Words changes the World, and it is abruptly true in the world of Economics whereby the theories propounded by various economists comes to play in determining the economic effects; but what gave fillip to the major Economic thoughts and created a revolutionary impact is an intellectual effort of David Warsh, who through the stratagem of the invisible hands, speaks benevolently on increasing returns in the Free Market situation. His book, “Knowledge and the Wealth of Nations” is apparently about a paper written by Stanford’s Paul Romer, which was published in the Journal of Political Economy in 1990, but, it takes us to a glorious tours of economic thoughts of Smith, Malthus, Ricardo, Mills, Walras, Marshall, von Neumann, Keynes, Robinson, Ramsey, Samuelson, Solow, Arrow, Debreu, Dixit, Stiglitz, Summers, Mankiw and Krugman, shaping the wealth of nations.
His book probes into the questions these economists have raised, how they have determined the wealth of nations and how their contributions impact our thinking process. According to Warsh, it was Romer (1990), who was able to solve one of the biggest riddle taking an example of a Pin Factory that means the way to combine Adam Smith’s Pin Factory with his Competitive Equilibrium. It was known that increasing returns comes to play in the Pin Factory and the manufacturer benefits from increasing returns due to the increase in sales and larger productivity, which is caused due to the lower costs leading to lower prices and more sales. Romer allowed growth and technological change to vary based on the actions of people, who act primarily through profit-seeking investment decisions.
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Generally in increasing returns, large monopolies govern the markets. And hereby the question that creeps up, in a situation of competitive equilibrium, thousands of small firms compete on prices to provide consumers with what they want at the lowest possible price and so economists are fixed in prisoners dilemma, in this Invisible hand theory, as Michael Schrage, said that Invisible hand is about the rising costs and increasing returns, whereas Pin factory is about falling costs and decreasing returns. When Paul Romer, again revised the paper, he identified that one of his teachers had seen this dilemma. Even in 1951, George Stigler wrote, “Either the pision of labor is limited by the extent of the market and, characteristically, industries are monopolized; or industries are characteristically competitive and the [Invisible Hand] theorem is false or of little significance.” Further stressing this point Stigler said that, they cannot both be true. But, Warsh Romer’s model has solved the riddle, by allowing the space for increasing returns for growth, while keeping general equilibrium at competitive framework.
In his “Knowledge and the Wealth of Nations”, Warsh chronicled the new economic thoughts that emerged from the series of arguments that ensued in as early as 1979 and provides deep insight into how actually an economy takes its shape and grows. Warsh solved all the contradictions and answered the questions that were puzzling the economists in a very easy language and understandable to non-economists too, which could be easily witnessed by economists who succeeded in solving the Smith’s 200 years old dilemma by giving new dimension to the advancements in technology and made it as an integral part of the economic growth instead of putting it under the new banner of parallel development. He developed the new growth theory which has helped to explain the monopolistic roles of the firms like IBM or Microsoft and bring to forth the importance of intellectual property and along-with this acts as an advisor to those who are helping in the expansion of the economy.
Columnist Warsh treats the Adam Smith’s invisible hand and pision of Labor concepts in his Wealth of Nations as contradictory. Willfully and with thought provoking ideologies that he advocated, he identifies this contradiction as the struggle between the Pin Factory and the Invisible Hand. On one side, Smith emphasized that there can be huge increase in productivity by the pision of labor, as for e.g. in pin factory where by piding the labor according to their specialization, the quality and the quantity of products can be increased tremendously like one man pulls the wire, another straighten it, third one can cut it.
In this way to manufacture such a small pin requires separate specialization of eighteen hands and Smith’s calculation states that if dozen persons are employed, they can manufacture 5000 pins in a day, and as a result the pins will require a large market. On the other hand, he advocated that how the market economy can exploit the self interest of each employee to achieve the common goal and, thus taking each inpidual on a route towards over all economic development as if “by an invisible hand to promote an end which was no part of his intention.” (Krugman, on review of Knowledge and Wealth of Nations, para.3).
This example clearly brings forth the importance of increasing returns to scale-the bigger the pin factory will be, the more specialized will be its workers, and thus the quantity of the pins produced will be more. But on the other hand, it is also true that increasing returns creates a situation of monopoly, because then there is a domination of large players and the small players are thrown out of the industry.
It is also true that for invisible hand to work effectively, there ought to be number of players in the competition in any given industry, and if there are number of players in any given industry then there won’t be any monopolistic position and as such diminishing returns will occur, as has continuously been embarked upon by economists since last two centuries. About this Warsh explains that it was happening because the economics has always been visualized and conceptualized by the mathematical formulas whereas increasing returns is more of ideology and can hardly be understood mathematically. But nobody can ignore this reality that it is the increasing returns that is playing its part in the economy. Its best example can be given of Railways. Warsh rightfully quoted Kenneth Arrow, a recipient of Noble prize in economic science for work that, “increasing returns were an “underground river” in economic thought, always there, yet rarely seeing the light of day”.
In the second half of the book, Warsh advocates the Romer’s idea of pision of economics into people, ideas and things instead of land, labor and capital, and thus created a revolution that is predominantly being adopted by the economists in the New Growth Theory, and thus shown to the world that how this underground water finally became a fountain. And this became a Romer’s theory of endogenous growth. Romer took up this idea from Robert Solow, who states that, “A country’s long run growth rate was fixed, based on a stated rate of technological change”, whereas Romer insists that growth and technological change depends on the investment decisions of the profit motivating people.
The important point that needs to be noticed in the book is his discussions about the traditional macro economic policies concepts such as the monetary policy, education policy, NIH funding, immigration policy regarding visas for scientists and students, and federal policy regarding stem cell search. Warsh pinpoints that Romer has offered a Framework and made the economists think about the importance of knowledge in generating “wealth of nations”. For the knowledge he said that it is a non-rival good, which can be used through trade secrets or patents. This was brought in front while discussing about rival and non rival goods under the heading of growth theory. A good is considered as a rival good when its use by one person restricts its use by another, whereas non rival goods can be used by quite number of people. Before 1980, the concept of rival and non-rival goods was rarely discussed, but now its importance is being understood by economists the world wide.
Developing nations can take adequate advantage of all this. They can import the knowledge from other countries without causing disadvantage situation to developed nations. This they should do in the area where there is an ample scope for further study and developed nations can stimulate their knowledge base through various training and educational schemes, and Romer insists that this aim can be achieved if the governments act from the supply side, by increasing the supply of technically competent persons like engineers, scientists for further research and development. Whatever the benefits are attained can be achieved by rewarding the companies with upfront prize rather then giving them monopolistic rights, and there can be share of benefits wisely.
Many economists and reviewers even pinpointed that there are no contradictions in Adam Smith as pointed by David Warsh in invisible hand and pision of Labor. But there were contradictions which were sorted out beautifully by economists as great as David Warsh.
Romers education at Chicago University in physics and Economics at MIT, Queens, and Chicago exposed him to the thoughts and ideas of various economists and notable among them were von Neumann growth model, the work of Robert Lucas and Jose Scheinkman, which erupted to what came to be known as growth theory in monopolistic competition. Since last twenty years David Warsh is contributing his services for www.economicprinicpls.com, as a Journalist, editor and a proprietor. He is a two time winner of financial journalism Loeb Award and was a fellow of the American Academy in Berlin in 2004. He also gave his outstanding reviews of the world of economics for the Boston Globe. Besides, he also wrote on business for Forbes, The Wall Street Journal, Pacific Stars and Stripes and Newsweek. Besides giving this outstanding world of the Knowledge and Wealth of Nations, to his credit are also two books: The Idea of Economic Complexity and Economic Principals: Masters and Mavericks of Modern Economics which was a collection of his newspaper columns.
WORKS CITED
- Krugman Paul “Review of ‘Knowledge and the Wealth of Nations,’ by David Warsh”Economist’s View Internet (May 03, 2006) Available: http://economistsview.typepad.com/economistsview/2006/05/krugman_review_.html,March 2nd, 2007.
- Smith, Adam (1723-1790) An Inquiry into the Nature and Causes of the Wealth of Nations London: Methuen and Co., Ltd., ed. Edwin Cannan, 1904. Fifth edition. First published: 1776. http://www.bibliomania.com/2/1/65/112/frameset.html