Knowledge and the Wealth of Nations: A Story of Economic Discovery

Politics and Economy
Review by: 
Ugo Panizza
David Warsh
W. W. Norton & Company
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What drives economic growth? Why are some countries rich and other poor? What actions could Latin American countries take that would led them to grow as rapidly as South Korea? Nobel Laureate Robert Lucas once stated that: "The consequences for human welfare involved in questions like these are simply staggering: once one starts to think about them, it is hard to think about anything else."

"Knowledge and the Wealth of Nations: A Story of Economic Discovery" is neither a new book, nor a book that deals specifically with Latin America. However, it is a must-read for anybody interested in development economics. It describes and explains in simple language how economists think about economic growth. The book is also fun to read. Warsh is a great storyteller and the book is full of anecdotes and interesting stories about the scholars that populate world of academic economic research.

The book revolves around the idea of increasing returns. Specifically, Warsh tells us the fascinating story of Paul Romer, a 24-year old graduate student who embarked in an 8-year journey which ended up redefining the way in which we model economic growth. However, the book is not a mere description of the seminal "Romer 1990" paper, it is a fascinating journey through the intellectual history of increasing returns.

Warsh goes back to the origin of economics and discusses a fundamental contradiction in Adam Smith's two main contributions: the invisible hand and the pin factory. The contradiction lies in the fact that the invisible hand requires competition while the increasing returns of the pin factory can be a source of monopoly power.

Next, the book discusses why until the late 1980s early 1990s economics was dominated by models with decreasing returns. The bottomline is that decreasing returns are easier to model. Many economists were fully aware that the assumption of decreasing returns was unrealistic and that increasing returns were the norm in many industries and sectors. However, nobody knew how to rigorously model increasing returns and, in choosing between realism and rigor, many great economists opted for rigor (Joseph Schumpeter was a rare exception).

Warsh concludes by describing how Romer and a small group of young economists revolutionized economic research by building rigorous and internally consistent growth models with increasing returns. A fascinating story on many levels.