Declining Unit Costs as a Result of Increasing Production Volumes
An Article in the Compendium of Market-Based Social-Ecological Economics
Key issues in view of the neoliberal crisis:
How can we guarantee employment and fair income?
How can we protect the environment effectively?
How should we shape the economic globalization?
What should the economic sciences contribute?
What must be the vital tasks of economic policy?
How can we legitimize economic policy democratically?
Table of Contents
The increasing centralization and mass production of the »liberalized« global economy is justified by decreasing unit and transaction costs due to so-called economies of scale. Neoliberal advocates argue that these cost savings are absolutely necessary for productivity growth and global prosperity. However, their argument conceals the selfish striving for the highest return on investment and the advancing territorial concentration of productive capital. Furthermore, social and environmental indicators reveal that (1) the centralization of economic activities causes excessively high costs in society and environment, that (2) prosperity and welfare can only arise from decentralized, democratically implemented economic structures and decentralized responsibility, and that (3) economies of scale can only unfold sustainable beneficial effects under these structural and political conditions.
2. Economies of Scale
Enterprises can achieve economies of scale when their production volume (their output) grows. Such economies are achievable both in the production of goods – where they lead to decreasing unit costs – as well as in the provision of services where they effect reduced transaction costs. It should be noted, however, that economies of scale can be diminished or absorbed by the higher coordination effort that is required for a greater segmentation of production and division of labor.
Economies of scale emerge when, as a result of growing output, …
3. Economies of Scope
Economies of scale must be distinguished from economies of scope that can be achieved between independent productions within multi-product firms (conglomerates). In the case of scope economies cost reductions are realized by exploiting synergies (possible effects of collaboration) between similar value chains, for example by fully or partially merging previously independent departments in research and development, production, purchasing or administration. As a rule, the highest savings can be achieved by reducing redundantly staffed jobs in those departments. However, economies of scope are much more difficult to accomplish than economies of scale because possible synergies can be diminished or even prevented by incompatible business cultures.
Economies of scale as well as economies of scope are both a major incentive for and a cause of business concentrations which are brought about by mergers of companies or acquisitions of smaller companies by larger companies. Without economic regulation, for example by renouncing on antitrust laws, the incentives inevitably provoke a continuing process of concentration of economic power and economic capital – including the associated centralization of economic structures and the de-industrialization of peripheral geographic areas.
Processes of economic concentration are basically driven by the »natural« and actually economically desirable entrepreneurial pursuit of the highest return on investment. However, politically unregulated processes of concentration generate uncontrolled external costs in society and environment, costs that are neither disclosed in corporate balance sheets nor in national accounts. The actual productivities are then lower than the reported (apparent) productivities, and can even be negative. Negative productivity is, without exception, to be equated with the substantial destruction of productive factors (labor, natural resources and capital).
4. Business versus Macroeconomic Productivity
Business productivity is derived from the ratio of the expenses for labor, natural resources and physical capital (the input) required for a production to the achieved output of goods or services. The productivity grows when the output grows at constant input level or when the output remains unchanged at reduced input level. Therefore, economies of scale and scope provide gains in business productivity. However, under the present dogma of deregulation a given business productivity does not prejudge whether it equally contributes to macroeconomic (national) productivity.
Therefore, one of the greatest (and rarely mastered) challenges of economic policy is to regulate and control business processes – particularly with respect to the concentration of power and capital – such that business enterprises generate positive, socially and environmentally sustainable productivity, and that the macroeconomic aggregate of all business productivities is also positive. The widespread use of economies of scale and scope alone neither allows to draw conclusions on the actually achieved business productivities nor on the actually achieved productivities of national economies.
The first prerequisite for positive productivity is the efficient usage (the efficient allocation) of the productive factors »labor« and »natural resources«. The highest efficiency of factor allocation and the highest productivity of production processes are, in short, attained in a state of sustainable full employment and sustainable environmental protection when, at the same time, the lowest external costs are incurred.
In practical terms, this means: a positive macroeconomic productivity can only be achieved when the danger posed by social costs and inevitably caused environmental costs can be avoided or compensated by applying economic policy measures. Namely, on the one hand, by dynamically adjusting working hours and wages to productivity growth, and on the other hand, by reprocessing corrupted non-renewable resources and regenerating renewable ones. Or in other words: through measures aimed at lasting participation of all citizens able to contribute to the economic value added, including their equitable share of the economic outturn, as well as measures aimed at technical or biological recycling respectively of natural resources.
Then, and only then, does economic production contribute to sustainable optimal welfare, and only then does it not cause irrevocable intrinsic depreciation in society and environment. Thus, macroeconomic productivity has an inherent social and environmental function, and economic policy making has to lay down the rules to fulfil that function. The social aspect of this function is expressed in the dictum: The economy must serve the people, and not vice versa. Similarly, a dictum can be formulated for the ecological aspect: The human economy is dependent on nature, and not vice versa.
The apparently simple input-output calculation used for business productivity must therefore be complemented with social and environmental parameters. These parameters have to be incorporated into government regulations and taxation such that business productivities are accurately and truthfully calculated and reported in the balance sheets, that a foundation is built for the macroeconomic productivity to be calculated likewise and reported in national accounts, and that the economy can be navigated towards optimum social welfare via regulations and taxation.
Since the indicators from which the social and environmental parameters are derived are largely qualitative in nature, they need to be quantified (monetarized) before they can be entered into regulations and taxation as effective parameters. In addition, see the article Sustainable Social Welfare.
Characteristic Social Indicators:
Expressed positively: health status of the labor force, degree of equal distribution of income, income share of children, and the employment rate;
Expressed negatively: scope of work-related illnesses, degree of unequal distribution of income, child poverty rate and unemployment rate.
Characteristic Ecological Indicators:
Expressed neutrally: the availability or scarcity of non-renewable resources and their degree of reuse (technological recycling), and the condition of renewable resources such as soil, air, water, flora and fauna as well as their degree of regeneration (biological recycling).
The definition of macroeconomic productivity suggests that it can not be the responsibility of individual entrepreneurs to pursue provision for the future well-being of society as a whole. Entrepreneurs initially have no choice but to actively contribute to added value for their own benefit within the given regulatory framework. Would they stand up against a framework that is not welfare-oriented by following ethical convictions, they would inevitably endanger their own competitiveness. But regardless of their business activities, as citizens they are committed to take a stand for a welfare-oriented economic policy.
In democratic constitutional states it is the responsibility of the eligible voters (the sovereign people) to ensure – in the course of political policy-forming and decision-making – that the self-interest of entrepreneurs at the same time contributes to the common good. However, the economic development of the past thirty years shows how difficult it is for the sovereign people to fulfil their civic duty in dealing with powerful industrial players who use their financial means to indoctrinate the public. Because of this, the development has led to a doctrinal impasse of »market liberalization«. It characterizes this neoliberal condition that politicians repeatedly declare their political bankruptcy by suggesting it were the obligation of economic players, not their own, to create jobs. Thereby expressing the fact that in the course of the »market liberalization« more and more economic powers are transferred to transnationally operating oligarchies who use them to prejudice national and supranational legislation for their own benefit, namely in the World Trade Organization (WTO) but also in the EU (as a complement see the articles World Trade Organization (WTO), EU: Federal Superstate or Confederation? and Undemocratic EU Institutions).
5. The Absolutization of Economies of Scale
In the course of »liberalizing« markets the influence of nation-states and sub-national structures is increasingly repressed and superceded by supranational institutions such as the EU and WTO. With the centralization of economic policy decisions their democratic legitimacy is dwindling at the same time. Therefore, significant consequences arise for attaining positive economic productivity: As the »liberalization« of economic policy making is dictaded by private sector interests, the concerns of human labor and natural resources stumble into the dependence of productive capital that is more and more being concentrated in fewer hands. In economic terms, the efficiency of the productive factors »labor« and »natural resources« is subordinated to the efficiency of the factor »capital«, so that returns on investment, approved by a rudimentary economic policy, become the decisive criterion for entrepreneurship and economic policy.
This state of affairs is indicative of the current capitalist derailment of the neoliberal market economy. Meaning that the overall efficiency of factor allocation is negative and hence the overall productivity is negative too, because an isolated efficiency of the derivative factor capital at the expence of the originary factors work and natural resources is economically not feasible. In other words: As a derivative factor the productive capital is at the mercy of the integrity of the originary factors labor and natural resources. Whenever this principle is violated, a negative overall productivity inevitably arises, that is to say: a process of economic destruction.
The competitive and cost pressures in open global markets are »forcing« companies to implement economies of scale and scope through mergers and acquisitions, and to additionally reduce their labor and environmental costs. They achieve this primarily by passing on of cost pressures to national policy makers who consequently act as their accomplices of the systemic social and environmental dumping, that is so characteristic of the prevailing economic doctrine.
The economic productivity that intrinsically has a social and environmental function is reduced to a simple input-output accounting abstracted from social and environmental costs. This accounting method is both applied to corporate balance sheets as well as national accounts. In particular, the input to production processes is artificially reduced by implicit and explicit externalization of social and environmental costs, while the output is artificially increased through economies of scale and scope. The corresponding changes in input and output values suggest continued productivity growth on the corporate and national level.
Since externalized costs are not recorded in national accounts, the data for economic policy countermeasures are lacking. However, regardless of this, the actual state of society and environment can be determined from a number of statistics reflecting underemployment, poverty, climate change and biodiversity. On this basis it can be considered certain that economic costs currently by far exceed the profits, that the material losses in society and environment have already reached a dramatic level, and that the actual economic productivity has been negative for years.
In summary, it can be stated that under the cost-related concentration process in open global markets, accompanied by declining economic policy regulation, social and environmental dumping as well as economies of scale and scope are deployed to increase reported productivities on the basis of minimum input effort and maximum possible output of productions and, ultimately, to achieve the highest possible returns on investment. Social and environmental costs are passed on to the general public and deferred into the future and are neither considered in corporate balance sheets nor in national accounts. Thus, an impression is created of constantly growing corporate and national economic productivity, when in fact economic activity is only seemingly productive and the uncontrolled and hidden material losses in society and environment reach a dangerous level. For more details I recommend the article Excesses of Capitalism.
6. The Socio-Ecological Inclusion of Economies of Scale
Economies of scale are indispensable for productivity growth and socio-economic wellbeing also under social-ecological conditions. This general statement does, however, not apply to economies of scope; they are largely dispensable in a social-ecological market economy, which is, by its very nature, built upon decentralized structures. For economies of scale the following applies: The productivity gains achieved through them contribute to general prosperity and sustainable welfare only (1) when they are associated with social returns, which, as already mentioned, manifest themselves in reductions in overall working time and wage increases, (2) when they are free of severe environmental costs, and (3) when inevitable environmental damages are remediated in subsequent processes of technical or biological recycling.
The requirement for efficient allocation of the factors labor and natural resources initially precludes the natural entrepreneurial pursuit of maximum return on investment, maximum concentration of capital and maximum economies of scale. Due to this fact, the socio-ecological effect of economies of scale has to be achieved indirectly by a structure-building economic policy regime. Specifically, this means: Responsible economic policy is inherently linked to the obligation to limit the natural process of concentration by means of progressive taxation such that economic enterprises are regularly forced back (in a dynamic process) into subsidiary, prosperity and welfare securing structures.
This regulation results in a pyramidal structure with several levels, in which the capital intensity of productions increases from the lower to the upper levels and the labor intensity decreases accordingly. Thereby every production is, in accordance with its industry sector, located at the lowest possible technological level. The lowest level extensively comprises the large number of labor-intensive handicraft productions, retail trade and small businesses, the highest level comprises the small number of highly capital-intensive productions and services such as semiconductor production and basic research – concentrated at a small number of locations. The economic diversity constituted by subsidiary structures is, at the same time, an essential condition for decentralized responsibility and full employment as well as for broad-based innovation, qualitative growth and sustainable progress.
Economies of scale unfold a positive economic effect only when they are deployed within a socially and ecologically optimized economic structure. In other words: Economic gains from economies of scale only arise under optimal subsidiary size structures of enterprises, not under centralized structures.
The socio-ecological effect of economies of scale is furthermore secured when economic and political structures coincide in subsidiarity. Due to the congruence of structures decentralized responsibility and consistent economic policy decisions are promoted. The social gains arise from geographically distributed diversity of productions and from the resulting congruence of the labor demand of companies with the labor supply of the labor force. When productivity rises, full employment and purchasing power are maintained by reducing working hours and increasing wages. Thus, keeping economic cycles going and securing the macroeconomic equilibrium (balance). The avoidance of ecological losses results from the decentralized responsibility of economic players for resources and energy supplies, as well as from short transportation distances.
As a compliment I recommend the article Economic Subsidiarity.
The effective building of subsidiary economic structures under the conditions of the neoliberal globalization as a base for a post-neoliberal economic order is addressed in the article Building Subsidiary Economic Structures.
Click here for the German language version: Skalenerträge und Produktivität