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