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J Evol Econ (2010) 20:139162 DOI 10.

1007/s00191-009-0133-0 REGULAR ARTICLE

Firms and industries in evolutionary economics: lessons from Marshall, Young, Steindl and Penrose
Harry Bloch John Finch

Published online: 15 April 2009 Springer-Verlag 2009

Abstract Evolutionary economists have tended to assess rms and industries separately, neglecting the role of their interaction in the process of economic growth and development. We trace the separation of rms and industries to the introduction of population thinking in the discipline of industrial economics, including some broadly evolutionary analyses. If researchers conate a population of rms with an industry, they introduce thin means of relating rms to one another and to industries. Despite his device of the representative rm, Marshall develops thick means of relating rms to industries by means of their internal and external organizations. Penrose avoids the notion of industry by focussing on heterogeneous and potentially mobile rms. Young and Steindl develop mundane explanations of rms relations within groups and locate the impetus for economic growth in a poorly understood environment. We conclude that evolutionary economists should revisit rms boundaries, not in the sense of explaining the existence of rms but in a relating and

Financial support from the Australian Research Council is gratefully acknowledged. An earlier version of this paper was presented at the 18th HETSA conference held at the University of Western Australia in July 2005. The authors appreciate helpful comments from the audience as well as from Stan Metcalfe and from anonymous referees, but take full responsibility for any remaining errors or omissions. H. Bloch School of Economics and Finance, Curtin University of Technology, GPO Box U1987, 6845 Perth, Australia e-mail: harry.bloch@cbs.curtin.edu.au ) J. Finch (B Department of Marketing, University of Strathclyde Business School, Stenhouse Building, 173 Cathedral Street, Glasgow, G4 ORQ, UK e-mail: john.nch@strath.ac.uk

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communicating sense in which boundaries signify the selective means of rms relationships. Keywords Firms Industries Marshallian economics Organization Economies Firms boundaries JEL Classication B25 L14 O12

1 Introduction Metcalfe (2007a, p. 2) argues that while Marshall is routinely presented as a founder of modern neoclassical economics, he should properly be considered as a major gure in a thread of evolutionary reasoning that explores the restless, dynamic nature of modern capitalism, a thread that begins with Adam Smith and leads on through Marx, Schumpeter and Hayek. In particular, Metcalfe points to the Principles of Economics (Marshall 1920) and Industry and Trade (Marshall 1921) in which Marshalls analysis has a clear focus on the self-transforming as well as self-organizing nature of capitalism. We concur with Metcalfes assessment and argue that modern evolutionary economics would benet from incorporating elements of Marshalls analysis along with elements from the analyses of some later economists who, variously, extended or criticized his approach. In this paper, we focus on Marshalls analysis of the relationship between rms and the industries in which they operate. This remains an important question, especially as researchers continue to focus on the many questions of industrial clusters and districts, and surprisingly one that is neglected. Internal and external economies are perhaps too easily attributed to rms managerial and operating processes and to their environments, respectively, rather than their acquisition being seen as an achievement of business endeavour. The advantage of beginning with Marshall is that he leads us to question how rms might acquire internal and external economies by means of their internal and external organizations in ways which they nd problematic and uncertain. Because Marshall draws on the heterogeneity of rms in his evolutionary approach, we can expect that rms will pursue, communicate, suggest and experiment with novel products and processes, so perpetuating their heterogeneity by acquiring both internal and external economies in distinct ways. Marshall supports his evolutionary understanding of economic development with his supplementary hypotheses, the cumulative effect of which signicantly restrains individual rms from accumulating advantages. For instance, rms internal economies leak into an industry, becoming external economies that others might acquire in an industrial college, preventing a growing rm from establishing an unassailable advantage. Furthermore, Marshalls rms have nite durations through an intergenerational model in which family rms gradually lose their founders vigour and longevity.

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By contrast, some of Marshalls followers, including some broadly evolutionary researchers, have combined rms and industries by means of population thinking. Marshall (1920) provides something of a lead in this respect, albeit in inconsistent ways, with his notion of the representative rm. If Marshalls representative rm is in some sense or senses an average rm, he transforms the heterogeneity among interacting rms in industries into a distribution. Heterogeneity is vital to his understanding of economic development, but a distribution of rms implies that a group of rms are ordered across some indices. Marshalls contemporaries seized on his model of the representative rm, which is at best associated indirectly with his analyses of how rms relate to one another in industries. Pigou (1920) transformed the representative rm into the equilibrium rm and then Robinson (1931) transformed the equilibrium rm into the optimum rm. By seizing upon Marshalls concept of the representative rm, rather than his evolutionary explanation of economic development, those economists who followed Marshall prepared the way for an empty, even meaningless concept of industry. Marshalls analogy of an industry being like a forest, which itself could grow and develop, self-transform and self-organize, because it comprised growing and declining trees became a mature and seemingly static plantation of uniform and stationary members. We seek lessons for an evolutionary explanation of rms and industries by examining the analyses of Marshall and of selected later economists, who reject the emasculated form of the representative rm. In different ways, these later economists recover and reinterpret dimensions of Marshalls explanation of economic development, itself founded upon thick interactions among rms and industries. Our discussion compares and contrasts Marshalls approach to three successors who address the theory of growing rms and its implications for the evolution of industries: Young (1928), Penrose (1956, 1959, 1960) and Steindl (1945a, b, 1952). These authors each focus critically, develop and adapt to their contemporary settings particular aspects of Marshalls approach and in the process provide important pointers, which evolutionary economists can draw upon to extend, deepen and adapt once more to contemporary settings Marshalls original insights. Firms and industries have been central to research in modern evolutionary economics, at least since Nelson and Winters (1982) modelling. Following Nelson and Winter, competition is a process in which rms choose between strategies of instigating innovation or imitating others, with both being subject to stochastic outcomes. Some researchers, for instance Dosi et al. (2000), Murmann (2003) and Malerba (2006), have added more varied and complex networks of transferring knowledge and of co-evolution, extending to participants such as governments, universities and scientic organizations. However, there remains a tendency to analyze industries (as in Malerba 2006) or rms (as in Hodgson and Knudsen 2004, 2006) in isolation, or at least without allowing the full scope of their interactions in the process of economics of development. Evolutionary economists can learn important lessons from Marshall, Young, Steindl and Penrose that will aid in the endeavour of bringing rms and

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industries together in to the analysis of the self-ordering and self-transforming nature of capitalism.

2 Marshalls vision of rms and industries We focus on three related dimensions of Marshalls analysis of economic development: the organizing roles of rms and industries, the connection of the representative rm to population thinking, and the continuing nature of rms as captured in their accumulations of knowledge and capital especially in relation to scientic management. 2.1 Organizing economic development among rms and in industries In Principles of Economics, Marshall (1920) argues that the basis of economic development is found among rms relations with one another rather than within rms considered in isolation. Firms cannot help but diffuse their knowledge, and gain understandings from others, through localized and socialized industries, which act as industrial colleges with knowledge of new products and techniques being in the air (Marshall 1920, p. 217). Economic agents organize their knowledge across different contexts, such as a particular rm, other rms and an industry. Knowledge leaks to and from these organizing contexts, following the economic agents established patterns and encouraging them to forge new patterns too, among personal contacts, between competing rms, suppliers, customers, training institutes, trade journals and so on. The precise manifestations and consequences of productive knowledge being communicated within and among rms are unpredictable, implying that rms are investing speculatively or prospectively when attending to their external organizations, and that localized clusters offer participants a prospect of acquiring external economies. Economic development is driven by economic agents pursuit of economies, which are means of reducing the unit costs of production and are for any given period of time either internal to a rm or external and residing in an industry or market. Economic agents can acquire both types of economies by means of their organizing activities, but once installed these pertain for a while at least to relatively settled and tested ways of producing goods and services at successively lower unit costs. For instance, managers may devise a standard operating procedure, allowing their colleagues to adapt other practices to a larger scale of operating, or employ skilled employees who have trained at a college, or install equipment produced and supplied by another rm. Indeed, internal and external economies are phenomena that are at the cusp of different interpretations of Marshall. Are we interested in the processes of their emergence or in their consequences once acquired, for instance for equilibrium among rms and industries? Raffaelli (2003) argues that the tendencies of proposing adaptations, acquiring these as working models and standardizing

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these in organizations, are related intimately such that Marshalls economics is an evolutionary as well as developmental economics. Of the origins of different forms of economies, Marshall (1920, p. 266) argues that internal economies are dependent on the resources of the industrial houses of business engaged in it, on their organization and the efciency of their management. Management is to a signicant extent a personal capacity for Marshall, augmented by those published modern scientic theories about organizing. Later, Marshall (1920, p. 280) argues that new machinery and new processes are for the greater part devised by manufacturers for their own use. Each new departure is an experiment which may fail; those which succeed must pay for themselves and for the failure of others. Firms external economies feature their market-making and market-using capabilities, such that they can make things for which there is already a good market, or, more adventurously, undertake the making of new wants by showing people something which they had never thought of before (Marshall 1920, pp. 28081). But their internal economies are arguably more experimental in that they concern how to make things, perhaps simply as an adaptation to operating at larger scale, perhaps extending to making new products, whether for new or established markets. Marshall implies fairly harmonious adaptations rather than creative destruction in his explanation of economic development (Potts 2001). In explicitly evolutionary terms, Marshall (1920, p. 241) refers to Spencers simultaneous processes of integration and differentiation. Individually, rms can be idiosyncratic and innovating organizations but they struggle to capitalize on their experiments. Their innovative capacities emerge in the context of their own internal organizations, but as their products need to be marketed given some established or emerging external market connection, so the invisible colleges experts also make sense of that rms processes and means of organizing (Loasby 2001). Firms internal and external means of organizing blur as rms build on others contributions with as much likelihood as their own, but again with their searches of and for others contributions being ltered through their own idiosyncratic patterns of market and industry connections as with the broader appreciation developed and communicated through the industrys invisible college. The precise division of rms internal and external organizations is unclear, for instance as their personnel participate in the industrys invisible college and in making and sustaining market and marketing connections. Similarly, the distinctions between internal organization and internal economies, and external economies and external organization are unclear in practice if not in principle. Internal economies suggest a production function, upon which managers are able to predict the consequences for their unit costs of employing particular techniques. Internal organization reects the experimental and risky efforts of rms, and especially managers, in seeking to acquire internal and external economies, such that organization is a distinct type of productive factor (Marshall 1920, pp. 13839). External economies themselves are the known

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or knowable spillovers of others activities, which are difcult to acquire or take into account with any precision.1 In addition to Spencers processes of integration and differentiation, Marshall (1920, p. 242) also hints at a nascent systems theory when explaining rms essential heterogeneity by contrasting how rms may secure their survival by beneting from their environment rather than beneting their environment.2 Marshalls rms are essentially heterogeneous because each occupies a unique position relative to other heterogeneous rms, which we can envisage in networked terms. Later Marshallians have developed this insight into a particular capabilities perspective, in which rms cope with the problems of undertaking coordinated activities with one another while recognizing that each has unique and complementary capabilities (Downie 1958, Richardson 1972, 1975; Loasby 1978, 1998). 2.2 Marshalls representative rm and its links with population thinking Researchers have joined a path, often deliberately, to population thinking among rms and industries because they have been comfortable in concentrating on Marshalls discussion of internal and external economies and on his concept of the representative rm and its subsequent transformations. As a consequence, researchers have tended to neglect rms activities in seeking to acquire internal and external economies by means of experimental organizing.3 Marshall provides antecedents for population thinking where his analysis leads conceptually to a thinning (of substance or content) and standardizing of the boundaries between rms and industries. His static analysis requires a simplication of the tangle of internal and external organizing and economies. To begin with, Marshall (1920, p. 287) presumes the demise of family rms where a third generation of managers lack the personal motivation, commitment and vigour of the founders. Other employees are no longer encouraged and enthused by the prospect of discovering, adapting and building upon the

1 Callon

(1998) provides a broadly cognitive and processual perspective on externalities, which of course, include external economies. Hence, externalities spill-over the boundaries of a particular social system because, as with Coase (1960), there is as yet no generally accepted way for agents to take these into their accounts and calculations. 2 The nascent systems theory is distinct from the clear parallels between Marshalls references to Spencer, in integration and differentiation, which may be compared with Simons (1962) argument of complexity as a developing organizing form. The systems theory is in each organizing unit beneting from its environment, and may be also benetting its environment. 3 Firms focus their competitive efforts on selling their products to end users, drawing upon their external organization and so on their established marketing and market-making efforts. Marshall (1921, p. 270) describes these as the marketing reputation and connection of a business, which may be larger relative to earnings than its xed capital. Heterogeneity in rms productive capabilities can be reected further in heterogeneous products, although of course there are many ways of making comparable products. Consumers also cope with heterogeneous products in seeking to compare products.

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latest ideas abroad in their industry (Marshall 1920, p. 299). Marshall also hints at competence and technology traps, in which rms become so well adapted to a particular vintage of technology that it becomes difcult to write off this adaptation, to unravel it and its connections and begin anew with a new technology. Bounds on heterogeneity among rms, for instance in terms of their potential for growth and vintages of their technology, provide a basis for some tendencies towards of standardizing the relations between rms across an industry. Growing rms experience limits in securing internal economies from their internal organizing and the industrys invisible college permits some assistance to new rms, which are seeking to secure a market position. In other words, if at least some external economies can be acquired similarly by many rms, they become a standardizing feature of rms mutual boundaries. Marshalls concept of the representative rm is an analytical device. It marks his change of focus from explaining questions of growth and development to explaining the state of competition, approximated by the difference between current market prices and the associated supply prices (unit costs) for particular commodities. Rather than set out on the highly intricate, complex and ambiguous process of aggregating production across some group of rms, where even group membership must be unclear, Marshall devises the concept of the representative rm: We shall have to analyse carefully the normal cost of producing the commodity, relative to a given aggregate volume of production; and for this purpose we shall have to study the expenses of a representative producer for that aggregate volume. On the one hand we will not want to select that new producer just struggling into business, who works under many disadvantages, and has to be content for the time with little or no prots, but who is satised with the fact of establishing a connection and taking the rst steps towards building up a successful business; nor on the other hand, shall we want to take a rm which by exceptionally long-sustained ability and good fortune has got together a vast business, and well-ordered workshops that give it superiority over almost all its rivals....Thus, a representative rm is in a sense an average rm (Marshall 1920, pp. 2645, italics in original). Marshalls concept of the representative rm stands in for those interacting, experimenting and adapting rms in an industry and simplies their rich interactions specically for the purposes of devising that industrys normal schedule of supply prices (Sutton 2000). Additional information, especially of any divergences between market and supply prices, can provide a basis for those interested in public policy to make inferences about monopolies, or of the success of competition. Observers can propose judgements as to whether the balance of economies is internal to some leading rms or external among many competing rms. However, any judgements are after the fact of how rms managed to acquire internal and external economies by means of their internal and external organizing.

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Marshalls representative rm hints at population thinking, by which we mean the representation of a set of heterogeneous rms in an industry group as if they could be isolated from one another to signicant degree and ordered on the basis of some critical characteristics (Hannan and Freeman 1977). Marshalls lesson is that rms continue to exist because they co-exist. Population thinking features a version of rms co-existing in a set of common strategies, which are external to rms and from which each can select, acquire and adapt to without the need for costly experimental search, acquisition and application. Hence, Marshalls representative rm has attracted our attention because its representative quality derives from its centrality in the notional dispersion or distribution of rms. Mention of a distribution implies a translation of thinking from rms understood as being and remaining heterogeneous by being in a developing and interacting group to an industry being a population of rms.4 The representative rm is one manifestation of researchers switching their attention from rms experimental internal and external organizing to assessments after the fact of the balance of internal and external economies available to rms, perhaps differentially but non-problematically.5 If internal economies come to dominate external ones, rms with lower unit costs can devote more resources to experimenting with new processes, such as establishing a professional research and development function, new machinery and products. Marshall anticipates this with his mention of well-ordered workshops, in the citation above. The outcomes of rms innovative and experimenting activities are no longer consistent with random draws from some innovation process. Rather, it is as if the draws are now biased in favour of rms that are both large and seeking to grow. Even if knowledge is in the air, there is now a systemic pattern in rms abilities to acquire and adapt to new ideas, techniques, processes and industrial products. The many small steps of connections start showing gaps, requiring bigger leaps among potential imitators and also greater accumulations of resources to fund these leaps (Cantner and Pyka 1998). Population thinking implies that strategies, which are available commonly to an industrys rms, provide a thin and standardizing basis for the integration to the industry, which then dominates processes differentiation

4 In

attempting to translate heterogeneous rms in an industry empirically into a population of rms, we know that the ordering should be in the basis of average costs. In which case, the representative rm is something of a lagging indicator, suitable also for static or equilibrium analysis. If Marshalls emphasis were on growing rms ahead of the developing industry, surely more attention would be focussed on both the new entering rms and also on the exceptional long-lived rms that are enjoying internal economies, as indicated in the passage from Marshall, which we cite above. Metcalfe (2007b) provides an enlightening analysis of how the representative rm may be modelled to evolve in a manner capturing both the lagging and leading aspects of the concept. 5 Marshall recognizes that large rms can come to dominate industries: The advantages which a large business has over a small one are conspicuous in manufacturing. . . .But there is a strong tendency for large establishments to drive out small ones in many other industries (Marshall 1920, p. 297).

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among a group of rms. But if rms become so isolated that even standard means of connection break down, heterogeneity would become even more pronounced, as implied by Penrose (1959).6 2.3 Scientic management Marshall developed his analysis from many lengthy and detailed observations of rms and industries. Changing industrial conditions, especially in the increasing prominence and signicance of the joint-stock means of organizing rms and of scientic management, seems to render his analysis outmoded, irrespective of our concerns with the rise of population thinking. Arguably, our concerns with whether rms mutual boundaries are analysed in a thick or thin way are of little consequence in the light of the rise of megacorps (Baran and Sweezy 1966; Eichner 1976; Cowling 1982). Marshall has a thorough understanding of scientic management and of its potential consequences, for instance in chapters eleven and twelve of Industry and Trade, even if this is not reected fully in his analysis. Hence, The head of a large business can reserve all his strength for the broadest and most fundamental problems of his trade, while the small employer has not the time if he has the ability (Marshall 1920, p. 284). In Industry and Trade (Marshall 1921) refers to rms with a continuing accumulation of capital and knowledge, supported by techniques of scientic management, nance, marketing and retailing at large scale (see Whitaker 1999). Murmanns (2003) business history of chemicals companies developing the synthetic dye industry covers roughly the same time period as Marshall studied, but in a contemporary way. Murmann provides fascinating insights into the co-evolution of university chemistry, the chemicals industry and the different approaches taken by rms in Germany, the UK and the USA, especially in organizing their research and development as well as their marketing activities. Scientic management is important in explaining how large rms can continue to grow. We could categorize scientic management as an external economy which large rms can acquire and apply internally quite easily in their pursuit of growth. Marshall (1921) discusses Babbage and Taylor, on the separation of planning work and operating work, which was initially undertaken in rms experimentally, and is manifest in the development of systems of codifying practices and monitoring performances in normal business. In contemporary terms, larger rms can through ner processes of divisibility afford to allocate some

6 Once

the rm is treated in isolation it makes no sense to speak of the competitiveness of the rm, for competitiveness is a relational concept. This point that is often lost in business school discussions developed from Penroses analysis of the growing rm. Rugman and Verbeke (2002) and Lockett and Thompsons (2004) exchange is instructive in this respect. Rugman and Verbeke argue that Penrose provides little basis for isolating mechanisms, which they argue is integral to the resource-based view. Locket and Thompson counter that Penroses approach is compatible with managers seeking to create and protect rents through isolating mechanisms.

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personnel to overseeing and performing absorptive capacity (Cohen and Levinthal 1990). The balance of internal and external economies tips towards internal economies. This conclusion is qualied though if we consider scientic management be some amalgam of internal and external economies, of for instance bespoke and public training and science, which large organizations can only acquire experimentally, at signicant cost and with signicant risk. Marshall (1921, p. 315) takes a different tack in coping with large joint-stock rms, considering that it might be feasible for a rm to take over signicant proportions of economic activity, but that no one rm had demonstrated sufcient vigour and longevity, or had access to sufcient capital, for such an undertaking. Marshall drew upon phenomena associated with the familyowned rms that were prevalent in the nineteenth century to explain modern corporations that were already taking hold at the beginning of the twentieth century (Penrose 1952, p. 805). Marshall did not write a second volume of Principles and so the descriptive, historical and informal evolutionary and development insights of Industry and Trade had little impact on later economists readings of Principles, with its more formal analysis (Comin 2000; Raffaelli 2004).7 Part of the problem in applying Marshalls insights in modern evolutionary economics are the changes in corporate form and organization, which have been supported by the co-evolution of scientic managerial techniques, nancial markets and the regulation of corporate governance; trend which Marshall discussed. Neoclassical economists focussed on a restricted understanding of the representative rm, in which they see rms connections with one another and with an industry analytically in the thin terms of internal and external economies of operating at large scale. Pigou (1920, p. 790) replaced Marshalls concept of the representative rm with his equilibrium rm, which he dened as being in equilibrium whenever the industry itself was in equilibrium.8 Robinson (1931, p. 11) adopted the optimum rm, which was a rm operating at the scale at which in existing conditions of technique and organising ability it has the lowest average cost of production, when all those costs of production which must be covered in the long run are included. While Robinson recognizes that the optimum rm can differ from Marshalls representative rm, he argues that the former is likely to result from the ordinary play of economic forces where the market is perfect and sufcient to maintain a large number of rms of optimum size (Robinson 1931, p. 12). Consequently, technology is the sole determinant of rms sizes when compatible with prot maximizing behaviour,

7 Raffaelli (2004, p. 210) argues that Marshall had a coherent and general theory of development or

evolution, encompassing deliberative innovation and systemic selection and reproduction among innovations, embodied in repeatable or autonomous routines that exhibit tendencies of inertia. 8 Pigou (1920, p. 790) acknowledges in a footnote that Marshall had in mind something more, such as a typical rm or rm of average size. However he argues that such complications are irrelevant to his purpose of analysing the industry supply curve using the equilibrium rm to stand for all rms.

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conditional upon their market being sufciently large to accommodate rms in sufcient numbers to prevent market power from emerging. Economists have been bequeathed an amalgam of versions of representative, equilibrium and optimum rms, which provides no basis of evolutionary analyses.9 Coase (1972) was particularly critical of the narrowing of the scope of industrial organization as a sub-discipline of economics because it ignored Marshalls questions of how industry was organized, in all its richness and complexity (p. 61). It provides no basis for a meaningful group, even population, of rms as different actualizations and no meaningful set of connections and relations among rms to structure shared knowledge and communications.10 An alternative would be to focus on economic growth and development in which rms relate to one and other and their industry in the thick terms of rms drawing upon their internal and external means of organizing as ways of coping with operating at larger scale.

3 Allyn Youngs reinterpretation of organizing and external economies Marshall wrestled with the likelihood of there being differential and cumulative growth among rms in an industry and suggested that industries could be the sites of coherent economic growth and development where external economies dominated internal economies. Young (1928) developed the arguments of Smith and Marshall by explaining how industries, as distinct organizational forms, could themselves grow, develop and become more complex. This subtly alters the analytical focus from rms that are connected with one another in an industry to a group of rms, which can form and reform their relationships by forming and reforming different industries (Richardson 1975, p. 352). Youngs external economies lie beyond that particular or focal industry and provide an impetus for economic growth directly, whereas Marshall sought external economies through the immediate organization of those rms common and localized industry. Following Young (1928, p. 528), Although the internal economies of some rms producing, let us say, materials or appliances may gure as the external economies of other rms, not all the economies which are properly to be called external can be accounted for by adding up the internal economies of all the separate rms.

9 There are alternative neoclassical theories of the rm, particularly the theory due to Coase (1937), Williamson (1975) and Simon (1976) that relaxes the assumption of perfect knowledge and relates the boundaries of rm activity to transaction costs. However, this simply adds further external conditions, the degree of imperfect information and the costs of the technology for overcoming it, to the exogenous determinants of rm size. 10 The modern representative rm or agent is a travesty since it relates to uniform agency, which is to say it is representative of itself, which is most odd.

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Some economies belong initially and distinctly to rms, but seep out to other rms, becoming the bases for new rms and new groups of rms to become established through others deliberate and knowledgeable imitation (White 2002). Marshalls organizing processes, which support rms as they seek to acquire internal and external economies, imply that rms relate to one another regularly, intimately and locally as a normal activity. Young introduces something of a schism in our understanding of external organizing and economic development as he describes a process of growth which is initially externalizing. Young argues that economic development is capitalistic supporting increasingly round-a-bout means of production. In vertical terms, growth allows new rms to form and specialize in undertaking intermediate production, so lengthening production across greater numbers of rms considered in vertical relations with one another.11 Just as Marshall refers to a nascent systems theory in referring to a rms environment, so Young locates external economies in other industries even though these could in some circumstances by traced to some intermediate productive activities previously undertaken in closer connection to a particular rm. Hence, out there, in that obscurer eld from which derives its economies, changes of another order are occurring. New products are appearing, rms are assuming new tasks, and new industries are coming into being (Young 1928, p. 528). Although Young shares Marshalls expectation that technological change will be incremental, there comes a point where specialization becomes obscure to an industrys invisible college, so establishing a new and distinct system of organizing from which those original rms now buy industrial products and services. Adaptation could be through rms establishing themselves in a connected industry producing intermediate or capital goods of higher-order, which are fairly easy for a number of rms working at similar levels to acquire and apply.12 Youngs reinterpretation of external economies, now emerging through economic activities becoming organized in new and emerging industries in connection with a lengthening of capitalistic production in round-a-bout ways provides a cleaner way of identifying rms and their boundaries or connections with other rms and with industries. The external economies are of greatest importance where these emerge from that obscurer eld; the environment, which is by necessity poorly understood.13 Firms establish their identities
11 We are grateful to a referee for pointing out the similarity between Youngs discussion of round-

a-boutness, in which entrepreneurs propose new rms so proposing extensions in the division of labour, and Marshalls discussion of contrivances. Raffaelli (2003, p, 55) explains that by contrivance, Marshall means invention, creativity and innovation. Contrivances can challenge established routines, and through repetition can become a basis for new routines. 12 Higher-order is used in the sense of Menger (1976, p. 56): a large number of other things in our economy that cannot be put in any direct causal connection with the satisfaction of our needs, but which posses goods-character no less certainly than goods of rst order. 13 Metcalfe et al. (2006) draw on Youngs explanation of interdependence among industries in their emergent modelling of economic growth.

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within a competitive group rather than in an industry. Competitive group implies less complex connections among those rms by means of strategic interactions rather than the complex and intimate co-creations and acquisitions of external economies.14 If we can interpret the now mainly competitive relationships between rms as being orthogonal to the development of the rms or other competitive group, the translation of heterogeneous rms into a population of rms could be feasible. Youngs main point is that the economy itself grows more complex through greater round-a-boutness in its organization.

4 Steindls external limits to the growth of rms Steindl (1945b, p. 3) discusses the determinants of rms sizes and begins by criticizing Marshalls use of the representative rm. He notes that according to Marshall, The limitation to the size of the representative rm, to sum up, is due to the limits of the market and, is obviously assumed, to the large scale economies becoming less important from a certain size on. Furthermore, Steindl (1945b, p. 10) rejects what is admittedly an overly simplistic interpretation of Marshalls view of the determinants of rms sizes, instead arguing that small and large rms coexist with a general advantage to the bigger rm (italics in original). Steindl then addresses the co-existence of near-monopoly capital alongside entrepreneurial and small businesses.15 In effect, Steindl is dealing with the consequences of Marshalls inability to develop a theoretical framework that can accommodate large rms and growing rms. Steindls explanation is clearly connected to that of Young (1928). Steindl inherits Youngs reinterpretation of external economies emerging through the new organizational means of round-a-boutness in new and distinct industries, but includes capital market imperfection, greater variety among rms in an industry codied as variation in asset size, and indivisibilities in innovations embodied in capital goods.16 Steindl (1945a, b, pp. 1318) recognizes that entrepreneurs demand a risk premium on those investments with uncertain returns as compensation for their exposure to risks associated with a variance in returns, extending to a risk of bankruptcy. The risk premium increases with the amount of nance that a rm requires relative to its own capital.17 This means that the ability of rms to expand their productive capacity through the acquisition of additional capital equipment is realistically limited at any point in time. Further, small and

14 The competitive group re-appears as a unit of analysis in Caves and Porter (1977) and inuences strategy research thereafter. 15 Marshall does this too, but in a descriptive rather than systemic sense. 16 If innovations are embodied in capital goods, adoption may result in indivisibilities either in the form of minimum output scale for the equipment or the requirement that a whole production facility be redesigned to accommodate the new machines. 17 Steindls argument concerning the relationship between the variance of return and the risk premium closely follows Kaleckis principle of increasing risk (Kalecki 1937).

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large rms face different opportunities for undertaking risk-bearing activities that offer higher rates of return, because economies of scale tend to raise the return to large units of capital above that of small units of capital. Recognition of differential opportunities for small and large business underpins Steindls subsequent examination of trends in concentration in Maturity and Stagnation in American Capitalism (Steindl 1952). Here, the higher returns associated with economies of scale are combined with technical progress that brings improvements in productivity. However, improvements that occur at an uneven pace across rms in the same industry yield differences in the level of production cost, even among rms in the same size class.18 Firms with differing levels of production cost can coexist in the same industry due to imperfect competition, which leads to a general tendency towards price rigidity (Steindl 1952, pp. 1417).19 When prices are rigid, costreducing innovations lead in the rst instance to an increase in the gross prot margins of the innovating rms. If the excess capacity of the rms with the lowest unit costs is within acceptable limits, these progressive rms have no incentive to cut prices. This allows high-cost rms, which are small or reliant on older vintages of technology, to survive, even when these marginal rms do not gain access to the cost-reducing technology. Steindl argues that investment by rms is dominated by internal accumulation (the nancing of investment by retained earnings).20 Higher prots earned by progressive rms therefore lead to the expansion of their productive capacity relative to marginal rms. Eventually, the progressive rms become the largest rms in the industry. If the number of marginal producers is constant, the industry is subject to relative concentration through the faster rate of growth and growing market share for the limited number of largest rms. However, a sufciently high rate of growth of industry demand may attract new entrants, as small and relatively high-cost rms, thereby postponing the onset of relative concentration (Steindl 1952, pp. 4042). Steindls introduction of technological progress into the analysis loosens the nance constraint on rm growth. When technical progress raises the prots

18 Steindl follows the standard practice of statistical agencies, particularly the US Census Bureau, and denes industries in terms of common or overlapping production technology. This denition is appropriate in terms of Steindls focus on scale and adoption of best-practice technology as sources of cost advantage for rms in an industry, but ignores potential competition between products with competing uses that are produced using different production technologies. 19 This view of price rigidity as endemic with imperfect competition follows the arguments of Berle and Means (1932) on the prevalence of administered prices in big business. 20 Internal accumulation also features prominently in the post-Keynesian analyses of Eichner (1976) and Harcourt and Kenyon (1976), in which dominant rms set their prot margins to generate sufcient retained prots to carry out their desired investment in the expansion of productive capacity. However, causality differs from that in Steindl, where investment increases to the level set by the interaction of a rigid price with falling unit cost. In the post-Keynesian analyses, it is price that increases to the level required to nance desired investment expenditures, given the rms unit cost and demand for its product.

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of progressive rms, the rates of internal accumulation and growth for these rms also increase. Given a predetermined rate of growth for industry demand, unplanned excess capacity eventually emerges as a result of the enlargement of capacity.21 Initially, progressive rms react to this unplanned excess capacity by engaging in aggressive price or selling competition. Marginal rms cannot match the aggressive competition due to their smaller gross prot margins, so they are forced to cede market share to the progressive rms. Some of them will go bankrupt and exit the industry. The reduced gross prot margins also dissuade entry of new rms into the industry. Concentration of the industry rises in absolute terms in the sense that, with the decline in the number and size of the marginal rms, there is a decline in the total sales of small rms and a rise in the total sales of large rms (Steindl 1952, pp. 4243). Steindls progressive rms are able to overcome the external constraint on growth posed by market demand growth below their rate of internal accumulation through the use of aggressive competition. However, this aggressive competition reduces the prot margins for themselves as well as for competing rms, hence reducing the rate of internal accumulation and the rate of rm growth throughout the industry. Thus, the environment inuences rm growth, but only in a way that is intermediated through the development process of rms and of the competition between rms. This is most clearly indicated when Steindl suggests that the increasing industry concentration eventually leads to an abatement of capacity expansion by the progressive rms, even though prots are available for investment. Managers of the progressive rms come to recognize that there is little possibility of capturing a sufcient share of a market from the remaining competing rms to maintain growth in sales (Steindl 1952, pp. 5355). Steindl uses the division of rms into the two generic types of marginal and progressive to analyse competition as a process, as an ideal pattern of competition. In this pattern, the internal constraint on progressive rm growth of limited nance is sequentially replaced by the constraint of the presence of marginal rms in the market and then by the limited growth of the overall market. Only at this last step of the process, which Steindl terms maturity, is a type of equilibrium obtained (Steindl 1952, p. 60). Thus, heterogeneity of rms drives the analysis in a manner that would be impossible with the representative rm as an ideal type, or even with the broader interpretation of Marshalls notion of the representative rm as an average type.

21 Levine (1981) and Shapiro (1986) relax this restrictive aspect of Steindls analysis and consider innovation in terms of new product development as a means to overcoming a given growth rate of market demand for established products. Bloch (2006) considers the implications of new product development for Steindls analysis of the pattern of competition between progressive and marginal rms.

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5 Penrose on internal limits to the growth of rms Penrose (1959, p. 2) is clear in her rejection of the idea that there is a rm size that is somehow best: It is often presumed that there is a most protable size of rm and that no further explanation than the search for prot is needed of how and why rms reach that size. Such an explanation of the size of rms will be rejected in this study. She goes on to state that, it will be argued that size is but a by-product of the process of growth, that there is no optimum, or even most protable, size of rm. As we shall see, traditional theory has always had trouble with the limits to the size of rms, and I think we shall nd the source of the trouble. Penrose shares with Steindl the notion that it is the growth of rms, rather than their size, which is limited under capitalism. However, where Steindl argues that rm growth is constrained by an external factor of limited access to capital, Penrose (1959) locates the constraint on growth within the rm. She argues that investment exhibits path dependence, with the increments to rms resources being specic to its unique growth trajectory. In other words, additional resources are of value as productive services only in a complementary and intangible connection with the rms established productive services drawn from its prior resources. Initially, those resources that rms have freed up are most useful in expanding their current production. However, as a rm grows and develops, attractive opportunities for the employment of these productive services may be in areas outside a rms current areas of specialization, dened in terms of either technologies or markets (Penrose 1959, pp. 109111). Thus, in Penroses analysis even the size of the market for a rms original products poses no limit to its growth as diversication is a likely outcome to the continued internal development of rms. The potential for diversication complicates the denition of the industry. Penrose makes no clear distinction between internal and external economies, probably because to her external is everything that is beyond the rm and its immediate network of suppliers and buyers. Indeed, because the rm has fuzzy boundaries, and a signicant, though still fuzzy, boundary internally between the senior management team and the rms operations, it is difcult to establish meanings of internal and external, whether as means of organizing or sources of economies. Instead, Penrose (1959, pp, 99102) acknowledges as economies of growth the possibility of freely available productivity improvements, which can emerge organically as by-products of the rms growth. Penroses economies of growth, which are not divided into internal and external components, full a comparable function and also share some of the characteristics of Marshalls external economies because they have to be acquired and integratedor organizedinto an overall managerial or entrepreneurial vision. Indeed, Loasby (1999) argues that Penrose is thoroughly Marshallian without really referring to Marshall. Penroses analysis of the development of productive knowledge is carried out primarily within rms, while she acknowledges some role for resources

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that are close at hand to rms either in supply, in competitive relations or among product users. This is the closest that Penrose gets to industries. Even this is more focused on connections of exchange rather than on interactions between rms that share productive techniques or other criteria for identifying industries.22 In fact, Penrose goes much further than Chamberlin (1933) in freeing her analysis, and so her heterogeneous rms, from the conation of rms and industry in Marshalls discussions. Her heterogeneous rms are not even anchored to particular markets or industries. Penrose presents a generic type of rm, so replacing the representative rm of neoclassical analysis with a growing rm in order to explain processes that are presumed to be common to all rms that are pursuing growth, but not determining an outcome in any particular case. Importantly, it is a distinct subset of special rms that pursue growth, so that Penroses generic rm type diverges sharply from Marshalls discussion in which analytically rms have complex or thick relationships with one another and with industries. Following Penrose, growing rms can learn from one another by virtue of their ambitions to grow per se, rather than by participating in a specic industrys invisible college. All rms that seek to grow have the same general processes, but emerge from and are shaped by idiosyncratic historical paths. Firms develop different resources (which become so in connection with an entrepreneurial plan developed within the senior managerial team) and managers have different capabilities and outlooks; these differences affect how the rms carry out their productive activities. Hence, free productive resources, which Marshall termed external economies, are still in the air, but there is a very limited group of individuals, including managers of the particular focal rm and perhaps other rms located in close proximity, that are in a position to devote other resources to interpreting and assimilating these, or which have opportunities of interpreting and assimilating these. Most of Marshalls rms could absorb external, and more or less free, improvements to productivity quite easily. Penroses growing rms, like Marshalls rms in industries, require managerial competence (which cannot be hired at short notice and with immediate effectiveness) and other resources to capture and direct the economies of growth. Further, the necessary incumbent managerial competence is available episodically as ongoing activities (selected in previous episodes) become routine, freeing up resources, particularly managerial resources. For Penrose (1959) the factor that limits the internal development and growth of the rm ultimately is the capacity of its management. She argues that, Since the services from inherited managerial resources control the amount of new managerial resources that can be absorbed, they create a fundamental and inescapable limit to the amount of expansion that a rm can undertake at any time (Penrose 1959, p. 48). Thus, managerial resources

22 See

Sraffa (1926) for a discussion of alternative criteria for dening an industry.

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too can develop over time, exhibiting a receding limit. Penrose views rms as repositories of resources, which include xed capital alongside intangible resources, such as knowledge and routines, from among which managers can select and congure plans in the form of combinations of productive services. This neatly captures Penroses (1952) objections to biological analogies in economics, a cautionary point for modern evolutionary economics. Penrose (1959, pp. 107108) pays some attention to the relationship between rm, market and industry, and her discussion recognizes concepts such as diversication and product differentiation to be inherently relative or ambiguous. All growing rms have unique bundles of resources from which managers congure sets of productive services (ibid., p. 77). Firms sell in markets by undertaking spending efforts that seek to build customer loyalty, but Penrose emphasizes that this does not mean a rms resources are tied to a particular market (ibid., pp. 116118). Penrose is so successful in isolating rms from one another, and making the growth of rms dependent on accumulated capacities aligned with the entrepreneurial vision of its managerial team, that it becomes very difcult to translate heterogeneity into an industry, let alone a population.23 Nevertheless, in her foreword to the third edition, Penrose draws on Richardson (1972, 1975) to argue that administrative boundaries of the linked rms become increasingly fuzzy and the effective extent to which any individual rm exercises is not at all clear (Penrose 1995, p. xix). By contrast, Richardson (1975) in his essay on Adam Smith examines activities and capabilities in the context of industries. He argues that economies of scale affect industries but possibly with differential effects on clusters of activities and capabilities within rms. Hence, growth will encourage rms to specialize. There may be tendencies towards concentration, but Richardson adopts an evolutionary perspective such that rms experiments in specializing continually interrupt these tendencies. Langlois (1992) develops this perspective in the context of the rm and its boundaries.

6 Lessons for todays evolutionary economics What are the lessons for modern evolutionary economics from the efforts of Marshall, Young, Steindl and Penrose? We start with a general observation

theory sees the rm as a process extending into the future and deriving artefacts, lessons and practices from its past, in which managers develop administrative coordination and authoritative communication over some set of resources (Penrose 1995, p. xi). The rm has some resemblance to that featured as a representative in neoclassical economics, but, as one of our referees points out, develops, acquires, adjusts and experiments with, rather than assumes, its production function.

23 Penroses

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about the nature of work of all four and then point to lessons regarding the treatment of rms and industries from each of the authors in turn. The general observation that links the theorizing of each of our authors is that their analyses are conducted in a specic empirical context. This distinguishes their work from that of most mainstream theorists after Marshall. Compare the rich mixture of empirical observation and theory in Marshalls Principles to the high-level abstraction of subsequent theoretical tracts in mainstream economics, for example Hicks (1946) Value and Capital, Samuelsons (1947) Foundations of Economic Analysis or Varians (1992) Microeconomic Analysis. Young, Steindl and Penrose follow the Marshallian approach to theorizing, rather than participating in the mainstream pursuit of a universal economic theory devoid of any historical or institutional specicity. Given that our authors all give due heed to historical and institutional context that is central to evolutionary economics, they belong to a group of what might be termed, empirical evolutionary economists, that goes back to Adam Smith and before. Lesson one comes from Marshall (1920, 1921) and tells us to treat rms and industries as interdependent rather than focus on one and either ignore the other or treat it as derivative (as Nelson and Winter 1982, do in simulating changes in industry concentration from stochastic innovation outcomes of individual rms). Marshall has each rm identied in part through its unique set of relations with other entities, including other rms as well as organizations such as universities and industrial journalism. Relationships, or external connections, form part of each rms organizational capital and are means to new knowledge and understanding of industrial arts. Further, some external economies seem to belong to no one in particular, and rather are as if in the air. While rms can of course be identied separately, they can owe their continuation to informal networks of relations with other entities, which also grants each rm a unique perspective on the network and so an irreducible basis of heterogeneity (Loasby 2001, p. 408). This anticipates Granovetters (1985) problem of embeddedness, and of Uzzis (1997) empirically grounded paradox of embeddedness, in which rms cannot escape their networks of social and economic connections. Marshall (1920, p. 374) mentions something similar; each man fears to spoil his chance of getting a better price later on from his own customers; or, if he produces for a large and open market, he is more or less in fear of incurring the resentment of other producers, should he sell needlessly at a price that spoils the common market for all. Analytically, one way out, which might be feasible, is to recast embeddedness as nested selection, such that rms make selections of connections (that is choose or at least modify their own network position), and are then selected in part on the basis of network selections. In other words, industries are understood as entities that emerge from the network properties and interactions among a set of rms. However, Marshalls rms are both partly constitutive of one another and also of the industry so are redened rather than eliminated through emergence. The challenge for today

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is to further develop the analysis of the co-evolution of industries and their constituent rms. Lesson two comes from Young (1928) and tells us to look at the industry (in its relation to individual rms) and beyond to its connections with the rest of the economy for the driving mechanism of economic progress. This may be taken as a corollary to Marshalls lesson on interdependence of rms and their industry. Young gives the industry a life independent of that of its constituent rms. This is an approach that has resonated with many evolutionary economists. For example, Malerba (2006, p. 18) refers to Young as providing a rst discussion at a theoretical level of the co-evolution of vertically related industries due to the interdependence of the extent of the division of labour. Lesson three is from Steindls analysis and tells us to incorporate external constraints on rms into the analysis of dynamics of rms and industries. One constraint, the limited access that rms have to debt or equity nance for the expansion of productive capacity, comes from the broader economy but becomes industry specic through the mechanism of retained earnings as a source of internal nance. The second external constraint of limited demand for the industrys products interacts with the nance constraint through Steindls ideal pattern of competition to provide for the co-evolution of rms and the industry, leading up a mature industry in which rms behave differently towards investment and pricing than during the ideal pattern of competition. Steindls account provides an example that falls into the evolutionary economics category of subset selection (Hodgson and Knudsen 2006). Firms are selected on the basis of differential cost through rms with lower costs having faster growth rates and being able to survive aggressive price competition during the ideal pattern of competition. The reason for the differences in costs is not clearly explained by Steindl. If the differences are due to a trait that is distributed over the group of rms, such as willingness (as discussed by Marshall and Young) to adopt and adapt to new vintages of capital produced elsewhere, generative selection can replace subset selection as variation in the trait occurs due the interaction of rms with their environment (the industry and beyond). Thus, Steindls analysis offers a base on which to fruitfully apply evolutionary theorizing in a context that includes the interaction of rms and industries. Lesson four comes from Penrose and tells us to consider the constraints on rm growth arising from within the rm, particularly limits to managerial capability. Importantly the internal constraints are associated with the imperfect knowledge within the rm as an organization. Means of organizing improve within the rm over time, allowing the rm to extend the scale and scope of its enterprise without adding to managerial resources. Knowledge ows are at the core of much evolutionary theorizing (Loasby 1999 and 2002). Furthermore, the conception of the rm as having an internal structure that evolves through time has been taken up in formal evolutionary theorizing (Hodgson and Knudsen 2006). Penrose only deals vaguely with the industry concept, as she allows rms to transform their product and marketing orientation to escape

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markets that might otherwise constrain their growth. However, there is an implicit lesson that industries need to be construed broadly and, indeed, allowed to co-evolve with constituent rms.

7 Conclusions We proceed on the basis that evolutionary economists are not fully aware of the rich vein of economic analysis from Marshall, Young, Steindl and Penrose that deals with rms and industries empirically in an evolutionary spirit. We aim to draw attention to this work and to tease out some of its salient features that are particularly relevant to current developments in evolutionary theorizing. We hope that this encourages more researchers to treat rms and industries as interdependent and co-evolving. Our concern in writing this paper is to plot the means by which evolutionary researchers have kept rms and industries as distinct foci, especially where pursuing mainly empirical research projects. While industries comprise rms, they are not aggregations of rms because rms are a combination, even compromise, of internalizing and externalizing tendencies. In short, industries comprise rms not because rms share common technology, managerial techniques or potential customers, but because these shared dimensions emerge through signicant interactions and communications between rms, whether collaborative or competitive. Our paper shows that researchers, even those who undertake research close to rms and in the spirit of Marshalls evolutionary framing, deploy considerable discretion in stabilizing the relationship between rms and industries, thereby isolating one from the other. Firms are irreducibly heterogeneous because they have idiosyncratic histories and experiences, extending to their personnel. Heterogeneity establishes notable and stimulating differences among rms, which is a basis for there being an industry. A dominant analytical strategy for coping with difference is to convert heterogeneity to variety and then variation, which is found in Marshalls construct of the representative rm, and in population thinking more generally. Marshall also employs the auxiliary or reinforcing assumptions of the death of rms and the localizing of rms in order to place meaningful bounds on variation. The theorists discussed in this paper have nascent systems theories and place the analytical distinction of (rm or industrial) system and its environment differently. For instance, Penrose focuses on heterogeneous rms and so considers relations among rms, which may form loose groupings or associations temporarily, informally. Young and Steindl group rms into industries and characterize their relationships in mundane terms, compared with activities that are of greater signicance to the group which are presumed to be occurring elsewhere, in the poorly understood environment. The above are largely negative conclusions in that they account for how researchers have used analytical devices to loosen the connection of rms and industries. In a positive sense, our paper suggests that evolutionary research

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should be redirected fundamentally at the question of rms boundaries. Given evolutionary interests in development and growth, rms boundaries lose their deterministic and foundational quality, which signify the existence of rms. Rather, corporate boundaries are recast as means of communication and interaction. The question facing rms is not so much where our boundaries are, but rather with whom do we share boundaries and how are the boundaries shared? This leads to the empirical question of how sharing boundaries changes as a consequence of the co-evolution of rms and industries, particularly as rms engage in boundary creating and destroying activities.

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