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 / First Quarter 1997 / Issue 6(originally published by Booz & Company)


An Interview with Paul M. Romer

Stanford university economics professor Paul Romer explains how the knowledge economy is creating monopoly power and changing the nature of competition. This stems from the ability of knowledge-based industries to generate increasing returns by capturing as much market share as possible. Unlike traditional monopolies, however, information age giants will face being superseded by new entrants and little danger exists of permanent monopolies -- even in an industry like software.

It is hard to label an economist who just turned 40 as venerable, but that is what Paul M. Romer's peers call the Stanford University economics professor. Professor Romer, who also teaches at the University of California at Berkeley while conducting research at the Hoover Institution at Stanford and the Canadian Institute for Advanced Research in Toronto, is best known for his theories about the dynamics of growth. In Professor Romer's view, knowledge is the unsung hero of the growth game. While most classical economists -- not to mention Marx -- focused on production, labor and capital, Professor Romer added knowledge and technology to the mix.

The classical approach operates well in the physical economy of resource extraction and commodity production, according to the professor. That economy is characterized by diminishing returns, since each additional ton of copper or barrel of oil is harder to find than the previous one and is -- by definition -- scarcer and therefore more expensive to extract from the earth.

The information economy is different, however. Large upfront costs are incurred to write a complicated piece of software or to discover specific gene sequences. But after the initial work is done, the cost of each additional "unit" is minimal or sometimes even nil. Software can be copied onto disks at very low prices or sent out over the Internet. Each gram of protein produced by genetically altered bacteria only adds to the world's supply. As a result, while returns diminish in the physical economy, they increase in the knowledge economy -- a cause for hope, according to Professor Romer.

There is another important tenet in the professor's world view. It is that the more we discover new things, the better we get at the process of discovery itself. Knowledge builds on itself. As a result, the capacity to create wealth and value increases over time, surely another reason for optimism.

Professor Romer's work is serious and academic. But while most economists have their cadre of on-the-one-hand, on-the-other-hand adherents and detractors, Professor Romer's work has so far attracted far more support than dissent among his peers, prompting speculation that he may someday be a recipient of the Nobel Prize for economics. Economist Paul Krugman and management theorist Peter F. Drucker are among Professor Romer's biggest and most public boosters.

Professor Romer recently spoke with Strategy & Business at his Stanford office, in Palo Alto, Calif. What follows are excerpts from that conversation.

S&B: For the most part, knowledge, like technology, has been taken for granted by economists who look at the factors that propel growth. But in your work, you assert that knowledge can raise returns on investments and that it is a factor of production, like capital, labor and raw materials. Does the information economy work differently from the classical economy?

Paul Romer: Let's back up. My work on growth can be traced back to an attempt to isolate the differences between the information or knowledge-based economy and what came before it. My belief is that those differences are important for our understanding of growth. Those distinctions matter to people running firms and they should matter to policymakers. They are issues that show up at a number of points in the economy. And since those issues are topical right now, it makes my work in this area a lot of fun.

S&B: What differences are you referring to?

Paul Romer: Let me articulate it this way. One feature of knowledge can be summarized by Isaac Newton's statement that he could see far because he could stand on the shoulders of giants. In other words, his notion was that knowledge builds on itself, which means that as we learn more, we get better and better at discovering new things. It also means that there's no limit to the amount of things we can discover.

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