Theory of the Growth of the Firm Read online

  Penrose struggled with the idea whether such networks, clusters, webs, etc., require a theory of the firm that was different to hers, pointing in particular (in private discussions) to the single-person, single-computer terminal ‘firm’ in IT industries. Her conclusion was that

  The individual companies do not lose their ‘independent’ identity; but the administrative boundaries in each of the linked firms may become increasingly amorphous and the effective extent to which any individual firm exercises control is often not at all clear (1996, p. 1722).

  IV. Influence

  Penrose’s ideas on the theory of the firm have been noted, discussed, and praised. In this sense, they have been undoubtedly influential. However, it is arguable that this influence has fallen well short of a recognition of her overall contribution as described above, let alone of the realization and application of the full potential of her ideas for mainstream economic theory. There may be various reasons for this and some speculative thoughts are presented below, following a short account of the way in which her early work was perceived and received by mainstream economics.

  IV.a. Penrose and Neoclassical Theory

  An important focus of managerial theories of the firm was on the extent to which managerially run firms could pursue objectives different to short-term profit maximization like, for example, the maximization of sales revenue (Baumol 1959, 1962), discretionary expenditures (Williamson 1964), growth maximization (Marris 1964), and on the implications of such behaviour for ‘managerial capitalism’.21

  Penrose’s own role in this context was seen in terms of her providing justification for the motivation for growth and the ‘Penrose effect’. Concerning the former, and following a critique by Marris (1961) that her treatment of profits and growth was ‘woolly’, as well as Slater’s (1980a) work, Penrose (1985) admitted that profits and growth could not be treated as ‘equivalent criteria for the selection of investment programmes’ (p. 8). Nevertheless, she maintained that she found

  the assumption that managers of firms try in general to make as much money as seems practical to be not only the most useful, but in fact the only general assumption from which reasonably general conclusions can be drawn (p. 12).22

  In that paper, Penrose also conceded the limitations of her theory on the issue of capital markets, and the relation between diversification of consumers’ demand and that of new products. She praised Marris’s theoretical contributions on this front. She was also able, however, to point out that the remarkably similar and independent work of Chandler (1962) provided support for her theory of growth, while Williamson’s (1981) analysis of the M-form organization provided powerful support for her view that growing firms ‘expand their ability to manage growth efficiently, with minimum interference with on-going operation’ (1985, p. 11).

  Penrose quotes, not disapprovingly, various applications of the ‘Penrose effect’, which ‘has been applied in a number of contexts, and even to my surprise to agricultural products’ (1985, p. 9).

  As already shown, in the (evolutionary) context and way it developed, the ‘Penrose effect’ is of importance. It simultaneously describes and determines firms’ limits to endogenous growth and the receding boundaries of the firm. Out of context, the ‘Penrose effect’ could be seen as just another reason why there can be constraints to ‘optimal growth’. Arguably, Penrose’s name in mainstream economics is synonymous with the concept of managerial limits to growth (see Malmgren 1960, Shen 1970). Stripped from its context, that was also the one contribution that was not too hard to formalize in models of firm growth, optimal investment, and ‘optimal growth’. Besides Marris’s (1964) seminal contribution, notable examples are Slater (1980b) and Gander (1991) for the theory of the firm, Buckley and Casson (2007) for the multinational firm, and Uzawa (1969) for the theory of macroeconomic (endogenous) growth which pre-dated the subsequent and very influential endogenous growth theory (see Pitelis 2009a and below). A problem with such literature, however, noted in Foss (1999), was that it allowed the mainstream to consider that

  ‘the Penrose effect was just a minor detail in the neoclassical analysis of optimal investment’ and that ‘Penrose’s critique of equilibrium economics should not really be taken seriously, as her ideas were fully compatible with extended notions of equilibrium’ (in Pitelis 2002, p. 94).

  A conclusion from the above is that while Penrose’s work has been noted and used, and has influenced mainstream thinking, this was done is a way which downplayed, even ignored, her major insights. As noted, these were the endogenous, production-side growth advantages associated with the knowledge creation process through specialization and division of labour, in an evolving, cohesive shell called a firm. This is not efficient allocation of scarce resources under conditions of perfect knowledge, it is not static, it is not equilibrium; in a word it is not neoclassical. Accordingly, it is not too surprising that while

  the total effect of Edith Penrose’s work was that of destruction of the neoclassical model of the firm, followed by reconstruction... In the following years, and despite the wide recognition the work received, classroom microeconomic theory, and also classroom industrial organisation, often seemed to continue as if nothing had happened (Marris 1987, p. 831)

  More than twenty years on the situation is arguably worse. As noted above, even the apparently most relevant texts written by mainstream economists, do not cite Penrose!

  One can come up with various reasons why that has happened, some discussed by Loasby (1999), Richardson (1999) (and below). Here we provide a number of speculative ideas. An obvious observation is that, in part, this was due to Penrose herself. She tended not to look back; she had often chosen not to link her early work with later developments; and, importantly, she had never really tried to promote her ideas, especially in more mainstream directions.23 It is interesting that at INSEAD she did not even teach a course on the ‘growth of the firm’.

  An additional reason in this category is that her uncompromising attitude rendered her impossible to pigeonhole. Her views on efficiency and monopoly, on international trade, on big business competition, while fully consistent with her analysis, could often sound simultaneously Schumpeterian, Hayekian, and even Marxist. All these are linked together in their focus on dynamics and resource creation (as opposed to efficient resource allocation). Yet they are so ideologically diverse that they can render anyone who holds such views simultaneously too much to handle.

  Another, related, reason is that Penrose chose to ‘cultivate’ her own ‘garden’, insisting that the neoclassical theory had its uses, but it was simply unsuitable for her concerns, and that it was not useful to try to integrate the two. Her choice not to ‘quarrel’ with the neoclassicists would help explain why, in their turn, they chose not to quarrel with her.

  It is also arguable that attempts to integrate Penrose with the neoclassical theory could prove problematic. Importantly, this is due to the issue of knowledge. The neoclassical perspective focuses on the efficient allocation of scarce resources given the assumption of perfect (even if asymmetric) information. In Penrose’s theory knowledge, in the form of experience, is not just ‘tacit’ and hard to transmit, but it can simply not be known in advance both because of uncertainty and because it is being created in the context of an evolutionary process and through the very purposeful actions of economic agents, not least firms. Additionally, knowledge is not really scarce in the conventional sense. Its use by someone need not necessarily always exclude somebody else from using it, and the exchange of knowledge can actually help to enhance it. A theory that starts by assuming full, pre-existing knowledge is clearly unsuitable to deal with these issues. But these, as Hayek (1945) has shown, are the issues.

  In addition to the above, as already noted, and in contrast to the neoclassical theory, Penrose does not have conventional, rational optimizing agents, does not focus on efficient allocation of scarce resources alone, does not look for an equilibrium. In all, and while we do not doubt the signi
ficance of, and need to bring together, coordination and growth, we claim that neoclassical theory simply could not fathom Edith’s ideas and remain neoclassical. Incorporating her ideas could amount to committing mass suicide, not likely in a profession populated by self-interested optimizing agents. In this context the apparent failure of her work to make significant inroads to neoclassical economics is less hard to appreciate.

  IV.b. Penrose and the Resource, Knowledge, and (Dynamic) Capabilities-Based Perspective

  In stark contrast to neoclassical economics, the past 25 years or so have experienced a major resurrection of Penrose’s work in other fields, notably organizational economics, strategic management, international business, (strategic) entrepreneurship, and even (strategic) human resource management. In these fields the resource-based, competence-based, or knowledge-based theory of the firm, with or without explicit acknowledgement of her work, has revisited all her main points. Already in 1985 Edith became aware of these emerging developments.

  Some of the rapidly growing literature and research on strategy and strategic management .. .tend, by their very nature, to merge what I have called the ‘resources approach’ with the ‘environment approach’ and are likely to produce empirical results useful in testing a theory of the growth of firm (p. 15).

  Penrose here refers not just to the ‘industry attractiveness’ and ‘positioning’, Porter-type approach to strategy (Porter 1980, 1985), but also to the then emerging resource-based, competence-based, (dynamic) capabilities-based, and/or knowledge-based approach to strategy. All these were building consciously or unconsciously on her work, as well as that of Chandler (1962), Demsetz (1973), and others, including founding figures of economics, such as Adam Smith and Alfred Marshall. Being in a business school at the time, Penrose had already come across some of the early literature, notably Teece’s (1982) now classic article which combined Penrose-inspired resource-based and transaction costs ideas in order to explain the multi-product firm.

  Since then, the literature has expanded by leaps and bounds. The resource, knowledge, and more recently dynamic capabilities-based perspective is now arguably the dominant one in strategic management and organization science. The major journals in the area have edited special issues on the topic (Strategic Management Journal, 1996, Winter Special Issue; Organization Science, September–October 1996) and it is now hard to find a new issue in any major journal in this field without reference to these issues and Penrose. Every aspect of the firm, including the multinational, is currently influenced by this work (see Pitelis 2007a). Special issues of journals such as Contributions to Political Economy (1999), Journal of Management Studies (2004), Managerial and Decision Economics (2005), Management International Review (2007), and Organization Studies (2008) have been devoted to Penrose’s ideas—the last-mentioned published her last article on the Metamorphosis of the Firm (Penrose 2008).

  More recently the emergent literature on (strategic) human resource management (SHRM) and (strategic) entrepreneurship use TGF and the resource-based view (RBV) as one of their main pillars. So does the dynamic capabilities (DCs) perspective that is currently very popular in strategy thinking (see Pitelis and Pseiridis (1999) and Foss et al. (2008) for entrepreneurship, Georgiadis and Pitelis (2008) and Teece (2008) for SHRM, and Teece and Pisano (1994), Teece et al. (1997), Teece (2007), Helfat et al. (2007), and Augier and Teece (2008) for the DC perspective). Even more recently, Pitelis and Teece (2009) build on Penrosean ideas and revisit the nature and essence of the firm (see also Kay and Pitelis 2009 for interfirm cooperation and Teece and Pitelis 2009 for the MNE). The (strategic) marketing literature also drew on RBV ideas (Hunt2000). Resource and capability-based arguments are now central in the explanation of firm-level sustainable advantage (Teece 2007; Pitelis 2009b). At the more macro-level, endogenous growth and capabilities-related ideas are dominant in macroeconomic theories of endogenous growth (Lucas1988;Romer1986, 1990;AghionandDurlaf2005), in economic development (Sen1999), and the sustainable advantage of firms and nations (Pitelis2009a). Syntheses of Penrose’s ideas with those of the behavioural School have been produced by among others Pitelis (2007b)(see also Organization Science’s 2007) special issue on Cyert and March’s work).24 There is no obvious limittothegrowth of such literature, ifanythingitseemstobebranchingoutatan alarming rate in increasingly novel and unpredictable directions.

  Edith was fortunate to see and enjoy the first signs of this new wave of recognition. While at Waterbeach, she was approached by contributors in the field asking for her comments and contribution. Sure enough she returned to the issue. Her 1996 paper ‘Growth of the Firm and Networking’ revisits the issues she raised and comments on the then current state of play. She recognized the importance of transactions costs issues, which she considered as one of the ‘two major types of explanation for the growth of firms in a market economy’ (1996, p. 1717). The second was the resource-based view she helped originate. Interestingly, she felt that ‘the two approaches are not mutually exclusive’ (p. 1717), a view shared by Coase. (In a letter to this author, Coase comments on Penrose’s views as follows: ‘I do not regard her views as an alternative view to mine in “‘The Nature of the Firm”, but as a necessary addition to it. As I indicated in my Yale lectures...there has been insufficient attention to the role of the firm in “‘running a business”.’)

  Coase’s recognition of the need to go back to production, to ‘running a business’, represents an important vindication of Penrose’s ideas. All the same, there is an important sense in which the transaction costs perspective of Coase, as developed by Williamson (1975, 1981), is easier to assimilate into neoclasssical thinking. It assumes optimizing agents and focuses on static equilibria. While there is scope for rendering transaction costs theorizing dynamic, and for integrating transaction costs with Penrosean ideas (see for example Pitelis 1991; Langlois and Robertson 1995; Pitelis and Teece 2009), it is arguable that this cannot be done without either stripping Penrose of her fundamental insights or stripping neoclassical theory from its very neoclassicism. A battle of paradigms way well be involved. No less than the outright domination of one theory may be required. In the absence of a full return to the resource-wealth creation tradition of economics, it could well be that Penrose’s ideas will continue to find it difficult to be fully appreciated and acknowledged by, and assimilated into mainstream economic theory.

  V. An Overall Assessment

  V.a. The Argument and Some Recent Critiques and Debates

  Penrose’s major contribution and lasting influence pertain to both her argument and her method-epistemology. The argument, first, is not simply about the theory of the growth of the firm; it is an argument about the theory of (growth of) knowledge. For anything and everything new to even be conceived, perceived, let alone implemented, one needs prior knowledge, including the very capacity to obtain knowledge, i.e. to learn. There exists a variety of institutions that help achieve this: families, schools, norms, customs and traditions, human interaction in society at large. Hayek’s (1945) view was that this knowledge is dispersed and that there is, at least in capitalist economies, an institution par excellence, the market, that facilitates its transmission and (thus) the coordination of individual plans and in the society at large. This is a fundamental insight. For Penrose it is firms which help create knowledge, indeed firms are seen by her as better at doing so than markets. If so, Penrose both critiques Hayek, since firms involve planning, and complements him, since private firms and markets together—the market system—both create new and transmit (dispersed) knowledge. Penrose’s contribution, however, goes deeper. If knowledge in general, or even a type of knowledge most suitable for production-related activities, is engendered more efficiently within firms than without firms, and to the extent that this knowledge is of relevance or use to society as a whole, everything and anything we conceive or perceive and the lens through which we do so, is predicated upon the existence and functioning of firms.

  As we saw, Penrose
’s method-epistemology involved a dynamic interplay between induction and deduction, structure and agency, in the context of a history-informed path-dependent evolutionary dynamic, shaped by actors’ conscious, yet path-dependent and structure-moulded actions, in the context of a purposive organization, the firm, operating under conditions of uncertainty.

  Both the argument and the method of Penrose are more suited to the concerns of non-neoclassical economics and to strategy scholars. Concerning economics, one can identify two major camps; one focusing on efficient allocation of (scarce) resources, the other on resource and wealth creation.25 Most classical economists, notably Adam Smith and Karl Marx, but also Joseph Schumpeter (1942), have paid attention to the issue of resource and wealth creation. To varying degrees, these economists also dealt with the related issue of resource allocation. Adam Smith, for example, arguably owes his place as the father figure of modern (neoclassical) economics to his very analysis of the allocative and coordination role of the ‘invisible hand’, or the market. Yet, he believed in the labour theory of value, and attributed wealth creation to labour productivity engendered within firms e.g., his famous pin factory, from where his The Wealth of Nations starts. In the pin factory, labour productivity is achieved through specialization, the division of labour and teamwork, which leads, among other things, to new inventions. For Smith, the realization of these benefits is limited by the size of the market. In Allyn Young’s (1928) powerful insight, the size of the market itself is determined by specialization and the division of labour; the latter leading to further, more elaborate subdivision of labour and extending the size of the market.