Paul Romer’s Nobel Prize In Economics Marks A New Era Of Innovation Driven By Ideas

by Tom Koulopoulos

Understanding the idea economy challenges much of what we’ve come to accept as industrial era economic gospel.

Paul Romer let his phone ring on the morning of October 8th . It was early and he wasn’t expecting a call. But when he checked to see who was calling he noticed it was from Sweden. When he called back he was put on hold.

It was a minor inconvenience, since, in many ways Paul Romer has been on hold waiting for the Nobel prize for nearly three decades. On Monday October 8 Romer and William Nordhaus, an economist at Yale, were awarded the Nobel for work both had done in helping us better understand the post-industrial era economy.

I had the opportunity to meet Romer in 1999 at an event I’d put on in San Diego. I didn’t know much about his work before that, but when Peter Drucker, who was also at the event, specifically asked to meet up with Romer for dinner it was clear to me that I needed to pay close attention.

Idea Economics

Ten years earlier, in 1990, Romer published what has come to be a cornerstone of economic thinking, especially as it applies to the role technology plays in the growth of the economy, global progress and productivity.

Before Romer’s work conventional thinking was that technological progress just sort of happened and accelerated over time. Not much thought was given as to the “why” behind the acceleration of technology.

We knew, through observation, that technology was becoming more complex, more powerful, and more pervasive, but we accepted that as though it was just the way things worked. We didn’t understand why technology moves faster in some economies than in others and, more specifically, how we can architect technology to further economic growth and progress.

Romer described how ideas were very different than the classic factors of production; raw materials, labor, and capital. In the classic view of economics those who own the factors of production profit and benefit from them. In a world of ideas we all profit and benefit from each others’ ideas. Just because I use an idea does not make it any less valuable to you, in fact it’s just the opposite; the more people who use the idea the more valuable it becomes. Think of software, email, crowdsourced GPS, even Uber. The more pervasive it is the more we all benefit. As Romer puts it, “The more we know, the easier it gets to discover.”

If this phenomenon sounds familiar it’s because we have come to realize it at an intuitive level through our experiencing it.

However, Romer went into far more detail in a 1990 paper that was the foundation for his Nobel. If you haven’t heard of it it may be because the title, Endogenous Technical Change, didn’t exactly roll off the tip of your tongue. Endogenous simply means that change, growth, and productivity happens through specific efforts by government or private industry rather than by unexplainable external or what economics refer to as exogenous factors.

If that still seems a bit obtuse, Romer summed it up much better when he later said,

“Every generation has perceived the limits to growth that finite resources and undesirable side effects would pose if no new recipes or ideas were discovered. And every generation has underestimated the potential for finding new recipes and ideas. We consistently fail to grasp how many ideas remain to be discovered. Possibilities do not add up. They multiply.”

That multiplier effect is the economic cornerstone for how innovation and technology shape an economy of ideas. It also helps to describe the phenomenon we’ve seen over and over with large tech companies such as Google or Facebook which operate as near monopolies. While the thought of a monopoly may seem anathema within an industrial era context, aspects of it become foundational to how an idea economy works.

You’re likely thinking that this creates an enormous innovation liability since it limits or eliminate competition. But that’s exactly the industrial age thinking that stifles innovation.

In an earlier Inc article I described how significantly disruptive technologies had to exist initially as “natural” monopolies for a period of time in order to justify both the investment needed to build out a new industry and to adequately control the vertical integration needed to build a complex product or service. The same applies to many other industries, such as pharmaceuticals where the fundamental asset that must be protected is a recipe that requires enormous initial investment and virtually no incremental per-unit cost. Again, think of software or code which is reproduced with near zero cost.

The easiest way to think of Romer’s work is to think of the shift from the material value of industrial era products to the value of the ideas and experiences of products. According to Romer, “Human material existence is limited by ideas, not stuff, people don’t need copper wires they need ways to communicate, oil was a contaminant, then it became a fuel.”

Coming Down From The Ivory Tower

One of the things that most impressed me when I first met Romer, and which differentiates him from many economists who live in academic ivory towers, is that he gave up tenure at Stanford to take a five year break from academia and start Aplia, a company that was one of the earliest providers of online education. It was no coincidence that Romer started a company which had as its mission the dissemination of ideas, applying many of his theories to his own startup. He later sold Aplia to Cengage before returning to NYU where he directs the Marron Institute of Urban Management. Despite his achievements to date, this is where Romer’s most influential work may yet to be done

Despite the promise of virtual work, populations are flocking to cities. This is true of developed economies but much more so for developing economies in Asia and Africa.

The challenge in these economies is to get out of what Romer calls the coordination trap. That’s the challenge of trying to rebuild the many components of an economy from the inside out, where they are stifled by existing rules, laws, policies, procedures, and cultural constraints. Innovation within these constraints is something that’s close to impossible.

Romer’s answer to this is what he calls Charter Cities. These are effectively startup cities that have the ability to operate outside of the stifling influences of the status quo. In the same way that established incumbent companies are disrupted by innovative startups unencumbered by legacy, countries need an equivalent startup model for cities.

Romer points to cities such as Hong Kong and Shenzhen China and examples of how city startups can revolutionize and redefine a country’s economy by providing a safe zone where a new economic model and culture can evolve. Referring to how Hong Kong has been instrumental in helping develop the Chinese economy, Romer says, “In a sense, Britain inadvertently, through its actions in Hong Kong, did more to reduce world poverty than all the aid programs that we’ve undertaken in the last century.”

The long term implications of Romer’s work will be foundational to how we build the 21st century economy, our businesses, and the urban landscapes that many of us will inhabit.

In an interview with the official site of the Nobel Prize Romer recounted how he had been notified twice before that he had won the Nobel, only to find out the reports were false. So, you have to wonder what he was thinking when he saw the call coming in from Sweden.

Probably that after a few decades he could wait to call back.

This article was originally published on Inc.

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Tom Koulopoulos is the author of 10 books and founder of the Delphi Group , a 25-year-old Boston-based think tank and a past Inc. 500 company that focuses on innovation and the future of business. He tweets from @tkspeaks.