Dissertations

I spent most of the past week trying to untangle two models of economic growth: the neoclassical growth model and the new growth economics model.  (Or, as others call them, the Solow-Swan model and the Romer model.)  If you don't understand foundational models like those devised by Robert Solow and Paul Romer, you're pretty much screwed when you need to decypher anything written afterwards.  And for an aspiring law and econ geek like myself, that presents a problem when dissertations come due.

Solow won a Nobel prize in economics for a paper he published in the 1950s.  The key discoveries of Solow's work were that physical capital and labor exhibit diminishing returns, and that nations use inputs efficiently.  The Solow-Swan model therefore predicts the following: 

First, increasing capital relative to labor creates economic growth, since people can be more productive given more capital. Second, poor countries with less capital per person will grow faster because each investment in capital will produce a higher return than rich countries with ample capital. Third, because of diminishing returns to capital, economies will eventually reach a point at which no new increase in capital will create economic growth.

Sound familiar?  I think so too.

When forced to calculate how innovation occurs, however, Solow described it as an "exogenous phenomenon."  That is, when Solow couldn't figure out a way to describe how innovation occurs using mathematics, he concluded that innovation occurs as a result of forces that occur outside (exogenous) of the market.  Huh?

Thank goodness for Paul Romer.  In and around the time he left the University of Chicago, where fun goes to die, Romer figured out how to represent innovation mathematically using "human capital" as an input. Romer thus extended the Solow-Swan model by smashing it together with some ideas from fellow Chicagoan and Nobel laureate Gary Becker.  Romer's model is thus an endogenous growth model, because it shows how technological progress happens within the market, and not as something occuring in the ether.  But the key insight of Romer's model is that, unlike physical capital, innovation demonstrates increasing rates of return.  (If you're interested, Romer gave a plain-English interview on his theories back in 2001.)

What does this have to do with China and Chinese law?  Well, China tends to overinvest in physical capital and to underinvest in human capital, and uses foreign direct investment law to do the same.  So, eventually, if China doesn't get its act together in terms of human capital, it's not going to innovate, and growth will slow.  (Indeed, that might have already happened.)  For a country that hopes to foster independent/indigenous innovation, a system of laws that overly encourages physical capital investment is not the way to go.