NCPA - National Center for Policy Analysis

Are New Economy "Network Effects" The Same Old "Economies Of Scale?"

July 6, 2000

Is the new economy governed by different principles than the old economy?

  • Many business gurus claim we now live in a "network society" in which profitability does not diminish as investment expands -- and thus is not subject to the old economy concept of "diminishing returns."
  • They say there are now "positive feedback loops" because it costs so little to reach a new customer or make a new connection.
  • Thus, the bigger the network, the higher the returns on investment -- and the ultimate network is, of course, the World Wide Web.

But how new is all this? The same economies of scale that worked in the late 1800s may also be creating rapid productivity gains in the new economy. Consider steel, for instance:

  • In 1880, steel rails cost about $68 a ton to produce.
  • But largely because of economies of scale, the price fell to about $18 a ton by 1900.

New companies are selling standardized products to enormous mass markets, just as in the good old days. Ever hear of Microsoft Windows? In fact, today's most successful companies have enormous market shares, and enjoy economies of scale based on standardized (if complex) products. The national economic data shows unusual gains in productivity in just such computer hardware and software companies.

In fact, the Internet probably gives even more advantage to large companies because the nonmarketing costs of reaching one additional customer are virtually nil.

Moreover, many new economies of scale are in service industries, and as John Kwoka, a George Washington University economist, points out, the government does not gather data about them.

Source: Jeff Madrick, "The New Economy's 'Network Society' Plays by Old-Economy Rules," New York Times, July 6, 2000.


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