Page 127 - Global Political Economy_Understanding The International Economic Order

CHA PTER F IVE
(1) Investment in knowledge-creation and R & D activities by profit-
seeking entrepreneurs is an important determinant ofeconomic
growth.
(2) While the results ofR & D are partially captured or appropriated
by the investing firm, some ofthe results are not captured but
spill over and constitute public goods that can be exploited by
other firms, thus stimulating economic and productivity growth
throughout an economy.
(3) Nevertheless, most ofthe benefits ofthe new technology are cap-
tured by the investing firm and give it a competitive advantage
over its rivals; this can lead to an oligopolistic market.
(4) Firms tend to underinvest in R & D, and governments should
take appropriate actions to overcome this market failure.
(5) A nation’s human capital and skills determine its long-term
growth rate and its success in economic development. 24
The new growth theory has many important implications for the
nature ofthe economy and the status ofneoclassical economics. The
new theory is inconsistent with the fundamental assumption in neo-
classical economics ofperfect competition; that is, the beliefthat firms
are “price-takers” because prices are determined by the market and
firms cannot easily change the prices they charge. Although neoclassi-
cal theory assumes that ifa firm should lower its price to increase its
market share and should also increase its production, the increased
output will not lead to economies ofscale but only to lost profits;
the new growth theory assumes that because increasing returns are
possible, increasing output lowers unit costs and the firm can there-
fore increase its profit. And this means that the firm is a “price setter”
rather than a “price-taker.” To the extent that the new growth theory
is correct, the market must be viewed as an imperfect or oligopolistic
market rather than as a perfect one.
The new growth theory has engendered considerable controversy
within the economics profession. Some critics charge that there is
nothing especially novel about the new theory, asserting that its au-
thors have merely codified in their model the technological innova-
tion, monopolistic pricing, and increasing returns that have long been
familiar to economists. Other critics argue that the traditional vari-
ables ofgrowth such as capital investment and increases in the labor
supply have far greater explanatory power than the new theory sug-

24
Paul M. Romer, “Endogenous Technological Change,” Journal of Political Econ-
omy 98, no. 5 (October 1990): S71.
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