BUSINESS FIRMS AND ECONOMIC GROWTH

the first industrial revolution
relationship to economic growth
the second industrial revolution
big business and the wealth of nations
bibliography

The business firm was the basic building block of the Western world's economic growth during the First and Second Industrial Revolutions. Its evolution has been often disregarded, and historians have generally emphasized issues related to technology and/or to the social transformation introduced by the industrialization process. Historians have also been more inclined to examine the macroeconomic effects on general indicators (demographic or economic, for instance, the gross national product [GNP] growth rate) of the revolutions in production and trade that occurred from the early nineteenth century than the transformations that occurred at a micro-organizational level.

From the beginning of the First Industrial Revolution to World War I, almost everywhere in the West the business enterprise was radically transformed, both in its internal structures and processes and in its relationships with the external environment. The sources of these changes were both technological and related to changes in the size and dynamism of the market. To achieve its goals the firm had to become innovative at the production and organizational level. In this process entrepreneurs played a central role.

the first industrial revolution

The mechanized factory in which hundreds of salaried workers were concentrated started to be diffused during the First Industrial Revolution (which occurred in Britain roughly from the last decade of the eighteenth century to the 1850s), replacing (although not completely) the old system of production based on craftwork and putting out. The "rise of the factory" as the dominant organizational form is one of the most intriguing issues in business and economic history. The main explanations emphasize (1) the requirements of the new technologies of production (economies of scale and division of labor); (2) the inadequacy of the previous organizational forms to cope with an increased dynamism in market demand (transaction and information costs); (3) a more efficient exploitation of the workers by the entrepreneurs; and (4) the radical change in the nature of knowledge, which had to be transmitted through new processes that called for a centralization of training. In legal terms the transformation was much slower: for a long period, from the beginning of the Industrial Revolution to the second half of the nineteenth century, in fact, the individual firm and the partnership (very often based on kinship ties) remained the rule, while the diffusion of the joint-stock company was limited all over Europe because of legal obstacles. The persistence of simple legal arrangements, based mainly on the family, points to the limited capital needs and governance structure of the business firm during the First Industrial Revolution, as well as the need to cope with a high degree of uncertainty in business activity. At this stage the mechanization of several parts of the production process in textiles and fundamental innovations in mining, metalworking, and mechanics did not require increases in investment; a single wealthy individual, sometimes in partnership with an inventor, could typically afford the required capital. Individual or family patrimonies accumulated from commerce or land were enough to sustain the needs of investments in fixed and working capital, other sources of finance such as regional banks being active mostly locally. The scarce integration of the production process (merchants, for instance, were still distributing manufactured goods to the final customer) made it possible for the owner-entrepreneur and his partners to manage directly all the aspects of the activity with just the help of foremen. The result was to create an organizational structure characterized by elementary information flows, reflected in double-entry book-keeping accounting methods.

Another feature of the low degree of integration of the production process was the tendency of business firms to cluster geographically to minimize transportation and communication costs and to link external economies, for instance, in terms of human capital availability, knowledge circulation, and transport facilities. European industrialization was more a regional than a national process. "Industrial districts" and specialized production areas were present, sometimes crossing borders all over the Continent, from the British Midlands (metalworking) to Alsace (metalworking, textiles, and mechanics), from Lyon (silk production) to the pre-Alpine region in northern Italy (silk, cotton, and wool production, metalworking, furniture). This resulted in an industrialization pattern committed more to product differentiation than to standardization. This orientation toward specialization would remain a permanent feature of European industrialization well into the twentieth century in industries such as engineering that elsewhere were undergoing processes of integration and standardization. This was particularly evident in Italy and France where the roles of small specialized firms and the industrial district remained prominent throughout the twentieth century.

relationship to economic growth

The relationship between the diffusion of the business firm and economic growth is evident when national economies are taken into consideration, even if there were significant differences in the timing of the takeoff and in the degree of development introduced by the industrialization process. Around 1860, the production of raw cotton in kilograms per capita was 15.1 in the United Kingdom, 2.7 in France, 1.4 in Germany, and only 0.2 in Italy. More striking are the figures for iron production: 54 kilograms per capita in the United Kingdom, 25 in France, and 14 in Germany. Other general estimates of the degree of industrialization put Britain first, with a level of industrialization more than three times that of Germany, four times that of France, and around ten times that of Italy. Not surprisingly, in the latecomer countries these differences soon called for the intervention of the state to fill the gap. This was the case in Italy and Russia, and partially in Germany, countries in which the state contributed heavily to the industrialization process, through tariffs, contract subsidies, and other kinds of support. The relationship between the nature and structure of the business firm and the process of economic growth was revolutionized by a radical transformation in production, communication, and transport technologies, which had an effect on strategies and hence on the organizational structures adopted by the business firm itself.

the second industrial revolution

The impact of the transport and communication revolution on the business firm was also notable in Europe. The new technologies of production typical of the Second Industrial Revolution (starting in the United States and diffusing among the industrialized countries during the last quarter of the nineteenth century) were adopted in many industries, such as steel, chemicals, and food processing, while the spread of the railway network at a national and transnational level fostered the formation of a wide system of distribution that made it necessary for large corporations to adopt economies of scale, as was happening in the United States. Europe adopted the new technologies and strategies of the Second Industrial Revolution in capital-intensive industries, but with radical modifications. There were marked national differences in the degree of diffusion of large firms in Europe for a number of reasons, including the dynamism and dimensions of the national market, the dominant business cultures of each nation, and the type of national industrial specialization. Germany quickly took a leading role in this process, while other nations that had led the way during the First Industrial Revolution, such as Britain, as well as latecomers such as Italy, experienced many difficulties in the new environment, and instead of adopting the large, integrated enterprise, they maintained an industrial system oriented toward small and medium-sized firms and specialization of the production process. But large firms in modern, concentrated industries were nevertheless needed to stay among the most industrialized nations. Almost everywhere in Europe this meant a further involvement of the state through various economic policies designed to increase the competitiveness of the industrial system, ranging from financing to direct intervention through the creation of state-owned enterprises.

From the beginning, the European route to the Second Industrial Revolution was slightly different from the American one, giving rise to a particular version of capitalism now commonly known as Rhineland capitalism to stress its Continental origins. The first difference was in the governance system; the European corporation has generally been characterized by the persistence of family leadership, very often accompanied by collaborative relations with the trade unions, and normally by close links with a powerful financial institution providing the owner-entrepreneur some of the resources necessary for the firm's growth and integration. As happened in the United States, the legal structure of the large firm also changed from the individual firm and partnership to the joint-stock corporation, which came into general use in Europe in the late nineteenth century.

Until the eve of World War I, the market for corporate control remained generally reduced almost everywhere, and the separation between ownership and control remained as well, resulting in the diffusion of the large family firm as a Continental model of management associated with companies that were in general smaller than their American counterparts. For instance, in 1912 the median market capitalization of the largest U.S. corporation, U.S. Steel, was $757 million, more than twice that of the largest British corporation, J & P Coats, and five times that of the German steel company Krupp. In the same year, the top hundred firms accounted for 22 percent of the net manufacturing output in Germany, whereas the same figure was 16 percent in Britain and only 12 percent in France. Another feature of the European capitalism of the Second Industrial Revolution was the diffusion (sometimes on an international scale) of cartels and other cooperative agreements, aimed at regulating the competition among the large firms to reduce uncertainty.

big business and the wealth of nations

The advent of the large business firm typical of the Second Industrial Revolution meant a further change in the equilibrium among the most industrialized nations of the Western world. Germany's capacity for meeting the requirements typical of the new technologies of production (high and constant throughput, a wide distribution network, and backward/forward integration policies) made that country the European leader of the Second Industrial Revolution, surpassing Britain in terms of economic growth and dynamism. Notwithstanding the relevant contribution of the small firms and of the specialized industrial districts, on the eve of World War I the correlation between the presence of large firms in capital-intensive industries and a country's economic welfare was indisputable. By 1913 the rankings among the leading nations had been transformed, with Germany now close to Britain (the industrialization index standing at 115 in Britain and 85 in Germany) and the others lagging far behind (the same index showing 59 for France, 36 for Italy, and only 20 for Russia). Germany by 1910 had overtaken the United Kingdom not only in steel production but also in the share of world industrial output (in 1870 the British share of the latter amounted to 32 percent, the German 13 percent; by 1913 the percentages were 14 and 16, respectively). More interesting, however, are the indicators of aggregate economic growth during the period from 1870 to 1913, which show the close relationship between the presence of big business and the wealth and welfare of a nation. Throughout this entire period, the average annual American growth rate was 2 percent, the German 1.6 percent, the French 1.5 percent, and the British only 1 percent, reflecting a relative decline of the country that had led the First Industrial Revolution, as well as the rise of the European champion of the Second Industrial Revolution, Germany.

See alsoEconomic Growth and Industrialism; Industrial Revolution, First; Industrial Revolution, Second.

bibliography

Boyce, Gordon, and Simon Ville. The Development of Modern Business. London, 2002.

Chandler, Alfred D., Jr., Franco Amatori, and Takashi Hikino, eds. Big Business and the Wealth of Nations. Cambridge, U.K., 1997.

McCraw, Thomas K., ed. Creating Modern Capitalism: How Entrepreneurs, Companies, and Countries Triumphed in Three Industrial Revolutions. Cambridge, Mass., 1997.

Micklethwait, John, and Adrian Wooldridge. The Company: A Short History of a Revolutionary Idea. New York, 2003.

Pollard, Sidney. The Genesis of Modern Management: A Study of the Industrial Revolution in Great Britain. London, 1965.

Rosenberg, Nathan, and L. E. Birdzell, Jr. How the West Grew Rich: The Economic Transformation of the Industrial World. New York, 1986.

Schmitz, Christopher J. The Growth of Big Business in the United States and Western Europe, 1850–1939. Basing-stoke, U.K., 1993.

Andrea Colli