The Return to Increasing Returns.

• Author: Song, Frank

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...