On “Economies of Scale” and Other Magical Incantations

There’s a certain kind of economic technocrat who tosses around the term “economies of scale” like a Young Earth creationist tosses around the Second Law of Thermodynamics. This is true of legacy liberalism, obviously, which is still defined by the mid-20th century mass-production paradigm of Joseph Schumpeter, John Kenneth Galbraith and Alfred Chandler. It’s also true of most Austrian economists in the tradition of Mises, who see capital-intensiveness or “round-aboutness,” as such, as the key to productivity. A recent example of this mindset — as it relates to development economics — appears in a Foreign Policy article by Daniel Altman, an NYU economics professor (“Please Do Not Teach This Woman to Fish,” June 29). The subtitle, appropriately enough, is “Why poor countries have too many entrepreneurs and not enough factory workers.”

Altman’s target is what he regards as an over-emphasis on entrepreneurship, supported by micro-finance, as a means of economic development in the Third World. The old approach, which he yearns for, was the direct one: you increase industrial employment by building factories, you increase agricultural output by giving farmers fertilizer, and you support industrial and agricultural growth by building roads and ports to get crops to the cities and export food and industrial goods. The new approach — which he attributes to “free market” advocates — is indirect. As an example, he gives British Prime Minister Cameron’s call to promote “conditions that enable open economies and open societies to thrive: the rule of law, the absence of conflict and corruption, and the presence of property rights and strong institutions.”

Just in passing, let me say that what Altman calls “free market economics,” with its lionization of the heroic “entrepreneur,” is actually a lot closer to the neoconservative parody of free markets spouted by Jack Kemp and Newt Gingrich. Any call for “property rights” that doesn’t address the issue of justice in acquisition — the fact that the overwhelming majority of arable land, oil and mineral wealth held by native elites or global corporations is stolen property — is a mockery of genuine free market principles.

And the same is true for “strong institutions” and “rule of law,” if by that is meant simply adherence to procedure — any procedure — without regard to who controls the institutions and makes the laws, and whose interests they serve. As I said a few years back,

a country characterized by what neocons call “rule of law,” with lots and lots of Weberian rationality and professionalism, can be a far more efficient plutocracy than the Latin American kind…. …[P]lutocracy, rather than being a function of the patron’s personal relations with the death squads and generals, can be built into the rules themselves. And the more apparently “neutral” the rules and the expertise of the technocrats administering them, the more efficient the plutocracy at fleecing its victims without any unseemly bleating.

Further, for Altman to juxtapose this neoconservative pablum against the mass-production dinosaur model of our grandparents’ time, as the only available alternatives, is absolutely ludicrous.

At any rate, Altman says, this view of civil society — such as it is — dovetails with another “fad in the global development community: entrepreneurship.” And a major part of the model of entrepreneurship that assorted development aid organizations promoted was village-based small enterprise financed by micro-lending.

Altman goes on to criticize small scale economic activity — which he equates to the Kemp-Gingrich nonsense — on the basis of “economies of scale.”

How big can a business be in a rural village? There aren’t many customers there, and incomes aren’t very high either. A business would have to serve several villages to start creating jobs in any significant numbers. Now, consider rural women with families. They may be reliable repayers of loans, but they’re much less mobile than single men. Single men can move to cities, or at least cover a lot of ground in the countryside, in an effort to win new customers. By contrast, even women without children face constraints on their movements in plenty of countries. Microfinance may have given a lot of people a little, but it was never designed to give anyone a lot. Unlike the microenterprises founded in rural villages, businesses that serve lots of customers take advantage of economies of scale in production and distribution. These economies of scale are essential for economic growth. After all, which economy is more productive — one in which every single person is an entrepreneur, or one in which a minority of entrepreneurs employ the majority of people?

Cameron’s legal and economic “reforms” (strengthened “property rights” and so forth) are an excellent idea, Altman continues — but only stripped of its excessive focus on entrepreneurship. What’s really needed is a legal and institutional climate that will open up a country to large-scale outside investment.

Eliminating corruption and strengthening property rights would be a green light for some of the world’s biggest investors, both domestic and foreign. These are the kinds of players who open massive industrial parks, agribusiness facilities, and research centers. With investments in the millions and billions of dollars, they create hundreds or thousands of jobs at a stroke. Of course, these jobs won’t always go to the rural women helped by microfinance programs. Microfinance programs may be one of the best ways to help them, short of having their children take jobs in cities. Nor are these jobs necessarily the ones that fulfill the social goals in the mission statements of Western nonprofit organizations. But they are the kinds of jobs that brought hundreds of millions of Chinese out of poverty…. In these countries, the quickest way to escape poverty is likely to be via bus to the nearest city for a manufacturing job.



There you have it: an economy based on colonization by big-money foreign investors, dominated by giant, hierarchical, capital-intensive and high-overhead hierarchies, and focused on mass wage employment. Sounds just like The New Industrial State — or Brazil.

Altman’s unstated assumptions — and his stated ones backed by nothing save his own bare assertion — are far from the facts of nature he treats them as. Willow Brugh, whose critique of this article (“Teaching People to Fish,” willowbl00, Oct. 31) brought it to my attention, points to some of them. The first is that income is the main determinant of one’s subjective living conditions, rather than something that might — or might not — improve some aspects of those conditions. Things like agency and alienation — for example the lack of agency, and increased sense of alienation, involved in wage employment — are also real factors in whether life is good or bad.

Income is also very misleading as an indicator of well-being because a great deal of nominal income or GDP increase in the Third World reflects the forcible monetization of activities that were previously carried out — quite satisfactorily — in the informal, household or social economies. They were monetized only because 1) monetizing the social economy would make it more legible (in anarchist James Scott’s terms) to ruling elites, and thus easier to skim off the top, and 2) forcing producers into the money economy would compel them to accept wage employment and work as hard and cheap as the employing classes wanted (exactly as the Enclosures were designed to do in 18th century England).

Take a peasant family, successfully feeding itself from its share of arable land in an open field village, or subsisting off the common waste and common pasturage rights. If you expropriate those rights from them and instead compel them to become wage laborers to earn the money to pay for food on the cash nexus, their nominal income and the nominal GDP have both increased considerably. But are they better off?

Second is the assumption that hierarchy is inherently necessary, and that the economy is of necessity divided up into those who “provide jobs” and tell people what to do, and those who work at those jobs and do as they’re told.

I would add that Altman’s assumptions about “economies of scale,” in particular, are based on an understanding of industrial and technological history that’s been obsolete for decades (if it was ever valid).

Even at the height of the mass-production era, Ralph Borsodi observed that most of the alleged efficiencies of large-scale production were questionable if not spurious. That’s because the only real cost savings were in unit production cost, and were captured entirely at the factory itself. But those unit costs at the factory were only the first of many costs.

In the majority of cases, the cost savings at the point of production were more than offset by all the increased distribution costs downstream — most of them generated by the nature of mass production itself. Even before we leave the factory, we see enormous costs of bureaucratic overhead resulting from large scale, and from all the knowledge and incentive problems that authoritarian hierarchies give rise to. All the irrationalities of the Soviet centrally planned economy can be found, to some degree, in the large corporation.

But most of the increased costs result from the fact that, to achieve those “efficiencies” of unit cost of production within the factory, it’s necessary to use extremely large, expensive and specialized machinery, and then keep it running to amortize those enormous capital outlays over as many units as possible. This means that, to minimize unit production costs, production must be undertaken without regard to preexisting demand. Which means, in turn, that a very costly and inefficient distribution system must be created to guarantee that product will be consumed one way or the other. First off all, the increased scale of production requires a larger distribution area, a longer distribution chain, and greater shipping costs that offset much of the production cost savings. In addition, because the divorce of production from demand requires a batch-and-queue distribution system, there are enormous warehousing costs. And for the same reason, enormous investments must be put into high-pressure advertising, canvassing and the like.

Don’t forget, also, industrial “dumping” of surplus product overseas that can’t be sold at the cartel price, and the large military establishments and wars required to open up foreign markets to overproduced goods.

All these costs of bloated bureaucratic overhead, inventory, distribution and promotion, taken together, are usually more than enough to offset the savings from those “efficient” factories with their productive “economies of scale.”

When the offsetting distribution costs were taken into account, Borsodi said, many kinds of home production were more efficient on the whole than factory production. This was true of the total costs of growing and canning one’s own tomatoes, for instance, compared to the price of tomatoes grown on big mechanized farms and processed in canneries. Likewise, when all the costs of distribution and marketing were taken into account, an electric kitchen mill was far cheaper as a source of flour than the giant mills in Minneapolis. Not to mention, in the latter case, that the freshly ground flour contained wheat germ, whereas the shelf-life requirements of a batch-and-queue distribution system resulted in mummified, denatured flour designed for storage and transport rather than consumption. In both cases, home production was cheaper, despite the higher unit cost of the production machinery itself, because — when something was consumed at the point of production — production cost was the final cost.

But the same was true of manufacturing to a considerable extent. As Borsodi pointed out, the development of electrically powered machinery had removed much of the need for large factories. The large factory, in the age of steam and water power, had resulted from the need to conserve on power from prime movers. Because there were genuine economies of scale in steam engines, it made sense to build an entire factory around a large steam engine and then run as many machines as possible off drive shafts running from that engine. But the electric motor made it possible to build a prime mover into each separate machine, site the machine as close as feasible to the point of consumption, scale production flow to preexisting demand, and scale the machine to production flow. In other words what we today call lean, demand-pull or just-in-time.

Indeed Pyotr Kropotkin, in Fields, Factories and Workshops (available in a C4SS pdf edition, with introduction by yours truly) envisioned a future distributed economy of village manufacturing in artisan shops using electrically powered general-purpose tools. But instead of the Kropotkinian economy of agro-industrial villages we got the industrial Moloch of the 20th century — not because it was more efficient, but because the state intervened with subsidies and restraints on competition to make it artificially profitable. It’s too long to go into here, but I discuss it at length in Chapter Two of my book The Homebrew Industrial Revolution (available online here) if you want to know more.

But Galbraith’s “Industrial State,” all the state’s tipping of the scale notwithstanding, only delayed the triumph of more efficient Kropotkinian industry. The main direction of production technology these days is towards cheap, small-scale tools of an efficiency Kropotkin or Borsodi could never have imagined in their wildest dreams. A garage-size shop with $10,000 or $20,000 worth of open-source tabletop CNC machinery — cutting table, router, 3-D printer, smelting furnace, etc. — can produce most of the things a large-factory can, but on a scale geared toward the needs of a village economy. And it can do it in a local economy of worker-owned, self-managed shops. And it can do so without — unlike the technocratic Washington Consensus model Altman is so enamored of — the enormous distribution and marketing costs of a corporation, the monopoly price markups of a global corporation, the need for workers to leave their village, live in barracks and sell their souls to company management, or the requirement that the country’s economy become a neo-colonial outpost of global corporate Empire.

All the evils of the Dark Satanic Mill — the factory system and the wage system — resulted from a technological shift from individually affordable, general-purpose artisan tools to expensive specialized machinery that only the very rich could afford to buy, and hire laborers to work for them. The technological shift today is back in the opposite direction — toward cheap, high-tech artisan tools for local economies — and in the process it’s destroying the material basis for the factory system and wage system. The general-purpose computer, as an artisan tool, already bids fair to destroy corporate control of all forms of information production and replace it with peer production. The open-source hardware and micro-manufacturing revolution will do to corporate manufacturing what the computer and file-sharing have already begun doing to the music, publishing and software industries.

Although Altman’s model of development is especially horrific, both models he discusses — his industrial Moloch and the neoconservative vision of little “entrepreneurs” hustling in a cash nexus economy — are pretty bad. The fact that multilateral aid institutions and national foreign aid programs all promote some mixture of those two models just shows how irrelevant — or directly hostile — they are to the kind of genuine development that will actually enhance the lives of ordinary people. Fortunately, by the very nature of the technologies involved, the big-money finance of government foreign aid and corporate investment are becoming less and less necessary. The Kropotkinian successor economy of artisan shop manufacturing, village horticulture and commons-based peer production is ephemeral and low-overhead.

The old world of Daniel Altman, and all the corporate-state institutions and mindsets he represents, is dying. In the words of Bob Dylan, please get out of the new world if you can’t lend a hand.