The evidence about growth that economists have long taken for granted
and that poses a challenge for growth theorists can be distilled to five basic
facts.
Fact #I: There are many firms in a market economy. The fact is so obvious that
we often do not bother to state it, but it clearly will not do to have a model in
which there are overwhelming forces that tend to concentrate all output in the
hands of a single, economy-wide monopolist.
Fact #2: Discoveries dzfer from other inputs in the sense that many people can use
them at the same tzme. The idea behind the transistor, the principles behind
internal combustion, the organizational structure of a modern corporation, the
concepts of double entry bookkeeping-all these pieces of information and
many more like them have the property that it is technologically possible for
everybody and every firm to make use of them at the same time. In the
language of public finance, ordinary goods are rival goods, but information is
nonrival.
Fact #3: It zs possible to replzcate physical actzvities. Replication implies that
the aggregate production function representing a competitive market should
be characterized by homogeneity of degree one in all of its conventional (that is,
rival) inputs. If we represent output in the form Y = AF(K, H, L), then doubling
all three of K, H, and L should allow a doubling of output. There is no
need to double the nonrival inputs represented by A because the existing pieces
of information can be used in both instances of the productive activity at the
same time. (The assumption that the market is competitive means that the
existing activity already operates at the minimum efficient scale, so there are no
economies of scale from building a single plant that is twice as large as the
existing one.)
If farming were the relevant activity instead of manufacturing, we would
clearly need to include land as an input in production, and in the economy as a
whole, it is not possible to double the stock of land. This does not change the
fundamental implication of the replication argument. If aggregate output is
homogeneous of degree 1 in the rival inputs and firms are price takers, Euler's
theorem implies that the compensation paid to the rival inputs must exactly
equal the value of output produced. This fact is part of what makes the
neoclassical model so simple and makes growth accounting work. The only
problem is that this leaves nothing to compensate any inputs that were used to
produce the discoveries that lead to increases in A.
Fact #4: Technologzcal advance comes,from things that people do. No economist,
so far as I know, has ever been willing to make a serious defense of the
proposition that technological change is literally a function of elapsed calendar
time. Being explicit about the issues here is important nevertheless, because it
can help untangle a link that is sometimes made between exogeneity and
randomness. If I am prospecting for gold or looking for a change in the DNA
of a bacterium that will let it eat the oil from an oil spill, success for me will be
dominated by chance. Discovery will seem to be an exogenous event in the
Paul M. Romer 13
sense that forces outside of my control seem to determine whether I succeed.
But the aggregate rate of discovery is endogenous. When more people start
prospecting for gold or experimenting with bacteria, more valuable discoveries
will be found. This will be true even if discoveries are accidental side effects of
some other activity (finding gold as a side effect of ditch-digging) or if market
incentives play no role in encouraging the activity (as when discoveries about
basic molecular biology were induced by government research grants). The
aggregate rate of discovery is still determined by things that people do.