Increasing Returns and Path Dependence in the Economy

Preface

Preface When the University of Michigan Press approached me to bring out a book of collected papers on increasing returns in economics I was surprised. I had thought that only older researchers, venerable and near retirement, issued collected works. But Timur Kuran, my editor, and Colin Day, the Press's director, argued that although the papers collected here have been receiving much attention lately, several of them have appeared in obscure places and are not easy to track down. In book form they would be accessible. Moreover, if they were brought together, a wider picture might emerge from the mosaic they create than from the individual pieces. This sounded like sufficient rationalization to me, and I accepted their invitation with gusto. Ideas that invoke some form of increasing returns are now acceptable in economics-indeed they have become highly fashionable. But this was not always so. As recently as the mid-1980s, many economists still regarded increasing returns with skepticism. In March 1987 I went to myoid university , Berkeley, to have lunch with two of its most respected economists. What was I working on? Increasing returns. "Well, we know that increasing returns don't exist," said one. "Besides, if they do," said the other, "we couldn't allow them. Otherwise every two-bit industry in the country would be looking for a handout." I was surprised by these comments. Increasing returns did exist in the real economy, I believed. And while they might have unwelcome implications, that seemed no reason to ignore them. Since then much has changed. The whole decade of the 1980s in fact saw an intense burst of activity in increasing returns economics. Nonconvexities and positive feedback mechanisms are now central to modem theorizing in international trade theory, growth theory, the economics of technology, industrial organization, macroeconomics, regional economics, economic development , and political economy. Of course this turnabout did not happen in just a decade; it has been coming for a long time. In a sense, ideas that made use of increasing returns have always been part of the literature in economics. But in the past they were only partially articulated and were difficult to bring under mathematical control . And they tended to have disturbing implications. As a result many in our profession chose to disregard or dismiss them. This distaste reached its peak xii Preface in the early 1970s with the broad acceptance in economics that all properly specified economic problems should show a unique equilibrium solution. I was a graduate student about this time, and all results in economics were served to us with the incantation that they were true, "providing there is sufficient convexity-that is, diminishing returns on the margin." I was curious about what might happen when there were increasing returns on the margin, but none of my professors seemed interested in the question or willing to answer it. Examples with increasing returns and nonconvexities were of course mentioned from time to time. But in the main they were treated like the pathological specimens in labeled jars that used to be paraded to medical students-anomalies, freaks, malformations that were rare, but that nevertheless could serve as object lessons against interference in the natural workings of the economy. Part of the change, part of the very acceptance of the place of increasing returns, came out of the more formal part of economics itself. Generalequilibrium and game theorists have known for many years that even under the most benign assumptions, multiple equilibria and indeterminate solutions occur naturally in the problems they deal with. Hence they found little difficulty accepting multiple equilibria when they arose from increasing returns. International trade theory, a less formal part of economics, needed to explain the peculiarity of intra-industry trade-France selling electronics to Germany and Germany selling electronics to France-and to deal more realistically with trade in manufactured goods. This forced it to include the possibility of increasing returns in production. Just as important as the broader acceptance of nonconvexities in trade theory and mathematical economics has been the development of new methods that deal analytically with the market imperfections and stochastic dynamics that arise in increasing returns problems. Economists can now explore into the terrain of increasing returns with much better equipment than they could ten or twenty years ago. As they do this they are rediscovering outposts from earlier expeditions: not just Adam Smith's familiar writings on specialization, Myrdal's notion of cumulative causation, Kaldor 's work on mechanisms of regional disparity, Rosenstein...