At last — Paul Romer got his ‘Nobel prize’​

8 October, 2018 at 14:29 | Posted in Economics | 10 Comments

Among Swedish economists, Paul Romer has for many years been the favourite candidate for receiving the ‘Nobel Prize’ in economics. This year the prediction turned out right. Romer got the prize (together with William Nordhaus).

The ‘Nobel prize’ in economics has almost exclusively gone to mainstream economists, and most often to Chicago economists. So how refreshing it is that we for once have a winner who has been brave enough to openly criticize the ‘post-real’ things that emanate from the Chicago ivory tower!

Adam Smith once wrote that a really good explanation is “practically seamless.”

Is there any such theory within one of the most important fields of social sciences — economic growth?

Paul Romer‘s theory presented in Endogenous Technological Change (1990) – where knowledge is made the most important driving force of growth – is probably as close as we get.

Knowledge – or ideas – are according to Romer the locomotive of growth. But as Allyn Young, Piero Sraffa and others had shown already in the 1920s, knowledge is also something that has to do with increasing returns to scale and therefore not really compatible with neoclassical economics with its emphasis on decreasing returns to scale.

Increasing returns generated by nonrivalry between ideas is simply not compatible with pure competition and the simplistic invisible hand dogma. That is probably also the reason why neoclassical economists have been so reluctant to embrace the theory whole-heartedly.

Neoclassical economics has tried to save itself by more or less substituting human capital for knowledge/ideas. But Romer’s pathbreaking ideas should not be confused with human capital. Although some have problems with the distinction between ideas and human capital in modern endogenous growth theory, this passage from Romer’s article The New Kaldor Facts: Ideas, Institutions, Population, and Human Capital gives a succinct and accessible account of the difference:

Of the three state variables​ that we endogenize, ideas have been the hardest to bring into the applied general equilibrium structure. The difficulty arises because of the defining characteristic of an idea, that it is a pure nonrival good. A given idea is not scarce in the same way that land or capital or other objects are scarce; instead, an idea can be used by any number of people simultaneously without congestion or depletion.

Because they are nonrival goods, ideas force two distinct changes in our thinking about growth, changes that are sometimes conflated but are logically distinct. Ideas introduce scale effects. They also change the feasible and optimal economic institutions. The institutional implications have attracted more attention but the scale effects are more important for understanding the big sweep of human history.

The distinction between rival and nonrival goods is easy to blur at the aggregate level but inescapable in any microeconomic setting. Picture, for example, a house that is under construction. The land on which it sits, capital in the form of a measuring tape, and the human capital of the carpenter are all rival goods. They can be used to build this house but not simultaneously any other. Contrast this with the Pythagorean Theorem, which the carpenter uses implicitly by constructing a triangle with sides in the proportions of 3, 4 and 5. This idea is nonrival. Every carpenter in the world can use it at the same time to create a right angle.

Of course, human capital and ideas are tightly linked in production and use. Just as capital produces output and forgone output can be used to produce capital, human capital produces ideas and ideas are used in the educational process to produce human capital. Yet ideas and human capital are fundamentally distinct. At the micro level, human capital in our triangle example literally consists of new connections between neurons in a carpenter’s head, a rival good. The 3-4-5 triangle is the nonrival idea. At the macro level, one cannot state the assertion that skill-biased technical change is increasing the demand for education without distinguishing between ideas and human capital.

Paul’s idea about ideas is well worth a ‘Nobel Prize.’ Congratulations Paul!

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10 Comments

  1. Somewhat shocking after his excellent tear down ‘The Trouble Macro.’ https://paulromer.net/wp-content/uploads/2016/09/WP-Trouble.pdf

  2. Working as a senior architect @ the Planning and building agency in Oslo, I heard of Romer’s ideas – the charter cities – ca. 10 years ago. For me it sounded like some kind of neo-colonialism project.
    In 2011, Oxfam thougt pessimistically about it, too.
    https://oxfamblogs.org/fp2p/honduras-builds-a-charter-city-this-is-never-going-to-work/
    In 2018, The Economist showed some negatively results. https://www.economist.com/the-americas/2017/08/12/honduras-experiments-with-charter-cities
    Ideas/knowledge as pull factor to cities in developing countries, which are established by countries, which export their laws to them? That’s nothing but cheap labour for colonies!

  3. Hej Lars, I fail to see why you are so enthusiastic about Romer. He throws an unobervable extra term for “ideas” into a growth equation, and we will live happily ever after. In fact, today’s news from the IPCC is that Romer-bliss is impossible. As it turns out, energy use (per unit of time) is proportional to real output (per unit of time), making CO2 emission proportional to output. Without major intervention,the growing atmospheric CO2 level will soon destroy all of Romer’s new ideas.

    • Thanks for your comment, Lance. I think one of the reasons I appreciate Paul is that he dares to be explicit in his critique of large parts of mainstream economics and name names:
      .
      “Some of the economists who agree about the state of macro in private conversations will not say so in public. This is consistent with the explanation based on different prices. Yet some of them also discourage me from disagreeing openly, which calls for some other explanation.”
      .
      “They may feel that they will pay a price too if they have to witness the unpleasant reaction that criticism of a revered leader provokes. There is no question that the emotions are intense. After I criticized a paper by Lucas, I had a chance encounter with someone who was so angry that at first he could not speak. Eventually, he told me, ‘You are killing Bob.’”
      .
      “But my sense is that the problem goes even deeper that avoidance. Several economists I know seem to have assimilated a norm that the post-real macroeconomists actively promote – that it is an extremely serious violation of some honor code for anyone to criticize openly a revered authority figure – and that neither facts that are false, nor predictions that are wrong, nor models that make no sense matter enough to worry about …”
      .
      “Science, and all the other research fields spawned by the enlightenment, survive by ‘turning the dial to zero’ on these innate moral senses. Members cultivate the conviction that nothing is sacred and that authority should always be challenged … By rejecting any reliance on central authority, the members of a research field can coordinate their independent efforts only by maintaining an unwavering commitment to the pursuit of truth, established imperfectly, via the rough consensus that emerges from many independent assessments of publicly disclosed facts and logic; assessments that are made by people who honor clearly stated disagreement, who accept their own fallibility, and relish the chance to subvert any claim of authority, not to mention any claim of infallibility.”
      .
      Everyone knows what he says is true, but few — especially within the mainstream establishment — have the courage to openly speak and write about it. That’s one reason I am sort of ‘enthusiastic’ about Paul.

      • Ok but basically he is a Chicago boy who tied TFPG (itself idiotic of course) to production by labor of “ideas” which in no way can be quantified. At least the older generation of Scandi economists from Hechscher down through Johansen tied decreasing costs to scale economies in production which can be measured in terms of power laws. Why you guys (e.g Sandbu in the FT) take Romer’s and the rest of endogenous growth’s metaphysics seriously is beyond me.

  4. Don’t neoliberals solve Romer’s nonrival goods by patenting ideas and restricting access to their use by law? Amazon’s one-click idea was obvious but it was turned into a rival good. It would be like charging carpenters for using the Pythagorean Theorem. I’m sure neoliberals will be doing that soon …

    • The Pythagorean Theorem can only truly be valued if it has a price on its use. Wouldn’t Hayek claim that? You can’t evaluate the real value of the Pythagorean Theorem unless it has a price attached …

  5. What is the story behind Romers idea of setting up enclaves in Sweden to “solve” the migrant crisis?

  6. […] Enfin – Paul Romer a obtenu son « prix Nobel » Lars P. Syll. UserFriendly: “Un peu choquant après son problème avec le document macro …. un de mes favoris. ” […]


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