The Production of Increasing Returns: Physical Technology, Institutional Technology, and the Pitfalls of Production Functions

Abstract

Economists often model the delicate relationship between production, innovation, and economic growth as a production function that exhibits increasing returns to scale (IRS). The existence of "knowledge spillovers" or "learning by doing" often implies conclusions about the optimal use of protectionist trade and industrial policies that increase national welfare by artificially reallocating productive resources in order to exploit IRS. We argue this often fails to capture the institutions that govern entrepreneurial production choices. By clarifying the nature and economic relationships of information, and the limitations of existing models of production, we contribute a new understanding of research with applications to innovation, economic growth, and trade policy.

Keywords: Technology, innovation, Increasing returns to scale, learning by doing, production functions, protectionism, industrial policy, institutions

JEL Classification: D20, O25, O38