Monday
Shell Economist Prize winners announced
Import workers or export jobs? The winning essays are available here. The first prize went to Claudia O'Keefe who provides a touching first-person account and a much needed "shut up and think" in the dogmatic discussion around outsourcing. Hopefully the prize money will afford her the comfort and opportunity to write more.
Friday
Copycat or creative genius?
In this Newyorker piece Malcolm Gladwell looks at the line that separates copyright infringement and borrowing from someone else's work as part of a creative process. He wrote it after a playwright used some quotes from one of his Newyorker articles in a play.
Old words in the service of a new idea aren’t the problem. What inhibits creativity is new words in the service of an old idea.
And this is the second problem with plagiarism. It is not merely extremist. It has also become disconnected from the broader question of what does and does not inhibit creativity. We accept the right of one writer to engage in a full-scale knockoff of another—think how many serial-killer novels have been cloned from “The Silence of the Lambs.” Yet, when Kathy Acker incorporated parts of a Harold Robbins sex scene verbatim in a satiric novel, she was denounced as a plagiarist (and threatened with a lawsuit). When I worked at a newspaper, we were routinely dispatched to “match” a story from the Times: to do a new version of someone else’s idea. But had we “matched” any of the Times’ words—even the most banal of phrases—it could have been a firing offense. The ethics of plagiarism have turned into the narcissism of small differences: because journalism cannot own up to its heavily derivative nature, it must enforce originality on the level of the sentence.
Or, in musical terms:
He knew enough about music to know that these patterns of influence—cribbing, tweaking, transforming—were at the very heart of the creative process. True, copying could go too far. There were times when one artist was simply replicating the work of another, and to let that pass inhibited true creativity. But it was equally dangerous to be overly vigilant in policing creative expression, because if Led Zeppelin hadn’t been free to mine the blues for inspiration we wouldn’t have got “Whole Lotta Love,” and if Kurt Cobain couldn’t listen to “More Than a Feeling” and pick out and transform the part he really liked we wouldn’t have “Smells Like Teen Spirit”—and, in the evolution of rock, “Smells Like Teen Spirit” was a real step forward from “More Than a Feeling.” A successful music executive has to understand the distinction between borrowing that is transformative and borrowing that is merely derivative
Old words in the service of a new idea aren’t the problem. What inhibits creativity is new words in the service of an old idea.
And this is the second problem with plagiarism. It is not merely extremist. It has also become disconnected from the broader question of what does and does not inhibit creativity. We accept the right of one writer to engage in a full-scale knockoff of another—think how many serial-killer novels have been cloned from “The Silence of the Lambs.” Yet, when Kathy Acker incorporated parts of a Harold Robbins sex scene verbatim in a satiric novel, she was denounced as a plagiarist (and threatened with a lawsuit). When I worked at a newspaper, we were routinely dispatched to “match” a story from the Times: to do a new version of someone else’s idea. But had we “matched” any of the Times’ words—even the most banal of phrases—it could have been a firing offense. The ethics of plagiarism have turned into the narcissism of small differences: because journalism cannot own up to its heavily derivative nature, it must enforce originality on the level of the sentence.
Or, in musical terms:
He knew enough about music to know that these patterns of influence—cribbing, tweaking, transforming—were at the very heart of the creative process. True, copying could go too far. There were times when one artist was simply replicating the work of another, and to let that pass inhibited true creativity. But it was equally dangerous to be overly vigilant in policing creative expression, because if Led Zeppelin hadn’t been free to mine the blues for inspiration we wouldn’t have got “Whole Lotta Love,” and if Kurt Cobain couldn’t listen to “More Than a Feeling” and pick out and transform the part he really liked we wouldn’t have “Smells Like Teen Spirit”—and, in the evolution of rock, “Smells Like Teen Spirit” was a real step forward from “More Than a Feeling.” A successful music executive has to understand the distinction between borrowing that is transformative and borrowing that is merely derivative
Wednesday
IT Conversations
I recently discovered a useful source on social and economic effects of IT: IT Conversations. It's a collection of audio pieces (conferences, presentations, discussions) about IT in our world. Recent topics have included Richard Florida's take on creativity and view-points on the role of blogging in the U.S. presidential elections.
Friday
Global sourcing challenges
New rules for global component sourcing: the quality imperative in electronics, Economist Intelligence Unit, 2004, London, New York, Hong Kong.
Global sourcing is becoming more complex, moving from a tactical task to a strategic one for large electronics manufacturers. It provides flexibility and cost advantages, but as it gets more complex, other factors come into play as well. As the level of complexity rises, firms must share more information with their suppliers and manage them more closely.
Some interesting results from the EIU's survey of 70 senior exeutives in the electronics industry:
Price isn't the only factor anymore. The top 2 most important business benefits of respondents' sourcing initiatives remain reduced labor costs (40%) and reduced direct materials costs (56%). However, the third most important is "access to unique materials, services or R&D assets" (37%).
40% of respondents named "mitigating risks involved with long-distance business relation ships and multiple hand-offs" as one of their top 3 biggest risk management issues in developing a global sourcing initiative -- outweighed only by (1) responsiveness toward variations in demand and (2) ensuring that total acquisition costs (materials, logistics, customs) do not erode the net benefits promised by the initial purchase cost. By contrast, "cross-cultural communication in both negotiation and execution" was mentioned least (26%).
Global sourcing is becoming more complex, moving from a tactical task to a strategic one for large electronics manufacturers. It provides flexibility and cost advantages, but as it gets more complex, other factors come into play as well. As the level of complexity rises, firms must share more information with their suppliers and manage them more closely.
Some interesting results from the EIU's survey of 70 senior exeutives in the electronics industry:
Price isn't the only factor anymore. The top 2 most important business benefits of respondents' sourcing initiatives remain reduced labor costs (40%) and reduced direct materials costs (56%). However, the third most important is "access to unique materials, services or R&D assets" (37%).
40% of respondents named "mitigating risks involved with long-distance business relation ships and multiple hand-offs" as one of their top 3 biggest risk management issues in developing a global sourcing initiative -- outweighed only by (1) responsiveness toward variations in demand and (2) ensuring that total acquisition costs (materials, logistics, customs) do not erode the net benefits promised by the initial purchase cost. By contrast, "cross-cultural communication in both negotiation and execution" was mentioned least (26%).
Thursday
Horizontal innovation networks: open source software and surfing
Eric von Hippel, Horizontal innovation networks - by and for users, 2002, MIT Sloan Working Paper
Von Hippel's horizontal innovation networks are in many ways modern day versions of collective invention. He examines various networks of users engaged in the production, distribution and consumption (use) of innovations.
Even as the intellectual property rights discussion is heating up, the evidence suggests that patents (or copyright) and licensing aren't optimal ways of appropriating returns, except in the chemicals and pharmaceuticals industries -- and, therefore aren't the best way of encouraging innovation. One frequently mentioned alternative to patent regimes is the open-source movement, an example of von Hippel's horizontal networks. So, when might such horizontal innovation networks work?
User networks can function entirely independently of manufactureres when
(1) at least some users have sufficient incentive to innovate;
(2) at least some users have an incentive to voluntarily reveal their innovations, and
(3) diffusion of innovations by users is low cost and can compete with commercial production and distribution.
When only the first tow conditions hold, a patten of user innovation and trial and improvement will occur within user networks, followed by commercial manufacture and distribution of innovations that prove to be of general interest.
Non-users might also contribute to these networks (e.g. suppliers, producers of complementary products). However, this isn't necessary for them to work.
While user innovation in open source software is well known, it is not a unique case. Von Hippel's second example is high performance windsurfing. Here, users experiment with new equipment designs and techniques which are traded in the windsurfing community, mainly at competitive events where the core of the community regularly meets.
One question that often comes up in large-scale innovative collaboration is whether participants in an innovation network need to feel a sense of community. Von Hippel argues that windsurfers are members of a community (which forms the basis of trust and sharing), whereas open source programmers aren't. However, even in open source projects there may be communal norms, such as "generalized reciprocity" at work.
He cites a different concern: level of competitiveness. The effect of competition on willingness to free reveal has recently been documented by Franke and Shah (2002) in their study of four communities of sports enthusiasts ... They found that a statement regarding free revealing of innovations ... was significantly less agreed with by innovating members of the more rivalrous communities than by innovators within the less rivalrous communities ... They also found that assistance provided by one community member to another during the innovation development process was significantly less within the more competitive communities.
An interesting question raised by von Hippel at the end of the paper is whether there might be "life cycle" patterns, e.g. that user innovation is stronger in the early stages of a product's life cycle and weaker as it reaches maturity.
Summary
First, von Hippel explains why users innovate in the first place:
- In some product categories users may reasonably expect a higher reward from innovating than can manufacturers. For example, if a user firm develops a new process machine for in-house use that enables it to produce a major new product line, and keeps its innovation secret while benefiting from it, it may make more profit from that machine than would a manufacturer-innovator that must reveal the machine in order to sell it.
- Second, user innovation costs can be significantly lower than manufacturer innovation costs when the problem-solving work of innovation developers requires access to "sticky" -- costly to transfer -- information regarding user needs and the context of use. cf. Ogawa (1997)
Often lead users will be the first to innovate. Given that lead users experience needs in advance of the bulk of a target market, the nature, risks, and eventual size of that target market are often not clear to manufacturers. This lack of clarity can reduce manufacturers' incentives to innovate, and increase the likelihood that lead users will be the first to develop their own innovative solutions for needs that later prove to represent mainstream market demand.
However, even when users innovate, they need not necessarily reveal their innovations to a larger public that includes collaborators, competitors, and free riders, essentially making them a public good. Why do they?
Empirical studies show innovating users often choose to freely reveal details of their innovations to other users and to manufacturers as well. ...Free revealing can be the dominant way innovations are diffused in some fields and under some conditions. This happens when the benefits from free revealing exceed the benefits that are practically obtainable from licensing or secrecy:
- obtaining patents and licensing intellectual property may be impossible, too costly, or not an effective form of protection,
- similarly, maintaining a trade secret may be too costly or impractical once a product is on the market,
- faced with the choice between voluntary free revealing now and involuntary free revealing later, innovators may have more incentive to free reveal voluntarily, (which is what happened in Allen's study of collective invention in 19th century iron furnaces),
- in addition to Allen's findings, Harhoff et al find that an innovator may have an interest in rapid diffusion since an innovation that is freely revealed and adopted by others can become an informal standard that may preempt the development an/or commercialization of other versions of the innovation,
- as in the case of collective invention, innovators may be able to benefit through reputation increases among peers and potential employers (and firms may benefit from a reputation of being employers of contributors to open source and similar projects),
- there may be intrinsic benefits in terms of enjoyment and learning that arise from participation in horizontal innovation networks,
- finally communal norms, e.g. "generalized reciprocity," may also play a role.
Even if users free reveal, it is not clear that they will be able to diffuse the innovation. What does this depend on?
Often innovation streams that have a large cumulative impact are likely to be made up of relatively small individual innovations. We have also seen ... that benefits to innovators from free-revealing, while higher than benefits they could expect from licensing or secrecy, may well be low. On this basis we speculate that most innovations diffused via a user innovation network are likely to be of relatively low benefit to both diffusers and adopters, and so must be diffused at a low cost if they are to be diffused at all.
Von Hippel's horizontal innovation networks are in many ways modern day versions of collective invention. He examines various networks of users engaged in the production, distribution and consumption (use) of innovations.
Even as the intellectual property rights discussion is heating up, the evidence suggests that patents (or copyright) and licensing aren't optimal ways of appropriating returns, except in the chemicals and pharmaceuticals industries -- and, therefore aren't the best way of encouraging innovation. One frequently mentioned alternative to patent regimes is the open-source movement, an example of von Hippel's horizontal networks. So, when might such horizontal innovation networks work?
User networks can function entirely independently of manufactureres when
(1) at least some users have sufficient incentive to innovate;
(2) at least some users have an incentive to voluntarily reveal their innovations, and
(3) diffusion of innovations by users is low cost and can compete with commercial production and distribution.
When only the first tow conditions hold, a patten of user innovation and trial and improvement will occur within user networks, followed by commercial manufacture and distribution of innovations that prove to be of general interest.
Non-users might also contribute to these networks (e.g. suppliers, producers of complementary products). However, this isn't necessary for them to work.
While user innovation in open source software is well known, it is not a unique case. Von Hippel's second example is high performance windsurfing. Here, users experiment with new equipment designs and techniques which are traded in the windsurfing community, mainly at competitive events where the core of the community regularly meets.
One question that often comes up in large-scale innovative collaboration is whether participants in an innovation network need to feel a sense of community. Von Hippel argues that windsurfers are members of a community (which forms the basis of trust and sharing), whereas open source programmers aren't. However, even in open source projects there may be communal norms, such as "generalized reciprocity" at work.
He cites a different concern: level of competitiveness. The effect of competition on willingness to free reveal has recently been documented by Franke and Shah (2002) in their study of four communities of sports enthusiasts ... They found that a statement regarding free revealing of innovations ... was significantly less agreed with by innovating members of the more rivalrous communities than by innovators within the less rivalrous communities ... They also found that assistance provided by one community member to another during the innovation development process was significantly less within the more competitive communities.
An interesting question raised by von Hippel at the end of the paper is whether there might be "life cycle" patterns, e.g. that user innovation is stronger in the early stages of a product's life cycle and weaker as it reaches maturity.
Summary
First, von Hippel explains why users innovate in the first place:
- In some product categories users may reasonably expect a higher reward from innovating than can manufacturers. For example, if a user firm develops a new process machine for in-house use that enables it to produce a major new product line, and keeps its innovation secret while benefiting from it, it may make more profit from that machine than would a manufacturer-innovator that must reveal the machine in order to sell it.
- Second, user innovation costs can be significantly lower than manufacturer innovation costs when the problem-solving work of innovation developers requires access to "sticky" -- costly to transfer -- information regarding user needs and the context of use. cf. Ogawa (1997)
Often lead users will be the first to innovate. Given that lead users experience needs in advance of the bulk of a target market, the nature, risks, and eventual size of that target market are often not clear to manufacturers. This lack of clarity can reduce manufacturers' incentives to innovate, and increase the likelihood that lead users will be the first to develop their own innovative solutions for needs that later prove to represent mainstream market demand.
However, even when users innovate, they need not necessarily reveal their innovations to a larger public that includes collaborators, competitors, and free riders, essentially making them a public good. Why do they?
Empirical studies show innovating users often choose to freely reveal details of their innovations to other users and to manufacturers as well. ...Free revealing can be the dominant way innovations are diffused in some fields and under some conditions. This happens when the benefits from free revealing exceed the benefits that are practically obtainable from licensing or secrecy:
- obtaining patents and licensing intellectual property may be impossible, too costly, or not an effective form of protection,
- similarly, maintaining a trade secret may be too costly or impractical once a product is on the market,
- faced with the choice between voluntary free revealing now and involuntary free revealing later, innovators may have more incentive to free reveal voluntarily, (which is what happened in Allen's study of collective invention in 19th century iron furnaces),
- in addition to Allen's findings, Harhoff et al find that an innovator may have an interest in rapid diffusion since an innovation that is freely revealed and adopted by others can become an informal standard that may preempt the development an/or commercialization of other versions of the innovation,
- as in the case of collective invention, innovators may be able to benefit through reputation increases among peers and potential employers (and firms may benefit from a reputation of being employers of contributors to open source and similar projects),
- there may be intrinsic benefits in terms of enjoyment and learning that arise from participation in horizontal innovation networks,
- finally communal norms, e.g. "generalized reciprocity," may also play a role.
Even if users free reveal, it is not clear that they will be able to diffuse the innovation. What does this depend on?
Often innovation streams that have a large cumulative impact are likely to be made up of relatively small individual innovations. We have also seen ... that benefits to innovators from free-revealing, while higher than benefits they could expect from licensing or secrecy, may well be low. On this basis we speculate that most innovations diffused via a user innovation network are likely to be of relatively low benefit to both diffusers and adopters, and so must be diffused at a low cost if they are to be diffused at all.
Wednesday
Collective invention
Collective invention, R. C. Allen, 1983, Journal of Economic Behavior and Organization
All too often R&D and innovation are used interchangeably. Obviously, innovation doesn't always happen in a lab, under a dedicated budget or even with the explicit intention of increasing profits.
Allen describes an alternative way of organizing innovation: collective invention.
Allen focuses on the iron industry and the development of blast furnaces in the 19th century. He finds that competing firms freely exchanged information on improvements to the design of their furnaces through a) informal networks and b) engineering societies and their publications. This meant that current and potential competitors could easily acquire knowledge of best practices. The first firm to experiment with a new design would carry the risk that the change would increase production cost. Subsequent adopters of the design could then benefit from the first firm's experience and data. This let firms "leapfrog" each other and led to a high rate of innovation.
Why would firms share valuable information so freely with their competitors and even potential entrants to the industry? Allen identifies several reasons:
- Design improvements were incremental and didn't legally qualify as "novel," i.e., they couldn't be patented.Under circumstances of competition and non-approbriablility, an individual inventor or a firm allocating resources to invention could expect an economic return far less than the social value of any invention.
- Once a new furnace was built, it was very costly if not impossible to keep the design changes secret since industry consultants and many (poorly paid and easily bribed) workers were involved in setting it up and running it.
- Since returns on design improvements couldn't be appropriated, there was nothing to be gained from keeping the innovations secret. Yet, there could be some gains in making it available.
- There was no R&D budget -- any design improvements were tested and implemented when a new furnace was built, severely limiting the pace of innovation that any single firm could achieve. Firms expected that their sharing of information would be reciprocated so that they would benefit from industry-wide experience and best practices when they built the next furnace. By spreading costs and risks among firms, collective invention meant that competitive industries could have high rates of invention even if the enventions were not patentable.
- Managers of the firm often had professional ambitions that could be advanced by releasing information about the operation of their firms. Under those circumstances the profits of the firm might be sacrificed and information released.
- Firms seem often to have engaged in competitions in advancing size or output. ... Since you cannot win the contest unless you reveal valuable information, these competitions fostered information release.
- Another reason that firms might have released technical information is that that behaviour might have been profitable. Hirschleifer (1971) has argued that inventors can be compensated for their efforts if they successfully speculate in assets that appreciate in value due to the invention. ... The characteristics of the situation that made collective invention profitable were the specificity of the resulting technical progress to lacal conditions and the fact that the Cleveland industry was only a small part of the world industry so that the price of iron could be regarded as exogenous. Under these circumstances, the owners of the natrual resource would actively foster information propagation since they could not lose by it and might well gain.
All too often R&D and innovation are used interchangeably. Obviously, innovation doesn't always happen in a lab, under a dedicated budget or even with the explicit intention of increasing profits.
Allen describes an alternative way of organizing innovation: collective invention.
Allen focuses on the iron industry and the development of blast furnaces in the 19th century. He finds that competing firms freely exchanged information on improvements to the design of their furnaces through a) informal networks and b) engineering societies and their publications. This meant that current and potential competitors could easily acquire knowledge of best practices. The first firm to experiment with a new design would carry the risk that the change would increase production cost. Subsequent adopters of the design could then benefit from the first firm's experience and data. This let firms "leapfrog" each other and led to a high rate of innovation.
Why would firms share valuable information so freely with their competitors and even potential entrants to the industry? Allen identifies several reasons:
- Design improvements were incremental and didn't legally qualify as "novel," i.e., they couldn't be patented.Under circumstances of competition and non-approbriablility, an individual inventor or a firm allocating resources to invention could expect an economic return far less than the social value of any invention.
- Once a new furnace was built, it was very costly if not impossible to keep the design changes secret since industry consultants and many (poorly paid and easily bribed) workers were involved in setting it up and running it.
- Since returns on design improvements couldn't be appropriated, there was nothing to be gained from keeping the innovations secret. Yet, there could be some gains in making it available.
- There was no R&D budget -- any design improvements were tested and implemented when a new furnace was built, severely limiting the pace of innovation that any single firm could achieve. Firms expected that their sharing of information would be reciprocated so that they would benefit from industry-wide experience and best practices when they built the next furnace. By spreading costs and risks among firms, collective invention meant that competitive industries could have high rates of invention even if the enventions were not patentable.
- Managers of the firm often had professional ambitions that could be advanced by releasing information about the operation of their firms. Under those circumstances the profits of the firm might be sacrificed and information released.
- Firms seem often to have engaged in competitions in advancing size or output. ... Since you cannot win the contest unless you reveal valuable information, these competitions fostered information release.
- Another reason that firms might have released technical information is that that behaviour might have been profitable. Hirschleifer (1971) has argued that inventors can be compensated for their efforts if they successfully speculate in assets that appreciate in value due to the invention. ... The characteristics of the situation that made collective invention profitable were the specificity of the resulting technical progress to lacal conditions and the fact that the Cleveland industry was only a small part of the world industry so that the price of iron could be regarded as exogenous. Under these circumstances, the owners of the natrual resource would actively foster information propagation since they could not lose by it and might well gain.
Monday
Krugman's spatial economics
Development, Geography, and Economic Theory, Paul Krugman, 1995
More from Krugman. He gives a particularly good summary of various economic theories of agglomeration.
Germanic geometry
1. Weberian location theory:
Alfred Weber and his followers ... analyzed the location decision of a firm serving one or more markets and relying on one or more sources of supply, with the total number of such relevant points not less than three. The problem was that this was essentially geometry and didn't take into account who was making the decisions and how; there was no mention of competitors, pricing etc.; and there was no explanation why there should be only one production site.
2. Central-place theory (Loesch, Christaller)
This analyzed the location and roles of manufacturing/marketing/ect. centers serving a hypothetical evenly spread agricultural population. In this tradition, Loesch had the big geometric insight -- that market areas should be hexagonal -- while Christaller produced the empirically fruitful idea that tere should be a hierarchy of central places, with nested market areas. ... the trade-off between economies of scale and transportation leads producers to cluster together into a hierarchy of cities serving nested, hexagonal market areas. But on closer inspection it becomes unclear exactly what is supposed to be going on. Who is making location decisions? There is also no clear description of market structures.
Central-place theory implies that we are in a world in which there are unexhausted economies of scale, and thus in a world of imperfect competition. You can't tell a story about central-place formation unless you are prepared to offer some description, however stylized, of that imperfectly competitive market structure. And that, until relatively recently, was something economists felt unable to do.
Social physics
This is economic geography done by analogy to physics: working with the problem of balancing several discrete forces of attraction and developing new theories to explain empirical regularities (e.g. Zipf's law of city size distribution).
In the 1950s American geographers came up with the idea that firms tend, other things equal, to choose locations of maximum "market potential," where the market potential of a site was defined as some index of its access to markets, involving both the purchasing power of all the markets to which it might sell and the distance to those markets. However, it is completely unclear what is being maximized when a firm chooses a point of maximum market potential. Again, market structure is the problem. Firms cannot exhibit constant returns to scale -- otherwise one would simply establish a facility to serve every market, ... nor can they be producing goods that are perfect substitutes.
Cumulative causation
One immediately obvious implication of the market potential analysis is the possibility of circularity. Firms want to locate where market potential is high, that is, where lots of firms locate. So one is led naturally to a consideration of the possibility of self-reinforcing regional growth or decline. This line of thinking follows the "Big Push" model of high development theory. While Big Push-type stories may be implausible for the economy as a whole (since they assume perfectly elastic supply of labor), they may make perfectly good sense for a particular region since the supply of factors to any specific region will typically be very elastic because they can come from somewhere else.
Some of the authors of the classic high development tracts seem to have realized this. ... The explicit application of high development concepts to region growth, however, is something one usually associates with Alan Pred (1966). Pred's story is essentially a variant on the Big Push. Suppose that a regional economy grows to the critical point at which it becomes profitable to replace imports of some good subject to scale economies with local production. This import substitution will expand regional employment, drawing in workders from other regions; and in so doing will further expand the local market. This market expansion may, in turn, provide the market size necessary to induce a second round of import substitution, and son on -- a cascade of growth reflecting the circular relationship between market size and the range of industries that a region possesses.
(I find that this resonates very much with Jane Jacobs' ideas about how the earliest cities formed.)
Local external economies
The idea that clustering of producers in a particular lcation yields advantages, and that these advantages in turn explain such clustering, is an old one. ... Indeed, to those who imagine that increasing returns are something only recently discovered, it is startling to see how much attention is given in Marshall's 'Principles' to local externalities. They are emphasized both for their intrinsic importance and for the way they exemplify his concept of external economies in general.
What Marshall meant by an external economy was not exactly what later authors meant. In the 1940s and 1950s economists came to make a clear distinction between technological external economies -- pure spillovers -- and pecuniary externalities mediated through the market. In a world of constant returns at the level of the firm and perfect competition, pecuniary externalities don't have any particular importance, so onl technological spillovers matter. Marshall, however, did not make this distinction. ... In the light of current theory, of cours, he was right to do so. We now understand that the sharp distinction between technological and pecuniary external economies holds only in a contant-returns world; in general market-size external economies are just as real as technological spillovers. ...
Suppose that we think of positive local external economies, which tend to promote concentration of production, as being opposed by other effects -- congestion or land costs -- that tend to promote dispersal. Then we are on our way toward a story about both the optimal size of cities and, if we are prepared to make some assumptions about the process of city formation, a theory of the actual size and number of cities. (cf. Vernon Henderson, 1974).
Land rent and land use
The analysis of land rent and land use derives directly from von Thuenen's Isolated State. He envisaged an agricultural plain supplying a variety of products to an isolated central city; and he realized that one could think of the simultaneous determination of a land rent gradient declining from the center to an outer limit of cultivation, and of a series of rings in which different crops would be clutivated and/or different farming methods adopted. Thus the high-rent land near the center would be reserved for crops with high costs of transportation and/or crops yielding high value per acre; the outermost ring would consist of either land-intensive or cheaply transported crops. This model conforms surprisingly well to neo-classical economics in that it includes the idea of an equilibrium and the idea that 'value' is an emergent consequence of a market process, goods and factor prices, and efficient outcomes of markets. Unfortunately, it simply assumes the thing you want to understand: the existence of a central urban market. Indeed, the whole thrust of the model is to understand the forces that spread economic activity away from that center, the "centrifugal" forces if you will. About the "centripetal" forces that create centers, that pull economic activity together, it can and does say nothing.
The "new urban economics," which deals mainly with central business districts followed in this tradition in the late 1960s and early 1970s.
Krugman's model
In Krugman's own words: I imagine an economy with a number of separate locations. There are two sectors: agriculture, which is geographically immobile, and manufacturing, which is mobile over time. The geographic reallocation of manufacturing is, however, not instantaneous. ...
Manufacturing consists of many firms producing differentiated products; increasing returns ensure that not all potential goods are produced, and thus that each plant produces a unique good ... . The monopolistic competition assumption neatly, if implausibly, disposes of problems like strategic behavior. All that firms need to do is choose an optimal location, taking into account the spatial distribution of demand and the transportation costs they must pay. ...
The most important thing I learned is that all of my first four traditions in spatial analysis ... make perfectly good sense in terms of a rigorous economic model. ... Moreover, it turns out that all four traditions are really different aspects of the same story.
More from Krugman. He gives a particularly good summary of various economic theories of agglomeration.
Germanic geometry
1. Weberian location theory:
Alfred Weber and his followers ... analyzed the location decision of a firm serving one or more markets and relying on one or more sources of supply, with the total number of such relevant points not less than three. The problem was that this was essentially geometry and didn't take into account who was making the decisions and how; there was no mention of competitors, pricing etc.; and there was no explanation why there should be only one production site.
2. Central-place theory (Loesch, Christaller)
This analyzed the location and roles of manufacturing/marketing/ect. centers serving a hypothetical evenly spread agricultural population. In this tradition, Loesch had the big geometric insight -- that market areas should be hexagonal -- while Christaller produced the empirically fruitful idea that tere should be a hierarchy of central places, with nested market areas. ... the trade-off between economies of scale and transportation leads producers to cluster together into a hierarchy of cities serving nested, hexagonal market areas. But on closer inspection it becomes unclear exactly what is supposed to be going on. Who is making location decisions? There is also no clear description of market structures.
Central-place theory implies that we are in a world in which there are unexhausted economies of scale, and thus in a world of imperfect competition. You can't tell a story about central-place formation unless you are prepared to offer some description, however stylized, of that imperfectly competitive market structure. And that, until relatively recently, was something economists felt unable to do.
Social physics
This is economic geography done by analogy to physics: working with the problem of balancing several discrete forces of attraction and developing new theories to explain empirical regularities (e.g. Zipf's law of city size distribution).
In the 1950s American geographers came up with the idea that firms tend, other things equal, to choose locations of maximum "market potential," where the market potential of a site was defined as some index of its access to markets, involving both the purchasing power of all the markets to which it might sell and the distance to those markets. However, it is completely unclear what is being maximized when a firm chooses a point of maximum market potential. Again, market structure is the problem. Firms cannot exhibit constant returns to scale -- otherwise one would simply establish a facility to serve every market, ... nor can they be producing goods that are perfect substitutes.
Cumulative causation
One immediately obvious implication of the market potential analysis is the possibility of circularity. Firms want to locate where market potential is high, that is, where lots of firms locate. So one is led naturally to a consideration of the possibility of self-reinforcing regional growth or decline. This line of thinking follows the "Big Push" model of high development theory. While Big Push-type stories may be implausible for the economy as a whole (since they assume perfectly elastic supply of labor), they may make perfectly good sense for a particular region since the supply of factors to any specific region will typically be very elastic because they can come from somewhere else.
Some of the authors of the classic high development tracts seem to have realized this. ... The explicit application of high development concepts to region growth, however, is something one usually associates with Alan Pred (1966). Pred's story is essentially a variant on the Big Push. Suppose that a regional economy grows to the critical point at which it becomes profitable to replace imports of some good subject to scale economies with local production. This import substitution will expand regional employment, drawing in workders from other regions; and in so doing will further expand the local market. This market expansion may, in turn, provide the market size necessary to induce a second round of import substitution, and son on -- a cascade of growth reflecting the circular relationship between market size and the range of industries that a region possesses.
(I find that this resonates very much with Jane Jacobs' ideas about how the earliest cities formed.)
Local external economies
The idea that clustering of producers in a particular lcation yields advantages, and that these advantages in turn explain such clustering, is an old one. ... Indeed, to those who imagine that increasing returns are something only recently discovered, it is startling to see how much attention is given in Marshall's 'Principles' to local externalities. They are emphasized both for their intrinsic importance and for the way they exemplify his concept of external economies in general.
What Marshall meant by an external economy was not exactly what later authors meant. In the 1940s and 1950s economists came to make a clear distinction between technological external economies -- pure spillovers -- and pecuniary externalities mediated through the market. In a world of constant returns at the level of the firm and perfect competition, pecuniary externalities don't have any particular importance, so onl technological spillovers matter. Marshall, however, did not make this distinction. ... In the light of current theory, of cours, he was right to do so. We now understand that the sharp distinction between technological and pecuniary external economies holds only in a contant-returns world; in general market-size external economies are just as real as technological spillovers. ...
Suppose that we think of positive local external economies, which tend to promote concentration of production, as being opposed by other effects -- congestion or land costs -- that tend to promote dispersal. Then we are on our way toward a story about both the optimal size of cities and, if we are prepared to make some assumptions about the process of city formation, a theory of the actual size and number of cities. (cf. Vernon Henderson, 1974).
Land rent and land use
The analysis of land rent and land use derives directly from von Thuenen's Isolated State. He envisaged an agricultural plain supplying a variety of products to an isolated central city; and he realized that one could think of the simultaneous determination of a land rent gradient declining from the center to an outer limit of cultivation, and of a series of rings in which different crops would be clutivated and/or different farming methods adopted. Thus the high-rent land near the center would be reserved for crops with high costs of transportation and/or crops yielding high value per acre; the outermost ring would consist of either land-intensive or cheaply transported crops. This model conforms surprisingly well to neo-classical economics in that it includes the idea of an equilibrium and the idea that 'value' is an emergent consequence of a market process, goods and factor prices, and efficient outcomes of markets. Unfortunately, it simply assumes the thing you want to understand: the existence of a central urban market. Indeed, the whole thrust of the model is to understand the forces that spread economic activity away from that center, the "centrifugal" forces if you will. About the "centripetal" forces that create centers, that pull economic activity together, it can and does say nothing.
The "new urban economics," which deals mainly with central business districts followed in this tradition in the late 1960s and early 1970s.
Krugman's model
In Krugman's own words: I imagine an economy with a number of separate locations. There are two sectors: agriculture, which is geographically immobile, and manufacturing, which is mobile over time. The geographic reallocation of manufacturing is, however, not instantaneous. ...
Manufacturing consists of many firms producing differentiated products; increasing returns ensure that not all potential goods are produced, and thus that each plant produces a unique good ... . The monopolistic competition assumption neatly, if implausibly, disposes of problems like strategic behavior. All that firms need to do is choose an optimal location, taking into account the spatial distribution of demand and the transportation costs they must pay. ...
The most important thing I learned is that all of my first four traditions in spatial analysis ... make perfectly good sense in terms of a rigorous economic model. ... Moreover, it turns out that all four traditions are really different aspects of the same story.
The case for and against economic modelling
Development, Geography, and Economic Theory, Paul Krugman, 1995
I have always had a problem with economics' obsession with mathematical modelling. Part of the blame probably lies with my first macro teacher who began the semester by proclaiming that the world could be described in 3 equations, and that performing calculus on these equations would eventually explain "everything". (I'll take "42" over that any day.)
Now, I wish that I had come across Krugman's book much earlier. Finally, an explanation of the strengths and weaknesses of mathematical modelling and an honest look at the ways modelling can limit economists' perspective.
Essentially, Krugman traces the history of high development theory and spatial economics. In the early 20th century, there were important theories in both fields. However, they were neglected later because mathematical modelling techniques that could deal with problems of increasing returns and market structure (as opposed to assuming perfect competition) weren't available. As mathematical standards became more rigorous, economists dropped development and spatial economics for lack of instruments to describe them and still be taken seriously.
Krugman still defends the use of mathematical models - for the rigourous logic they impose and for their ability to explain otherwise obscured aspects of economics, even though important fields are sometimes neglected simply because the mathematics to deal with them aren't available.
I have always had a problem with economics' obsession with mathematical modelling. Part of the blame probably lies with my first macro teacher who began the semester by proclaiming that the world could be described in 3 equations, and that performing calculus on these equations would eventually explain "everything". (I'll take "42" over that any day.)
Now, I wish that I had come across Krugman's book much earlier. Finally, an explanation of the strengths and weaknesses of mathematical modelling and an honest look at the ways modelling can limit economists' perspective.
Essentially, Krugman traces the history of high development theory and spatial economics. In the early 20th century, there were important theories in both fields. However, they were neglected later because mathematical modelling techniques that could deal with problems of increasing returns and market structure (as opposed to assuming perfect competition) weren't available. As mathematical standards became more rigorous, economists dropped development and spatial economics for lack of instruments to describe them and still be taken seriously.
Krugman still defends the use of mathematical models - for the rigourous logic they impose and for their ability to explain otherwise obscured aspects of economics, even though important fields are sometimes neglected simply because the mathematics to deal with them aren't available.
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