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How We Economists Missed the Boat
By   Shlomo Maital   

As an economics student, many years ago, I was taught that production (both industrial and agricultural) was ruled by a Law. The Law of Diminishing Returns.  (See diagram). The more effort you invest in something, the less and less additional output you get. This law originated in agriculture. For a given plot of land, the output of food it produces rises by less than the labor and resources invested in it. Here is the proof: If there WERE increasing returns, you could grow all the world’s wheat in a flowerpot. The same “law” translated as well into industrial production.

   Some 23 years ago, in 1996, a brilliant and convention-breaking economists named W. Brian Arthur published an article in Harvard Business Review. The title: Increasing Returns and the New World of Business. I wish I had paid closer attention to it. Here in his words is why the ‘law’ of diminishing returns has been repealed forever.

     The powers of mind are everywhere ascendant over the brute force of things. As the economy shifts steadily away from the brute force of things into the powers of mind, from resource-based bulk processing into knowledge-based design and reproduction, so it is hsifting from a base of diminishing returns to one of increasing returns. A new economics – one very different from that in the textbooks – now applies, and nowhere is this more true than in high technology. Success will strongly favor those who understand this new way of thinking.

   What does this mean for us ordinary people, in simple language? Mainly, this. If you live in a world of increasing returns, then follow what a brilliant Israeli manager once decreed: first to imagine, first to move, first to scale. Think of a great idea. Get it rolling. And then scale it up fast! Because – winner takes all. The farther ahead you are of competitors, the more efficient and more profitable you become. And in the end, you, the winner, rule the market and can eliminate or buy up all your competitors.  And basically, do whatever you want to make piles of profit.  Including —   hire armies of lobbyists.

     Does this sound familiar?   Apple? Google? Facebook?  Amazon?

     Problem is, our political and regulatory systems still do not fully understand this. Only now are government bodies beginning to investigate the monopolistic practices of Facebook and Google.   These huge winner-take-all operations operate globally, so checking their power locally, in individual countries, is very difficult.

       The dominant economic idea of free markets and open competition does not hold when the law of diminishing returns has been repealed and replaced by increasing returns. In this new world, little fish grow bigger, swallow the smaller fish and become predatory whales.   Despite Arthur’s seminar article written in 1996, I believe it has not fully dawned on us that the old economics is gone forever. 

     We need to rethink how we regulate economies dominated by predatory whales rather than vigorous little minnows.

 

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Blog entries written by Prof. Shlomo Maital

Shlomo Maital
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