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Abstract
The 1500–1970 literature on the theory of production/the firm can be usefully divided into four approaches to the positive analysis of production or the firm: aggregate production, market structure, the representative firm and micro-production. Each approach will be examined to establish the nature and development of the approach and the relationships between them.
Acknowledgments
This essay draws on material from Walker (Citation2018, Citation2021). I wish to thank, but not implicate, an anonymous referee for helpful comments and suggestions utilised in the revision of the paper.
Notes
1 For a discussion of the normative period see Walker (Citation2021, Chapter 2).
2 Given the nature of the economy at the time, production was chiefly agricultural production.
3 Strictly speaking Smith's discussion of large firms began with an examination of the English East India Company in a long footnote added to the second edition of ‘The Wealth of Nations’. This discussion was expanded in a supplement to the second edition and this supplement was incorporated into the text of the third edition. Smith added this material to a subsection on ‘Of the publick Works and Institutions for facilitating the Commerce of the Society’, which is to do with goods and services largely provided by the government today. To us this may seem a strange placement until it is realised, as Donoghue (Citation2020, p. 12) notes, that ‘[t]he key historical fact is that in Smith's time private enterprise was often the vehicle utilised for the delivery of public works’ and ‘[…] Smith's discussion of public works under the heading, the “third duty of the Sovereign”, designates the sovereign's traditional roles and responsibilities in respect of public works in an era before such responsibilities were absorbed by the modern state’. Here public works included the provision of roads, bridges, canals and water supply. Thus Smith's placement of the discussion makes sense since Smith saw joint-stock firms, such as the East India Company, as a way of providing public works.
4 For a concise history of the idea of marginal revenue see Shackle (Citation1967, Chapter 4).
5 See appendix 1 of Walker (Citation2022) for more explanation. There is a PEC for each point on a supply curve.
6 ‘Recent economists, while adhering to the doctrine of marginal cost as a price-determinant in the case of commodities subject to the law of diminishing returns, have been disposed to accept Marshall's theory of the representative firm in the case of commodities subject to the law of constant or decreasing cost. It is not towards the cost of production to the least efficient producer that price gravitates, they say, but to that of the well-established, solid business man – the man doing a conservative, prosperous, but not phenomenally brilliant business’ (Wright, Citation1919, p. 560).
7 It does not matter whether we think of Marshall's framework is one of perfect competition, as many interpreted it, or as one of imperfect competition, as some thought – e.g. Hollander (Citation1961) – both frameworks are implicitly zero transaction cost frameworks.
8 I thank the anonymous referee for raising this point and motivating the next three paragraphs. For a more detailed but still brief discussion of the historical development of production see Walker (Citation2022, Section 2.1).
9 The Sreni of ancient India, the waqf in the Islamic world and the clan corporation in China all had some of, but not all of, the features of what in Europe would develop as the business corporation (Walker, Citation2022, Section 2.1).
10 An important step in the development of the modern corporation was the introduction of limited liability. The original joint-stock corporations were created by royal charter, the first being the Russia Company of 1557. The important feature of the Russia Company was its joint-stock with legal personality, which allowed the firm to act as a legal person distinct from its owners and managers. This meant that the firm could enter into contracts more efficiently, sue and be sued in the name of the firm's designated officers, own assets including real estate and pledge said assets and real estate to creditors. The majority of companies that were created in the sixteenth century were mercantilist corporations which were, in addition to being incorporated by the state, given the added advantage of monopoly trading rights with a particular country or area. Importantly, these mercantilist companies came in two organisational forms (1) the regulated companies and (2) the joint-stock corporation. The main distinction between them is that regulated companies did not necessarily have a transferable joint stock. The members of the company would simply trade on their own behalf. Neither form of organisation necessarily included a concept of perpetual existence, they had to renew their charters every so often. Harris (Citation2000, p. 45) states that in the first two decades of the 1600s about 40 (mostly regulated) companies were formed and were granted monopoly trading rights with a total membership coming close to 10,000. ‘Royal charters conferring legal personality continued to be granted to English companies, the most significant being English East India Company (1599). When receiving a new charter in 1654, this company won the right to perpetual existence, following the precedent set by the Dutch East India Company in 1623. Free transferability of East India Company shares soon followed, setting a precedent for future corporations’ (Hickson & Turner, Citation2006, p. 164). Unincorporated corporations were, in theory, illegal under the Bubble Act of 1720 but in practice, many such businesses existed. Despite the law, the joint-stock company proved to be successful in both its incorporated and unincorporated forms. Businesses that required a large amount of capital but could not incorporate resorted to the unincorporated company. ‘This form emerged when the trust form was applied to the partnership. The enterprise's assets (including land) were held in a trust by trustees who were appointed by the partners. This meant that the partners or stockholders could sell their shares because the trustees stayed the same’ (Turner, Citation2017, p. 11). Significantly unincorporated companies did not have a separate legal personality. Shares in these companies were transferable, but not freely transferable. There was much uncertainty as to whether or not unincorporated firms had limited liability. It is only in 1844 that the Joint Stock Companies Registration and Regulation Act granting freedom of incorporation was passed. This Act gave businesses formed under it, every aspect of corporate status apart from limited liability. In the United States, there were moves towards chartering corporations with limited liability in Connecticut and Massachusetts as early as 1817. ‘In 1855 an Act for “Limiting the Liability of Members of Certain Joint Stock Companies” was passed by Parliament, but was quickly repealed. The act was re-enacted in 1856 as “An Act for the Incorporation and Regulation of Joint Stock Companies, and other Associations”. These two acts enabled businesses upon registration to incorporate as limited liability companies’ (Turner, Citation2017, p. 19). In Britain, the effects of these two Acts were significate, according to Shannon (Citation1933) nearly 5,000 limited liability companies had been established in England by the end of 1856. For a brief general history of the development of the limited liability company see Hickson and Turner (Citation2006) and Turner (Citation2017). See Copp (Citation2008) for a discussion of the reasons for the introduction of limited liability in the U.K. Limited liability protects investors from claims of the company, organisational law also does the converse. The assets of the company are protected from claims by investors. Hansmann and Kraakman (Citation2000a, Citation2000b) and Hansmann, Kraakman, and Squire (Citation2005) emphasise the importance of this 'asset separation' to the development of the firm. Hansmann, Kraakman, and Squire (Citation2006) trace the history of the emergence of entity shielding.
11 For more on the development of the corporate form see Dari-Mattiacci, Gelderblom, Jonker, and Perotti (Citation2017). For a discussion of the emergence of the modern corporation, in particular the Dutch and English East India Companies, see Harris (Citation2020).
12 Desmet and Parente (Citation2009, pp. 7–8) briefly discuss firm size in the UK and USA since industrialisation. They argue that in both countries firm size has increased. For example, the median number of workers in cotton firms in Manchester more than tripled between 1815 and 1841. For pig iron, English production per furnace grew from 400 tons in 1750 to 550 in 1790. It is also argued that studies have shown similar patterns for manufacturing industries over the 19th century in the USA. For the USA firm size was increasing before 1860 and firms grew even in industries that did not mechanise. A relationship is also seen between market size and firm size, more densely populated areas had larger firms. In the wool textiles industry, for example, the average firm size (average number of employees per firm) was 38.7 in New England, compared to 14.5 in the Mid Atlantic and 6.6. in the rest of the country. For the period 1500 to 1700, it is argued that firm size in England was increasing in advance of the industrial revolution.
13 Mokyr (Citation2000, p. 5) argues that the Industrial Revolution in the UK bought about an increase in both the size and number of factories. As an example he discusses the cotton industry. ‘Notwithstanding these precursors, the Industrial Revolution brought about factories where none were before. The transition was relentless but gradual. Most firms did not switch abruptly from the domestic system to a factory system, but continued to farm out some processes to domestic workers, until mechanisation and technological complexity had sufficiently expanded to make it worthwhile to bring the workers under one roof. The cotton industry provides the best example of this mixed factory system. In 1760, this industry was overwhelmingly a domestic industry. The water frame spinning machine changed all that. Richard Arkwright's works in Cromford employed about 300 workers; he also helped found the New Lanark mills in Scotland which employed a workforce of 1600 in 1815 (most of which were indoor). Such huge firms were unusual, perhaps, but by 1800, there were in Britain around 900 cotton-spinning factories, of which a third were “mills” employing over 50 workers and the rest small sheds and workshops, with a handful of workers – though even those by that time were larger than households. The mule, especially after it was coupled to steam power, changed the distribution of firms quickly: at first, in the early 1790s we observe something like a lognormal in which the majority of cotton were still small firms employing at most 10 workers, with a few Arkwright-type mills of 300–400 workers. By the early 1830s, when reasonable statistics rather than guesswork and pronouncements of contemporaries become the basis of our estimates, the average Manchester mill had about 400 workers. The very large and very small firms made room for medium sized ones, between 150 and 400 workers. The domestic spinner had by that time long disappeared’.
14 See Walker (Citation2021, chapter 3) for more discussion of production and the division of labour.
15 Examples of this literature include Frank (Citation1925), Robinson (Citation1931), Stigler (Citation1951), Becker and Murphy (Citation1992) and Rauh (Citation2018).
16 Wernerfelt (Citation2022, p. 345, footnote 1) states that ‘[t]he combined worldwide sales of the US Fortune 500, almost all of which operate in multiple businesses, is roughly equal to of the US GDP’.
17 As an indicator of the relative importance of different types of production consider data from Lebergott (Citation1966, Table 1, p. 118; Table 2, p. 119). Lebergott looks at the size of the labour force by industry and the percentage distribution of the labour force by industry for the USA over time.
At the very least the trend in the data suggests the increasing importance of the non-agricultural sector and thus the firms in it. Given the absolute and relative increase in employment either there are more firms or firms are just getting larger or both. By the 20th century, the non-farm sectors were dominant. Lebergott's data suggests the farm/non-farm labour force percentages would have been 50:50 somewhere between 1880 and 1890.18 For more on the reasons for the neglect of the theory of the firm see Walker (Citation2018, Chapter 4)