the steel market mostly from the world market. The market was now protected and highly competitive. MITI now offered subsidies to the firms that operated the most modern and efficient plants. In order to stay in the business firm had to modernize their plants and tear down their old plants which lead to a really fast rate of innovation. This big influence on the market was kept until the late 1970’s.
At the end of the century Japan became the second most powerful economy in the world, after the USA, because of the great growth rate of their firms.
Harvard made a study about whether together with the large-scale enterprise in Europe there was also organizational modernization. They investigated the period between 1950 and 1970 and found out that most companies showed a shift to the M-form. (Multidivisional form) Most firms therefore also used product diversification.
This shift to the M-form with diversification can be seen as Americanization of Europe since after the war the USA invested heavily in Europe (Marshall plan) and there was also a spillover of American culture. The plan to help Europe recover after the war by investing in it, led to an increase in purchasing power of the European people. Now that there was lively competition on the market the European countries signed several trade agreements that resulted in the creation of the European Common Market (ECM) America invested continuously through FDI in Europe and brought several new technologies and organizational forms to the market.
The conclusion that most firms shifted to the M-form by the Harvard researcher was not always true, in general European firms adopted the M-shape but there were small differences depending on the country itself There was a second study from 1985 to 195 that showed that the M-form spread further while being adapted slightly for every country.
The M-form spread through Americanization, however, there were also other system that were important for Europe at that time such as the industrial districts (many small firms working close together), the multidivisional network or state-owned companies that had a different structure, which is why the chapter is called ‘hybrid Europe’. (The multidivisional network is a group of small entrepreneurial firms working together)
At the end of the reconstruction years in Europe (around 1950) many states started interventions through subsidies or special taxes and bought firms that should be controlled by the state. Those states were called ‘activist states’. Especially energy production companies, but also banks were bought by the government. The state owned companies had to find an organizational structure that made a compromise between efficiency and social benefit. Most of them adopted the holding form.
This whole process lasted until the early 1980’s, when inefficiencies led to a wave of privatization that reverted some of the government owned companies into private hands. The process and the degree of privatization were different in every country.
Similarities between South Korea and Argentina
Both countries had similar internal markets. Because the countries are both small it was difficult to use economies of scale, therefore the markets were filled with multidivisional companies. In addition, both countries had authoritarian governments.
South Korea’s way
Korea decided to give the private sector incentives for growth through subsidies and protected several industries from international competition through tariffs. In return, the new businesses that were created had to build state of the art plants that were much more modern than the old ones. Through this modernization South Korea could now achieve economies of scale even though it was small. In addition, the workers were heavily trained and were soon some of the best trained in the world.
The South Korean market was characterized by Chaebol. Chaebol are groups of company that work together and are diversified in unrelated sectors just like the Japanese Keiretsu. The main difference between a Chaebol and a Keiretsu is that Chaebol do not have own banks who own shares of the company and give credits since banks were the property of the state in South Korea. Due to these Chaebol there was significant economic growth in many sectors, however many small and medium enterprises suffered from it, as the Chaebol received subsidies and important jobs from the government that were impossible to reach for SME’s.
Argentina’s way
Argentina owned a lot of natural resources, good agriculture products and had a good starting point to catch up in general, however the ruling class only focused on their self -interest which kept the economy from being efficient. Even when the company build a train network it did not facilitate the creation of more businesses that were of a large scale. At the beginning of the 1900’s the market was controlled by several big company groups like in Japan and South Korea, which also had their own banks.
In 1946 Argentina’s new leader, Juan Domingo Perón, the government focused its attention on government-owned companies that were created and small businesses, to give them a chance against the big groups. Later in 1930 Argentina tried to attract foreign companies while regulating imports through very high tariffs at the same time. However, even that did not lead to success because the approach was too inconsistent and changed a lot. In the middle of the 1970’s there was a period of de-industrialization and a big drop in output of the country due to the failed attempts to get the economy on a good track. This time, the government focused again on the big groups that it had forgotten several years. In total, companies spend many resources on lobbying against the government but not on increasing their efficiency or output, also the small domestic market had a negative effect.
There was a lot of potential that was wasted by bad government policy but during the 1990’s president Menem tried to correct them by privatizing many state owned companies, increased liberalization and by entering the Mercosur Trade-bloc. Argentina is on a better way today but still they lack behind other states.
Multinationals became more and more common since there were no wars between industrialized nations and existing companies that used the M-shape could internationalize easily. Soon ‘free standing companies’ were founded, which only had the purpose to invest in other countries unlike normal companies that do business in their home country and then invest abroad. FDI increased worldwide with the USA as the biggest investor. (Mostly in Europe during the Americanization time)
Different reasons led to multinational companies, the book is quite lengthy about this but it can be broken down into FSA’s that could be used abroad or a saturated home-market. Stephen Hymer introduced the ownership advantage concept. It explains that the firm is going abroad because it has superior technical knowledge or skills that is can use in the host country. (So basically FSA’s) Later the concept of saturated markets was added. The Uppsala Approach describes how the firm goes step-by-step from one country to another when it internationalizes. The OLI model focuses on the importance of internalization to avoid transaction costs. (OLI is not explained in detail, so I don’t think we have to learn it by heart)
At the end of the 1970’s the USA lost their world-leadership in FDI due to several reasons one of which was the devaluation of the Dollar at that time while other countries, like Japan, increased their FDI at the same time.
The reasons for Asian firms going abroad were not the same as for Western ones. In the West it happened mostly due to the competitive advantages in production or marketing while Asian companies could go abroad because of better organizational capabilities, subsidies from the government and good relations with their home banks (cheap credit) They were called ‘Dragon Multinationals’ and pursued very unique strategies for internationalization compared to the western ones.
In the late 1980 multinationals came up with new structures, Bartlett and Ghoshal identified:
-The transnational firm (Network of mostly independent subsidiaries that exchange knowledge and information)
-The international firm (Not described in detail in the book)
-The multinational firm (Subsidiaries are responsive to local needs)
-The global firm (One mother-company in control, only weak subsidiaries, resembled normal US multinational at that time)
The internet made it possible to have long value chains with multiple companies that are specialized in their specific parts. Also cross-border alliances were more common after the internet revolution. Also small family companies could internationalize with specialized products. (---> pocket multinationals)
In total, international business became more diverse through the different firm structures than before.
The new 20th century technologies like computers and internet reduced transaction cost and led to more decentralized and diversified companies. The overall production volume decreased and the companies diversified themselves more instead.
There was also a tendency of disintegration among big companies which means that formerly vertically integrated processes were now done outside the company from someone else. Together with this development came the rise of outsourcing activities to specialized suppliers. Therefore, the market mechanism became more important since suppliers had to compete more with each other instead of being internalized in one company.
Companies often decreased in size and had more activities abroad. In addition, modular structures in production processes were on a rise. The best example would be computer manufacturing, which has been vertically integrated in the past and now became modular in the sense that different suppliers produced different parts that were then put together by the mother-company. Often network structures emerged when the corporations cooperated over a longer period of time, which included sharing knowledge.
The role of big business changed to coordinating the alliances, suppliers and partner firms while holding crucial parts of the network within the main company. (Such as R&D)
During the 1990’s the USA again had a leadership role in technology and research intensive markets because the Clinton government built the infrastructure for it and the oil price sank drastically. The new economy emerged in the 1990’s. New economy describes the shift from labor-intensive to high value added activities.
Many high-tech companies were founded as small start-ups looking for bigger investors. So called venture capital firms financed the small start-ups with their own money if they had a good idea. They often paid very high returns if they were successful. (30-40% ROI) Examples of this are Apple, Microsoft and Amazon.
New technology led to better ways of distributing products and provided cost savings that helped the new economy grow further.
During the 1990’s most companies directed their efforts towards maximizing the shareholder value because issuing shares and keeping the shareholders happy became more and more important as they started to look closer at the efficiency and the return of their company. Some managers only goal was it to maximize the value on a short-term basis which resulted in several accounting-fraud scandals involving many American firms.
While the US economy created the ‘new economy’ and was growing fast, the European economy was rather slow in its growth. Europe had many welfare economies that needed high taxes to finance them, which reduced demand on the market. Also, while America had many high-tech companies Europe mostly relied on mid-tech or sometimes low-tech. While American productivity per labor hour was rising Europe’s productivity was stagnant so in the long-rung Europe lost its competitive advantage to the USA.
In Japan there was a big crash at the Japanese stock exchange at the beginning of the 1990’s caused by a speculative bubble on the real estate market. This crash heavily influenced Japan, led to more unemployment and several house-banks of the Keiretsu had trouble receiving loaned out money back. The crisis also reduced the amount of cross-shareholding between companies which was one of the main characteristics of the Japanese companies. The firms even needed foreign capital in some cases to stay in business. Some managers of those companies adopted a more shareholder value oriented approach during that time.
The lifetime employment in a Keiretsu that the Japanese had before was also abandoned due to the crisis and was replaced by a system that paid more attention to efficiency and meritocracy. Mobility and flexibility were now more wanted characteristics among new workers.
China’s growth began after Mao died and lost his power. Today it has the advantage of extremely cheap labor which is the main reason firms relocate their production there. China is not only present in the work-intensive sectors but also acquired and developed own companies in the high-tech sector to produce TV’s and other products.
China helped the ‘big groups’ inside the country with cheap credit and tariff protection such as in Japan or South Korea in order to achieve economic growth. The plan was to specialize in industries that required medium tech that could make the maximum use of the enormous economies of scale.
China also created four ‘special economic zones’ that should attract foreign capital by offering unique benefits such as tax exceptions etc. Attracting the foreign capital is also known as ‘open door policy’.
Issues in the future are the development of the political party in China and the impact the Chinese way of producing has on the environment.
India
Big advantages of India are the amount of people in the workforce who speak English (Almost everyone) compared with the enormous amount of people in the workforce. Also, India is leading in many service sectors such as call centers for western firms who outsource their operations to India.
The Indian market is characterized by company that diversified their operation unrelatedly. A good example is the biggest group in India called ‘Tata group’ which is doing business in almost all sectors of the market at once. The Tata group also drove the scientific education in the country by founding the Indian Institute of Science which is now responsible for new developments in the software sector.
In India there are several companies following the idea of social entrepreneurship. They make profit but provide their workers very good living conditions or make their services cheap so they are available for everyone.
At the beginning of 2000 India was ranked in the 3 top economies together with the US and China.
Bron
- Deze samenvatting is gebaseerd op het studiejaar 2013-2014.
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