The Decades‐long Dispute Over Scale Effects in the Theory of Economic Growth

Abstract

The so‐called “new growth theory” is characterized by the now Nobel Prize winning insight that ideas are a nonrival input to and output from endogenous investment in innovation. Nonrivalry implies increasing returns to scale, but this also unintentionally creates an empirically disputed scale effect that a growing population implies an ever‐increasing growth rate. Empirical evidence supports fully‐endogenous growth without scale effects, but theoretical issues sustain the decades‐long dispute over exactly how to negate the scale effect. This article surveys theoretical approaches to resolving the scale effect and shows how four generations of endogenous growth theory are defined by the maturing of modeling techniques for constraining increasing returns. The synthesis suggests that the dispute over scale effects is really a narrative about how the powerful application of increasing returns has followed a standard theoretical development pattern. This implies that a fourth generation is now emerging that negates the scale effect while retaining fully‐endogenous growth without relying on assumptions of linearity. Instead, the market response to excessive increasing returns to innovation constrains explosive growth by expanding the market, rather than by a linear assumption. This latest class of endogenous growth models may be the final chapter to resolving the long‐running dispute.

The unintended consequences of increasing returns to scale in geographical economics

“…As a result, increased research effort by firms or sectors increases the growth rate of technology, but increases in the scale of population only increase the number of varieties, thereby eliminating the scale effect from first generation models. Theoretical arguments strongly support the Schumpeterian approach to modelling endogenous growth without scale effects (Peretto, 2018;Bond-Smith, 2019).…”

“…Endogenous growth theories can be characterized into generations by the scale effect (Jones, 1999;Bond-Smith, 2019). Each generation is followed by its application to core-periphery or trade models to understand the spatial implications of growth.…”

“…Other spatial mechanisms may explain why innovation costs differ between cities, such as land rents for lab space, wage costs for scientists to live in an expensive location or congestion costs for scientists travelling to work, but these spatial models are the appropriate tool to directly model such mechanisms rather than rely on implicit biases in assumptions about scale in the innovation production function. Instead Bond-Smith et al ( 2018 Most recently Peretto (2018) represents a fourth generation model of endogenous growth (see (Bond-Smith, 2019)). In this model, quality improvements are explosive, but the number of varieties expands in response to explosive quality improvements.…”

“…At the same time, economic growth is unrelated to scale (Jones, 1995b). The dispute over scale effects is really about how to reconcile these two stylised facts (Bond-Smith, 2019). Recent models of growth allow innovation to be explosive even if growth is not (Peretto, 2018).…”

“…The spatial nature of knowledge spillovers (Audretsch and Feldman, 1996) and similarities in modelling techniques implied a suitable marriage between endogenous growth and economic geography (Bond-Smith and McCann, 2014). The continued development of endogenous growth theories over four generations (Bond-Smith, 2019) is repeatedly followed by spatial versions to understand the geographic implications of endogenous growth.…”