New Growth Theory & Internet Policy

As I mentioned in my last post, which focused on Modern Monetary Theory (MMT), I’m working toward a post that will explain how a combination of MMT and New Growth Theory (NGT) can have major significance related to Internet policy and economic growth.

In this post I’ll focus on how New Growth Theory fits into this picture.  Be forewarned, the post is very long, with no entertaining videos to break up the text.  But I hope you’ll find the material worthwhile.  Most of it was originally written not by me, but by people whose thinking I greatly admire and believe is important…so, needless to say, I’d highly recommend it.

First a little background:

About four years ago I wrote a paper entitled “Spectrum Policy 2.0: White Space, the Internet and the Public Interest.”  (click here to access only the chapter most relevant to this blog post).

Though, as its title suggests, the paper focused specifically on spectrum policy, it also addressed broader questions of communication policy.  As I was working on it, I came across a paper written by Susan Crawford, a professor at Cordozo Law School and currently a visiting professor at Harvard.  Since then, Crawford has also served as a Special Assistant to President Obama for Science, Technology, and Innovation Policy, and co-led the FCC transition team between the Bush and Obama administrations. Later this year her new book entitled “Captive Audience” will be published. I’ve read drafts of it and would strongly recommend it to anyone who cares about the future of the Internet in this country.

Since at that time I’d never heard of New Growth Theory, I was blown away by its simple brilliance and significance, and that of Crawford’s application of it to Internet policy. My appreciation for the value and significance of their work is reflected in the length of this post, which includes key excerpts from Crawford’s paper and writings by and an interview with Romer.  I feel similarly about Yochai Benkler’s 2006 book entitled The Wealth of Networks: How Social Production Transforms Markets and Freedoms, which I also cited extensively in my paper (and also in this post).

To get us started, here’s a very brief introduction from my paper to New Growth Theory and its significance to communication policy:

New Growth Theory differs in key respects from the dominant neoclassical approach to economic analysis, which is often used as a basis for telecommunications public policy…Whereas the latter focuses heavily on market optimization via price-based supply and demand equilibriums, New Growth Theory focuses on an area largely ignored by neoclassical economists–“the economics of ideas.”…

This distinction—and its implications—underscore the Internet’s uniquely powerful potential to drive economic growth, and the need for communication policy to be geared toward realizing that potential.

Developing an “economics of ideas”

In her paper, Crawford summarized the evolution in economic thinking that culminated in Romer’s development of New Growth Theory (all bolding in this post is mine):

Traditional economics assumes implicitly that the economy as a whole is a closed system that will eventually reach equilibrium…In the view of an equilibrium economist, ideas are exogenous…

[I]n recent years, traditional economics has had to open its doors to work that rigorously examines the sources of increased productivity and focuses on the centrality of new ideas to economic growth. This research has transformed economics from a dismal science, preoccupied with the scarcity of land, labor, and capital (and concerned about the diminishing returns these resources will generate as markets perfect themselves) into a field that spends much of its time focusing on abundance, increasing returns, and the power of new ideas.

Robert Solow’s breakthrough work fifty years ago showed that “technological progress” allows economies to add to their outputs without the addition of more labor and capital. But Solow called this key technological-change element responsible for eighty percent or more of economic growth the “residual,” and dealt with it as an unexplained exogenous influence.

Beginning in the mid-1980s Paul Romer seized the challenge of transforming the “residual” of technological change into an endogenous element of his model explaining economic growth. Since then, Romer has pointed out in a series of papers that (1) nonrival but (2) partially excludable ideas can prompt increasing returns when they are (3) exploited on a large scale. We are beginning to understand that the growth in social wealth per capita in terms of real income per person over the last millennia is deeply related to the increase in the diversity of new ideas that has occurred over the same time…

Back to my paper, which discusses an interview with Romer, in which he clarifies the economic uniqueness and significance of ideas.

As Romer put it in a December 2001 interview published at Reason.com, “[t]here’s no problem of overuse or overgrazing or overfishing an idea. If you give an idea away for free, you don’t get any of the problems when you try and give objects away for free.”

In fact, rather than diminishing returns, ideas are characterized by increasing returns, since ideas can generate new ideas and new and better ways of doing things, ad infinitum. As such, they don’t fit very well within traditional economic analysis which, to retain its internal consistency and ability to generate seemingly meaningful mathematical calculations, has tended to ignore their significance

Romer has described “the combinatorial explosion of ideas” as a key source of economic growth. To exploit this potent source of growth most effectively, he says, “[y]ou have to have systems which explore lots of different paths, but then those systems have to rigorously shut off the ones that aren’t paying off and shift resources into directions which look more promising.” Another key ingredient, he says, is “freedom,” which he suggests “may be the fundamental hinge on which everything turns.”

Since the large-scale and highly efficient sharing, evaluation, interaction, expansion and implementation of ideas is an essential element of the Internet’s value, function and basic design, it makes sense that Romer’s New Growth Theory can provide a more solid foundation for analysis of Internet policy than traditional economic analysis, which has relatively little useful to say about the economics of ideas. And since the Internet has become central to virtually every sector of the communications industry (and arguably to most every sector of our economy), this would also apply to communication policy in general and, potentially, to a range of economic policy issues, especially those tied to industries that make heavy use of the Internet.

Applying NGT to communication policy

In the following passages, Crawford eloquently explains the significance of New Growth Theory and the economics of ideas to Internet policy, which in turn speaks to the historical significance of the Internet itself:

In the last 200 years or so, technological progress and concomitant economic growth have been particularly dramatic. Romer and others suggest that this may be happening because more people and more (and better) institutions are out looking for new ideas and new technologies. The freedom to look for these ideas is fundamental to economic growth…

The new growth theorists put scale in the foreground as a fundamental aspect of modern economic understanding, because larger markets induce the creation of more new ideas and hence faster growth. The human communications made possible by the internet have the greatest scale of any communications modality we have known thus far… 

The internet provides a particularly fertile environment for the development of diverse new thoughts that will drive growth. It supports the development of groups and other forms of online communication that are potentially highly responsive to the feedback of human beings and highly likely (given the enormous scale and connectivity of the internet) to trigger exponential development of unpredictably diverse new ideas that are nonrivalrous…

Thus, there is something new about the internet that separates online communications from all former communications modalities…The internet can do more than just transport bits and facilitate momentary person-to-person communications. It can also provide a substrate that enables new ideas and new forms of social organisms to emerge, created by many different decisions to pay attention…[I]nvestment of our attention in these collaborative efforts has a greater payoff than investment of attention in either the one-to-many transactions made possible by broadcast or the one to one (peer) transactions made possible by telephony…

[E]conomic growth theory, with its emphasis on new ideas, diversity, and scale producing increasing returns, combines with our newfound understanding of communications complexity in a fruitful way. Our national economic policy, which looks for opportunities for increased economic growth, should be closely tied to communications policy that facilitates the interactive, group-forming attributes of the internet. …

Online communications are not just like any other form of economic activity. Ideas are not like goods; they are potentially far more valuable. The online world enables the creation of new relationships and thus new ideas that are key to our future economic growth. Communications law can no longer afford to ignore this central fact and its radical implications for policy.

The key organizing principle for communications law must be to support the emergence of diverse new ideas online because that is where economic growth for society as a whole will come from. This form of diversity support is not the same as the kind of quota-driven artificial “diversity” that has been used to force broadcast content regulation to reflect minority viewpoints. Rather, this kind of online diversity stems from allowing the end-to-end, content-neutral, layer-independent functions of the internet to flourish and allowing groups and human attention to pick and choose from among the bad ideas presented online, enabling good ideas to persist and replicate…

Ideas fundamentally different than objects

As Romer explains in the 2001 interview cited above, New Growth Theory raises important policy questions related to an idea-driven growth model. While the equilibrium price models of traditional economics work reasonably well for analysis of markets for “objects,” Romer says these market-clearing pricing models cannot accurately be applied to “ideas.”

The miracle of the market system is that for objects, especially transformed objects, there’s a single price which does two different jobs. It creates an incentive for somebody to produce the right amount of a good, and it allocates who it should go to. A farmer looks at the price of a bushel of wheat and decides whether to plant wheat or plant corn. The price helps motivate the production of wheat. On the other side, when a consumer has to decide whether to buy bread or corn meal, the price allocates the wheat between the different possible users. One price does both jobs, so you can just let the market system create the price and everything works wonderfully.

With ideas, you can’t get one price to do both things. Let me give an extreme example. Oral rehydration therapy is…a simple scientific insight about how you can save the life of a child who’s suffering from diarrhea. Literally millions of lives have been saved with it. So what price should you charge people for using it?

Because everybody can use the idea at the same time, there’s no tragedy of the commons in the intellectual sphere…If you give an idea away for free, you don’t get any of the problems when you try and give objects away for free. So the efficient thing for society is to offer really big rewards for some scientist who discovers an oral rehydration therapy. But then as soon as we discover it, we give the idea away for free to everybody throughout the world… So with ideas, you have this tension: You want high prices to motivate discovery, but you want low prices to achieve efficient widespread use. You can’t with a single price achieve both, so if you push things into the market, you try to compromise between those two, and it’s often an unhappy compromise.

Crawford’s analysis suggests that the Internet can play a key role in bridging the apparent conflict between the value of high prices as a motivator of idea creation and sharing, and the broader social value of low (or no) prices for idea dissemination. One way it does this is by facilitating the free, fluid and cost-efficient exchange and “combinatorial explosion” of ideas that Romer’s theories identify as key drivers of economic growth.  Or put another way, the Internet can help reduce the cost and operational and institutional frictions associated with developing, enhancing, “remixing” and disseminating valuable ideas.

An expanding role for “nonmarket social production”

The work of Yale Law School professor Yochai Benkler builds on this notion, adding to it a dynamic he refers to as “nonmarket social production.” Benkler is considered a leading thinker on commons-based approaches to economic production, including peer-based production, open source software and creative commons copyright.

A basic premise of Benkler’s book, The Wealth of Networks: How Social Production Transforms Markets and Freedoms, is that the Internet’s technology and structure is enabling increasingly efficient “nonmarket social production.” This development, Benkler suggests, promises significant and potentially dramatic benefits in economic, social and political spheres.

Benkler’s focus on “nonmarket social production” speaks to Romer’s observation that “because the economics of ideas are so different from the economics of markets, we’re going to have to develop a richer understanding of non-market institutions, science-like institutions. This is going to be a new endeavor for economics.”

More specifically, Benkler’s arguments suggest that “nonmarket social production” can help bridge the “pricing dilemma” Romer sees in a market-based “idea economy,” by leveraging non-price-based motivations to create and share ideas, while also lowering the cost of doing so by leveraging the highly-efficient communication, collaboration and computational capabilities of the Internet and related digital technologies.  Both of these dynamics have potential to significantly reduce the price level required to motivate and accelerate self-generating cycles of idea creation, sharing and “remixing.”

As Benkler explains:

[W]e are seeing the emergence of a new stage in the information economy, which I call the “networked information economy.” It is displacing the industrial information economy that typified information production from about the second half of the nineteenth century and throughout the twentieth century.

The most advanced economies in the world today have made two parallel shifts that, paradoxically, make possible a significant attenuation of the limitations that market-based production places on the pursuit of the political values central to liberal societies. The first move, in the making for more than a century, is to an economy centered on information…and cultural…production, and the manipulation of symbols…The second is the move to a communications environment built on cheap processors with high computation capabilities, interconnected in a pervasive network—the phenomenon we associate with the Internet.

It is this second shift that allows for an increasing role for nonmarket production in the information and cultural production sector, organized in a radically more decentralized pattern than was true of this sector in the twentieth century. The first shift means that these new patterns of production—nonmarket and radically decentralized —will emerge, if permitted, at the core, rather than the periphery of the most advanced economies. It promises to enable social production and exchange to play a much larger role, alongside property- and market-based production, than they ever have in modern democracies.

What characterizes the networked information economy is that decentralized individual action—specifically, new and important cooperative and coordinate action carried out through radically distributed, nonmarket mechanisms that do not depend on proprietary strategies—plays a much greater role than it did, or could have, in the industrial information economy. The catalyst for this change is the happenstance of the fabrication technology of computation, and its ripple effects throughout the technologies of communication and storage.

Benkler offers three key observations about “the emerging information production system.”

First, nonproprietary strategies have always been more important in information production than they were in the production of steel or automobiles, even when the economics of communication weighed in favor of industrial models. Education, arts and sciences, political debate, and theological disputation have always been much more importantly infused with nonmarket motivations and actors than, say, the automobile industry. As the material barrier that ultimately nonetheless drove much of our information environment to be funneled through the proprietary, market-based strategies is removed, these basic nonmarket, nonproprietary, motivations and organizational forms should in principle become even more important to the information production system.

Second, we have in fact seen the rise of nonmarket production to much greater importance. Individuals can reach and inform or edify millions around the world. Such a reach was simply unavailable to diversely motivated individuals before, unless they funneled their efforts through either market organizations or philanthropically or state-funded efforts. The fact that every such effort is available to anyone connected to the network, from anywhere, has led to the emergence of coordinate effects, where the aggregate effect of individual action, even when it is not self-consciously cooperative, produces the coordinate effect of a new and rich information environment. One needs only to run a Google search on any subject of interest to see how the “information good” that is the response to one’s query is produced by the coordinate effects of the uncoordinated actions of a wide and diverse range of individuals and organizations acting on a wide range of motivations—both market and nonmarket, state-based and nonstate.

Third, and likely most radical, new, and difficult for observers to believe, is the rise of effective, large-scale cooperative efforts—peer production of information, knowledge, and culture. These are typified by the emergence of free and open-source software. We are beginning to see the expansion of this model not only to our core software platforms, but beyond them into every domain of information and cultural production—and this book visits these in many different domains—from peer production of encyclopedias, to news and commentary, to immersive entertainment.

Benkler suggests that the dominant neoclassical approach to economics largely–and mistakenly–ignores this growing sector of the 21st century economy. The implication is that strictly market-based analysis will become less and less relevant to the extent social production increases its share of value creation.

It is easy to miss these changes. They run against the grain of some of our most basic Economics 101 intuitions, intuitions honed in the industrial economy at a time when the only serious alternative seen was state Communism —an alternative almost universally considered unattractive today…Human beings are, and always have been, diversely motivated beings. We act instrumentally, but also noninstrumentally. We act for material gain, but also for psychological well-being and gratification, and for social connectedness. There is nothing new or earth-shattering about this, except perhaps to some economists.

While the above is on one hand a humorous commentary on the limitations of traditional economics, it also points to a serious and potentially radical transformation in how human beings will create and exchange value in the 21st century.

In the industrial economy in general, and the industrial information economy as well, most opportunities to make things that were valuable and important to many people were constrained by the physical capital requirements of making them. From the steam engine to the assembly line, from the double-rotary printing press to the communications satellite, the capital constraints on action were such that simply wanting to do something was rarely a sufficient condition to enable one to do it. Financing the necessary physical capital, in turn, oriented the necessarily capital-intensive projects toward a production and organizational strategy that could justify the investments. In market economies, that meant orienting toward market production. In state-run economies, that meant orienting production toward the goals of the state bureaucracy. In either case, the practical individual freedom to cooperate with others in making things of value was limited by the extent of the capital requirements of production.

In the networked information economy, the physical capital required for production is broadly distributed throughout society. Personal computers and network connections are ubiquitous. This does not mean that they cannot be used for markets, or that individuals cease to seek market opportunities. It does mean, however, that whenever someone, somewhere, among the billion connected human beings, and ultimately among all those who will be connected, wants to make something that requires human creativity, a computer, and a network connection, he or she can do so—alone, or in cooperation with others. He or she already has the capital capacity necessary to do so; if not alone, then at least in cooperation with other individuals acting for complementary reasons. The result is that a good deal more that human beings value can now be done by individuals, who interact with each other socially, as human beings and as social beings, rather than as market actors through the price system.

Sometimes…these nonmarket collaborations can be better at motivating effort and can allow creative people to work on information projects more efficiently than would traditional market mechanisms and corporations. The result is a flourishing nonmarket sector of information, knowledge, and cultural production, based in the networked environment, and applied to anything that the many individuals connected to it can imagine. Its outputs, in turn, are not treated as exclusive property. They are instead subject to an increasingly robust ethic of open sharing, open for all others to build on, extend, and make their own.

Benkler appears to be describing an Internet-enabled and relatively cost-efficient dynamic that facilitates the “combinatorial explosion of ideas” that, according to Romer, drives economic growth. It does this by using the Internet to leverage the idea-generating power of “decentralized individual action,” “nonmarket collaborations,” and “cooperative and coordinate action carried out through radically distributed, nonmarket mechanisms that do not depend on proprietary strategies.”

As noted above, these nonmarket mechanisms can help alleviate the “idea-pricing” dilemma cited by Romer as one of the key challenges facing economic growth policy.  The increasing proliferation of high-value but low-cost (or free) web-based services since the publication of Benkler’s book is compelling evidence that this dynamic is real and expanding in scope and impact.

The economic value of “neutral” networks

Comments by Crawford bring us back to the choice we now face as a society regarding Internet and communication policy and, specifically, with regard to the value of neutral high-capacity networks.

To generations accustomed to centrally-controlled entertainment modalities like television and cable, this limitation to “channels” provided by network providers may not seem important.  Surely there will be vast amounts of digitized material to absorb online. Why should it matter whether some of it is prioritized?  The reason this prioritization matters is that we do not know what new forms of group-oriented collaborative interactions (social, commercial, or cultural), or what kinds of new ideas, will emerge from this network of networks.

Prioritization will make a difference because network providers will cease to be commodity transport-providers and will instead become gatekeepers, pickers-of-winners, and controllers-of-experiences on a massive scale.  The diversity of online experiences, and thus the range of freedom of human connection, human relationships, and the diverse generation of new ideas will diminish.

Neutrality of symmetric high speed access is important for a host of reasons:  it will enable diverse new applications to emerge that are not controlled by network providers; it will cause new forms of interaction to grow, even apart from the introduction of applications; and it will enable diversity in various real-time communications that otherwise will be controlled and monetized by the network providers.  All of this diversity has great potential to be positively associated with economic growth…

One frequent argument against network neutrality is that users want simplicity.  Verizon representatives talk animatedly about the need for an interface for online broadcasts that can be controlled in the dark with one hand — because the other hand will be busy holding a beer.  But this conception of user behavior shows a lack of imagination.  People do want to relax and be entertained, and Americans have great strengths in this domain, but network neutrality is not incompatible with either simplicity or high entertainment value.  The key question is who will be in a position to control access to simple and highly-entertaining activities and engagements provided online.  

If network providers act as gatekeepers, deciding which new ideas will fail and which will succeed, then they will be artificially amplifying particular ideas.  Instead of the internet, we will have a broadcast television network, in which success is decided on “from above” rather than emerging from the interactions of agents.

NGT + MMT:  an Internet policy game-changer?

As I noted at the start of this post, in a future post I’ll be combining elements of New Growth Theory and Modern Monetary Theory to provide a rationale for increased federal investment in neutral, very-high-capacity broadband networks.

This federal investment would leverage the U.S. government’s ability to deploy its sovereign currency in ways that support accelerated Internet-driven economic growth (as explained by New Growth Theory), without causing “deficit-problems” related to the solvency of the U.S. government, nor driving problematic inflation (as explained by Modern Monetary Theory).

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