ISSN 1881-6436

DISCUSSION PAPER SERIES

No. 07-03

An Entrepreneur as a Leader:
Frederic Lavington on the Modern Business Society
Atsushi Komine
June 2007

For

HETSA Conference 2007
The University of Queensland, Australia
11-13 July, 2007

Faculty of Economics,
Ryukoku University
67 Tsukamoto-cho, Fukakusa Fushimi-ku,
Kyoto 612-8577 Japan
Phone: +81-75-642-1111
FAX: +81-75-643-8510

0An Entrepreneur as a Leader:
Frederic Lavington on the Modern Business Society
Atsushi Komine
Faculty of Economics
Ryukoku University
Kyoto 612-8577, Japankomine@econ.ryukoku.ac.jp
15 June 2007
Preliminary version 1.5
Not to be quoted
Key Words: Frederic Lavington, entrepreneur, business risks, trade cycle,
industrial organization, view of market, the Marshallian tradition
JEL Classification: B10, B31, L16
Abstract
Lavington’s insight on capitalism can be understood as a threefold-layer
structure, at the core of which is an entrepreneur. This structure comprises
the following: (1) micro-layer, related to the demand for money (puretheory), (2) macro-layer, related to the trade cycle (reality) and (3)meso-layer, related to industrial organization (ideal). The first is concernedwith rational behaviour under uncertainty; the second, with irrational
disturbances and the third, with a coordination problem: if the captains ofindustry work well in business organizations, the gap between the microand macro-layers tends to reduce. Lavington's expectation of evolution inthis manner is in accordance with that of Marshall.

1

Contents
1 Introduction
2 Biographical Note
3 Nature of the Modern Business Society
4 From Risks and Estimates to the Trade Cycle
5 Industrial Structures
6 Concluding Remarks
1 Introduction
Fredrick Lavington (1881–1927) is a forgotten figure. On the one
hand, most scholars 1 , including his contemporaries such as H Wright,
admitted that he ‘was the most orthodox of Cambridge economists’, and his
favourite dictum was ‘it’s all in Marshall, if you’ll only take the trouble todig it out’ (W[right] 1927, pp. 503–4). On the other hand, someresearchers 2 appreciated his theories and regarded them as being
considerably original, which possibly had power to break the
Marshallian—or orthodox—tradition. Previous studies have not identified
the reason why these seemingly contradictory evaluations 3 continued;
moreover, they have not addressed another one of Lavington’s researchareas—industrial organization—or for that matter, his vision on capitalism.
The primary aim of this paper is to extract Lavington’s insight on themodern business society. In order to achieve this, we employ the following
two procedures. First, we investigate his complete published writings andunderstand them as a coherent message. Second, we reconstruct them into
the following three independent, but connected, layers: (1) micro-layer,
related to the demand for money (pure theory); (2) macro-layer, related to
1

Hicks (1935, p. 2; n1), Hicks (1937, p. 152; n3), Robertson (1937, p. 431; n4) andEshag (1963) gave importance to the Marshallian tradition even in Keynes’ liquidity
preference by referring to Lavington’s contribution. Laidler (1999, p. 83; n7) questioned
why Keynes had disregarded Lavington.
2
See Bridel (1987, pp. 96–100), Bigg (1990), Komine (1995a), Komine (1995b) and
Bridel (2004).
3
See a controversy with regard to Say’s Law; Clower (1989, p. 26), Bigg (1990, p. 51),
and Kates (1998, pp. 108–11).
2

the trade cycle 4 (reality) and (3) meso-layer, related to industrialorganization (ideal). Considering the third element and subsequently
understanding the three as one consistent structure is one of the main aims5of this paper.
The remainder of this paper is organized as follows. Section 2
presents a short biography of Lavington. Section 3 argues his insight oncapitalism in the 1910s and 1920s. Section 4 discusses micro- andmacroeconomic theories. Section 5 addresses mesoeconomics by referring
to four case studies. Finally, the concluding remarks are presented in
Section 6.
2 Biographical Note6
Lavington was born on 19 November 1881 in a south-western
English county (Broad Hinton, Wiltshire). After completing his studies at
Marlborough College, he worked for the Capital and Counties Bank foreleven years 7 . At Emmanuel College, Cambridge, he became one of J M
Keynes’ first students, alongside D H Robertson, H D Henderson, G F
Shove, H Dalton et al.8 C R Fay stated ‘Lavington was the first and best
economics pupil I ever had’ (F[ay] 1927, p. 504). Fay’s testimony was
further supported by the following facts: (1) Lavington achieved first classin Part 1/2 of the Economics Tripos in 1910/1911, (2) he obtained 60
pounds as a research scholarship from his College 9 , (3) he presented his
paper ‘Loan Policy of Joint Stock Banks’ at Section F of the British
Association for the Advancement of Science on 5 September 1910 10 and
4

Haberler (1937, p. 134, p. 137) described it as a psychological explanation. Kojima(2004) compared it with that of Pigou and Taussig.
5
Only Raffaelli (2003, p. 123) and Raffaelli (2006, p. 11) referred to the issue on
industrial organization. However, their interests were to position him alongside otherCambridge economists.
6This section is generally indebted to W[right] and F[ay] (1927), Bridel (1987) [1998],
and Bridel (2004).
7
The Times, 18 June 1910.
8
See Robinson (1947, p. 15).
9The Times, 21 June 1910.
10
The Times, 26August 1910.
3

(4) he won the Adam Smith Prize 11 for a dissertation on ‘The Agencies bywhich Capital is Associated with Business Power’.
Despite his excellent performance in college, in 1912, Lavington
joined the Labour Exchanges Department of the Board of Trade, where W
H Beveridge12 was the director. While it is uncertain as to why Lavington
changed his job, it is certain that he can be classified as an
economics-trained government official, together with Keynes, Henderson,
Dalton, Salter, Stamp and Beveridge. Although he developed a pancreatic
disorder, he remained active in civil service, for instance, he served as a
joint secretary of a committee 13 that investigated how women, instead ofmen, could be employed in the manufacturing industries during wartime.
Serious illness compelled him to return to Cambridge in 1918. In
1920, after being elected to the Girdlers’ Lectureship 14 , as a successor toKeynes, Lavington published ‘his magnum opus’ (Bridel 2004, p. 724) The
English Capital Market in 1921. Subsequently, he became a Fellow of
Emmanuel College and published a textbook, The Trade Cycle, in 1922. He
joined a committee in Section F on German reparations, which
recommended that the amount to be paid should be decided in accordancewith common sense and economic law15 . Further, he served as chairman ofa session of the Association of Teachers of Economics in January 192716 .
From 1911 to 1927, Lavington published eight academic papers in The
Economic Journal (five) and Economica (three), seven book reviews andthree books. As a result of being overworked, owing to his several
administrative roles17 at the College, Lavington died in a harness on 8 July
11

Keynes also won the prize in 1909 for his essay on ‘The Method of Index Numberswith Special Reference to the Measurement of General Exchange Value’.
12
For his Unemployment, see Komine (2004).
13
The Times, 6 March 1916. This committee was a part of the Board of Trade andcomprised13 members including B S Rowntree, J S Nicholson and Beveridge.
14
The Times, 1 July 1920.
15
The Times, 14 September 1922. The committee consisted of 16 members, including
Robertson, Dalton, Stamp, C W Guillebaud and J H Clapham.
16
The Economic Journal, 37(145). March 1927, pp. 151–153.
17
He was appointed at least twice as the chairman of the examiners of Part 2 of the
Economic Tripos. The Times, 13 February 1924, and 17 December 1924.
4

1927. ‘The years of high theory’ were over for him, although according to
G L S Shackle, in general, it had just begun in 1926.
3 Nature of the Modern Business Society
In order to understand Lavington’s insight on the modern businesssociety during his time, we need to consider the following.
3-1 Facts and phenomena
Lavington regarded the modern business society highly because it
could demonstrate ‘the great growth in the industrial power’ (Lavington
1921, p. 1) and ‘a persistent upward movement in output her [sic] head andconsequently in material well-being’ (Lavington 1922, p. 13). People hadenjoyed ‘the average standard of material comfort above that of any
previous age’ (p. 102). However, he pointed out two evils which theindustrial society had itself created18 : cyclical movements and inequalities
of wealth. The former was divided into three movements, namely, those in
price, output and employment. Although fluctuations in price were the mostconspicuous and significant (p. 15), those in the volume of production werealso remarkable, particularly ‘the construction of capital goods expands andcontracts in a marked degree’ (p. 16). Moreover, Lavington clearlyrecognized the problem that resulted from the first two movements asfollows:
These cyclical changes of business activity are probably the mostimportant single cause of unemployment (p. 16).
With regard to the latter evil, i.e. inequalities of wealth, he pointed out twophases, both with seemingly equal importance. On the one hand, special
opportunities made it possible to ‘organize resources as to increase theincomes of themselves [the rich] and of the community’ (p. 97). This was
18‘[F]rom this essential characteristic ... the strength and weakness of the system alikearise’ (Lavington 1922, p. 95).
5

more pronounced if their large incomes were saved and not dissipated on
extravagant living. In other words, inequalities of income were justified ifthey ‘arose only from differences in the ability, energy and thrift of those
who contribute[d] to production’ (p. 98). On the other hand, the privilege,
resulting from the practice of the freedom of bequest, accentuatedinequalities of opportunity and interfered with the right selection ofindustrial leaders (p. 98). Regardless, these two evils should be consideredin the discussion of the trade cycle.
3-2 A fundamental gap in the modern economic system
Lavington distinctly recognized the economic mechanism as‘something strangely contradictory’ (Lavington 1911, p. 53) between
micro- and macro-levels. He considered it to be a coordination problem inthat it was difficult to determine how to adjust ‘social resources to social
wants with no central co-ordinating control’ (p. 53). With the exception of‘a system of State Socialism’ (Lavington 1925/26, p. 191), the following
three strict conditions were necessary to identify self-interest ‘with social
material welfare’ (Lavington 1911, p. 53): (1) competition was essential toguarantee the survival of the most efficient type of organization, (2) the
individual considered a very long period of time when adjusting his/herresources and (3) owing to the limitations of human knowledge and ability,
even competition could eradicate some defects. There were not such
defects thanks to organization. Inversely, Lavington admitted that modern
economies did not satisfy these conditions.
Consequently, given that coordination fails and ‘value is subject tochange uncertain both in kind and degree’ (Lavington 1921, p. 82), therewas ‘a continuous maladjustment of resources—a continuous social waste,
which is irregularly distributed over individuals in the form of gain andloss’ (Lavington 1912, p. 398). Lavington took it for granted that there wasa gap between individual economic actions and subsequent collective
results. This recognition was the starting point for his analysis.

63-3 Three economic units
Let us now address the characteristics of the following three
economic units that were extracted: entrepreneur, market as a whole andintermediate organization.
At the microeconomic level, independent economic agents, who canuninterruptedly engage in a specialized field of work (specialization), wereat the central position in business. Such agents can be referred to as
entrepreneurs (or businessmen). Although, traditionally, there were threegroups in an economy (landowners, capitalists 19 and workers), only
entrepreneurs assumed the responsibility and control of production.
the entrepreneur stands at the centre of the economic organization,
for under his control pass all the productive resources of the community. It
is he who estimates future demands; it is he who sets resources in motion
now to meet those distant demands. (Lavington 1922, p. 27)
Further, entrepreneurs combine the services of land, capital and labour(Lavington 1921, p. 274). They are not only manufacturers but alsomerchants because they are businessmen in each chain of operations,
undertaking the responsibility of initiating and organizing production(Lavington 1922, p. 20).
Moreover, entrepreneurs have a variety of characteristics: individual
initiative, freedom of enterprise, the strongest impulses of human nature,ambition and ability, independent industrial adventure and the strongest
motives of self-interest (p. 95). Above all, two roles are significant. One isto bear business risks in microeconomics, and the other is to estimate thefuture conditions of the markets in question in macroeconomics. For
Lavington, entrepreneurs can be regarded as having the most important rolein economies.
At the macroeconomic level, Lavington attempted ‘to trace the19

In the money market, they can be referred to as investors. Joining capital and businessabilities can increase the productive capacity of society (Lavington 1921, pp. 3–4).
7

nature of the economies which the market effects as part of the organizationof production, and to express those economics in terms of economic
welfare’ (Lavington 1921, preface p. 6). A market is ‘a coherent part of theorganization by which resources are adjusted to needs’, and ‘an organic
thing, i.e. as a part of a living and developing industrial system’. Since amarket itself formed a ‘part of the general means of communication’, it‘thus encouraged an organic development of society’ (p. 5). For Lavington,a market as a whole was a sphere in which each industry (organization ormarket) was highly independent and decentralized but connected tightly as
a network. Thus, similar to Marshall, Lavington also considered a market
as an entity that evolved spontaneously.
At the mesoeconomic level (individual organization or industry),
Lavington investigated (1) banks; (2) the stock exchange; (3) three markets(of money, capital and credit); (4) monopoly; and (5) industrial structures(particularly vertical integration).
Given the above, let us address how Lavington’s vision can beapplied to economic theories. We will examine the following three aspects:
micro-, macro- and mesoeconomic ideas, which correspond to the theories
on asset demand, the trade cycle and industrial organization (structure),
respectively.
4 From Risks and Estimates to the Trade Cycle
Based on the abovementioned premise, we continue to examine
Lavington’s theoretical contributions. In this section, we will discuss his
theories on asset demand and the trade cycle, based on the entrepreneurs’
behaviour regarding risks and estimates.
4-1 Distinction between risk and uncertainty
Lavington pointed out two factors which generate risk anduncertainty: imperfect knowledge (incalculability) and immobility ofinvested resources (intractability) (Lavington 1921, pp. 82–3; 1925/26, p.

8186).
From 1911 to 1926, Lavington had attempted to distinguish risk anduncertainty; however, there was a confusion in terminology in his attempts.
A well-known distinction between risk and uncertainty made by Frank
Knight20 had almost no relation to the one proposed by Lavington. For
Knight, risk indicated phenomena with definite probability distribution,
whereas uncertainty implied phenomena that could not be grasped byprobability distribution. By contrast, Lavington attempted to establish
another concept. In general, he seemed to differentiate risk fromuncertainty in the following manner: risk was related to unforeseeable
undertaking, investment action (supply of capital) and production costs,
whereas uncertainty was associated with an irregularity of incomes,
consumption action and defects in distribution. Let us examine each aspect
as well as the changes in their meanings over the years.
In 1912, risk was simply ‘an unrelieved probability of loss’(Lavington 1912, p. 398). Uncertainty, or in other words, ‘the personal
Risks’ (p. 407) or ‘the result of a particular form of Ignorance’ (p. 400),
was related to ‘the amount of gain or loss’ and ‘the spread of a curve ofprospective net returns’ (p. 399, emphasis in original). In 1913, thedistinction was more obscure, only suggesting that uncertainty was linked
to sudden contractions in the available resources at an entrepreneur’sdisposal (Lavington 1913, p. 38). Lavington did not use the term risk,
barring one instance (p. 38). Conversely, in 1914 (book reviews), he onlyused the term ‘risk-bearing’ (Lavington 1914, p. 264, p. 266). In 192121 , aclear distinction was revealed in his portfolio selection theory: risk was ‘anunrelieved probability of loss’ and uncertainty was an ‘irregularity of
return’ (Lavington 1921, p. 86). He again, as he had in 1912, defined
uncertainty as the spread of the curves which indicated prospective net
returns in each investment or venture (p. 87). He admitted that the idea ofrisk was now included as a part of the more general conception, uncertainty.
20

See Knight (1919 [1964], p. 20).
This was also year Knight published Risk, Uncertainty and Profit, which was theextended version of his 1916 dissertation.

21

9However, despite the admittance, Lavington decided to discard the concept
of uncertainty, both clumsy and unfamiliar (p. 89). Thus, the confusions interminology remained 22 .
Lavington addressed the distinction between risk and uncertainty
for the last time in 1925/26, where he emphasized a subjective aspect ofundertaking 23 . He stated as follows:
inasmuch as they [business risks] arise mainly in the development ofventures whose prospects are not susceptible of precise mathematicalexpression, it is convenient to emphasise the fact that they depend more
upon personal than upon actuarial valuations. This may be done by slightly
amending the definition of Risk: by defining it not as the (actuarial)
probability, but as the (individual) expectation, of loss. (Lavington 1925/26,
p. 189, emphasis in original)
Furthermore, he linked risk with the expectation of loss and the realized
loss in production, and linked uncertainty with the likely error of that
expectation and reduced efficiency—or irregularity (p. 194)—of individual
incomes (p. 192). He explained that a fire insurance company could reduce
uncertainty but not risk; this was because while insurance could balance theirregularity of incomes, it could not reduce the expectation of loss from fire(p. 199).
4-2 Rational behaviour under business risks
In microeconomics, Lavington focused on the formation of rational
behaviour under uncertainty. In the Marshallian tradition, this was an asset(money and security) demand theory, which consequently led to Keynes’
liquidity preference and Markowitz–Tobin means-variance analysis. In thissection, we will summarize that which has been examined in detail in

22

According to Bigg (1990, p. 47), ‘the distinction remains blurred’.
Bigg (1990, p. 49) saw this aspect as ‘an important step away from the substantively
rational schema in the Marshallian Tradition’.

23

10

previous studies 24 .
In 1921, Lavington argued that the individual demand for money
was influenced not only by an individual’s income but also by the rate ofinterest and the state of his/her expectations. He ascertained the triple
simultaneous decision model for consumption, money-holding andsecurity-holding. In the equilibrium, respective yields from the marginalunit on consumption, marginal utility of convenience and security and the
net rate of interest coincided. This was what D H Robertson later termedthe ‘threefold-margin-of-preference theory of interest’. A modern businesssociety compelled entrepreneurs to hold a stock of money ‘as a first
defence against the uncertain events of the future’ (Lavington 1921, p. 30).
Further, Lavington, particularly in 1912 and 1921, developed amean-variance analysis by drawing two graphs (average and spread of
returns in safe and risky securities)25 . Risky securities, which meant avariety of possible returns, were only preferred if their average returns werehigher than those of the safe securities. The difference of returns
represented a disutility, or uncertainty, ‘for which a payment must be madein addition to the net rate of interest’ (Lavington 1912, p. 399). This,
including a discussion of risk premium, was an early version ofMarkowitz–Tobin analysis.
4-3 Irrational consequences in the trade cycle
At the macroeconomic level, however, the entrepreneurs’ rationality
did not always succeed in accomplishing coordination; in fact, more often
than not it failed to achieve it. While pure theorists may have appreciated adecentralized system which spontaneously obtained an optimal position
owing to price mechanism, it appeared that Lavington hesitated to directly
reach a simple answer. Consequently, he adopted a manner in which hespecified two main causes and one consequence.
First, entrepreneurs were so central in the production process that24
25

See Bridel (1987, p. 54), Bridel (2004, p. 724) and Komine (1995a, p. 799).
For further details, see Komine (1995a, pp. 802–4).
11their forecasts were vital in the trade cycle. Moreover, since production
involved a long period of time (Lavington 1922, p. 20), estimates had to be
on future conditions, and not on the current ones.
the activity of business depends not on current conditions, but on theestimates which entrepreneurs form of the conditions of their markets atsome distant date in the future. (p. 21)
Originally, the estimate was an independent rational judgment, at least ex
ante and subjectively. However, these estimates inevitably included lethal
errors because they were strongly coloured by the business atmosphere (p.
31). Additionally, these errors were further strengthened by arbitrary
variations in the price index (p. 27). Finally, ‘rationally based confidence
gives way to optimism—judgments are infected by a general error’ (p. 37).
Second, the increased interdependence between industries had an
impact. Each specialized group producing specialized products had to ‘sell
its products for those of other groups’ (p. 22).
the ability of each to market its own products depends on the output
by the other groups of the goods with which these products are bought. (p.
22)
Thus, capitalists, entrepreneurs and workers were in turn consumers. Bymeans of the system of communications (transport of intelligence, material
goods and value), the dissociated parts could be interconnected (Lavington
1921, p. 2). One impulse was spread out, and another stronger would
generate.
Third, economies, as a result, had cumulative processes ‘in all
directions in the same manner as the original stimulus’ (Lavington 1922, p.
36). For instance, wide oscillations of general prices added to the risks ofbusiness undertaking, which in turn resulted in an increase in cost of
production, consequently leading to disturbing effects upon employment

12

(Lavington 1911, p. 58). Lavington concluded as follows:
first, that there exist influences which, reacting upon andstrengthening one another, cause a cumulative increase in business
confidence and consequently in business activity; secondly, that thisgrowing activity ultimately destroys the confidence on which it is based,with the result that the influences at work are reversed and there follows acumulative decline in business confidence which leads to a condition ofmarked business depression. (Lavington 1922, pp. 29–30, emphasis inoriginal)
An improvement in the business outlook actualizes production activity; theimpact of which is so cumulative that business judgments are transformed
from a rational basis into over-optimism. This situation in itself triggers thedownward movements. The boom, with prices rising, involves thewithdrawal of legal tenders and leads to dependence on over-commitments
among business men (pp. 63–4). Apart from financial constrains (ordisturbances), real factors are also significant; the quality of business
management and the efficiency of labour decline as the boom proceeds (p.
75). Consequently, a turning point of the cycles is reached which may leadto cumulative depression.
In sum, economies are always vulnerable to the trade cycle 26 .
Lavington envisioned that the modern business society was always subject
to fluctuations, mainly due to the existence and importance ofentrepreneurs and modern business structures. This is an example of how
individual rationality leads to collective disturbances, or irrationality.
5 Industrial Structures
Previous studies, especially Bridel (1987) and Bigg (1990), hadconsidered in part up to this point. However, we question whether
26

Lavington (1922, p. 14) classified the rhythmical movements into three phases (rising,a brief interlude of apprehension and declining).
13

Lavington had a definite solution to fill the gap. In this section, we consider
four case studies at the meso-level.
5-1 Bankers
A banking system27 , as a particular branch of production, had highly
evolved in England; this system was the most suitable case study ‘tomeasure the divergence between the lines of direction of individual action
and those of material social welfare’ (Lavington 1911, p. 60). In this regard,
Lavington primarily questioned himself as follows: (1) Did banks earn
undue and abnormally high profits? (2) In the event of any considerable
divergence, did we need restrictive or supplementary action to correct the
disparity of interest between the part and the whole (p. 54)?
With regard to the first question, Lavington responded in thefollowing manner by raising four issues: (1) No, because at least a part of
the great reserve funds are used in the business (p. 55); (2) no, banks could
add for ‘the valuable immaterial organization—business connections andpublic confidence’ (p. 55); (3) no, the surplus profit of banks was ‘only atransfer from an inert class in possession of disposable wealth to a body ofshareholders’ (p. 57) 28 and (4) yes, it was due to ‘the imperfect bargaining
between banker and customer’ (p. 56). In sum, Lavington concluded that‘the high social cost of banking services is not a considerable evil’ (p. 60).
Further, with regard to the second question, in banks, selection of thegoverning body was now done by democratic election as opposed to theearlier system of hereditary management. This change eliminated social
waste and brought great stability to the banking institutions (p. 57). The
great joint stock banks, with their superior size and management, offered
the public greater security and were able to distribute capital much more
evenly (p. 57). However, there was still room for improvement: (1) theneed for common action among banks to control discount rates and the
supply of currency, for stabilizing price levels (p. 59); (2) the necessary
27

Its function was the transport of capital and the supply of money (p. 54).
This phase is reminiscent of Keynes’ comment, ‘the euthanasia of the rentier, of thefunctionless investor’.

28

14

growth of banking experience and tradition (p. 59) and (3) the
inaccessibility of capital to certain classes that were quite capable of using
it effectively, due to imperfect human knowledge and experience. For
instance, given that bank managers at huge banks are frequently relocated,their local knowledge must be inferior to that of small private bankers (p.
57, p. 60).
Despite these present conditions, Lavington was optimistic. The
evolved banks would pursue a far-seeing policy; thus, there was ‘every
reason to welcome recent changes in the system and to expect greater
services in the future’ (p. 60).
5-2 A speculator in the stock exchange
Speculation is the yardstick by which researchers regard markets. Let
us examine Lavington’s view on this subject taking into consideration theyears 1913 and 1921. A speculative transaction can be defined as one that is
conducted by a person whose operation is ‘influenced mainly byconsideration of the future capital value of the security’ (Lavington 1913, p.
40). Its peculiarity lies in that it redistributes the disutilities, involved in the
supply of capital, among issuers of securities. The supply price of capitalcomprises three disutilities: pure waiting, risk-bearing and financial
insecurity bearing (precautionary motive). This was the other side of thethreefold-margin theory. The first disutility corresponded to the utility on
consumption, the second to the net return of security and the third to theutility on money-holding. When determining whether or not speculation
was detrimental, Lavington considered two effects based on a criterion.
His standard was a correlation between individual and social net
gains. He noticed the severance and stated the following:
the public interest in speculative transactions requires that theyshould be based on knowledge of what future prices should be, while thespeculator is concerned only that they should be based on knowledge ofwhat future prices will obtain. (p. 48, emphasis in original)

15

Ostensibly, the speculator’s profit was limited only by a difference of pricemultiplied by the volume of his transactions. However, over and above thisprofit, the social advantage substantially consisted of an additional utility
added (p. 42) to both direct and indirect services by means of speculation.
Direct effects of speculation were both reducing uncertainty (orrisks) by forecasting the changes in value, and bearing the residue which
the speculator could not still eliminate (p. 40). In other words, increasing
the marketability of securities reduced the cost in the supply of capital.
Without the stock exchange, big undertakings such as railways could nothave been successful. Although monopolizing superior knowledge isharmful, unequal bargaining power can be destroyed by complete
competition, the pressure of experts (p. 43). Indirect effects included
discontinuity, moral evils and influences upon the price of securities.
Discontinuity referred to the impact which speculative operations would
bring daily life into instability. This impact would destroy the relation
between conduct and consequence, which was the basis of rational action(p. 47; Lavington 1921, p. 258). Moral evils, such as increasing thepleasures of speculation per se, were a matter of opinion. After all,Lavington abandoned his attempts to ascertain the accurate effects of thetwo, by concentrating on the third element. Again, it was not based on apriori assurance, but on facts (p. 259; Lavington 1913, p. 46). Further,effects on the prices of securities and on the characters of the public were,in general, considered desirable.
Thus, Lavington, on the whole, both in 1913 and 1921, wasoptimistic. Although he still had a few reservations (without monopolistic
powers, disregarding indirect effects other than on prices and so on), he
concluded that the prices of securities approached more closely toinvestment values, thus speculation yielded a considerable net advantage tosociety.
5-3 Monopoly

16

The third case study was on monopoly. Lavington was primarily
concerned with whether or not a disinterested monopolist could contributeto increasing the stability of business. Here, ‘a disinterested monopolist’
implied an economic agent ‘who was concerned to regulate his business in
the interests of society’ (Lavington 1926, p. 135), whereas ‘the stability ofbusiness’ indicated a situation where ‘the retardation or acceleration of theflow of purchases ... is likely to be at a minimum’ (p. 141). Here, thestability of business was the most important criterion. Lavington made thefollowing three assumptions: (1) this consideration was not actual but
theoretical, (2) a monopolist acquired absolute control of supply and (3) the
conditions of supply conformed to the law of constant cost (p. 131). Basedon these assumptions, Lavington examined the following two aspects.
The first was with regard to fixed price. The initial point was theintersection between the normal long period demand curve and the supply
curve. The supply curve was horizontal (infinite elastic) at a fixed price.
Suppose the short period demand curve fluctuated vertically about thenormal curve; then a comparison of the short intersection (upward supply
curve) with the long intersection clearly reveals that shifting the demand
curve upward meant a greater expansion of output (vice versa) owing tomore elastic output. Thus, a policy of fixed price led to the instability ofbusiness (p. 139). However, such a situation could yield the following two
scenarios: (1) in interdependent industries, the effect of a stable price might
result in a reduction in the commercial risks of the subsequent producer(fixed contracts) and (2) if the ‘market sentiment is pessimistic, a policy of
fixed price is superior on the ground that a policy of flexible price operates
as an artificial lowering of the demand curve’ (p. 141). Thus, fixed pricethwarted the expectation of a further decline in the demand during thedepression. Therefore, the whole effect of fixed price was ambiguous andindeterminate (p. 142).
The second dealt with fixed output. Lavington observed fixing
output at a level below that ‘which would be prescribed for the monopolist
by the doctrine of maximum satisfaction’ (p. 146). This fixed output point17

led to a reduction in the instability of business. This was because at thatpoint, appliances of production and workpeople would be employed more
continuously, consequently leading to a substantial reduction in the
expenses of production (p. 147).
These arguments were not conventional to the market clearing theory.
Even if there was a monopoly (fixing either price or output), various
conditions, such as market sentiment and costs of hiring additional
resources, would have affected the conclusions. Above all, these arguments
revealed that a continuous employment of production elements (plant andworkpeople) was the most significant criterion for economic welfare.
5-4 Vertical disintegration
The fourth case study was an investigation of the form and size of abusiness unit. In 1927, Lavington provided a contradictory scenario to thereal phenomena in economies during his time; he proposed a theoretical
ideal espoused by his mentor, Alfred Marshal in Industry and Trade (1919).
Let us define the following three terms: (1) vertical integration as ‘theassociation of unlike processes in successive stages’ in the production of asingle good; (2) lateral integration as ‘the association of unlike processes inthe same stage’ (Lavington 1927, p. 30) in that of more than two goods29
and (3) vertical disintegration, or horizontal combination, as ‘an expansion
in the output of a given restricted variety of products’ (p. 30). His logic was
to first point out the reality in modern business situations and then note atheoretical tendency to vertical disintegration.
A few technical conditions hindered the natural evolution of anindustry. First, as was evident in industries such as heavy iron, steel andlight chemical, the successive processes needed to be carried out in close
physical conjunction, due to the technical interdependence of products30 .
Second, as was typical in the pottery (Wedgewood) and motor car
industries, the quality of products at the various interconnected production
29

Lavington did not distinguish a single good from many goods.
‘The manufacturer may send away his cloth to be finished and dyed; but coal ispicked and washed by the colliery’ (p. 33).

30

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stages was so uncertain that supervision at every stage was necessary (p.
34). Third, a balanced plant was needed; a plant whose successive
processes were adjusted such that each process was conducted on a scale
which was economically adapted in its productive capacity to the demandsof the succeeding process (p. 34). It appeared that Lavington regarded these
conditions as exceptional, yet he admitted that vertical (lateral) integration
was evident in a few, but remarkable, industries.
Given the above, the question of identifying the natural tendency tovertical disintegration arises. This tendency can be defined as ‘the principleof concentrating human faculty on a narrowed range of tasks’ (p. 27). The
division of labour31 simplified the task of direction, which would thenincrease the volume of output. Further, this simplification and expansion
could ‘be efficiently controlled by a single mind’ (p. 27). Vertical andlateral integrations implied ‘a proportionate increase in the complexity ofthe business unit and therefore in the difficulties of management’ (p. 30).
Lavington stated as follows:
The fact that the concentration of human faculty on a small range ofproblems is economical can only mean that there are sharp limits to thecomplexity of the undertaking which can be efficiently controlled by asingle mind: in other words, that in each industry the growth in size andcomplexity of the representative firm is strictly limited by the organizing
capacity of the representative entrepreneur. (p. 300, emphasis added)
It followed that the foremost was the control and governance by a single(able) entrepreneur, and therefore, Lavington preferred verticaldisintegration, in which large-scale production and proper management
were compatible. This was not his finding with regard to the realdevelopment in economies; rather, it was his aspiration for an ideal world,
inspired by Marshall32 .
31

See Laffaelli (2006, p. 11).
This confirms that Marshall shared Lavington’s view on business units. See Marshall(1919, p. 216).

32

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6 Concluding Remarks
In this section, we provide a summary of all the arguments presented
in this paper. Thus far, we have outlined Lavington’s insight on the modern
business society. This insight is understood as a threefold-layer structure at
the core of which is a peculiar economic agent: an entrepreneur.
The micro-layer deals with a (pure) theory represented by the theoryof the demand for money, which would subsequently result in two moresophisticated theories, namely, liquidity preference and portfolio selection.
Lavington, one of the pioneers in those theories, described a typicalsituation of entrepreneurs under uncertainty who ventured to bear risks andundertakings as rational behaviour.
The macro-layer pertains to the perception of the present economic
peculiarities. It is represented by the theory of the trade cycle. While it is atheory in macroeconomics, it can be regarded as Lavington’s conceptionthat modern economies suffered from cumulative ups and downs in trade.
This was mainly due to an error in judgement made by an entrepreneurwith regard to future estimates and due to the interdependence between
firms and industries. At this stage, a divergence between individual rational
actions and collective irrational consequences escalates to a maximum
point.
The meso-layer is concerned with the ideal. It is represented by thetheory of industrial organization and structure, which is divided into four
subsets: bank, speculator, monopoly and business size. In each of these
subsets, each agent has a dual function 33 . On the one hand, in each market,
inferior participants had a tendency to merely follow the general situation.
For instance, some bankers were so inexperienced and ill-informed thatthey were not worthy of high profits. Some speculators in the stock
exchange, based on a short and restricted perspective, disturbed the market.
33

This point generates seemingly contradictory interpretations. Researchers, who gave
importance to Lavington’s view on instability (stability), tended to associate him with
Keynes (Marshall).
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Some monopolists had no scope of social benefits. Some entrepreneurs
could not handle complex processes of production and possibly disturbed
the order of the market. On the other hand, the captains of industry or
leaders in the industry, based on economic chivalry, had the ability tocorrect such disturbances. Superior bankers could pursue common benefits
for customers and other bankers. Good speculators could behave as
arbitrators to move the prices of securities closely into true investment
value. Admirable monopolists could reduce the fluctuations in resource
employment by adopting, for example, a fixed output policy. Virtuous
entrepreneurs could fully utilize his/her abilities in the specialized
processes of production by controlling the management of the organization.
Lavington noticed that the captains of industry were ideal and that
there was a considerable gap between the reality and the ideal, or themacro- and micro-layers. This was the starting point for Lavington.
However, economies had a third layer as well, the meso-layer, where there
were several able leaders in collective groups, such as organizations, firms
and industries. Moreover, here, entrepreneurs, as ‘the modern organ ofmanagement’ (p. 35), could correct the gap and wield control so as to adjust
the social resources to the social ends if they evolved in the same line with
Marshall’s expectations. Lavington believed that the evolution of the
English capital and commodity market would take place in this manner.
Thus, from 1911 to 1927, he was constantly optimistic about the future of
the modern business society.
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Lavington, F. 1913. ‘The Social Interest in Speculation on the Stock Exchange’, The
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Sangyo University Faculty of Economics, No.13, July 1995, pp. 73-80, (in Japanese).
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