Paul Romer’s idea and object concept is highly prominent among the endogenous growth theories. By referring to the role of recipes in mixing ingredients, he emphasized the importance of ideas in creating economic value. Subsequently, he formulated his endogenous growth model by making economic output as a function of ideas and objects. He argued that by adopting better ideas or recipes, we can extract more financial benefits from the same stock of ingredients while causing less environmental harm. For establishing the role of ideas as endogenous factors, Y=F(ideas, objects), the Romer Growth Model received the Nobel Prize in 2018.
Due to material, energy, labor, time, and pollution-saving roles, ideas are indispensable for extracting increasing value from inputs while causing less wastage and emission. Besides, ideas increase the perceived value and willingness to pay for the outputs. Hence, the Romer growth model tends to promote the belief that by increasing the supply of ideas, a firm or nation will be experiencing proportionate economic benefit.
There is no denying that there has been a positive correlation between STEM (science, technology, engineering, and math) graduates, scientific publications, patents, and economic growth in advanced countries like the USA, UK, Japan, and South Korea. However, does it suggest that such a correlation is scalable for those countries? Besides, if aspiring new countries start increasing those indicators, will their economic growth also proportionately increase?
Although ideas are at the root of creating economic value, more than 94 percent of patents are never used. Besides, over 75 percent of innovative products retire without generating profitable revenue. On the other hand, there has been growing unemployment of STM graduates—seed corn for idea production—in less developed countries. Hence, it’s time to look into further details about what is missing in the belief promoted by the Romer growth model.
Merits of Romer growth model
Kitchen and recipe analogy
Paul Romer used a cooking metaphor to explain the role of ideas in economic value creation through production. He argued that without improving recipes, we cannot improve the quality of our cooked food and reduce the pollution that cooking causes. He further stated that economic value creation is like cooking—mixing ingredients with recipes or ideas. As his analogy showed a natural correlation, people found merit in his endogenous growth theory—economic output is a function of ideas and objects. Hence, it tends to promote the belief that as you increase the supply of ideas with the engagement of a growing number of scientists, your economy will grow further, causing less environmental harm. It appears to be a miracle formula for addressing sustainable economic growth challenges. Therefore, Paul Romer rightfully deserved the Nobel Prize.
Rising GDP, population, and life expectancy
In favor of his observation about the role of ideas at the macro level, Paul Romer referred to the simultaneous growth of population, per capita GDP, and life expectancy over the 1000 years. Notably, he pointed to the exponential growth since the first industrial revolution. Hence, he argued that due to the increasing Flow of Ideas, the human race has been experiencing this conflicting reality—growing Wealth and quality of living standards of the increasing population from the same natural resource stock.
GDP growth and R&D investment of selected countries
A quick search indicates that advanced countries have been making far more investments in R&D than less developed countries. For example, South Korea invested 4.81 percent of its GDP in R&D in 2018. In comparison, Bangladesh’s investment in R&D of 0.1 percent of GDP has been negligible. Besides, in the early 1960s, South Korea’s R&D investment was also insignificant. Hence, it does not take much argument to make a point that South Korea’s economy sustained far higher growth than that of Bangladesh over 60 years due to South Korea’s rapid growth of R&D investment.
Similarly, references could be made in explaining the rise of a few countries at high-income status while the rest remained low- or middle-income ones. Of course, ideas supplied by the R&D investment have played a role in making advanced countries wealthy. However, if less developed countries make a similar investment, will they also reach high-income status? To shed light on this vital question, let us contemplate on realities.
Reality check about the role of ideas in creating economic value
There could be many definitions of economic value. However, in this article, economic value refers to creating consumer and producer surpluses in a competitive market through producing and consuming goods and services. Producers must succeed in profitably delivering ideas as products to customers at a lower price than the willingness to pay to create economic value. Whether the supply of ideas is good enough to create economic value, let’s contemplate the following issues:
1. Why are grassroots idea producers, practitioners, and traders remaining poor?
2. If a firm or country keeps increasing idea (like patents) supply and rolling out them in the market, will the economic output keep proportionately increasing?
3. Why is a small fraction of ideas succeeding in generating profit while the rest end up in loss?
4. Although ideas are vital in creating economic value, why do most inventors die poor?
5. Despite having a rich supply of Objects and ideas, why has the USA been losing its Innovation edge to Japan, Taiwan, and China?
6. If a less developed country starts increasing investment in producing ideas (education and R&D), improving infrastructure (objects), and giving seed capital to Startups, will it keep gaining economic traction? It’s worth noting that over 94% of patents are never commercialized.
7. If ideas destroy the market of ideas, how can proprietary ideas keep producing profitable revenue?
8. If a less developed country keeps opening the door of idea import, will it end up creating a barrier to the growth of the local idea economy?
9. Upon rolling out ideas in the market and maintaining proprietorship, why do more than 70% of innovations suffer from loss?
10. Why do great ideas begin the journey at a loss, and what does it take to turn them into profit?
Genesis of ideas in creating wealth
In the raw form–other than air, freshwater, and fruits–natural resource stock of the world has little or no value to human beings. Hence, the natural wealth supply is minimal. However, once raw ingredients are manipulated with ideas, usable value is distilled—creating wealth. For example, raw meat is mostly non-consumable. However, processing it with ideas creates wealth in the form of a delicious dish. Similarly, the idea of processing natural silicon and other materials to store information creates value in Getting jobs done better.
Sustaining wealth creation from ideas
The market plays a vital role in deriving wealth from ideas. Due to the freedom of competition to profit from ideas, supply and rivalry increase. In a competitive market, adding value through ideas is not enough to create economic value. Producers must succeed in trading processed output by outperforming competing ideas at a profit to generate producer and consumer surpluses. Without profit, producers do not benefit from the possibility of creating wealth from ideas.
Besides, the prolonged loss or lack of incentives will end up ceasing the delivery of the concept-containing products to the consumer. Hence, ideas are not enough to produce economic outputs. Producers must succeed in profiting from them to generate and sustain wealth from ideas. Hence, understanding wealth creation dynamics and making rational decisions to benefit from is vital for creating wealth from ideas. Therefore, the supply of ideas is insufficient for extracting additional wealth from ingredients or objects.
Scalability, idea life cycle and wealth creation dynamics
Grassroots ideas instantly produce economic value by helping the idea producers get the target jobs done better. However, such ideas often do not scale up, assisting others to get their jobs done. Hence, grassroots idea producers do not profit from idea trade due to a lack of scalability. On the other hand, all great ideas are born in a primitive form, producing no economic value. They must be nurtured to grow and cross a threshold to qualify for profitable production and delivery. Hence, idea supply alone does not create economic output. Besides, idea producers must win the competition to generate profitable revenue.
Furthermore, upon crossing the growth phase, all ideas mature and, eventually, get taken over by next-generation ideas—destroying existing skills, jobs, production capacities, and firms. Surprisingly, incumbent firms profiting from proven ideas often fail to pursue the loss-making beginning of new idea waves, resulting in suffering from disruptive effects. Consequentially, epicenters of economic value creation from ideas migrate across the boundaries of firms and nations. Hence, economic value creation from ideas is not benign. Therefore, understanding this dynamic is crucial to leveraging ideas for creating and sustaining jobs and driving prosperity. Therefore, understanding the dynamics of economic value creation from ideas in a competitive market and making rational decisions are essential.
What is missing in the Romer growth model?
Paul Romer’s endogenous growth theory states that economic output is a function of ideas (A) and objects (X). Hence, economic output, Y=F(A, X).
The natural tendency of Paul Romer’s theory
As ‘A’ is an endogenous factor, there could be a tendency to believe that Y=AX (or their variations with exponents). Hence, it tends to support the investment policy decision to increase the supply of A–graduates, publications, and patents. However, due to higher level automation and the import of capital machinery, the scope of adding value in production through the local supply of knowledge has been shrinking.
On the other hand, economic value creation from ideas depends on (i) scaling up ideas through a cumulative flow of ideas, (ii) crossing the threshold, (iii) winning and sustaining in the global competition, (iv) succeeding in reinvention waves, (v) absorbing the loss before reaching and sustaining profit, (vi) staying in course in the midst of uncertainty, and (vii) building internal, local and global ecosystem for idea flow, supply and distribution, whether serving local or global markets. Hence, there is no natural correlation between idea supply and economic output. Therefore, Paul Romer’s endogenous growth theory runs the risk of misguiding policy decisions.
To overcome the limitation of Paul Romer’s endogenous theory, a factor D could be introduced: Y=(A, D, X). D refers to understanding the dynamics of economic value creation out of ideas and objects and the decision taken to pursue it. In simple form, the relation could be Y=ADX (of course, exponents could be added to refer to quality or effectiveness); the value of D may vary from -1 to +1. Hence, the reality of suffering from loss or wasting of resources due to pursuing ideas could be brought in the theorization of wealth creation out of ideas. Once D is introduced, understanding the economic value creation dynamics in a competitive market and rational decisions will be important in the policy, strategy, and investment discourse.
Why is Romer’s model important?
The motivation for updating Romer’s model is to increase the importance of understanding the dynamics and making rational decisions to clarify the linkage between ideas, objects, and economic outputs.
We may agree that before Romer’s work and human capital theories, the importance was on capital (including infrastructure), labor, and natural resources for economic development. However, although there has been growing importance placed on investment in education and R&D, how to leverage the outputs of education and R&D to drive economic growth is unclear to most people, including economists and STEM experts. Unfortunately, Romer growth model could not go further than highlighting the importance of ideas as an endogenous factor. Hence, wasteful investment in education, R&D, startups, and the innovation ecosystem has been growing. Besides, harmful regulatory and policy instruments are being pursued to benefit from technological innovations.
Therefore, it may not be unfair to reason that the human race as a whole, notably people of less developed countries, have been suffering from a lack of realization and clarity about how to relate knowledge and ideas to economic growth.