Tuesday, 12 January 2010

Paul Romer' views on trade and growth


This is an overdue summary of the presentation Stanford's Paul Romer gave at the signature growth panel at the Atlanta AEAs ...

Romer started by observing the divergence of international incomes has been a powerful and vexing trend. Despite the ever-widening gap between developed and developing economies, he also noted research showing how life expectancy across countries has converged. This bodes well for the future, and suggests to me a stepping stone to convergence in other things.

Second, Romer made a fantastic point that the workhorse model of gains from trade (globalization) is comparative advantage, but it is a story that should be updated with new goods. Instead of the two trade goods being fish and apples, for example, we should talk about trade in cholesterol pills and blood pressure pills. The first implication seems to be the consumption benefits of trade are too often neglected. The implication Romer was making is that trading in recipe-driven goods represents an inefficiency. We should imagine a globalized economy where production is localized and IP is licensed, rather than one where final goods (physical objects) are traded. In his words, "globalization should be a flow of ideas, not goods."

But the real insight offered in Romer's talk was when he called out the "two errors" of development thinking. He got to them by sketching out a few growth equations, starting with the familiar

Y = A * F(K,H,L)

and then expanding the A term as a function of technology and rules:

Y = A(Technology,Rules) * F(K,H,L).

Understanding the importance of rules is the key insight. Private property is a kind of formal rule governing social interaction. We have other rules for marriage, educational advancement, and so on. Technology is the conventional way economists thought about the growth equation and includes hardware like computers, phones, and printing presses.

When thinking about how to accelerate economic development, the first error people tend to make “Technology cannot change.” The given tech level of a country is given. The second, and more important, error is that "Rules can change with stroke of a pen.” While there is a growing consensus that rules are the most important factor in permanent changes in a developing country, Romer forces us to accept that rules are very difficult to change. Nations in particular, even when its leaders recognize the need for rules to change, have difficulty making them happen.

Here in America, there is tremendous acrimony about new legislation of almost any kind. Witness the current fight in the U.S. Congress over health care reform. So why do we imagine it would be trivial for another country to change its laws, let alone norms, customs, cultures? So the real challenge for development practitioners is how to make rule-changing easier. Any thoughts?

No comments: