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Experience curves and industrial policy
International Journal of Industrial Organization 1 ~1983) 95-106. North-Holland
EXPERIENCE
CURVES
AND INDUSTRIAL
POLICY
P.E. H A R T *
University of Reading. Reading R G6 2.4 A. I_:K Experience curves purport to show that average real price or costs of a product decrease with its cumulative output and are used to justify increases in industrial concentration on efficienc) grounds. But the published evidence for their existence is not always convincing. Even if they do exist, they are merely mongrel relationships reflecting many economic forces including lechnical progress and economies of scale in addition to "learning" or "experience'. The3 should not be generalised to all products or be used to underpin industrial policy.
1. Introduction T h e last L a b o u r G o v e r n m e n t ' s G r e e n P a p e r (1978), A Reriew o/ Monopolies and Mergers Policy, c o n t a i n s a m o s t interesting a p p e n d i x on E c o n o m i e s of Scale a n d L e a r n i n g Effects. T h e c o n c l u d i n g p a r a g r a p h s on the significance for c o m p e t i t i o n policy claim that the c o m b i n e d effects of e c o n o m i e s of scale, learning effects a n d technological progress lead to increases in i n d u s t r i a l c o n c e n t r a t i o n 'which confers on the leading p r o d u c e r a real cost a d v a n t a g e a n d it is this real cost a d v a n t a g e which m a i n t a i n s its s u p e r i o r profitability r a t h e r t h a n e x p l o i t a t i v e b e h a v i o u r in the m a r k e t or i m p r o p e r restraints on c o m p e t i t i o n ' , t T h u s references to the M o n o p o l i e s and M e r g e r s C o m m i s s i o n which hinge on the profitability of d o m i n a n t suppliers should give due weight to this e x p l a n a t i o n of their higher profitability. T h e theoretical a r g u m e n t s that e c o n o m i e s of scale and technological progress p r o d u c e increases in industrial c o n c e n t r a t i o n and profitability a p p e a r in s t a n d a r d t e x t b o o k s . But the effects of learning curves are not given sufficient e m p h a s i s in e c o n o m i c s t e x t b o o k s , even t h o u g h W r i g h t ' s learning curve b a s e d on airframe p r o d u c t i o n d a t e s back to 1936. 2 T h e experience curve is a g e n e r a l i s a t i o n of the learning curve p r o p o s e d by the Boston *This is a shortened version of a paper given at a meeting of businessmen, civil servants and academic economists at the National Institute of Economic and Social Research. There were three papers which, together with a summary of the discussion, were issued as Discussion Paper No. 45 of the N.1.E.S.R. I am deeply indebted to all the other contributors to this symposium and to the anonymous referees of this journal for their most helpful comments on my paper. 'Green Paper (1978, p. 86, para. 24). 2Wrigh! (1936). 0167-7187/83/0000-0000/$03.00 © N o r t h - H o l l a n d
P.E. ttart, Experience curves and industrial policy
96
Consulting G r o u p 3 (1972). It may be written
C, =o~
Q,
,
t = 1.....
(1)
where Ct is average cost, ~ Q t is accumulated output, and t is a time subscript. 4 BCG (1972) apply it to twenty-two U.S. manufactured products. to U.S. electricity generation and to Japanese beer. The Green Paper (1978) provides ten more examples of (1) prepared by BCG relating to two U . K manufactured products (float glass and refrigerators), to four more U.S products, to one West German and one Japanese product, and to two U.S service trades (advertising and life insurance). These generalisations extend the analysis far beyond the airframe industry, in fact even beyonc manufacturing industry itself. Representatives from BCG who participated ir, the National Institute symposium claimed that,their work brought them int~ contact with many experience curves as in (1) which could not be publishe(i because of the confidentiality of the data. Businessmen at the symposiun". argued that their firms found experience curves very useful and of cours~ they backed their opinions by providing the confidential data and paying fo analysis in the form of experience curves. As an example of an academic us~ of experience curves, a recent paper by Spence (1981) may be cited. Clearly experience curves have aroused widespread interest. The present paper makean economic appraisal of published experience curves and of the implication-, for industrial policy drawn by the Green Paper (1978). Sections 2 and i, discuss the experience curve in terms of prices and costs, while section ,~ reviews the implications for industrial policy. 2. Prices and the experience curve
In the Green Paper on Monopolies and Mergers Policy (1978) the pric~ curves of the Boston Consulting G r o u p decline with increases i: accumulated output, but the rate of decline is usually slow at first and the~ followed by a much faster decline. These breaks are attributed to the decisio~ of the leading producer in each industry (who has lowest costs as the resu:' of greater experience) to go for a larger market share at the expense (~ smaller and less experienced producers who were previously sheltering und¢' the 'price umbrella" of the market leader. 5 This kinked price curve refers t, 'Hereafler also referred to as BCG. ~BC(; 11072~define costs on pages 64 65: ~change in accumulated cash flow divided by chant: in a,:cumulated experience'. The denominator is Q,. The definition of cash flow in the numeral~, i, n~t exactly lhe same as accounting costs, which defer some reported costs (by capitalisatio~ tmtil rc~enue,~are realized, hut over large volumes these differences average out (p. 64). "(;recn Paper{lqT~.p 85. para. 221.
P.E. lfart. Experience curl:e.,; and industrial policy
97
'the majority of industries' according to the Green Paper (1978), p. 85). although in some technology based industries, where the patents of the leading producers expire, a reverse sequence occurs with new entrants decreasing the market shares of the leading producers. Thus there are economic reasons for extending the experience curve from costs to prices, in addition to the statistical reason that average industry price data are more readily available than average cost data. In terms of prices, the experience curve is written log P, = ~t- fl log ( ~ Q,),
(2!
where P, denotes the price of the product at time t. deflated by a price index to remove inflation, and y" Q~ denotes the accumulated output of the product from the first period to period t. Since output cannot be negative, ~Q~ cannot decrease. Furthermore, since P, is deflated by a price index, it is impossible for the real or relative prices of all products to decrease. It follows that the experience curve in (2) cannot hold in general: there must be many products with increasing relative prices, with falling Q,, but nevertheless have upward sloping experience curves since their ~ Q, continues to increase. Thus there is no reason whatsoever for accepting the assertion in footnote 3 on page 85 of the Green Paper (1978) that the process they describe of downward sloping price-experience curves refers to the majority of industries. Presumably upward sloping price-experience curves apply to some service trades, to unsuccessful manufactured products, and also to the last stages in the life cycle of product-lines which were successful in the past# Appendix A of the Boston Consulting Group's (1972) Perspectires on Experience gives the data and price-experience curves of twenty-four products: Germanium transistors, Silicon transistors, Germanium diodes. Silicon diodes, Integrated circuits, Crude oil, Motor gasoline, Ethylene, Benzene, Paraxylene, Low density polyethylene, Polypropylene, Polystyrene, Polyvinylchloride, Primary aluminum, Primary magnesium. Titanium sponge, Monochrome television receivers, Total free standing gas ranges, Total free standing electric ranges, Facial tissues, Japanese beer, Electric power, Refined cane sugar. There is no suggestion that they are a random sample of all American products and the extent to which they are representative is not known. Ten experience curves are published in the Green Paper (1978). Seven of them relate costs to accumulated output and are considered in the next section. The three price-experience curves relate to Japanese Time recorders 1962-72, U.K. Refrigerators 1957-71, and U.S. 6Note that the argument at this point refers to price-experiencecurves. Of course, it is theoretically possible for most, or even all, cost-experiencecurves to fall over time. implying that profit margins would increase for those products experiencing real price increases. But this is unlikely to occur in practice.
98
P.E. Hart, Experience curves and industrial policy
Silicon transistors 1954-73. Thus the published evidence is somewhat limited. But given these estimated price-experience curves, what conclusions, if any, can we draw from them? Of the twenty-four price-experience curves in the Boston Consulting Group (1972), six are not consistent with the specification in (2). Refined cane sugar provides no evidence of any curve at all. While the other five (Crude oil, Motor gasoline, Benzene, Primary aluminum, Total free standing gas ranges) exhibit upward sloping relationships between log P and l o g ~ Q for part of the time. A seventh, the Facial tissue curve, slopes upwards 1945-48 which suggests that factors other than experience must be considered in this case, even though eq. (2) provides good fits 1933-1945, and 1948-1966. Thirteen products have kinked price-experience curves (sometimes with more than one kink) with the curve falling more sharply after the kink. In a fourteenth, Electric power, the kinked curve falls less sharply. The remaining three curves, Japanese beer, Integrated circuits, and Primary magnesium 1929-38 satisfy eq. (2). However, the Integrated circuit curve is based on data for 1964-68 which is probably too short a period to reveal a reliable trend, and country-specific effects are likely to be especially important in the case of the Japanese beer curve. Thissuggests the Primary magnesium is the best and most reliable example to select for further study. It is particularly unfortunate that the kinked curves contain too few observations before and after the kink to justify any serious statistical analysis. As an example of this, we may cite the Silicon transistors curve which has two kinks (1959-60 and 1965) in the Boston Consulting Group I197L p. 71} based on data for 1954 to 1968, but only one kink (1959-60) in the Green Paper (1978, p. 96) based on data for 1954 to 1973. The earlier source indicated a different slope for 1965-68 but the period was too short to be confident that this was in fact the case. When more data became available, the later source indicated no change in slope 1959-60 to 1973. The only price-experience curve for the U.K. included in the Green Paper (1978) relates to Refrigerators 1957-71. This is downwards sloping after 1959, with two kinks at 1959 and 1963. Once again the number of observations for each slope is too small for statistical analysis. Thus our more detailed appraisal of eq. (2) is confined to the U,S. product Primary magnesium. The basic time series on the output, accumulated output, and relative price of Primary magnesium are shown in fig. 1, with a logarithmic scale on the ordinate. The output series shows a sharp upswing from the 1932 depression to a peak in the Second World War, followed by a post-war decline and another upswing to 1952. Thereafter, there was little trend to 1968 but cycles 1952-57 and 1957-62 are clearly visible. The accumulated output series shows a steep upward trend 1929-44 and a less steep upward trend 1944-68. The real price series has a downward trend 1929-68. To explain these movements we should have to investigate the host of
99
P.E. Hart, Experience curves and industrial policy
Accumulatedoutput ~Qt
Output2000~ i i
10i
5o02
/
lOO. 550-
j 2 ~ 1041 • 5-, ~"
0.11
/i
// //
//
i
';
1
1929
Realprices r 1.0 Pt ,o~
35
40
"o,
45
,+''''
50
,
55
. . . .
,
60
,'05 j
~ ........
I
65
58
Fig. 1
demand and supply factors which govern the market for Primary magnesium. The data in fig. 1 are insufficient for such an analysis. We might assume that the downward trend in the relative price series traced out a long-run supply curve, by asserting that the shifting (but unknown) demand curve identified the supply curve. However, to assume that the long-run supply curve is downward sloping but fixed is inconsistent with technological progress and with the 'learning by doing process' which underlies the very concept of the experience curve. Thus we cannot identify the separate effects of supply and demand or price by assuming that the supply curve is fixed. The standard economic approach to measuring the separate effects of supply and demand on price would be to specify additional variables thought to influence the market for Primary magnesium and to obtain the required estimates by an appropriate simultaneous equations technique. But the 'experience curve' approach is quite different and may be simply explained as follows. Let the downward trend in price in fig. 1 be specified by log P = cq - fll t,
(3)
and let the overall upward trend in accumulated output be
log~ Q, =~t2 +fl2t,
(4)
where the stochastic disturbance terms are omitted for greater simplicity.
P.E. ttart, Experience curves and industrial policy
lO0
Since the 'experience curve' is given by (2) it is clear that the elasticit, given by the simple ratio of two trends in (3) and (4), namely d log P
dt
d log P
dt dlog~ Qt= -fll/fl2=dlog~Qi =-fl" The ordinary least squares estimates of fll and f12 are 0.028 (:2()()li 0.176 (+0.011) so we should expect - f l to be about -0.159. Thu,~ ,~]~. accumulated output of Primary magnesium increases by 1 percent x~. expect relative prices to decrease by about 0.16 percent. That i,. :~ percent experience curve was appropriate for Primary magnesium o~ ~ over the period 1929-68. 7 This is consistent with Exhibit 29 ~! ',.i Consulting G r o u p (1972, p. 88). However, the above d i s c u ~ identification makes it clear that this ratio of trends is the outcome ,~i number of market forces and cannot be attributed to one factor al,,~ as experience or learning. The experience curve is a mongrel relationship. The same critici,t~ be made of Wright's {1936) learning curve which was certainly not to qearning', i.e., to improved labour productivity as workers bec:~ _ used to assembling a particular type of airframe. On the c o n t r a r y ';' stressed that larger output made it possible to reduce skilled labour t,, new tooling techniques and unskilled labour. The investment in new ~ was justified by a large output. He also stressed that larger outputs !i,, ~ larger discounts on the larger purchases of raw materials and als(, ~, overhead costs per unit of output. In many ways, his term 'learnir~: was just as much a misnomer as the later term, 'experience curve'.
3. Costs and the experience curve
In terms of average costs, rather than prices, the experience curw: by (1). Seven examples are provided by the Green Paper (1978) r~:t ~, Bottle caps [West Germany), Life insurance (U.S.A.), Pilkington H.:~ float glass, Electric shavers (U.S.A.), Advertising (U.S.A.), Plastic ~e~ , Steam turbine generators. Many factors influence the ratio of the t r e ~ to that of Q, and, while it is theoretically possible that "expeii~,; "learning' play an important part, it is not easy to measure its contrib~ T lhe reduction in costs over time. Other influences might easily ~:, ' , "learning" or "experience' as emphasised by Gold (1981) and LIosct ; Again. Prais (1978) provides a statistical explanation of the ten~lc~ : strike-proneness to increase with the size of plant, which is yet ~
P.E. Hart, Experience curves and industrial policy
101
example of why higher average costs might arise in larger plants, s Thus the experience curve is not very convincing. To obtain a more reliable assessment of the importance of the experience curve, we must attempt to disentangle the major forces influencing the ratio of trends. This is not easy. Perhaps the electricity industry has the most suitable data. The Boston Consulting G r o u p (1972) published an experience curve for the U.S. electric power industry 1939-68, and for the period 1943-68 the observations followed the 80 percent curve very closely. There is also a considerable literature on production functions in this industry in the U.S.A., and to a lesser extent in the U.K. In principle it should be possible to c o m p a r e cross-section estimates of the effects of size of generating plant on output, together with estimates of the effect of technical progress obtained by stratifying the cross-sections by different vintages of plant, with the time-series estimates of the effects of experience. If increases in size of plant and newer vintage equipment explain most of the reduction in average costs there is little left for 'experience' or 'learning' to contribute. The coal-fired, steam-generated electricity industry was in fact chosen by the N I E S R for detailed investigation in its Strategic Factors in Economic G r o w t h research project, because it had experienced rapid technological progress, because its output is relatively homogeneous, and because the data available are comparatively good. 9 Brechling and Surrey (1966) found that the average level and rate of growth of fuel productivity in this industry in the U.K. were less than in France or in the U.S.A. Hart and Chawla (1970) qualified these findings by stratifying electricity generating plants in the U.K. and the U.S.A. by vintage of capital equipment and by estimating a series of cross-section Leontief production functions for each vintage in each country over the period 1959-63. Old vintage plants installed before 1954 appeared to be less efficient in the U.K. than their counterparts in the U.S.A. But new vintage plants installed after 1954 in the U.K. c o m p a r e d favourably with new vintage plants in the U.S.A. in the sense that they were not on a lower production function. For the U.S.A. a 1 percent increase in output, measured 8The diseconomies of large size arising from labour problems require more investigation. There is no point in having a large plant to take advantage of engineering economies of scale if
it tends to have a bad strike record. Indeed, in order to ensure the continuity of the supplies of components, it makes good sense for a firm to obtain supplies from two or three suppliers even though it might be possible in principle for one supplier to provide all the required components. If this component has a downward sloping cost curve, the fact that each supplier's output is too small makes unit costs too high. The excess may be regarded as an insurance premium against discontinuity of supply, but the problem arises of who should pay this premium. This problem occurs in BL which pays more for its British components than it would if it purchased foreign components which are made on a larger scale. See The Times, 20th June 1981, p. 15. 9For example, all the different quantities of coal inputs were reduced to British Thermal Units. Again, data were available for the size of each turbo-alternator and boiler, and for each steam pressure and temperature. These data permitted more precise specification and estimation than is usually possible in economics.
102
P.E. Hart, Experience curves and industrial policy
by kilowatt-hours, required about 0.86 of 1 percent increase in ,:;~E~ ;~1 equipment, whereas the corresponding figure for U.K. was 0.88 t-loa~cxc ' ~s a result of the implied increasing returns to scale, the U.S. plant bud b.i! cr efficiencies, as traditionally measured by the ratio of output to an ~+1 J':, simply because their generating plants tended to be larger. Thus it bcun' cs important to distinguish between a movement along a production ftu~t :a and a shift in the production function. A shift in the production function is attributable to a type of tcui~t .~1 progress. For example, in the U.K. a 1 percent increase in output ,.~ 1,t vintage plants required an increase of 0.96 percent in capital eqt~,r~.+l Itt compared with the 0.88 percent required by new vintage plant.s. It~ t ~ : ~ ,,| fuel requirements, measured by British Thermal Units, the same ~,, {s would follow if the Leontief specification and all the data weru ,:x:, :y correct. In fact, cross-section regression analysis showed that old , ~ t [:e plants in the U.K. required a 0.93 percent increase in fuel for evurv 1 i><: y~t increase in output, compared with the 0.89 percent required by new ,. ~lt: [e plants. The agreement is not exact but it is close enough for 1-~,:, r! purposes, particularly for generating plants installed since 1954 ((i).88 ~.'~. i,;l 0.89). It is clear that any industry-wide measure of efficiency, or c h a r ~ : n efficiency, will depend on the mixture of old and new vintage ptanb c~t ~J into operation at different times, on technical progress, and on the ,i,~ ff plant installed. Within each vintage of a plant in the U.K. and :in the 1 i -~,.. ~he Leontief production function specification had very high expl~n~tl. :3 power: out of forty cross-section regressions, r 2 never fell below (1!+92 i" +is the scope for improving our understanding of the difference betwuu~ he efficiencies of the U.K. and U.S. electricity industries in term:q of dii~lc+ t l learning or experience processes is somewhat limited. Against this, it might be argued that the electricity industry :is not ',,,.,:,i. ~.,I fuel and capital account for most of total costs and labour input, '+,'t~cb experiences the learning process, is relatively small whereas in many ~'~1 L::v industries it is very large. Furthermore, because U.K. new vintage plants ::e smaller than U.S. new vintage plants, it has been possible in principle t~:, 1,: ;'r from the U.S. experience of operating large plants rather than to under!!,:, he sometimes painful and very expensive procedure (in terms of mistake,;+ :>t' 'learning by doing'. This possibility might not apply to most U.K. inttu:~l~ ~s. although with the rapid transmission of non-secret knowledge and 1~ multi-national companies readily able to transmit confidential informati,>t c subsidiaries overseas, it is unlikely that many firms manufacture estabtis ~:d products on the basis of 'learning by doing'. For new products, such ~ a new type of airframe, the learning process is obviously of fundame~ titl importance, although even in this case it is always possible to obtain s(, t~e' experience by hiring appropriate experts possibly from other firms with n,~ ,'e experience.
P.E. Hart, Experience curves and industrial policy
103
Finally, it is possible to lump together the effects of scale, of technical progress, of learning and any other factor which influences costs, and summarise all effects as 'experience'. This approach is followed by the Boston Consulting Group in general and in the specific case of electricity generation [BCG (1972, p. 28)], although in this case the Group claims there has been no really fundamental change in technology between the invention of alternating current and of atomic power. But the above comparison of efficiency of the electricity industries in the U.K. and U.S.A. clearly shows that there are advantages to be gained from specifying and measuring the individual effects of each force operating on costs. In fact this delineation of different effects is continued in the next section on policy where scale effects receive special attention.
4. Industrial policy The implications of experience curves (or the combined effects of scale, technology and learning) for industrial policy are discussed in the Green Paper (1978). The apparent theme is that successful firms are lower down the experience curve than are other firms, and their lower costs and prices increase their market share and their profitability. Thus the resulting increase in industrial concentration is no cause for concern. Now, if an industry is subject to significant increasing returns to scale there is much to be said for the view that 'the consumer is best served by letting the dominant producer emerge, or even encourage his development and the concentration of production', to use the words of the Boston Consulting Group quoted in the Green Paper (1978, p. 86). In the case of electricity production in the U.K., the concentration of production required to maximize efficiency has been achieved, although the distribution of these gains between producers and consumers is still open to question. It could be argued that large parts of the gains in efficiency have been absorbed by labour, both in the electricity industry and in the nationalised coal industry which supplies fuel at relatively high prices. This simple example makes it clear that even if any industry does have increasing returns to scale, it does not necessarily follow that its consumers will gain from the concentration of production unless its prices are monitored and ultimately controlled by some independent authority such as the Monopolies Commission. The possible reaction of labour, in the form of higher wage claims or higher strike rates, to the concentration of production must not be overlooked; they might easily outweigh some of the technical advantages of larger-scale production. Nevertheless, most people in the U.K. would not advocate the disaggregation of the Central Electricity Generating Board; where there are significant increasing returns to scale in an industry, the concentration of production is widely accepted. But the possible existence of gains from large scale is only
104
P.E. Hart, Experience curves and industrial policy
one question to be considered by policy-makers. The second question concerns the distribution of those gains between producers (be they workers or shareholders) and the consumers. But the typical manufacturing industry differs from electricity generation. Usually the outputs classified to a Census of Production 'industry' are very heterogeneous. Moreover, increasing returns to scale are not the norm; there is usually scope for small-scale production of specialised high-quality goods, possibly designed to meet requirements of specific customers, which cannot easily be transferred to the mass-production processes of large firms. Thus a Census industry contains products which may have the same name but which are not homogeneous. For example, according to the Green Paper (1978, p. 87) there should be a minimum of seven and a maximum of fifty breweries in the U.K. if all had at least the minimum efficient size, compared with the actual number of 162 in 1973. But these engineering results must be qualified: not only are transport costs important, but consumers' preferences are vital and both would tend to rule out the concentration of U.K. production into seven breweries. Provided that consumers' tastes do not alter (in spite of the large-scale advertising of the large brewers), small specialist brewers will continue to be profitable. The conclusion to draw from table 1 on pages 87-88 of the Green Paper is that while hypothetical engineering estimates of plant economies are instructive, they must not blind us to the importance of transport costs and of consumers' preferences in determining the optimum number of plants in each industry. Table 2 on page 90 of the Green Paper supports the view that highly concentrated industries are more profitable. It is based on a cross-section analysis of 594 +businesses' of 57 North American companies. By measuring profitability and market shares of 'a division, product line or other profit centre within its parent company, selling a distinct set of products and/or services to an identifiable group of customers in competition with a welldefined set of competitors', the authors of the relevant study have apparently overcome the problems of heterogeneity which were mentioned above in connection with the U.K. brewing industry. Moreover, the Green Paper states that the American results are replicated for 80 businesses in the U.K. Although no U K . results are published, it might well be that, providing the market is homogeneous, there is a tendency for market-shares and profit margins to be positively associated; if the different types of beer appear among the 80 U.K. businesses, the small local breweries will have large market shares of a small local output, and within the national market those giant brewers which are more successful than their fellow giants are also likely to be more profitable. This result is not tautological, because it is always possible for the potential extra-profitability of the more successful businesses to be absorbed by higher wages, better fringe benefits, or even by more luxurious office accommodation, etc.
P.E. ftart. Experience curves and industrial policy
105
However, the results in table 2 of the Green Paper require further investigation. The original authors, Buzzell, Gale and Siltan (1975), obtained the data from the 57 companies in connection with a project on the Profit Impact of Market Strategies (PIMS). While the information on individual product lines is rare, it might not be representative, for we are not told how the sample of 57 companies was selected. Moreover, Buzzell et al. (1975) published average profitability for each size class of market share and in effect provided a regression without any indication of goodness of fit. The standard error might be large, the correlation might be low, and we should then expect to find m a n y examples of product lines with low market share and high profitability. More analysis of the data must be provided before any policy conclusions can be drawn from table 2 in the Green Paper. The measurement of the importance of each of the influences of the supply and demand sides of the market of a product, which ultimately govern profitability, requires painstaking applied economics research. Short-cuts are dangerous and in the past have been used to reach misleading conclusions on industrial policy. H o w many people would have invested in the production of the Concorde, even though the French and British firms were way ahead of their rivals in the design and production of supersonic aircraft? Being further down the learning or experience curves than any other firm does not necessarily produce profitability. It might, but it might not: before we can be confident that it will, careful economic research must be undertaken to assess the importance of experience, technology and all the other influences on profitability. Even those policy-makers who are unable to wait for such research results would be well-advised to study the BCG's experience curves very carefully before reaching conclusions on policy. The BCG states that 'experience curves apply essentially to specific products - - not to companies. The characteristic and proper response of the high cost producer is to find a segment of the product market in which he in turn can be the dominant producer ... companies survive because of certain products in which they are the dominant producer and which provide most of this profit'.1° Thus the Green Paper (1978, p. 86) misinterprets the BCG dynamic model of competition when it asserts that it 'drives industries towards concentrated
1°Boston Consulting Group (1972, p. 47). The need to search for a particular segment of the product market is emphasised by Hamermesh et al. (1978). Standard economics textbooks have stressed the same point, in the form of product differentiation, for the past fifty years or so. An alternative approach at the purely theoretical level has been suggested by Spence (1981), who assumes a homogeneous product, with unit costs which decline with accumulated output, and constructs various models of market equilibria which produce different numbers of firms according to the different values of the parameters in his models. One suspects that product differentiation is more important than the calculus of variations in summarising the behaviour of firms in the real world.
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P.E. Hart, Experience curves and industrial policy
structures,.~l As long as an enterprise classified to a particular heterogereou~ Census industry can find a particular product line in which it has comparative cost advantage, there is no reason whatsoever why the d,zgre,: concentration in the industry as a whole should increase. Of cc,ursc concentration increases at the level of the individual product line - - to 1()~ percent in the limit. But even then there would still be competition between: the different product lines classified to the same industry, The Green Paper (1978, p. 76) also oversimplifies the explanation cf li~ industrial success of some Japanese oligopolies. The different socioiogic;~ b a c k g r o u n d in Japan, especially the different experience in industri;~ relations, makes it unwise to attempt to reproduce Japanese-type oligopoli~', in the U.K. without having Japanese industrial relations, notwithstanding '~1~ experience curve. M a n y U.K. companies would be improved considerabl~ i they could adopt the more successful practices of m a n y overseas c o m p a ~ t , in connection with industrial training and industrial relations, ~i~i management techniques, and with technology. But the obstacles to makiT,: such changes in the U.K. have a long history and cannot be r e m o ; ~ overnight by short-cut methods. This is not to deny that someway or oth~:: we have to speed up our adaptation to economic change, for it is clea~ essential for us to do so. Nevertheless, there is no point in m a k i n g any rn,:~ mistakes in industrial policy by fostering increased industrial concentrati<~, in the hope that this will make British industry more efficient. F o r there is ~, satisfactory theoretical reason or empirical evidence to justify the belief t h increases in industrial concentration will raise efficiency. ~~Green Paper (1978, p. 86, para. 24).
References
Boston Consulting Group, 1972, Perspectives on experience (BCG, Boston, MA). Brechling, F.PR. and A.J. Surrey, 1966, An international comparison of production techni~.~,~' The coal-fired electricity industry, National Institute Economic Review, no. 36, 30-42. Buzzell, R.D., B.T. Gale and R.G.M. Sultan, 1975, Market share: A key to profitability, Har~ ;, Business Review 53, 97-106. Gold, B.. 1981, Changing perspectives on size, scale, and returns: An interpretive survey, Jot:~L of Economic Literature 19, 5-53. Hamermesh, R.G.. J.J. Anderson and J.E. Harris, 1978, Strategies for low market sii businesses, Harvard Business Review 56, 95-102. Hart, P.E. and R.K. Chawla, 1970, An international comparison of production functions: I coal-fired electricity generating industry, Economica N.S. 37, 164-177. Lloyd, R.A., 1979, Experience curve analysis, Applied Economics 11,221-234. Prais, S.J., 1978, The strike-proneness of large plants in Britain, Journal of the Royal Stat:i~.~: Society A 141,368-384. Revie~ of Monopolies and Mergers Policy, 1978, A consultative document (Green P~q~,: Cmnd. 7198 (H.M.S.O., London). Spence. A.M.. 1981. The learning curve and competition, Bell Journal of Economics 12, 49-'711] Wright. T.P.. 1936. Factors affecting the cost of airplanes, Journal of Aerospace Science 3, 1~':!
EXPERIENCE
CURVES
AND INDUSTRIAL
POLICY
P.E. H A R T *
University of Reading. Reading R G6 2.4 A. I_:K Experience curves purport to show that average real price or costs of a product decrease with its cumulative output and are used to justify increases in industrial concentration on efficienc) grounds. But the published evidence for their existence is not always convincing. Even if they do exist, they are merely mongrel relationships reflecting many economic forces including lechnical progress and economies of scale in addition to "learning" or "experience'. The3 should not be generalised to all products or be used to underpin industrial policy.
1. Introduction T h e last L a b o u r G o v e r n m e n t ' s G r e e n P a p e r (1978), A Reriew o/ Monopolies and Mergers Policy, c o n t a i n s a m o s t interesting a p p e n d i x on E c o n o m i e s of Scale a n d L e a r n i n g Effects. T h e c o n c l u d i n g p a r a g r a p h s on the significance for c o m p e t i t i o n policy claim that the c o m b i n e d effects of e c o n o m i e s of scale, learning effects a n d technological progress lead to increases in i n d u s t r i a l c o n c e n t r a t i o n 'which confers on the leading p r o d u c e r a real cost a d v a n t a g e a n d it is this real cost a d v a n t a g e which m a i n t a i n s its s u p e r i o r profitability r a t h e r t h a n e x p l o i t a t i v e b e h a v i o u r in the m a r k e t or i m p r o p e r restraints on c o m p e t i t i o n ' , t T h u s references to the M o n o p o l i e s and M e r g e r s C o m m i s s i o n which hinge on the profitability of d o m i n a n t suppliers should give due weight to this e x p l a n a t i o n of their higher profitability. T h e theoretical a r g u m e n t s that e c o n o m i e s of scale and technological progress p r o d u c e increases in industrial c o n c e n t r a t i o n and profitability a p p e a r in s t a n d a r d t e x t b o o k s . But the effects of learning curves are not given sufficient e m p h a s i s in e c o n o m i c s t e x t b o o k s , even t h o u g h W r i g h t ' s learning curve b a s e d on airframe p r o d u c t i o n d a t e s back to 1936. 2 T h e experience curve is a g e n e r a l i s a t i o n of the learning curve p r o p o s e d by the Boston *This is a shortened version of a paper given at a meeting of businessmen, civil servants and academic economists at the National Institute of Economic and Social Research. There were three papers which, together with a summary of the discussion, were issued as Discussion Paper No. 45 of the N.1.E.S.R. I am deeply indebted to all the other contributors to this symposium and to the anonymous referees of this journal for their most helpful comments on my paper. 'Green Paper (1978, p. 86, para. 24). 2Wrigh! (1936). 0167-7187/83/0000-0000/$03.00 © N o r t h - H o l l a n d
P.E. ttart, Experience curves and industrial policy
96
Consulting G r o u p 3 (1972). It may be written
C, =o~
Q,
,
t = 1.....
(1)
where Ct is average cost, ~ Q t is accumulated output, and t is a time subscript. 4 BCG (1972) apply it to twenty-two U.S. manufactured products. to U.S. electricity generation and to Japanese beer. The Green Paper (1978) provides ten more examples of (1) prepared by BCG relating to two U . K manufactured products (float glass and refrigerators), to four more U.S products, to one West German and one Japanese product, and to two U.S service trades (advertising and life insurance). These generalisations extend the analysis far beyond the airframe industry, in fact even beyonc manufacturing industry itself. Representatives from BCG who participated ir, the National Institute symposium claimed that,their work brought them int~ contact with many experience curves as in (1) which could not be publishe(i because of the confidentiality of the data. Businessmen at the symposiun". argued that their firms found experience curves very useful and of cours~ they backed their opinions by providing the confidential data and paying fo analysis in the form of experience curves. As an example of an academic us~ of experience curves, a recent paper by Spence (1981) may be cited. Clearly experience curves have aroused widespread interest. The present paper makean economic appraisal of published experience curves and of the implication-, for industrial policy drawn by the Green Paper (1978). Sections 2 and i, discuss the experience curve in terms of prices and costs, while section ,~ reviews the implications for industrial policy. 2. Prices and the experience curve
In the Green Paper on Monopolies and Mergers Policy (1978) the pric~ curves of the Boston Consulting G r o u p decline with increases i: accumulated output, but the rate of decline is usually slow at first and the~ followed by a much faster decline. These breaks are attributed to the decisio~ of the leading producer in each industry (who has lowest costs as the resu:' of greater experience) to go for a larger market share at the expense (~ smaller and less experienced producers who were previously sheltering und¢' the 'price umbrella" of the market leader. 5 This kinked price curve refers t, 'Hereafler also referred to as BCG. ~BC(; 11072~define costs on pages 64 65: ~change in accumulated cash flow divided by chant: in a,:cumulated experience'. The denominator is Q,. The definition of cash flow in the numeral~, i, n~t exactly lhe same as accounting costs, which defer some reported costs (by capitalisatio~ tmtil rc~enue,~are realized, hut over large volumes these differences average out (p. 64). "(;recn Paper{lqT~.p 85. para. 221.
P.E. lfart. Experience curl:e.,; and industrial policy
97
'the majority of industries' according to the Green Paper (1978), p. 85). although in some technology based industries, where the patents of the leading producers expire, a reverse sequence occurs with new entrants decreasing the market shares of the leading producers. Thus there are economic reasons for extending the experience curve from costs to prices, in addition to the statistical reason that average industry price data are more readily available than average cost data. In terms of prices, the experience curve is written log P, = ~t- fl log ( ~ Q,),
(2!
where P, denotes the price of the product at time t. deflated by a price index to remove inflation, and y" Q~ denotes the accumulated output of the product from the first period to period t. Since output cannot be negative, ~Q~ cannot decrease. Furthermore, since P, is deflated by a price index, it is impossible for the real or relative prices of all products to decrease. It follows that the experience curve in (2) cannot hold in general: there must be many products with increasing relative prices, with falling Q,, but nevertheless have upward sloping experience curves since their ~ Q, continues to increase. Thus there is no reason whatsoever for accepting the assertion in footnote 3 on page 85 of the Green Paper (1978) that the process they describe of downward sloping price-experience curves refers to the majority of industries. Presumably upward sloping price-experience curves apply to some service trades, to unsuccessful manufactured products, and also to the last stages in the life cycle of product-lines which were successful in the past# Appendix A of the Boston Consulting Group's (1972) Perspectires on Experience gives the data and price-experience curves of twenty-four products: Germanium transistors, Silicon transistors, Germanium diodes. Silicon diodes, Integrated circuits, Crude oil, Motor gasoline, Ethylene, Benzene, Paraxylene, Low density polyethylene, Polypropylene, Polystyrene, Polyvinylchloride, Primary aluminum, Primary magnesium. Titanium sponge, Monochrome television receivers, Total free standing gas ranges, Total free standing electric ranges, Facial tissues, Japanese beer, Electric power, Refined cane sugar. There is no suggestion that they are a random sample of all American products and the extent to which they are representative is not known. Ten experience curves are published in the Green Paper (1978). Seven of them relate costs to accumulated output and are considered in the next section. The three price-experience curves relate to Japanese Time recorders 1962-72, U.K. Refrigerators 1957-71, and U.S. 6Note that the argument at this point refers to price-experiencecurves. Of course, it is theoretically possible for most, or even all, cost-experiencecurves to fall over time. implying that profit margins would increase for those products experiencing real price increases. But this is unlikely to occur in practice.
98
P.E. Hart, Experience curves and industrial policy
Silicon transistors 1954-73. Thus the published evidence is somewhat limited. But given these estimated price-experience curves, what conclusions, if any, can we draw from them? Of the twenty-four price-experience curves in the Boston Consulting Group (1972), six are not consistent with the specification in (2). Refined cane sugar provides no evidence of any curve at all. While the other five (Crude oil, Motor gasoline, Benzene, Primary aluminum, Total free standing gas ranges) exhibit upward sloping relationships between log P and l o g ~ Q for part of the time. A seventh, the Facial tissue curve, slopes upwards 1945-48 which suggests that factors other than experience must be considered in this case, even though eq. (2) provides good fits 1933-1945, and 1948-1966. Thirteen products have kinked price-experience curves (sometimes with more than one kink) with the curve falling more sharply after the kink. In a fourteenth, Electric power, the kinked curve falls less sharply. The remaining three curves, Japanese beer, Integrated circuits, and Primary magnesium 1929-38 satisfy eq. (2). However, the Integrated circuit curve is based on data for 1964-68 which is probably too short a period to reveal a reliable trend, and country-specific effects are likely to be especially important in the case of the Japanese beer curve. Thissuggests the Primary magnesium is the best and most reliable example to select for further study. It is particularly unfortunate that the kinked curves contain too few observations before and after the kink to justify any serious statistical analysis. As an example of this, we may cite the Silicon transistors curve which has two kinks (1959-60 and 1965) in the Boston Consulting Group I197L p. 71} based on data for 1954 to 1968, but only one kink (1959-60) in the Green Paper (1978, p. 96) based on data for 1954 to 1973. The earlier source indicated a different slope for 1965-68 but the period was too short to be confident that this was in fact the case. When more data became available, the later source indicated no change in slope 1959-60 to 1973. The only price-experience curve for the U.K. included in the Green Paper (1978) relates to Refrigerators 1957-71. This is downwards sloping after 1959, with two kinks at 1959 and 1963. Once again the number of observations for each slope is too small for statistical analysis. Thus our more detailed appraisal of eq. (2) is confined to the U,S. product Primary magnesium. The basic time series on the output, accumulated output, and relative price of Primary magnesium are shown in fig. 1, with a logarithmic scale on the ordinate. The output series shows a sharp upswing from the 1932 depression to a peak in the Second World War, followed by a post-war decline and another upswing to 1952. Thereafter, there was little trend to 1968 but cycles 1952-57 and 1957-62 are clearly visible. The accumulated output series shows a steep upward trend 1929-44 and a less steep upward trend 1944-68. The real price series has a downward trend 1929-68. To explain these movements we should have to investigate the host of
99
P.E. Hart, Experience curves and industrial policy
Accumulatedoutput ~Qt
Output2000~ i i
10i
5o02
/
lOO. 550-
j 2 ~ 1041 • 5-, ~"
0.11
/i
// //
//
i
';
1
1929
Realprices r 1.0 Pt ,o~
35
40
"o,
45
,+''''
50
,
55
. . . .
,
60
,'05 j
~ ........
I
65
58
Fig. 1
demand and supply factors which govern the market for Primary magnesium. The data in fig. 1 are insufficient for such an analysis. We might assume that the downward trend in the relative price series traced out a long-run supply curve, by asserting that the shifting (but unknown) demand curve identified the supply curve. However, to assume that the long-run supply curve is downward sloping but fixed is inconsistent with technological progress and with the 'learning by doing process' which underlies the very concept of the experience curve. Thus we cannot identify the separate effects of supply and demand or price by assuming that the supply curve is fixed. The standard economic approach to measuring the separate effects of supply and demand on price would be to specify additional variables thought to influence the market for Primary magnesium and to obtain the required estimates by an appropriate simultaneous equations technique. But the 'experience curve' approach is quite different and may be simply explained as follows. Let the downward trend in price in fig. 1 be specified by log P = cq - fll t,
(3)
and let the overall upward trend in accumulated output be
log~ Q, =~t2 +fl2t,
(4)
where the stochastic disturbance terms are omitted for greater simplicity.
P.E. ttart, Experience curves and industrial policy
lO0
Since the 'experience curve' is given by (2) it is clear that the elasticit, given by the simple ratio of two trends in (3) and (4), namely d log P
dt
d log P
dt dlog~ Qt= -fll/fl2=dlog~Qi =-fl" The ordinary least squares estimates of fll and f12 are 0.028 (:2()()li 0.176 (+0.011) so we should expect - f l to be about -0.159. Thu,~ ,~]~. accumulated output of Primary magnesium increases by 1 percent x~. expect relative prices to decrease by about 0.16 percent. That i,. :~ percent experience curve was appropriate for Primary magnesium o~ ~ over the period 1929-68. 7 This is consistent with Exhibit 29 ~! ',.i Consulting G r o u p (1972, p. 88). However, the above d i s c u ~ identification makes it clear that this ratio of trends is the outcome ,~i number of market forces and cannot be attributed to one factor al,,~ as experience or learning. The experience curve is a mongrel relationship. The same critici,t~ be made of Wright's {1936) learning curve which was certainly not to qearning', i.e., to improved labour productivity as workers bec:~ _ used to assembling a particular type of airframe. On the c o n t r a r y ';' stressed that larger output made it possible to reduce skilled labour t,, new tooling techniques and unskilled labour. The investment in new ~ was justified by a large output. He also stressed that larger outputs !i,, ~ larger discounts on the larger purchases of raw materials and als(, ~, overhead costs per unit of output. In many ways, his term 'learnir~: was just as much a misnomer as the later term, 'experience curve'.
3. Costs and the experience curve
In terms of average costs, rather than prices, the experience curw: by (1). Seven examples are provided by the Green Paper (1978) r~:t ~, Bottle caps [West Germany), Life insurance (U.S.A.), Pilkington H.:~ float glass, Electric shavers (U.S.A.), Advertising (U.S.A.), Plastic ~e~ , Steam turbine generators. Many factors influence the ratio of the t r e ~ to that of Q, and, while it is theoretically possible that "expeii~,; "learning' play an important part, it is not easy to measure its contrib~ T lhe reduction in costs over time. Other influences might easily ~:, ' , "learning" or "experience' as emphasised by Gold (1981) and LIosct ; Again. Prais (1978) provides a statistical explanation of the ten~lc~ : strike-proneness to increase with the size of plant, which is yet ~
P.E. Hart, Experience curves and industrial policy
101
example of why higher average costs might arise in larger plants, s Thus the experience curve is not very convincing. To obtain a more reliable assessment of the importance of the experience curve, we must attempt to disentangle the major forces influencing the ratio of trends. This is not easy. Perhaps the electricity industry has the most suitable data. The Boston Consulting G r o u p (1972) published an experience curve for the U.S. electric power industry 1939-68, and for the period 1943-68 the observations followed the 80 percent curve very closely. There is also a considerable literature on production functions in this industry in the U.S.A., and to a lesser extent in the U.K. In principle it should be possible to c o m p a r e cross-section estimates of the effects of size of generating plant on output, together with estimates of the effect of technical progress obtained by stratifying the cross-sections by different vintages of plant, with the time-series estimates of the effects of experience. If increases in size of plant and newer vintage equipment explain most of the reduction in average costs there is little left for 'experience' or 'learning' to contribute. The coal-fired, steam-generated electricity industry was in fact chosen by the N I E S R for detailed investigation in its Strategic Factors in Economic G r o w t h research project, because it had experienced rapid technological progress, because its output is relatively homogeneous, and because the data available are comparatively good. 9 Brechling and Surrey (1966) found that the average level and rate of growth of fuel productivity in this industry in the U.K. were less than in France or in the U.S.A. Hart and Chawla (1970) qualified these findings by stratifying electricity generating plants in the U.K. and the U.S.A. by vintage of capital equipment and by estimating a series of cross-section Leontief production functions for each vintage in each country over the period 1959-63. Old vintage plants installed before 1954 appeared to be less efficient in the U.K. than their counterparts in the U.S.A. But new vintage plants installed after 1954 in the U.K. c o m p a r e d favourably with new vintage plants in the U.S.A. in the sense that they were not on a lower production function. For the U.S.A. a 1 percent increase in output, measured 8The diseconomies of large size arising from labour problems require more investigation. There is no point in having a large plant to take advantage of engineering economies of scale if
it tends to have a bad strike record. Indeed, in order to ensure the continuity of the supplies of components, it makes good sense for a firm to obtain supplies from two or three suppliers even though it might be possible in principle for one supplier to provide all the required components. If this component has a downward sloping cost curve, the fact that each supplier's output is too small makes unit costs too high. The excess may be regarded as an insurance premium against discontinuity of supply, but the problem arises of who should pay this premium. This problem occurs in BL which pays more for its British components than it would if it purchased foreign components which are made on a larger scale. See The Times, 20th June 1981, p. 15. 9For example, all the different quantities of coal inputs were reduced to British Thermal Units. Again, data were available for the size of each turbo-alternator and boiler, and for each steam pressure and temperature. These data permitted more precise specification and estimation than is usually possible in economics.
102
P.E. Hart, Experience curves and industrial policy
by kilowatt-hours, required about 0.86 of 1 percent increase in ,:;~E~ ;~1 equipment, whereas the corresponding figure for U.K. was 0.88 t-loa~cxc ' ~s a result of the implied increasing returns to scale, the U.S. plant bud b.i! cr efficiencies, as traditionally measured by the ratio of output to an ~+1 J':, simply because their generating plants tended to be larger. Thus it bcun' cs important to distinguish between a movement along a production ftu~t :a and a shift in the production function. A shift in the production function is attributable to a type of tcui~t .~1 progress. For example, in the U.K. a 1 percent increase in output ,.~ 1,t vintage plants required an increase of 0.96 percent in capital eqt~,r~.+l Itt compared with the 0.88 percent required by new vintage plant.s. It~ t ~ : ~ ,,| fuel requirements, measured by British Thermal Units, the same ~,, {s would follow if the Leontief specification and all the data weru ,:x:, :y correct. In fact, cross-section regression analysis showed that old , ~ t [:e plants in the U.K. required a 0.93 percent increase in fuel for evurv 1 i><: y~t increase in output, compared with the 0.89 percent required by new ,. ~lt: [e plants. The agreement is not exact but it is close enough for 1-~,:, r! purposes, particularly for generating plants installed since 1954 ((i).88 ~.'~. i,;l 0.89). It is clear that any industry-wide measure of efficiency, or c h a r ~ : n efficiency, will depend on the mixture of old and new vintage ptanb c~t ~J into operation at different times, on technical progress, and on the ,i,~ ff plant installed. Within each vintage of a plant in the U.K. and :in the 1 i -~,.. ~he Leontief production function specification had very high expl~n~tl. :3 power: out of forty cross-section regressions, r 2 never fell below (1!+92 i" +is the scope for improving our understanding of the difference betwuu~ he efficiencies of the U.K. and U.S. electricity industries in term:q of dii~lc+ t l learning or experience processes is somewhat limited. Against this, it might be argued that the electricity industry :is not ',,,.,:,i. ~.,I fuel and capital account for most of total costs and labour input, '+,'t~cb experiences the learning process, is relatively small whereas in many ~'~1 L::v industries it is very large. Furthermore, because U.K. new vintage plants ::e smaller than U.S. new vintage plants, it has been possible in principle t~:, 1,: ;'r from the U.S. experience of operating large plants rather than to under!!,:, he sometimes painful and very expensive procedure (in terms of mistake,;+ :>t' 'learning by doing'. This possibility might not apply to most U.K. inttu:~l~ ~s. although with the rapid transmission of non-secret knowledge and 1~ multi-national companies readily able to transmit confidential informati,>t c subsidiaries overseas, it is unlikely that many firms manufacture estabtis ~:d products on the basis of 'learning by doing'. For new products, such ~ a new type of airframe, the learning process is obviously of fundame~ titl importance, although even in this case it is always possible to obtain s(, t~e' experience by hiring appropriate experts possibly from other firms with n,~ ,'e experience.
P.E. Hart, Experience curves and industrial policy
103
Finally, it is possible to lump together the effects of scale, of technical progress, of learning and any other factor which influences costs, and summarise all effects as 'experience'. This approach is followed by the Boston Consulting Group in general and in the specific case of electricity generation [BCG (1972, p. 28)], although in this case the Group claims there has been no really fundamental change in technology between the invention of alternating current and of atomic power. But the above comparison of efficiency of the electricity industries in the U.K. and U.S.A. clearly shows that there are advantages to be gained from specifying and measuring the individual effects of each force operating on costs. In fact this delineation of different effects is continued in the next section on policy where scale effects receive special attention.
4. Industrial policy The implications of experience curves (or the combined effects of scale, technology and learning) for industrial policy are discussed in the Green Paper (1978). The apparent theme is that successful firms are lower down the experience curve than are other firms, and their lower costs and prices increase their market share and their profitability. Thus the resulting increase in industrial concentration is no cause for concern. Now, if an industry is subject to significant increasing returns to scale there is much to be said for the view that 'the consumer is best served by letting the dominant producer emerge, or even encourage his development and the concentration of production', to use the words of the Boston Consulting Group quoted in the Green Paper (1978, p. 86). In the case of electricity production in the U.K., the concentration of production required to maximize efficiency has been achieved, although the distribution of these gains between producers and consumers is still open to question. It could be argued that large parts of the gains in efficiency have been absorbed by labour, both in the electricity industry and in the nationalised coal industry which supplies fuel at relatively high prices. This simple example makes it clear that even if any industry does have increasing returns to scale, it does not necessarily follow that its consumers will gain from the concentration of production unless its prices are monitored and ultimately controlled by some independent authority such as the Monopolies Commission. The possible reaction of labour, in the form of higher wage claims or higher strike rates, to the concentration of production must not be overlooked; they might easily outweigh some of the technical advantages of larger-scale production. Nevertheless, most people in the U.K. would not advocate the disaggregation of the Central Electricity Generating Board; where there are significant increasing returns to scale in an industry, the concentration of production is widely accepted. But the possible existence of gains from large scale is only
104
P.E. Hart, Experience curves and industrial policy
one question to be considered by policy-makers. The second question concerns the distribution of those gains between producers (be they workers or shareholders) and the consumers. But the typical manufacturing industry differs from electricity generation. Usually the outputs classified to a Census of Production 'industry' are very heterogeneous. Moreover, increasing returns to scale are not the norm; there is usually scope for small-scale production of specialised high-quality goods, possibly designed to meet requirements of specific customers, which cannot easily be transferred to the mass-production processes of large firms. Thus a Census industry contains products which may have the same name but which are not homogeneous. For example, according to the Green Paper (1978, p. 87) there should be a minimum of seven and a maximum of fifty breweries in the U.K. if all had at least the minimum efficient size, compared with the actual number of 162 in 1973. But these engineering results must be qualified: not only are transport costs important, but consumers' preferences are vital and both would tend to rule out the concentration of U.K. production into seven breweries. Provided that consumers' tastes do not alter (in spite of the large-scale advertising of the large brewers), small specialist brewers will continue to be profitable. The conclusion to draw from table 1 on pages 87-88 of the Green Paper is that while hypothetical engineering estimates of plant economies are instructive, they must not blind us to the importance of transport costs and of consumers' preferences in determining the optimum number of plants in each industry. Table 2 on page 90 of the Green Paper supports the view that highly concentrated industries are more profitable. It is based on a cross-section analysis of 594 +businesses' of 57 North American companies. By measuring profitability and market shares of 'a division, product line or other profit centre within its parent company, selling a distinct set of products and/or services to an identifiable group of customers in competition with a welldefined set of competitors', the authors of the relevant study have apparently overcome the problems of heterogeneity which were mentioned above in connection with the U.K. brewing industry. Moreover, the Green Paper states that the American results are replicated for 80 businesses in the U.K. Although no U K . results are published, it might well be that, providing the market is homogeneous, there is a tendency for market-shares and profit margins to be positively associated; if the different types of beer appear among the 80 U.K. businesses, the small local breweries will have large market shares of a small local output, and within the national market those giant brewers which are more successful than their fellow giants are also likely to be more profitable. This result is not tautological, because it is always possible for the potential extra-profitability of the more successful businesses to be absorbed by higher wages, better fringe benefits, or even by more luxurious office accommodation, etc.
P.E. ftart. Experience curves and industrial policy
105
However, the results in table 2 of the Green Paper require further investigation. The original authors, Buzzell, Gale and Siltan (1975), obtained the data from the 57 companies in connection with a project on the Profit Impact of Market Strategies (PIMS). While the information on individual product lines is rare, it might not be representative, for we are not told how the sample of 57 companies was selected. Moreover, Buzzell et al. (1975) published average profitability for each size class of market share and in effect provided a regression without any indication of goodness of fit. The standard error might be large, the correlation might be low, and we should then expect to find m a n y examples of product lines with low market share and high profitability. More analysis of the data must be provided before any policy conclusions can be drawn from table 2 in the Green Paper. The measurement of the importance of each of the influences of the supply and demand sides of the market of a product, which ultimately govern profitability, requires painstaking applied economics research. Short-cuts are dangerous and in the past have been used to reach misleading conclusions on industrial policy. H o w many people would have invested in the production of the Concorde, even though the French and British firms were way ahead of their rivals in the design and production of supersonic aircraft? Being further down the learning or experience curves than any other firm does not necessarily produce profitability. It might, but it might not: before we can be confident that it will, careful economic research must be undertaken to assess the importance of experience, technology and all the other influences on profitability. Even those policy-makers who are unable to wait for such research results would be well-advised to study the BCG's experience curves very carefully before reaching conclusions on policy. The BCG states that 'experience curves apply essentially to specific products - - not to companies. The characteristic and proper response of the high cost producer is to find a segment of the product market in which he in turn can be the dominant producer ... companies survive because of certain products in which they are the dominant producer and which provide most of this profit'.1° Thus the Green Paper (1978, p. 86) misinterprets the BCG dynamic model of competition when it asserts that it 'drives industries towards concentrated
1°Boston Consulting Group (1972, p. 47). The need to search for a particular segment of the product market is emphasised by Hamermesh et al. (1978). Standard economics textbooks have stressed the same point, in the form of product differentiation, for the past fifty years or so. An alternative approach at the purely theoretical level has been suggested by Spence (1981), who assumes a homogeneous product, with unit costs which decline with accumulated output, and constructs various models of market equilibria which produce different numbers of firms according to the different values of the parameters in his models. One suspects that product differentiation is more important than the calculus of variations in summarising the behaviour of firms in the real world.
106
P.E. Hart, Experience curves and industrial policy
structures,.~l As long as an enterprise classified to a particular heterogereou~ Census industry can find a particular product line in which it has comparative cost advantage, there is no reason whatsoever why the d,zgre,: concentration in the industry as a whole should increase. Of cc,ursc concentration increases at the level of the individual product line - - to 1()~ percent in the limit. But even then there would still be competition between: the different product lines classified to the same industry, The Green Paper (1978, p. 76) also oversimplifies the explanation cf li~ industrial success of some Japanese oligopolies. The different socioiogic;~ b a c k g r o u n d in Japan, especially the different experience in industri;~ relations, makes it unwise to attempt to reproduce Japanese-type oligopoli~', in the U.K. without having Japanese industrial relations, notwithstanding '~1~ experience curve. M a n y U.K. companies would be improved considerabl~ i they could adopt the more successful practices of m a n y overseas c o m p a ~ t , in connection with industrial training and industrial relations, ~i~i management techniques, and with technology. But the obstacles to makiT,: such changes in the U.K. have a long history and cannot be r e m o ; ~ overnight by short-cut methods. This is not to deny that someway or oth~:: we have to speed up our adaptation to economic change, for it is clea~ essential for us to do so. Nevertheless, there is no point in m a k i n g any rn,:~ mistakes in industrial policy by fostering increased industrial concentrati<~, in the hope that this will make British industry more efficient. F o r there is ~, satisfactory theoretical reason or empirical evidence to justify the belief t h increases in industrial concentration will raise efficiency. ~~Green Paper (1978, p. 86, para. 24).
References
Boston Consulting Group, 1972, Perspectives on experience (BCG, Boston, MA). Brechling, F.PR. and A.J. Surrey, 1966, An international comparison of production techni~.~,~' The coal-fired electricity industry, National Institute Economic Review, no. 36, 30-42. Buzzell, R.D., B.T. Gale and R.G.M. Sultan, 1975, Market share: A key to profitability, Har~ ;, Business Review 53, 97-106. Gold, B.. 1981, Changing perspectives on size, scale, and returns: An interpretive survey, Jot:~L of Economic Literature 19, 5-53. Hamermesh, R.G.. J.J. Anderson and J.E. Harris, 1978, Strategies for low market sii businesses, Harvard Business Review 56, 95-102. Hart, P.E. and R.K. Chawla, 1970, An international comparison of production functions: I coal-fired electricity generating industry, Economica N.S. 37, 164-177. Lloyd, R.A., 1979, Experience curve analysis, Applied Economics 11,221-234. Prais, S.J., 1978, The strike-proneness of large plants in Britain, Journal of the Royal Stat:i~.~: Society A 141,368-384. Revie~ of Monopolies and Mergers Policy, 1978, A consultative document (Green P~q~,: Cmnd. 7198 (H.M.S.O., London). Spence. A.M.. 1981. The learning curve and competition, Bell Journal of Economics 12, 49-'711] Wright. T.P.. 1936. Factors affecting the cost of airplanes, Journal of Aerospace Science 3, 1~':!