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External Economies and Diseconomies in Economic Development with Reference to Canada George R Iowa State University Capstones, Theses and Retrospective Theses and Dissertations Dissertations 1962 External economies and diseconomies in economic development with reference to Canada George R. Winter Iowa State University Follow this and additional works at: https://lib.dr.iastate.edu/rtd Part of the Economics Commons Recommended Citation Winter, George R., "External economies and diseconomies in economic development with reference to Canada" (1962). Retrospective Theses and Dissertations. 2031. https://lib.dr.iastate.edu/rtd/2031 This Dissertation is brought to you for free and open access by the Iowa State University Capstones, Theses and Dissertations at Iowa State University Digital Repository. It has been accepted for inclusion in Retrospective Theses and Dissertations by an authorized administrator of Iowa State University Digital Repository. For more information, please contact [email protected]. EXTERNAL ECONOMIES AND DISECONOMIES H ECONOMIC DEVELOPMENT WITH REFERENCE TO CANADA by George Robert Winter A Dissertation Submitted to the Graduate Faculty in Partial Fulfillment of The Requirements for the Degree of DOCTOR OF PHILOSOPHY Major Subject: General Economics Approved: Signature was redacted for privacy. In Charge of Major Work Signature was redacted for privacy. Head of Major Department Signature was redacted for privacy. Graduate College Iowa State University Of Science and Technology Ames, Iowa 1962 ii TABLE OF CONTENTS Page PREFACE vi I. INTRODUCTION 1 A. Background of Externalities in Economic Development 1 1. Purpose 1 2. Definitions 2 B. Situations That Give Rise to Externalities 6 1. Examples 6 2. Alternative economic systems 8 II. EVOLUTION OF THE CONCEPT 10 A. External and Internal Economies 10 1. The shifting definitions 10 2. Meaningful definitions 13 3. Definitions and measurement lU B. Importance of Economies of Scale lU. 1. Some evidence 15 C. Technological Development as Related to Scale of Output 16 1. Trends toward monopoly 21 2. Economies of scale and balanced growth 23 D. Cost Curves and Rents 25 1. The number of cost curves 26 2. Pigou was partly right 28 3. Types of models 29 E. Can Pecuniary Externalities Result in Market Failure? 31 1. Financing economic activity 31 2. Pecuniary externalities are alleged to cause market failure _ 31 iii Page F. Summary 35 III. NORMS AND ASSUMPTIONS 36 A. Capital Formation 36 1. Introduction 36 2. Ideal rate 36 B. Welfare Implications of a Simple Model i|2 1. Types of market failure in a welfare model 50 a. Indivisibilities 51 b. Interdependence 52 c. Social goods 55 d. Technological changes 57 e. Irreversibilities 58 f. Equilibrium difficulties 60 C. Theory of the Second Best 61 . D„ Summary 63 IV. DEFINITIONS AND A MODEL 6k A. Difficulties of Definition 6I4 B. Definitions to be Used 65 C. A Model of Economic Development 75 1. Internal financing 77 2. Innovation 82 D. Summary 89 V. EXTERNALITIES IN COMPARATIVE STATICS 91 A. Types of Market Failure in Comparative Statics 91 1. Factor indivisibilities 92 2. Non-approprlabilities 95 3. Appropriability, culpability and conditions of entry 97 iv Page a. Completing entry 99 b. Aggressive entry 100 c. Neutral entry 102 a. Cost externalities and the choice of product 103 e. Entry and non-appropriabilities lOh Lu Irreversible externalities and technological advances 105 a. Non-convexity 113 5» Equilibrium difficulties 115 6. Social goods 119 B. Summary 131 VI. AM EMPIRICAL INVESTIGATION 133 A. The Externality Matrix 133 1. Data 136 a. Data requirements 136 b. Available data 137 c. Deficiencies of data 138 2. The productivity vector ll±2 3. Summary of previous studies llil. U. Economies of scale vector 158 5. Summary of calculations 162 6. Requirements for investment funds 165 B. Summary 167 VII. SUMMARY AMD CONCLUSIONS 169 A. Purpose I69 B. Definitions 170 C. Historical Development 172 D. "types of Market Failure I75 1. Factor indivisibilities 176 2. Non-convexity 176 3. Non-appropri abilities 177 U. Irreversibilities 177 5. Equilibrium difficulties 178 6. Social goods 178 V Page E. The Question of Entry 180 F. Quantification of Pecuniary Externalities 181 G. Suggestions for Further Research 186 VIII. BIBLIOGRAPHY 188 JX. APPENDIX 20L vi PREFACE External economies and diseconomies considered jointly will, in this thesis, be called externalities. An externality, for the moment, may be defined as an effect on the cost structure of a firm which is not attrib­ utable to the action of that firm. Such effects may raise or lower costs. The following question is to be considered. Do externalities affect economic development and if so, in what manner? Incidental to this inquiry it is necessary to examine whether externalities are likely to advance or retard the rate of economic growth. There are two views. On the one hand there are those who regard externalities as important. This group includes, to name only a few, m Scitovsky (192), Chenery (29), Colin Clark (36), Hirschman (95), Islam (103), and Schumpeter (189). (Only Schumpeter and Hirschman argue that externalities systematically promote economic development; the others apparently believe the converse.) On the other hand, a group of economists including Fleming (66), Stockfish (205), Meade (137), Knight (116), and Young (236) appear to regard externalities, at least in pure competition, as so insignificant that it is difficult to find any realistic and con­ vincing examples. Moreover, there is confusion over whether externalities should be defined as attributable to a general range of market imperfec­ tions (including fewness of competitors), as is believed by Bator (9), or as attributable almost exclusively to dynamic factors as is believed by Ellis and Feliner (55), Thus, although a large number of articles concerned with externalities have been published, the subject is still somewhat confused. vii In this study, the problems have been approached on two fronts. First it seemed necessary to examine the relationship of externalities to economic development using theory. This is done in chapters one to five. Problems are delimited in chapter one, while chapter two provides a review and synthesis of the literature—though this review is more con­ cerned with externalities than with economic development. The evolution of externality concepts has been closely related to both socialist thinking and welfare economics, as a study of Pigou's Economics of welfare (159) or Baumol's Welfare economics and the theory of the state (12) will confirm. Chapter three, therefore, is an attempt to apply modern welfare concepts to the problem. This procedure is more useful than might at first be imagined, because it helps a good deal in resolving definitional problems. In fact the definitions throughout, reflect the analysis of chapter three. Chapters four and five attempt to relate the externality concepts reviewed and extended in earlier chapters to problems of economic develop­ ment. It must be admitted that this section is more closely related to economic growth (as opposed to development) than is desirable and that in most places the argument proceeds little beyond comparative statics. But it does develop meaningful concepts for statistical examination. The second approach to externalities in development has been empir­ ical. This part of the study follows concepts developed in the earlier theoretical part, but it is only partly a parallel study. It is much narrower in scope and much more detailed. But even so it is cast in terms of large aggregates so that the econometric procedure involves a number of assumptions and estimates that are not as neat as one might desire. viii The empirical part involves, first, an examination of how frequent and important are economies of scale; second, a method for estimating marginal costs to the industry of increments in output is developed; third, an attempt is made to estimate the extent of pecuniary external­ ities for various Canadian industries and to determine whether these accrue in such a manner that industrial expansion can be self-financing. The data on which this empirical work is based is not of uniformly high quality and the results must be interpreted with caution. But it may be concluded that, if prices to the industry are assumed constant, falling costs (in the industry) are fairly common. Pecuniary external economies (funds which are potential sources of internal financing) vary a good deal from one industry to the next and these variations do not appear always to correspond to capital intensity or to capital longevity. To the extent that they do not, the capital market is called upon to redirect the flow of investment funds. It is possible to conclude that economic growth may be less than is achievable because of externalities. However, because development implies an increase in welfare, it is not clear that externalities do, in fact, interfere with economic development. It is clear that they might under certain circumstances, but that is a different matter. Pecuniary exter­ nalities are much easier to treat than technological externalities and one may even go some distance toward quantification of the former. But quantification of technological externalities appears remote. 1 I. INTRODUCTION A. Background of Externalities in Economic Development 1. Purpose This study is an attempt to clarify the relationship between exter­ nalities and economic development. It is not clear whether externalities are important in the study of growth and development, nor is it clear whether externalities are more important in developed than underdeveloped regions, and finally it is not clear whether the presence of externalities impedes development and growth or actually aids development and growth. All these problems need to be examined both theoretically and, where possible, empirically. But while externalities have been the subject of a considerable volume of literature, and while economic development has recently been extensively investigated, there has been relatively little work devoted to the manner in which the two are related. This situation prevails, despite frequent reference in the development literature to external economies and diseconomies.
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