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Dear Dr. Dollar:

I am trying to figure out what propels corporations toward a compulsive expansion. I can think of the following: 1) Competition with domestic and foreign rivals; 2) need for markets; 3) need for raw materials; and 4) advanced technology requiring greater investments and thus greater profits. Would there be other causes? I teach high-school students who are highly motivated to know this. I am most grateful for your publication.
—Jack Stone, San Rafael, California

This article is from the January/February 2002 issue of Dollars and Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org/archives/2002/0102dollar.html

issue 239 cover

This article is from the January/February 2002 issue of Dollars & Sense magazine.

What you describe has been a part of capitalism since it originated in Europe in the 1600s and 1700s. Virtually all commentators on early capitalist development noted the drive to “accumulate capital”—to expand the size of the firm and acquire new plant and equipment—as the new order’s most compelling feature.

This drive for growth and global expansion arises from intense competition between businesses, which pushes prices down towards production costs and threatens profits. To remain ahead of one’s rivals, business owners continually need to devise new production processes that increase labor output and reduce per-unit costs. Suppose, for example, that a pair of shoes costs $20 to manufacture and distribute. As competition drives prices down to $20, profits will plummet and businesses will begin to fail. By introducing new production techniques that reduce costs to $10, an innovating firm can sell for $20 and still earn above-average profits, at least until the rest of the footwear industry adopts the new technique.

This process, which compels capitalist enterprises to constantly “revolutionize the means of production” (Marx’s words), generates the abundance of cheap consumer goods and improvement in material living standards which observers have come to associate with capitalist economies. It also generates the periodic crises characteristic of capitalism—what we call recessions and depressions. Finding buyers for all of these cheap goods presents a continual challenge. Foreign markets provide an important source of sales. So too, gaining control over cheap materials or laborers overseas can be a source of competitive advantage to businesses trying to reduce costs below those of their rivals.

In addition, an innovating firm hopes that its own growth will drive competitors out of business and allow it to consolidate its grip on the market. Such consolidation, as you suspect, gives businesses an even deeper pool of profits from which to draw, in developing yet newer methods of staying ahead of the competition. Consolidation also enables successful businesses to control market prices and insulate themselves from competitive pressures.

But the drive to grow and expand does not cease when a market ceases to be competitive. Even in industries like pharmaceuticals, where firms are insulated from competitive pressures, the compulsion to expand persists. Here, the expansion impulse is driven by the financial markets, which place all firms in a competitive race over investment performance—even those that face little or no competition in their particular industries.

Here’s how it works. Stockholders pay money in exchange for an ownership share in a corporation. Corporate stock carries no promise of a financial return—a corporation that issues common stock incurs no obligation to repay that money or even to pay interest on it. Instead, the financial returns from holding stock accrue from anticipated capital gains—the net profit that will result when a rise in the market price of a stock allows the holder to sell for a higher price than she paid. But why would the price of a stock rise? Generally, financial markets bid up the price of a stock because they expect that the profits of the issuing corporation will rise and/or that the corporation’s value (the dollar value of its sales, equipment, etc.) will rise. In other words, they expect the business to grow. Businesses that fail to grow see their stock prices stagnate or decline.

Sometimes this has little impact on corporate behavior. When returns on financial assets are low in general—for example, if interest rates are low and the stock market is stagnant—then shareholders might suffer in silence. But if other investments show higher earnings, shareholders will punish corporate managers for a lack of growth—by firing the management or arranging a takeover by a more aggressive rival. In recent years, business consultants have advised corporations to tie management pay to stock prices—paying executives with stock options, for example—so as to align management goals more closely with shareholders’ desires.

So, with the addition of pressure from the financial markets, you have correctly identified the main causes of corporate expansion. Just remember what’s behind all of these causes: the desire to increase financial returns.

Ellen Frank teaches economics at Emmanuel College and is a member of the Dollars & Sense collective.

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