Chapter 9 introduces the concept of external economies of scale. The following tells the story of external economies of scale in the development of the machine tool industry.

The machine-tool industry is an important one. Machine tools are the lathes and milling machines that create car bodies, bicycles, and high-tech military equipment out of steel, aluminum, and other metals. Today there are thousands of machine-tool factories around the world. One indicator of the importance of the machine-tool industry is that governments have tried—usually unsuccessfully—to protect the industry from foreign competition. Almost 200 years ago the government of England prohibited the export of machine tools because it was concerned other countries would learn how to make them. The U.S. government now has an agreement with foreign governments to restrict the amount of foreign-made machine tools brought into the United States.

The rapid growth of the machine-tool industry in the United States provides one of the classic examples of external economies of scale. There was no machine-tool industry in the United States in 1820. It began to grow rapidly when the firearm industry expanded in the mid-1820s. As rifle production increased, it became worthwhile for firms to specialize in the production of lathes and milling machines to produce gunstocks. Eli Whitney, the famous inventor of the cotton gin, invented the milling machine around this time, which was a key factor in industry growth.

Of course, the development of the machine-tool industry reduced the costs in firearm manufacturing. Eli Whitney may have had the incentive to concentrate his thinking on inventing machine tools for firearm production, much as students at agricultural schools would have the incentive to specialize in Zinfandel grapes when grape production expands, as mentioned in the text.

The story of external economies of scale due to machine tools goes beyond the firearm industry. The expertise developed in the machine-tool industry became useful in the production of other goods. As the bicycle industry rose sharply in the 1890s, the need for lightweight, sturdy parts increased, and the machine-tool industry was able to make them. New machine tools were invented—such as the oil tube drill—as the bicycle industry expanded. Further growth and specialization in the machine-tool industry was made possible by the growth of the bicycle industry. The cost of bicycles in turn was reduced.

The story continues. The automobile industry started to rise just as the bicycle industry was declining. The automobile industry was aided by the existence of machine tools and as it grew, the machine-tool industry could specialize even further. Thus, the external economies of scale reduced costs in the automobile industry. The same thing happened in the aircraft industry.

This continuing story of the role of the machine-tool industry in leading to external economies of scale first in firearm production, then bicycles, then automobiles, then aircraft is fascinating. It is tempting to imagine a Back to the Future or It’s a Wonderful Life type of scenario. If the firearm industry had not expanded in the United States, then Eli Whitney’s milling machine and the whole machine-tool industry may not have developed. What would this have implied for the bicycle? For the automobile? For the airplane?