Should-Read: Dietrich Vollrath (2015): What Assumptions Matter for Growth Theory?: "Somewhere along I-40 and I-81 I was able to get a little clarity...
...in this whole "price-taking" versus "market power" part of the debate. I'll circle back to the actual "mathiness" issue at the end of the post.... Do inputs to production earn their marginal product?... Do the owners of non-rival ideas have market power or not?... Here are three statements that could be true.
- Output is constant returns to scale in rival inputs
- Non-rival inputs receive some portion of output
- Rival inputs receive output equal to their marginal product
Romer's argument is that (1) and (2) are true... through replication arguments... [and] an empirical fact. Therefore, (3) cannot be true.... I don't need to say anything about how the non-rival inputs are compensated.... If they earn anything... the rival inputs cannot be earning their marginal product.... McGrattan and Prescott abandoned (1) in favor of (2) and (3). Boldrin and Levine dropped (2) and accepted (1) and (3).... If there is a sticking point with McGrattan and Prescott, Boldrin and Levine, or other papers, it is not "price-taking" by innovators. It is rather the unwillingness to abandon (3), that factors earn their marginal products. Holding onto this assumption means that they are forced to abandon either (1) or (2).
From Romer's perspective, abandoning (1) makes no sense due to replication.... Abandoning (2) also does not make sense for Romer. We clearly have non-rival ideas in the world. Some of those non-rival ideas are remunerated in some way, whether there is market power or not.... The "mathiness" comes from authors trying to elide the fact that they are abandoning (1) or (2). McGrattan and Prescott have this stuff about location, which is just to ensure that (1) is false. Lucas (2009), as Romer explained here, is abandoning (2), and asserts that this is something we know as a result of prior work. It's not....
Now you can talk about market power or the lack of it. Romer, taking (1) and (2) as given, asks how non-rival inputs could possibly be earning output.... Non-rival ideas must be excludable, to some extent, in order to earn the output we see them earning in reality.... The lack of full market power here is fully compatible with (1) and (2) being true, and (3) being false. The issue with Boldrin and Levine isn't that they allow people to compete with the innovator immediately, it's that they dismiss the whole idea of non-rival ideas and abandon (2)...
- Dietrich Vollrath (2016): The Returns to Societal Capital
- Dietrich Vollrath (2015): What Assumptions Matter for Growth Theory?
- Dietrich Vollrath (2015): Mathiness versus Science in Growth Economics: