The Return to Increasing Returns.

The neoclassical economic theory relies on the major premise that firms, industries and economies have constant returns to scale in production. Only recently has the increasing returns postulate gained wider acceptance through analyses of endogenous growth, international trade, unemployment, and the economics of ethics. James M. Buchanan and Yong J. Yoon edited an impressive collection of essays on increasing returns, ranging from classical origins of Adam Smith, Alfred Marshall, Allyn Young to more recent developments in trade, growth, macroeconomics and the economics of ethics by such authors as Paul Krugman, Martin L. Weitzman, Paul M. Romer, James M. Buchanan and others. The book is comprehensive and well-organized. It can be used as an excellent reference book and readings for researchers and graduate students in the above mentioned fields.

In part 2 of the book, the editors selected three essays that help trace out the classical origins of and the neoclassical evolution of the basic theory. In The Wealth of Nations, Adam Smith assigned primary of place to the division of labor in his explanation of how and why nations are or can become wealthy. Although not spelled out explicitly, one can infer the idea of generalized increasing returns in Adam Smith's theorem on the effect of the division of labor. Alfred Marshall, in his famous Principles of Economics, invented the notion of external economies to reconcile the concepts of competitive economy and increasing returns. The idea is that the advantage of scales due to extended specialization are generalized over a sufficiently inclusive "space" of the economy, over whole industries or industrial categories. The single firm acts as if it operates under constant returns to scale and competitive organization is still viable. In his 1928 paper, "Increasing Returns and Economic Progress," Allyn Young returned to Adam Smith's central proposition on the division of labor. He developed a dynamic model under conditions of increasing returns. The division of labor depends upon the extent of the market, but the effect of the market depends upon the division of labor.

Part 3 of the book includes articles by George J. Stigler, Hendrik S. Houthakker, and Kenneth J. Arrow. These articles prepared some of the ground work for more rigorous formal treatment of the division of labor or specialization. George Stigler, in "The Division of Labor Is Limited by the Extent of the Market" (1951), reiterated the fundamental principle of the division of labor in economic organization. Hendrik S. Houthakker, in "Economics and Biology: Specialization and Speciation" (1956), provided some arguments for the generality of specialization even among non-human living world. Kenneth J. Arrow argued the pressure for efficiency in the broadest sense (not merely economic but also political and social) lead to the division of labor and specialization of knowledge. However, the division of labor leads to a division of society into smaller social groups which communication is limited and both economic and social intercourse is restricted.

Part 4 of the book contains articles that criticize the constant-returns postulate and develop formal models that deviate from standard assumptions of constant returns to scale and competition in the neo-classical paradigm. In "The Irrelevance of Equilibrium Economics" (1972) and "Interregional Trade and Cumulative Causation" (1985), Nicholas Kaldor objected to the use of constant returns to scale as a device of economic analysis. Instead, he used the postulate of increasing returns to derive some implications that contradicted those of standard neoclassical theory of trade. John S. Chipman, in "External Economies of Scale and Competitive Equilibrium" (1970), supported Marshall by demonstrating the existence of competitive equilibrium with externalities. Avinash K. Dixit and Joseph E. Stiglitz in "Monopolistic Competition and Optimum Product Diversity" (1977), provided a model of product diversity in monopolistic competition, which becomes the basis for the analysis of increasing returns. John Hicks, in "The Assumption of Constant Returns to Scale" (reprint in 1989), recommended keeping both increasing returns and constant returns to scale in play.

Part 5 through 8 contain recent applications of increasing returns to different areas in economics. In part 5, Wilfred J. Ethier, in "National and International Returns to Scale in the Modern Theory of International Trade" (1982), developed a simple model of the interaction of national scale economies with the modern, factor-endowments, theory of international trade. He was able to explain intraindustry trade in manufactures as complementary to international factor movements. Paul Krugman in "Increasing Returns, Monopolistic Competition, and International Trade" (1979) further argued, because of the scale economies, markets are imperfectly competitive. Nonetheless, one can show that trade, and gains from trade, will occur, even between countries with identical tastes, technology, and factor endowments. Gene M. Grossman and Elhanan Helpman, in "Comparative Advantage and Long-Run Growth," studied the role that external trading environment and that trade and industrial policies play in the determination of long-run growth rates.

In part 6, Martin L. Weitzman provided an application of increasing returns to macroeconomics. In "Increasing Returns and the Foundations of Unemployment Theory" (1982), he argued that increasing returns to scale is the primary obstacle blocking unemployed agents from breaking out of a low level equilibrium trap unless there is overall coordination or stimulation.

Part 7 contains three articles dealing with increasing returns and economic growth. In "Growth Based on Increasing Returns" (1987) and "Endogenous Technological Change" (1990), Paul M. Romer identified technology as the output that emerges from a production process that exhibits increasing returns to scale. By investing in knowledge, in human capital, final output will increase more than proportionately due to the impetus given to the introduction of new technology. Jeffery I. Borland and Xiaokai Yang in "Specialization and a New Approach to Economic Organization" (1992) reviewed several recent studies which involve the application of a new framework for formally modeling specialization.

Finally, in part 8, James M. Buchanan and Yong J. Yoon have considered the individual work-leisure choice within the context of Adam Smith's theorem that the division of labor is limited by the extent of the market. The increased labor input, which a work ethic generates, will extend the market. Hence, under increasing returns to scale, individual participants in an economy are ethically interdependent in nonfamiliar ways. These articles demonstrate there is a great potential to apply the postulate of increasing returns to scale to other issues in economics.

To conclude, I would like to cite a statement from Yong J. Yoon [Ch 22, "Conclusion and Summary," p. 365], a statement I fully endorse: "Indeed, the primary motivation for putting this volume together is our sense that generalized increasing returns is a research program only in its 'take-off' stage of development, at precisely the point where a single volume's accessibility can prove maximally helpful to further participating contributors, as well as to economists generally."

Frank Song Cleveland State University