Marshall's theory of external increasing returns was a matter of serious debate during his time. Opinions on the subject varied because most economists couldn't completely understand it. A.C. Pigou, Marshall's successor, claimed that externalities were so important that the government should either subsidize or tax businesses based on falling or rising costs. Others, like John Clapham, protested that it it was an "empty economic box" without any evidence or data. Frank Knight's logic was that "one man's spillover is another man's internal economy," asserting that it was prevalent in manufacturing.
Allyn Young was the one that made the most progress in the theory. He narrowed it down to the division of labor, but in a way that had never been thought of before. His idea was that the division of labor also dealt with knowledge, innovation, and differentiating products. That meant manufacturers could find new applications, thereby leading to specialization. He was soon elected president of the British Association's economies and statics and gave a speech titled "Increasing Returns and Economic Progress." This was probably his greatest contribution before he passed away shortly before the great depression.
B for Mitch: statics and statistics aren't the same thing. Sometimes you need to double-check your spellchecker.
ReplyDeleteI think the point of Young's contribution has been missed.
All of these people are debating Marshall's assertion that technological improvements coming from outside the firm (spillovers or externalities) were driving growth and diminishing costs.
Young turns that on its head, and in 1928 makes an argument that's very common right now: that technological improvement isn't primarily about creating better ways of doing old things, but rather about creating new ways of doing new things that no one had thought of before.
Part of the key to this is "thick" markets. Fifty years later Krugman is the first to show that thick markets lead to new profit opportunities to provide the first new explanation of trade since Ricardo.