Tag Archives: Miles Kimball

My idea in the Wall Street Journal

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Far and away the best policy solution I’ve seen to the economic hardships created by our response to the Covid-19 pandemic is a proposal by economist Arnold Kling.

That is Tom Giovanetti, of the Institute for Policy Innovation. He continues with an excellent write-up of the credit-line proposal and its rationale.

UPDATE: Following a trail from Tyler Cowen, I got to this post by Miles Kimball.

Instead of mailing $1000 check to each person as is being discussed, mail each adult a government credit card with a $5000 line of credit. Mail similar government credit cards with lines of credit that are a certain percentage of previous revenue to small businesses that would be most strongly affected by the coronavirus.

He wrote that on March 19. So I think he had the idea before I did.

More sentences lifted from the comments

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1. On disciplined software development:

There’s a trap here. The trap is that is the “visible disciplined rules” are how the business actually works, AND that the business CAN work with visible disciplined rules in its market.

…So perhaps Freddie Mac was badly managed. But it may also be that any entity in that market *HAD* to be “badly managed” to stay in the business. In other words, if you didn’t make ad-hoc weird deals with originators, they’d go to a competitor, or to congress.

Exactly. There was tension between the customer-facing divisions of the business, who wanted to be flexible and creative, and the information technology division, which wanted to work with clearly-articulated business rules. The IT people saw the business people as constantly breaking their data model, and the business people saw the IT people as trying to drive the business “from the back seat.”

In recent years, there has been talk of having Freddie and Fannie, or some combination, operating as a “securitization platform.” I figure that this would limit their flexibility and perhaps even put an end to innovation in their business processes–which would not necessarily be a bad thing.

2. On the limits to firm size:

Aren’t many of these questions answered in Sraffa (1926) and Allen and Lueck (1998)?

Piero Sraffa pointed out that in classical economics there was both a law of diminishing returns and a law of increasing returns. The law of diminishing returns applied to land, as exemplified by Ricardo’s theory of rent. The law of increasing returns applied to specialization and trade, as exemplified by Adam Smith saying that the larger the extent of trade, the greater scope for specialization.

Concerning economies of scale at the firm level, Sraffa wrote

Everyday experience shows that a very large number of undertakings-and the majority of those which produce manufactured consumers’ goods-work under conditions of individual diminishing costs. Almost any producer of such goods, if he could rely upon the market in which he sells his products being prepared to take any quantity of them from him at the current price, without any trouble on his part except that of producing them, would extend his business enormously. .. Business men, who regard themselves as being subject to competitive conditions, would consider absurd the assertion that the limit to their production is to be found in the internal conditions of production in their firm, which do not permit of the production of a greater quantity without an increase in cost. The chief obstacle against which they have to contend when they want gradually to increase their production does not lie in the cost of production which, indeed, generally favours them in that direction-but in the difficulty of selling the larger quantity of goods without reducing the price, or without having to face increased marketing expenses.

This describes monopolistic competition before there was such a term in the literature.

As for Allen and Lueck, a description of their work says

They posit that if there are gains to be captured from specialization, then partnership or corporate farm organizational arrangements could be more efficient than farms in which ownership and control is combined– if partners could monitor and enforce farmer effort at lower cost. But because most agriculture production is heavily influenced by nature, it becomes too costly to differentiate production deficiencies from lack of farmer effort or from effects of nature.

Well, I did not claim that my thoughts were original.

What is the limit on firm size?

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Miles Kimball wrote,

Given the replication argument, there is no scale of operation that is beyond efficient scale. There may be ample reason to make different plants or divisions quasi-independent so they do not interfere with one another’s operations. But that is not an argument against scale per se. There may even be reason to set up incentives so that different divisions are almost like separate firms, headed by someone in an entrepreneurlike position. But that still is not, properly speaking, an example of diseconomies of scale.

Read the whole post.

So what are we to make of this?

1. For the economy as a whole, the law of diminishing returns applies. You cannot grow all the world’s wheat in a single flower pot.

2. But the size of any one farm is not limited to a single flower pot. Any one farm can keep adding land (until it gets to be large relative to the earth’s arable land).

3. Kimball sees the assumption of diminishing returns at the firm level as a staple of standard pedagogy. But it is more than that. Dropping that assumption takes you away from the perfectly competitive equilibrium, as Kimball spells out in his important follow-up.

4. What about the notion that the entrepreneur’s time or skill is a fixed factor? This appears to be a way to show that firm size must be limited. But it also is like question-begging or hand-waving. If you start with a traditional production function, with output a function of the two factors of homogeneous labor and homogeneous capital, then you have a hard time rationalizing diseconomies of scale until the firm gets to be really big relative to the whole market. So you tack on a fixed factor, and call it “entrepreneur’s time.” But the original production function assumed away the entrepreneur to begin with, and you never did spell out the entrepreneur’s role in that context.

5. Kimball’s approach in the second post consists of postulating a demand curve and zero profits and solving for firm size. That also strikes me as hand-waving, with math. Call it math-waving.

6. Think of a real-world example of monopolistic competition. I like to use ethnic restaurants in Wheaton, Maryland, near where I live. What stops a single owner from taking over multiple restaurants under the auspices of one firm? What stops an owner from then expanding to other locations far away, where the local demand curve is not a limiting factor?

7. When you do this thought experiment, you realize that firm size is not determined by the tangible variables that are central to neoclassical economics. Instead, you have to turn to principal-agent problems and whatever else might help deal with the “boundary of the firm” problem that has been articulated but not necessarily solved in a satisfactory way by Coase, Williamson, and Alchian and Demsetz.

8. Why are farms in two different states separate businesses? I would say that it is because it is costly for the Iowa farmer to observe the Kansas farmer’s effort, giving rise to a principal-agent problem. This may turn out to be a testable hypothesis. It predicts that as the cost of monitoring goes down (because of cheaper surveillance technology), we will see mergers take place that would have been unthinkable until recently.

9. This year, Amazon bought Whole Foods. Where does it stop? Where are the diseconomies (of scope, if not of scale)? Suppose that in order not to incur management costs, Amazon leaves Whole Foods executives in place and adopts a hands-off approach. Then from the point of view of somebody who owned shares in both firms, the merger only changed the form of ownership. You used to own a sort of mutual fund, and it was your choice how to weight the shares of Amazon and the shares of Whole Foods in that fund. Now you own shares in a conglomerate, with the weight fixed–you can no longer simultaneously reduce your holdings of Whole Foods while increasing your holdings of Amazon.

10. From the foregoing, it would appear that shareholders always lose in a merger, because they lose the option to alter the weights of their holdings. In fact, mergers have other effects, but they involve those intangible “boundaries of the firm” phenomena.

11. Suppose that a major element in a corporate merger is ego. The CEO of the company being acquired gives up status but gains wealth for the firm’s shareholders. The CEO of the acquiring firm does the opposite. The ego hypothesis predicts that immediately after the merger the acquiring firm will not give the post of CEO to someone from the acquired firm. It also predicts that the merger will be positive for the shareholders of the acquired firm but not for those of the acquiring firm. I haven’t kept up with the literature, but it used to be that those predictions held up.

12. In conclusion, the attempt to rationalize diminishing returns at the level of a firm in neoclassical economics opens up a can of worms, and Kimball’s math-waving with the demand curve does not close it.