Abstract
Most business cycle theories originate from a paradigmatic vision with a two fold simplicity. The first of which is that firms are bound through simple relations in which they influence each other anonymously via prices but not directly through non-price rivalrous competition. And the second is that firms have immutable and transparent cores. These presumptions yield an economy whose natural state is one of stability. Macroeconomic dynamics, or change more generally, is brought about by exogenous shocks. This paper develops an alternate vision for understanding business cycle dynamics. We consider the dynamics that emerge from micro changes that originate from deep within firms. Each firm is surprised by externally visible innovations of other firms because they cannot observe each others’ high dimensional interiors. Innovations can cascade because of the complex microeconomic interrelations between the plans of firms. The interaction between external-observable attributes and internal-unobservable active cores of firms is capable of generating change without exogenous shocks.
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Notes
While older literature used aggregate shocks, modern work argues that idiosyncratic firm level shocks can generate volatility when firms are related to each other on a network (Acemoglu et al. 2012). This modern literature uses networks as a mere amplification mechanism within an equilibrium-setting (Veetil Forthcoming, Sections 4.2 and 4.3). Networks are limited to serving as a loud speaker if you will to dampen the averaging out of millions of firm innovations in a large economy (Kirman 2016, p. 14).
Nor did Darwin. As DeVries put it in the Species and Varieties: Their Origin by Mutation, “Natural selection may explain the survival of the fittest, but it cannot explain the arrival of the fittest”.
The problem is peculiar to a production economy with inter-temporal decision-making, it may be entirely absent in an endowment economy. The Edgeworth barter process for instance describes a setting without a local-global consistency problem. Consider an endowment economy with m agents and n goods. Suppose the initial distribution of endowments is not Pareto optimal. Edgeworth studied a process of successive bartering until a point is reached where no barter was possible to make individuals better off (Uzawa 1962). Note that in the Edgeworth barter process an exhaustion of gains from trade between two individuals necessarily exhausts some of the gains from trade in the system as a whole. In other words, an increase in the coordination between any two agents generates an increase in systemic coordination.
This is reminiscent of the Library of Babel as described by Borges (1962). The library contains all the books that can be written using 22 letters of the alphabet, comma, period, and space. Most books contains meaningless words strung together into meaningless sentences. Some books have a handful of meaningful words or some sensible sentences. Though the library contains large numbers of novels and scientific treatise, perhaps its own catalogue too, the vast majority of books are meaningless assortment of letters. In fact sensible books are lost among a super-astronomical number of senseless documents.
Put differently, the knowledge acquired through the market process generates creative responses that can be miscoordinating. Hayek (1937, pp. 50-51) was quite right in asserting the any equilibrating tendency of the market depends on structures of interactions that dampen miscoordinating creative dynamics.
Within an economy in which the coordination problem arises not from micro interdependence but from the presence of macro variables in micro choice functions (as in Keynesian models), one cannot meaningfully construe cascades of innovations that emerge from one firm responding to another’s changes. The ability of one firm to influence another firm by independently altering the macro variables which affect all firms is likely to be small. After all, firms no matter how large are small relative to the economy as a whole.
Schumpeter (1928, p. 382) says that the dynamics of the macro economy cannot be looked up as a “continuous process” which irons out at the discontinuous changes at the firm level. Similarly, Schumpeter (1935, p. 10) says “the phenomenon of the cycle cannot be defined and understood as a sort of average between independent changes in individual industries”.
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Reddy, K.K., Veetil, V.P. Business cycles and the internal dynamics of firms. Rev Austrian Econ 36, 43–60 (2023). https://doi.org/10.1007/s11138-020-00538-1
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DOI: https://doi.org/10.1007/s11138-020-00538-1