I’ve mentioned this paper by the legendary Nate Rosenberg before on this site, but I’ve recently reread it and want to discuss in slightly more depth. The problem is the following: why do firms and inventors choose to invent what they do? A classic argument appearing throughout the 1800s and early 1900s is that firms try to invent labor-saving technology when labor is dear, and likewise when capital is dear. But Samuelson (aka the GOAT), among others, points out that this argument is wrong. In equilibrium, factors are used until the price of the factor equals marginal factor productivity, so there is no sense in which a factor can be “more expensive” than any other factor. Even out of equilibrium, firms increase by profits by lowering costs, full stop, and it does not matter how those costs are lowered.
Problematically, both (wrong) intuition and many, many statements by inventors claim that “high” factor prices induced inventive activity. How can this paradox be resolved? Rosenberg discusses three ways in which day-to-day routine at a firm can focus attention on particular problems, thus resolving a firm’s indifference about where to direct inventive activity. These explanations are compulsion, avoidance of uncertainty/hold-up, and shocks.
By compulsion, we mean that, particularly in manufacturing, there is an “obvious” next invention. That is, high powered rifles in the 1850s were quickly followed by armored shielding on ships, and high-speed steel in cutting tools was quickly followed by beds and slides that could handle such rapid movement. You (not Rosenberg; he is one of the last remnants of the informal narrative in economics) might model this by letting the arrival rate of new inventions increase after similar inventions appear, since the idea is now, in some sense, in the air.
By avoidance of uncertainty, Rosenberg (and, in much of his writing which takes a similar tack, Marx) generally means worried about strikes will induce research on labor-saving technology. There is massive anecdotal evidence to this effect. It’s tough to model this formally for a risk-neutral profit maximizer, however; at least, I don’t see how it can be done. Note that if you have a model that works here, Rosenberg has a footnote discussing application of the idea to a broader class than just labor: for instance, frequent disruptions in water supply in the 19th century may have been important in the introduction of steam powered mills.
Finally, shocks can induce invention when a factor disappears for some external reason; e.g., World War II led to unavailability of SE Asian rubber in the US, and is often said to have led to the development of the synthetic rubber industry there. Again, you need more than a factor price explanation here. Rosenberg is definitely not saying that constraints make invention easier or anything similar; he’s merely claiming that, since firms are agnostic about which factor they should use more efficiently, the external constraint may focus managerial or inventor attention on one particular factor.
I still believe (as I perhaps too often say here) that invention is the most critical part of the economic world of which we still have a poor understanding. Perhaps this article will induce some research of your own?
http://www.jstor.org/pss/1152198 (360 citations, but I can’t find a non-gated version. Our copyright policy is complete nonsense.)
Not sure I get Samuelson’s argument. Fine, the price ratio of labor/capital is the same as the ratio of marginal productivity. Whatever you call it, this ratio will affect incentives for invention.
On the micro level, a firm takes the price ratio as given and picks their technology so the MP ratio matches. So on the micro level, it really is price that’s the exogenous factor and everything is determined by it. Where am I misreading the GOAT?
Could you ponit the original article by Samuelson? I’m with Weinstein here. I’m likely missing something, but what?
Samuelson’s comment is discussed in the first couple pages of the Rosenberg article. All he’s saying is that there is no distinction between “expensive” and “inexpensive” factors of production: all are paid their marginal product. So a firm that can invent a technology which reduces the need for labor, saving $10 per unit of output, is completely indifferent between that technology and one which reduces the need for capital, saving $10 per unit of output.
I’m with the others in not finding this satisfactory. If, of the $1000 it costs to produce a unit of output, $900 is cost of labor and $100 is cost of capital, then to save $10 per unit of output you need to find a way of using 10% less capital, but only 1.1% less labor. So unless it is ten times easier to reduce capital requirements than labor requirements, a firm in this situation will focus much more attention on using less labor.
No doubt I am missing something very elementary.
Here’s the full Samuelson/Salter/etc argument. A shock hits labor costs, making them “relatively expensive”. The firm changes their allocation of labor and capital in the production function to a new optimal level. At this new level, every factor is being paid its marginal product. So even though a shock hit labor costs, there is no sense in which labor or capital can be an expensive or a cheap factor for a firm when all are paid their MP.
what you have in mind, I think, are some of the later models which essentially assume a frontier of possible inventions that is static, and that save a percentage of factor costs if implemented. Then if the *share* of labor cost increases in a firm’s production function, it will reallocate R&D effort toward labor-saving new technology. That’s fine. But the Samuelson/Salter/Rosenberg critique, and the original Hicks (among many others) argument about invention inducement has no model at all of invention frontiers. Rather, it argues that a shock to labor costs will make labor relatively more expensive for a firm, and they will want to find R&D to reduce use of the expensive factor. Once you remember that firms will reallocate labor/capital use at the new prices to equate marginal products, then it’s clear that argument makes no sense.
[…] theory suggests this argument is not totally correct. As discussed on this blog earlier this year, Samuelson pointed out decades ago that there is, from the perspective of a firm in general […]
“The problem is the following: why do firms and inventors choose to invent what they do?” … “But Samuelson (aka the GOAT), among others, points out that this argument is wrong.”
Having read your article on vagueness, your use of the words “points out” rather than “disagrees with” implies an inference of irrefutable fact, rather than merely an opposing argument. I happen to disagree with your irrefutable fact.
Unless I misunderstand, the gist of your question is “Samuelson establishes as irrefutable fact that innovation is profitless, which poses the question, why do entrepreneurs continue to do it?”
Getting to the discussion you were seeking, there are many reasons that people invent things:
1. Benjamin Franklin invented the lightning rod out of an altruistic desire to save lives (after a dinner party where a woman seated immediately next to Betsy Ross was insta-roasted by lightning to the point where the woman’s fork melted — a rather gruesome thought).
2. Henry Ford perfected the assembly line in order to make cars for the masses, choosing to pursue absolute profit rather than merely profit margin.
3. Christopher Columbus developed his theory of a seaward trade route to India in hopes of reaping the potentially enormous profit to be gained by such an endeavor. Not only Spain, but England also agreed (save that Spain merely said yes first) to finance what they knew to be a suicide mission, but given the magnitude of the potential reward, were nonetheless willing to part with the substantial investment.
4. Eli Whitney invented the “Saw” cotton gin (many other kinds of cotton gins existed prior, dating back to 15th century India) for the purpose of capturing the cotton cleaning industry. Whitney did not intend to sell the machines, but rather, intended to own and operate cotton cleaning services for fee.
5. Stanford Ovshinsky originally studied the electrical properties of amorphous materials as an inquiry into the mechanisms of the human brain.
In none of these examples was the innovation explicitly nor directly made for the purpose of labor saving. However:
1. Old Ben found that there was a huge market for his life saving device, increasing his wealth by a considerable margin from his ownership of the patent.
2. In the case of Ford, Samuelson’s “fact” is directly proved wrong: Ford could only maximize profit by INCREASING the per-unit labor factor cost – from $2.50 per day to $5.00 per *shorter* day (i.e.. by about 120 percent per person-hour), directly resulting in Ford becoming the 3rd richest man who ever lived.
3. Old Eli Whitney never ended up seeing a nickel on the Saw cotton gin (the plantation owners merely stole his patent design and built their own), but his invention had the backfire result of massively increasing demand for CHEAP labor.
4. Columbus never made it to India, but we all know the rest of that story.
5. Ovshinsky never figured out how the brain works, but he discovered the first amorphous (non-crystalline) semiconductors, from which his company now produces low-cost solar panels.
It appears from this short list that many innovations do not ultimately achieve the goals sought, while others discovered profitable markets though not originally contemplated for profit. However, many other innovations were directly contrived and succeeded in being profitable, while many others failed.
Benjamin Holt invented the caterpillar track, (which made the bulldozer possible) for the purpose of drawing larger loads than were feasible by horse-drawn apparatus. It is to be noted that this invention was developed AFTER most of the avenues of cheap labor had been foreclosed (i.e. a “shock” to the cost of labor), namely by the Thirteenth Amendment, the Chinese Exclusion Act, and the Alien Contract Labor law.
One notable property of inventions and innovations is that they tend to come from individuals, not firms — inventions are nearly universally the product of a single mind — the idea synthesized from component ideas forged in one and only one mental factory. With that in mind, some firms hire R&D staff to generate proprietary “think tanks” for the purpose of profiting from owning the rights to whatever is produced. The transistor was invented and developed in-house by scientists on the payroll of Bell Laboratories, for example.
So what is the relationship to dear labor? Well, consider this… suppose that in one closed economic sphere, all laborers enjoy zero profit – they all earn barely enough to provide for mere sustenance, and no more. What kind of market demand would such a workforce constitute? Obviously, only that market which most directly and inexpensively facilitates such bare survival. Such a workforce would itself surely constitute no kind of market demand for innovations such as refrigerators and televisions.
On the other hand, in a “dear labor” market, where a substantial amount of the employing firm’s profits ends up in the hands of the worker, the market for labor saving innovations explodes. Dishwashers, washing machines, vacuum cleaners, refrigerators, and cars are all examples of personal labor saving devices, allowing the worker to spend less time on providing for, and more time on enjoying life. With more time to enjoy life, this creates an additional market demand for innovation for devices that inexpensively provide for entertainment. Essentially, dear labor spreads the wealth around, and thus creates a more robust market, which, in turn, demands even more labor, thereby increasing yet again the demand-side competition for labor, which yet again in turn increases its price. This creates a yet larger market for innovation.
I have not read Samuelson. Does he even mention competition?
Different firms in the same business invest radically varying amounts into R&D. There does, however, appear to be an underlying factor that correlates R&D expenditure as a percentage of revenue to one scalar attribute of the respective firms: percentage of closely held shares (CHS).
Firms with high percentages of closely held shares, such as (until very recently) Microsoft and Toyota tend to invest more in R&D than firms with relatively few closely held shares by percentage, such as Procter & Gamble and General Motors. I would argue that the common thread here is long-term versus short-term profit views. The long-termist would see that future growth would depend heavily on innovation, whereas the short-termist would be more concerned with this quarter’s profits. Consequently, since R&D is a risky venture that would not pay off for years, and possibly never, companies with short-term priorities would eschew R&D in favor of cutting costs. Companies with long-term priorities would do rather the reverse.
I would argue that it is for this reason that the Prius (representing over 10 years of R&D) was developed by Toyota (well over 20 percent CHS) rather than GM (less than 1 percent CHS), just as Mac and Windows were developed by Apple and Microsoft respectively, while such ideas were scrapped by Xerox and IBM respectively, as promising too little payoff in the short term.
[…] old and incorrect answer, previously discussed on this site, is that innovation will replace “expensive” factors of production. If labor is dear, […]