Thursday, May 04, 2006

The Romer Model

Paul Krugman recently reviewed a new book by David Warsh, Knowledge and the Wealth of Nations. [Here is a link to some extracts from the review].

One bit got my interest ...

Maybe that slight sloppiness reflects Warsh's relative lack of interest in applications of increasing returns other than the one he believes to be most crucial: as an explanation of economic growth. He portrays a famous 1990 paper about increasing returns and growth by Paul Romer of Stanford University as a
sort of pivot around which the whole way economists see the world changed.

Now "Romer 1990" is a terrific paper — I wish I had written it, which is the highest praise one economist can give to another. Yet I don't think it can bear the weight Warsh places on it. Nor is it clear that increasing returns really did transform our understanding of economic growth. In fact, Warsh seems to concede as much. "So there is a new economics of knowledge. What has changed as a result? The answer, it seems to me, is not much."

I think Paul Krugman is living in a different academic world from mine. For me, the Romer model was a watershed. Let's first go to the statistics on influence -- not just academic but wider. If we look at you will find that the Romer's 1990 Journal of Political Economy paper receives 3122 citations. This paper was a follow-up to his 1986 paper that resolved a number of technical issues (with 3621 citations). These would place it at the top of influencial papers in economics in the last 20 years. By contrast, Paul Krugman's most cited 'increasing returns' work (his 1991 book Geography and Trade) received 2312 citations. Still alot but it was a book not a single paper.

What the Romer model did was identify the main issue for public policy with respect to economic growth: that is, that knowledge was a partially-excludable but non-rival good. What this meant is that the market would underprovide this as a matter of course but also provide us with too little innovation in terms of new products. That had been said before. What Romer showed was that this would lead to an additional and on-going distortion to the labour market for knowledge intensive workers. The returns to becoming a scientist or engineer were too low relative to other activities. It is this that would fundamentally limit growth rates both within a country but also across them as skilled workers migrated. This is what general equilibrium modelling was all about.

The Romer model was clear, it was precise and it was useable by others -- both theorists and empirical economists alike. And more importantly, its message was never misunderstood.

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