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Monday, November 2, 2009
Tuesday, October 27, 2009
A Theory of Growth
Earlier this year well known growth economist Paul Romer, in a lecture titled ‘A Theory of History, With Application’, attempted to explain trends in economic growth throughout history. Technology and rules, according Romer, have been the two drivers of economic growth.
Technologies are recipes that enable economies to use resources more productively. More importantly, a new technology is likely to cause a redistribution of both demand and supply of resources leading to creation of new markets while eliminating others. Think how the Green Revolution rubbished concerns of the Malthusian trap! The uniqueness of technology as compared to other material resources is its non-rival nature. In fact more widespread the use of technology the greater the benefits of having technology, technically called increasing returns to scale. Greater use of technology, in turn, leads to an accelerated pace of innovation. Isaac Newton once wrote ‘If I have seen a little further it is by standing on the shoulders of giants’. A more contemporary example is the rise in market share of the open-source internet browser Firefox challenging Internet Explorer. Open-source has allowed developers around the world to improvise upon the work of other developers to create a far more robust browser.
China, with inventions like the decimal system, silk, paper, compass and many more, was at the forefront of technology until about 1000 AD. However, since then the gap between China’s income per capita and that of the world leader of the day has only been widening for the worse. Thus, there is more to growth than just superiority in technology. This is where, Romer says, rules come into play. Introduction of patent laws or laws protecting private ownership of property, for example, has aided innovation and enterprise respectively. Rules typically structure the interaction between innovators (viz. researchers, entrepreneurs) and the rest of the society which benefits from them.
I believe innovation, whether scientific or for that matter financial, is best left to the market. Two reasons: First, the customer orientation of markets encourages it to invest in technologies that are viable. Second, markets presuppose competition, which, I think, helps to enhance the rate of innovation. Governments cannot be expected to display either of the characteristics.
Markets serve their buyer and sellers and can be expected to ensure welfare of both. However, markets fail to ensure the well-being of those who are not part of the market. That may not have been such a problem, but what is of concern is markets might impose a cost on non-participants, i.e. negative externalities. For example: industries polluting river used for fishing. Another shortcoming of the market is that it under provides for markets with positive externalities. For example: the rate of innovation was abysmally lower before the introduction of patent laws and shot up dramatically thereafter. In my opinion, markets are not capable of forming rules and enforcing them, it takes away from their primary objective of serving the market and innovating.
Technologies are recipes that enable economies to use resources more productively. More importantly, a new technology is likely to cause a redistribution of both demand and supply of resources leading to creation of new markets while eliminating others. Think how the Green Revolution rubbished concerns of the Malthusian trap! The uniqueness of technology as compared to other material resources is its non-rival nature. In fact more widespread the use of technology the greater the benefits of having technology, technically called increasing returns to scale. Greater use of technology, in turn, leads to an accelerated pace of innovation. Isaac Newton once wrote ‘If I have seen a little further it is by standing on the shoulders of giants’. A more contemporary example is the rise in market share of the open-source internet browser Firefox challenging Internet Explorer. Open-source has allowed developers around the world to improvise upon the work of other developers to create a far more robust browser.
China, with inventions like the decimal system, silk, paper, compass and many more, was at the forefront of technology until about 1000 AD. However, since then the gap between China’s income per capita and that of the world leader of the day has only been widening for the worse. Thus, there is more to growth than just superiority in technology. This is where, Romer says, rules come into play. Introduction of patent laws or laws protecting private ownership of property, for example, has aided innovation and enterprise respectively. Rules typically structure the interaction between innovators (viz. researchers, entrepreneurs) and the rest of the society which benefits from them.
I believe innovation, whether scientific or for that matter financial, is best left to the market. Two reasons: First, the customer orientation of markets encourages it to invest in technologies that are viable. Second, markets presuppose competition, which, I think, helps to enhance the rate of innovation. Governments cannot be expected to display either of the characteristics.
Markets serve their buyer and sellers and can be expected to ensure welfare of both. However, markets fail to ensure the well-being of those who are not part of the market. That may not have been such a problem, but what is of concern is markets might impose a cost on non-participants, i.e. negative externalities. For example: industries polluting river used for fishing. Another shortcoming of the market is that it under provides for markets with positive externalities. For example: the rate of innovation was abysmally lower before the introduction of patent laws and shot up dramatically thereafter. In my opinion, markets are not capable of forming rules and enforcing them, it takes away from their primary objective of serving the market and innovating.
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