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How the West grew rich? |
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Till
about 200 years back, abject poverty characterized the world.
It is only since the 19th century, a significant
proportion of people in the west have become affluent and better fed and
healthier. Their book is about how a group of countries collectively
referred to as the ‘west’ have become rich and prosperous. The
authors explain the various factors which have made the western nations
so wealthy over time. The
authors explain the objective of the book, “The story of the move from
poverty to wealth offers enough mysteries, surprises, exposes, triumphs
and tragedies to make it worth the retelling for its own sake. Moreover, a better understanding of how economic growth came
about in the west should be helpful to those westerners who are
concerned with public policy, the comparative significance of the
west’s many economic institutions, the future of the western economies
themselves and most of all to those who feel some responsibility for
passing along to the next generation an opportunity to better their own
conditions at least as much as has the current generation.” A
gradual process The
process of development of the west has been gradual.
Even over an entire decade in the early stages of development,
the economic gains were generally perceived to be insignificant.
Despite some radical innovations, the process of growing rich was
gradual. “There was never
a day nor even a generation, when a television anchor or a newspaper
editor, however astute, could have led off with news of an economic or
technological development which rescued the west from poverty.” But as decade after decade of growth continued, it become
clear that the proportion of affluent people was rising. Explanations
for the West’s growing rich Many
of the traditional explanations for the development of the western world
are inadequate. China and
the Islamic nations were at one point of time well ahead of western
countries in science and
technology. Yet, they were
left behind. The
availability of natural resources is also not a satisfactory
explanation, when we take into account the development of countries like
Switzerland and Japan. Some
have argued that the affluence of the west is the result of the pursuit
of personal riches by businessmen.
Others have attribute it to lucky circumstances.
A major expansion in trade during the 15th century,
the first industrial revolution of the 18th century, the
second industrial revolution of the 19th century and the
current electronic revolution came in quick succession, giving a
tremendous momentum to the growth process.
The leftists have argued that the development of the west has
come at a heavy price – tremendous income inequalities, exploitation
of workers, colonialism and imperialism.
The
authors argue that the western countries succeeded because it created
conditions that encouraged innovations in trade, technology and
organization. This enabled
them to accumulate capital and labour and exploit natural resources.
Moreover, they gave their enterprises the autonomy to make a
number of decisions made by political and religious authorities in other
nations. It became easy to
set up enterprises. Trading
took place without much restriction.
Owners of enterprises also received some sort of reassurance that
the business assets would not be arbitrarily seized by the political
authorities. As the authors
put it, “The economic enterprise had become a unit for making a wide
range of economic decisions and its gains and losses from the decisions
were expected to accrue to the enterprise, or less abstractly, to its
owners. Virtually, without thought or discussion, the west delegated
to enterprises the making of a decision basic in the innovation process:
which ideas should be tested and which should be allowed to die.
For economic innovation requires not only an idea but an
experimental test of the idea in laboratory, factory and market.”
The
process of development The
authors have outlined the process of development of the western nations.
The
west emphasized the use of experiment in technology and organization to
harness resources to the satisfaction of human wants.
The key elements of the system were the wide diffusion of the
authority and resources necessary to experiment; minimal political and
religious restrictions on experiment and incentives which combined ample
rewards for success with severe penalties for failing to experiment. The
Middle ages During
the middle ages, Chinese and Islamic technology were probably more
advanced than that in the west. But
the west was on the verge of getting ahead. In the 1400s, the west began
to replace medieval institutions with modern ones.
The seeds were sown for the formation of nation states in France,
Spain, Portugal and Ireland. Advances
in shipbuilding helped reduce transportation costs.
Trade and exploration activities gained momentum. It
is interesting to understand the differences between the medieval and
modern times. The medieval economy was overwhelmingly agricultural.
Political and economic authority were combined in the same
institutions – the manor in the country and the guild in the towns.
Terms of exchange were determined not by negotiations between
traders but by custom, usage and law. Medieval
society was preoccupied with providing food.
Between the 15th and 18th centuries,
roughly 80 to 90% of the world’s population was engaged in raising
food. Rural life revolved around manors which were production
enterprises of considerable size and complexity.
They grew crops, raised animals, milled their own grain, baked
their bread, spun thread and wove cloth, made their own plows and did
most of their own metal work. The
three most important features of manors were the unity of political and
economic spheres, widespread use of servile labour and a high degree of
self sufficiency. Most
participants in the manorial system had no say in deciding what
occupation to follow, what trading activities to conduct and what crops
to cultivate or what animals to rear.
Within the manor, the fundamental exchange was the trade of
labour for the use of land. Only
a minor fraction of the production of the manorial system was consumed
outside it. In the case of
most transactions, the sellers were selling the product of their own
work and the buyers were buying for their own use. The feudal economy
did not encourage the development of credit.
There was little trade surplus that could be used to pay off a
loan. The church passed
strictures on the taking of interest. The
towns were less self-sufficient than the manors and became centres of
trade. Exchange with the
outside world was far more important for the towns.
In general, the town residents acquired most of their food,
clothing and shelter through trade.
Urban dwellers also possessed some kinds of special privileges
and some powers of self government that were absent in the villages. The
guilds had the political authority to make rules and to punish
violations. The guilds were undemocratic as far as membership was
concerned but guild leaders could not exploit guild members for their
personal benefit as the manor leaders could. Medieval towns obtained a
degree of political autonomy by the purchase of charters from their
suzerains. Some towns attempted to get more powers for themselves in
areas such as taxation. They
also tried to gain control over the guilds.
The towns however did not make any concerted efforts to end the
rigid political control of trade characterized by the feudal system. A
few towns like Venice, Geneva and Florence became major centres of
trade. The extent of self
government in these city states was unprecedented.
The
medieval people were not equipped to identify and manage risks
effectively. The biggest
uncertainty was crop failure. Rules
also changed from time to time. According
to the authors, “The possibility of calculation, of assessing
prospective magnitudes of cost and revenue and the probability of
alternative outcomes in a novel enterprise, of profiting from judicious
buying and selling rather than from diligent service to one’s lord or
from industriously plying one’s trade was wholly alien to the customary order
of feudal society… The
amassing of wealth through skill and luck in the calculation of future
consequences, through the discovery of new customers and new sources of
goods and through the artful sharing and hedging of risks transcended
medieval understanding and had no legitimate place in the medieval
system… Ironically, in seeking security through a life wholly
regulated by custom, usage and law, in preference to the insecurity of
unregulated trade, medieval society appreciably reduced the security of
its people.” Meanwhile,
technological advances were gaining momentum. From the 8th to
13th centuries, there was a gradual expansion in iron
production in several parts of Europe.
As early as the 8th century, foundries began casting
bronze church bells. Later, they began to cast cannon in bronze and iron.
Medieval chemistry produced soaps, paints, varnishes, dyes,
sulphur and saltpeter. The
Roman technology for making ceramics and glass was improved upon.
So was the case in textiles.
The introduction of the padded horse collar in the 12th
century facilitated the substitution of horses for oxen in plowing.
Probably, the most formidable technological advancement of the middle
ages was the invention of the clock in the late 13th century.
The clockmakers’ shops
became research centres for mechanical arts, friction, precision metal
work and study of the behaviour of materials under different
temperatures and pressures. Two
instruments, the telescope and the microscope contributed significantly
to the technological revolution
of the 17th century. Over
a period of 1000 years from the fall of Rome in the 5th
century to the 15th century (when the modern age began),
technology progressed steadily but surely.
Ways of cultivating the land, logging, mining, smelting,
spinning, weaving, building, making plots, bricks and glass changed but
so slowly that the change was very gradual. Unlike
China and the ancient empires, the Europe of the late medieval city
states and the early monarchies did not have a central authority strong
enough to check the determination of its merchants to gain access to
profitable trading opportunities. This pluralistic aspect of western
feudalism, according to the authors, played an important role in the
development of the west. Western
feudalism rejected the notion of an absolute state.
Moreover, the
chieftain’s tenure of the land along with the obligation to perform
military service, stayed in the family – even after the Chieftain’s
death. If the Chieftain had
only a life interest in the holdings, his subordinates might have
shifted their loyalties to his superiors as the Chieftain grew old.
This would have strengthened loyalties to the sovereign as
opposed to the feudal vessels. Since the tenure continued within the family, the trend
became reinvesting income in long-term improvements. Towards
the end of the 15th century, the military capability of the
feudal chivalry declined. Professional
armies combining infantry, siege artillery and cavalry came into vogue.
The new arrangements made the capabilities of part-time soldiers
outdated. Professional
armies became popular in Italy in the late 14th century.
The 100 years war between France and England also accelerated
this process. By the end of the 15th century, countries like
France were using professional armies.
Before the introduction of siege cannon, the lords’ castles had
supplied them with fortified bases from which they could defy their
feudal superiors with impunity. The
introduction of siege cannon ended the military usefulness of the
castle. The decay of the
barter economy of the manors and the rise of money based agriculture (as
opposed to barter of labour for land) also contributed to the decline of
feudalism. The
growth of trade Between
the middle of the 15th century and the middle of the 18th,
trade grew impressively. The
three-masted trading vessel reduced transportation costs and facilitated
travel over longer distances. The
basis for trade also changed from one based on custom and usage to one
based on negotiation between traders. Rapid
expansion of Europe’s overseas trade and the work of explorers like
Vasco da Gama generated new profit making opportunities and aided the
development of markets. The merchant class successfully stepped into the
vacuum created by the decline of feudalism and manorialism.
The rise in population, growth in inter-urban trade, growth of
cities and improvements in transportation all contributed to the
development of markets. Between
1600 and 1800, the population of Europe doubled.
Intra European trading volumes also increased sharply, thanks to
differences in climate, natural resources and population densities
within the continent. For
example, the Baltic region provided timber, other forest products and
later cereals. The Iberian peninsula exported wool, vegetable oils,
dyestuffs, iron ore and some fruits. As
trading volumes and urbanization picked up, a merchant class emerged.
As the authors explain, “Cities live on the difference between
what they have to pay for raw materials for their shops and factories
and what they can obtain for the finished products plus what they can
net from outsiders by selling such specialized services as banking,
insurance, warehousing, commodity trading, medicine, law, government and
religion. Agricultural life
requires less trading than urban life because the farm is more
self-sufficient than the city apartment: a movement from farm to city is
inevitably a movement towards more trading.”
The
full-rigged ship served as the main carrier of western maritime commerce
until the latter part of the 19th century. Since the Roman times, merchant ships had been designed to
sail nearly dead downwind. The
full-rigged ship could tackle much more hostile wind conditions. Merchant vessels also increased in size during the 15th
century. Large
vessels were faster than smaller ones. They also reduced the cost per unit of cargo.
There were also economies of scale in staffing.
Larger vessels were more seaworthy, could store more rations and
offered greater protection against pirates. What
happened in the 15th century was an interlinked growth of
trade and maritime technology. Both
were urban activities. Like its earlier growth within Europe overseas
expansion reinforced merchant capitalism and nourished its further
growth. Much
of early modern European history is a story of a continual tug-of-war
between a nascent political class and the established political
structure. The emergence of
a reasonably autonomous business class occurred more readily in Western
Europe, more specifically in the UK and the Netherlands.
Governments did attempt to control trade in many ways but when it
came to trade between two regions under different jurisdictions,
opportunities were generated for voluntary trade on negotiated terms. The
landholding feudal magnates supported the expanding role of merchants
because they gained materially by buying from and selling to merchants.
The authors conjecture that the wealth of the feudal aristocracy
must have increased rather than decreased even as feudalism declined.
“It makes a more interesting account of the west’s transition from
feudalism to capitalism to tell the story as a melodrama in which an
ancient aristocracy was gobbled up alive by the upstart wolves of trade.
Dramatic, though they are, such accounts do not accurately
reflect the general experience of either landowners or merchants.”
The merchant class got its power from the feudal nobility not by
displacing the feudal nobility in agricultural activities but by
expanding the trading activities in which it had been traditionally
engaged. Moreover,
governments were compelled to take care of their interests more
seriously than they had in the past.
Also, after 1500, the merchant class became successful in gaining
autonomy from political and religious interference.
By
1750, the growth of trade had significantly improved economic welfare
through greater specialization and exchange.
Change from manorial agriculture to one based on individual
peasant holdings materially improved the food supply.
Mercantile capitalism emerged as a successor to feudalism.
Improved agricultural methods created a pool of landless farm
labourers, who were ready to take up alternative employment.
The
evolution of institutions favourable to commerce While
studying the economic development of the west, a lot of emphasis has
been laid on technology. Yet,
it is the organizational innovations which played a key role in
generating growth. The
development of commercial law, commercial courts and commercial
instruments was a response to the expansion of commerce. Insurance
instruments became available from the 16th century. Lloyd’s
the insurance company was formed in the late 17th century.
The development of marine insurance markets in Italy, Amsterdam
and London made possible risky voyages.
The division of risk between the perils of the sea and the
uncertainties of the markets was essential to the development of
maritime commerce. Towards the end of the 18th century, the royal
courts in London had accumulated enough experience in setting disputes
related to insurance, bills of exchange, ships’ charters, sales
contracts, partnership agreements, patents, arbitrations, etc.
The reputation for fairness developed by English counts. They
played a very important role in the growth of English commerce. The
Magna Carta was an important development in establishing property
rights. Magna Carta gave
the English a considerable lead on their neighbours.
The abandonment of arbitrary levies and their replacement by
regular taxes at stipulated rates were a major step towards encouraging
businessmen to develop their own ways of creating and accumulating
wealth. The distinction between confiscation and taxation made the
greatest difference in Holland and England.
In both countries, the power to impose taxes resided in
parliaments in which the merchant class was strongly represented. Another
important development was the double entry book keeping system.
It gave an impetus to the development of financial accounting and
the practice of evaluating the credit worthiness of the enterprise by
analyzing its balance sheet and profit and loss statement. The
growth of commerce demanded high moral standards. The merchant class
evolved a moral system suited to life in highly organized enterprises.
This was the only way by which enterprises could go beyond the
family and manage colonization, foreign trade and canal building and
find the institutional loyalties necessary to discharge their economic
functions. The moral outlook for mercantile capitalism was supplied in
the sixteenth century by the Protestant Reformation. The merchant community needed independence from religious
authorities. Religion was
gradually transformed from a restraining influence upon capitalist
development to a force that sanctioned mercantile capitalism by
precisely the moral teachings required for the smooth running of the
expanding commercial system. Protestantism
supplied the merchant class with both a highly individualized moral
responsibility outside the control of the clergy and with moral dogmas
that emphasized exactly the thrift, industry, honesty and promise
keeping needed for capitalist institutions. An
institutional innovation that was important in smoothing the politics of
transition from feudalism to capitalism was partnership or alliance
between governments and their merchant classes.
Governments granted trading monopolies to merchants.
In turn they became substantial personal participants in the
profits of these business enterprises. The
development of capitalism in the west also owed a good deal to the
fragmentation of Europe into a multitude of states and principalities.
Had the merchants been dealing with a political monopoly, they
might not have been able to purchase the required freedom of action at a
reasonable price. On the
other hand, individual centres of competing political power had a great
deal to gain from introducing technological changes that promised
commercial or industrial advantage, and hence greater government
revenues. In fact they had much to lose from allowing others to
introduce them first. According
to the authors, “It may be that a pre requisite to sustained economic
growth is an economy trading across a geographical area divided among a
number of rival states, each too small to dream of imperial wars and too
fearful of the economic competition of other states to impose massive
exactions on its own economic sphere.”
As in Europe, the United States also had a federal system in the
19th and early 20th centuries. Intervention by the
federal government was limited and states faced economic competition
from each other. Modern
Japan also grew out of a decentralized feudal society The
development of industry: 1750-1880 By
1750, three hundred years of gradual expansion in markets had been
accompanied by a corresponding expansion in agricultural and handicrafts
production. Until 1880, the principal technological advancements of
western industry were in the mechanical arts.
In struggling with the problems of building accurate clocks and
portable watches, clockmakers developed knowledge of precision
machining, the effects of changes in temperature on different materials,
friction, gear trains, levers, ratchets, springs, lubrication and
mechanical durability. By
1750, when the industrial revolution demanded skill and ingenuity from
mechanical designers, western clock makers had already developed
considerable expertise in mechanical design. In the 17th
century, scientific method became experimental. Hypotheses were tested by experiment. The
factory system could not be introduced in isolation.
There had to be parallel changes in the production of raw
materials and finished goods, in wholesale and retail trade, insurance
and banking. The steam
engine helped produce more coal by pumping water out of coal mines.
This provided the fuel necessary to expand the production of
finished goods. In the 19th
century, there was also a revolution in communication. Innovations
occurred where the economic system not only encouraged invention and
discovery but was also quick to put them to commercial use. The
steam engine facilitated the movement of production from the cottage to
the factory. It helped
expand production of iron and steel and at a lower cost. It also
provided the power for mining, transportation by rail and water and for
the mills themselves. Demand
for iron and steel also rose due to the growth of steam engines, rail
roads and later ships. The
Bessemer process introduced in 1856 made steel production far more
efficient. The late 19th
and early 20th century began to be known as the age of steel.
Replacement of wood by iron and steel resulted in gains in
longevity, feasible speed of operation, precision of construction and
possibilities of mechanical complexity. The
growth of factories was led by the textile industry in both England and
the U.S. Powered machinery were introduced for spinning yarn.
Over the years, the power loom improved steadily, both in
productivity and in its ability to weave cloth of better grades. The shift from handloom to power loom involved a change in
both technology and organization of production from cottage to factory.
The
factory system came to ceramics because there were advantages to united
control of the step production process, further advantages to
specialising workers at each step in the process and yet further
advantages in a central source of power.
But the invention of specialized machinery did not play an
important part in bringing the factory system to the ceramics industry
as in the textile and iron and steel industries. The
development of the factory system produced an enormous increase in the
output. Until 1750, the
expansion of trade was the result of falling transportation costs and
mercantile initiative in building new markets.
During the 19th century, growth in trade was
stimulated mainly by the falling cost of factory output, which lowered
prices. Historical
evidence suggests that the capital required for the early factories was
modest. Moreover, the
capital was not painfully accumulated. There was no reduction in real
income or consumption of workers or land owners.
There was no concerted effort to increase savings.
The increase in output generated by the factories was more than
sufficient to pay capital costs over a short period of time. An
agricultural revolution reduced the proportion of the population
required for providing food from the medieval 80-90% to less than 5%.
The enforced displacement of agricultural workers to the cities
provided labour for the factories.
The major factors driving the agricultural revolution were
mechanical energy, an increased use of fertilizers, improved seeds,
improvements in methods of cultivation and animal husbandry, improved
transportation and development of regional specialization in
agriculture. Impact
of factories on labour The
industrial revolution improved the living standards of labourers.
According to the authors, the romantic view that workers in
pre-industrial Europe lived well need not be taken serioulsy.
If early factory work was oppressive, the alternatives to factory
work were worse. Indeed,
the early factories could attract workers because
the wages were still above the poverty level.
“The Industrial Revolution is not, as many have thought, a
precedent for imposing sacrifices on the living generation in the hope
that things will be better for later generations….
Its lesson is that economies progress rapidly when the fruits of
progress are widely and contemporaneously enjoyed.” To
summarise, the revolutionary changes in western industry and
transportation between 1750 and 1880 are traceable to one organizational
development, two technological developments and two social changes. The
first was the introduction of the factory.
The first of the two technological developments was the enormous
increase in the use of steam and water power in factory production and
the application of steam power to land and water transportation.
The second major technological change was the substitution of
iron and steel for wood in fabricating machinery and other products.
This substitution changed the size, longevity, precision and
mechanical complexity of a wide range of products, from sewing machines
to ships. The two social
changes were the rapid rise in population and the steadily improving
agricultural productivity. Diversity
of organization: The Corporation By
the closing decades of the 19th century, the use of the
corporate mode of organization in the west gone beyond monopoly
enterprises backed by government powers.
The concept of group-owned enterprises conducting their business
through agents elected by owners had achieved general acceptance. The
publicly held corporation had two major advantages.
It enabled investors to spread the risk of investment.
It minimized agency risk by enabling stockholders to express
their dissatisfaction with the management by selling their shares. In
the US, the history of forming corporations by registration under
general incorporation laws paralleled England’s in some respects.
In both countries, it was the third step after first
experimenting with corporations formed for religious, charitable and
local governmental purposes and a period of extensive
formation of franchised corporations.
But limited liability seems to have been more emphasized in the
US than in England. In the
US, allowing the formation of corporations by registration without
obtaining a charter by special act of the legislature, began with
statutes limited to specific lines of business.
Beginning in 1837 in Connecticut, some of the American states
adopted broad general incorporation laws applicable to most lines of
business activity. This enabled firms to obtain corporate charters
without procuring a special legislative enactment. Only in the second half of the 18th century, did
it become possible to adapt the incorporated mode of enterprise
organization to an increasingly wide variety of business situations. The years 1864-1870 were a peak period for incorporation in
American industrial states. Corporate
enterprises could raise venture capital from wealthy individuals and
investment banks even if securities markets were still not as well
developed. In 1891, New Jersey adopted a general incorporation statute.
It proposed inter state operation, permitted corporations to own stock
in other corporations and provided the same degree of freedom in forming
corporations that England had provided earlier.
During
the 19th century, the same economic forces that encouraged
England and the US to adopt general incorporation laws produced the same
result in France and Germany. The
need for a form of group ownership, adapted to a multitude of different
lines of business and to variations in the size and distribution of
ownership, resulted in a system of incorporation by registration.
European governments, like the American states, realized
that, if their incorporation laws were unduly restrictive,
businesses would migrate to neighbouring countries. But
the tendency to incorporate was not universal.
Many enterprises, including some that were very large, continued
to operate as proprietorships or partnerships.
The organization of western enterprise continued to be diverse,
proliferating and adhoc to the different circumstances of different
enterprises. In the long
run, innovations in corporate law supplied the legal framework for
meeting the organizational needs of 19th century enterprise. Technology,
trusts and marketable stock After
the American civil war, there were a number of striking advances in
technology that helped to reduced production costs.
There was progress in metallurgy.
Steel was substituted for cast iron.
Advance in machining made possible the interchangeability of
parts. Mass production of
agricultural machinery, sewing machines, typewriters, cash registers,
bicycles and automobiles received a boost.
In the US, the number of steam engines in use doubled between
1860 and 1880 and again between 1880 and 1900. Before
the introduction of electricity, the distribution of power to factory
machines depended on drive shafts, gears and pulleys.
The layout of the factory was governed by the need to locate the
machines with the greatest power demand closest to the engine.
The efficient flow of work remained a secondary consideration.
About 1890, it became possible to provide each machine with an
electric motor and to transmit power to the motor through an electric
wire. Wires could be bent
to any shape and run to almost any desired length, since transmission
losses were relatively small. This
introduced new flexibility into the design of the factories and the
efficient flow of work between successive steps in the products regained
priority. Substitution of
mechanical power by electric power facilitated the construction of large
plants. It also enabled smaller plants to become more efficient.
The development of the IC engine sparked off a second industrial
revolution. Progress in electromagnetism started a revolution in
communications. As capacity
increased and technology improved, the need for more capital was
automatic. From 1880 onwards, there was a fall in the price of
manufactured goods. Consequently,
internally accumulated surpluses were not necessary to meet the rising
capital requirements. The
range of functions performed by a single enterprise was also increasing. U.S. steel makers and oil refiners integrated backwards.
Marketing became more sophisticated.
During the days of artisans, selling was an incidental part of
the artisan’s work. In the modern industrial enterprise, the mass
manufacturer of a line of products began to be combined with
distribution within one enterprise.
The distribution departments of many national manufacturers grew
larger than the leading mercantile enterprises in the 18th
and 19th centuries. Before
1890, publicly held industrial corporations were very rare.
By 1914, many major industrial enterprises were incorporated and
publicly held. Stock exchanges originated through the trading of
government securities and the securities of chartered companies. Until the 1890s, shares of railroads and utilities were
mainly traded. England was
ahead of the US in developing markets for industrial stocks.
This helped British companies to raise capital for capacity
expansion and tapping new technological opportunities.
American companies were in contrast, dependent for finance on
personal contacts with wealthy individuals or banks.
Large
scale trading in American stocks originated in trading in trust
certificates issued by the trusts of the 1880s.
Initially, they traded as
unlisted shares. But after
1891, they were fully listed on the New York Stock Exchange.
Beginning in the fall of 1897, a post depression merger movement
virtually completed the shift of most American companies to publicly
held corporations with listed shares. The
corporation with transferable shares converted the underlying long-term
risk of a very large amount of capital into a short-term risk of small
amounts of capital. Marketable
securities also enabled investors to spread their risk. Large
enterprises are characterized by agency risk. Agents and employees may
fail to act diligently. They may consciously or unconsciously act in
their own interests than in the interests of the owners.
Managers in charge of different functions lobby to get funds for
their own functions. But
there are advantages in setting up large enterprises managed by
professionals. So, what is
necessary is a mechanism to
set up effective devices
for controlling/minimizing agency risks.
This is taken care of through marketable stock.
If the investors do not like the way in which the company is
being managed, they can sell off their shares and drive down the market
value of the stock. Economic
development is possible only if there exist investors with no financial
or bureaucratic interest in preserving an arrangement which is less
economical than an available successor.
So, there must be decision makers for whom sunk costs must have
zero values. One of the
most distinctive features of capitalist economies has been the practice
of decentralizing authority over investments to substantial members of
individuals who stand to make large personal gains if their decisions
are right, who stand to lose heavily if their decisions are wrong and
who lack the economic or political power to prevent at least some others
from proving them wrong. According
to the authors, the diffusion of authority to select capital expenditure
programs is essentially about the diffusion of authority to select
projects for innovation. Large
corporations had to cope with the difficulties of organizing work forces
of unprecedented size. The
confrontational aspects of the relationship encouraged the substitution
of capital-intensive production for labour intensive production wherever
possible. The
link between science and wealth At
the beginning of the 19th century, most industrial
technology, including the technology of the industrial revolution was
the work of artisans or engineers with little or no scientific training.
Among the various branches of science, chemistry was the first
discipline to produce results useful for industry.
The first industrial research laboratories in the US were
established by chemists. The first phase of the application of science to industrial
processes and products consisted of testing, measuring, analyzing, and
quantifying process and products in place.
Such laboratories contributed information rather than invention
or new scientific insights. Chemistry
not only offered a better understanding of processes but in some cases,
it also led to the development of new products.
In many cases, the best way to improve a product was to improve
the materials of which it was made.
Physics had developed as a body of knowledge before chemistry. But its usefulness was more clear in astronomy than in
everyday life. The full
impact of science on industrial technology could be felt only after
1875. Bell laboratories, established in 1925, launched a program to
improve the reliability and longevity of vacuum tubes.
In the 1940s, William Shockley developed an electronic amplifier
of semi conductive material instead of using vacuum tubes. After
1880, industry became more closely linked with science.
The intervals between scientific discovery and commercial
application began to grow shorter.
By the early years of the 20th century, industrial
research had quite clearly turned toward the development of new products
and processes. As long as industrial technology was focused on the visible
world of the mechanical arts, advances in technology originated almost
entirely with artisans who were imaginative and ingenious but in no
sense learned scientists. About
1875, the frontier of western industrial technology began to move from
the visible world of levers, gears, cams, shafts, pulleys and cranks to
the invisible world of atoms, molecules, electron flows, electromagnetic
waves, inductance, capacitance, magnetism, amperes, volts, bacteria,
viruses and genes. There
was an immense gulf between societies in which science was in the hands
of a few wise men, with individual agendas and western society’s
thousands of specialized scientists seeking to contribute to a coherent
understanding of all natural phenomena.
The experimental method was adopted by a number of researchers
and their common method united them in a community of working
scientists. The west scored
over other societies, by getting a large number of scientists,
specialized by different disciplines, to cooperate in creating an
immense body of tested and organized knowledge whose reliability could
be accepted by all scientists. The
west successfully organized its scientists with little hierarchy. This
encouraged independent thinking. Hierarchical
organization might have resulted if the funding of basic science could
have come from only one source. The
diversity of sources of finding enabled western society to undertake
research activities on a large scale.
Western science also rose at a time when political and religious
authorities lacked the power to suppress new ideas with incompatible
explanations of natural phenomena. Western
society encouraged a large number of companies to work on different
ideas. Consequently, the
system became biased towards acceptance of proposals.
Innovation is more likely to occur in a society that is open to
the formation of new enterprises than in a society that relies on
existing companies for innovation.
The openness of western societies to the formation of new
organizations and to changes in the activities of existing organizations
encouraged innovation by the threat of penalty for failure to innovate.
The organization of the scientific side of western innovation
took the form of a proliferation of research laboratories widely
different in size, sponsorship, goals, personnel and facilities.
According to the authors, “Innovators must be, by
self-selection, more willing to take risks than the average individual,
more given to dissent from the status quo, more willing to upset
applicants. They are therefore more likely to flourish in a society that
either fails to inculcate a complete respect for authority or that
offers a number of competing authorities to its members. Individuality has found expression not simply in western
innovation, but in the multiplicity of ways the west went about the work
of innovation.” Growth
is a form of change. Change
implies innovation. The
western system of innovation depended on the wide diffusion of power to
undertake and use innovations, coupled with rewards for success and
penalties for failure. The
system of innovation penalized those who failed to cope with change.
Scientific and technical knowledge could be converted into economic
growth became western society enjoyed a social consensus that favoured
the everyday use of the products of innovation. Diversity
of Enterprise Large
publicly held corporations in mass-production industries are the most
conspicuous type of economic organization in the west. But they arrived
on the scene too late to qualify as a fundamental explanation of western
economic growth. Undue
emphasis on large corporations understates the role of smaller
enterprises in the development of the west.
Many innovations in the west have succeeded by trying out new
ideas in new enterprises organized on an experimental scale, with little
commitment to the status quo. Moreover,
the western system employed enterprises of all types and sizes,
depending on the nature of the economic mission for which the enterprise
was organized. Not just the large corporations. The
formation of new enterprises plays an important part in growth by
innovation. New enterprises can be established on a small, experimental
scale at relatively low cost. Their
efforts can be intensely focused on a single target.
Many of the smaller enterprises fail but the few which succeed
constitute an important source of innovation.
The easy formation of new enterprises tends to act as a
disciplinary device for older enterprises.
New enterprises, specializing in new technologies have been
instrumental in the introduction of electricity, the internal combustion
engine, automobiles, aircraft, electronics, aluminium, petroleum,
plastic materials and many other advances.
Many Third World countries have
made the mistake of seeking growth by imitating the largest mature
western enterprises instead of facilitating growth by experiment, though
start ups. In
the west, in the same industry, firms of different types and sizes tend
to coexist. The same
industry may have contract, brand-name and specialized manufacturers.
Smaller firms engage in activities that are quite different from
those of larger ones. The
main thrust of the publicly-held industrial corporation, as an
institution, is to use capital intensive, labour-saving methods of
manufacturing. As a result, most of the labour force in countries like the
US is employed outside the manufacturing sector.
Most of the work of producing and distributing goods and services
in western economies is done in smaller enterprises. Large industrial organizations organize a higher proportion
of the economy’s capital resources than of its labour resources.
But labour is the more important resource, in terms of social
significance. And
industrial giants are not the institutions used to organize labour. A
fundamental characteristic of organization in western economies has been
decentralization. The
strength of the tendency to decentralization in western economies has
not been adequately appreciated. There
have been many prophecies that capitalism will end in the domination of
western economies by a few capitalists.
Such prophecies have turned out to be false. Implications/Comparisons The
relation of the political to the economic sphere may be analyzed by the
methods of economics. From
the viewpoint of economics, one would expect the division of output
between the holders of political power and the economic sector to
encounter some maximum point: the level of expropriation beyond which
further exactions would diminish political revenues. Organizational
innovations tend to benefit a small number of innovators a great deal, a
large number of consumers, a great deal in total but very little
individually. On the other
hand, it may threaten a number of people committed to the status quo.
As a result, there is often an adverse political response.
Innovations will be retarded if there is political verbal
decision making and enhanced if market methods of decision making are
used. Organizational
innovations in the West have not stopped in the past few decades. During the period 1920-1960, it became the practice to
separate strategic decision making and control from the operating parts
of the enterprise. The
operating functions were decentralized.
This led to the conglomerate form of organization in the 1960s. During the 1970s, the corporate sector became a significant
factor in the control and the structuring of economic organizations.
In the case of smaller enterprises, innovations have included
franchise systems and high-tech corporations.
The high tech corporation is managed by scientists or engineers
and funded by venture capital. Conclusion How
can the Third World catch up with the West?
The starting conditions for growth are irretrievably different. The West was behind the Chinese and Islamic civilizations, at
the time its growth took off. There
is also nothing to suggest that the west deliberately created a
merchant, entrepreneurial, capitalist class.
It developed out of internal dynamics. But this gap was not as
large. Another problem is
that unlike in the west at the take-off stage, political and economic
power are consolidated in Third World countries.
But one silver lining is that growth through technology came
relatively late in the history of western expansion.
In the initial stages, trade was the primary source of growth. The success of Korea, Taiwan, Hong Kong and Singapore brings
out the tremendous trading opportunities available to Third World
countries. The
Third World can learn a great deal from both capitalist and socialist
experiences. There is no simple prescription for costless, painless,
economic growth. Some developing countries have experimented with planning.
But planning looks at an economic system as a lifeless machine,
without the internal capacity to change, adapt, grow, renew, reproduce
itself and shape its own future. As the authors put it, “Plans can lead to steel, concrete
and machinery supplied with property trained workers, but they do not
ordinarily provide for creating extensive classes of people with the
capacity to engage in independent economic activities not envisioned by
the plan. But a growth
system is like a living organism with impulses of its own.
The result of planning for growth is to produce an economy, that
is, it not a wholly lifeless statue of the real thing, at best a tame
zoo-bred shadow of the natural animal.”
The experience of the Soviet Union should convince third world
countries about the futility of planning. In socialist countries, there
is only one form of ownership. Western
economies on the other hand, have experimented with different forms of
ownership. Investor ownership has become the most popular arrangement.
The decision to reject principal organizational solutions that
merged through experimentation in the west, has been one of the
fundamental weaknesses of the Soviet economy.
Russian managers had little discretion to respond to consumer
judgment. How much to produce and what to charge became a matter of
politics than economic judgment. This
easily explains Russian’s plight today.
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