Friday, May 01, 2015

Paul Romer

Paul Romer's endogenous growth model (which treats ideas as part of the economic model, rather than something which is set outside of, or "exogenous to", the economic growth process) offers what I think is one of the most useful macro frameworks; however, it seems to have fallen out of favor for some reason.

In this interview with Cloud Yip of iMoney Magazine, he talks about the importance of urbanization, his growth model, and why non-rival, partially excludable goods (like ideas) mean that the primary micro market model to study is that of monopolistic competition (many competitors, differentiated goods, neither price taking nor price setting completely):

Q: So are you not going back to work on growth theory?

Romer: Actually I am writing something about growth theory right now, but it is mostly a commentary on what happened to growth theory. To be honest, I think that a substantial fraction of the work that people are now doing on growth has to be judged a failure from a scientific perspective.

In particular – and I apologize if this relies too much on the jargon of our field — monopolistic competition turns out to be just the tool for understanding the economic ideas. (It also turns out to be the tool for understanding international trade, economic geography, and macroeconomics.) But there has been a series of models that are associated with the University of Chicago – from what some people call the freshwater camp in macroeconomics – that are continuing a fight that George Stigler started in the 1930s to keep monopolistic competition from being used in economics. It is hard to explain to an outsider why a whole group of economists have ended up on the wrong side of scientific progress, resisting the direction that all of modern economic theory is taking, but they are.

In the economics of ideas, we have to be willing to at least consider the possibility that someone could have some control over an idea, hence some monopoly power associated with ideas. This could come from patent or a copyright. It could also come from secrecy.

Then we can ask if it is a good idea or a bad idea to have more intellectual property rights or more protection of ownership of ideas. We know that the answer here is mixed. Sometimes some amount of it can be good, but it can also be harmful if the property rights are too strong or are given to the wrong types of ideas. But if you don’t even allow for the possibility of ex post monopoly rents from the discovery of ideas, you can’t even ask the question.

So it is scientifically unacceptable to have people who say, “We will never, as a matter of principle, consider a model in which there are ever any monopolies. We will dogmatically stick only to models of price-taking competition.” I think this an untenable scientific stance.

I don’t think that this critique is going to reignite interest in growth theory. But like I said, when it’s time for interest to come back, somebody have a new take on growth theory, and work in this area will start again. But in the meantime, we have to stop tolerating work that is scientifically unjustifiable.

Q: I thought the endogenous growth model paved a new direction for growth theory to further develop, yet the academic interest in this theory just stopped. And even textbooks just briefly mention the endogenous growth model. What is the problem?

Romer: Well, I think the thing we learn from endogenous growth is something very simple. It is the notion of an idea as a nonrival good. The statement that an idea is a nonrival good is very powerful because what that tells you is the value of an idea is proportional to, or at least scales with, the total number of people who can use it. So it means that scale effects are at the heart of economic activity. This is why globalization is so important, because it is now possible for any idea to be used by everyone.

The Solow model already allows for a non-rival good, but the model also made it nonexcludable – which means that no one could control or own an idea. This turns a nonrival good into a public good. What endogenous growth theory said is that, there are some nonrival goods that can be at least partially excludable. This means that incentives start to matter, both for discovering ideas and for spreading ideas. The people who want to stick with price-taking never want to allow the possibility of that a nonrival good could be even partially excludable. Because of their untenable insistence on price-taking models, they have tried to stop the spread of the key insight from endogenous growth theory. And they have been at least partially successful in doing so.

Once you admit that there are some nonrival goods, globalization becomes much more important than standard theory suggests. And if you allow that some of them are partially excludable, then incentives matter a lot more than standard theory suggests, for better and for worse.

So for example, there is a non-rival idea that a firm can control. They can keep it secret. They can take it to work in a factory in India. If they want to locate in India but there are no gateway cities there, they may go elsewhere in the world. So the policies that make a place like Mumbai so dysfunctional influence growth for the entire country.

What a government can do is influence the incentives for people to bring ideas into a country. One way to think about why Shenzhen was so powerful is that it created incentives for firms to bring ideas into China and combine those ideas with Chinese workers.

You don’t even need a formal model for that. Once you see the underlying idea, sometimes the words and the clarity of thinking are what really matters, not the math. You can use the math to get there, but once you got there, you don’t need that anymore. It is unfortunate that these ideas are not being communicated to students in our textbooks, because these are the exciting ideas.

(via Mark Thoma/Economist's View)

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