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


An Interview with Paul M. Romer

S&B: What are the policy implications of the knowledge economy?

Paul Romer: There are big implications stemming from the recognition of the difference between the classical world of objects and the idea-based world. With objects, we have a good idea of what the right institutional arrangements are. We just establish infinite-lived property rights, make sure that there is no monopoly control and then let the market operate. This will lead to efficient allocations of physical objects. That is the lesson of laissez-faire, and it is still a very powerful lesson, one that too many politicians still do not understand.

S&B: And the aim of laissez-faire in that respect is greater economic efficiency?

Paul Romer: Yes. But more importantly, I would say the aim in both of these worlds is to generate or create more value. The kinds of problems you've got to solve in the classical realm are relatively simple. You just have to allocate scarce commodities among alternative users and between alternative producers.

S&B: It would seem that the aim of regulation in the commodity-producer world is to foster efficient production, while the aim in the knowledge world is to bolster future discovery. These are different roles for the Government, aren't they?

Paul Romer: Yes, they are. There is something inherently static about the classical vision -- that if there were nothing changing, nothing new being discovered, the price systems would be a good way to decide which mine should produce the next unit of copper. It also works well to decide which power plant should generate the extra megawatts of electricity and so on.

But over here, in the knowledge economy, there are these other imperatives. We have to worry not just about getting efficient usage from what we've got right now, but to figure out ways to discover all the new things we might need or be able to use. That is not a set of static problems. It is very dynamic.

S&B: Do the right institutions exist to make those policy choices?

Paul Romer: What's interesting about the knowledge economy is that we haven't figured out what the optimal institutions are. That's still a wide-open question. What is the best way to structure our economic world? This is true not only at the level of policy formation for a nation, but also for firms. Firms are really struggling with how they should organize themselves internally.

S&B: What are some of the policy issues within firms?

Paul Romer: The traditional logic within companies was like that in government. In the Government, people might look at medical discovery, for example, and say, "Gee, this is a market failure, we can't make the market work perfectly here." So the Government would then step in. It would collect taxes, use the revenue to pay for research taking place at universities and use that research to develop discoveries, like the principles behind vaccines. It would then give this knowledge away for free. We invented non-market institutions like universities to aid us in the production and distribution of ideas.

Firms, to a certain extent, have mimicked that solution. They say, "O.K., we need to generate new knowledge. We have different divisions that we can treat as profit centers. So, what we will do is tax those profit centers to create something that looks like a mini-internal university -- the R.&D. department." They then gave the funds to the R.&D. department and told it to do good work, just like the national Government does with the universities.

Over time, when the R.&D. department produces something, it gives that something away for free -- gives this knowledge away -- to any of the operating divisions that needs it.

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