The Competitiveness of Nations
in a Global Knowledge-Based Economy
October 200
3Allyn A. Young
Increasing Returns and Economic Progress [1]
The
Economic Journal
Vol. 38, No. 152
Dec. 1928, 527-542.*
My subject
may appear alarmingly formidable, but I did not intend it to be so. The words economic progress, taken by themselves, would suggest the pursuit of some philosophy of
history, of some way of appraising the results of past and possible future
changes in forms of economic organisation and modes
of economic activities. But as I have
used them, joined to the other half of my title, they are meant merely to
dispel apprehensions, by suggesting that I do not propose to discuss any of
those alluring but highly technical questions relating to the precise way in
which some sort of equilibrium of supply and demand is achieved in the market
for the products of industries which can increase their output without
increasing their costs proportionately, or to the possible advantages of
fostering the development of such industries while putting a handicap upon
industries whose output can be increased only at the expense of a more than
proportionate increase of costs. I
suspect, indeed, that the apparatus which economists have built up for dealing
effectively with the range of questions to which I have just referred may stand
in the way of a clear view of the more general or elementary aspects of the
phenomena of increasing returns, such as I wish to comment upon in this paper.
Consider, for
example, Alfred Marshall’s fruitful distinction between the internal productive
economies which a particular firm is able to secure as the growth of the market
permits it to enlarge the scale of its operations and the economies external to
the individual firm which show themselves only in changes of the organisation of the industry as a whole. This distinction has been useful in at least
two different ways. In the first place
it is, or ought to be, a safeguard against the common error of assuming that
wherever increasing returns operate there is necessarily an effective tendency
towards monopoly. In the second
1.
Presidential
Address before Section F (Economic Science and Statistics) of the British
Association for the Advancement of Science, Glasgow, September 10, 1928.
2.
* HHC: excludes
technical note, pages 540-542
527
place
it simplifies the analysis of the manner in which the prices of commodities
produced under conditions of increasing returns are determined. A representative firm within the industry,
maintaining its own identity and devoting itself to a given range of
activities, is made to be the vehicle or medium through which the economies
achieved by the industry as a whole are transmitted to the market and have
their effect upon the price of the product.
The view of
the nature of the processes of industrial progress which is implied in the
distinction between internal and external economies is necessarily a partial
view. Certain aspects of those processes
are illuminated, while, for that very reason, certain other aspects, important
in relation to other problems, are obscured. This will be clear, I think, if we observe
that, although the internal economies of some firms producing, let us say,
materials or appliances may figure as the external economies of other firms,
not all of the economies which are properly to be called external can be
accounted for by adding up the. internal economies of
all the separate firms. When we look at
the internal economies of a particular firm we envisage a condition of comparative
stability. Year after year the firm,
like its competitors, is manufacturing a particular product or group of
products, or is confining itself to certain definite stages in the work of
forwarding the products towards their final form. Its operations change in the sense that they
are progressively adapted to an increasing output, but they are kept within
definitely circumscribed bounds. Out
beyond, in that obscurer field from which it derives its external economies,
changes of another order are occurring. New products are appearing, firms are assuming
new tasks, and new industries are coming into being. In short, change in this external field is
qualitative as well as quantitative. No
analysis of the forces making for economic equilibrium, forces which we might
say are tangential at any moment of time, will serve to illumine this field,
for movements away from equilibrium, departures from previous trends, are
characteristic of it. Not much is to be
gained by probing into it to see how increasing returns show themselves in the
costs of individual firms and in the prices at which they offer their products.
Instead, we have to go back to a simpler and more inclusive view, such as some of the older economists took when they contrasted the increasing returns which they thought were characteristic of manufacturing industry taken as a whole with the diminishing returns which they thought were dominant in agriculture because of an increasingly unfavourable proportioning
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of labour and land. Most
of them were disappointingly vague with respect to the origins and the precise
nature of the “improvements “ which they counted upon
to retard somewhat the operation of the tendency towards diminishing returns in
agriculture and to secure a progressively more effective use of labour in manufactures. Their opinions appear to have rested partly
upon an empirical generalisation. Improvements had been made, they were still
being made, and it might be assumed that they would continue to be made. If they had looked back they would have seen
that there were centuries during which there were few significant changes in
either agricultural or industrial methods. But they were living in an age when men had
turned their faces in a new direction and when economic progress was not only
consciously sought but seemed in some way to grow out of the nature of things. Improvements, then, were not something to be
explained. They were natural phenomena,
like the precession of the equinoxes.
There were certain important exceptions, however, to this incurious attitude towards what might seem to be one of the most important of all economic problems. Senior’s positive doctrine is well known, and there were others who made note of the circumstance that with the growth of population and of markets new opportunities for the division of labour appear and new advantages attach to it. In this way, and in this way only, were the generally commonplace things which they said about “improvements” related to anything which could properly be called a doctrine of increasing returns. They added nothing to Adam Smith’s famous theorem that the division of labour depends upon the extent of the market. That theorem, I have always thought, is one of the most illuminating and fruitful generalisations which can be-found anywhere in the whole literature of economics. In fact, as I am bound to confess, I am taking it as the text of this paper, in much the way that some minor composer borrows a theme from one of the masters and adds certain developments or variations of his own. To-day, of course, we mean by the division of labour something much broader in scope than that splitting up of occupations and development of specialised crafts which Adam Smith mostly had in mind. No one, so far as I know, has tried to enumerate all of the different aspects of the division of labour, and I do not propose to undertake that task. I shall deal with two related aspects only: the growth of indirect or roundabout methods of production and the division of labour among industries.
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It is
generally agreed that Adam Smith, when he suggested that the division of labour leads to inventions because workmen engaged in specialised routine operations come to see better ways of
accomplishing the same results, missed the main point. The important thing, of course, is that with
the division of labour a group of complex processes
is transformed into a succession of simpler processes, some of which, at least,
lend themselves to the use of machinery. In the use of machinery and the adoption of
indirect processes there is a further division of labour,
the economies of which are again limited by the extent of the market. It would be wasteful to make a hammer to drive
a single nail; it would be better to use whatever awkward implement lies conveniently
at hand. It would be wasteful to furnish
a factory with an elaborate equipment of specially constructed jigs, gauges,
lathes, drills, presses and conveyors to build a hundred automobiles; it would
be better to rely mostly upon tools and machines of standard types, so as to
make a relatively larger use of directly-applied and a relatively smaller use
of indirectly-applied labour. Mr. Ford’s methods would be absurdly
uneconomical if his output were very small, and would be unprofitable even if
his output were what many other manufacturers of automobiles would call large.
Then, of
course, there are economies of what might be called a secondary order. How far it pays to go in equipping factories
with special appliances for making hammers or for constructing specialised machinery for use in making different parts of
automobiles depends again upon how many nails are to be driven and how many
automobiles can be sold. In some
instances, I suppose, these secondary economies, though real, have only a
secondary importance. The derived
demands for many types of specialised production
appliances are inelastic over a fairly large range. If the benefits and the costs of using such
appliances are spread over a relatively large volume of final products, their
technical effectiveness is a larger factor in determining whether it is
profitable to use them than any difference which producing them on a large or a
small scale would commonly make in their costs. In other instances the demand for productive
appliances is more elastic, and beyond a certain level of costs demand may fail
completely. In such circumstances
secondary economies may become highly important.
Doubtless, much of what I have said has been familiar and even elementary. I shall venture, nevertheless, to put further stress upon two points, which may be among those which have
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a
familiar ring, but which appear sometimes to be in danger of being forgotten. (Otherwise, economists of standing could not
have suggested that increasing returns may be altogether illusory, or have
maintained that where they are present they must lead to monopoly.) The first point is that the principal
economies which manifest themselves in increasing returns are the economies of
capitalistic or roundabout methods of production. These economies, again, are largely identical
with the economies of the division of labour in its
most important modern forms. In fact,
these economies lie under our eyes, but we may miss them if we try to make of large-scale
production (in the sense of production by large firms or large industries),
as contrasted with large production, any more than an incident in the
general process by which increasing returns are secured and if accordingly we
look too much at the individual firm or even, as I shall suggest presently, at
the individual industry.
The second
point is that the-economies of roundabout methods, even more than the economies
of other forms of the division of labour, depend upon the extent of the market - and that, of
course, is why we discuss them under the head of increasing returns. It would hardly be necessary to stress this
point, if it were not that the economies of large-scale operations and of
“mass-production” are often referred to as though they could be had for the
taking, by means of a “rational” reorgariisation of
industry. Now I grant that at any given
time routine and inertia play a very large part in the organization and conduct
of industrial operations. Real
leadership is no more common in industrial than in other pursuits. New catch-words or slogans like
mass-production and rationalisation may operate as
stimuli; they may rouse men from routine and lead them to scrutinise
again the organisation and processes of industry and to
try to discover particular ways in which they can be bettered. For example, no one can doubt that there are
genuine economies to be achieved in the way of “simplification and standardisation,” or that the securing of these economies
requires that certain deeply rooted competitive wastes be extirpated. This last requires a definite concerted
effort - precisely the kind of thing which ordinary competitive motives are
often powerless to effect, but which might come more easily as the response to
the dissemination of a new idea.
There is a danger, however, that we shall expect too much from these “rational” industrial reforms. Pressed beyond a certain point they become the reverse of rational. I have
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naturally
been interested in British opinions respecting the reasons for the relatively
high productivity (per labourer or per hour of labour) of representative American industries. The error of those who suggest that the
explanation is to be found in the relatively high wages which prevail in
America is not that they confuse cause and effect, but that they hold that what
are really only two aspects of a single situation are, the one cause, and the
other effect. Those who hold that
American industry is managed better, that its leaders study its problems more
intelligently and plan more courageously and more wisely can cite no facts in
support of their opinion save the differences in the results achieved. Allowing for the circumstance that British
industry, as a whole, has proved to be rather badly adjusted to the new
post-war economic situation, I know of no facts which prove or even indicate
that British industry, seen against the background of its own problems and its
own possibilities, is less efficiently organised or
less ably directed than American industry or the industry of any other country.
Sometimes the
fact that the average American labourer works with
the help of a larger supply of power-driven labour-saving
machinery than the labourer of other countries is
cited as evidence of the superior intelligence of the average American
employer. But this will not do, for, as
every economist knows, the greater the degree in which labour
is productive or scarce - the words have the same meaning - the greater is the
relative economy of using it in such indirect or roundabout ways as are
technically advantageous, even though such procedure calls for larger advances
of capital than simpler methods do.
It is encouraging to find that a fairly large number of commentators upon the volume of the American industrial product and the scale of American industrial organisation have come to surmise that the extent of the American domestic market, unimpeded by tariff barriers, may have something to do with the matter. This opinion seems even to be forced upon thoughtful observers by the general character of the facts, whether or no the observers think in terms of the economists’ conception of increasing returns. In certain industries, although by no means in all, productive methods are economical and profitable in America which would not be profitable elsewhere. The importance of coal and iron and other natural resources needs no comment. Taking a country’s economic endowment as given, however, the most important single factor in determining the effectiveness of its industry appears to be the size of the market. But
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just
what constitutes a large market? Not
area or population alone, but buying power, the capacity to absorb a large
annual output of goods. This trite observation,
however, at once suggests another equally trite, namely, that capacity to buy
depends upon capacity to produce. In an
inclusive view, considering the market not as an outlet for the products of a
particular industry, and therefore external to that industry, but as the outlet
for goods in general, the size of the market is determined and defined by the
volume of production. If this statement
needs any qualification, it is that the conception of a market in this
inclusive sense - an aggregate of productive activities, tied together by trade
- carries with it the notion that there must be some sort of balance, that
different productive activities must be proportioned one to another.
Modified, then, in the light of this broader conception of the
market, Adam Smith’s dictum amounts to the theorem that the division of labour depends in large part upon the division of labour. This
is more than mere tautology. It means,
if I read its significance rightly, that the counter forces which are continually
defeating the forces which make for economic equilibrium are more pervasive and
more deeply rooted in the constitution of the modern economic system than we
commonly realise. Not only new or adventitious elements, coming
in from the outside, but elements which are permanent characteristics of the
ways in which goods are produced make continuously for change. Every important advance in the organisation of production, regardless of whether it is
based upon anything which, in a narrow or technical sense, would be called a
new “invention,” or involves a fresh application of the fruits of scientific
progress to industry, alters the conditions of industrial activity and
initiates responses elsewhere in the industrial structure which in turn have a
further unsettling effect. Thus change
becomes progressive and propagates itself in a cumulative way.
The apparatus which economists have built up for the analysis of supply and demand in their relations to prices does not seem to be particularly helpful for the purposes of an inquiry into these broader aspects of increasing returns. In fact, as I have already suggested, reliance upon it may divert attention to incidental or partial aspects of a process which ought to be seen as a whole. If, nevertheless, one insists upon seeing just how far one can get into the problem by using the formulas of supply and demand, the simplest way, I suppose, is to begin by inquiring into the operations of reciprocal demand when the commodities exchanged
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are produced competitively under
conditions of increasing returns and when the demand for each commodity is
elastic, in the special sense that a small increase in its supply will be
attended by an increase in the amounts of other commodities which can be had in
exchange for it. [1] Under
such conditions an increase in the supply of one commodity is an
increase in the demand for other commodities, and it must be supposed that
every increase in demand will evoke an increase in supply. The rate at which any one industry grows is
conditioned by the rate at which other industries grow, but since the elasticities of demand and of supply will differ for
different products, some industries will grow faster than others. Even with a stationary population and in the
absence of new discoveries [2] in pure or applied science there are no limits to the
process of expansion except the limits beyond which demand is not elastic and
returns do not increase.
If, under
these hypothetical conditions, progress were unimpeded and frictionless, if it
were not dependent in part upon a process of trial and error, if the organisation of industry were always such as, in relation
to the immediate situation, is most economical, the realising
of increasing returns might be progressive and continuous, although, for
technical reasons, it could not always proceed at an even rate. But it would remain a process requiring time. An industrial dictator, with foresight and
knowledge, could hasten the pace somewhat, but he could not achieve an
Aladdin-like transformation of a country’s industry, so as to reap the fruits
of a half-century’s ordinary progress in a few years. The obstacles are of two sorts. First, the human material which has to be used
is resistant to change. New trades have
to be learnt and new habits have to be acquired. There has to be a new geographical
distribution of the population and established communal groups have to be
broken up. Second, the accumulation of
the necessary capital takes time, even though the process of accumulation is
largely one of turning part of an increasing product into forms which will
serve in securing a further increase of product. An acceleration of the rate of accumulation
encounters increasing costs, into which both technical and psychological
elements enter. One who likes
1. If the circumstance that commodity a is produced under conditions of
increasing returns is taken into account as a factor in the elasticity of
demand for b in terms of a, elasticity of demand and elasticity
of supply may be looked upon as different ways of expressing a single
functional relation.
2. As contrasted with such new ways of organising production and such new “inventions” as are
merely adaptations of known ways of doing things, made practicable and
economical by an enlarged scale of production.
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to conceive of all economic
processes in terms of tendencies towards an equilibrium might even maintain
that increasing returns, so far as they depend upon the economies of indirect
methods of production and the size of the market, are offset and negated by
their costs, and that under such simplified conditions as I have dealt with the
realising of increasing returns would be spread
through time in such a way as to secure an equilibrium of costs and advantages.
This would amount to saying that no real
economic progress could come through the operation of forces engendered within
the economic system - a conclusion repugnant to common sense. To deal with this point thoroughly would take
us too far afield. I shall merely observe, first, that the appropriate
conception is that of a moving equilibrium, and second, that the costs
which (under increasing returns) grow less rapidly than the product are not the
“costs” which figure in an “equilibrium of costs and advantages.”
Moving away
from these abstract considerations, so as to get closer to the complications of
the real situation, account has to be taken, first, of various kinds of
obstacles. The demand for some products
is inelastic, or, with an increasing supply, soon becomes so. The producers of such commodities, however,
often share in the advantages of the increase of the general scale of production
in related industries, and so far as they do productive resources are released
for other uses. Then there are natural
scarcities, limitations or inelasticities of supply,
such as effectively block the way to the securing of any important economies in
the production of some commodities and which impair the effectiveness of the
economies secured in the production of other commodities. In most fields, moreover, progress is not and
cannot be continuous. The next important
step forward is often initially costly, and cannot be taken until a certain
quantum of prospective advantages has accumulated.
On the other side of the account are various factors which reinforce the influences which make for increasing returns. The discovery of new natural resources and of new uses for them and the growth of scientific knowledge are probably the most potent of such factors. The causal connections between the growth of industry and the progress of science run in both directions, but on which side the preponderant influence lies no one can say. At any rate, out of better knowledge of the materials and forces upon which men can lay their hands there come both new ways of producing familiar commodities and new products, and these last have a presumptive claim to be regarded as em-
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bodying
more economical uses of productive resources than the uses which they displace. Some weight has to be given also to the way
in which, with the advance of the scientific spirit, a new kind of interest - which
might be described as a scientific interest conditioned by an economic interest
- is beginning to infiltrate into industry. It is a point of controversy, but I venture to
maintain that under most circumstances, though not in all, the growth of
population still has to be counted a factor making for a larger per capita product
- although even that cautious statement needs to be interpreted and qualified. But just as there may be population growth
with no increase of the average per capita product, so also, as I have
tried to suggest, markets may grow and increasing returns may be secured while
the population remains stationary.
It is
dangerous to assign to any single factor the leading role in that continuing
economic revolution which has taken the modern world so far away from the world
of a few hundred years ago. But is there
any other factor which has a better claim to that role than the persisting
search for markets? No other hypothesis
so well unites economic history and economic theory. The Industrial Revolution of the eighteenth
century has come to be generally regarded, not as a cataclysm brought about by
certain inspired improvements in industrial technique, but as a series of
changes related in an orderly way to prior changes in industrial organisation and to the enlargement of markets. It is sometimes said, however, that while in
the Middle Ages and in the early modern period industry was the servant of commerce,
since the rise of “industrial capitalism” the relation has been reversed,
commerce being now merely an agent of industry. If this means that the finding of markets is
one of the tasks of modern industry it is true. If it means that industry imposes its will
upon the market, that whereas formerly the things which were produced were the
things which could be sold, now the things which have to be sold are the things
that are produced, it is not true.
The great change, I imagine, is in the new importance which the potential market has in the planning and management of large industries. The difference between the cost per unit of output in an industry or in an individual plant properly adapted to a given volume of output and in an industry or plant equally well adapted to an output five times as large is often much greater than one would infer from looking merely at the economies which may accrue as an existing establishment gradually extends the
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scale
of its operations. Potential demand,
then, in the planning of industrial undertakings, has to be balanced against
potential economies, elasticity of demand against decreasing costs. The search for markets is not a matter of
disposing of a “surplus product,” in the Marxian sense, but of finding an
outlet for a potential product. Nor is
it wholly a matter of multiplying profits by multiplying sales; it is partly a
matter of augmenting profits by reducing costs.
Although the
initial displacement may be considerable and the repercussions upon particular
industries unfavourable, the enlarging of the market
for any one commodity, produced under conditions of increasing returns,
generally has the net effect, as I have tried to show, of enlarging the market
for other commodities. The business
man’s mercantilistic emphasis upon markets may have a
sounder basis than the economist who thinks mostly in terms of economic statics is prone to admit. How far “selling expenses,” for example, are
to be counted sheer economic waste depends upon their effects upon the
aggregate product of industry, as distinguished from their effects upon the
fortunes of particular undertakings.
Increasing
returns are often spoken of as though they were attached always to the growth
of “industries,” and I have not tried to avoid that way of speaking of them,
although I think that it may be a misleading way. The point which I have in mind is something
more than a quibble about the proper definition of an industry, for it involves
a particular thesis with respect to the way in which increasing returns are
reflected in changes in the organisation of
industrial activities. Much has been
said about industrial integration as a concomitant or a natural result of an
increasing industrial output. It
obviously is, under particular conditions, though I know of no satisfactory
statement of just what those particular conditions are. But the opposed process, industrial
differentiation, has been and remains the type of change characteristically associated
with the growth of production. Notable
as has been the increase in the complexity of the apparatus of living, as shown
by the increase in the variety of goods offered in consumers’ markets, the
increase in the diversification of intermediate products and of industries
manufacturing special products or groups of products has gone even further.
The successors of the early printers, it has often been observed, are not only the printers of to-day, with their own specialised establishments, but also the producers of wood pulp, of various
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kinds
of paper, of inks and their different ingredients, of type-metal and of type,
the group of industries concerned with the technical parts of the producing of
illustrations, and the manufacturers of specialised
tools and machines for use in printing and in these various auxiliary
industries. The list could be extended,
both by enumerating other industries which are directly ancillary to the
present printing trades and by going back to industries which, while supplying
the industries which supply the printing trades, also supply other industries,
concerned with preliminary stages in the making of final products other than
printed books and newspapers. I do not
think that the printing trades are an exceptional instance, but I shall not
give other examples, for I do not want this paper to be too much like a primer
of descriptive economics or an index to the reports of a census of production. It is sufficiently obvious,
anyhow, that over a large part of the field of industry an increasingly
intricate nexus of specialised undertakings has
inserted itself between the producer of raw materials and the consumer of the
final product.
With the extension of the division of labour among industries the representative firm, like the industry of which it is a part, loses its identity. Its internal economies dissolve into the internal and external economies of the more highly specialised undertakings which are its successors, and are supplemented by new economies. In so far as it is an adjustment to a new situation created by the growth of the market for the final products of industry the division of labour among industries is a vehicle of increasing returns. It is more than a change of form incidental to the full securing of the advantages of capitalistic methods of production - although it is largely that - for it has some advantages of its own which are independent of changes in productive technique. For example, it permits of a higher degree of specialisation in management, and the advantages of such specialisation are doubtless often real, though they may easily be given too much weight. Again, it lends itself to a better geographical distribution of industrial operations, and this advantage is unquestionably both real and important. Nearness to the source of supply of a particular raw material or to cheap power counts for most in one part of a series of industrial processes, nearness to other industries or to cheap transport in another part, and nearness to a larger centre of population in yet another. A better combination of advantages of location, with a smaller element of compromise, can be had by the more
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specialised industries. But the largest advantage secured by the
division of labour among industries is the fuller realising of the economies of capitalistic or roundabout
methods of production. This should be
sufficiently obvious if we assume, as we must, that in most industries there
are effective, though elastic, limits to the economical size of the individual
firm. The output of the individual firm
is generally a relatively small proportion of the aggregate output of an
industry. The degree in which it can
secure economies by making its own operations more roundabout is limited. But certain roundabout methods are fairly sure
to become feasible and economical when their advantages can be spread over the
output of the whole industry. These
potential economies, then, are segregated and achieved by the operations of specialised undertakings which, taken together, constitute
a new industry. It might conceivably be
maintained that the scale upon which the firms in the new industry are
able to operate is the secret of their ability to realise
economies for industry as a whole, while presumably making profits for themselves.
This is true in a way, but misleading. The scale of their operations (which is only
incidentally or under special conditions a matter of the size of the individual
firm) merely reflects the size of the market for the final products of the
industry or industries to whose operations their own are ancillary. And the principal advantage of large-scale
operation at this stage is that it again makes methods economical which would
be uneconomical if their benefits could not be diffused over a large final
product.
In recapitulation of these variations on a theme from Adam Smith there are three points to be stressed. First, the mechanism of increasing returns is not to be discerned adequately by observing the effects of variations in the size of an individual firm or of a particular industry, for the progressive division and specialisation of industries is an essential part of the process by which increasing returns are realised. What is required is that industrial operations be seen as an interrelated whole. Second, the securing of increasing returns depends upon the progressive division of labour, and the principal economies of the division of labour, in its modern forms, are the economies which are to be had by using labour in roundabout or indirect ways. Third, the division of labour depends upon the extent of the market, but the extent of the market also depends upon the division of labour. In this circumstance lies the possibility of economic progress, apart from the progress which comes as a result of the new knowledge
539
which men are able to gain, whether in the pursuit of their
economic or of their non-economic interests.
ALLYN A. YOUNG
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Note not included
The Competitiveness of Nations
in a Global Knowledge-Based Economy
October 200
3