by Jurgen Brauer, June 2007
Copyright: J. Brauer. No reproduction without permission.

Most everyone has heard of economies of scale. Even if the precise, technical definition does not readily spring to mind, most people will have at least a hazy notion that operating on a larger scale somehow reduces average costs and hence that savings, or economies, are being reaped. When college students double or triple up to share an apartment’s cost, the reap economies of scale. The overhead of rent and utilities can be distributed among the room mates and savings result.

Although equally straightforward, less well-known is the concept of economies of scope. If a retailer offered nothing but size 36 pants, predictably it would make relatively few sales. The cost involved in setting up the store, relative to the likely sales, would probably not result in a profitable venture. But if the store is already set up, the retailer might as well offer a greater variety of goods - obtain scope - and spread the cost over a larger set of offerings. The additional cost of attaining scope is small relative to the additional customers attracted and sales made. Thus, as a rule universities offer more than one degree; car dealerships more than one car make; law offices more than one type of legal service; and manufacturers more than one type of product. Not only can it pay to stretch overhead expenses over a large quantity of goods or services, but it can pay to offer a large variety of goods and services.

A third economies concept is even less-well known. Called economies of agglomeration, it refers to the bunching of economic activity in particular geographic locales. For example, the moviemaking industry in concentrated in Hollywood, computer firms stack up in Silicon Valley, financial markets in New York City, commodity markets in Chicago, defense firms and consultants all have offices in or near Washington, DC, and research parks generally locate near research universities. The explanation is obvious. Despite advances in communications technology, people working in a particular industry find it advantageous to work near each other, the better to meet in person and be near the action. Also, for both employees and employers it becomes much easier to look for a new job or a new hire.

Because agglomeration refers to physical space, we are in the realm of economic geography. In earlier times, when economies where built predominantly around the harvesting and trading of nature’s products - think of fishing - hubs of economic activity would evolve in and revolve around places intimately linked to nature. To this day, for example, a large number of the world’s great cities are based on their history as harbors, for example, Sydney and Auckland in Australia and New Zealand, Bombay and Shanghai and India and China, Venice, Lisbon, Rotterdam, and Hamburg in Europe, Cape Town and Cairo in Africa, Buenos Aires and Rio de Janeiro in Latin America, and in the United States the cross from Miami to Seattle and from New York to San Francisco. Many of these, in turn, are not just cities with splendid access to and yet shelter from the oceans but are located at the end of mighty rivers. Go upstream and additional population centers, that is centers of economic activity, come into view.

That by far the majority of humans live along waterways is the natural consequence of the importance of water for transportation in the early history of humankind. Just as mountains divided, rivers united. Once fishing and trade focused on the harbors, other industries sprang up to serve these industries. In essence, people attract more people or, more precisely, the economic activity of some people attracts the economic activity of additional people. Even in the mythical “wild west,” there was no town without its general store, barber, and saloon. Cities arise and agglomerations emerge, then, not only within industries, such as moviemaking or research parks, but also across industries as specialists in one are needed near-by to work with specialists in another.

Even in an age where electronic, long-distance communication has become easy, cheap, and reasonably reliable, this does not seem to impede the continuing growth of cities. A headline went around the world recently, saying that very soon more than half of humanity will live in cities (up from about one-seventh a hundred years ago). There are now over 400 cities with populations of over one million people each. Interestingly, part of the attraction is that cities not only aggregate the diverse skills of its inhabitants, but that they offer economies of scale, for example, in the building of utility infrastructure, and economies of scope, for example, in the variety of cultural offerings they host.

All glory for the city, then? Not quite. For economics has one more concept that is of interest here: diseconomies.

All glory for the city, then? Not quite. For economics has one more concept that is of interest here: diseconomies. There are diseconomies of scale, of scope, and of agglomeration. Simply put, things can get too large, too complex, and too convoluted. My favorite example is that of a lineman on a football team. Surely, a 280-pound lineman will be more useful to the team than a 180-pounder in that position. Economies of “scale” are important. But when the lineman weighs in at 380 pounds, it’s too much of a good thing because at that weight he cannot possibly be nimble enough to do his job well. And so it is with firms, variety, and cities. As they become monstrous they become disfunctional. Who hasn't complained about firms so big that one can't find the person to speak to, of variety so vast that one is overwhelmed by the options, and of cities so huge that one gets stuck in traffic? And yet, firms, variety, and cities - and linemen - have grown over time. The primary reason is that from time to time inventions in product technology and process technique have come along that permit the effective management of ever-larger things. Still, there are limits. Instead of one super-sized firm, we have many very large firms and instead of one super-sized city, we have many very large cities. What determines these limits is, however, another story and best saved for another column.