Another thing about endogenous growth models – particularly Romer’s one – that always seemed lacking to me was their ability to account for some of the key scientific / technological developments that have been foundational to long run economic growth.
On the Romer model, technology (or “ideas”) is modelled as having similar characteristics to that of a public good: non-rivalry and non-excludability. Following Micro 101 reasoning, the positive externalities associated with public goods lead to under-provision; and thus, in the absence of market intervention, we should expect a suboptimal amount of technological innovation to take place. The intuition behind this result is straightforward: in perfectly competitive markets, factor inputs are paid their marginal products, which exhaust total output, thereby leaving no rents to reward technological innovation. Under perfect competition firms must price goods at marginal cost, and because technological development is usually a fixed cost, there is no economic incentive to innovate: there is no prospect that a firm which does so will be compensated for the fixed cost that it's sunk into R&D. This leaves a role for government intervention to ensure that firms that engage in technological development can secure rents on their investment – typically, through the assignment of property rights or the provision of subsidies / tax breaks to firms engaged in R&D.
Increasing returns to scale and the non-excludability of technological innovation are, however, not the only sources of market failure in a setting of perfect competition. Another, and it would seem to me more salient, source of market failure is radically incomplete information. Assigning property rights to technological developments will raise innovation only if prospective innovators perceive the rents those rights would allow them to capture. However, in the case of groundbreaking technological developments such as the discovery of calculus or the development of the internet, this would require anticipating all the markets and surplus that those innovations created. Ex ante, this is impossible. Therefore, assigning property rights (or trying to internalise rents generally) will not be sufficient to increase the amount of technological innovation. Innovators need not only the possibility of rents but also the ability to discern them. If this is the case, then I don’t see how Romer’s model – and endogenous growth models more generally – can suffice to explain the long run economic growth we’ve observed over recent centuries.
My basic point is that, in the case of groundbreaking technological developments, prospective innovators cannot discern the potential rents of their discoveries; therefore, incentive schemes based on increasing the size of these rents will not have a significant impact on their R&D decisions.
Maybe this is pedantic but this is kind of inaccurate (or maybe just unclear):
"The share of output to each factor is determined by the exponents multiplying them. If Cobb-Douglas, these exponents add up to one, and thus the share to each is equivalent to their share of one. (...) Thus, we can represent changes in technology as a change in a scalar A, which multiplies labor alone."
"Add up to one" is constant returns to scale, not necessarily CD. You can have CD with decreasing, constant or increasing R2S. You can have not-CD where shares add up to one. And if you do just assume CD then it doesnt matter what A multiplies, its all three types of neutral progress simultaneously; Harrod, Hicks and Solos.
Similarly, "ideas get harder to discover" and "diminishing returns to researchers" are two different phenomena. And even if you have them you dont really converge to Solow model (unless you have 0 pop growth so you run out of extra researchers) except that in steady state growth rate is constant (but not exogenous!)
You are correct. I was defining Cobb-Douglas too narrowly. However, constant returns to scale is by far the most common version.
“Are ideas getting harder to find” is, as the authors admit, another way of asking “is exponential growth getting harder to maintain?” I think they’re very similar. And yes, I was imprecise. It is not a steady state, but rather exogenously determined.
"One of the main tasks of macroeconomists is to forecast the future economy."
No. That's the job of every stock buyer/seller, businessman and consumer.
The macro or micro _economist's_ job is to make forecasts conditional on policy.
Another thing about endogenous growth models – particularly Romer’s one – that always seemed lacking to me was their ability to account for some of the key scientific / technological developments that have been foundational to long run economic growth.
On the Romer model, technology (or “ideas”) is modelled as having similar characteristics to that of a public good: non-rivalry and non-excludability. Following Micro 101 reasoning, the positive externalities associated with public goods lead to under-provision; and thus, in the absence of market intervention, we should expect a suboptimal amount of technological innovation to take place. The intuition behind this result is straightforward: in perfectly competitive markets, factor inputs are paid their marginal products, which exhaust total output, thereby leaving no rents to reward technological innovation. Under perfect competition firms must price goods at marginal cost, and because technological development is usually a fixed cost, there is no economic incentive to innovate: there is no prospect that a firm which does so will be compensated for the fixed cost that it's sunk into R&D. This leaves a role for government intervention to ensure that firms that engage in technological development can secure rents on their investment – typically, through the assignment of property rights or the provision of subsidies / tax breaks to firms engaged in R&D.
Increasing returns to scale and the non-excludability of technological innovation are, however, not the only sources of market failure in a setting of perfect competition. Another, and it would seem to me more salient, source of market failure is radically incomplete information. Assigning property rights to technological developments will raise innovation only if prospective innovators perceive the rents those rights would allow them to capture. However, in the case of groundbreaking technological developments such as the discovery of calculus or the development of the internet, this would require anticipating all the markets and surplus that those innovations created. Ex ante, this is impossible. Therefore, assigning property rights (or trying to internalise rents generally) will not be sufficient to increase the amount of technological innovation. Innovators need not only the possibility of rents but also the ability to discern them. If this is the case, then I don’t see how Romer’s model – and endogenous growth models more generally – can suffice to explain the long run economic growth we’ve observed over recent centuries.
My basic point is that, in the case of groundbreaking technological developments, prospective innovators cannot discern the potential rents of their discoveries; therefore, incentive schemes based on increasing the size of these rents will not have a significant impact on their R&D decisions.
Curious to hear your thoughts!
@Nicholasdecker
Maybe this is pedantic but this is kind of inaccurate (or maybe just unclear):
"The share of output to each factor is determined by the exponents multiplying them. If Cobb-Douglas, these exponents add up to one, and thus the share to each is equivalent to their share of one. (...) Thus, we can represent changes in technology as a change in a scalar A, which multiplies labor alone."
"Add up to one" is constant returns to scale, not necessarily CD. You can have CD with decreasing, constant or increasing R2S. You can have not-CD where shares add up to one. And if you do just assume CD then it doesnt matter what A multiplies, its all three types of neutral progress simultaneously; Harrod, Hicks and Solos.
Similarly, "ideas get harder to discover" and "diminishing returns to researchers" are two different phenomena. And even if you have them you dont really converge to Solow model (unless you have 0 pop growth so you run out of extra researchers) except that in steady state growth rate is constant (but not exogenous!)
You are correct. I was defining Cobb-Douglas too narrowly. However, constant returns to scale is by far the most common version.
“Are ideas getting harder to find” is, as the authors admit, another way of asking “is exponential growth getting harder to maintain?” I think they’re very similar. And yes, I was imprecise. It is not a steady state, but rather exogenously determined.