What The Standard Theories Do Not Explain

Much of the recent mainstream literature is concerned with the growing empirical evidence from growth-accounting studies, namely that factor accumulation - even with broad redefined factors, such as 'human capital' - matters less than TFP growth, which still remains essentially unexplained, except in qualitative terms. Models comparing growth over a large sample of countries are forced to make 'heroic' assumptions about the basic common growth rate, about the initial stocks of capital and technology and about the creation of and access to technology. As Mulder notes,

The heroic assumption of an identical [growth rate] across countries goes back to the traditional neoclassical assumption that technology is a public good ('blueprints can be found in handbooks and now even on the internet, so everybody has free access to the latest innovations'). One needs not much empirical research to know that this can be far from the real life of technological change and technology diffusion, and technological progress can differ substantially across countries. (Mulder 2004)

In short, neoclassical growth theory does not reflect the patterns of technological progress in the real world, or our two 'stylized facts' 14 and 15.

Homo economicus is supposed to be a rational (utility-maximizing) decision-maker and H. economicus equates utility with money, at least in situations where a monetary calculation is possible. It follows that rational economic agents do not invest in projects that are known to have a negative rate of return or a negative expectation value (of utility). They do not buy lottery tickets or bet on horses, or prospect for gold to make money, though they might do so for the excitement. More important, some of the people who like risky adventures (including lottery tickets) are the crazy inventors who refuse to consider the very low odds of success and who nevertheless persevere. A very few, but a very important few, are the ones who come up with history-making 'radical innovations' in the Schumpeterian tradition (stylized fact 15). Standard theory cannot explain this fact.

Romer, in particular, argues that it is the number of innovations - or new 'recipes', in his words - rather than their quality, that contributes to economic growth (Romer 2002). But most inventions, and improvements, are so small and so narrowly focused on a particular product that they have essentially no spillover effect (see item, 14). This also means that formal R&D, in the aggregate, also has very little spillover effect. It is very hard to see how a razor with five blades, a new corkscrew, a new depilatory, a new lipstick color or hair-dye, a livelier golf ball, or a new fiberglass golf club can contribute even slightly to economic growth. Innovations such as these are very narrowly focused and in most cases merely replace an earlier product in the same market segment without increasing overall demand.

The radical innovations that yield major spillovers are comparatively rare and easily recognized. Practical applications of nuclear energy or superconductivity, or semiconductors, or space technology or lasers or gene splicing create fundamentally new products and services. They drive long-term economic growth by cutting costs and prices, keeping the economy far from equilibrium. They are not really accounted for in current neoclassical economic theory.

Most macro-models still assume (for convenience) that knowledge growth is exogenous, although microeconomists who work in the area of technology per se realize that the contrary must be true. However, there is another feature of technological evolution that has been given much less attention than it deserves, from the standpoint of macroeconomic theory. It is quite simply that 'knowledge', in recent economic models of the AK type, is regarded (for convenience) as homogeneous and fungible (that is, uniformly applicable across sectors).

On the contrary, we think technology is inhomogeneous and - with rare exceptions - non-fungible. Inhomogeneity means that some technologies have vastly more economic importance (that is, are more productive) than others. Indeed, it is fairly easy to identify some of those technologies, or families of technologies, that currently have the greatest impact. Candidates might include iron and steel, steam power, internal combustion engines, electric power and its many applications, telecommunications and information processing. Non-fungibility means that improvements in a specific technology may have no impact (that is, spillover) on others. That is true of all of the examples mentioned in a previous paragraph (five-bladed razors, depilatories, corkscrews, lipstick colors, golf balls, etc.).

Neoclassical growth theory also cannot explain the other two stylized facts, namely 16 and 17. It is important to note that the underlying accounting identities and physical conservation laws are applicable in any system, whether physical or economic, and whether or not the system is in, or near, equilibrium (in any sense). Granted that economics is not thermodynamics and economic equilibrium is somewhat different from thermodynamic equilibrium. But the basic characteristic of a system in any sort of equilibrium state is that 'nothing happens' spontaneously, that is, without exogenous intervention.

Nevertheless, the standard representation of the economic system is as an abstract box model, with production, investment and consumption linked by flows of money representing payments for labor services, capital services and consumption goods. In this model there is no special role for energy or raw materials, and there is no waste or dissipation.

We contend, on the contrary, that it makes more sense to view the economic system as a materials-extraction and processing system, in which raw materials are converted, through a series of stages, into physical work and finished materials, material products and finally, services. The materials that are extracted, whether or not they are embodied in products (or structures), and whether or not they are repaired, renovated, remanufac-tured or recycled, must eventually return to the environment in a degraded form (Ayres and Kneese 1969). While environmental and resource economists have for many decades recognized that these flows exist and that they have economic significance, they still play no role in the standard theory of economic growth.

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