October 2006 SGE Monthly Luncheon
Review of Remarks by David Warsh
Editor of EconomicPrincipals.com
Knowledge and the Wealth of Nations
Rapporteur: Michael Wolf
David Warsh’s new book, Knowledge and the Wealth of Nations discusses the story of Paul Romer’s 1990 endogenous growth model and how it has affected contemporary thinking on economic development. The topic of this academic paper was chosen because Warsh’s believes Romer’s paper broke new ground in the growth literature and fundamentally changed the way economists view the world and the global economy.
Warsh’s talk began with a brief description of Romer’s formative years. He studied physics as an undergraduate at Chicago, and then pursued economics as a graduate student at MIT, Queens, and Chicago. These varied experiences, together with time at Rochester, exposed him to a number of ideas—among them the von Neumann growth model, the work of Robert Lucas and Jose Scheinkman, and monopolistic competition—that drove his thoughts on growth theory to their final conclusion.
The end result eventually became Romer’s theory of endogenous growth, which broke from the ideas of Robert Solow, whose theory stated that a country’s long run growth rate was fixed, based on a stated rate of technological change. Romer instead allowed growth and technological change to vary based on the actions of people, who act primarily through profit-seeking investment decisions.
The importance of technological change in growth theory led to a discussion of rival and nonrival goods. The concept of rival and nonrival goods was not common in economic discourse before the 1980s. However, there is an important conceptual difference between them that has important implications for development: A good is a rival good if its use by one actor prevents or limits its use by another, whereas nonrival goods can be used by many actors simultaneously. Most physical objects are rival goods, whereas nonrival goods tend to be intangible, such as television programming (as opposed to the physical receiver).
The importance of rival and nonrival goods for growth theory is that knowledge is a nonrival good; once a new device or production method has been developed, it can be used worldwide. This does not mean that it is immediately available for anyone to use, since nonrival goods can still be excludable. In terms of knowledge this is primarily done through trade secrets (preventing the information from becoming common knowledge) or patents (restricting the use of common knowledge by others). However, many basic developments are difficult to exclude, as Warsh indicated by referencing the economic espionage of the English textile industry by Francis Cabot Lowell, which jumpstarted the American industrial revolution.
A similar process can take place today to help developing countries. Knowledge of production processes in manufacturing do not have to be developed from scratch in these countries, but can instead be imported directly from developed countries at no loss to developed countries because knowledge is a nonrival good. However, that does not mean that the results from the diffusion of knowledge will not increase competition that developed countries face. The best method for developing countries to effectively tap this available knowledge base is an area that can see further study.
For developed countries, growth can be stimulated by increasing knowledge through training and education programs. Romer believes, however, that governments should stimulate knowledge development from the supply side; that is, by increasing the supply of engineers and scientists to do basic research and development, rather than by telling existing scientists and engineers what they should be working on discovering.
The increasing diffusion of knowledge will begin to make existing intellectual property rights increasingly futile as knowledge becomes even less excludable. Developed countries can cope by ensuring that they continue to produce new knowledge through adequate research and development. Changes in patents for certain types of knowledge, such as pharmaceuticals, can also help. If companies are rewarded with an upfront prize, rather than an extended period of monopolistic rights, there is no longer a risk to the sharing of knowledge and the benefits can be shared more efficiently.