2 Economic growth and global connectedness
2.1 The old and new theories of economic growth
There is growing acceptance that openness to international exchanges contributes to a country’s economic performance. Yet the mechanisms by which trade and other international exchanges promotes long-run growth have been less often articulated.
The traditional theory of growth dating from Solow (1956, 1957) emphasised labour and capital accumulation and technical progress as the drivers of long-run growth. The central importance of technological progress was accepted but not explained by Solow. The conclusion of Solow’s theory was that long-run real economic growth did not depend strongly on economic policy. Most of long-run economic growth was determined by extra-economic factors: the general progress of science and technology.
The new theories of economic growth, usually associated with the writings of Romer (1986, 1990, 1994), Romer and Rivera-Batiz (1991a, 1991b), Lucas (1988, 1993, 2002), and Grossman and Helpman (1991, 1994), suggest that international economic integration, human capital, learning by doing, intentional industrial innovation, and local and cross-border spillovers from innovation are all important to the growth process. The new theories of growth provide many new ways to think about growth and a more diverse set of mechanisms for analysing the role of government policy in raising living standards.
Romer and others analysed technological change as part of an economy, not outside it as Solow had done. Both new and old theories of growth accept as fundamental that most increases in productivity and in living standards come from advances in knowledge, and in improvements in the application of knowledge. However, the new growth theories suggest that pro-growth policies can nurture and anti-growth policies can stifle long-run growth. The implication was that economic variables that could be accessible to policy manipulation, such as interest and tax rates, as well as subsidies for research and technical education, may influence the rate of innovation and the rate of economic growth.
The incentives for innovation are important in the new growth theories. Economic growth arrives in the form of a greater variety of products and as improvements in existing products. A major part of technological progress requires, at some stage, an intentional investment of resources by entrepreneurs (Grossman and Helpman 1991, 1994). The process of finding new technologies is a process in which no discovery is guaranteed, but the return to new technologies has to be such that firms have an incentive to invest in the process. R&D buys a chance of discovering the next generation of a targeted product.
A highly educated labour force is a key input into R&D. Human capital is vital to producing the new ideas that sustain growth. Worker productivity depends on the aggregate skill level of all workers. Societies with more skilled workers—a high stock of human capital—should generate more ideas and grow faster (Lucas 2002, Romer 1990).
A sufficient level of human capital is a prerequisite to imitation and adaptation by technological followers both at home and abroad (Caselli and Coleman 2001, Caselli and Wilson 2003 and Benhabib and Spiegel forthcoming) and to the innovation that creates the new technologies in the first place (Romer 1990, Lucas 2002).
2.2 Technology transfer and technology spillovers
The diffusion of new technologies is a lengthy process and many firms continue to invest in the older technologies. Each firm must weigh the benefits of adoption now versus adoption later. Adoption of a new technology can imply the scrapping of existing equipment and human capital and retraining. As the costs or benefits of adoption change, the number of adopters changes. Technology transfer is the cumulative result of a series of individual calculations that weigh the incremental benefits of adopting a new technology against the costs of change, often in an environment of uncertainty as to the future evolution of the technology and its benefits and by limited information about the benefits and costs and even about the very existence of the technology.
New products and processes must be adapted to fit each national market. There are costs involved in exchanging designs and providing training. There are three types of technology transfer. The first is material transfer, which is the simple import of materials (e.g., seeds, machines) and local adoption is not attempted. The second is design transfer, which is in the form of blueprints, handbooks, and formulas. The foreign equipment may be imported to be reverse engineered, so that local engineers can learn about the technology. The third is capacity transfer: the transfer of scientific knowledge and technical capability. This often requires strengthening of education and technical capacity. Firms are better able to adopt complex innovations if they can do R&D to adapt the technology to local conditions. The second and third forms of technology transfer are more likely to call for significant pre-existing human capital and then learning by doing.
Technology diffusion or transfer can come in the form of an arm’s length transaction. When a technology is transferred in this way, the price is attempting to capture the full value of the innovation. However, if the cost of obtaining technological knowledge is less than the cost of its invention, including R&D costs, a spillover has occurred.
Spillovers can occur at the time of purchase despite price premiums due to intellectual property rights. Spillovers may result from importing intermediate and capital goods because the product improvements from the supplier’s R&D efforts are often not fully absorbed in its price. This inability to embody fully the higher quality into prices arises from competitive pressures common in innovating industries. Competition from the ever expanding variety of inputs and displacement by a succession of product improvements by other firms means that the price premium on each innovation is often short and less than the full value of the technical breakthrough. Other firms take advantage of the new technical knowledge, eliminating the innovative firm's monopoly profits by producing goods that are similar or more advanced (Grossman and Helpman 1991).
Spillovers most commonly occur slowly across time because as firms develop new technologies, they can make discoveries that can be applied by others, at no extra cost. In addition, when innovators bring out new generations of similar products, they have begun where their predecessors finished, building on their insights and work. Romer (1990) contends that any technical knowledge discovered by a firm (and embodied in its products) will eventually benefit other firms, even those not engaged in R&D. Lucas (2002) observed that with growth driven by new ideas, much of the return from an idea, and virtually all of it for a really important idea, accrues to people other than the originator.
The new growth theories propose that innovation feeds on and adds to the cumulative stock of national and often global knowledge. R&D contributes to the stock of knowledge, which enhances the productivity of an economy, stimulating its growth and, importantly, it may generate spillovers that enhance the productivity of other nations.
2.3 Trade and technology transfer
Countries trade with one another, communicate with one another and learn from one another more than ever before. New Zealand can raise its productivity by learning from new products and ideas from abroad. A country that is integrated into world markets is likely to enjoy access to a larger knowledge base than those living in isolation.
There are a number of ways in which trade contributes to economic growth. Trade expands the stock of knowledge available to those engaging in R&D in New Zealand by exposing them to more goods produced using the latest designs which can be imitated and developed further. Trade spurs growth because a firm that invents a new product will have access to a larger market. Trade prevents duplication in research—the fixed costs of R&D needed to develop new designs need only be incurred once when results are fully disseminated. Economic integration means that the fixed costs of R&D can be recovered over larger markets. Trade provides channels of communication that stimulate cross-border learning, copying and adaptation of production methods and product designs.
The new growth theories suggest that external linkages that strengthen the cross-border flow of new technology and knowledge may increase New Zealand’s growth rate. Our links with Australia are an example that could be used to deepen relationships with other countries. The policies that led to close economic relationships with Australia included free trade, free movement of people, and now regulatory harmonisation.
