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Economic Growth and Ideas

Economic Growth and Ideas

It is commonly understood that the generation and implementation of new ideas and technologies, or the development of knowledge, are major factors underlying economic performance and growth. Versions of this position go back at least to Schumpeter.

A central debate within new growth theory is focused on the role of the “ideas” sector in sustaining equilibrium productivity growth. In Paul Romer’s seminal model of endogenous technological change, productivity growth is driven by a constant allocation of resources to an ideas-producing sector (Romer, 1990), a result which depends critically on strong positive intertemporal spill overs in ideas production. Specifically, to generate ideas-driven growth, ideas sector productivity must increase proportionally with the stock of ideas already discovered.

The significance of ideas-driven growth therefore depends on whether the production function for ideas satisfies this critical property. To evaluate this claim, several authors have examined the relationship between the Total Factor Productivity (TFP) growth rate and the size of the workforce devoted to the production of ideas (Jones, 1995). The Romer model predicts that expansion in the number of ideas workers leads to a permanent increase in the TFP growth rate.

The full translation of ideas and new technologies into productive output depends on many intervening factors, including the technical and human capital of the workforce, whether the economy’s physical and information infrastructure are positioned to take advantage of new technologies, and whether the industrial organization of adopting sectors is conducive to taking advantage of technological development.

Identifying the specific mechanisms by which linkages among the ideas and production sectors of the economy lead to higher rates of diffusion and what factors limit the applicability of new technologies to generating productivity gains seems an extremely promising area for further theoretical and empirical research.

Thinking carefully about the way in which ideas are different from other economic goods leads to a profound change in the way we understand economic growth. The nonrivalry of ideas implies that increasing returns to scale are likely to characterize production possibilities. This leads to a world in which scale itself can serve as a source of long term growth. The more inventors we have, the more ideas we discover, and the richer we all are. This also leads to a world where the first fundamental welfare theorem no longer necessarily holds. Perfectly competitive markets may not lead to the optimal allocation of resources. This means that other institutions may be needed to improve welfare. The patent system and research universities are examples of such institutions, but there is little reason to think we have found the best institutions – after all, these institutions are themselves ideas.

While we have made much progress in understanding economic growth in a world where ideas are important, there remain many open, interesting research questions. The first is: “What is the shape of the idea production function?”. How do ideas get produced? The current research practice of modelling the idea production function as a stable Cobb-Douglas combination of research and the existing stock of ideas is elegant, but, at this point, the proofs are inconclusive for us to believe that it is correct. One insight that illustrates the incompleteness of our knowledge is that there is no reason why research productivity in the idea production function should be a smooth, monotonic function of the stock of ideas.

A second unresolved research question is: “What is the long-run elasticity of output per worker with respect to population?”.

Finally, a policy-related question: “What institutions and policies are better for encouraging the efficient amount of research?”. There is a large, suggestive literature on social rates of return to research and on the extent to which firms might underinvest in research.

References

Jones, C. (1995). “R&D Based Models of Economic Growth,” Journal of Political Economy, 103: 739-784.
Romer, P. (1990). “Endogenous Technological Change,” Journal of Political Economy, 98: S71-S102.
Schumpeter J.A. (1934). Theory of Economic Development. Harvard University Press, Cambridge.
Schumpeter J.A. (1950). Capitalism, Socialism, and Democracy, 3rd edition. Harper and Row, New York.
Cantner U.; Gaffard J.L., Nesta L. (Editors) (2009). Schumpeterian Perspectives on Innovation, Competition and Growth. Springer-Verlag Berlin Heidelberg.
 
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OEconomica No. 1, 2016