Monday, May 28, 2007

David Warsh: Knowledge and the Wealth of Nations

David Warsh describes the develpment of economists' models of growth and progress in his book Knowledge and the Wealth of Nations . The story revolves around the origins and consequences of a particular paper ("Endogenous Technological Change" by Paul Romer, 1990) in order to give us a view into the way economists think and the way economic theory evolves.

The book spent more time on personalities and personality clashes that I would have preferred, but Warsh apparently wanted this book to say more about how economists work than about the ideas they've developed. As a result, you have to work a little harder to keep track of how economists' models of progress evolve from Adam Smith to the present.

It shouldn't be a surprise that models of the real world (in any field) usually start simple, and accumulate details as people discover areas where the models' predictions aren't sufficiently clear to answer questions that arise. The thing that's interesting and hard to track when looking backward is remembering where the gaps were, and the order in which the problems were addressed. Warsh traces the earliest descriptions of how business works, and how progress is made to Adam Smith and his description of the division of labor in his Pin Factory example.

But the earliest economists described everything in prose. When the models were formalized, they started out simple. Until quite recently, all formal models of production in an economy were static: they assumed the means of production didn't change over time. Often the eonomists who presented these models explicitly recognized that that was an important factor that was missing from their models, but they still had to start simple in order to have models they could manage.

The path of evolution of the models next added the idea of growth, but assumed that progress was constant and outside the influence of the manufacturers in the model. This allowed the economists to model and describe more sophisticated situations, but didn't match what people could see about how developing countries advanced over time. Romer's contribution to the field was to build a model that made entrepreneurial investments change the cost of doing business and the alternatives available to actors within the model.

Romer's model assumes that the technological advances produced as a side effect of investment are general knowledge (they are non-rival goods), but that some of the benefits can be monopolized by the developer for a time (they are partially excludable). One of the major consequences of this is that the model predicts that trade barriers prevent underdeveloped countries from advancing, and that borders that are open to trade all lesser developed nations to gradually catch up with their trading partners, since they can take advantage of the greater stock of knowledge in the market.

I've read several books over the last few years that point out that the idea of progress is failry recent in human history. Romer's contribution wasn't in noticing it, it was deciding it was important, and figuring out a way of bringing it into the models that economists use. Now that invention, discovery, and the sharing and hoarding of knowledge are explicit in the models, economists' recommendations to policy makers more often point in the direction of investment in education and new technology.

Along the way, Warsh presents an interesting history, and describes other ideas Romer and his colleagues were struggling with and how they led to the particular paths chosen. If you're interested in the history of this particular idea, or how economists (or scientists in general) work, it's an engaging book.

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