We don’t hear that much in the mainstream press about the economist Paul Romer, mostly because he’s not interested in the kind of short-term macroeconomic analysis the the current policical environment is obsessed about. Romer’s landscape is much broader and deeper. He focuses on how ideas and innovation drive economic growth. Previous economic models had simply assumed that innovation happens, on its own, and that growth depended on factors like labor supply, investment, and consumer spending. Romer’s theory — called New Economic Growth — argues that technological innovation (broadly defined) is very much a part of the picture of how an economy grows, and that innovation is driven by factors like rules and institutions. David Warsh’s Knowledge and the Wealth of Nations does a great job capturing the development of Romer’s ideas as well as their slow, grudging acceptance by the economic community.
In a few talks over the last few years (Long Now Foundation and TED), Romer has been talking about how to accelerate growth by innovating the rules which influence how ideas are created and then brought to market. Over time, he argues, the creation of new countries, able to start a legal and regulatory structure from scratch, has had a lot to do with economic growth. Bankruptcy law which allowed risktakers to start fresh after failures and corporate law which let investors limit personal losses, for example, helped America leapfrog the rest of the world in the last half of the 19th century. Today’s international framework makes creating new countries highly unlikely, but technology is making it possible to create entirely new cities, and it’s in the new megacity that Romer sees opportunity for policy innovation and growth. If given the necessary freedom from their host countries, these city-states could bring enormous growth by starting with modern rules friendly to innovation and idea creation.
London may yet wind up an example, given David Cameron’s decision to part ways with the rest of the eurozone countries over a new pact which would tighten centralized control over member country budgets and regulatory structures. Reportedly the final straw was the continent’s insistence on centralized oversight of London’s dominant financial markets — the hub of the UK’s economy. Cameron pushed back, France and Germany held the line, and finally Cameron left the talks.
Cameron is being criticized for marginalizing and isolating the UK, but most of this criticism is based on the assumption that European countries are stronger individually when they’re acting as a unit. Diplomatically and militarily, this makes perfect sense. And economically, in an economy based on production and manufacture, I think it it holds up. In an economy of things, the EU nations are going to be each others’ biggest trading partners, simply because of geography. A common regulatory structure means something made in Germany doesn’t have to go through an entirely different regulatory checklist when crossing the border to Denmark or France, which both makes markets more efficient within Europe and gives European manufactures a competitive advantage (perfectly fair) against non-EU members.
But it doesn’t work so well when your economy has more to do with innovation and intangible products, like financial services. London’s financial markets have been so successful because they have global reach and because their rules respond to needs of investors everywhere, not because they’re close to Frankfurt and Paris. Cutting free from Brussels might cost them business from the continent, but much more probably will help them compete for more promising demand from the rest of the world, particularly South America and the oil states. That logic doesn’t stop with financial service firms; the country’s economy is one of the most thoroughly globalized in the world, and in industries like media, energy, pharmaceutical, and aerospace, it has worldwide leaders. The mere fact that English is recognized as the international language of business gives the UK a huge advantage in an increasingly global marketplace.
So by passing on the demands of the continent’s big powers, Cameron might actually be setting the UK up to compete much more successfully in a new economy, one marked by information, innovation, and growth in the developing world. He might be turning England’s back to its traditional partners in Europe, but also facing much more directly new opportunities in much more promising parts of the world. And by retaining domestic control over regulation and policy, England might be setting itself up as the kind of entrepreneurial role in regulation that Paul Romer talks about in reference to newer, less developed nations and city-states. Again, he’s being roundly criticized, but I can’t help but think that this is the smart move. If you were running England, where would you make your bet: on being a good neighbor within the EU, with its bureaucratic culture and desperate demographics, or on tending to and servicing the rest of the world? I think I know my answer.
