Romer’s Model of Technological Change

Endogenous Growth Models: Romer’s Model of Technological Change (1990)

  • Paul Romer presented this model in 1990.

  • It identifies a research sector specifically for producing ideas.

  • The research sector uses human capital and the existing stock of knowledge to create ideas or new knowledge.

  • A cornerstone of the analysis is the importance of ideas over resources.

    • Example: Japan is cited as a country with few natural resources but high growth due to openness to new ideas and technology.

  • New knowledge (ideas) enters the production process in three ways:

    1. New designs are used in the intermediate goods sector to produce new intermediate inputs.

    2. In the final goods sector, labor, human capital, and available producer durables produce the final product.

    3. A new design increases the total stock of knowledge, which boosts the productivity of human capital in the research sector itself.

  • Assumptions of the model include:

    • Economic growth is driven by technological change.

    • Technological change is endogenous (determined within the system).

    • Market incentives are important for making technological changes available.

    • Inventing a new design requires a specific amount of human capital.

    • The total supply of human capital is fixed.

    • Knowledge (a new design) is partially excludable and retainable by the inventor (e.g., via patents), providing incentives for R&D.

    • Investment in R&D can still be done by other firms, and they can benefit (partially) from the results.

    • Technology (a new design) is a non-rival input.

    • An existing design can be used by multiple firms repeatedly without reducing its value or requiring additional costs.

    • The low cost of using existing designs reduces the cost of creating new ones.

    • When firms invest in R&D and create a new design, there are externalities, but these are internalized by private agreements. (Note: This contradicts the earlier Romer model which emphasized spillovers due to inadequate patent protection. The source presents both aspects of Romer's work).

  • The technology production function is given by: ΔA = F(KA, HA, A)

    • ΔA: Change in technology (production of new technology/ideas).

    • KA: Capital invested in producing new designs/technology.

    • HA: Human capital employed in R&D.

    • A: Existing technology/stock of designs.

  • This function shows that technology is endogenous.

  • More human capital (*HA*) in R&D leads to a larger increase in technology (*ΔA*).

  • Due to technology being a non-rival input and partially excludable, there are positive spillover effects that other firms can use.

  • Production of new technology (knowledge/ideas) can be increased using physical capital (*KA*), human capital (*HA*), and existing technology (*A*).

Example based on the source: In Romer's 1990 model, a firm might employ engineers (*human capital*, HA) and use specialized equipment (*physical capital*, KA) to develop a new chip design (*ΔA*). This R&D effort benefits from the existing pool of knowledge about electronics (*A*). Once patented, this new design can be used by the firm (*partially excludable*) to create new intermediate inputs (new chips). Other firms, although they cannot illegally copy the design, can learn from the idea or the principles embodied in the design (*non-rival input*, positive spillover effects), making it easier for them to innovate in related areas. The original firm internalizes some gains through the patent, while the overall stock of knowledge increases, benefiting the economy. The importance of ideas is highlighted by Japan, which leveraged foreign ideas rather than natural resources for growth.

1-Minute Summary: Romer’s Model of Technological Change (1990) Romer's 1990 model centers on an *endogenous* research sector that creates new ideas and technological change. It emphasizes human capital and existing knowledge as inputs into producing new ideas (*ΔA = F(KA, HA, A)*). Key assumptions include ideas over resources, technological change as the growth driver, partially excludable but non-rival technology, market incentives for innovation, and positive spillover effects from new knowledge. This creation of new ideas, driven by R&D, leads to long-run growth.

Visual Summary: Mindmap

[Endogenous Growth Models]
    |
    +--- [Lucas Model]
    |       |
    |       +--- Basis: Uzawa's model
    |       +--- Key Driver: *Human Capital Investment* (Education)
    |       +--- Effects of HC:
    |       |   +--- *Internal* (Individual productivity)
    |       |   +--- *External* (Spillovers to others, technology)
    |       +--- Spillovers from: *Human Capital* (more than Physical)
    |       +--- Returns to Scale:
    |       |   +--- Firm Level: *Constant Returns*
    |       |   +--- Economy Level: *Increasing Returns*
    |       +--- Formula: *Yi = A(Ki). (Hi)H^e*
    |       +--- Crucial Factor: *Economy's average skills/knowledge* (H)
    |
    +--- [Romer's Model of Technological Change (1990)]
            |
            +--- Key Mechanism: *Endogenous Technological Change*
            +--- Central Element: *Research Sector* producing Ideas/Knowledge
            +--- Inputs to New Ideas (ΔA): *KA* (Capital in R&D), *HA* (HC in R&D), *A* (Existing Knowledge)
            +--- Importance: *Ideas over Resources*
            +--- New Knowledge enters production:
            |   +--- Intermediate Goods (New inputs)
            |   +--- Final Goods (Production process)
            |   +--- Research Sector (Boosts productivity of HA in R&D)
            +--- Nature of Knowledge:
            |   +--- *Partially Excludable* (Patents)
            |   +--- *Non-rival Input* (Used repeatedly without cost)
            |   +--- Leads to *Positive Spillover Effects*
            +--- Incentives: Market incentives important
            +--- Relationship: Low cost of existing designs -> Low cost of new designs
            +--- Formula: *ΔA = F(KA, HA, A)*