How innovation increases wellbeing
The American economist Paul Romer showed how new discoveries create a virtuous cycle of growth
The 2018 economics Nobel prize went to Paul Romer and William Nordhaus, an extremely deserving pair of economists. In addition to honoring two scholars whose contributions have deeply influenced their field, the award points to a crucially important issue that the world is beginning to give short shrift — economic growth.
That’s bad news. Of course, it’s good for people in the US, France or Japan to have higher living standards. But rich-country growth is also crucial for poorer nations.
When they’re growing faster, rich countries have more purchasing power with which to buy poor countries’ products.
Even more importantly, richcountry growth means that the living standards of people in places like India or Vietnam can rise without threatening the livelihoods of the middle classes in developed nations. Growth is what allows the world economy to avoid the kind of zerosum game in which beggaring one’s neighbor is the only way to improve a nation’s material wellbeing.
So why are rich countries growing so slowly? Part of it is due to the lingering effects of the Great Recession, but part is due to a slowdown in the rate of productivity growth.
Productivity is any economy’s long-term underlying engine of growth: Once you put all of a country’s people to work and provide them with as much capital equipment as they can use, further growth depends on the efficiency with which they can create goods and services — i.e., on productivity.
In poor countries, productivity can be increased relatively rapidly, by copying foreign technologies and ways of doing business. But for an industrialised nation, further gains must come from hard-won improvements in technology, business methods or government policy. In the long run, technology is the driver — even the most well-run country in 1920 wouldn’t be particularly rich by modern standards, due to all the innovation that has happened since then.
The invention of automobiles, televisions, and other consumer technologies is only part of the story; improvements in production processes, materials and IT allow products to be made more cheaply and better than before.
The problem is that no one really knows how to increase the rate of technology growth. Some freemarketers are hopeful that simply getting governments out of the way of innovation will do the trick. Others think that fiscal and monetary stimulus can induce companies to spend more on upgrading their technology to meet the needs of a boom.
But the global uniformity of the productivity slowdown, despite differences in regulatory systems and stimulus policies across various developed countries, means that we
should temper our expectations for these measures.
There is, however, a third option — spend more money on research. This is where Romer’s work comes in. In a pair of famous papers, the first in 1986 and the second in 1990, Romer laid out a mathematical model in which research spending generates new ideas, leading to economic growth, which provides the resources for yet more research spending, generating a virtuous cycle.
Testing these mathematical models is very difficult. But there are plenty of success stories in which government funding has helped give birth to transformative technologies, especially in the US.
Nuclear power, hydraulic fracturing, the internet, globalpositioning systems, mobile phones, and lithium-ion batteries are just a few examples.
Many of these advances have come via special-purpose initiatives like the Department of Defense’s DARPA, while many others come from government funding of basic research at universities and national laboratories. Reading the history of these successes is like watching Romer’s math take physical form.
Technology is also the key to combining economic growth with environmental sustainability.
Nordhaus, the co-winner of the Nobel mainly for modeling the economic impact of climate change, has argued that ensuring the longterm sustainability of industrialised economies requires finding evermore efficient ways to use the planet’s resources, largely through improvements in environmental technology.
In recent years, however, the US has dropped the ball when it comes to research spending. Federal research spending as a percentage of gross domestic product has fallen.
Since 2010, the trend has gotten worse, with spending falling outright.
Meanwhile, the US as a whole, including private companies, spends less of its output on research than Germany, Japan or South Korea.
This is exactly the wrong direction for the country. As growth slows and productivity stagnates in the rich world, Romer’s insights are more important than ever.
For the world to avoid stagnation and zero-sum thinking, continue uplifting the global poor and improve environmental sustainability, the US government must spend more, not less, on the technologies of tomorrow.
Nobel economics prizewinner Paul Romer.