From American Affairs Journal:
The knowledge economy is the science- and technology-intensive
practice of production, devoted to perpetual innovation, that has
begun to assume a commanding role in all the major economies of the
world. It is present in every sector of these economies—in services
and even agriculture, as well as in advanced manufacturing. In each
sector, however, it remains a fringe, excluding the vast majority of
workers and firms.
The insular character of this new vanguard of production has
become a powerful driver both of economic stagnation, seen in slowing
productivity growth, and of economic inequality, aggravated by the
increasing distance between advanced and backward parts of the
production system. It matters to the future of the United States, and
of every country in the world today, that we understand both what the
knowledge economy is now and what it can become. We have a stake in
its deepening and dissemination: in the development of an inclusive
productive vanguardism.
Paul Romer authored two papers, published in 1986 and 1990, that
laid out what became—and what has remained—the most influential
account of the knowledge economy within economics.1
Charles Jones has recently presented an elucidation and defense of
Romer’s approach.2
An analysis of Jones’s spirited case helps reveal the deficiencies
of Romer’s view as a basis for understanding the knowledge economy
and its possible futures. These deficiencies speak to the inadequacy
of the ways in which contemporary economics has addressed economic
growth. They go more broadly to the limitations of neo-marginalist
economic theory, which arose from late nineteenth‑century
marginalism and remains at the heart of economics today. We need an
alternative account of the knowledge economy, one that will have
significant implications for economics and its methods.3
Economics and legal thought are the two major disciplines of
power. When they misrepresent both how the market economy works under
established institutional arrangements, and how it might work under
alternative arrangements, they become enemies of prosperity and
democracy, as they are now.
The Dominant View of the Knowledge
Economy
The dominant approach to the knowledge economy, inspired by
Romer’s early work, consists of three elements. The first element
begins with the seemingly uncontroversial claim that, unlike all
previous forms of production, whether advanced or not, the knowledge
economy is organized around ideas. Ideas, unlike the inputs and
products of past forms of production, are “nonrivalrous”: their
consumption fails to deplete them. When a new computer code or a new
treatment for malaria is used by some people, it does not become any
less usable by others (unless, that is, intellectual property law
intervenes to limit access to its use).
The nonrivalrous character of ideas, which are supposedly the main
object of the knowledge economy, in turn explains the possibility of
increasing returns to scale. Without increasing returns to scale, the
possibility of continued breakthroughs in productivity and growth
remains doomed, as it is under the theories of economic growth that
were most influential when Romer made his proposals.
The second element in Romer’s treatment of the knowledge economy
is the role of profit-maximizing entrepreneurs and imperfect
competition. Although ideas and their resulting material benefits may
be nonrivalrous, the law of intellectual property may intervene to
limit or discipline access to their use and make them, under certain
conditions, “excludable.” Because ideas—or the goods and
services in which they are embodied—are partly excludable and thus
are not pure public goods, there is a place for private economic
incentives and self-interested entrepreneurs in their development.
There is also room for policies and arrangements that can bridge the
gap between what private gains support and what social gains
recommend.
The third element of Romer’s account is its statement in a form
that allows it to be adapted to the familiar formulas and equations
of the production function: the economic concept describing the
relationship between the quantity of output and the different
quantities of inputs used in the production process. To fit the new
protagonist—idea-based production—into the linear production
function of growth theory, it suffices to substitute knowledge for
physical capital in the respective equations. In the revised formula,
the productivity parameter, as reshaped by the knowledge-based
potential for increasing returns to scale, the amount of human
capital in the economy, and the equilibrium fraction of human capital
allocated to research (the expansion of knowledge) determine the path
and rate of economic growth.
In this way, what seemed to be a fresh approach, focused on the
importance of ideas to the new economy and on their nonrivalrous
character, could be taken up without disturbing the settled habits of
mind and the accepted methods of the discipline. Substantive novelty
could be achieved without methodological disruption.
Of these three elements, the first plays the decisive role: it
makes a claim about what is distinctive to the knowledge economy and
why this difference matters. The second element builds a bridge to
the incentive-based workings of a real-world, imperfectly competitive
market order. The third element reconciles this story of the
knowledge economy with what the economics departments of the leading
American research universities regard as the hallmark of the field:
its diversification of mathematical models, defined by the
specification of new variables and of their values, against the
background of a consistent theoretical conception of economic
phenomena—indeed, a background that has barely changed, in its
essentials, since the late nineteenth century.
It follows from this understanding of the structure of Romer’s
view that any criticism must focus on the first and most
consequential of its three elements. Romer’s account of the
knowledge economy stands or falls on the merits of his description of
what is distinctive about the knowledge economy.
Ideas and the Knowledge Economy
Is there—or can there be—a practice of production that, alone
among all practices of production, gives a commanding role to ideas
and exhibits in its development the consequences of their nonrivalry?
And does that practice lie at the heart of today’s knowledge
economy? The answer to both of these questions must be no.
On the one hand, there has never been a practice of production
that fails to rely on ideas, and to translate them into a way of
combining technology and labor. Consider the immediate precursor to
today’s knowledge economy as the most advanced productive practice
of its time: mechanized manufacturing and its development into
industrial mass-production. The mechanical inventions and
organizational innovations that sustained nineteenth- and
twentieth-century industry relied on the science of the time. Like
every technology before or since, industrial production connected a
way of mobilizing nature (in the form of energy) with a way of
organizing work (in the technical division of labor). And like every
technology before or since, it developed formulaic devices and work
practices aiming at increasing efficiency by having machines perform
many repetitive tasks.
If mechanized manufacturing and industrial mass-production failed
to achieve their full potential to improve productivity, part of the
reason may have been that they evolved in ways that consigned workers
to a narrow stock of repetitious movements, leading the workers to
work as if they themselves were machines. The shortfall from
potential productivity had more to do with the distribution of
property and power than with the intrinsic limitations of the
technology of the time, or of the science on which it depended.
There are no idealess practices of production. But it is equally
true that there is no practice of production that traffics in
disembodied ideas and their nonrivalrous, and thus potentially
inexhaustible, use. Neither is today’s knowledge economy such a
practice; it is not an economic equivalent to nature without
friction.
Those who claim that the knowledge economy represents a jump into
such a world argue that, because ideas (such as a computer code or a
treatment for disease) can be used without depletion, they yield
increasing returns to scale and consequently lay the basis for
exponential growth. Jones makes such an argument when he
distinguishes production under the knowledge economy from production
as it previously evolved and was studied in the literature of
economics: “Solow had constant returns to scale and therefore
diminishing returns to capital, and this is what dooms growth in the
neoclassical model. Now that we have increasing returns to objects
and ideas together, it is not clear that diminishing returns . . .
dooms us in the same way.”4
There should be no diminishing returns to the use of ideas in the way
that, under the Solow growth model, there were diminishing returns to
capital against the background of constant returns to scale.
Of course, the need to reconcile the economic consequences of
nonrivalrous ideas with the logic of economic incentives remains: the
law of intellectual property will have to allow certain economic
agents to control, in their own interest, access to otherwise
inexhaustible ideas. By being made excludable, the ideas—or the
products in which they result—become objects of an economic
interest and even the sources of a rent. There is always the danger
that the legal logic of excludability will interfere with the
advantage of nonrivalry and with its promise of increasing returns to
scale. In this narrative, however, the risk of such interference is a
price that we must pay to bring the revolutionary advantage enjoyed
by nonrivalrous ideas down to the earth of interests and incentives.
Before exploring the confusions and fallacies that lie at the
heart of this narrative, it is important to pause on a prior point:
the conception of the knowledge economy as a practice of production
that is not only organized around ideas but that also shares in the
attributes of ideas. Because it shares in their attributes, it
differs from all previous forms of production, which had no such
internal and intimate relation to ideas.
Today’s knowledge economy does differ from earlier practices of
production, but it is no easy matter to settle on an accurate view of
what distinguishes it. In each sector in which the knowledge economy
has taken hold, it remains an insular vanguard, underdeveloped and
even elusive. A practice of production reveals its deepest features
and higher potential only as its spreads across a wide range of forms
of economic activity, but the knowledge economy has yet to do that.
We cannot do justice to its nature—in the arrested version that it
now takes or in the deeper and widespread form that it might take in
the future—by representing it as an economy of ideas that happens
to be given material expression and to intersect with economic
arrangements and incentives. Just as no practice of production has
ever been idealess, no practice of production can ever work, or be
understood, as bodiless—if by the body we mean the detailed ways in
which we bring together our discoveries of the workings of nature,
our mechanical devices, and our regimes of cooperation.
Consider the example of the application of artificial intelligence
to the task of organizing the way in which high-skill workers use 3-D
printers and other numerically controlled and adjustable machine
tools in advanced manufacturing. Among the tasks to be addressed is
the allocation of machine and labor time among three main tasks: (1)
the manufacture of variable batches of relatively standardized
products; (2) the occasional development, by analogical extension, of
new variants of these standardized products; and (3) exploratory
tinkering with the goal of creating products that no one ever
envisioned before but that people working with advanced machines
discover that they can make. This third category evokes the
difference between a national defense strategy that is organized
around foreseeable combat situations (for example, a conventional war
on a particular frontier or an asymmetrical proxy war against a
distant power manipulating a troublesome neighbor) and a strategy
that is built around military capabilities and their alternative
uses. The allocation of resources and time among these three tasks is
a problem that must rank high in the concerns of a contemporary
knowledge economy. As in the role of algorithm-based investment
decisions in finance, the division of labor between machines
replacing human minds and minds monitoring and using machines remains
open to experience and experiment.
How can the development of artificial intelligence in computer
science and mechanical or electrical engineering be driven by
attempts to accomplish these three tasks? How can production be set
up so that it becomes part of the process of perpetual innovation
rather than a passive, occasional beneficiary of scientific
discoveries and technological breakthroughs external to itself? What
kind of worker, educated in what way, can rise to this challenge?
What way of organizing work can make the most of technical and
economic opportunities? And under what legally defined institutional
arrangements and cultural impulses is such a way of organizing work
most likely to prevail and flourish?
None of these questions speaks to the conventional account of the
knowledge economy as a practice of production organized around
disembodied, nonrivalrous ideas that the law of intellectual property
allows profit-seeking entrepreneurs to turn into sources of rents.
All these questions concern the nature of innovation—its episodic
or perpetual character, the extent to which it is or is not
integrated into productive activity, and the degree to which
experimentation is favored or inhibited by established institutions
and culture. It is there, rather than in the specious contrast
between production-as-ideas and idealess production, that we must
look for what makes—or can make—the knowledge economy
distinctive. And the distinctiveness is likely to show and to count
only as the knowledge economy begins to break out of the insular
vanguards to which it has thus far remained confined.
Increasing Returns to Scale and
Diminishing Marginal Returns
If the first basis of Romer’s view is an untenable contrast
between a practice of production centered on ideas (supposedly
today’s knowledge economy) and all earlier productive practices,
the second basis is a thesis about the potential of the knowledge
economy to yield increasing returns to scale. To understand the
content of this thesis and the mistake that it makes, we need to
address an unrecognized source of confusion in standard economic
theory: the relation between constant returns to scale and
diminishing marginal returns. The confusion is all the more
significant and influential—yet largely disregarded—because it
forms part of the basic education of economists (as well as that of
the much larger number of young people who are exposed to
introductory courses in the discipline but go on to specialize in
other fields). One can often find this confusion, misrepresented as
simple logic, in an early chapter of many textbooks.....
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