Scale effect versus young's 'acceleration principle': the empirical issues.

AuthorPadhi, Satya Prasad
PositionReport - Statistical data

This paper maintains that the conceptualization of a large firm that is based on the realization of increasing returns to scale phenomenon, which is based on pecuniary external economies created by other such large firms, is problematic. It, by design, is dependent on the external increase in the size of the market. An alternative is the Youngian conception of the 'increasing returns' phenomenon that provides a better policy focus. It discusses the conditions under which investment by a 'large firm' in an industry that is productive (i.e. embodies technological improvement) creates external economies, and forms the basis of further investments that are more productive. The Youngian external economies-based 'acceleration' principle propagates in a cumulative way, permitting in turn continuous advanced growth.


One of the initiatives of a liberalization process is the provision of proper incentives to make the firms more dynamic. The expectation is that this transition would bring in more 'developed' overall growth processes and confer a developed status to the economy. This is an important thrust area. Here, the Schumpeterian tradition suggests that intense competition defines such firms who rely on technological improvements as a competitive strategic conduct. In this, there is no role of normal profits. The firms are driven by the desire to increase (maintain) higher profits and their technological improvements support such objectives.

In this context, the present paper holds that the conceptualization of dynamic firms is an important policy concern; in a way, the basic Schumpeterian insight into the role of higher profits (as such) prompts two different types. One is the profitable firms who take advantage of higher scale economies and the other is the ones who seek higher profits through industrial differentiations, as discussed by Young (1928), where production processes are sub divided into many tasks and different firms of different size carry out such tasks.

This distinction is important if the 'competitive' environment that supports higher growth prospects is a concern. Chandra and Sandilands (2005) note that the recent endogenous growth literature gives more importance to the increasing returns to scale that glorifies monopoly profits, rationalized by the incidence of higher fixed costs, and it undermines the growth inducing competitive forces that are generated by the Youngian industrial differentiation. The present paper goes further to underline the need for the elaboration (see I below) that the very conceptualization of a growth process based on scale economies (and monopoly elements) is a problematic one, as borne by the fact that technological progress does not co-exist with monopoly profits.

There is another important motive at play. If there is the discussion of a link between the working of the dynamic firms and the growth of aggregate output (or technological progress), the minimal assumption is that the firms create external economies. Different conceptualizations of dynamic firms provide different conceptualizations of the economies. The present paper tries to show that their specificity in the context of scale economies is such that the scale adjusts to higher growth of output (and demand), rather than being the cause of growth. On the other hand, in the context of industrial differentiation, their discussion (as in Young, 1928) provides the understanding of how more productive investment (that aim at higher profits) creates external economies and begets further such opportunities and this 'acceleration' principle is responsible for higher growth that is associated with technological progress.

The issues raised above are taken up in Section I of the present paper. Section II deals with the empirical issues to distinguish the different conceptions of dynamic firms and Section III provides the related data set for the Indian industry, to conclude.

I Firm & the Developed Status: Stylized Facts of Growth

In the development economics literature, higher developed status can underline the importance of Rosenstein-Rodian industrialization based on scale economies. This does not require any change in technology and takes place with unchanged endowments and preferences (Murphy, Shleifer& Vishny, 1989), but in an important way, shows that higher monopoly profits are consistent with higher aggregate output. Here, an important assumption is that higher scale economies is associated with higher fixed costs and calls for compensation in terms of higher profits. Since these profits are specific to higher output realization to take advantage of the scale economies, the outcome (with the assumption that all profits are spent) can generate higher aggregate demand, which, amounting to pecuniary external economies, can support such investment elsewhere. The only catch is that its own profitability based on higher output expectations also depends on such pecuniary external economies created by the large-scale investments in other sectors. In other words, there are strategic complementarities between large investment projects across sectors based on pecuniary external economies. However, the market mechanism fails to coordinate such diverse investment programs. There is therefore the possibility of multiple equilibria when the market outcome is based either on pessimism where no one takes the initiative to industrialize, which pins down investment by others, or on optimism where every one simultaneously takes the investment decision, supporting each other. Pessimism leads to bad outcome (say, pre-existing low productivity level) and optimism realizes increasing returns to scale in an aggregate sense. However, commenting on such models, Solow (1998; also see Mookherjee and Ray, 2001) notes that they do not compare to the models that can predict; the outcomes depend on such factors as history, expectations, accidents, psychological factors etc. (Krugman, 1991; Ray, 1998; Mookerjee and Ray, 2001). In other words, these formalizations have a Keynesian flavor (in as much as Keynesian theory depends on imperfect markets) that highlights the role of government to 'big push' the economy.

In this sense, the purpose of this paper is to highlight that if 'technological progress' is mainly viewed as achieving higher scale economies, its actualization is dependent exogenously on more profitable investment opportunities (or, on one time subsidy (Phelps, 1970: 508), which through pecuniary external economies, would push the aggregate economy towards good outcome). Then, such technological progress is exogenous and has to be supported by higher pace of capital accumulation. It should be noted that Solow in his Nobel (prize) acceptance lecture recognized the importance of the association between pace of capital accumulation and technological progress. A particular form of the embodiment hypothesis could be that higher pace of investment leads to the realization of higher scale economies. However, if there is a possible slackening of the exogenous investment opportunities, it is more likely to be associated with periodic non-realization of scale economies-based profits i.e., the possibility of short run Keynesian problems (Solow, 1998; 2003).

In any case, even if the pace of exogenous growth of income is maintained (how so ever generated), there are also inherent problems regarding the growth of technological progress based on ever growing scale economies. There are surely limits to the expansion of a plant...

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