Profits of capital and business power

Book 6, Chapter 7

§1. “Business power” relies on capital (prior chapter), managerial talent, and an organization that combines inputs into outputs. In cases of “beating the trodden path,” the returns to talent will be proportional to their social value but not so for innovators, as they will rarely be able to capture the entire value of good ideas that diffuse to competitors nor share the risks of failures. Economists to this day are interested in this problem of public goods and/or positive externalities (Paul Romer won the 2018 Nobel for his work on “endogenous innovation”).

§2. The ratio of supervisors to “floor” employees will depend on their wages as well as their contribution to overall productivity. A supervisor who boosts employee productivity should be paid in proportion to that gain. One who does not should perhaps be replaced by workers.

§3. The owner’s role depends on their ability to manage, since they need to create enough value to pay the cost of supervising others rather than being directly productive. If they lack such skills, then they should not grow the firm, because that’s not profitable.

§4. Larger firms might have access to cheaper inputs and capital but smaller firms have fewer managers to pay.

§5. New entrepreneurs are often willing to work harder, for lower rewards, than incumbents. In fast-moving industries, these newcomers can succeed, but they will have a hard time when turnover is slow, much capital is needed, and incumbents with cheaper capital prefer the profits of work over the price they’d receive by selling out.

§6. Joint-stock [publicly traded] companies have elaborate (costly) relations among managers, shareholders and directors but they can dominate in businesses where professional management, heavy capital requirements and slow change are more useful than nimbleness.

§7. There is no “correct” mix of large and small companies, old or new, since success can flow from different mixes of inputs. The business “ecosystem” (not Marshall’s term) will therefore be evolving and complex like a natural ecosystem, as profits and opportunities are revealed, exploited and lost. For most participants, it’s hard to see the whole, let alone understand their relative position, besides ongoing existence.

This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

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