In a previous post, I discussed the fundamental qualities of a great business – Productivity & Uniqueness . However these qualities are internal to the business and can be driven/controlled by people within the business.
There are some qualities that lie outside the business, in the external environment that can substantially determine the course of the business.
- Size of market
- Regulation
I will start with a macro example of countries and extrapolate it to businesses. Growth accounting for countries helps split growth into (decreasing order of impact)
- Intermediate inputs (division of labour)
- Capital
- Labour
- productivity
classical theory and Chinese growth
One of the key drivers that drive productivity & output is – division of labor (classical theory of Adam smith). The hypothesis is that specialization drives improved efficiency and also helps with technological advances in each sub-specialization.
Size of market
For division of labour to be viable, one of the pre-requisites is a large scale market. A clock -maker cannot implement division of labour, when the total size of his market does not warrant it. A ready-made way to increase the size of the market for countries is international trade. This increases the potential customer base/output and can lend itself as a segway for the division of labour.
Regulation
The second pre-requisite is the investment of capital stock. One of the over-arching requirements to support capital investment is “social infrastructure” / regulation. It determines if people are ready to sacrifice consumption for future gains. If the regulation ensures that private sacrifice and capital investment will result in commensurate returns on the capital, it will spur the investment of capital stock (physical & human) http://web.stanford.edu/~chadj/pon400.pdf
The mechanics
Now given the two prerequisites of a “large market” and “favorable regulation”, how would division of labor result in growth?
- Capital investment leads to increase in stock e.g.: garment maker with one handloom, invests in a second machine (physical capital). And trains one more employee (human capital). This will result in increased output, assuming constant stock per worker.
- This can drive productivity eg: specialization in a different looming process, ensuring that worker 1 works only on production of cross-weaves and worker 2 works only on the production of plain weaves. This eliminates setting up times, change-over time, efficiency from increased experience etc.
- Increased capital/stock per worker can also give productivity gains Eg: the garment maker invests in a computer to simplify accounting. And in his free time uses the computer explore better ways of looming. (Research & development)
This is the typical course of productivity, technology enhancement and economic progress. I think it is relevant to re-iterate what economic progress is defined as. http://gregorynitin.blogspot.in/2012/10/basically.html
Interesting reading about an alternate view. Myth of Asian miracle
Some pointers for companies and countries
- Try to increase the size of market (trade/expansion)
- Look for regulatory environments where the focus is on creating value and not distribution of value (capitalist light touch regulation)
- Focus on improved productivity & uniqueness to increase returns on capital ( Eg: Cost , R&D)