Paul Romer

Today, we're going to be
talking about Paul Romer.

Paul Romer taught for a long time
at Stanford University.

More recently, he moved
to New York University.

And he's most famous for being
one of the architects of new growth theory,

though, more recently,
he's becoming famous

for his work in development economics,

in fact, for his entrepreneurship
in development economics.

More on that soon.

Romer's most famous paper is called
"Endogenous Technical Change".

This is a monumental paper,
a foundational paper in new growth theory,

and it has led to a huge outpouring
of work in growth theory.

We'll be able to discuss
the paper in much detail,

but let me just give you
an essence of where it came from.

Let's remember the Solow model.

In the Solow model,
output is a function of A as ideas,

and a combination of capital and labor.

Now, Solow made
two assumptions about ideas, A.

First, ideas were a public good.

They were freely available
to anyone in the world.

Second, --

the growth in ideas was exogenous,
that is, outside the model.

Ideas just kind of accumulated over time.

Now, --

in some ways,

this was not such a terrible assumption,
particularly the first part.

So, a lot of ideas are public good.

So, for example,

a force is equal
to mass times acceleration,

the Pythagorean theorem,

These are public goods
available to everyone.

However, the second assumption
is really problematic, --

because growth is about new ideas.

And if you look around in the world,

most research and development
is produced by for-profit firms.

Growth ideas are not
coming out of the ether,

they're not just arriving magically,

they happen in some places
and not in other places,

and they happen for a reason.

They happen because, most of the time,
someone is out to make a profit.

In developed economies,

60% to 80% of research and development
is privately produced by for-profit firms.

Now, Solow, however, made
these assumptions for a reason.

He made these assumptions because
they made the model much much simpler,

because, with these assumptions,
ideas are freely available,

they're literally free,
they're not priced.

That means that capital and labor
can be sold in competitive markets;

they can each receive
their marginal product.

The product itself can be sold
in competitive markets,

and the payments to capital and labor

will nicely sum up to exactly
equal the price of the product.

So everything works out beautifully
with competitive firms

when ideas are not priced.

However, --

when ideas are priced,
we have a problem.

Let's take a look.

Ideas are non-rivalrous,

and they cannot be sold
in competitive markets

because the marginal cost is zero.

So the classic example here
is the pharmaceutical.

The first pill costs a billion dollars.

The second pill costs 50 cents.

That 50 cents that can be produced,

the 2nd pill, and the 3rd,
and the 4th, and the 5th, --

and the nth pill can be produced
in competitive markets.

The 50 cents comes from
payments to capital and labor,

which are just enough to cover
the 50 cents cost of the product.

But, --

that doesn't leave anything over
for producing the formula,

for producing the idea which made --

the pharmaceutical possible
in the first place.

So you can't sell pharmaceuticals
in competitive markets, --

because that doesn't leave
enough left over

to fund the research and development

which went into producing
the product in the first place.

There has to be some monopoly power.

Either the monopoly power
maybe comes from a patent,

or maybe it comes from
being first to market,

or having a trade secret,
or having some knowledge,

or being able to do things better
than other people do.

But you need some monopoly power --

to fund these ideas.

Ideas also create spillovers,
even when you have monopoly power.

Well, the patent runs out over time.

The idea itself can be copied
not directly but can be --

the idea can still be useful
and still spread around the world.

So what did Romer do?

But what Romer did is he created
a model of growth based on ideas

which were privately produced
by for-profit firms

in monopolistically competitive
markets with spillovers.

Now, --

in one way, that's just
following the formula,

that's just doing exactly what
we would hope a model should do.

But bear in mind that everyone knew
this was kind of the right way to go.

Everyone knew this was the right model.

But Arrow failed to create this model,

Samuelson failed to create this model,

Solow failed to create this model.

It wasn't until Romer,
that all the knots were tied,

that we had all of these characteristics,
which we know are true,

that ideas are produced
by monopolistic firms,

that ideas are really important in growth.

Ideas have spillovers.

All of these ideas combined in a model;

that was really Romer's,

a supreme accomplishment,
in this paper of 1990.

Now, I said the model was
a real technical achievement.

That's true, --

but the really important aspect is that

economists often don't start to think
about things until we have a model.

And what Romer did is he put ideas
at the heart of growth theory.

And once you do that,

you start to open up and start thinking
about a lot of new things.

Like in the Solow model,

it's all about
the accumulation of capital.

Once you have ideas
at the heart of the model,

you start thinking about things like
patents and intellectual property.

You start thinking about universities,

about capital markets
like venture capitalists

and having a capital market,
strong capital market,

so that entrepreneurs can
take their firms public.

You start thinking about human capital,

and why we might not have
enough human capital in research,

why research might be underfunded,

because we get spillovers,
because that's a monopolistic industry.

You start asking yourselves
questions about:

why do some ideas,

how do ideas transmit
themselves across the world?

How do they flow across the world?

Where do ideas begin?

Why does it take some ideas
a long time to transmit

and other ideas move across
the world quite quickly?

You get a whole new perspective on trade,

and the importance of market size

as generating the incentives
to produce R&D.

You begin to think about differences
in types of ideas like technologies.

These seem much more amenable
to be communicated across --

different countries than do rules.

Rules, by rules I mean things like:
how do people interact?

Rules about --

rules like how to create a corporation,

how to create honest government.

Rules like --

democracy, the rule of law,

honest judges,

judges separated from politicians,

a separation of powers.

Much harder to transmit these ideas
and have these ideas adopted

than it is to have ideas about, --

you know, how to create
an engine, for example.

You also begin to think about
where ideas are created

and what is necessary to create new ideas.
You think about cities, --

you think about density,

of getting people close together
to transmit knowledge.

You think about networks.

So all of these ideas about ideas
were introduced --

by the Romer model and put at
the center of growth theory by Paul Romer.

So in the late 1980s,

Romer had produced a number
of papers in new growth theory,

culminating in this great 1990 paper.

Many people thought he was
on the track for a Nobel Prize,

which he may yet win deservedly in my view.

And then something strange happened.

Romer disappeared, --

or at least it seemed that way
to many people in the economics profession.

Romer actually gave up tenure.

He gave up tenure at Stanford.

He took an extended
five-year leave of absence from Stanford.

To do what?

Well, Romer created a startup.

He created Aplia --

which, long before it became
the buzzword that it is now,

Aplia was the beginnings
of online education.

Aplia was a homework solution.

Professors could assign quizzes,

could grade all their homework online,

could do experiments online in economics.

They could shift the demand curve.
Students could shift demand curves

and supply curves.

It was a fantastic, fantastic device, --

and very successful.

Romer ran Aplia for about seven years

and then sold it for
a lot of money to Cengage.

Aplia is still going strong today.

So, did Romer leave new growth theory?

Or did he take the lessons
of new growth theory,

the importance of ideas,

the importance of ideas
to create new ideas,

to increase productivity,

and did he apply those lessons
to a great startup?

I think the latter.

And Romer's story has not yet ended.

Most recently, Romer has come up
with a startling new idea for development,

charter cities.

What is this?

Well, let's go back to the problem.

The problem is the iron rule of rules.

What I mean by this is
that we saw that some rules,

things like the rule of law,
things like anti-corruption,

things like honesty in government.

These types of rules are hard
to transmit.

Now, why are they hard to transmit?

Well, they may be hard to transmit
because they require a lot of interaction

and a lot of coordination.

It's kind of like getting everyone

from driving on
the left-hand side of the road

to switch to driving
on the right-hand side of the road.

Everyone must agree to coordinate
on the new equilibrium,

and that's really hard.

There may be forces.

You can't you do it, you know,
halfway, in halfway steps,

you can't do it a little bit at a time.

You've got to go all the way or nothing,
and that is very, very difficult.

Sweden, by the way, actually
managed to do this in the 1970s.

So in just the same way that
it's hard to get people to coordinate

on switching from the right-hand side
to the left-hand side or vice-versa,

it may be hard to get people
to coordinate out of the corruption trap.

Once you become known,

once the rules of helping out your cousin,
of helping out your tribe member.

Once that rule becomes laid down,
a single person breaking from that rule --

is gonna have a really hard time.

they're gonna be squashed
right back down again.

If you don't help out your cousin,
you're gonna be thrown out of the family.

It's really hard to break out
of these coordination traps.

So how do you do it?

Well, the solution is startups --

or a big push in ideas.

This is like the big push idea coming
back to us again, but now it's in ideas.

What do I mean exactly?

Well, what I mean and what Romer means is

to start up a new city,

a new city on unoccupied land,
with a charter of new rules.

What does he have in mind
for these new rules?

Well, he wants the rules
to come from outside

to launch this new equilibrium.

So, for example, you take
an unoccupied piece of land

in a developed country,

and you would turn
that unoccupied piece of land over --

to Canada, over to Great Britain,

and have them apply this new set of rules,

and then have people
voluntarily enter the city,

voluntarily put themselves
under the new set of rules.

Hong Kong here is the classic example.

Remember it was Hong Kong, --

which has actually completely
revolutionized China.

And that's what Romer is hoping.
Start up a new city,

create it not only as an end in itself
but as a demonstration project.

New city of 10 million people or so
operating under completely new rules.

New rules which have been
successful elsewhere,

bring them to the new city.

Now, Romer introduced this idea
only in 2010 or so; it's very recent.

And yet, incredibly,

he's already had some success
in pushing the idea --

around the world.

So Honduras, for example,
has indicated that it will create,

in fact, has created
this unoccupied piece of land

where these new rules
could be put in place.

Right now, --

Romer is looking for a third party
to come in and help run the new city.

Canada is one possibility.

He's got the judges from outside,

also being willing to come in
and apply the new rules.

Now bear in mind here;
something really important;

and that is that the world
is urbanizing at a really fast rate.

So take India, for example,

it's got 800 million people or so
still living a rural existence.

But it's clear,
over the next 20 to 30 years,

hundreds of millions of these people
are going to be coming to cities,

many of them new cities.

So now is a great opportunity --

to create fresh new cities.

Cities not beholden to the old rules.

Cities, for example, where caste
would no longer be recognized.

That, at least is the hope.

Will Romer be successful?

Who knows. But it's a bold idea.

He has revolutionized economics education,

he revolutionized new growth theory.

Perhaps this idea
is going to take off as well.

Here's a couple of places you can
find out more about Paul Romer,

particularly about
this new idea of charter cities.

Russ Roberts has an excellent
interview at EconTalk.

You can also look at Romer's TED talk.

I want to also close with the following.

You know, I see Paul Romer
is a lot like Coase,

and that Coase didn't write very much.

He produced only a handful of papers.

But those papers were
absolutely revolutionary,

and Romer is the same way.

He hasn't written a lot, but what
he has written has been very deep,

has been very fundamental,
has been much more important --

than most other work
which goes on in economics.

Indeed, when I think about the economists
which have most influenced me,

when I think about the ideas which
I think about most on an everyday basis,

which I use to interpret the world, --

ideas which I use to interpret the world,

a lot of them about growth theory,
about the importance of ideas,

about trade, about markets,
they're coming from Paul Romer.

So indeed, if you want
to take a look at my TED talk,

Tabarrok's TED talk,

you'll see that that's
really an introduction

to the ideas of Paul Romer in many ways.

So, thanks very much.