Romer: The Origins of Endogenous Growth

Romer, Paul M. (1994). The Origins of Endogenous Growth (Vol. 8, 3-22): American Economic Association.

Endogenous growth breaks from neoclassical growth theories by explaining that economic growth comes about because of an economic system, and not because of the forces that influence from the outside. While there are similarities to neoclassical growth theory (examining the economy as a whole, for example), endogenous growth theory does not see technical advances occurring outside the economic system as being highly relevant in the shaping of patterns of economic growth.

The paper tells two stories of endogenous growth. The first relates to the convergence controversy. The other story concerns the attempt to create a viable alternative theory for the perfect competition model.

The Convergence Controversy:

Is per capita income in different countries converging? If we use traditional understandings of the Cobb-Douglas model, it is not possible to explain conflicting stories across countries. The example that Romer gives is that of the US and the Philippines in the middle of the 20th century. Using a standard A variable before the LK calculation, as is common in the Cobb-Douglas function, one can calculate the production of both the Philippines and the US based on their relative labor and capital pools. The calculation shows that the US worker is much more productive, and implies that the Philippine worker is working with relatively less capital per worker. However, this is misleading, as the A variable used in the calculation was the same in both cases. It is not true empirically that the US and the Philippines had the same A value in the middle of the 20th century.

Romer proposes a spill-over effect to explain why the standard Cobb-Douglas formulation is ineffective in explaining productivity cross-nationally. This spill-over effect takes into consideration knowledge transfers that occur through extended use of technology. Barry and Sala i Martin also explore the transfer of knowledge. They note that this knowledge spill-over would be much greater with capital mobility. Other approaches to understanding this phenomena are explored briefly by Romer.

Romer concludes that the convergence approach only captures some of the phenomena that are missing in the standard, neo-classical account of growth.

The Passing of Perfect Competition:

This approach assumes that there is enough evidence to reject standard growth models. It suggests that, “There is a creative act associated with the construction of new models that is also crucial to the process” (11).

There are five facts that have been used to explain growth that, “…have long [been] taken for granted that poses a challenge for growth theorists…” (12). These are the following” There are many firms in a market economy, discoveries differ from other inputs in that many people can use them at the same time, it is possible to replicate physical activities, technological advance comes from things people do and that many individuals and firms have market power and earn monopoly rents on discoveries (12-3). Neoclassical economic theory addressed the first three growth and technology transfer assumptions above. Endogenous growth theory attempts to rectify the fourth, and possibly the fifth assumptions.

Neo-Schumpeterian Growth:

Two steps are required for this model. Firstly, growth theorists gave up on perfect competition. Secondly, there had to be a reconciliation of the equation: time derivative of a equals blank times a to a variable that was a constant. However, if the exponent was above 1, then technological growth was exponential. Below 1, and things ground to a halt.

Eventually, the models of economic growth have moved towards models of imperfect competition.