romer 1990 with conclusion
Growth in this model is driven by technological change that arises from intentional investment decisions made by profit-maximizing agents. The distinguishing feature of the technology as an input is that it is neither a conventional good nor a public good; it is a nonrival, partially excludable good. Because of the nonconvexity introduced by a nonrival good, price-taking competition cannot be supported. Instead, the equilibrium is one with monopolistic competition. The main conclusions are that the stock of human capital determines the rate of growth, that too little human capital is devoted to research in equilibrium, that integration into world markets will increase growth rates, and that having a large population is not sufficient to generate growth.
Introduction Output per hour worked in the United States today is 10 times as valuable as output per hour worked 100 years ago (Maddison 1982). In the 1950s, economists attributed almost all the change in output per hour worked to technological change (Abramovitz 1956; Kendrick 1956; Solow 1957). Subsequent analysis raised our estimates of the importance of increases in the effective labor force and the effective stock of capital in generating growth in output per worker (Jorgenson, Gollop, and Fraumeni 1987), but technological change has surely been important as well. The raw materials that we use have not changed, but as a result of trial and error, experimentation, refinement, and scientific investigation, the instructions that we follow for combining raw materials have become vastly more sophisticated. One hundred years ago, all we could do to get visual stimulation from iron oxide was to use it as a pigment. Now we put it on plastic tape and use it to make videocassette recordings. The argument presented in this paper is based on three premises. The first is that technological change-improvement in the instructions for mixing together raw materials-lies at the heart of economic growth. As a result, the model presented here resembles the Solow (1956) model with technological change. Technological change provides the incentive for continued capital accumulation, and together, capital accumulation and technological change account for much of the increase in output per hour worked. The second premise is that technological change arises in large part because of intentional actions taken by people who respond to market incentives. Thus the model is one of endogenous rather than exogenous technological change. This does not mean that everyone who contributes to technological change is motivated by market incentives. An academic scientist who is supported by government grants may be totally insulated from them. The premise here is that market incentives nonetheless play an essential role in the process whereby new knowledge is translated into goods with practical value. Our initial understanding of electromagnetism arose from research conducted in academic institutions, but magnetic tape and home videocassette recorders resulted from attempts by private firms to earn a profit. The third and most fundamental premise is that instructions for working with raw materials are inherently different from other economic goods. Once the cost of creating a new set of instructions has been incurred, the instructions can be used over and over again at no additional cost. Developing new and better instructions is equivalent to incurring a fixed cost. This property is taken to be the defining characteristic of technology. Most models of aggregate growth, even those with spillovers or external effects, rely on price-taking behavior. But once these three premises are granted, it follows directly that an equilibrium with price taking cannot be supported. Section I1 of the paper starts by showing why this is so. It also indicates which of the premises is dropped in growth models that do depend on price-taking behavior. The argument in this section is fundamental to the motivation for the particular model of monopolistic competition that follows, but it is more general than the model itself. In the specific model outlined in Section 111, a firm incurs fixed design or research and development costs when it creates a new good. It recovers those costs by selling the new good for a price that is higher than its constant cost of production. Since there is free entry into this activity, firms earn zero profit in a present value sense. The conclusions of the model follow directly from this specification. On the basis of results from the static theory of trade with differentiated goods (see, e.g., Helpman and Krugman 1985),one should expect that fixed costs lead to gains from increases in the size of the market and therefore to gains from trade between different countries. Perhaps the most interesting feature of the equilibrium calculated for the model constructed here is that increases in the size of the market have effects not only on the level of income and welfare but also on the rate of growth. Larger markets induce more research and faster growth. The analysis also suggests why population is not the right measure of market size and why the presence of a large domestic market in countries such as China or India is not a substitute for trade with the rest of the world. The growth rate is increasing in the stock of human capital, but it does not depend on the total size of the labor force or the population. In a limiting case that may be relevant for historical analysis and for the poorest countries today, if the stock of human capital is too low, growth may not take place at all. These implications of the model are taken up briefly in the final sections of the paper. Section I11 describes the functional forms that are used to describe the preferences and the technology for the model. It defines an equilibrium that allows for both monopolistic competition and external effects arising from knowledge spillovers. Section IV offers a brief intuitive description of a balanced growth equilibrium for the model. Section V formally characterizes the equilibrium. Section VI describes the welfare properties of the equilibrium. Section VII discusses the connection implied by the model between trade, research, and growth. Algebraic details of the derivations are placed in the Appendix.
Conclusion
The model presented here is essentially the one-sector neoclassical model with technological change, augmented to give an endogenous explanation of the source of the technological change. The most robust welfare conclusion from the model is that because research projects exchange current costs for a stream of benefits in the future, the rate of technological change is sensitive to the rate of interest. Although all the research is embodied in capital goods, a subsidy to physical capital accumulation may be a very poor substitute for direct subsidies that increase the incentive to undertake research. In the absence of feasible policies that can remove the divergence between the social and private returns to research, a second-best policy would be to subsidize the accumulation of total human capital. The most interesting positive implication of the model is that an economy with a larger total stock of human capital will experience faster growth. This finding suggests that free international trade can act to speed up growth. It also suggests a way to understand what it is about developed economies in the twentieth century that permitted rates of growth of income per capita that are unprecedented in human history. The model also suggests that low levels of human capital may help explain why growth is not observed in underdeveloped economies that are closed and why a less developed economy with a very large population can still benefit from economic integration with the rest of the world.
Introduction Output per hour worked in the United States today is 10 times as valuable as output per hour worked 100 years ago (Maddison 1982). In the 1950s, economists attributed almost all the change in output per hour worked to technological change (Abramovitz 1956; Kendrick 1956; Solow 1957). Subsequent analysis raised our estimates of the importance of increases in the effective labor force and the effective stock of capital in generating growth in output per worker (Jorgenson, Gollop, and Fraumeni 1987), but technological change has surely been important as well. The raw materials that we use have not changed, but as a result of trial and error, experimentation, refinement, and scientific investigation, the instructions that we follow for combining raw materials have become vastly more sophisticated. One hundred years ago, all we could do to get visual stimulation from iron oxide was to use it as a pigment. Now we put it on plastic tape and use it to make videocassette recordings. The argument presented in this paper is based on three premises. The first is that technological change-improvement in the instructions for mixing together raw materials-lies at the heart of economic growth. As a result, the model presented here resembles the Solow (1956) model with technological change. Technological change provides the incentive for continued capital accumulation, and together, capital accumulation and technological change account for much of the increase in output per hour worked. The second premise is that technological change arises in large part because of intentional actions taken by people who respond to market incentives. Thus the model is one of endogenous rather than exogenous technological change. This does not mean that everyone who contributes to technological change is motivated by market incentives. An academic scientist who is supported by government grants may be totally insulated from them. The premise here is that market incentives nonetheless play an essential role in the process whereby new knowledge is translated into goods with practical value. Our initial understanding of electromagnetism arose from research conducted in academic institutions, but magnetic tape and home videocassette recorders resulted from attempts by private firms to earn a profit. The third and most fundamental premise is that instructions for working with raw materials are inherently different from other economic goods. Once the cost of creating a new set of instructions has been incurred, the instructions can be used over and over again at no additional cost. Developing new and better instructions is equivalent to incurring a fixed cost. This property is taken to be the defining characteristic of technology. Most models of aggregate growth, even those with spillovers or external effects, rely on price-taking behavior. But once these three premises are granted, it follows directly that an equilibrium with price taking cannot be supported. Section I1 of the paper starts by showing why this is so. It also indicates which of the premises is dropped in growth models that do depend on price-taking behavior. The argument in this section is fundamental to the motivation for the particular model of monopolistic competition that follows, but it is more general than the model itself. In the specific model outlined in Section 111, a firm incurs fixed design or research and development costs when it creates a new good. It recovers those costs by selling the new good for a price that is higher than its constant cost of production. Since there is free entry into this activity, firms earn zero profit in a present value sense. The conclusions of the model follow directly from this specification. On the basis of results from the static theory of trade with differentiated goods (see, e.g., Helpman and Krugman 1985),one should expect that fixed costs lead to gains from increases in the size of the market and therefore to gains from trade between different countries. Perhaps the most interesting feature of the equilibrium calculated for the model constructed here is that increases in the size of the market have effects not only on the level of income and welfare but also on the rate of growth. Larger markets induce more research and faster growth. The analysis also suggests why population is not the right measure of market size and why the presence of a large domestic market in countries such as China or India is not a substitute for trade with the rest of the world. The growth rate is increasing in the stock of human capital, but it does not depend on the total size of the labor force or the population. In a limiting case that may be relevant for historical analysis and for the poorest countries today, if the stock of human capital is too low, growth may not take place at all. These implications of the model are taken up briefly in the final sections of the paper. Section I11 describes the functional forms that are used to describe the preferences and the technology for the model. It defines an equilibrium that allows for both monopolistic competition and external effects arising from knowledge spillovers. Section IV offers a brief intuitive description of a balanced growth equilibrium for the model. Section V formally characterizes the equilibrium. Section VI describes the welfare properties of the equilibrium. Section VII discusses the connection implied by the model between trade, research, and growth. Algebraic details of the derivations are placed in the Appendix.
Conclusion
The model presented here is essentially the one-sector neoclassical model with technological change, augmented to give an endogenous explanation of the source of the technological change. The most robust welfare conclusion from the model is that because research projects exchange current costs for a stream of benefits in the future, the rate of technological change is sensitive to the rate of interest. Although all the research is embodied in capital goods, a subsidy to physical capital accumulation may be a very poor substitute for direct subsidies that increase the incentive to undertake research. In the absence of feasible policies that can remove the divergence between the social and private returns to research, a second-best policy would be to subsidize the accumulation of total human capital. The most interesting positive implication of the model is that an economy with a larger total stock of human capital will experience faster growth. This finding suggests that free international trade can act to speed up growth. It also suggests a way to understand what it is about developed economies in the twentieth century that permitted rates of growth of income per capita that are unprecedented in human history. The model also suggests that low levels of human capital may help explain why growth is not observed in underdeveloped economies that are closed and why a less developed economy with a very large population can still benefit from economic integration with the rest of the world.
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