Why the length of value chains matter

A value chain is the number if steps in the process of production, where each step is marked by a salable intermediary good. I'm going by memory, so if there's a more concise definition, please forgive.

Think of the steps in the construction of a car. Raw materials are iron, carbon, rubber, and petroleum products. Each material has a process of extraction, transportation to refiners, transportation to factories to produce components, and then finally assembly into a car. There is value added at every step. A bar of refined iron is more valuable than the same amount of iron in ore form ; a widget made of iron is more valuable than the same iron in the form of an ingot ; steel is more valuable than its component iron and carbon. Each step can be done by a separate business, or several steps can be combined into one business, which is called "vertical integration." Vertical integration is hugely advantageous because the company can cut out the premium charged by suppliers as well as reduce logistics costs.

Now, if you add up the costs of production along the entire value chain, there's theoretically a final minimum price for the finished good, if the seller is to remain in profit. This is technically an incorrect way to think of prices, but its sufficient for the sake of understanding value chains. A vertically integrated business can cut costs and reduce the final price, so this is advantageous. But vertical integration is usually politically unpopular because it puts people out of work and closes businesses. It can be very detrimental to an economy on a small scale - towns that once had dozens of factories have become ghost towns after those factories were bought and closed down. But there's a clear pattern to observe : countries which blocked mergers have ended up losing their industries. South Korea rose on telecoms and shipbuilding. Taiwan rose on plastic toys and semiconductors. China rose on plastic goods that moved from Taiwan to take advantage of cheap labor and WTO accession, and has kept/expanded its exports by keeping logistics cheap. America could have kept these industries. Those countries only had one real advantage : they encouraged vertical integration. Cheap labor was counteracted by lack of infrastructure, initially, so it wasn't a factor to get it started. They needed integration so badly, they actually subsidized chosen national conglomerates in various ways. The result was, they produce stuff cheaper than the US can. All other factors - cost of labor, logistics, government type, whatever - are subordinate to the effect of vertical integration, since its the consolidation of the value chain that moves and organizes capital.

Now, zoom out a bit. How many steps in the value chain can a nation support? Imagine some fantastically complicated vehicle, like a spaceship with FTL and energy shields and plasma weaponry. We can't build that right now. Its not only that we don't know how - even if we did, we couldn't do it. The number of steps in the chain of production are too numerous.

Now think of the most advanced technology of 15th century Vienna, a city in its prime, the seat of an empire... The arts are flourishing, the merchant estate is stepping into its power, multistoried buildings are being built, its prestige in Europe is unequalled, and the Ottoman empire can't conquer it, despite its lust to do so. How long is their longest value chain? What is it, a suit of armor maybe? Maybe three steps in total. Mine, refine, bang it out. Excluding innovation, what allows modern society to build more complicated stuff along longer chains of production? Only one thing : property rights. We have courts, and our courts mostly don't favor aristocracy as a birthright, and instead impartially uphold property rights.

Property rights allow for free trade, and free trade allows for ever longer chains of production, as one merchant makes a widget and another finds a use for the widget in another widget, and so on, until you get cars and airplanes.

With this in mind, NOW we can make comparisons of civilizations. How advanced a civilization is, is not determined by it's total knowledge, but rather the length of its value chains. The length of value chain that can be supported, ie have demand for its finished product sufficient to justify the investment along the chain, is determined by property rights and consolidation - and the right to consolidate should be a given, if you have strong property rights.

Thus, the comparison of the productive capacity of civilizations is really a comparison of property rights, which is to say, the emancipation of the lowest "class." Inviolable property means people can build and they can buy. Any system where only some people can build and buy is inferior to a system where all people can build and buy ; and between two systems of equal rights, the one with a higher population wins, since it can support a greater diversity and lower margins.

Okay! All this was written to refer to in another note I've been tapping out... I got a bit carried away, but I do love thinking about chains of production. It would have been silly to include all this in the one note, so I split it off.