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Dr. Harry Hillman Chartrand, PhD

Cultural Economist & Publisher

Compiler Press

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h.h.chartrand@compilerpress.ca

215 Lake Crescent

Saskatoon, Saskatchewan

Canada, S7H 3A1
 

Curriculum Vitae

 

Launched  1998

 

 

Introduction to Industrial Organization

MBA 7003

4.0 Performance

4.0 Performance

4.1 Allocative Efficiency & Profitability

Perfect Competition

Monopolistic Competition

Monopoly/Monopsony

Oligopoly/Oligopsony

4.2 Competitiveness/Fitness/Sustainability

4.3 Conservation, Present Value & the Precautionary Principle    

4.4 Equity, Ethics & Moral Sentiments

4.5 Externalities & Public Goods

4.6 National Innovation System

Some argue that Basic Conditions lead to Structure; Structure leads to Conduct; and, Conduct leads to Performance. Others, however, including Joe Bain, argue that Structure leads to Performance. In either case the question remains: How well does an industry perform – internally and externally?

Internal Performance is reflected by, among other things, how efficiently an industry utilizes its resources, accounts for its opportunity costs and benefits and the profit that it earns. External Performance is reflected by, among other things, the external costs and benefits an industry generates in the natural environment or biosphere and in society. This last point is critical. Performance accounts not just for costs and benefits internal but also external to the industry such as environmental impact and economic equity.  Put another way: the economy is a means to satisfy human ends; it is not an end in and of itself.

 

4.1 Allocative Efficiency & Profitability

Allocative efficiency implies all factors of production and all commodities demanded by consumers are in their best use and receive their opportunity cost.  Further, it is assumed that there are no external cost or benefits, i.e. all external costs and benefits have been ‘internalized’.  Three conditions must hold:

(i) Consumer Efficiency:  when consumer cannot increase utility by reallocating budget;

(ii) Producer Efficiency: when firm cannot reduce cost by shifting input mix; 

(iii) Exchange Efficiency: when all gains from trade have been exhausted.  Gains from trade to consumer is called consumer surplus which measures difference between what consumer are willing to pay and what they actually pay for a total quantity of a good or service at market price.  Gains from trade to producers are called producer surplus which measures the difference between what producer are willing to accept and what they actually receive for providing a market equilibrium level of supply (P&B 4th Ed. Fig. 12.12; 5th Ed. Fig. 11.12; 7th Ed Fig. 12.12; R&L 13th Ed not displayed).  

I will now examine allocative efficiency and profitability of the four forms of market competition.

Perfect Competition

To determine profit-maximizing output of a firm under perfect competition, one can use two methods:

(i)             total revenue less total cost; and,

(ii)            marginal analysis.

(i) Total Revenue less Total Cost

Profit equals TR – TC.   By plotting TR and TC curves one can see the changing relationship: initially there is a section of economic loss followed by economic profit followed by economic loss with two points of ‘normal’ profit points (P&B 4th Ed. Fig. 12.2; 5th Ed Fig. 11.2; 7th Ed Fig. 12.2; R&L 13th Ed Fig. 9-4i).

(ii) Marginal Analysis

Marginal revenue (MR) can be compared with average cost (AC). To maximize profit a firm must sell at MR = P = MC.   But if MR > AC producing an additional unit output will add more revenue than cost, i.e. economic profit earned in the SR.  If MR = AC then ‘normal profit’ is earned, i.e. all factors of production paid their opportunity cost value.  If MR < AC producing another unit with result in a loss (P&B 4th Ed. Fig. 12.3; 5th Ed. Fig. 11.3; P&B 7th Ed Fig. 12.3; R&L 13th Ed Fig. 9-4ii).  Three possible outcomes are possible for the firm in the short-run: normal profit, economic profit or economic loss (P&B 4th Ed. Fig. 12.4; 5th Ed. Fig. 11.4; 7th Ed Fig. 12.8; R&L 13th Ed Fig. 9-8).

In short-run firm will continue producing if at least all variable costs are covered even if the firm suffers a loss because it is not covering all of its fixed costs.  If all variable cost cannot be covered, the firm will shutdown (P&B 4th Ed. Fig. 12.5; 5th Ed. Fig. 11.5; 7th Ed Fig. 12.4).  In the LR, firms suffering short-run losses either adjust their scale of production (assuming economies of scale are available) or they exit the industry.  Exit reduces supply (shifts SC to left) and raises price (R&L 13th Ed Fig. 9-10).  The LRAC curve is the envelop of minimum points of sequence of SRACs reflecting scale increases.

If some firms enjoy SR economic profits, new firms will enter increasing supply (shifting SC to right) and reducing price (P&B 4th Ed. Fig. 12.8; 5th Ed. Fig. 11.8; 7th Ed Fig. 12.9; R&L 13th Ed Fig. 9-9).   

In the long-run, firms can adjust the size of their plants creating a series of short-run average and marginal cost curves.  The long-run average cost curve is made up of an envelope of the minimum points of the short-run average cost curves where SR average cost equals SR marginal cost.  At some point the most efficient plant size is achieved where LR average cost is lowest for a particular short-run situation.  At this size the short-run marginal cost curves, in effect, becomes, the long-run marginal cost curve (P&B 4th Ed. Fig. 12.9; 5th Ed. 11.9; 7th Ed not displayed; R&L 13th Ed Fig. 9-12).

Monopolistic Competition

Given that each firm’s product is slightly different it faces a negatively sloped demand curve or rather a ‘market niche’.  In effect, the industry demand curve is disaggregated into market segments.  The position of the demand curve depends, however, on the price of other firm’s output.  Thus an increase in the prices of rivals will shift the firm’s demand curve up to the right; a decrease would cause a shift to the left.  In the short-run equilibrium will be reached where marginal cost equals marginal revenue, i.e. profit maximizing.  In the long-run, however, firms are able to change the scale of product and enter or leave the industry.  Therefore long-run equilibrium is reached where long-run average cost is tangent to the demand curve and where marginal cost is equal to marginal revenue, i.e., firms are maximizing profits.  But because price is equal to average cost, economic profits are zero.  At this point there is no incentive to entry and equilibrium is established (P&B 4th Ed. Fig. 14.2; 5th Ed. Fig. 13.2; 7th Ed Fig. 14.1 & Fig. 14.3; R&L 13th Ed Fig. 11-2).

Monopoly/Monopsony

The monopolist faces the same demand curve as the industry.  As in perfect competition, the market demand curve is constructed from the horizontal summation of individual consumer demand curves and is usually negatively sloped, i.e. if price goes up, demand goes down.  In perfect competition, however, if the market price (over which the perfect competitor has no control facing a horizontal demand curve) goes up the quantity supplied by firms will increase.  In monopoly, however, an increase in price will cause a decrease in the quantity supplied by the monopolist.  Thus unlike the perfect competitor, a monopolist can choose which price to charge and thereby what quantity will be demanded.  The monopolist can thereby charge a price that supplies a quantity that maximizes profits but cannot adjust both independently.  This can be seen by reference to marginal revenue in perfect competition and monopoly: if

·    R = pq

·    MR = dR/dq

·    in perfect competition, the firm is a price taker at a given market price facing a horizontal demand curve and therefore MR = p

·    in monopoly facing a negatively sloping demand curve, the firm is a price setter and MR does not = p because an additional unit of q can only be sold at a lower price (P&B 4th Ed Fig. 13.2; 5th Ed Fig. 12.2; 7th Ed Fig. 13.2; R&L 13th Ed Fig. 10-1)

(i) Short-Run Equilibrium

If free from outside interference a monopolist will choose the price/quantity relationship where the difference between total revenue and total cost is at a maximum, i.e. maximum profits.  In perfect competition, the maximizing firm will equate price to marginal cost to maximize profit and the supply curve is derived from these points.  Under monopoly, maximum profit is obtained when output is at the point where marginal revenue equals marginal cost.  Thus at any output where marginal revenue exceeds marginal cost, total or accumulated profits can be increased by more output.  When marginal cost exceeds marginal revenue, accumulated profits decline and can only be increased by reducing output (P&B 4th Ed. Fig. 13.4; 5th Ed Fig. 12.4; 7th Ed Fig. 13.4; R&L 13th Ed Fig. 10.2).

In perfect competition a unique relationship exists between the price and the output supplied.  In monopoly there is not a unique relationship.  This is because variation in marginal revenue of the monopolist caused by a shift in demand can result in a different output level but at the same price.

(ii) Long-Run Equilibrium

In perfect competition there can be no long-run economic profits or losses because firms will enter or leave the market.  In monopoly, there are no long-run competitors unless the industry ceases to be a monopoly - by definition.  Thus long-run equilibrium in a monopoly will be characterized by economic profits.  If, on the other hand, a monopoly experiences short-run losses it will adjust the scale and characteristic of its plant to eliminate such losses in the long-run.  If this is not possible the monopolist will leave the industry.

Assuming short-run profits, in the long-run the monopolist will adjust its plant to achieve even larger profits.  Output will be provided at the level at which long-run marginal cost equals long-run marginal revenue.  

The most profitable form of monopoly is the price discriminating monopolist who, in effect, is able to disaggregate the market demand curve into individual consumer demand curves and charge each consumer a price that maximizes profit on each sale (P&B 7th Ed Fig. 13.9; R&L 13th Ed Fig. 10-6). Classic example is the town doctor who charges the farmer a chicken or sheep for a broken leg but charges the town banker a much higher price for the same service

Oligopoly/Oligopsony

In perfect competition and monopoly there exists a determinant solution to a firm’s price and output decision-making.  When there are only a few sellers, however, each firm recognizes that its best choice depends on choices made by rivals.  There are dozens of alternative oligopoly pricing theories and some economists claim there is no determinant solution.  In an oligopolistic market there is usually price stability because of the interdependence of sellers.  Interdependence results in ‘game playing’ behavior whereby suppliers act like players in a game acting and reacting to the moves of their competitors.  Competition tends to take place on a secondary level of: product differentiation; technological innovation; and, diversification, i.e. producing more than one commodity.  In theory, oligopoly is considered inefficient because price is higher and quantity lower than under perfect competition. 

(i) Cournot Solution 

The Cournot Solution proposes that firms choose an output that will maximize profits assuming the output of rivals is fixed.  The solution concludes that there is a determinant and stable price-quantity equilibrium that varies according to the number of sellers.  In effect each firm makes assumptions about its rival’s output that are tested in the market.  Adjustment or reaction follows reaction until each firm successfully guesses the correct output of its rivals.

A much more sophisticated and complex solution known as the ‘Nash-Cournot’ equilibrium was proposed by John Forbes Nash, the protagonist of the movie ‘A Beautiful Mind’.

(ii)) Sweezy Kinked Demand Curve Solution

The Sweezy solution postulates that oligopolists face two subjectively determined demand curves that assume:

· rivals will maintain their prices; and, 

· rivals will exactly match any price change. 

A key assumption is that rivals will choose the alternative least favorably to the initiator. If initiator raises p, rivals will not follow; if lowers price everyone follows. The result is p will be relative rigid in the face of moderate changes in cost or demand (P&B 4th Ed. Fig. 14.6; 5th Ed. Fig. 13.6; 7th Ed Fig. 15.2; R&L 13th Ed not displayed).

Perfect Competition vs. Imperfect Competition

First, under perfect competition, each firm operates at the point where long-run and short-run average costs are at a minimum.  Under all forms of imperfect competition, however, the firm will operate at minimum average cost but not at its long-run minimum.

Second, under perfect competition output tends to larger and price lower (P = MC) than under imperfect competition (MR = MC).  This results in the ‘dead weight loss’ of imperfect competition which reflects the fact that the consumer surplus is reduced but the gain to the firm is less than the loss to consumers (P&B 4th Ed. Fig.’s 13.5 & 13.6; 5th Ed. Fig.’s 12.5 & 12.6; 7th Ed Fig. 13.5 & Fig 13.6; R&L 13th Ed Fig. 10-3).  

4.2 Competitiveness/Fitness/Sustainability

There is no doubt that competitiveness results from the division and specialization of labour in a larger market.  But competitiveness as comparative advantage has its limits.  In sports, the preferred metaphor used in discussing competitiveness, it is the opposing team that is the challenge.  The playing field, the environment itself, is generally fixed, invariant and subsidiary to the consciousness of players at play. In biology, however, natural selection involves not just an opponent but also an ever changing environment or ‘fitness landscape’.

Given an active environment, autonomous agents, organisms or institutions, constantly adapt, adjust and evolve or go extinct.  They adapt by experimenting with mutations called preadaptations or exaptations.  According to Kauffman, these come from the adjacent possible - the realm where possibilities one step away from being realized reside.  Creativity, inventiveness and imagination are required to see them and courage and confidence to grasp them.

New products and processes generated by R&D in the Natural & Engineering Sciences; new methods emerging from the Humanities & Social Sciences including management sciences; and, new aesthetics, forms and designs thrown up by the Arts, this is creative destruction.  Biological systems expand or explore the adjacent possible filling all possible niches as quickly as possible subject to timely selection of the fit and unfit, e.g., going out of business.  Such timely selection is called ‘early visibility’ and ‘fast failing’ in the innovation literature.

If selection takes too long, then fitness may decline or simply melt away. Arguably, this explains ‘de-industrialization’ of Anglosphere Nation-States. They maintained existing plant and equipment, e.g., in steel production, until fully depreciated through voluntary (and sometimes involuntary) quotas on imports from developing Asian producers who invested in the best new technologies emerging from the adjacent possible. The fitness of the West fell, at least in terms of the traditional manufacturing-based economy. A balance must be struck between fitness defined as the ability to adapt to a changing environment and competitiveness defined as optimal adaptation to the current environment.  This balance includes conserving and preserving the best of the Past.  More dramatically it means maintaining some minimum domestic capacity in case of interruption to international trade, e.g., caused by a deadly world flu pandemic.  For 3 to 6 months international shipping may stop.  Competitiveness means being the best in the current environment.  Fitness means surviving environmental change. Sustainability means staying fit through time.

‘Sustainability’ is a term with many meanings to many people.  It can mean sustaining our current life style and/or standard of living into the future.  This is analogous to the long-run outcome of perfect competition in economics - the steady state.  It is an equilibrium end state.  It can mean curtailing our current standard of living to ensure future generations have resources available to sustain their needs into their future.   It can mean curtailing our current standards in order to sustain the remaining ‘natural’ environment and other species.  Such curtailment, to be effective, would, however, require what futurists of the 1970 called ‘the spontaneous dawning of awareness’ by virtually the entire human population.  It can also, as suggested in the Bruntland Report, simply mean meeting the needs of the present without compromising the future.  This last definition sounds like Bain’s definition of economic conservation - wise use (See 4.3 Conservation & Present Value).

 

4.3 Conservation, Present Value & the Precautionary Principle

As benefits and costs extend out into the future they become ever more uncertain. One calculates their current worth – their present value - using a discount rate. The higher the rate, the lower the present value of future benefits or costs. Determining the appropriate discount rate is critical to properly valuing future costs and benefits.  There is, however, also plain ignorance (lack of knowledge) concerning many future values as explain by Keynes.

With respect to public intervention or production of public goods there is, however, an added dimension to present value – politics. While future benefits or costs may be significant they are politically discounted to maximize election and re-election of politicians and governments. Three examples demonstrate. First, with an aging electorate politicians are more concerned with present older voters than with future generations. Quite simply future generations are not politically relevant unless the current generation says so at the ballot box.

Second, there is the political ‘edifice complex’. A new $100 million bridge or building bearing a politician’s name is much more valuable politically than an annual $20,000 paint job required to preserve and maintain an existing structure for 100 years. Arguably the much reported deterioration of public infrastructure in the United States and Canada reflects this political discount rate.

Third, no matter political intentions about the future the reality is we simply cannot know for certain what future generations will want, need or desire from us today. This is especially important when considering questions of sustainability. The concept of sustainability is roughly analogous to the economic concept of a ‘steady state’ where the existing pattern of economic activity continues through time. In the view of some economists resources are highly substitutable or fungible. Technological change will, in this view, provide a substitute for any resource that is depleted through current use. Whether or not it is appropriate to preserve a current resource for future generations thus becomes a question of substitutability.

A related question is preservation (non-use) versus conservation (wise use) of a natural resource. Economist Joe Bain in his classic Industrial Organization lays out the question:

For any of a group of industries whose operations involve extraction of natural resources (mining, petroleum production, agricultural cultivation, lumbering, commercial fisheries) a significant dimension of the market performance of the firms engaged involves how well they do in the matter of “conservation” of resources. To paraphrase the popular literature on this matter, conservation in an economic sense of course does not mean non-use or simple deferment of use, but “wise use” of the resources being exploited. In technical terms, good conservation requires a choice of technique of exploitation, time pattern of production, and time pattern of investments and other costs, which together yield an optimal net social benefit relative to costs over all future time periods in which society is interested. In determining this optimum, distant future benefits and costs should be appropriately discounted by whatever rate of “time preference” society wishes to assign in assessing the relative importance of current as opposed to future benefits and sacrifices. And conservation performance is poor to the extent that enterprises deviate from this abstract ideal.

An adequate operational definition of ideal conservation performance is extremely complex and next to impossible to apply fully in the evaluation of actual performance. Using the definition just given as a guide, however, it is possible to identify certain types of gross departure from good conservation which would have to be censured under any acceptable criterion. These include:

1. Exploitation of resources by a technique that raises both present and future costs above the obtainable minimum while reducing or not increasing the amount of resources ultimately recovered, or the amount of use obtained from resources over time.

2. Unduly rapid or intensive current use of resources which has the result of impairing (or eliminating) future use of the resources to a degree not compensated by current additions to output.

3. Pinching on current costs or investments in the use and development of resources in a way that curtails future use or raises future costs of use to a disproportionate degree.

What of the actual performance of industries in regard to conservation? Of course, only a minor proportion of all industries are sufficiently involved in extraction to make conservation an issue, and for these we do not have highly organized, systematic information on which to base an overall appraisal. However, a broad scattering of evidence on individual cases suggests that, among extractive industries, conservation performance is or has very frequently been poor.

Thus we observe in petroleum production in the United States a history of gross elevation of recovery costs coupled with a substantial reduction of ultimate recovery of available petroleum, attributable largely to the selection of techniques in the context of competitive exploitation of individual oil pools by antagonistic interests. In both lumbering and commercial fisheries, and in some agriculture, we find that a serious long-run depletion of resource productivity has resulted from overintensive immediate rates of extraction or exploitation of the available resources. In much of agriculture, a history of pinching on current costs for or investments in the preservation of the land (against erosion or reduction in fertility) has resulted in long-run losses in soil productivity.

These deviations from reasonably good conservation performance seem in large part attributable to four things: (1) antagonistic exploitation of resource deposits by competing interests, in which a competitive race to capture the resource or its output before others do results in a disregard of long-run yield considerations; (2) an inherent “short-sightedness” of firms engaged in exploiting resources - firms that attach much less importance to distant future production than society would, or than they do to immediate profits; (3) competitive conditions which bring about such low returns to firms in some extractive industries that they cannot afford to invest in the long-run maintenance of resource yields; and (4) stupidity. Whatever the cause, poor market performance in the matter of conservation has evidently been chargeable against firms in many extractive industries. It is encouraging, in the light of this, that in the past twenty or thirty years there has been a rapidly increasing body of governmental regulations designed to encourage or require better conservation performance on the part of these industries.

Bain 1968, 425-427

Cost-benefit analysis involves calculation of the probability and magnitude of costs and benefits associated with a new technology, public intervention in the market place or production of public goods and services.  If probable benefits outweigh probable costs it is approved; if not it is rejected.

Applying the ‘precautionary principle’, however, means that if a new initiative has any chance of generating irreversible harm, no matter its short-term benefits, it is rejected in spite of any positive cost-benefit ratio.  In fact, the precautionary principle is both an economic and moral criterion.  It invokes a social responsibility to protect the public from harm if scientific investigation finds a plausible risk.  In the Rio Convention and in the European Union, the precautionary principle has been made into a statutory requirement. Its application is most apparent with respect to genetically modified foods. In the Anglosphere cost-benefit analysis has consistently found them to be a good investment. In most cases natural and genetically modified crops and animals are treated as equally safe. In the European Union, however, the remote possibility of irreversible harm to human health or the environment has led to significant restrictions on the use of genetically modified foods including labeling of all products.  Some observers argue that this ‘plant protection racket’ is fuelled by a Veblen Effect, named after economist Thorstein Veblen who introduced the concept of ‘conspicuous consumption’.  Please see: my Environmental, Natural Resource & Ecological Economics - non-testable.

 

4.4 Externalities & Public Goods

Until now we have assumed that market price includes or ‘internalizes’ all relevant costs and benefits. This means the consumer captures all benefits and the producer pays all the costs. An externality refers to costs and benefits that are not captured by market price for whatever reasons, i.e., they are external to market price.

In effect, the market demand curve reflects only marginal private benefits (MPB) (R&L 13th 16-1) of consumers but not the external benefits accruing to society. When such external benefits are added, vertically, we derive the marginal social benefit curve (MSB) inclusive of both private and public benefits.

Similarly, the market supply curve reflects only marginal private costs (MPC) but not costs external to the firm’s accounting, e.g., pollution that society must pay. When social costs are added, vertically, to the supply curve we derive the marginal social cost (MSC) curve inclusive of both private and public costs.

The standard model of market economics is thus based on the assumption that all relevant costs and benefits are internalized in market price, i.e., there are no externalities. If this assumption holds then ‘X’ marks the spot. If, however, there are externalities then market equilibrium must be adjusted (R&L 17-1, 17-2, 17-3, 17-4, 17-5, 17-6, 17-7). External or social costs and benefits must be added to private costs and benefits reflected in the market supply and/or demand curves. The point is that such external costs must be paid and external benefits accounted for if the appropriate price/quantity equilibrium is to be established. The agency to do so is not the market but rather government. Put another way, the market ‘X’ solution is superseded by a social ‘X” marking the spot and it is up to government to correct the miscalculation of private agents to generate a new socially optimal equilibrium. This is a controversial view. It is expressed in the tradition of both welfare economics (a sub-discipline) and the Keynesian view.

On the other side are those arguably including the Austrian school of economics - von Hayek and von Mises being leading protagonists - who argue: Let the market do it! If consumers are willing to pay then providers will be willing to supply. If a sufficient number are not willing to pay, for example, because of the ‘free rider’ problem associated with public goods, to make it profitable to suppliers then there will be no provision, no market and people will get what they paid for.

Excludability and rivalrousness distinguish private from public goods.  If I buy a car I can exclude others from using it by lock and key.  I alone extract its utility.  Similarly, if I am driving no one else can, i.e., driving is rivalrous. Public goods, on the other hand, are non-rivalrous in consumption, i.e. my consumption does not reduce the amount available to you. If I watch a fireworks display it does not reduce the amount available to you. Similarly, public goods are non-excludable, i.e. a user cannot be easily prevented from consuming a public good. This creates the ‘free-rider’ problem. Extending the fireworks example, while not willing to pay to enter the stadium I can still watch the display from the balcony of my apartment at no charge.

Allowing for externalities (discussed above) there is in fact a spectrum of goods ranging from pure private to pure public in nature. The more public a good the less likely it is that private producers will be willing to supply a socially optimal output and the more likely that only government will be willing to do so, e.g., national defense, the Census or inoculation against infectious diseases.

The response of the government to problems presented by public goods varies according to the nature of the good. Non-market benefits and costs may be considered sufficiently important to justify public action. In the case of benefits, such goods are called “merit goods”. In the case of costs, they are called “demerit” goods. There are thus times and situations in which a democratic government decides that the free market is not producing socially or politically acceptable outcomes and chooses to override the marketplace.

 The modern environmental movement was born with publication of Silent Spring by Rachel Carson in 1962.   The 1960s & 1970s were a pre-revolutionary period characterized by radical new ideas on campus and a general stirring up of society’s status quo.  A materially satisfied and educated middle class, specifically its younger generation, awoke to a new spectrum of needs. 

It appeared to some that material success was paid for with environmental degradation plus international, racial and gender inequity.  Cities burned; riots and protests plagued campus; presidents fell; civil, environmental and gender rights became slogans of mass movements.  And into the headlines were propelled pacifism, a.k.a., hippies, Woodstock and the anti-war/anti-draft movement, as well as extremist groups, e.g., the Yippies, Weathermen, Black Panthers, et al.

It was in this context that economics met ecology with publication in 1967 and 1968 (the year of the Democratic Convention in Chicago and the down fall of President Johnson together with his dream of a ‘Great Society’) of two very different yet related texts.

In December 1968, Garrett Hardin, a biologist, published “The Tragedy of the Commons”.  The article was based on his presidential address to the Pacific Division of the American Association for the Advancement of Science in June 1968.  Hardin demonstrated that unfettered competition for natural resources within and between countries was destroying the natural commons, a.k.a., the environment or biosphere including the air, water, land and biodiversity living therein.  Given such resources belong to everyone yet to no one, i.e., they are ‘public goods’, competitive self-interest dictates getting for oneself as much as possible as quickly as possible with no consideration for others – past, present or future.  This is “The Tragedy of the Commons”.   Unfortunately, a variation on this theme also plagued Second World or communist command economies resulting in even greater environmental damage, debilitation and destruction.

If a public good belongs to everyone but to no one then one way to solve the problem is to assign ownership to someone.  That someone will then have a vested interest to ‘conserve’ the resource.  This is the approach taken in the Conventions on the Law of the Seas and on Biodiversity (CBD) and the Kyoto Accord.  In the case of the Law of the Seas and CBD ownership is vested in the Nation-State.  In the case of Kyoto it is similarly vested in the Nation-State but some have transferred ownership to private agents – both natural and legal persons, e.g., using carbon auctions and even personal carbon credits

Public Goods, ;'Common' Natural Resources, Knowledge-Based Industries

4.5 Equity, Ethics & Moral Sentiments

With respect to Equity in Law we have seen it is justifies market interventions by government, e.g., agriculture, minimum wage and rent control.  Arguably it also applies in cases of market failure where consumer surplus is appropriated by producers.  In the Standard Model of Market Economics such intervention to approximate the outcome under perfect competition is also accepted.

With respect to Ethics #8 of the Ten Humorous Reasons for studying economics reads: Although ethics teaches that virtue is its own reward, in economics we get taught that reward is its own virtue JokEc In the Benthamite tradition, however, maximizing pleasure was restrained by the tenets of Ethical Hedonism, a very Protestant Ethic.  This ethic, beyond concern with the moral value of work, also involved social inhibitions against conspicuous consumption (Veblen 1899).  Such ethical or moral restrictions were reinforced by the lingering effects of feudal sumptuary legislation which made “status forgeries illegal and created the disincentive of trial and punishment” (McCracken 1988: 33).  However when the Protestant ethic collapsed during the Industrial Revolution, only hedonism remained -- in all its unrestrained, irrational incarnations (Bell 1976: 20-22).  Without a generally accepted moral code, the law became the accepted social institution to moderate individual pleasure-seeking.  Benthamite traditions concerning crime and punishment in fact continue to guide both the law and economic research, e.g. Bentham's famous and seemingly plausible dictum `the more deficient in certainty a punishment is, the severer it should be' (Becker 1968).

While self-interest or ‘Me-ism’ lays at the heart of the Standard Model Economics itself  is in fact qualified by moral considerations.  Thus while Adam Smith is remembered as the founder of modern economics with the 1776 publication of his Inquiry into the Wealth of Nations some 17 years earlier in 1759 he published The Theory of Moral Sentiments (1759) providing the ethical, philosophical, psychological, and methodological underpinnings to all his later works.  Today such concerns are summed up in expressions such as ‘market sentiments’.  Such sentiments include, among other things, trust.  Overtime buyers and sellers, producers and suppliers, employers and employees develop trust reducing what are called transactions costs.  Without such trust every exchange must be carefully and expensively scrutinized to insure all terms of a contract are fulfilled by both parties.  In times of severe recession, such as now, relations tend to break down with producers and/or their suppliers going out of business, employees laid off, etc.  Like a rug or woven sweater relations unravel and if this last long enough new supplier or new employees must be engaged who, at the beginning of the relationship, are subject to uncertainty and a lack of trust raising transaction costs.

The Benthamite tradition also places limits on what phenomena are considered legitimate subjects of economic investigation.  It continues to blind mainstream economists to the cultural context of economic behaviour.  Daniel Bell, quoting the author of the most widely read economics textbook in history observed:

Paul Samuelson has noted that many economists would “separate economics from sociology on the basis of rational or irrational behavior, where these terms are defined in the penumbra of utility theory.”   Utility is defined as egoism, or self-interest, and rationality is defined as consistency - that is, preferences are transitive ....

Yet the crucial question is whether the obverse of the rational is the irrational rather than the non-rational, and whether or not non-rational motivations can provide a valid assumption for an understanding of economic behaviour, i.e. to behavior which seeks to enhance the wealth and welfare of mankind (Bell 1981: 70-72).

Put another way, can non-rational motivations provide the foundation of an inclusive or catholic economics to balance the materialistic, protestant, exclusionary rationality of contemporary economics?  In this regard, Tibor Scitovsky (1972, 1976, 1989) has gone further than anyone in re-tooling economics to account for `irrational' behaviour, e.g. cultural activities including the arts.  Where Bentham used the associationist psychology of his, day to define pleasure and pain as the ultimate principles of behaviour, Scitovsky, after investigating contemporary clinical psychology, substitutes `comfort and stimulus'.  Among other things he uses this distinction to differentiate consumption in the United States (comfort) from what is now the European Union (stimulus).  His model, however, still uses marginal utility (Scitovsky 1989).  His work is in the tradition of welfare economics

From a welfare economist's perspective, there are two types of social behavior.  The first are onerous activities not performed for inherent satisfaction but for what they yield, i.e. work.  Thus the disutility of work is theoretically to be compensated by a pay check.  Second, there are activities that are the opposite of work.  They give satisfaction to those performing them.  In turn there are two types of such activities.  The first are antisocial activities that give pleasure by inflicting pain or suffering on others.  Social costs usually outweigh benefits because benefits are transitory while suffering is often long lasting or permanent.  Third, there are 'social' activities that impose no physical burden or harm on anyone yet can give satisfaction or pleasure to all.  They include the most benign and valuable of human activities such as love, learning and the Arts (Scitovsky 1989).

Yet another attempt to grasp the ethical and moral dimensions of economic behaviour is developing in two new sub-discipline: behavioural and experimental economics.  While providing meaningful insights into economic behaviour they do not, at least yet, offer any basis for modelling of the economy as a whole.

4.6 National Innovation System

Phillips and Khachatourians (2001), quoting Metcalfe, define the national system of innovation (NSI) as “that set of distinct institutions which jointly and individually contribute to the development and diffusion of new technology and which provides the framework within which governments form and implement policies to influence the innovation process.  As such it is a system of interconnected institutions to create, store and transfer the knowledge, skills and artifacts which define new technologies.”  The OECD formalized the concept the knowledge-based economy in 1996 and then a blue print for its members called National Innovation Systems (OECD 1997).

Governments around the world are now consciously designing NIS’s in an effort to enhance their competitiveness (Pagan 1999).  Intellectual property rights regimes can arguably be considered a critical part of the NIS.  The biotech sector is one of the chief objects of such NSI.  However, the role of multinational corporations is generating stresses and strains on its successful operation in many countries (Patel and Pavitt 1998). 

For my purposes, the NIS can be defined a nonprofit academic institutions partnering with government and private for-profit actors to create networks of specialized research centres in priority knowledge domains, disciplines, sub-disciplines and specialties.  Such centres are intended to facilitate commercial exploitation of new knowledge and enhance the competitiveness of the nation.  In the process, three important structural changes are taking place.

First, the mandate of the university is changing.  The medieval university was focused on interpretation of old knowledge.  This mandate changed little following the Scientific Revolution of the 17th century.  With religious wars waging, the university – Protestant and Catholic – were busy defending religious doctrines and resisted the new experimental philosophy.  In effect, the university remained a training ground for elites in traditional and proper ways of knowing.  It was not until 1809 that the first research university was founded in Berlin transforming the mandate of the university - traditional and conservative heartland of Western knowledge - from interpretation of old to the generation of new knowledge. Today, the mandate of the university is arguably being enfolded within the NIS transforming it to generation and commercial exploitation of new knowledge (Nagy Nov. 3, 2005).  As predicted, this has produced a significant clash of cultures within the university itself (Chartrand 1989). In turn this clash is causing the birth of the third age of the university - from interpretation to generation to commercialization of knowledge - including the teaching function (Chartrand 2008).  Biotech has been a major change agent in this process producing a new breed - the entrepreneurial scientist.  The process itself, however, began in the USA with a change of government policy concerning the use of federally funded research.  Until 1980 (the year of the first biotech patent), the federal government held all rights to to results of such research; after with passage of the Bayh-Dole Act, the university and its employees - the professoriate - retained such rights.

Second, as patron of the national knowledge-base, Government fosters and promotes production of knowledge through arm’s length institutions.  Such institutions generally direct funding according to peer evaluation.  In Canada, for example, during the last decade the federal government has endowed a number of quasi-public foundations to support knowledge production, e.g., “Canada Health Infoway Inc., received $500 million from the federal government; others have received multiple payments amounting to, for example, $300 million to Genome Canada and $250 million for the Green Municipal Funds” (Auditor-General of Canada Status Report, April 2002, 1.9).  In the past foundations, endowments or grant-giving councils were involved in the production of knowledge for knowledge sake.  Today, however, as part of the national innovation strategy these new foundations are concerned with ‘knowledge for profit’.  This means that commercial confidentiality veils many of their activities from public scrutiny.  This, in turn, raises serious questions about the accountability of private interests serving the public purpose, i.e., Government by Moonlight: The Hybrid Parts of the State (Birkinshaw, Harden and Lewis 1990) [Also see my book review].

Third, to date, the NIS has been restricted to the natural & engineering sciences.  There is, however, no reason why it cannot be extended to other knowledge domains and practices.  For example, national cultural policy corresponds to NIS in the Sciences.  The practices, with the notable exceptions of medicine and related engineering, have not, however, been the subject of NIS.  Accounting and legal praxis are applied to develop NIS. They have not themselves, however, been subjected to comparative advantage analysis, nor networked into NIS nor held accountable for their contributions – positive and negative – to competitiveness.   I suspect they will, formally or informally, shortly be enfolded within the NIS framework.  Arguably, heated political debate in the United States concerning tort and product liability represents the opening move towards seeing national legal systems from a competitiveness perspective.  Similarly, the accounting profession in the United States is, under the terms of the Sarbanes-Oxley Act of 2002, now subject to oversight unknown before the Enron scandal and the collapse of Arthur Anderson & Co.   This too may be but a first step in enfolding accountancy within the NIS web.

 

 

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