Knowledge and the Wealth of Nations by David Warsh's
Reviewed by Christopher P. Adams, U.S. Federal Trade Commission
David Warsh's Knowledge and the Wealth of Nations is ostensibly about a paper written by Stanford's Paul Romer and published in the Journal of Political Economy in 1990, but, in fact, the book is an amazing tour through the history of economic thought on the question of what determines the wealth of nations. The book takes the reader through the seminal contributions of Smith, Malthus, Ricardo, Mills, Walras, Marshall, von Neumann, Keynes, Robinson, Ramsey, Samuelson, Solow, Arrow, Debreu, Dixit, Stiglitz, Summers, Mankiw, Krugman, Romer, Romer and Romer (to name a few Romers). It shows how these people came to question what determines the wealth of nations and how their contribution increased or, in some cases, decreased our understanding. Warsh argues that Romer (1990) solved one of the great questions of theoretical economics: how to combine Adam Smith’s Pin Factory with his Competitive Equilibrium. In the Pin Factory the manufacturer enjoys increasing returns through the virtuous cycle of more sales leading to greater productivity and lower costs leading to lower prices and more sales, e.g., Walmart. Increasing returns suggests large monopolies will dominate their markets. In a competitive equilibrium, thousands of small firms compete on price to provide consumers with what they want at the lowest possible price, e.g., the Five and Dime. How is it that an economy can have both? Doesn’t one necessarily contradict the other? According to Warsh, Romer’s model allows increasing returns to lead to growth while still having a general equilibrium competitive framework.
I thoroughly enjoyed the book. Warsh provides an amazing insight into the history of economic thought of how an economy grows. For a non-economist, Warsh has an amazing understanding of economics and economists. I only came across one factual error. In a discussion of how Buzz Brock changed the Chicago Economic’s Department, Warsh states that Buzz is a tap dancer. Now, as every Wisconsin grad knows, Buzz is a clogger. But if you are willing to live with such variations on the truth and you are looking for an excellent overview of the economics of growth, then I recommend this book.
My biggest disappointment with the book is that I still don’t really understand the contribution of Romer (1990). I was exposed to Romer (1990) and its brethren in first year Macro. However, my understanding of the paper (to the extent I had any) was expunged as I walked out of the Macro prelim. By reading this book, I was hoping to get some insight into what I had been taught in Macro and possibly get some understanding of what it is that Macro economists do. Warsh provides all the pieces of the puzzle. He explains the inherent contradiction in Smith’s Wealth of Nations. He argues the importance of knowledge to understanding economic growth. He describes how Romer allows knowledge to be created endogenously in the market. He explains the need for market power to explain why investment in knowledge is profitable. What Warsh does not do, is put all the pieces together to explain how and why Romer (1990) works. I guess I will have to break open the seal on my Macro notes or, heaven forbid, actually read Romer (1990).
The most interesting thing about the book is the discussion of the policy implications. Warsh argues that traditional macroeconomic policies such as monetary policy, may be of secondary importance relative to education policy and NIH funding. To these policies I would add immigration policy, particularly in relationship to visas for scientists and students, and federal policy regarding stem cell research. I recently witnessed two examples of how economies grow. The first example was a New York Times article about the government of Singapore’s strategy for developing a biotechnology industry. The article argued that Singapore’s less stringent laws regarding research on stem cells are encouraging scientists to move there. In this example, a country attempts to “pick winners” and encourage growth in a particular industry or sector. The second example was provided by two people sitting next to me in the restaurant. One was an entrepreneur working with a firm developing a new technology to teach reading to children, while the other was an executive in a publishing house. The two were discussing the possibility of the publishing executive coming over to the new firm and using her experience to develop the product. In this example, the growth policy is to let New York City be a Very Large City. In New York City growth happens because people can get together over breakfast and create new firms and new technologies.
What leads to the wealth of nations? Thomas Friedman argues in the The World is Flat that India’s huge recent gains are the result of two things. One was India’s government’s long term investment in education. This policy has provided India (and the United States through immigration) with a large number of extremely well educated people. The second was the overinvestment in fiber optic cable by private firms during the Tech Bubble. The fiber optic cable brought India closer to the United States and Europe and the education policy provided know how to take advantage of the opportunity. Warsh argues that Romer (1990) provides a framework for thinking about growth and the importance of knowledge in creating the wealth of nations.