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40

3.4 The Nature of Knowledge and the Determinants of the Allocation of Resources to R&D

Overview

Virtually all of the previous discussion takes the saving rate, s, and the fractions of inputs devoted to R&D, ai and , as given. The models of Chapter 2 (and of Chapter 7 as well) show the ingredients that are needed to make s endogenous. This leaves the question of what determines ai and . This section is devoted to that issue.

So far we have simply described the "A" variable produced by R&D as knowledge. But knowledge comes in many forms. It is useful to think of there being a continuum of types of knowledge, ranging from the highly abstract to the highly applied. At one extreme is basic scientific knowledge with broad applicability, such as the Pythagorean theorem, the germ theory of disease, and the theory of quantum mechanics. At the other extreme is knowledge about specific goods, such as how to start a particular lawn mower on a cold morning. In between is a wide range of ideas relevant to various classes of products, from the design of the transistor or the invention of the record player to an improved layout for the kitchen of a fast-food restaurant or a recipe for a better-tasting soft drink.

Many of these different types of knowledge play important roles in economic growth. Imagine, for example, that a hundred years ago there had been a halt to basic scientific progress, or to the invention of applied technologies useful in broad classes of goods, or to the invention of new products, or to improvements in the design and use of products after their invention. These changes would have had different effects on growth, and those effects would have occurred with different lags, but it seems likely that all of them would have led to substantial reductions in growth.

There is no reason to expect the determinants of the accumulation of these different types of knowledge to be the same: the forces underlying, for example, the advancement of basic mathematics are different from those behind improvements in the design of fast-food restaurants. There is thus no reason to expect a unified theory of the growth of knowledge. Rather, we should expect to find various factors underlying the accumulation of knowledge.

At the same time, as Romer (1990) emphasizes, all types of knowledge share one essential feature: they are nonrival. That is, the use of an item of knowledge, whether it is the Pythagorean theorem or a soft-drink recipe, in one application makes its use by someone else no more difficult. Conventional private economic goods, in contrast, are rival: the use of, say, an it em of clothing by one individual precludes its simultaneous use by someone else.



An immediate implication of this fundamental property of knowledge is that the production and allocation of knowledge cannot be completely governed by competitive market forces. The marginal cost of supplying an item of knowledge to an additional user, once the knowledge has been discovered, is zero. Thus the rental price of knowledge in a competitive market is zero. But then the creation of knowledge could not be motivated by the desire for private economic gain. It follows that either knowledge is sold at above its marginal cost or its development is not motivated by market forces. Thus some departure from a competitive model is needed.

Romer emphasizes that, although all knowledge is nonrival, it is heterogeneous along a second dimension: excludability. A good is excludable if it is possible to prevent others from using it. Thus conventional private goods are excludable: the owner of a piece of clothing can prevent others from using it.

In the case of knowledge, excludability depends on both the nature of the knowledge itself and on economic institutions governing property rights. Patent laws, for example, give inventors rights over the use of their designs and discoveries. Under a different set of laws, inventors ability to prevent the use of their discoveries by others might be smaller. To give another example, copyright laws give an author who finds a better organization for a textbook little ability to prevent other authors from adopting that organization. Thus the excludability of the superior organization is limited. (Because, however, the copyright laws prevent other authors from simply copying the entire textbook, adoption of the improved organization requires some effort; as a result there is some degree of excludability, and thus some potential to earn a return from the superior organization.) But it would be possible to alter the law to give authors stronger rights concerning the use of similar organizations by others.

In some cases, excludability is more dependent on the nature of the knowledge and less dependeni on the legal system. The recipe for Coca-Cola is sufficiently complex that it can be kept secret without copyright or patent protection. The technology for recording television programs onto videocassette is sufficiently simple that the makers of the programs were unable to prevent viewers from recording the programs (and the "knowledge" they contained) even before courts ruled that such recording for personal use is legal.

The degree of excludability is likely to have a strong influence on how the development and allocation of knowledge depart from perfect competition. If a type of knowledge is entirely nonexcludable, there can be no private gain in its development; thus R&D in these areas must come from elsewhere. But when knowledge is excludable, the producers of new knowledge can license the right to use the knowledge at positive prices, and hence hope to eam positive returns on their R&D efforts.

With these broad remarks, we can now turn to a discussion of some of the major forces governing the allocation of resources to the development



"Ttiis implication makes academics sympathetic to this view of knowledge.

of knowledge. Four forces have received the most attention: support for basic scientific research, private incentives for R&D and innovation, alternative opportimities for talented individuals, and learning-by-doing.

Support for Basic Scientific Research

Basic scientific knowledge has traditionally been made available relatively freely; the same is true of the results of research undertaken in such institutions as modern universities and medieval monasteries. Thus this research is not motivated by the desire to earn private returns in the market. Instead it is supported by governments, charities, and wealthy individuals and is pursued by individuals motivated by this support, by desire for fame, and perhaps even by love of knowledge.

The economics of this type of knowledge are relatively straightforward. Since it is given away at zero cost and since it is useful in production, it has a positive externahty. Thus its production should be subsidized. If one added, for example, the infinitely-lived households of the Ramsey model to a model of growth based on this view of knowledge accumulation, one could compute the optimal research subsidy. Phelps (1966b), Nordhaus (1967), and Shell (1966, 1967) provide examples of this type of analysis.

Private Incentives for R&D and Innovation

Many innovations, ranging from the introductions of entirely new products to small improvements in existing goods, receive little or no external support and are motivated almost entirely by the desire for private gain. The modehng of these private R&D activities and their implications for economic growth has been the subject of considerable recent research; important examples include Romer (1990), Grossman and Helpman (1991a), and Aghion and Howitt (1992).

As suggested above, for R&D to result from economic incentives, the knowledge created by this R&D must be at least somewhat excludable. Thus the developer of a new idea has some degree of market power. Typically, the developer is modeled as having exclusive control over the use of the idea and as hcensing its use to the producers of final goods. The fee that the innovator can charge for the use of the idea is limited by the usefulness of the idea in production, or by the possibility that others, motivated by the prospect of high returns, will devote resources to learning the idea. The quantities of the factors of production engaged in R&D are modeled in turn as resulting from factor movements that equate the private factor payments in R&D with the factor payments in the production of final goods.



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