Russ Roberts

Romer on Growth

EconTalk Episode with Paul Romer
Hosted by Russ Roberts
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Paul RomerPaul Romer, Stanford University professor and Hoover Institution Senior Fellow talks with EconTalk host Russ Roberts about growth, China, innovation, and the role of human capital. Also discussed are ideas in creating growth, the idea that ideas allow for increasing returns, and intellectual property and how it should be treated. This 75 minute podcast is a wonderful introduction to thinking about what creates and sustains our standard of living in the modern world.

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0:36Intro. CEE article: Why do small changes in growth rates matter? Power of compounding. At a 2.1% rate of growth per year income per capita can increase by a factor of 8 over 100 years, so per capita income could go from $30,000 to $240,000 per year. At 2.6%, factor of 13, end up with $390,000. Big difference in standard of living. Currently in U.S. we've had a 2.1% rate of growth for the last century. Some places like China are growing faster, but they are starting from a lower base, catching up; they won't surpass us. Sometimes a nation that is behind can grow faster--U.S. surpassed U.K. historically--so why won't China surpass us? Why is China growing so fast now? They have the advantage of being able to import--copy--existing technology. Harder to develop brand new things. In U.S., we developed institutions which encouraged more rapid discovery. Historians and economists are still struggling with which details of those institutions were the critical ones for why we developed. U.S. also imported people--immigration.
6:18How important is it for a nation to be the developer rather than the importer? Do we care where car or TV is invented? No. When thinking about rivalry between countries, it's helpful to reframe the question to think about rivalries between states in the U.S. Would it upset us if we lived in IL and Intel was making microprocessors in CA? Of course not. We buy them cheap. We're better off to be able to trade with CA. U.S. had advantage at the turn of the century by being a big trading block when the rest of the world was relatively closed to trade.
8:36How do economists look at growth? How has answer to what causes growth changed in the last 25 years? Smith and Malthus: notions of growth based on physical objects. Plots of land, pieces of wood, are finite. But economists recognized that there are also formulas for ideas and technological change, but they didn't know how to study it, so instead they took technological change as given and studied capital and labor. Didn't pay attention to the recipe. Instead we talked about the production function, a black box, factories, but didn't consider the whole idea of technology or innovation. To a physicist whole idea of a production function sounds wrong. Fixing up a house is merely rearranging. But there are recipes, formulas. Same simple ingredients can give us a soufflé if you know how. We have a huge tinker toy set to play with, how do we rearrange them? Economists focused on idea of diminishing returns: low-lying fruit, easy things about how to combine things at first, then think of more complicated things. This leads to the idea that all the good things, like the wheel, have been discovered, and all we have left is to discover little things like mint flavored floss. But this isn't the way it's turned out. Why is that? First, none of the new work overturns diminishing returns in a traditional sense. What is meant by diminishing returns? Think of goods in a distribution center: goods come in from different centers, you move them around and send them out to different places. The first forklift would be really valuable--one person can do a lot. But the 30th forklift doesn't help as much, maybe one is sitting on the side held in reserve. That's diminishing returns. If you try to grow just by adding physical capital, you do run into diminishing returns. Soviet Union tried this. Grew for a bit because they'd started out short on capital, but soon hit diminishing returns. Have to have new ideas. To maintain a given percentage rate of growth you've got to discover more new things per year. Looks like as we learn more it's getting easier to discover new things, knowledge is building on itself. Newton said he can see farther because he is standing on the shoulders of giants. But it's not quite getting easier enough to maintain a constant rate of growth. What we've done is train people to discover more. More people worldwide total and in the U.S. Knowledge builds on knowledge, plus more people doing it--two things together are both needed to maintain growth rate.
18:08Investment in human capital, the discovery process. You don't eat all your seeds, you put some aside for tomorrow. A hundred years ago people would have worried about destroying jobs in agriculture because it used to be 40% of population. Instead we've educated their children, freeing up human resources to engage in this discovery activity. Can even listen to podcasts! Meta-ideas. How did we get more and more people pitching in on discovery? Some just from population growth. Most important part from changes in institutions--universities, patent laws, research grants create incentives to engage in creating more discovery. Meta-idea helps in creation of more ideas. Land-grant universities focused on practical activities rather than Greek manuscripts. Football team at Purdue still called the boiler-makers, from railroads. Have other countries copied that or other U.S. meta-ideas? In the U.S. we did a few things that were complimentary: committed heavily to institutions of learning and discovery, but also to the market, competition, free enterprise. Interaction, science. Many countries have copied the education institutions but have been slower to commit to the market. Cuba--great educational system, U.S.S.R. had great scientific institutes, Lysenkoism--but spent time on the wrong things. In U.S.S.R. building good MiGs had to compete with building good refrigerators. U.S. has a tolerance for change. Security over dynamism valued in Europe? "Everybody's in favor of growth but nobody wants change." France in 1970s and '80s: "How could you possibly have many different phone companies? How could people decide? The government has to run it!" Now we can see the power of multiple phone companies through cell phones.
27:30What are the policy implications for both the U.S. and for poorer countries? Institutions, role in fostering ideas. Incentives matter. What was missing was a simple economic theory to describe the process. Endogenous growth theory. Ideas differ in a fundamental way from scarce resources like iron ore. With iron ore, can rely on Smith result: one price can serve two jobs. It can motivate the production of the good and allocate the good, who should get it. Ethanol is another example. (In fact we don't use the price system for ethanol.) Doesn't work with ideas. Oral rehydration therapy example: For children with severe diarrhea, if you just give them water or water with salt they still die, but just mix in a little glucose and it solves the problem, saves millions of lives. Simple idea, formula. What's the right price for a discovery like that? Society should be willing to pay a lot to save so many lives. But what's the right price for deciding who gets to use it? Should be zero once it's discovered. Not like a pasture, no tragedy of the commons, no tragedy of the intellectual commons, for using the idea (not talking about using the glucose here, just about using the idea). Some ideas we might want to treat as public goods, giving the idea away for free once it's discovered. Very different from market, with notion of property right. With an idea, science, opposite. We will reward you for coming up with an idea and giving it away. Policy question: Where do most of the ideas lie? More like the market or more like science, strong vs. weak property rights? U.S. has a healthy middle point, some property rights, patents, copyrights, some secrecy, but not permanent. "Endogenous Technological Change," rivalrous goods, impossible to make a living selling something once idea gets out. Suppose there is no institution requiring me to reveal the secret of oral rehydration and I keep it secret, selling the product at a high price. Other institutions might spring up, redistributing income to the poor who are being charged a lot for the product. Isn't that the source of the tension? Forklifts, cross-docking: Wal-mart, docks on both sides of building increases efficiency. Idea can be copied, but little details are hard to copy. Information leaks out over time. Wal-mart has to discover the next new things. Secrecy is like a patent with a finite life. Coke, Pepsi.
39:44Controversy: Some people argue that we need to extend patents, give more incentive to create ideas, more monopoly rights. Others argue that's a mistake and we should in fact get rid of patents, let the market evolve other methods to protect intellectual property. What do we know about this? Economists don't yet know the answer. We know a lot about how to structure competition in the world of physical objects, but less about the world of how best to get institutions to do incentives for ideas. Probably right solution is in between. Software, Microsoft example: Property rights solution covers Microsoft, but simultaneously open source software. Webserver software, Apache, is the winner open source; but property rights solution like Microsoft may be better for software that is easy to use. Apple, Steve Jobs, built on Linux but from end has property rights. No one-size fits all. Also: even if we give people strong property rights, say pharmaceuticals, still don't want to give someone blocking power that prevents innovation. People who say the right solution is to go to the extreme in giving property rights are probably wrong. Property rights for playing an A-minor chord would be too extreme. Great idea for land, but not for ideas. Political process: Mickey Mouse has a long life, Disney's protection of idea is not really a big loss for society. Can we be confident that the political process will pick the right mix? Universities, researchers get grants from public sources. Can create large lobbying efforts which may not represent the good of the nation as a whole. We are moving a little back toward the middle with patents, slightly narrower rights, so some restoring forces even within the political dynamic. Copyrights not as damaging.
49:01If you have weak property rights on discovery--say, letting patents expire quickly--we won't get enough discovery, value to society of discovering something new would be bigger than the value to that individual. Want to encourage more, but what meta-ideas would solve this? Can unleash strong lobby groups or find other ways. Reward students for going on in science and engineering, which fields are great for discovery process. We don't know what they'll do or discover, just let them go. Alternative ways to handle subsidizing ideas: grants to researchers tries to pick the discovery subjects. Music, science of music? Somebody has to draw a line saying this is science and this is not. Grants to professors vs. grants to students. In innovation it's great to free up the young people who have lots of freedom. Portable fellowships, students would vote with their feet. Hard to start a new university, education coupled with other things like lifestyle. Research grants, alumni giving, tuition: first limits entry. Graduate education especially is funded by the latter. MBA programs. Business schools model of how higher education should look, more funding by tuition. Business Week rankings of business schools, may have silly methodology but transparency shook up world of business schools. In physical world we get a ton of discovery even though the rewards aren't captured fully. There are still lots of incentives for discovery, curiosity, reputation. Doing okay. But imagine if we just turned up the dial a little bit. You don't want to strangle the golden goose. Better off with no subsidies at all than to subsidize the wrong things. Don't just want innovation. If you were to just rely on the non-market incentives of glory, fame, curiosity, how much innovation would you get and what types? Bob Lucas or Nancy Stokey: research grants to universities are not always the best. What if all music were developed on college campuses? Pretty awful music. Music industry: are incentives healthy or have they been damaged by Napster and uncontrolled web? How can new talent get heard? Web can encourage that, but record labels and radio stations have huge influence. Why doesn't iTunes just become a record label? Apple, iTunes succeeded because they have some property rights. Has put a premium on live music, can close the doors of the concert hall.
1:01:44Different causes of growth: roles of religion, cognitive ability, institutions. Is bottom line that they all enhance ideas? Cluster of institutions that influence production and distribution of new ideas. Religious systems, cultural norms, etc. Combine with flourishing market system. Wal-mart might have had an idea but still need people to build the doors. Institutions alongside of competition. May be many different paths. What is role of trade, particularly international trade? Two paths nations have used. China, Singapore have relied on foreign investment. Japan, South Korea tried to use domestic firms. Not a clear answer as to whether direct foreign investment is the best. Phenomenally effective for China, but some nations have done well without it. Are they finding ways to use state- of-the art-ideas. What doesn't work is like India 20 or 30 years ago: let car manufacturers come in but then throw up trade barriers. No incentive to improve cars. Critics of trade argue that multinationals exploit the workers of the host country. Nike. It's sad that people live lives worse than ours. But Nike helped people when they came in. The fact that they are still worse off than we are is not a sign that Nike is doing something wrong; it's just that they are starting off from a level that is much lower than we are. Unambiguously positive change brought in by Nike. Was it kindness or competition? Competition. China: investing firms let in ultimately had to compete for talent within the country, driving up wages paid by these companies in China. Are workers exploiting the knowledge that the multinational has. Nike's discovered a recipe for taking rubber and cloth, worth pennies, into something U.S. citizens will pay $100 for. Over time competition for workers to do the rearranging, bidding up wages paid to workers. Value created by Nike is taken away and redistributed to workers. Endogenous Technical Change": Human capital is more important than the size of the market. India and China, very large, you think they'd get all the benefits of trade internally. U.S. is a very large country, tempting to say that a large country doesn't need trade as much as a small country. Think about nonrivalrous goods like oral re-hydration therapy. Not just sunny climate versus rainy climate trading suitable goods, per Ricardian example. If we trade with entire world and take advantage of ideas discovered throughout world, we are more likely to come up with, say, a cure for Alzheimer's. Talking about the "threat" of 200 million software designers in India misses the boat. Different from usual rational for trade: gains from scale that don't max out. In fact get more benefits if the trading part is more like us. Californian pollution is however an example where that doesn't work. Or does it? Are you optimistic about the future? Yes. Started work in the 1970s, people were pessimistic, even predicting that our standard of living would collapse. Historical pattern is one of accelerating growth, not just sustained growth.

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COMMENTS (13 to date)
Floccina writes:

I have a few comments:

1. I have a very small quibble. It is possible that ethanol through corn or whatever could be the most efficient way to turn coal or say nuclear energy into liquid fuel even though it takes more energy to make the ethanol than the ethanol contains.

2 As one who has home schooled my children for a while I have great doubts about the value of government schooling. Also the Thomas Edisons and Michael Faradays and my grand parents make me question the value of government schooling there are real costs to schooling apart from the cash that pays for it.

3. Is it not possible that the land grant universities just squeezed out private innovation.

Floccina writes:

PS I should have made it clear that think that the ethanol subsidy is really bad and ridiculous and that ethanol is very far from being the most efficient way to turn coal into liquid fuel. I just wanted to explain that it would not be impossible for the market put more energy into making a fuel than that fuel contained if the output fuel had some other characteristic that made it more desirable than the energy source.

BTW On Schooling can I request that you have Richard Vedder on the show?

Richard Sprague writes:

re: France in the 70's and 80's wondering how people could decide which competing phone company...

How come Europe and Asia have so much more innovation in mobile phone technology today, when those markets are relatively more regulated? Are there some products that thrive when there are actually FEWER choices and LESS competition? because it allows people to gain a valuable benefit (e.g. phone service) without worrying about which of a zillion phone plans to buy.

PlayDumb writes:

In reply to Richard Sprague,

Having lived in India, Thailand and UK over the last 15 years, here's my take on why Asia/Europe have more mobile innovation.

Landline telephony WAS/IS more regulated in those places but mobile is much less so. In fact mobile technology and innovation spread faster in the most landline regulated telecom countries because (all costs considered, specially the time cost), mobile was cheaper. In effect mobile acted as a competitor to the (regulated, nee monopolized in many cases) landline. And yes, even mobile was regulated but by then market forces and the beneficiaries - most people - ensured it was minimal. Now many can't remember why landline was regulated in the first place. 'National security' is cited as the most common reason by the flustered bureaucrats.

PlayDumb

Per Kurowski writes:

I found the discussion around the public policy issues of the intellectual property rights extremely balanced and interesting. I missed though the angle of the costs of defending the IPRs and that are not borne by the owners of the IPRs but by the society as a whole, not only in terms of dollars but also in terms of providing a growth opportunity for those who thrive in the world of the illicit.

The society awards IPRs and backs their enforcement and there is nothing wrong with that. Nonetheless society has done very little about controls and regulations that would assure it that those monopolistic IPRs are not then unduly exploited. Sometimes it would seem that society has outsourced part of the regulations to pirates who by doing their dirty unlawful job manage at least to impose some control on the excesses. What would the cost of a CD be today were it not for the pirates?

Per Kurowski writes:

On the issue of “Investment in human capital, the discovery process. You don't eat all your seeds, you put some aside for tomorrow…. committed heavily to institutions of learning and discovery, but also to the market, competition, free enterprise”, if there is another occasion, it would be great to ask Paul Romer who seems to have though about this a lot, whether all higher education should not be more of joint ventures with their students, and instead of charging tuition for all those “seeds” upfront they should have to wait for the results to see if they germinate, and using to that effect what has sometimes been labeled as human-capital contracts.

shayne writes:

Excellent podcast. Thank you.

A comment:
With regard to your intellectual property (IP) rights discussion, there are a few subtleties that want discussing in order to get a better idea of the problem.

The most prominent current problem is that IP legal protection is mis-applied to protecting the existing marketing/business models, rather than protecting the rights of the innovators as intended. This can be readily seen in both the examples of the music and software industries you discussed.

In the current music industry marketing/business model, the original artist/author (innovator) cedes most of their copyrights (and proceeds) to the recording company/publisher in return for compensation as a result of the success of that industry's/publisher's marketing/business model. The same applies to the Microsoft model of software development and distribution. The innovators (software designers, writers) cede their rights to the marketing/business models of Microsoft, et. al. - both through IP and employment agency law.

The result being that IP law, intended to incentivize and protect innovation and innovators, has most dominantly been mis-applied to protecting obsolete and inefficient business models, in many cases to the detriment of both innovators and society.

The iTunes model, developed by Apple is a case in point. Why did a computer company have to invent iTunes? Why didn't the recording industry invent this marketing device, applying new technologies to improve the nature of their product? Evidence suggests the recording industry was far more inclined to use IP law to preserve their pre-existing marketing/business models than to encourage, or even apply, innovation.

In addition to teaching graduate level management information systems and other management courses, I write software and consult on IT systems. Different models of software development (conventional [Microsoft], open source, etc.) get a great deal of discussion in my courses and in my consulting work. I believe in IP law, and the protections it is intended to provide for innovators, and I concur that protections such as these are critical institutions for economic incentives and growth. But using IP law to preserve and protect obsolete business models is a mis-application of the law and a severe warpage of its most positive economic purpose.

muirgeo writes:

Great pod-cast as always however I felt that the subject of quality of growth was not addressed. The recent census data is depressing considering how little of the growth went to the middle class. Yet other growth periods such as the 90's were even greater, less dependent on debt and more equitably distributed. What are the factors that result in the variability of "growth equity" and how would Libertarians characterize these two periods of growth?

Isaac Crawford writes:

I am always interested in growth economics, but this particular podcast seemed to assume an already well functioning economy. Living in Yemen for the past year has definitely had an impact on me. It seems to me that the places that need to grow the most have the economies in the worst shape. IP rights are a ways down the priority list here, things like trying to disarm the private armies has a slightly higher priority. Does anyone else feel like Romer's ideas are really interesting in places with a good handle on rule of law, but not of much help in the typical 3d world country?

Isaac Crawford
Blogging in Yemen
www.isaharr.com

Russ Roberts writes:

Isaac,

Hope you're well in Yemen. Nice to hear from you.

You might enjoy the Weingast podcast (http://www.econtalk.org/archives/2007/08/weingast_on_vio.html)

It deals with why some nations fail to reap the potential benefits from growth that Romer discusses.

Lab Rat writes:

I want to make a couple of comments from a computer geek's point of view:

First is a somewhat minor correction: Apple's new version of Mac OS is not based on Linux, but rather a separate Unix platform known as BSD.

Second, he discussion of proprietary versus open-source centered around strong IP versus weak IP, ending with a recognition that a balance of these two extremes was probably the most efficient position.

The original open source projects, coming from academic and science-oriented communities, used an extremely permissive license which stated that one could use the source code in any way one wished, provided that the copyright notice was preserved. The most common way commercial entities interact with this license is to proprietize the source code, keeping changes in-house. As such, the success of these projects is not dependent on any sort of IP protection.

However, recent open-source projects tend to use more restrictive licenses. The common feature of these licenses is an insistence that any changes an entity makes to the source should be contributed back to the community. They are in fact dependent on the existence of strong IP, or rather strong copyright, which serves as an enforcement mechanism. I view this as tending more towards the balanced, rather than the extreme weak-IP, position.

Thank you for the hard work you put into these podcasts, Russ. You are an effective host, keeping the conversations smooth and productive, and you display an impressive familiarity with each guest's work.

vchoi writes:

just like to say thank you for this incredible site.

mulp writes:

Flippant comment: who has time to sit around listening to econtalk?

You need to thank the Chinese striving to catchup for being willing to work harder for lower wages so the government will buy gasoline high and sell low out of the trade surpluses from exporting more to the US than they import. No way would I risk a $400 iPod in the woods while I cut firewood, but a $25 mp3 player wouldn't be a disaster if I crushed it.

Less flippant, isn't government handouts a big factor in growth? For example, one of the big handouts in the US was the government taking land from its owners and then giving it to the immigrants and others for a really low price if they made an investment in the land that demonstrated some commitment. This was also used to create the incentive to invest in canals and railroads and telegraph: free land for the path plus plots of free land all long the route. And if you sought out minerals like gold and silver, you got almost free land from the government. And all the old growth forest products come from the government as prices that are a fraction of what private owners would need to earn to justify growing old growth forests for their products.

By the way, a much better example of diminishing returns is oil production in Texas. Government policy encouraged drilling more oil wells to increase production of oil, and I remember Milton Friedman railing against the oil depletion allowance leading to the concrete ingredient depletion allowances leading to the sand depletion allowances. Data is hard to come by, but my estimate is that the US drilled about two million oil and gas wells in a quarter century seeking to gain the reward of that government policy.

Energy production is clearly an example of diminishing returns over the long term. Each decade the cost of finding and exploiting the available stored energy resources has increased in cost - whether trees, peat, coal, oil, gas, water flows, and even the renewable energy resources like solar heating and solar crop production.

Price has seldom reflected the cost of energy, but low energy prices have clearly been spurs to growth. China has a lower energy prices than the US and I suspect that if the price of energy in the US reduced by government action to match that in China, growth in the US would increase.

[I haven't listened to the entire podcast yet, so my comments might be inconsistent with the later 40 minutes.]

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