A Kaldorian Link Between Increasing Returns to Scale, Non-Equilibrium Growth, and Money & Banking

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Lord Kaldor argues that equilibrium economics ignores the fact that modern economies are characterised by increasing returns to scale — unlike models of equilibrium outcomes which expressly rely on the assumption of constant returns to scale.

The point here seems to be that constant returns to scale are compatible with the conservative, in fact stationary view of an economy underlying the notion of an economy tending toward or resting in a state of equilibrium. The equilibrium itself depends on a number of unchanging conditions. Whenever the "moving parts" of the overall system touch the unaltering walls of the equilibrium framework, they are deflected to fall into place as they are supposed to. It is a deterministic system without surprises. 

With increasing returns to scale things work out differently.

Progress and growth become more indeterminate, it is no longer a matter of tending toward an eternally identical arrangement of balanced rest.

Factors other than relative prices become efficacious — like the size of a market. It is possible for disproportions to build up, for competitors, products, and tastes to differentiate themselves into an unstable order far removed from the utter uniformity of the actors enlisted in the models of equilibrium economics.

In [...] markets where increasing returns to scale exist often producers carry their own stocks and adjust their output in response to demand (Kaldor 1972: 1250). 

The ability to increase production in response to demand is achieved in modern capitalism by an endogenous money supply: a banking and monetary system where capital investment can be financed by new money. 

Kaldor notes that 

“This is the real significance of the invention of paper money and of credit creation through the banking system. It provided the pre-condition of self-sustained growth. With a purely metallic currency, where the supply of money is given irrespective of the demand for credit, the ability of the system to expand in response to profit opportunities is far more narrowly confined.” (Kaldor 1972: 1250).

The source.

So, equilibrating processes cannot describe, let alone explain the dynamics of modern economies — increasing returns to scale can, and the ability to respond to profit opportunities implied in new patterns of demand. This capacity is supported by the banking system of a fiat money regime. 

Economics systematically ignores these two fundamental facts:

the absence of 

(1) equilibrating processes constrained by conditions of constant returns to scale driving the overall performance of the economy, and 

the presence of

(2) money (as an agent shaping the economy's real variables with the help of banks and other agents of the banking system characteristic of a regime of fiat money).

PS

What I gather from the below is at least that increasing returns to scale mean a market structure may evolve outside of a framework of perfect competition, mind you Allen had this in mind — Source:

It might sound intimidating but its easy to think of this question in two parts. Firstly, understand what increasing returns to scale (IRS)is  means and then look up the characteristics of perfect competition. Then, put these two thoughts together to see whether they are compatible.

One way to look at the incompatibility is to use the cost approach. Increasing returns to scale would mean that the average cost (AC) of producing a good decreases as more and more of that good is produced, that is as output increases. Now, the marginal cost (MC) curve which is the rate of change of the Total cost (TC) under IRS is always below the AC curve. Given this scenario, in a competitive industry the MC-pricing,

(P = AR = MC < AC)

means that the price being charged by the firm for the good is lesser than the average cost to produce it. Naturally, this translates into losses for the firm as it will not be able to recover even the cost of producing the good. This is evidence enough to conclude that increasing returns to scale (IRS) I snot compatible with perfect competition.

Further, as a consequence of P < AC, one by one firms posting losses will start exiting the industry/market, eventually boiling down to one firm which will remain leading to a situation that is referred to as natural monopoly.

P.S : We might encounter an IRS situation in traditional industries like utilities (water, electricity, gas) which are regulated to have one monopoly suppliers in a certain region. It is important to note however that, without regulation in these industries, it will lead to a natural monopoly which might not necessarily produce socially optimum quantities of output.