In today’s world, the discipline of economics finds itself at an inflection point. The mainstream orthodoxy, often criticised for being made up of half-truths, is starting to unravel. As a result, a transformative shift is happening.

Assumptions

Mainstream economic theory is built upon a foundation of assumptions that are becoming increasingly outdated. For example, the way that businesses operate has changed drastically over the lifetime of the discipline, though many of the core assumptions of economics have remained unchanged.

The shift towards the ‘knowledge economy’ and the idea of ‘economies of scale’ are proof of this business evolution. Both of these concepts have great appeal for capitalists – if companies get bigger, they benefit from cost savings. Bulk buying, advertising discounts, lower borrowing costs, and the ability to reduce fixed costs proportionally can all help bigger organisations reduce their average spend.

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However, should companies get too large, ‘diseconomies of scale’ can set in. Perhaps production processes for different components can’t scale up at the same speed, communications get lost in translation, or workers start to feel less motivated. The theory implies that as businesses grow, they eventually hit limitations. This should mean that no company can grow large enough to corner the market. At least, that’s what we used to think.

Grow – Continuously.

While some companies still have scope for diseconomies of scale, in other cases, these forces can be offset by ‘increasing returns to scale’ which allow growing companies to reinforce their gains. Often described as ‘being ahead to get further ahead’, if a company grows by clever strategy – or even by chance – increasing returns can magnify this advantage. Therefore, the product, company, or technology can go on to lock in the market. In the new intangible economy, companies can grow – continuously.

There are different sources of increasing returns, too. For example, the idea of ‘learning by doing’ (the more experience you have in doing something, the better you become) is one mechanism by which companies can experience increasing returns.

Take the production of lithium-ion batteries for electric vehicles (EVs). According to Morgan Stanley researcher Michael Mauboussin, “cumulative output has moved Tesla down the cost curve faster than its competitors” for batteries and EV production. Morgan Stanley analysis finds that Tesla has benefited from lower battery costs and operates the most productive automobile plant in the US.

Another example is ‘network effects’, when the value of a good or service increases as more people use it. Platform businesses are a good example of these. If a ride-share company such as Uber attracts more riders, they will find it easier to recruit more drivers, customers will be able to find rides faster, these effects will attract more customers, and so on.

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The AI Catalyst: Accentuating Superstar Status

The advent of artificial intelligence (AI) is poised to further entrench the position of larger companies, amplifying their growth in sales, employment, and market valuations. By leveraging the power of AI, these "superstar" companies could solidify their dominance and exacerbate existing power imbalances within the global economy.

Counterbalancing Forces: Regulation and Complacency

Despite their formidable advantages, the rise of knowledge companies is not unstoppable. Regulations and the threat of complacency could serve as counterbalancing forces, curbing their unchecked growth and dominance.

Regulatory Oversight

Regulatory bodies can intervene to prevent monopolistic practices and promote fair competition, as exemplified by the recent US antitrust lawsuit against Apple alleging "exclusionary, anticompetitive conduct." While tech giants often defend such actions as necessary for innovation, regulatory oversight remains a crucial check on their power.

The Complacency Trap

Success can also breed complacency, leading companies to become overly reliant on their "golden goose" and neglect innovation. As warned by experts, even technologies with powerful network effects, like the fax machine, can be superseded by better alternatives if companies fail to adapt and innovate.

Embracing the Next Wave

As the renowned economist W. Brian Arthur cautioned, "the ability to profit under increasing returns is only as good as the ability to see what's coming in the next cycle and to position oneself for it." While the current wave of technological advancements has enriched some companies to stardom and reshaped the global economy, their fortunes are not guaranteed.

Complacency and a failure to anticipate the next disruptive innovation could render even the mightiest companies obsolete. As Arthur sagely advised, "Those who have made a killing on this cycle should not become complacent," for "technology comes in successive waves," and those who position themselves for the next wave may emerge victorious.

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INOMICS would like to thank the University of Bath for their support in the production of this article.

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