The Firm and Strategic Factor Markets: the Role of the Firm in the Creation of Factor Mistakes

0:00My name is client student number one.

0:07So I'm gonna talk to you about the firm and strategic factor markets. In this presentation, I'm gonna use factors, capital, means of production interchangeably. So whatever word I use, I kind of talk about machines and labor factors. Let's see here. The outline of this presentation. First I'll remind you of the problem, and I think you'll recognize it as soon as you see it. I'll go on to talk about the power of the market, the way we see it. And then I'll talk about the limits of the market. I'll talk about the dynamics of the market, the market process and what makes the market progress.

0:52And then I talk about a possible solution to a problem that I've identified. So let's see if you can follow me when I tie along here. So, for the reminder, some of you might recognize this as a problem. Many of you probably think about the common denominator of everything going on on Capitol Hill. And that's basically it. Socialism is the problem. Now, of course we know that socialism is impossible. That's what Mises taught us back in 1920. But why is it impossible? It's not impossible because you don't have all the knowledge, as Hayek was talking about, but because you don't have private ownership of the means of production.

1:39Which means that you don't have markets for all these capital and labor. You only have pretend markets for the consumption products. Which means that an entrepreneur cannot really calculate if something is going to be profitable or not. You cannot figure out if something is being done efficiently or not. So that is the main problem. In any capitalist economy, you have private ownership all throughout this process. Now, in this paper, I started thinking about imputation, which is the process of how factors are valued in the market, how you can set a price on machines and so forth.

2:28And as Austrians, we see imputation as something going from consumption products and the value that consumers put on the products they're consuming, and then how it's imputed back Backup, it's not a cost plus kind of thing that neoclassicals would do. So then I started thinking, what does Mises and Rothbard and all these people say about this? Well, they talk about if you have factor markets, then you're going to have the social valuation of these factors and then you have imputation and that's not a problem. Well then I thought, where do these markets come from? What if you invent a new machine? There's no market for something you just invented, you don't have the bidding, you don't have multiple buyers and sellers for this machine that no one knows anything about.

3:17So that is kind of the problem that I started to work on a little bit. So let's move on to the economic puzzle. Now as Austrians we have a few of these pieces of the puzzle, we have entrepreneurship of course. I mean entrepreneurship, the entrepreneurs are bidding for the factors and through this bidding back and forth you get the true value of the factors used in production. Of course you have economic calculation, which is the calculation of whether this is going to be profitable or not. It's a calculation of whether you're using materials and machines efficiently or not. You have heterogeneous assets, which is not at all part of the neoclassical view.

4:09I mean, you could say, those of you with an object of this bent, you know that A is A. I mean, what this really means is that K is not K and L is not L. K for capital is not the same as capital, because a machine is not like any other machine. It's very specific, right? And the same with labor. Remember, if I work somewhere, and if Chris works somewhere else, we can't do exactly the same things. We are not else, we're different kinds of else. Now there's an extra piece of the puzzle here that I think actually provides the solution to the problem that I mentioned in the beginning, and the funny thing is that I'm not going I'm not gonna really talk about this piece.

4:57Actually, I'm gonna leave this for the next session where I talk about my theory of this piece of the puzzle. I'm only gonna talk about how this piece fits with the other pieces, which means that I still have to talk a little bit about what it means, right? So, oh, I should mention here, too, that JC is talking about the same piece, but obviously he's wrong, because it's not me, And you know that L is not L, right? But, I mean, you can listen to him. It's an interesting theory and all, but you should stay put a couple of hours until I do the presentation on what this piece is. And that's the true one. Oh, Peter Klein is also wrong, by the way. Just so that you know. Okay, so what is the power of the market?

5:45If we just step back and do it from the beginning? Well, the division of labor is what makes the market glorious. The division of labor, specialization, is why we have trade at all. Like I said before, Chris and I are different else. If we did exactly the same things, why would we trade at all? If we start doing different things, we specialize in different things, there are gains from trade. We're both better off through specializing. And of course, Mises recognized this. Mises recognized almost everything. He said, the mechanization can be employed only in the social environment under the division of labor. Every step forward on the road toward the use of more specialized, more refined and more productive machines requires a further specialization on tasks.

6:32So here we have an identification of how the market progresses. You increase specialization, you have an increased division of labor all the time, which means you get more products for less labor, less effort, less materials, so forth. So you can satisfy more consumer wants with less means, basically. And of course, I want to just make sure that glorious is a value-free term, so this is positive science. That was a joke, by the way. It's okay to laugh. Now, in this market with a high degree of specialization and division of labor, You compete and you bid for different factors to use in your production structures.

7:25That is pretty obvious, but that's where I'm starting at. Now in a capital structure, as Lachman showed us, these factors are complementary in different ways. A certain tube fits with a certain machine and so forth. So this tube might not fit with another machine, but those with this kind of machine or those and also finding a use for this tube, they bid for the tube. And thereby we get the value, the market value of this bank. But there's also a limit to this market. And Adam Smith talked about this limit in his The Wealth of Nations. And the limit is the extent of the market. Of course you cannot go outside of the scope or the extent of the market to sell this tube or whatever.

8:15And the way I interpret this is that you really have incompatible specialization levels. So this tube has a certain radius and so forth, so it's specialized or specific in a certain way, which means that it doesn't fit with other things, which means it's very complementary with other things, right? So this is how I interpret it. You always need a graph. Now in this, what we're looking at here is from the point of view of one factor, anything, it doesn't matter what it is. So what you have is the total market for this factor, that is how many buyers and sellers for this thing are there, that you can actually reach.

9:03Now you have a level of specialization for this thing. And if you are at the same level basically as everything else, so the tube is at the same level as the machine, you have someone who can make the tube, and everything is basically on the same level, then the market is almost endless. The market is huge, right? Now if you think about labor factors, it might be easier, because if you specialize in a certain very very very narrow task, and do something very very small, and you can't really You can't really fit it with anything else. Of course you're going to be very specialized up here, but you're not going to have a market. Who is going to use what you're doing, right?

9:51You can't fit it with anything else. And of course if you don't specialize at all, if you go back to being Robinson Crusoe, then the market goes back to one, right, it's just you. So this is how I interpret the extent of the market limitation as Adam Smith saw it. So let's move on a little bit and now I'll try to put everything together at the end. So this is just going to seem like very loose pieces of the puzzle, I mean I showed you in the beginning how they fit together. The market process, now back to entrepreneurship which is the driving force in the market as as Mises saw it. Now, entrepreneurship means you do something new, something that hasn't been done before. You see an opportunity, you're alert to it, or you have a superior judgment or something like that, and you do something that no one has done before, in a way that no one has done it before, or something that is novel in this way. I mean, if you

11:01To do that, if you create this new tube, this new machine or something, it means that there are no buyers and sellers. There is no market already there for this thing because why would they buy and sell what is not existent yet, right? Which means that you cannot have a basis for economic calculation if you use the Mises and Rothbard discussion on this because you have to have the buyers and sellers who bid over each other to get this thing. That's how you get the market value. So what explains the process towards a higher degree of specialization and a greater division of labor? In other words, how can this new, more specialized thing be introduced in the The Market. If there is no market at all, how do you create this new market?

12:01And that's what I say here, the highly specialized capital, that market, how does it emerge? Of course, that's the missing piece, right? And I wanted to rely on an authority here, but Charlie Sheen is kind of not an authority anymore, so I couldn't use him. I went to another one, Tom Cruise, the firm, and that's the missing piece of the puzzle. That's what I'm going to talk about in the next session, how the firm offers a solution to this problem. Now I'm going to just quickly summarize the way I see the firm and how it fits into this, and of course talk about how this solves the problem with imputation and the factor markets.

12:49Now, the way I see it is that firms are islands of specialization. It's not an island of conscious power, which is how the mainstream uses this concept now. Coase quotes, is it Richardson or Robertson or something like that, saying that firms are like islands of conscious power. And maybe that fits in the 30s, but I don't see it that way. Now the way I see it is that an entrepreneur can, through the firm, get all these factors together, create all these factors and make them specialized or co-specialized so that you can actually create this new thing.

13:34You can follow the imagined opportunity that the entrepreneur has. So a firm is simply encapsulated, because you do it within the boundaries of the firm. You don't do it, it's through market contracting. It's high density, which means that you collect all these resources and everything very closely together. It doesn't necessarily mean that you're standing in the same place, but that you're very closely communicating or whatever. It's a process, obviously. Now, and it uses the extra market specialization. It's a higher degree.

14:20So, this would facilitate the introduction of new factors and use of new factors. Simply because they're used within the firm to produce something that is compatible with the market as a whole. And I'll get back to this in the next session, so stay put. Now, the question is, is this a solution to the problem? Well, I would claim it is, but leaving the firm, what about the factor of markets, right? So, how do we get back to this beautiful thing?

15:06How do we solve the problem? How do we get to the point where capitalism actually has these markets that are necessary for the evaluation of the capital and labor that is very specialized? Now, the market process, if you start from the beginning, then you would have a lot of people and a lot of capital, maybe, running around and doing market contracting. They would be specialized to basically the same degree. If someone specializes further, you wouldn't be able to trade with anyone, so it would be suicide basically. Now they work together on the same level like this to satisfy the wants of the consumer. And consumer is king, of course. Now let's have Let's have a look at this.

15:55This doesn't really support the progression towards higher degree or extent of division of labor, higher specialization, unless they all specialize at the same time. If they all get together and they work on more narrowly defined tasks doing the same thing so that they can do it more efficiently, the question is how do you get all these people Well, how do you introduce these new fancy machines, or this one? That is the question, right? Well the way I see it, the entrepreneur, he creates a firm within which he can utilize the power of this extra specialization that is not existent in the market and that is not compatible with the market as it is.

16:49is something new that he figures out. He collects whatever he needs, he puts it together, he allows them to co-specialize and thereby create something totally new, something very dense, something very efficient that hopefully, I mean if it's successful, will beat the market, produce something more cheaply, produce something totally new or something like that. And of course if he's successful, he's going to end up with this thing, we heard that before, Profit, right? But if he manages to get profit, well, then you have these other ones, the followers, other entrepreneurs who see that he's making profits, they want to share these profits, obviously. Now, they try to emulate this structure. Now, it's like encapsulated and there's tested knowledge and whatever in there, so they might not be able to do exactly exact copies of it but they make something that is similar now if you do this what happens then well obviously you create a situation where all these entrepreneurs with their firms can trade with each other using these these

18:10factors they're not compatible with anything else but they're compatible with all these structures and they can trade with each other, thereby creating a market for these factors. So how do the factor markets emerge? Well successful entrepreneurs, they're emulated because others are also seeking profits, they want to do what he's doing because he's making so much money. Now competition here becomes a discovery process just like Hayek talked about simply because you're trying to do what he is doing. He obviously did something that was really good and you're trying to do something as good as he does it or even better.

18:59You're trying to discover what he's doing and discover how he can do it even better. Now, this also creates, as we saw, markets for factors, but there are non-core competences in the firm as well. I mean, you have encapsulated this whole thing, but for the entrepreneur, you want to focus on what you are best at. So what you're doing, really, when all these firms start competing, doing these things, you can take small parts of it and have other entrepreneurs do that. I'm thinking accounting, IT services, whatever, think something like that. So suddenly we have a process flow where you might be able to explain outsourcing, which creates more markets, which just feeds the whole process and it builds on itself.

19:51So it goes faster and faster and faster and you get more division of labor, you get higher specialization, greater efficiency, more profits to satisfy more of consumers' wants, and the whole world is happy. Pretty good, huh? And that's it.