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William O. Shropshire: Oglethorpe University, Atlanta, Georgia, USA
Introduction
Adam Smith was first to observe that economies can be achieved at high levels of manufacturing production because labour can be increasingly divided as output levels increase. The division of labour and the concomitant economies of large production were "limited by the extent of the market" (Smith, 1776/1981, ch. 3). This possibility of increasing returns appears frequently in development theory[1], and its absence is cited as a significant cause of failure in less-developed countries by contributors to the "new theory" of international trade[2].
Although many writers have thought increasing returns to be important, they have not been in accord about why and how returns increase. Some have thought increasing returns augment the growth that originates in exogenous increases in labour and capital. Returns increase because output is greater, but the returns must await an initiating increase in inputs. This understanding probably underlies the isoquant diagrams used to illustrate returns to scale in microeconomic and development texts. The isoquants in these diagrams are drawn at equal product intervals and become closer together as output increases. This production-function approach is apparently also the basis of empirical studies that assign some part of growth to labour, some to growth of capital, and the rest to a residual that includes increasing returns along with improved technology, management, and resource allocation.
An alternative approach is that taken by Young (1928), who claimed that his theory of economic progress was not new but only a variation on a theme by Adam Smith. For Young, and his followers Currie (1981) and Kaldor (1967, 1972, 1981), increasing returns did not merely augment growth that originated elsewhere but were instead the very engine of growth. For these writers, higher output expands markets, and larger markets make further division of labour possible, which in turn enhances potential output. Unlike production-function theorists, who explain growing output by explaining the causes of input growth, Young and others emphasised the ways in which output can increase without commensurate increases in inputs. For them, moreover, many changes in capital and technique were not exogenous but were instead induced by expanding markets.
One aim of this paper is to illustrate and perhaps illuminate Young's approach to increasing returns by showing how...