Knowledge, growth without scale effects, and the product life cycle

In the early models of R&D-based growth, knowledge’s nonrivalrous nature gives rise to spillovers which in turn lead to a scale effect, i.e. larger economies, suitably measured, grow faster than smaller economies do. Empirical work has, however, pointed out that growth with scale effects as predicted by these early models is inconsistent with observed economic reality in which over the last 40 years the OECD countries have experienced a tremendous rise in population, total GDP and the number of people involved in R&D activities whereas the growth rates of per-capita income have shown no corresponding increase and have actually remained relatively constant. This observation led to new models of R&D-based growth in which growth scale effects are removed by limiting the extent of the spillovers associated with knowledge’s nonrivalrousness. Generally, however, this is done in an unearned way that lacks much-needed (micro-)economic foundation. This thesis’ objective is to gather clues that help further the understanding of (the mechanism underlying) the observed absence of growth scale effects and enhance the ability to credibly model growth without scale effects. For this purpose it takes a closer look at empirical work that reports on regularities and phenomena at both the microand the macro level which are expected to provide insight on this mechanism. The tenor of the empirical work is that spillovers are existent and that knowledge is (at least partly) nonrivalrous (but growth scale effects are absent nonetheless). However, there is also evidence that (i) spillovers resulting from knowledge’s nonrivalrous nature are diluted through technological distance, and that (ii) life-cycle effects are important, i.e. (many) products are subjected to a life cycle with the well-known phases of take-off, maturity and, eventually, decline. Life-cycle effects form the main mechanism behind the proposed solution to reconciling the seemingly contradictory findings of knowledge being (at least partly) nonrivalrous and giving rise to spillovers with the fact that there is no scale effect in growth. The idea is that over the life cycle of a product growth might actually exhibit a scale effect, i.e. the rate at which the ability of producing the product grows, increases over time. That growth at the aggregate level nonetheless does not increase over time is due to two important effects: (1) over time demand (consumption) continuously shifts from one product to another, and (2) the economy’s productivity in newly consumed products is lower than in the previously consumed products due to technological distance, which dilutes the knowledge stock firms have built with regard to the production of the previously consumed products, i.e. knowledge is at least partly product-specific. That knowledge used in the production of previously consumed goods has only limited usefulness in the production of currently consumed goods means that (product-specific) knowledge loses its value (i.e. depreciates or becomes obsolete) as demand (and price) for the associated product decline(s). Ultimately the result is that growth at the aggregate level (as measured by output increases measured in monetary units) follows a steady path with a growth rate that is roughly constant over time. Important in this mechanism, besides the continuous shift of demand to new (recently introduced) goods, is the complex interaction between factors like consumer preferences, demand, income, technological progress and well-being. People will only shift demand towards new (more expensive) products if this increases their wellbeing. In this way, growth may not exhibit a scale effect while well-being does. However, the relation between income, demand and well-being is such that new products do not only influence the level of well-being but also somehow diminish well-being, for instance by diminishing the utility people derive from the previously consumed (older) products. Consumption of the newly introduced products might then be needed just to keep the level of well-being constant. Work that has shown that for several countries the level of well-being has not increased, despite enormous increases of per-capita income, confirms this idea. The reason why growth does not exhibit a scale effect at the aggregate level consequently lies in what is here labeled ‘the endogeneity of the product life cycle’: the factors that give rise to the life cycle, e.g. productivity growth, monotonically declining prices, shifting preferences, the level of income etc., can all be traced back to a two-way causality between demand and technological progress in a broad sense. Demand factors influence firms’ R&D efforts and consequently technological progress, i.e. productivity growth and the introduction of new and/or improved products, in turn affecting demand and indeed future R&D activities, and along the way giving rise to several forms of creative destruction, e.g. the obsolescence of knowledge specific to products no longer in demand. By distancing themselves from the standard Dixit-Stiglitz production function (Dixit and Stiglitz 1977) (i.e. homothetic preferences) and instead using so-called hierarchic (nonhomothetic) preferences several researchers have not only endogenized the product life cycle, but also have provided a framework that could be used to model growth without scale effects more credibly than the currently existing models do. Knowledge, growth without scale effects, and the product life cycle 2