The standard neoclassical model assumes growth in a fluctuating but never-far-from equilibrium, driven by an exogenous force called 'technological progress' or 'total factor productivity' (TFP). Goods and services are abstractions. When there is excess demand for goods, prices rise, profits increase, there is competition for labor, and wages rise. Higher wages result in increased demand, which pushes up demand still further. However, higher wages induce producers to become more efficient. They increase labor productivity by investing in new capital equipment incorporating new technology.
These investments naturally take some time to come on stream. When they do, wages stop rising and demand stops increasing. The result is excess supply, such as the present situation in the world for most products. In a competitive 'free market', prices then start to fall, but in a world of oligopoly and cartels, prices do not fall, or fall very little. Nevertheless, older factories become less profitable, or unprofitable, and eventually they close (unless governments step in to prevent this). In the ideal competitive world, supply finally declines and demand increases due to falling prices, unless fear of unemployment causes consumers to stop spending, thus making the problem worse. Both expansion and contraction tend to feed on themselves, to some extent. Note that this idealized description does not depend in any way on natural resources, as such, except insofar as they are supplied like other goods subject to market demand.
Needless to say, the real world is not much like the idealized free market world where there are no essential resources (other than labor and capital), no wastes, no unions, no cartels, no regulators, no taxes, no subsidies and no crime or corruption. However, even in the neoclassical paradigm the microeconomic role of new technology is straightforward, provided the incentives for investment and the sources of profits to re-invest are not questioned: it results from investment aimed at cutting costs so as to reduce prices or to increase the performance or consumer appeal of products or services. Either way, the purpose of R&D for the firm is to hold or increase market share, which is the surest way to increase the profits of the firm.
The macroeconomic role of R&D in the neoclassical model is much less clear. As mentioned already, the majority of simple models assume that technological progress occurs automatically, in equilibrium, and that its effect is to increase productivity at a steady rate. Some recent models equate technology with knowledge and call it 'human capital'. But these models cannot be quantified or used for forecasting purposes, lacking a reliable measure of knowledge/human capital. As we have noted, the neoclassical paradigm has no convincing explanation of why technological progress should be uniform or continuous (since it isn't), or why generic R&D or innovation should occur at all in the assumed equilibrium state.
In the disequilibrium paradigm the macroeconomic role of technology is more straightforward: when products become cheaper due to technological improvements in production, or more attractive to consumers by virtue of improved performance, the result is to increase demand. Increased demand leads to increased output, higher wages, lower costs (thanks to economies of scale and learning), increased capital investment and more R&D. All of these combine in a positive feedback cycle that drives overall economic growth, insofar as saturation of demand allows.
Technology may be equated (in some sense) with a stock of knowledge, or 'human capital'. But we assert strongly that the stock is not homogeneous, nor is it fungible. It is simply not true that innovations in every field are equally productive. The stock is not homogeneous, as Romer's theory, for instance, implies (Romer 1994). In reality some technologies are much more productive - by means of spillovers - than others, and economic growth depends on continued innovation in productive technologies, rather than innovation in general. We will come back to this point later, especially in Chapter 6. We still lack a useful measure of the past and current state of technology. We also lack a quantifiable link between past technological change and resource consumption. These topics will be considered later. What we still need for macroeconomic modeling is a viable quantitative measure of the state of technology (knowledge, skills, etc.) at the national level. Later in this book we propose a new measure to serve this function by focusing on the impact of accumulating knowledge as applied specifically to aggregated materials-conversion processes in the economy. We suggest hereafter that a quantifiable thermodynamic measure, namely exergy conversion efficiency, can be regarded as a plausible surrogate for technical progress, at least in the past. This measure is defined and estimated subsequently, in Chapter 4.
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