Big Push Model - Indivisibilities and External Economies

Indivisibilities and External Economies

The concept of externalities is relevant for the Industrialization of underdeveloped countries, where decisions are to be made regarding distribution of savings among alternative investment opportunities. These arise from the interdependence in market economies.

Pecuniary economies are external economies transmitted through the price system, as prices are the signalling device (under conditions of perfect competition in a market economy). They arise in an industry (say industry X) due to internal economies of overcoming technical indivisibilities. This reduces the price of its product, which will benefit another industry (say industry Y) which use this output as an input or a factor of production. Subsequently, the profits of industry Y will rise, leading to its expansion and generating demand for the output of industry X. As a result, industry X's production and profits also expand.

However in underdeveloped countries, conditions of perfect competition are not present due to the decentralized and differentiated nature of the market. Prices fail to act as a signalling system in the following ways:

• Prices express the situation as it is and do not predict future economic situations
• Prices can decide present productive activities but cannot determine investments which would be appropriate for developing countries
• The response of the private sector to price signals is inadequate and imperfect due to the differentiation and decentralisation in developing countries

This justifies the need for centralized pan-industry planning of investment in Developing countries, as the private sector cannot undertake such planning.

Enlargement of the market size is another important externality which arises from the complementarity of industries. There exists an incentive to expand the scale of operations because the employees of one industry become the customers of another industry. In terms of products too (as in the above example of industries X and Y), one industry generates demand for the output of the other when the scale of operations increase.

Marshallian economies also accrue to a firm within a growing industry, resulting from agglomeration of industrial districts or clusters in a particular area. These occur due to the following advantages of agglomeration identified by Alfred Marshall:

1. Spillover of information
2. Specialization and division of labor
3. Development of a market for skilled labor.

Availability of skilled labour is an externality which arises when industrialization occurs, as workers acquire better training and skills. This is not achievable by mere establishment of a few industries, but requires a large program of industrial growth. It is one of the most important external economies because absence of skilled labor is a strong impediment to industrialization.