Just tonight I started reading Klein’s new book. I know, bout time. Anyway I’ve come to this:
Interesting stuff. Though I don’t feel I understand him properly.
Let’s say Robinson Crusoe can improve his ability to find food by using his savings to construct 2 types of tools, an A or a B. According to Klein, Crusoe suffers a calculation problem because, as he is the sole producer and user of his product, he is not able to discover whether an A or a B would be more efficient, that is, he cannot calculate the profitability of using an A over a B.
But it seems to me easy enough to discover this: The more efficient one is whichever one gets Crusoe more food.
This notion also seems to apply at the larger scale: Let’s say a firm has 3 divisions, 1, 2, and 3. Division 1 produces an internal product using outside resources and passes it along to 2, 2 converts the first internal product to a second one (thus, division 2 is the division completely separated from the market), and 3 converts the second product into the final, consumer good. Again, according to Klein, this firm suffers a calculation problem because it cannot calculate the profitability of division 2’s operation, as its workings are completely separated from the outside market.
But again it seems easy enough to discover this: Division 2’s profitability is dependent upon the profitability of the entire firm. Division 2’s activities can be calculated through the needs of divisions 1 and 3, the ones connected with the outer market.
When Division 3 calculates its earnings, it says to itself “We took division 2’s product, worth $10, and mixed it with other things that cost us $1, and sold the resullt for $15. Thus we made $4 for the company. Thus we are the most profitable division, because no other division made more than $1 profit for the company. We deserve to be expanded.”
The catch is, how do they know division 2’s product is worth $10? It’s not made nor sold on the market. Maybe it would sell for $20 if it was, and so division 3 is losing money for the company constantly by taking $21 worth of resources and selling them for $15.
Hmm… I see. Though I don’t feel my question is completely answered as this implies the divisions are in competition with each other for funding, as in a firm that sells multiple types of products. In my example they work in terms of vertical integration. The profitability of the firm as a whole, then, is division 3’s sales minus division 1’s costs, not a compounding of the profits/losses of every division.
I am not sure which is Klein’s book. A google for the phrase “no firm can become so large that it is both the unique producer and user” turned up, among other things, a free downloadable pdf file called “Economic Calculation and the Limits of Organization” by Klein. Over there, a paragraph or two above the key phrase indicates that indeed we are talking about a case where the divisions are “competing” with each other, with the more profitable ones expanded.
Indeed, I’m not sure if your case is what he’s talking about.
[Edit: Probably he isn’t for then expanding one division would probably require an expansion of all the others, right?]
I’m sorry, the book is “The Capitalist and the Entrepreneur”, I thought it’d be more obvious. “Economic Calculation and the Limits of Organization” is the name of the first chapter, which is indeed where my question comes from.
Anyway it doesn’t really make any sense to me to say a division which produces an intermediate product, isolated from the outside market, “competes” with the other divisions.
“The same problem affects a firm owning multiple stages of produc-
tion. A large, integrated firm is typically organized as groups of semi-
autonomous business units or “profit centers,” each unit or division spe-
cializing in a particular final or intermediate product. The central man-
agement of the firm uses the implicit incomes of the business units, as
reflected in statements of divisional profit and loss, to allocate physical
and financial capital across the divisions. More profitable divisions are
expanded, while less profitable divisions are scaled back.”
So although competition might not be the exact word, what he’s saying is that some divisions are going to be expanded, and some scaled back.
And they won’t know what to do with poor ole division3.
In my example the only inputs from Division 3 are Division 2’s outputs, and Division 2’s only inputs are Division 1’s outputs. Not counting possible efficiency manipulations (for example improved processes in D3’s work that creates less waste and more sellable product with the same input from D2) upscale or downscale any of them you have to do the same for all of them. If you could change them independently then Division 2 wouldn’t be separated from the market anymore.
Hmm…
I just thought of something. Maybe the problem is I’m looking at this through an input-output model, which Klein specifically calls insufficient at the beginning?
Seems to me, this is like trying to figure out the profitability of putting food on a fork, between the creation process of cooking and the consumptive end of eating.
Do we measure it against the alternatives (using a spoon, using a knife, using bare hands)?
His latest one, The Capitalist and the Entrepreneur. I tried to read it, it’s not written for entrepreneurs, it is written for economists trying to understand entrepreneurship.
neat it looks like the book is online so i am def going to check this out.
but in the mean time, i also am having a hard time understanding klien’s point in the op’s quote.
here is how i am reading it…
firms want to maximize profits, which is computed as total revenue minus total costs. suppose that total revenue is the price of the good multiplied by the number of units of the good sold and that total costs are those costs associated with the labor and capital used in production as well the cost of a unique intermediate good that is not traded on the open market. then we could write the problem as such:
maximize: Profit = pq - wl - rk - ui
where
p = price of the firm’s product
q = quantity sold
w = wage rate
l = amount of labor employed
r = rental rate
k = amount of capital employed
u = price of unique intermediate good
i = amount of unique intermediate good consumed in production
Klein seems to be saying that because we do not know what the price of the unique intermediate good (u) is (because the good is untraded) the firm will not how to allocate resources across production (not be able to maximize this funciton). At first it looks he is correct, because u is an important parameter here. however, the more I think about it seems to me that you really don’t need to know what u is–after all, the firm produces the unique intermediate good. so long as the firm knows the prices of the resources required to produce that intermediate good, then he can easily solve this equation. for example, suppose that only some form of specialized labor were required to produce the intermediate good. then the profit funciton would be…
maximize: Profit = pq - wl - r*k - w(s)*l(s)
then if he knows the wage rate for the specialized labor (w(s)) and he knows the wage rate for unskilled labor, the rental rate of capital, and the price of his good on the market, then he could easily decide where to allocate resources!
let me know if anyone has any thoughts. I’m going to read the book and see if he goes into more detail. could someone point me to the specific page where this quote appears?
Thank you for the reply, Student! You hit my question right on the head, although you put it in a much clearer way. Though I will warn you, however, capital is heterogeneous. You can’t just lump the “amount of capital employed” into the profit equation and expect it to reflect reality, although I don’t see any way your simplification could interfere with the problem at hand, so for now it’s good enough for me.
Unfortunately Klein doesn’t explain this problem any further in the chapter, although (or perhaps because) he does suggest it as an area of future Austrian research. In my PDF from the literature section the quote is on page 32.
it looks like the book is online so i am def going to check this out.