Academic journal article Journal of Private Enterprise

A Pitfall of New Growth Theory: Rhetoric, Rent Seeking and the Semi-Informed Voter

Academic journal article Journal of Private Enterprise

A Pitfall of New Growth Theory: Rhetoric, Rent Seeking and the Semi-Informed Voter

Article excerpt

New Growth Theory, or endogenous growth theory, provides economists with a more complete way to systematically investigate economic growth, as it focuses on the endogenous nature of growth due to positive externalities in knowledge (Romer, 1986; and Solow, 1994). Although a greater understanding of the importance of technology utilization in growth theory is kudable, New Growth theorists can provide intellectual ammunition to those willing to misuse the theory as a public-interest veneer over their rent-seeking activities.

Broadband providers, NASA, software companies, educators, and even stem-cell researchers have asked for and received government benefits under the auspices of New Growth Theory. Although New Growth Theory may present a theoretical reason for government interference in the technology sector, government agents may kck the knowledge or the incentives to deal with these externalities. Policy-oriented economists must be cautious when recommending government intervention, regardless of how reasonable intervention may seem. New Growth Theory, like many other reasonable sounding arguments, can be used to obscure rent seeking from semi-informed voters.

Differences between Classical and New Growth Theory

Classical Growth Theory

Classical Growth Theory suggests that capital is the answer to economic growth, but empirical evidence has found this theory wanting. In particular, classical growth theory suggested that the wealth of countries should converge to the same per capita GDP over time. Growth in rich countries should slow as the marginal productivity of capital diminishes, while capital inflows should speed the growth of poor countries. The real world shows little evidence of convergence, however, so economists have sought new theories (Easterly, 2002).

New Growth Theory

New Growth Theory focuses on a country's ability to utilize technology, which the theory posits is characterized by numerous positive externalities. When someone creates a new product or process, others not only copy it, but also use it as a springboard for other ideas (Easterly, 2002). Innovators often fail to see all the benefits of their ideas. Increased productivity raises wages in the long run, and higher wages lead to increased demand, which results in more capital and more R&D. Hence, in New Growth Theory, more capital is the result, not the cause, of increased growth.

The theoretical ammunition that New Growth Theory provides appears especially applicable to the technology sector. New technology and knowledge provide spillover benefits, or positive externalities, which are the strongest impetus for growth (Romer, 1986). This growth-causing new technology is largely the result of deliberate investment in a search for new technology (Grossman and Helpman, 1994; Schumpeter, 1934; Solow, 1970; Romer, 1990; and Aghion and Howitt, 1992). Because technology firms claim to spend a much greater percentage of their revenue on deliberate research and development than do firms in other sectors, in New Growth Theory the technology sector is a primary impetus for growth (Romer, 1986 and 1990). As such, technology companies can use the theory as rhetorical ammunition when they petition for government subsidies and inclusion in special programs. The danger of New Growth Theory is that if government could just spend enough money jump-start starting technology firms, those firms would continuously build a vibrant economic sector.

As illustrated in Figure A, technology firms will invest in R&D to optimize their marginal private benefit (Q1). This is an under-investment, according to standard welfare theory, because firms do not consider the social benefits of their research. Firms only produce those new technologies where they expect to reap benefits that recoup the costs, even if there is only a penny of private, appropriable benefit while ignoring of a dollar of social benefit. When private and social benefits diverge, the social optimum (Q*) will not be reached. …

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