The political economy of networks

by John Quiggin on July 5, 2008

I’ve had this post in mind for quite a while, and never got in finished to my satisfaction, but it’s been stimulated to a significant extent by reading Clay Shirky, so I thought I’d pop it up now, somewhat half-baked while he’s visiting here at CT.

I’ve updated it a bit, incorporating some comments and responding to others

The biggest single question in political economy is whether and to what extent we can achieve social equality without sacrificing other goods like liberty and prosperity. Neoclassical economics (a project in which I’m a participant) begins with models which imply that, with competitive markets, all factors of production will earn their marginal product. This in turn implies that any intervention that shifts wages or returns to capital away from their marginal product must imply a loss in aggregate income.

There are all sorts of problems with this result, and particularly with simple-minded applications of it, which are legion. For a start, it can only ever be true at the margin – everyone in a modern economy depends for their income on the centuries of effort that have gone into creating that economy. There are also plenty of technical issues which have been debated for a long time, such as the famous capital controversy. I’m particularly interested with questions relating to whether the standard result, derived under the assumption of certainty and perfect information, works under conditions of uncertainty (in my view, much of the activity of the social democratic welfare state can be explained as a form of collective risk management).

Still, in an economy that fits the standard model of lots of competing firms, all operating in a region where constant returns to scale apply, the standard neoclassical analysis has considerable force. But the growing part of the economy centred on the Internet doesn’t fit this model at all. The Internet is a network and the economies of networks are different, in critical ways, from those of the standard neoclassical model.
[click to continue…]