Is the most unproductive firm the foundation of the most efficient economy? Penrosian learning confronts the Neoclassical fallacy

William, Lazonick (2020): Is the most unproductive firm the foundation of the most efficient economy? Penrosian learning confronts the Neoclassical fallacy.

Abstract

Edith Penrose’s 1959 book The Theory of the Growth of the Firm [TGF] provides intellectual foundations for a theory of innovative enterprise, which is essential to any attempt to explain productivity growth, employment opportunity, and income distribution. Properly understood, Penrose’s theory of the firm is also an antidote to the deception that is foundational to neoclassical economics: The theory, taught by PhD economists to millions upon millions of college students for over seven decades, that the most unproductive firm is the foundation of the most efficient economy. The dissemination of this “neoclassical fallacy” to a mass audience of college students began with Paul A. Samuelson’s textbook, Economics: An Introductory Analysis, first published in 1948. Over the decades, the neoclassical fallacy has persisted through 18 revisions of Samuelson, Economics and in its countless “economics principles” clones. This essay challenges the intellectual hegemony of neoclassical economics by exposing the illogic of its foundational assumptions about how a modern economy functions and performs.

The neoclassical fallacy gained popularity in the 1950s, during which decade Samuelson revised Economics three times. Meanwhile, Penrose derived the logic of organizational learning that she lays out in TGF from the facts of firm growth, absorbing what was known in the 1950s about the large corporations that had come to dominate the U.S. economy. Also, during that decade, the knowledge base on the growth of firms on which economists could subsequently draw was undergoing an intellectual revolution, led by the business historian, Alfred D. Chandler, Jr. He was engaged in the first stage of a career that would span more than a half century, during which Chandler documented and analyzed the centrality to U.S economic development of what he would come to call “the managerial revolution in American business.”

In combination, the works of Penrose and Chandler form intellectual foundations for my own work on the Theory of Innovative Enterprise—an endeavor that has enabled me, as an economist, to recognize not only the profound importance of organizational learning for economic theory but also the illogic of the neoclassical theory of the firm for our understanding of the central institution of a modern economy, the business corporation. In this essay, I argue that the key characteristic of the innovative enterprise is fixed-cost investment in the productive capabilities of the company’s employees to engage in organizational learning. The purpose of this investment in organizational learning is to develop a higher-quality product than was previously available. When successful, the development of the higher-quality product enables the firm to capture a large extent of the market, transforming high fixed cost into low unit cost. The result is sustainable competitive advantage that enables the growth of the firm, contributing to the growth of the economy as a whole. I argue that to get beyond the neoclassical fallacy, economists have to stop relying on constrained-optimization methodology. Rather, they need to be trained in a “historical transformation” methodology that integrates history and theory. It is a methodology in which theory serves as both a distillation of what we have learned from the study of history and a guide to what we need to learn about reality as the “present as history” unfolds.

• Item Type: MPRA Paper
• Language: English
• Keywords: Theory of the firm, Penrosian learning, Chandlerian history, innovative enterprise, economic performance, Paul Samuelson, neoclassical fallacy, constrained optimization, historical transformation
• Subjects: A - General Economics and Teaching > A2 - Economic Education and Teaching of Economics; B - History of Economic Thought, Methodology, and Heterodox Approaches > B3 - History of Economic Thought: Individuals; N - Economic History > N8 - Micro-Business History

References

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Edith T. Penrose, The Theory of the Growth of the Firm, Blackwell, 1959

Alfred D. Chandler, Jr., Strategy and Structure: Chapters in the History of the American Industrial Enterprise, MIT Press,

; Alfred. D. Chandler, Jr., The Visible Hand: The Managerial Revolution in American Business, Harvard University Press, 1977

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Mary A. O’Sullivan, Contests for Corporate Control: Corporate Governance and Economic Performance in the United States and Germany, Oxford University Press, 2000, ch. 4;

William Lazonick, “Corporate Restructuring,” in Stephen Ackroyd, Rose Batt, Paul Thompson, and Pamela Tolbert, eds., The Oxford Handbook of Work and Organization, Oxford University Press, 2004: 577-601;

William Lazonick, “Alfred Chandler’s Managerial Revolution: Developing and Utilizing Productive Resources,” in William Lazonick and David J. Teece, eds., Management Innovation: Essays in the Spirit of Alfred D. Chandler, Jr, Oxford University Press, 2012: 89-121.

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William Lazonick, “The Theory of Innovative Enterprise: Foundation of Economic Analysis,” AIR Working Paper, August 2015, at http://www.theairnet.org/v3/backbone/uploads/2015/08/Lazonick.TIE-Foundations_AIR-WP13.0201.pdf.

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William Lazonick, “Labor in the Twenty-First Century: The Top 0.1% and the Disappearing Middle Class,” in Christian E. Weller, ed., Inequality, Uncertainty, and Opportunity: The Varied and Growing Role of Finance in Labor Relations, Cornell University Press, 2015: 143-192.

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cites J. A, Schumpeter, “Capitalism, Socialism, and Democracy“, Harper & Brothers: New York 1942.