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


An Interview with Paul M. Romer

But let's back up for a moment. If you want to get people to discover extremely valuable concepts like vaccines, you would like to offer them really high prices for their discovery. This creates an incentive to do the work necessary to make the discovery. So, in this world of knowledge and recipes, there is always an unavoidable tension between wanting to have low prices after the fact, so a knowledge-good can be distributed widely, and wanting to promise strong property rights and monopoly protections in advance, as an incentive and a motivation for discovery.

S&B: How do you resolve the problem, Paul?

Paul Romer: What we have to do is work out a balance between tolerating some monopolies and monopoly profits -- since that's how we motivate people to discover new recipes -- with competition to keep prices low and distribute products widely. We encourage this competition by granting property rights that are partial or incomplete. In practice, what this means is that while in the physical economy, with diminishing returns, there are perfect prices, in the knowledge economy, with its increasing returns, there are no perfect prices.

S&B: Are you suggesting that we must simply tolerate monopoly prices?

Paul Romer: Yes. I'm also suggesting that we have to establish property rights that are incomplete. In the world of objects, you don't have to make these kinds of compromises. We use Government policy to limit monopoly. We also establish very strong property rights. For example, it would be very wasteful for property rights on land to expire after a certain period of time and then for everyone to be able to use it freely. But this is precisely what we do with patents. One key difference is that in the world of ideas, you cannot have both strong property rights and competition. The other is that you don't get congestion over the use of ideas. When we look back on systems where a group of people did have free access to a physical resource like land, we speak of a "tragedy of the commons." But there is no similar tragedy of the intellectual commons.

Now, as I suggested above, if there were not all these additional things to discover, we would be pessimistic about this new world of ideas because of all the monopoly power we are creating with patents and copyrights. In fact, if there were nothing left to discover, we would treat all knowledge the same way we treat the knowledge behind the principle of vaccination. It would be common property and everybody would be free to use it.

But fortunately, in the knowledge economy, there are always new things to discover. We grant property rights over knowledge, and this leads to a leapfrogging process whereby the potential of future monopoly profits induces new discoveries. As a result, a new entity will emerge and come into a market at some point and leapfrog all the existing entities. When that happens, you'll get a big jump in terms of productivity and economic value, and the old monopolists will typically be displaced. Remember, this is a different dynamic from the one we described in the classical economy, where all competition was to produce existing goods at lower prices.

So over in this idea part of the economy, we worry much less about having the Government actively intervene to strike down any hint of monopoly power and keep all firms small. We rely much more on the process of what Schumpeter called "creative destruction," where you have a sequence of temporary monopolies that are superseded by new monopolists selling new products and services.

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