Issuu on Google+

jo s e p h e . st ig l i t z a n d bruce c. greenwald

c r e at i n g c r e at i n g a l e a r n i n g a learning ss o o cc ii ee tt yy

A New Approach to Growth, Development, and Social Progress


chapter twen ty- two

Commentary K E N N E Th J. A R R o W Professor Emeritus, stanford University

This is a very moving occasion. i have been identified as a product of Columbia University. i started my university studies many years ago in the fall of 1940, and i don’t know how many generations of professors have come and gone since then. There are obviously probably not many people in this room who were born at that point, except Bob. [Robert solow interjects, “i was a freshman in september 1940.�] But this is not the time for reminiscing, because what was taught under the heading of economics was so very, very different from what is taught today in so many ways i cannot even begin to describe. Back then, institutionalism was the dominant approach. People like Wesley Clair Mitchell, Arthur Burns and simon Kuznets (who was at the National Bureau of Economic Research at Columbus Circle at the time) were very influential in developing many wide-ranging ideas to do with the central issues of the day surrounding business cycles. in some sense it may be that Bruce Greenwald and Joe stiglitz in their paper are revisiting and reviving the plurality of ideas and viewpoints prevailing then. i am also moved, of course, by the tribute to me in


Commentary Kenneth J. Arrow

505

having the set of lectures in my old institution named for me and it is, i hope, a legacy that will be carefully tended. And it’s certainly starting out with a bang. i’m also grateful for having so many people here who are just good friends of mine, with varying degrees of length. Now, as for the stiglitz-Greenwald paper as in the written version, which i got only two days ago. i was more aggressive, i think, than Bob and Philippe, and i said i want to see a paper and one was produced! i read it on the plane coming here. That was my first chance to look at it.

Commentary in my comments, i will concentrate on the issue of learning and knowledge that the paper emphasizes, since this is a topic of great interest to me. What strikes me most strongly about the paper and the underlying model and logic is that the issue of knowledge spillovers and their effects on growth is not necessarily limited to a discussion of foreign trade at all. in fact, suppose you have a world government or a single closed economy, these issues would arise nonetheless. of course, the instruments that would be used in such cases would differ from those being considered here –broad and narrow tariffs—but the same insights would apply. Before that exercise however, i would like to begin by briefly mentioning a central related theme that the paper invokes, but does not follow up in great detail. Greenwald and stiglitz begin with the observation that most firms are operating below their efficient frontiers, whether in the United states or abroad. There are several possible reasons for this phenomenon including management styles, social cohesion within plants and others, but what has been established in the best empirical work is that there is substantial variation in efficiency. Richard Nelson and sidney Winter’s famous book on evolutionary economics (An Evolutionary Theory of Economic Change, 1982) provided examples of such large variation in both the United states and the Philippines. Another striking example of existing inefficiencies (provided in the current paper) is the study of firms facing strikes that were able to produce the end product with one-third the pre-strike number of workers. Apart from being a sub-optimal outcome from a social welfare point of view, such gross productive inefficiencies constitute somewhat of an embarrassment from the viewpoint of standard economic theory.


506 Commentary Kenneth J. Arrow

Why don’t competitive pressures, even mild ones, wipe out these inefficient firms? how do they survive? While there have been some answers provided—my colleague, Nicholas Bloom for example suggests that managerial differences explain differences in productivity across countries—i am still not completely clear on why these inefficiencies persist. This is an important issue which bears further thinking about. While the Greenwald-stiglitz paper alludes to the issue of competitive pressures and the effect on efficiency from tariffs and protection, it really does not pursue this question very much. Nor does it explore deeply another issue that it poses—that of macroeconomic stability. instead, the dominant theme of the paper is the question of spillovers and learning and how the presence of such effects may justify the adoption of industrial policies (the ‘infant economy’ argument). The persistence of inefficient firms and large differences in productivity mentioned in the paper suggest that spillover effects are not operating very well. This is especially so for firms producing the same product in competitive markets. Under these conditions, one should expect that there are large spillover effects since there is the most to learn from rival firms. if such inefficiencies persist in narrowly circumscribed situations such as this, there is certainly a puzzle. What we know about spillovers is that they tend to be local and that therefore geography matters. Certainly the latter point has been emphasized by the literature on agglomeration. silicon Valley and Route 28 in the Boston area are dominant in the high technology sector, even though they do not possess any obvious physical comparative advantage in producing computer chips and software. in fact, they may possess some disadvantages: in the case of the silicon Valley, the physical confines of being between a bay and a mountain ridge and the consequent lack of available inexpensive land acts as a deterrent to manufacturing activity, yet the headquarters and research laboratories of leading firms remain there. The usual explanation for this is that information and learning happen most effectively when people meet face-to-face and exchange ideas. Despite their devotion to the abolition of distance and space as an obstacle to communication these firms rely on face-to-face meetings for their innovation and growth. The interesting thing about knowledge is that it has an ability to spread rapidly and effectively. To extend the Jeffersonian formulation, these individuals and firms are lighting candles all over the place.


Commentary Kenneth J. Arrow

507

Now, this is an example of spillovers of knowledge and know-how in firms or industries which are similar, and in which learning from each other is therefore rewarded most directly. Greenwald and stiglitz’s paper however address different, more diffuse spillovers between segments of the economy they call ‘industry’ and one they call ‘Agriculture’. By this they do not mean necessarily the sectors of the economy defined by the national accounts, but between a progressive dynamic sector with more knowledge and one with lesser knowledge. What are the kinds of spillovers that are involved between such sectors, and does productivity growth occur through such spillovers? This is not clear. if one looks at U.s. history, it is hard to make the case that agriculture is a “backward industry.” The rate of growth of productivity in agriculture in the United states has been quite comparable to that of non-agricultural sectors. Further, it is difficult to trace the sources of that productivity to learning through industry. hybrid corn, as i learned from Zvi Griliches many years ago, was one of the big factors in increasing agricultural productivity and was certainly something not done by industry. The idea that industry is the progressive sector of the economy has of course taken many earlier forms, including ideas suggesting greater opportunities for obtaining economies of scale or for technological progress. As such the broad idea that there may be efficiency gains from knowledge spillovers between these sectors still holds. Knowledge is a free good. The biggest cost in its transmission is not in the production or distribution of knowledge, but in its assimilation. This is something that all teachers know. one of the advantages of trade is that it facilitates the spreading of information of technological knowledge. The fact that there is contact—that ideas are flowing—leads to spillover effects, learning, and greater competition. When foreign direct investment pours into China, for example, investing other firms. While Greenwald and stiglitz focus on spillovers and trade, most of these problems they consider arise in a closed economy. For example, if it is true that the larger the more progressive sector, then the greater the growth rate, then there is a case for intervention even in a closed economy. obviously tariffs are not a policy instrument but one could tax diminishing returns industries and subsidize increasing returns industries. This is in fact an older point made by Alfred Marshall. Following from this, even in a world of international trade, would not the subsidy at a domestic level be superior to a tax? This is a lesser important point


508

Commentary Kenneth J. Arrow

than the ones i have made before, but the focus on distorting trade flows does not seem so obvious. There is of course, the historical case to be made for trade protection, since countries which have succeeded have had greater protection. The prime example is the United states, and in fact Alexander hamilton’s early ideas about these matters during the late 18th century were taken up by continental economists like Friedrich List and spread across Europe. Yet protectionism also culminated in the smoot-hawley Tariff of 1930, which is widely thought to have been a very destructive policy and one which prolonged and exacerbated the Great Depression. having noted this, i think the fundamental concern evinced in the paper, the emphasis on moving the efficient frontier in the long run, is very important. That is the real technological limit to growth and welfare. At the same time the idea that at any moment we are well below the frontier is a truth which is very hard to explain. These kinds of ideas require more discussion. i want to close by saying that i am grateful for the occasion to comment on this paper.


Kenneth Arrow's Commentary on Creating a Learning Society