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Knowledge and growth

from Lars Syll

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If you have an apple and I have an apple and we exchange these apples then you and I will each have one apple.

But if you have an idea and I have an idea and we exchange these ideas, then each of us will have two ideas.

George Bernard Shaw


Adam Smith once wrote that a really good explanation is “practically seamless.” Is there any such theory within one of the most important fields of social sciences — economic growth?

In Paul Romer’s Endogenous Technological Change (1990) knowledge is made the most important driving force of growth. Knowledge (ideas) are presented as the locomotive of growth — but as Allyn Young, Piero Sraffa and others had shown already in the 1920s, knowledge is also something that has to do with increasing returns to scale and therefore not really compatible with neoclassical economics with its emphasis on decreasing returns to scale.

Increasing returns generated by non-rivalry between ideas is simply not compatible with pure competition and the simplistic invisible hand dogma. That is probably also the reason why neoclassical economists have been so reluctant to embrace the theory wholeheartedly.

Mainstream economics has tried to save itself by more or less substituting human capital for knowledge/ideas. But knowledge or ideas should not be confused with human capital. Although some have problems with the distinction between ideas and human capital in modern endogenous growth theory, this passage gives a succinct and accessible account of the difference:

Of the three statevariables that we endogenize, ideas have been the hardest to bring into the applied general equilibrium structure. The difficulty arises because of the defining characteristic of an idea, that it is a pure nonrival good. A given idea is not scarce in the same way that land or capital or other objects are scarce; instead, an idea can be used by any number of people simultaneously without congestion or depletion.

Because they are nonrival goods, ideas force two distinct changes in our thinking about growth, changes that are sometimes conflated but are logically distinct. Ideas introduce scale effects. They also change the feasible and optimal economic institutions. The institutional implications have attracted more attention but the scale effects are more important for understanding the big sweep of human history.

The distinction between rival and nonrival goods is easy to blur at the aggregate level but inescapable in any microeconomic setting. Picture, for example, a house that is under construction. The land on which it sits, capital in the form of a measuring tape, and the human capital of the carpenter are all rival goods. They can be used to build this house but not simultaneously any other. Contrast this with the Pythagorean Theorem, which the carpenter uses implicitly by constructing a triangle with sides in the proportions of 3, 4 and 5. This idea is nonrival. Every carpenter in the world can use it at the same time to create a right angle.

Of course, human capital and ideas are tightly linked in production and use. Just as capital produces output and forgone output can be used to produce capital, human capital produces ideas and ideas are used in the educational process to produce human capital. Yet ideas and human capital are fundamentally distinct. At the micro level, human capital in our triangle example literally consists of new connections between neurons in a carpenter’s head, a rival good. The 3-4-5 triangle is the nonrival idea. At the macro level, one cannot state the assertion that skill-biased technical change is increasing the demand for education without distinguishing between ideas and human capital. 

  1. Gerald Holtham
    December 18, 2022 at 11:39 pm

    The work of Hausmann and Hidalgo at Harvard is interesting. They look for data that might indicate the presence of know-how, explicit or implicit knowledge. They find it in extremely disaggregated trade data, which enables them to construct an index of an economy’s relative complexity. Complexity shows how widespread competitive know-how is in a given economy relative to others and this turns out to be a useful leading indicator for subsequent economic growth. It is a creative example of using real data to trace an important unobservable element in economic life. The results often overthrow conventional theory. They find, for example, that trade and development does not lead to specialisation. On the contrary the richest and most successful economies are generally the most diverse.

  2. yoshinorishiozawa
    December 20, 2022 at 1:04 pm

    It is a bit sad that this important question (the plausibility of Romer’s growth theory) does not attract interest of many readers. I sympathise with Lars Syll. Many readers of this page are only frustrated with the general state of the mainstream economics, but they are not interested of what are fatally wrong with mainstream economics.

    As for Gerald’s attention on Hausmann and Hidalgo’s work on complexity, I have a doubt if it is plausible to call their index “complexity.” It may be related to dynamic capability of nations, bot it seems much has to be done before we know the real (I mean causal) relations between them.

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