Industrial Economics

Industrial organisation, or industrial economics as it is more commonly known, first emerged in the 1950s as essentially an empirical study. Central to this was the SCP paradigm.

According to the SCP formula, external types of market structure, such as oligopoly, determine internal market behaviour, such as collusion. Market structure (S) determines market conduct (C) which in turn determines market performance (P)

This framework was popularised by Bain, though has its roots in the work of Chamberlain from the 30s. There were two main assumptions to the model. The first, was that all firms sought to maximise their profit. The second, was that firms could freely enter or exit the industry.

This approach was very advantageous for policy makers. It should that if there was monopolistic competition, then in the long run price would be equal to average cost. If certain forms of industrial structure led to excessive profits then the government could step in to prevent such activity

Those who favour the SCP approach are referred to as structuralists. Much of the empirical work based on the SCP paradigm has proved contradictory.

The Chicago School criticised the SCP approach and contributed to the dismantling of the paradigm as the core of industrial economics. It came under attack on a number of different fronts, each of which is associated with the neo-classical method.

SCP was criticised for being non-theoretical and for having diverged too far from the basic neoclassical price theory.  They stated that their perfect competition model was far more predictive of market outcomes. They also criticised the idea that large firms would lead to collusion and thus higher profit. They argued that larger firms tended to be more efficient and this was what led to the increased profit rate, which intervention would only harm.

Structuralists themselves began to question the linearity of their approach, with the idea that conduct and performance could both affect market structure. This became known as the anti-structuralist view and introduced the idea of simultaneous interdependence of the three.

The work of Cournot in the 19^th century have accorded conduct, rather than structure dominant role. This has been further substantiated by recent work of Stiglitz and Mathewson. Game Theory has also developed to explain behaviour.

A number of firms have focused on the idea if firms and markets as alternative means of organising production. This is known as new institutional economics. Comparing large firms to governmental agencies, Williamson showed how management man in fact limit growth.

All the above may be classified under the banners neo-classical and mainstream economics. There are three main radical alternatives; Hayekian, Schumpeterian and Marxian

Hayek and his followers, all part of the Austrian school of economics were of a very anti-interventionist approach based on the belief that important economic information is held by individuals in an extremely disaggregated way. To remain in business firms must constantly obtain information about market conditions and how they change. They view competition as a dynamic process and were thus very critical of government intervention.

Schumpeter disagreed with the theory that the economy was constantly in equilibrium. For him, minor fluctuations were important, and the dominant cause of these were technological and industrial innovation. The idea that incessant innovations by firms destroyed existing economic structures and led to new ones became known as creative destruction. If government intervention or collusion were necessary for such shifts, then they were acceptable

For Marx the accumulation of capital was crucial to both the existence of capital and to the growth of firms. Competition forced capitalists to accumulate new and better capital equipment to meet the challenge. There was a tendency for larger firms to be concentrated in the hands of fewer capitalists for three reasons. First, competition forces firms to adopt more and more capital intensive means of production. As capital intensity increases so does the minimum efficient scale. Large capitals will get the better of smaller ones. Second small firms will concentrate in industries not dominated by larger ones. Here competition rages until only the largest capitalists survive. Third the credit system is highly concentrated; larger firms are more credit worthy than the smaller counterparts.

Other alternatives to SCP the work of Porter and the work of Best are the two most frequently referenced. These approaches only in some ways constitute alternatives to SCP. Central to Porter’s work is his diamond conditions of demand, related industries, factor conditions and firm strategy. Best focuses on the internal organization of the firm.

Despite the many critics and alternatives, SCP continues to survive and there is a cross-fertilisation of ideas. There is even common ground to be found between the radicals and the mainstream economists.

Despite the importance of geography, it has largely been ignored by industrial economists. Economic geography can for example, explain why some firms choose to locate to other firms in the same industry. Krugman has done the most work on this topic, and brought economic geography towards the mainstream.

Game Theory has also become very important to the field of industrial economics. It focuses on the importance of strategic behaviour for economists. Examples include zero-sum games, Nash’s equilibrium, prisoners dilemma etc.

The SCP paradigm in its simple, linear determinist form was considered to be defective and has been revised by some and replaced by others. Nevertheless, in terms of interest in the three elements- structure, conduct and performance- the SCP paradigm continues to have an influence throughout the discipline. The theories of the firm, in many ways reflect a narrowing of focus of the broad theoretical approaches discussed above.