David Warsh's new book, Knowledge and the Wealth of Nations, is hailed  
by its publishers thus: Like James Gleick's Chaos or Brian Greene's The  
Elegant Universe, [it] takes us to the frontlines of scientific  
research; not since Robert Heilbroner's classic work The Worldly  
Philosophers have we had as attractive a glimpse of the essential  
science of economics.  
  
Paul Krugman, in yesterday's New York Times, hails it as a major effort  
to explain to the public the intellectual revolution of new growth  
theory and new trade theory, and how that revolution resolves the  
"contradiction that has lain at the heart of economic theory ever since  
1776... the struggle between the Pin Factory and the Invisible Hand".  
(www.nytimes.com/2006/05/07/books/review/07krugman.html)  
  
But it is evident from Krugman's review that he still has not grasped  
the deep import of Allyn Young famous paper on "Increasing Returns and  
Economic Progress" (EJ, 1928, in  
http://socserv2.mcmaster.ca/~econ/ugcm/3ll3/young/increas.html).  
Instead, he and most of modern endogenous growth theory (and new trade  
theory) interpret Adam Smith in terms of the size of the individual firm  
or the individual industry rather than the size of the overall economy.  
  
As Young wrote (1928, p.531):   
    "... Otherwise, economists of standing could not have suggested that  
increasing returns may be altogether illusory, or have maintained that  
where they are present they must lead to monopoly. The first point is  
that the principal economies which manifest themselves in increasing  
returns are the economies of capitalistic or roundabout methods of  
production. These economies, again, are largely identical with the  
economies of the division of labour in its most important modern forms.  
In fact, these economies lie under our eyes, but we may miss them if we  
try to make of _large-scale_ production (in the sense of production by  
large firms or large industries), as contrasted with _large_ production,  
any more than an incident in the general process by which increasing  
returns are secured and if accordingly we look to much at the individual  
firm or even... at the individual industry.  
   The second point is that the economies of roundabout methods, even  
more than the economies of other forms of the division of labour, depend  
upon the extent of the market-and that, of course, is why we discuss  
them under the head of increasing returns. It would hardly be necessary  
to stress this point, if it were not that the economies of large-scale  
operations and of "mass-production" are often referred to as though they  
could be had for the taking, by means of a "rational" reorganisation of  
industry."  
  
Krugman, Paul Romer etc (and now Warsh) seem to think that the pin  
factory suggests an incompatibility with competition. They congratulate  
themselves on having escaped the "mush" of old economics to develop  
rigorous mathematical models incorporating monopolistic competition and  
external economies -- such as arise from investment in human capital and  
R&D -- to justify protectionist government intervention to deal with  
"market failure".  
  
Let them instead ponder Allyn Young on the division of labour and size  
of the (free) market:  
  "In an inclusive view, considering the market not as an outlet for the  
products of a particular industry, and therefore external to that  
industry, but as the outlet for goods in general, the size of the market  
is determined and defined by the volume of production. If this statement  
needs any qualification, it is that the conception of a market in this  
inclusive sense -- an aggregate of productive activities, tied together  
by trade -- carries with it the notion that there must be some sort of  
balance, that different productive activities must be proportioned one  
to another.  
    Modified, then, in the light of this broader conception of the  
market, Adam Smith's dictum amounts to the theorem that the division of  
labour depends in large part upon the division of labour. This is more  
than mere tautology. It means, if I read its significance rightly, that  
the counterforces which are continually defeating the forces which make  
for economic equilibrium are more pervasive and more deeply rooted in the  
constitution of the modern economic system than we commonly realise. Not  
only new or adventitious elements, coming in from the outside, but  
elements which are permanent characteristics of the ways in which goods  
are produced make continuously for change. Every important advance in  
the organisation of  
production, regardless of whether it is based upon anything which, in a  
narrow or technical sense, would be called a new "invention," or  
involves a fresh application of the fruits of scientific progress to  
industry, alters the conditions of industrial activity and initiates  
responses elsewhere in the industrial structure which in turn have a  
further unsettling effect. Thus change becomes progressive and  
propagates itself in a cumulative way."  
  
Smithian increasing returns are thus macroeconomic (or "generalised"),  
not microeconomic nor even sectoral, and ensure that growth is truly  
endogenous in the sense that a main cause of growth is growth itself,  
through a progressive, induced division and specialisation of  
qualitatively different industries and firms as and when the overall  
size of the market justifies it.  
  
And, unlike modern endogenous growth theory that simply extends the  
neoclassical growth framework, it indicates why growth can be largely  
self-sustaining rather than self-exhausting.  
  
To see this, compare the following:  
   Buchanan, J.M. and Y.J. Yoon (1999), Generalised Increasing Returns,  
Euler's Theorem, and Competitive Equilibrium, _History of Political  
Economy_, 31(3), 511-23.  
   Buchanan, J.M. and Y.J. Yoon (2000), A Smithean Perspective on  
Increasing Returns, _Journal of the History of Economic Thought_, 22(1),  
43-8.  
   Currie, L. (1997), Implications of an Endogenous Theory of Growth in  
Allyn Young's Macroeconomic Concept of Increasing Returns, _History of  
Political Economy_, 29(3), 413-43.  
   Sandilands, R.J. (2000), Perspectives on Allyn Young in Theories of  
Endogenous Growth, _Journal of the History of Economic Thought_, 22(3),  
309-28.  
  
Roger Sandilands