Problems of restructuration through competitive advantage of scale  (Economy of Scale)

Example: Large Woodmill

Size, Economic power and democracy?

after:  Impacts of gorvernment subsidies on sawmill industry in the european union. Report Helsinki, September 4, 2002. INDUFOR. European Organisation of the sawmill industry (EOS. Finnish sawmill association. http://edit.onstage.ch/holz-bois/fileupload/20021025823.pdf 

Europe is rich in forests, and gets always richer, as everywhere less is harvested than produced by regrowth. Reasons for that are, that fuelwood was replaced by petrol, wastes are ever more dimineshed and reused, more forests get protected, woodlands reconquer pastures and forest policy was most the time very conservative, preferring to keep the capital standing in the forests rather than dumping it on low-price markets. Unluckily the expectation of higher prices did not materialise and the increase in capital stocks turns into a problem. Further reasons for underuse are the lacking demand, bottlenecks in infrastructure, low profits for forest owners, badly definded ownership regulations and controll. The forests of Europe produce nowadays some 1 billion of m³ per jear, the standing volume was 39 billion m³ in 2000 and will rise to 43 billion m³ in 2020 if the situation remains the way it is.

In the period between 2000 and 2010 some 140'000 workers will find employment in woodmills, especially in rural areas. The woodmill industry is a mature industry with low profit margins. Those are even reduced by fragmented production structures and a strong dependency on economic cycles (especially the construction industry).

The throughput of a modern woodmill is between 2500 and 3000 m³ per head and year. Some older, middle.sized mill processes 800 to 1000 m³, a typical small mill 200 to 600 m³.

But this is not even the whole problem. Growth in the wood industry happens actually in Eastern Europe, favoured by low salaries and prices of standing stocks. Roundwood as sawn wood costs in Russia about half of the prices payed in the EU.

Economy of Scale & the Results of Restructuration

The production costs of a sawmill able to process 500'000 m³ per year  are about 15% lower than those of a sawmill, processing only 10'000 m³ per year.

We see the clear advantage of size, but we see as well, what most people overlook when praising the advantages of fusions: The mentioned large woodmill is 50 times bigger than the traditional small ones. A profitable large mill won't be established by the cooperation or fusion of two small  ones ... but 65% of the saw mills are small ones with less than 10 employees.

A new sawmill with a yearly throughput of 500'000 m³ will create 200 jobs - but ruin 100 small mills and so a 1000 jobs. The social costs of restructuring are 800 unemployed - with professional skills most probably not needed anymore in the job market.

The positive effect of a restructuration, the production of the mighty mass of half a million m³, 15% cheaper, with a samill that would have a strong (oligopolistic) influence on the Swiss market, diverts the added value into the accounts of other productive factors, mainly capital and (forest-)soil, while before larger parts found their way  into the pockets of the workers and so into consumption. While capital is allready rather rare in rural areas, it moves progressively abroad (at least what concerns forests).

A widespread lack of logical thinking that can totally ruin some positive effects of restructuring and lower prices is, that often the elasticity of demand is assumed to be close to 1, that means that half the price would allow to sell twice the production. (s. Preis-Menge-Gesetz in German). Unluckily the demand is very inelastic what concerns wood. If prices are halfed, not the double, but only 1.2 to 1.4 times more can be sold! So, as rational as rationalisation may sound, as irrational are often the results, when workers have to produce 1.3 times more - for 3/4 of the salary . For companies that can't rise the sales of the rationalised cheaper products, rationalisation means diminuition and often elimination. Rationalisation withoug new products and markets is economically destructive, especially if we consider the political economy.

The effects of the use of economy of scale can be seen clearly, allready without (for the local economy) gigantic sawmills:

[Data http://www.agr-bfs.ch/deu/TableViewer/Wdsview/dispviewp.asp?ReportId=235

Small and middle sized sawmills have undertaken large efforts to enhance productivity - without improving the economic outcome. While only a few new sawmills have been created, lots of the small ones disappeared, and many jobs with them. Practically the total of additional processed wood went to large sammills, that were even able to reduce the number of employees further. Economically those facts can't be denied or changed. Our economy is a darwinian one, where the large ones eat the small ones. (The very agile velociraptors, able to attack giants, cut their bellies and eat them, are the famous exception that confirms the rule. Moreover the picture does not take into consideration, that a life among velociraptors looks not quite attractive.)

Moreover, the law of the economy of scale is not alone in favouring size. It is helped by the verdoorn law, stipulating a positive connection between productivity and growth of productivity. This one as well works perfectly. The larger mills are able to attract larger parts of the production - what offers them additional potentials for rationalisation. And here we got precisely the reason, why the so called free market tends to monopolies - if not submitted to some political control.

Conclusion: Economic liberalisation and globalisation enhances monopolies, at least regional monopolies! And that is the background to interprete their promises and programms.

What would be reasonable in respect to job creation and the distribution of wealth, what would be needed to diminish transports and enhance regional autonomy, is precisely opposed by what the free market creates by itself. If nowadays we claim that the establishment of a sammill with a capacity of 1 million m³ per year is economically unavoidable and will have very positive effects on the Swiss forestry, because this is the standard size in Germany, so tomorrow it will be a sawmill with 2 or 3 million m³ and after tomorrow one single sawmill for all Switzerland, a local and national monopoly, because only this size has still a (small) chance to survive on the global market. The effects on transports, wood- and job market you may guess yourself.

As "right" as structural adaptation is following the rules of the production market and trade, as stupid it is from the perspective of jobs and consumption:

While neoliberal economists, the majority today, present structural changes as a blessing the market offers to humanity, those mean in reality an ever fastening need of adaptation of people to the market - instead of the opposite. Instead of the market serving the people, the people serve the market, as earlier they served God, his representatives on earth and the worldly lords.

Size, Economic Power - and Democracy?

The example given above can easily be used to show, that free markets go hand in hand with the concentration of power rather than with democracy. (Note, that the international giant of forest and wood industry (place 344), Weyerhaeuser, sets the international standard for productivity, a sice and productivity almost impossible to reach for any Qwiss producer.

So, why are the USA the  most emphatic promoters of global trade? For humanitarian reasons? Because they wish that each world citicen is able to eat hamburgers? Or because their economy is large enough to influence or even steer the global economy? The largest economic space has the largest firms and the best chances, to profit from the economy of scale. But, what does this have to do with a reasonable economy, meaningful production and efficiency? Especially what concerns goods that have to be produced and used locally as grass, wood  and many other agricultural goods? What rules here is not an economic rationality (except if you define as rational to submit to the stronger), as the economists want to make us believe, but only economic power.

If we relate economic power to the surfaces the countries occupy, we get some additional interesting insights. The dominating economic areas as USA, Japan, UK, France and Germany, produce enormous amounts of goods and services on relatively small areas with a relatively small population. Russia, Canada, Australia produce on enormous spaces rather little. Outstanding are especially the population powers China and India, that, with each over a billion of people, do not (yet) dispose of a correspondent productive potential.

As well it gets clear from the presentation of the 33 largest economies on the right side, that South America, Africa, the Middle East and Russia most probably have some enormous, so far unused, potentials.

But it gets clear as well, that the economic use of Europe is allready very intense, much more intense than in the USA, in spite of the economic barriers posed by a multitude of languages and cultures - still there after the unification. This kind of natural barriers to growth should not be forgotten in the run for growth, if we do not want to use up the last remnant of nature.

What concerns the wood market, the map shows, that wood use most probably did by far not reach its climax. With the realisation of the development potentials of Asia, Africa and South-America, especially with increasing numbers of people settling and constructing houses in towns, their might be a gigantic demand for wood and wood products. Even if Switzerland is far from delivering wood to those markets, the result might still be, that the prices will reach again levels that cover at least production costs. To de-structuralise our forest- and wood industry, because in this forcibly passing phase prices are formed by extraction costs allone, would be careless.
 

for enlargement click on the picture

We see that, precisely because of the effects of the economy of scale, no branch can avoid the trend to size and power. Even branches where indeed regional economy should prevail, as food and retail, created giants, that lower the market prices to levels, where small competitors can not compete.,

That Microsoft occupies here only a position in the middle, while Gates is the richest world citicen with the highest income, shows, that a market-dominating position, combined with a sharp hierarchy of added value distribution (much income, little jobs and work), allows to cream off profits not justified by efficiency of efforts.

Remarkable as well, that even small Switzerland produced a few of those giants:

31 Credit Suissese

55 NESTLE

59 UBS

194 ABB

235 SWISS RE

257 NOVARTIS

288 ROCHE

375 Swiss Life

427 MIGROS

Coop missed the ranking short. Together the two have 2020 of 6083 retail shops in Switzerland and make half of the turnover in foodstuff of all Switzerland. This makes the competition so expensive and risky (s. sunk costs), that only a few have the means and can afford that. To speak of free market under such conditions is nothing but a bad joke.

An interesting comparison has been delivered by Tagesanzeiger: Marcel Speiser - Die Händler und die Macht [The Merchants and the Power] (Tagesanzeiger, 25. Juni 2004, S. 31), Titel: Sonderfall Schweiz [special case Switzerland]. What might one expect under such conditions from more restructuring? One single company covering 70% of the whole market?

For shure those giants have to survive international competition. But as shure is, that they are massively oversized what concerns their influence on the local environment, on the Swiss market.

While the largest one, Walmart, makes a turnaround of 220 billion $ with a market of some 270 million people and a gnp of som 10 trillions of $, so 2% of it, Migros makes a turnaround of 10 billion within a market of 7 million people and a gnp of 250 billion $, what represents 4%, so the double. The same is true for banks, insurances, etc. There is little to wonder, why the USA see little problems, what concerns the trend to size, because their economy is quite a different one from the rest of the world. Migros has in Switzerland twice the influence as the worlds largest firm, Walmart, in the USA, what concerns jobs, salaries, prices for foodstuff and of a large part of basic supplies. Bevore running after the USA, assisting their globalization efforts, those differences should be taken into consideration, and they should be taken serious. Do the USA have a bank with a turnaround of 20% of the gdp, what would be comparable to the UBS in Switzerland (that just those days claims record profits and new restructurations, with large cuts in jobs ...)? Does not the local and regional orientation suffer under the global one?

Such economic powers are a kind of state in the state. Moreover without the political split of powers into legislation, execution and justice. The international market plays the legislation, whose laws may be bought with sufficient money. Market powers disturb the market as much as political actions, if not more. The accusations of the political right wing against the state are often deaf on one ear and blind on both eyes, what concerns real power.

Here, using economical basic laws without critique, structures are being created that put ever more power into ever less hands. Instead of objective analysis, most economists deliver base flattery on the blessings of restructuration. They do not check, if the effects of the processes discussed here are wishful, at least useful - or even destructive. Control or steering of such processes is dismissed as bad, before anyone did the slightest analysis.  Not only newspapers, but even a majority of professors, praise such a development by the free market as the singers in the middle ages praised their kings. And most of them dare as little to utter critique as those dared to critizise their lords.

An interesting by-product of the analysis of international wood markets shows the influence of market-dominating powers:

What concerns fuelwood it is Asia that claims more than half of the worlds consumption, followed by India, China and Indonesia, that together use 71% of Asia's fuelwood.

In America its especially Brasil, in Europe Russia, but by far not with the same domination we find in Asia.

What concerns roundwood, the USA is dominating the world markets, followed by Canda. In Asia its China, Japan, Indonesia and India that use the largest amounts of roundwood.

Comments: One additional reason, besides the internal rationalisation, that favours large companies, is their better access to international markets. The analysis of economic trends of KOF (Konjunkturforschung ETH) shows, that companies with more than 200 employees have since one year some 5% higher orders than those with 50 to 200 employees. Compared with the small companies with less than 10 employees the difference is over 10%. The same holds true for production increase. Small companies that work on local or regional level, what in fact should be considered as the sustainable level, are cut off from international economic booms.

s. CASH Enterprise 13. Mai 2004, S. 3

Here we need a much tougher check of competition (mainly competition eviction) and cartels. The control of size was introduced in the USA first time 1914 with the Clayton Act, enlarged 1976 with the Scott-Radino Antitrust Improvement Act. But in the USA, as elsewhere, mergers are favoured by taxlaws. Inconsistency rules. As economy favoures efficiency and as efficiency is enhanced by size and global power, the existing antitrust laws can't stop the creation of private economic powers. That means, the market is not free but a system similar to the mediterranean feudalism.

The solution won't be simple, and so far its not to be found in economic textbooks. Still its important to recognise, that the solution can't be to follow, blindfoldedly, the rules of the market. Its exactly this behaviour that creates the majority of our present problems. We have here an old problem of democracy, whose solution still has not been found: What can a democracy do, if restrictions of freedom are acceptable for a majority? That happened in democratic Germany under Hitler, that happened in the new democracy of Algiers under the islamic fundamentalists, that happens in the USA under (media ballooned) threat of terrorism. Neither the dictatorship of politics, nor the dictatorship of money, nor the dictatorship of big business promise really a free development.

The dear market does not have the slightest intention,
to fulfill the role transfered to him by the liberals,
the role as benign invisible hand

That means we have to work at better solutions, most probably at a better optimisation between market and politics

Dominance of giants means a loss in diversity. A loss in diversity means a loss in quality of life.

Competition leads either to mergers, or to exclusion and the destruction of the small. The need for masses of customers leads to a strategy of mass-products, and to an adaptation to mass-taste (or to an adaptation of the masses taste to one's product). That means that size leads to lower prices on the one side - but it leads to the reduction of choice on the other side as well. Where size rules, the tastes have to be levelled. Levelling means a loss in quality of life and economic welfare.

But not only the tastes are levelled, opinions as well.

This loss in choice, what is a loss of freedom, might induce natural counteractions to the rule of the great.

Pascal Vandenberghe, General Director of Swiss bookshop Payot uttered a sentence, that shows how close advantages of size come to its disadvantages:

If you have to sail over the ocean, the trip is much safer in a big ship than in a small boat.

Well, shure, but:

1. who wants to sail over the oceans? And:

2. big ships make big waves, when they sink

3. big ships are only useful for mass transports

4. big ships are useful on the sea - but totally useless for inland traffic!

Martin Herzog, Basel, 17 march 2005