Romer’s Recipes and Their Limits

Excerpts from "Knowledge and Power: The Information Theory of Capitalism and How it is Revolutionizing our World" by George Gilder

Chapter 10

A FEW YEARS BEFORE William Nordhaus published his historic study of technology and the cost of lighting, a thirty-five-year-old economist published a paper that brought information and knowledge to center stage in theoretical economics. Paul Romer—whose father, Roy, was a governor of Colorado and became a co-chairman of the Democratic National Committee—had an undergraduate degree from the University of Chicago in physics, not in economics, the field in which he would make his mark. “Not an avid member of any clan,” as David Warsh describes Romer, “he walked out of the two best departments in the discipline, Chicago’s and MIT’s.”

Romer—now one of the leading economists in the world—looked at things differently from his brethren in Chicago and Cambridge. “People acted as if economic analysis couldn’t help us understand why the rate of technological change might be speeding up,” Romer told the economist Arnold Kling of the Cato Institute. Romer himself was thinking, “This may be the most important question in human history.”

In the fall of 1989, with technological change on his mind, he took a leap of faith—he left the tenure track at Chicago to be near Silicon Valley. He picked up a one-year fellowship at an institution funded by the technological change of a century ago: the Ford Foundation’s interdisciplinary Center for Advanced Study of Behavioral Science (“behavioral” being Henry Ford’s euphemism for “social,” a word that sounded too much like “socialism”).

Romer’s leap landed him on terra firma. By late 1990, he had a job at Berkeley and had published his now-famous paper, which would establish him as a pioneer of a movement called New Growth Theory. In contrast to his predecessors, who treated technological change as “exogenous” if they treated it at all, Romer titled his paper “Endogenous Technological Change.” Since technological change is the driving force of economic growth, moving innovation from outside the scope of economics to the core of the discipline is crucial to the redemption of the field. It was the culmination of Romer’s ceremonious but firm unseating of the four horsemen of economic muddle—self-extending markets; static input-output tables (without innovation); reified demand; and, at the heart of the fogbank, equilibrium.

As Kevin Kelly commented in a profile of Romer six years later in Wired, “economists, like cultists awaiting the apocalypse, had long looked to the day growth would end.” They realized, on some level, that “the set of traded goods in an economy is always changing,” but, as Romer commented acerbically in 1993, in their models, “this turbulence is an epiphenomenon of no fundamental interest.”

Romer looked where the cultists were looking and saw no signs of apocalypse: “I’ve been an optimist ever since I got started in economics,” he told his fellow economics professor Russ Roberts in 2007. “It may be just a personality trait but I think it’s been reinforced by the research.” He had been a graduate student in the late 1970s, “back in a time when people talked about the limits to growth…. People were saying that our standard of living … was going to collapse—there was no way we could sustain it. Those kinds of pessimistic forecasts have been made ever since the time of Malthus. And they’ve always been wrong.” Echoing the apostles of the learning curve, from Henry Adams and Bruce Henderson to William Bain and Ray Kurzweil, Romer declared, “The historical pattern has been one of accelerating growth—not just sustained growth but accelerating growth.”

Romer’s research led him through mathematical thickets and beyond the economist’s traditional trinity of land, labor, and capital to a model of growth that depended on technological change. Romer stressed not merely the calibration of labor costs and capital spending in a “production function,” but the transformative effect of ideas.

“I think part of why this question attracted me was because of my background in physics, and to a physicist, the whole notion of a production function sounds wrong. We don’t really produce anything. Everything was already here, so all we can ever do is rearrange things. Think of conservation of mass. We’ve got the same amount of stuff we’ve always had, but the world is a nicer place to live in because we’ve rearranged it….”

From this classical physics point of view, Romer thought about the structural or chemical changes that make up that “rearranging.” He realized, “It’s like cooking.” And here, Romer proposed, is where creation comes. Milk and other ingredients can be artfully brought together to “create something—a soufflé, which is really valuable, and gives us great pleasure when we eat it.” Clumsy or ignorant rearranging, on the other hand, leads to something worth less than what you started with: “sour milk.”

Beyond the skill of the chef and the quality of the ingredients and equipment, a good recipe itself is a valuable thing: “A canonical example is turning sand on the beach into semiconductors.” This, Romer believed, is how people create value in an economy—not burning through scarce raw materials until they’re all gone, but creating endless recipes to rearrange what’s there into states of greater and greater value. As a result, “there is absolutely no reason why we cannot have persistent growth as far into the future as you can imagine.”

So, by 1990, at least a few economists were grudgingly admitting that technological change stems from human creativity—from ideas. Romer took another step closer to information theory as he continued to mull over the question of the acceleration of technological growth.

“Evolution has not made us any smarter in the last 100,000 years,” he said to Ronald Bailey (in an interview in Reason titled “Post-Scarcity Prophet”).

Why for almost all of that time is there nothing going on, and then in the last 200 years things suddenly just go nuts?

One answer is that the more people you’re around, the better off you’re going to be…. If everything were just objects, like trees, then more people means there’s less wood per person. But if somebody discovers an idea, everybody gets to use it, so the more people you have who are potentially looking for ideas, the better off we’re all going to be. And each time we made a little improvement in technology, we could support a slightly larger population, and that led to more people who could go out and discover some new technology.

But some countries had lots of people and not very much technology, so there had to be another piece to the puzzle.

Another answer is that we developed better institutions. Neither the institutions of the market nor the institutions of science existed even as late as the Middle Ages. Instead we had the feudal system, where peasants couldn’t decide where to work and the lord couldn’t sell his land. On the science side, we had alchemy. What did you do if you discovered anything? You kept it secret. The last thing you’d do was tell anybody.

But institutions are like ideas—they can be discovered, and once they are discovered, they can be shared: “When good institutions work somewhere in the world, other places can copy them…. New Growth Theory describes what’s possible for us but says very explicitly that if you don’t have the right institutions in place, it won’t happen.”

In other words, the high-entropy signal will never reach its destination if it doesn’t have a low-entropy carrier.

Crucial to Romer’s scheme of knowledge-based growth is the idea of rival and non-rival goods with varying degrees of excludability. The distinction was evident to Thomas Jefferson in the early nineteenth century, to Henry Adams in the late nineteenth century,12 and was upgraded for modern use by a number of writers before Romer—including Nicholas Negroponte, who distinguished between sharable bits and consumable atoms.13 Perhaps Jefferson was most eloquent: “He who receives an idea from me receives instruction himself without lessening mine; as he who lights his taper at mine receives light without darkening me…. Ideas are incapable of confinement or exclusive appropriation.”

Romer can be credited with more cumbersome language, more mathematical symbols, and a willingness to put up with the considerable demands of the economics fraternity. But his invaluable contribution was to integrate the distinction with all his other insights in a model that ingeniously advances the profession into the information age.

A rival good is a thing that can be appropriated by only one person at a time—an egg, an apple, a book, a bond, a tennis racket, or an apartment. It tends to be used up as it is used. Non-rival goods, by contrast, are appropriable by any number of people at one time. As you use non-rival goods and services, they expand, according to network effects (Metcalfe’s Law), by the square of the number of compatibly linked users. Examples are books on Kindle, Google searches, Quicken spreadsheets, operating systems, dress designs, songs, television programs, or economic ideas.

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