The Endogenous Growth Theory
https://www.weforum.org/agenda/2015/06/what-is-endogenous-growth-theory/
Variation in standards of living across countries is clearly associated with different amounts of physical capital such as public infrastructure. So should we simply invest more in more roads and bridges to increase our standard of living?
The former Soviet Union tried this approach and failed.
The problem is that physical capital only explains about one-third of the variation in income per capita across countries. The other two-thirds are “explained” by a more nebulous concept that economists refer to as total factor productivity, or TFP for short. I have to put quotes around “explained” because we can only measure TFP as the residual component of income per capita not explained by capital.
The point is that massive investment in infrastructure would only ever get even the poorest country one-third of the way to catching up with rich countries. Worse yet, capital accumulation is subject to diminishing returns for all countries.
Yes, income per capita would increase with the amount of machinery and equipment per worker, but nowhere near proportionately. Rather than an easy path to prosperity, capital accumulation quickly becomes a lot like squeezing blood from a stone.
The prediction of diminishing returns to capital was the main insight of the Solow-Swan “neoclassical” theory of economic growth that undergraduate students in macroeconomics have been struggling with for decades – and one that politicians looking for growth elixirs in the form of public or private infrastructure have ignored at their peril.
https://www.weforum.org/agenda/2015/06/what-is-endogenous-growth-theory/
Variation in standards of living across countries is clearly associated with different amounts of physical capital such as public infrastructure. So should we simply invest more in more roads and bridges to increase our standard of living?
The former Soviet Union tried this approach and failed.
The problem is that physical capital only explains about one-third of the variation in income per capita across countries. The other two-thirds are “explained” by a more nebulous concept that economists refer to as total factor productivity, or TFP for short. I have to put quotes around “explained” because we can only measure TFP as the residual component of income per capita not explained by capital.
The point is that massive investment in infrastructure would only ever get even the poorest country one-third of the way to catching up with rich countries. Worse yet, capital accumulation is subject to diminishing returns for all countries.
Yes, income per capita would increase with the amount of machinery and equipment per worker, but nowhere near proportionately. Rather than an easy path to prosperity, capital accumulation quickly becomes a lot like squeezing blood from a stone.
The prediction of diminishing returns to capital was the main insight of the Solow-Swan “neoclassical” theory of economic growth that undergraduate students in macroeconomics have been struggling with for decades – and one that politicians looking for growth elixirs in the form of public or private infrastructure have ignored at their peril.
Economist Paul Romer has developed a theory of economic growth with “endogenous” technological change — that is, it can depend on population growth and capital accumulation. His endogenous growth theory ties the development of new ideas to the number of people working in the knowledge sector (think of this as effort devoted to R&D). These new ideas make everyone else producing regular goods and services more productive – that is, ideas increase TFP.
There are many variants of endogenous growth theory, but a robust prediction is that an increase in population or an increase in the share of people working in the knowledge sector will increase economic growth.
This theory is quite radical for two reasons.
First, the prediction of higher economic growth for a larger population suggests that neoclassical growth theory, not to mention even more pessimistic economic theories of population going back to Thomas Malthus, got things completely wrong.
Evidently, China’s single-child policy was a mistake, not just for social reasons, but also for economic reasons. According to endogenous growth theory, China and the rest of the world could have had more growth because China would have produced more new ideas with an even larger population.
Second, because ideas are what economists label as “non-rival” (meaning that my use of an idea, like a recipe or a mathematical formula, doesn’t prevent your use of it), there will only be an economic incentive for more people to work in the knowledge sector if there are intellectual property rights such as patents and copyright. Thus, it is necessary to restrict competition in the knowledge sector in order to stimulate growth, even though this leads to other distortions and disparities in the economy.
Understanding Romer
http://www.reed.edu/economics/parker/s12/314/Coursebook/Ch_05.pdf
https://www.brown.edu/Departments/Economics/Faculty/Peter_Howitt/publication/endogenous.pdf
http://economia.unipv.it/pagp/pagine_personali/lorenza.rossi/LECTURES_ENDO_GROWTH.pdf
https://www.youtube.com/watch?v=e0AqbVVODFw
Endogenous Technological Change (1990)
Y = AF(K,L)
- Solow treats A, ideas, as a public good.
- Growth in ideas is exogenous (outside the model)
- Growth is about new ideas and most R&D produced by for-profit firms.
- Ideas are non-rivalrous and cannot be sold in competitive markets becasue marginal cost is zero.
- Ideas create spillovers
- Romer created a model of growth based on ideas, privately produced by for-profit firms in monopolistically competitive markets with spillovers.
Ideas
- Patents/intellectual property
- Universities
- Capital markets
- Human capital in research
- Idea transmission
- Trade and Market Size
- Types of ideas (technologies, rules)
- Cities/agglomeration/density
However simple-seeming his ideas, Romer is no lightweight. Starting in the late 1980s, he produced a series of papers that changed the way his profession thinks about economic growth; his most celebrated contribution, published in 1990, “was one of the best papers in economics in 25 or 30 years,” in the estimation of Charles I. Jones, a colleague of Romer’s at Stanford. Before the Romer revolution, theorists had explained an economy’s growing output by looking at the obvious inputs—the number of hours worked, the skills of the workforce, the quantity of machinery and other physical capital.
But Romer stressed a fourth driver of growth, which he termed simply “ideas,” a category that encompassed everything from the formula for a new drug to the most efficient sequence for stitching 19 pieces of material into a sneaker. In statistical tests, the traditional inputs appeared to account for only half the differences in countries’ output per person, suggesting that ideas might account for the remaining half—and that leaving them out of a growth theory was like leaving the prince out of Hamlet. And whereas the old models had predicted that growth would slow as population expansion put stress on resources, and as new investment in skills and capital yielded diminishing returns, Romer’s New Growth Theory opened the window onto a sunnier worldview: a larger number of affluent people means more ideas, so prosperity and population expansion might cause growth to speed up.
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