PAUL M. ROMER
Universityof California, Berkeley
NationalBureau of Economic Research
CanadianInstitutefor AdvancedResearch

Implementinga National Technology
Strategy with Self-Organizing Industry
InvestmentBoards
THEMOSTIMPORTANT
LESSONfrom the study of research and development,

economicgrowth, and the history of technologyis that there are more
waysto arrangethe objectsof the physicalworldthanhumanscanpossibly
imagine.Ultimately,all increasesin standardsof living can be tracedto
discoveriesof more valuablearrangementsfor the things in the earth's
crustand atmosphere.The personalcomputerthat I used to write thispaperis madefrom almostexactly the same physicalmaterialsas the PC
thatI boughtten years ago-about thirtypoundsof steel, copper,aluminum,plastic,andsilicon, with bits of gold, ironoxide, andmiscellaneous
otherelementsmixed in. In my new PC these materialsare arrangedin aslightlydifferentway thatmakesthem aboutfifty times moreuseful thanthey werein the originalconfiguration.
No amountof savings and investment,no policy of macroeconomic
fine-tuning,no set of tax and spendingincentivescan generatesustained
economicgrowthunlessit is accompaniedby the countlesslargeandsmall
discoveriesthat are requiredto create more value from a fixed set of
naturalresources.These discoveriesare the productof a complicatedset
of marketandnonmarketinstitutionsthatconstitutewhathas been called
a nationalinnovationsystem. This paper considersboth the economic
The authorgratefullyacknowledgescommentsfrom the discussantsand the editors.
Thismaterialis based on work supportedby a NationalScience Foundationgrant.

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opportunities
andthe politicalrisks inherentin attemptsto strengthenthis
system.It proposesan institutionalarrangementthatcould providemore
financialsupportfor innovativeactivity and direct it towardareas withlargeeconomicpayoffs.
Even moreimpressivethanthe availabilityof a much fasterPC to do
wordprocessingis the fact thatmy family drinksmilk froma cow. If themilkcow did not exist, no one would ever believe thatcarbon,oxygen,hydrogen,and a few other types of atoms could possibly be assembled
into a chemicalrefinerythat automaticallyconvertsgrass, water, and air
into a nearlyperfectliquid proteindietarysupplement.This refineryoperateswith almostno humansupervision,is mobile so it can searchout
its own inputs, can heal most mechanicalfailures, and can detect andneutralizeany microscopicpathogensthatenterthe system. It even makes
morethanmilk. It can buildseveralreplacementfactoriesout of the samerawmaterials:grass, water, and air.
Comparedwith the cow, my PC has all the sophisticationof a Tinkertoy. And if the particulararrangementof atoms that make a cow cancometogetherthrougha blindprocessof mutationandselection-nature's
versionof trial and error-imagine how many otherways atomscan bearrangedthat are as astonishingand valuableas a microprocessorand acow. The fundamentalchallengein economicgrowthis to findthese newarrangements.
Thisoptimisticpotentialfor exploitingwhatVannevarBushcalled"theendlessfrontier"of scientificandtechnologicalopportunityis limitedonly
by the difficultyof organizingcollective action.I It takescollectiveaction
to encouragediscoveryandsustainthe free flow of ideas, andthe politicalmechanismsused to undertakecollectiveactionsufferfromseriousinherent defects.
But people createnew institutions,just as they discovernew technologies. Policy innovatorsdiscoverbetterways to undertakecollective action, just as scientists, engineers, and productdesignersdiscoverbetterways to arrangephysical objects. VannevarBush did more thanwrite areportaboutthe endless frontierof science. He midwifedthe birthof the
NationalScience Foundationand peer-reviewedresearchgrantsfor basic
researchat universities.He identifiedan importantopportunityfor collec1. Bush (1945).

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tive action and then constructedan institutionalarrangementto exploit
thisopportunityat minimalpoliticalcost.
Any contemporary
discussionof a nationaltechnologystrategyshould
be basedon a balancedassessmentof the potentialbenefitsfromcollective
actionto spurgrowthandthe risksinherentin undertaking
collectiveaction
throughthe politicalprocess. Even die-hardfree marketeersshouldconcede that there is an opportunityfor collective action to supportsome
formsof basic research.On the otherside, even the most ardentadvocate
of an activistgovernmentmust admitthat the nation'sfifty-yearexperimentwith an explicit industrialpolicy for the savings and loan industry
showshow badly awry well-intentionedcollective actioncan go when it
is implementedthroughthe existingpoliticalinstitutions.
Once the tension between the large opportunitiesfor benefitingfrom
collective action and limited political and institutionalcapabilitiesfor
undertaking
effectivecollective actionis recognized,it becomesclearthat
innovationin institutionalmechanismscouldbe veryvaluable.Surely,theto experimentwith new institutionsis as greatas the opporopportunity
tunityto experimentwith new arrangementsof physical objects. The
standard
dichotomyin economicpolicy debates-market exchangeversus
governmentintervention-does not capturethe complexityof the kindsof social institutionsalreadyused to achieve commongoals. It also fails
to suggestthe broadrangeof new institutionalarrangements
thatcouldbe
tried.In its purestform the marketis a mechanismfor allowingindependentactionby all individuals,with no explicitcoordination.The governmentis a mechanismfor explicitlycoordinatingthe actionsof all people.
Mosteconomicactivityis supportedby institutionalarrangements
thatareintermediate
betweenthese extremes.
After all, the modern capitalist economy is organizedneither as amarketnor as a government.It lets large numbersof people exploit thebenefitsof collective actionthroughexplicit, hierarchicalcoordinationas
membersof a corporation,and in this sense large partsof a capitalist
economyfunctionlike a government.But an economy with many firms
subjectseachto the disciplineof competition,so in this sensethe economy
is organizedmore like a market.The diversepopulationof corporations
is constantlychanging,constantlyfindingnew anddifferentways for large
groupsof peopleto worktowardsome collective end. Some corporations
findnew ways to structurethemselves.Othersdie off andarereplacedby

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new andbetterarrangements.Whata nationalinnovationsystemneeds issomethinglike this kindof dynamic,somethingthatlets us takeadvantage
of mutuallybeneficialcoordinatedaction and that uses the pressuresof

competition
anda markettest to shutdownineffectiveinstitutionalarrangementsandto rewardpromisingones.
To show how such a process might work, I describea specificpolicy
proposalconceivedwith this end in mind. Whateverthe finaljudgmentis
on this particularproposal,the general analyticalpoint will, I hope, be
clear.To encouragetechnicalchange, it is not enoughto call on businessleadersto be more innovative.Policymakersmust themselvesbe willingto experimentwith new institutionalarrangements.

Self-Organizing Industry Investment Boards
This proposalspecifies a process, not a specific policy. To see how
it would work, consider a hypotheticalexample. Suppose you run the
AcmeWidgetcompanyand I runConsolidatedWidgets. You and I andmany other widget makers come together and decide that there areindustry-wideopportunitiesand problems that independentaction byindividualfirmscannotaddress.You think, for example, thatuniversity
professorscould be doing useful researchon questions aboutthe basic
principlesof widget design and manufacturingif theyjust hadthe funds
and the incentive to do so. I believe that the upstreamindustrythat
manufactureswidget-makingequipmentcould be designingmoreusefulspecializedequipment.
Underthe proposaloutlined in this paper, widget makerscould takecollective action on these mattersby following the steps specified in a
generalpiece of enabling legislation. They would start by petitioning
the secretaryof commerce, giving the argumentfor provision of anindustry-specificpublic good. The secretarywould then hold a hearing
to certify that the proposal for collective action addresses a genuine
publicneed. If the proposalpasses this test, an election would be heldin whichall widget manufacturersvote whetherto levy, say, a 1 percent
taxon widget sales. If a large enough fractionof the industry(measured
as a fractionof total sales, as a fractionof the total numberof firms, orsome combinationof the two) votes in favor of this initiative, a tax

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backedby the full force of law would be imposedon the entireindustry.
The proceedsfrom the tax would not, however, go to the government.
Partof the presentationto the secretaryof commerceand then to theindustrywould outline plans for creating industryinvestmentboards.
You will take the initiative to organize an investmentboard that willfund university-basedwidget research. I will organize a board that
supportsthe developmentof widget-makingmachineryin the upstream
industry.Both of these boardswill functionas pass-throughs,accepting
tax obligationsfromcontributingfirmsand using these fundsto support
researchin universities in the first case or development in upstream
firmsin the second. After the tax is passed, the two boardswould solicit
the tax funds from the firmsin the industry. Supposethatyour firmhas
sales of $100 million a year, so it has to decide where to allocate its$1 million in annual tax obligations. Because you are organizing the"UniversityResearchBoard," you might decide to allocate all of the$1 millionto it. My firmhas sales of $200 million a year. I mightdecideto have my firm split its $2 million tax obligation, giving $1 million tothe "UpstreamEquipmentDevelopment Board" that I help organize
and$1 million to the University ResearchBoard. Each year the leadersof otherfirmswould have to decide how to allocatetheirtax obligations
between these two boards and any others that might be created. The
amountthey have to contributeis fixed by their sales and the tax rate.
They are free, nevertheless, to decide which boardreceives their contributions.If they do not approveof the boardsthatexist, they are free
to starta new one.
Each industryboard would have a boardof directorsanswerableto
its contributingfirms and would operate as a private, nonprofitfoundation.The boardswould be limitedby the generaltermsof the enabling
legislation but would otherwise have wide latitude to make decisions
withoutany direct oversight or second-guessingby the executive, legislative, orjudicial branchesof government.A generallimitationwould
requireeach board to invest only in common propertyresources that
benefitthe entire industry.For example, all specialized equipmentdevelopedby the UpstreamEquipmentDevelopmentBoardin collaborationwiththe upstreamindustrywould be availablefor sale to all widgetmakingfirms on equal terms. All research funded by the University
ResearchBoard would be freely distributedin the traditionof open
university-basedscience. Thus, neither board could fund researchor

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equipmentdevelopmentthat would be conductedin-house by a firmin
the widget industry. All of the activities of the boards would have to
be made public.
The enabling legislation should also specify that absolutely no tax
funds could be used to supportlobbying, public relations, or any kindof political activity. Also, no direct or indirectkickbacksor side paymentsto firms in the industrywould be permitted.The tax rateused ineach industrycould vary, but a maximumtax, on the orderof 2 percent
of sales, would need to be specified in the enabling legislation. The
legislationshouldalso articulatethe generalprinciplethatthe tax should
be a domestic consumption tax rather than a production tax. Units
produceddomestically for sale abroadwould not be subjectto the tax,
butunitsproducedabroadand sold domesticallywould. The legislation
would also mandateequal treatmentfor all firms. Foreignfirmswould
vote in the referendum, pay tax on their sales in the United States,
allocate their tax obligations, and participatein the governanceof theboardor boardsthey support, in exactly the same fashion as domestic
firms.
Suppose that other industry leaders come to believe that the mostimportantproblemfacing the industryis an inadequatesupply of postgraduateengineerswith special trainingin widget-relateddesign issues.
Orsupposethey decide that the most importantinvestmentwould be todisseminateexisting informationaboutthe principlesof manufacturing
to widget-makingfirms. Other firms might decide that junior college
trainingof basic skills for currentand futureworkersin the industryis
the most importantpriority. An interestedfirmor groupof firmscould,
at any time, petition the secretaryof commerce, participatein public
hearings,andthen establish a Ph.D. EngineeringFellowship Board, an
Extension and Diffusion Board, or a WorkerTraining Board. These
new boardswould compete with existing boardsfor the tax obligationsof the differentfirms in the industry.
Over time, if contributingfirms felt that the University Research
Boardwas funding an incestuous networkof scientists doing researchof limitedvalue to the industry,a competingresearchboardcould comeinto existence, or the funding firms could simply vote with their feetandtake their tax dollars to other boards. In the worst case, if none of
the boards were doing work that justified the cost, firms could use aperiodicallyscheduled election to rescind the tax altogether.

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The original proposal to the secretaryof commerce would have to
specifyhow the tax would be administered.Some boundarywould haveto be established, for example, between true widgets, which would betaxed, and near-widgets, which would not. An overall industryassociation, financedfrom an expressly limited share of total industrytax
revenue, would have to be created to administerthe tax system andperformthe basic audit and informationcollection activities necessary
to monitorcompliance. Cases of explicit fraudor intentionalnoncompliancecould be referredto an appropriategovernmentagency with thepowerto impose fines, compel testimony, and, if necessary, undertake
prosecution.

Precedents
This proposalmay sound like political science fiction, but it is modeled on arrangementsthat alreadyexist. The closest precedentis specified in the Agricultural Marketing Agreement Act of 1937, which
outlinesproceduresfor establishing arrangementscalled marketingorders.2Growersof a particularagriculturalcommoditycan petition thesecretaryof agricultureto establish a market order on their behalf.
Typically,the marketorderis approvedif eithertwo-thirdsof the growers or growersrepresentingtwo-thirdsof outputby volume supportthe
proposalin the subsequentreferendum.A new referendumis usually
heldevery six yearsto gauge growersupport.At any time, the secretaryof agriculturecan suspend any marketingorderthat is not operatingin
accordancewith the aims of the enabling legislation.
Marketingorders designed to support research and development(R&D)and marketpromotionactivities differ from the proposalin thispaperonly in that the funds raised by the tax automaticallygo to asingle marketingboard. There is no element of competition between
boardsand no free entry.
About three-quartersof the marketingorders in agriculturecollectfundsfor research, development, and marketpromotion. (This is how
the popularCaliforniaraisin advertisementswere financed, for example.) Marketingorderscan also specify package and containerregula2. Powers (1990).

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tions, or size and graderegulations. These kinds of activities shouldbe
sharplydistinguished from the notorious volume control regulations(that is, output restrictions) imposed in about half of all agricultural
marketingorders. Quantityrestrictions are clearly an activity that no
economistwould want to encourage, and they should not be tolerated,muchless encouraged,in legislation that specifies the acceptableactivities for the investmentboardscontemplatedhere.
This proposalhas other, less obvious parallelswith existing arrangements. For example, many (but not all) public electrical utilities contributeto the Electric Power ResearchInstitute(EPRI), which finances
researchon a variety of industry-relatedmatters.If local regulatorslet
contributionsto EPRI count as partof cost in figuringthe utility's ratebase, they are, in effect, using a government-sanctionedtax on electricityto supportindustry-relatedresearch.Just as in agriculture,however, thereare no alternativeresearchboards. Some observersmaintain
thatEPRImay not be as effective in stimulatingresearchas it once wasor as it could be, perhapsbecause it faces no competition.
Before the breakupof the Bell System, Bell Labs was supported
in a similarfashion. Each of the operatingcompaniespaid a few percent
of total revenues to AT&T, which supported Bell Labs out of theproceeds. Again, to the extent that this contributionwas built into therate base that utility regulators allowed the operating companies, itamountedto a government-sanctionedtax used for industry-relatedresearchpurposes. Because AT&T controlled the vast majorityof telephone operatingcompanies, free riding was not a problem.
Most observersjudge Bell Labs to have been an extremelyeffective
researchorganization.It made fundamentalcontributionsto basic science. Information theory was created there. Radio astronomy wasinventedthere. The backgroundradiationthatis the best evidence available for the "big bang" was discoveredthere. Bell Labs also produced
high-qualityscientificdiscoveries thathave hadenormouspracticalandcommercialimplications:the transistor,the laser, fiberoptic transmission of information,and Unix, the first majorcomputeroperatingsystem to run on computersmade by many differentmanufacturers.
As evidence that firms can come together and take actions that arein the interestof the industryas a whole, one need look no furtherthan
the pharmaceuticalindustry. It recently persuadedthe Food and Drug
Administration(FDA) to raise the fees it levies when a company sub-

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mits a drugfor approval.The explicit understandingwas thatthe FDA
would use the additionalrevenue from this fee to hire more evaluators
so thatthe agency could reduce the time it takes to reach a decision on
drugapproval.

The Economic Opportunities for Collective Action
It takes two argumentsto make a case for this proposal. I must show
why there are any importantunexploited economic gains that require
collective action. Then I must compare the potential gains with thepolitical risks of implementing the system. This section outlines thetheoreticalargumentfor large potential gains from collective action.
The next refers to evidence on their quantitativeimportance. Subsequent sections take up the political risks of this and other forms oftechnologypolicy.
If physical objects were the only economic goods, there would be
little opportunityfor collective action beyond the universally recognized need to establish a system of property rights. But as table 1
suggests, objects are not the only economic goods. They are not eventhe most importantgoods. The table presents a two-way classificationof differentkinds of economic goods. The left and right columns classify goods according to their costs of production. The horizontaldimensionclassifies them by the strengthof the propertyrights available
for each good.
The column on the left lists physical objects that are consumed directly or that provide services that are consumed. These kinds ofthings-land, fish, a worker's labor effort-are typically thoughtof as
economic goods. The column on the right lists goods that can be representedas bit strings. They are all examples of informationin themathematicalsense of the term. Whetherit is literallya bit string(suchas computercode or a digital musical recording)or is somethingrepresentedin words or symbols that could be converted into bit strings(the design for a microprocessor,the operationsmanualfor Wal-Mart
stores,or the resultsof scientific investigation),any good in this column
is a piece of pure information.
Thetechnicalterms from public financefor the types of goods in thetwo columnsare rival goods and nonrivalgoods. The objects are rival354

Brookings Papers: Microeconomics2, 1993

Table1. EconomicAttributesof VariousGoods
Degreeof
control(percent)
100

Rival goods(objects)

Nonrivalgoods(bit strings)

Privategoods:
for example,a piece of
unimprovedland

An encodedsatellitetelevision broadcast

A car

A worker'slaboreffort

A digitalmusicrecording
The designfor a microprocessor
Computercode
The operationsmanualfor
Wal-Martstores
Generalprinciplesof chemical engineering
Principlesbehindwindowbasedgraphicaluserinterfaces
The do-loopin computerprogramming

Fish in the sea
Cleanairo

Sterileinsectsused for pest
control

Publicgoods:
for example,basicresearchin physics

goods because you and I are rivals for their use. You can eat the fish
or I can, but not both of us. A bit string is a nonrival good because
once it has been produced, we are not rivals for its use. I can listen to
the musical recordingor take advantageof the software code without
in any way diminishingits usefulness to you or anyone else.
The most importantresult of the work on "endogenous growth"duringthe last ten years has been the renewedattentiondevotedto these
attributesof ideas as economic goods. The firstconclusionthatemerges
from the theory of growth was clear even in neoclassical models: it is
the productionof nonrivalgoods that makes growthpossible. The second conclusion, which has emerged only after a great deal of work, isthatthe usual invisible handresult applies only to an artificialeconomy
in which nonrivalgoods are providedexogenously by nature.In a real
economy, an inherent, unavoidableconflict exists between the incentives necessary to encourage the production of these goods and thePaul Romer

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incentivesthat lead to the optimal distributionof these goods, both tousersandto the developers of otherrelatednonrivalgoods. This meansthat private propertyrights and market exchange are not the perfect
institutionsfor supportinggrowth. In fact, no simple descriptionof theperfectinstitutionalarrangementcan exist. In any particularcontext,
one must explicitly address the trade-offs both between the incentives
for discovery and those for diffusion and between the limitations ofmarketmechanismsand those of political mechanisms.
The two columns in the table correspondroughly to the distinction
emphasizedin the introductionbetween physical objects andintangible
discoveriesaboutnew ways to arrangethose objects. Farming,resource
extraction,manufacturing,and distributionare all examples of actions
thattransformphysical objects. For most people, these are the kinds ofthings that first come to mind when they think of economic activity.
Discovery, in contrast, is how new, nonrivalinstructionsare found forusing rival goods more creatively. As the introductionsuggests, discovery is where the real action is in economic life. Because nonrival
goodsareintangible,they arehardto measure.Moreover,they typicallyaffect the economy in small incrementsthat are hardto perceive fromone year to the next. (The computerindustry, where dramaticchange
canbe seen in real time, is a notable exception.) But one needs to read
only a little history to appreciate the profound cumulative effect ofthese nonrival goods-these discoveries-in almost all areas of economic activity. If the Earth were returnedto the physical state thatexistedten thousandyears ago, wiping out all structures,physical capital, and civil engineeringprojects, but the total stock of accumulated
knowledgewere retained(in an exemptedlibrarywherebooks andotherrecordswere kept), current standardsof living would be recovered
within a few generations. If the experiment were reversed, with thephysicalstate of the world retainedbut the state of knowledgereturned
to what it was ten thousandyears ago, our economic prospectswould
be muchbleaker.
The sharpdistinctionthatthe table drawsbetweenrival andnonrival
goods is rarely apparentin practice because real goods are almost always a mixture of the two. If you buy shrink-wrappedsoftware, forexample, you purchase a bundle that consists of rival objects (somefloppydisks and a book) and a nonrivalgood (the legal right to use thebit stringthatencodes the computerprogram).The distinctionbetween

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an object such as a floppy disk and an intangible such as the computercode stored on the disk is important because it points to a fundamental
difference in the associated costs of production. The cost of producing
the computer code is virtually all fixed cost, or "first copy" cost. Firms
spend millions (sometimes hundreds of millions) of dollars finding justthe right bit string, but once they have it, they can replicate it atessentially zero cost. Once a nonrival good is produced, it is a goodwith no opportunity cost. The cost of the floppy disk, in contrast, isalmost entirely the constant cost of producing additional disks; almost,but not quite, because, of course, the floppy disk itself reflects a sophisticated design that required an important fixed-cost investment. The
floppy disk is not a pure rival good, but unimproved land is, because it
has no underlying design cost.
In contrast to the horizontal distinction between rival and nonrival
goods, the vertical dimension in the table reflects the more familiar
issue of property rights, appropriability, excludability, or, simply, control. It is possible to control different kinds of goods by maintaining
physical possession, perhaps with the assistance of the legal system, orby keeping some valuable piece of information secret. Land is placed
relatively high up in its column because it is rarely stolen and because
the cost of maintaining control over land is small compared with its
market value. An automobile is lower down the column, because cars
are more frequently stolen and the total resources spent by society on
maintaining control over cars is higher. Goods that are both object-like(that is, rival) and over which almost perfect control can be maintained
are called private goods. Land is a private good, and a car is closeenough for most analytical purposes.
Farther down the rival goods column are examples of objects (orservices from objects) for which property rights are weaker and control
is less complete. When a firm hires a worker, it purchases labor services
during certain periods of time. Because labor effort is difficult to observe, the firm does not always get the good for which it has paid. The
existing legal system cannot enforce this kind of contract at all well. It
would be absurd to propose that the firm go to court and sue for compensation whenever the employee leaves work early. Firms therefore
find ways to execute transactions with their workers that are cheaper
than writing explicit legal contracts that list all contingencies and thenlitigating every dispute. This is what the transactions cost theory of thePaul Romer

357

firmis all about.3It emphasizes that firms are institutionsthat provide
alternativesystems for establishing propertyrights and enforcing contracts. These institutions make possible investments and gains fromtradethat would otherwise be impossible to exploit.
At the bottom of the column are examples such as fish in the sea or
the sterile insects that are released in agriculturalsettings to control
pests. Fish and insects are objects. They are rival goods. The insects
can neutralizefertile pests in my valley or yours, but not both. They
unambiguouslybelong in the left-hand column. Control over thesegoods, however, is especially weak. If one farmerpaid for andreleased
sterileinsects, the benefitswould spill over onto the farmsof his neighbors. Much of the economic analysis of policy is framed in terms ofthesespillovers-these instancesof incompletepropertyrights. Control
can be weak, so spillovers can be present, both for rival and nonrival
goods.
The right column lists examples of pieces of pure informationwith
variousdifferent degrees of control. An encryptedsatellite television
broadcast,the kindused to distributemovie channelsto cable televisionsystems across the country, is a pure nonrival good with very strong
propertyrights. Musical recordings, microprocessordesigns, andcomputercode are examples of goods for which control is less thanperfect
but which nevertheless are supplied by commercial firms able to sell
their goods in the marketat a significant markupover marginalcost.
The kind of knowledge possessed by the Wal-Martcorporationabout
managingretail stores is only partlycontrolled-other firmscopy what
it does. That knowledge nevertheless represents an asset in which a
firmcan invest and on which it can earn a sizable return.
Next come goods over which control is even weaker-these include
goods such as the general principles that are the basis for chemicalengineering,the insights behindthe notionof a window-basedgraphicaluser interface for computer programs, or basic ideas such as the doloop in computerprogramming.Finally, at the bottom, are goods, suchas resultsfrom researchin physics, that are nonrivaland whose use isvirtually impossible to control. Economists call these pure public
goods. (The term is somewhatmisleading because not all public goods
are providedby the government-think of charitablecontributionsto
3. See, for example, Coase (1988); and Williamson(1975).

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support public television. Moreover, not all goods provided by thegovernment are what economists call public goods-think of the sterile
insects.)
One of the most important insights in economics is that if people
have strong control over ordinary objects (those in the upper left cornerof the table where the private goods are) and if there are many potential
buyers and sellers, decentralized exchange between self-interested traders leads to efficient outcomes. This is the lesson of laissez-faire, or
the invisible hand. If control over objects is weak, outcomes may beinefficient-as in the proverbial tragedy of the commons. Everyone
will be a free rider. These results are the basis for the strong, almost
unthinking reaction among some economists that moving up the columns of the table and increasing the degree of control will always
enhance efficiency. If others cannot be excluded from enjoying thebenefits of some service, the government may collect taxes and pay forthe service, as it does for the release of sterile insects, but this kind ofcollective action is used only as a last resort. Stronger property rights,
this line of thinking suggests, would always be preferable.
This intuition is correct for rival goods but simply does not apply tononrival goods, where strong property rights are inherently associatedwith monopoly power. If there are strong property rights, there cannot
be many sellers. If firms that produce nonrival goods are to avoid large
losses, these goods must sell for a price that is higher than marginalcost. Marginal cost on bit strings is zero, but the initial fixed costs ofproducing them can be very large.
To see why extremely strong property rights might be a problem,
imagine that Bell Labs had been given a nonexpiring, ironclad patenton the discovery of the transistor. Or even worse, imagine that such apatent had gone to an organization such as IBM or General Motors.
Think of how different the digital electronics and consumer electronics
industries would be if every inventor who improved on the design ofthe transistor and every person who applied the transistor in a newsetting had to negotiate with one of these large, bureaucratic organizations for permission to proceed. Not only would the prices have been
higher, but the rate of discovery of all the inventions that reduced thecost of transistors would have been lower. These kinds of discoveries,
which were made by many different individuals in many different firms,

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have in just a few decades caused a millionfold reduction in the cost of
producing a transistor.
A standardresponse to concern about strong patent rights is the claimthat if GM had owned the patent on the transistor, it would have had
an incentive to do everything right-to make all the right inventions
and to agree to efficient contracts with outsiders. The relevant retort isthat (M has had an incentive to find innovative ways to design andbuild high-quality automobiles and has not always succeeded in doing
so. In the car business consumers are protected by the presence of adiverse set of competing manufacturers. But with an effective patent,
all of the eggs would necessarily be placed in a single corporate basket.4
Or consider the computer software industry, an area of economic
activity where producers are exquisitely aware of the need for somedegree of intellectual property rights and monopoly power. Many
thoughtful participants have also recognized that property rights can be
too strong. Monopoly power can impose serious distortions and negotiation costs. Imagine, they say, if someone had been able to obtain along-lived patent on the do-loop or the blinking cursor.
If people were pathologically honest and compulsively followed instructions, the economic problem of producing nonrival goods would
be easy to solve. (This definitely is political science fiction.) In thiskind of world, undertaking collective action would pose no problem.
Everyone would diligently search out new opportunities for discoveries
as they went about their other activities and would report all theylearned to a central, coordinating agency. The government would directa subset of these people to do the R&D necessary to take advantage ofthe most promising opportunities. The government could request thateveryone else contribute a share of their income to the researchers who
produced the desired nonrival goods-the software, the movies, themusic, the books, the microprocessor designs, the innovative ways toorganize a retail chain, the technological and scientific discoveries.
These producers of nonrival goods could then give away all of theunderlying discoveries at marginal cost, zero.
A world populated by real people instead of these science fiction
4. See Mergesand Nelson (1992) for an extendedevaluationof these kinds of costs
fromstrongpropertyrights.

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automatons faces two distinct problems in providing nonrival goods:
how to share costs and how to select the most promising opportunities
for investment. Real people will choose to be free riders if they can.
They will not share the fixed costs of goods that are freely disseminatedif they do not have to. In addition, assembling all the informationnecessary to decide which of the extremely large number of possible
nonrival goods to produce is difficult. The kind of calculation showingthat there are many wonderful things to discover also implies that there
are an almost infinite number of ways to waste effort on interesting but
socially useless nonrival goods. Think about software. About 101,000?000

different bit strings can fit on a 360K floppy disk. For comparison, ayear has about 107 seconds, and about 1018 seconds have passed since
the big bang. Out of 101,000,000 possibilities

only a very small fractionneed to be useful for there to be many useful software programs still tobe discovered. But so many other possibilities also are available that
all human ingenuity for the rest of time could be devoted to producing
useless computer code.
The government's powers of coercion make it uniquely capable ofsolving the cost-sharing problem. Unfortunately, these powers also
make the government uniquely capable of wasting large amounts ofresources on socially useless purposes. (Recall the experience in thesavings and loan industry.) Markets, conversely, can solve the sharing
problem only by introducing monopoly distortions, but they are better
than governments at selecting the opportunities to pursue and avoiding
wasteful spending. Because people operating in the market are motivated by the potential for profit, they seek out only those nonrival goods
that have real value. The parallel or simultaneous search by large numbers of market participants can efficiently evaluate many possibilities.
Bankruptcy constraints quickly cut off the flow of resources to projects
that turn out to be unpromising.
Under the existing institutional arrangements for producing nonrival
goods, one or the other of these extreme mechanisms is typically selected as being most appropriate for a given type of good. In the public
good portion (the bottom) of the nonrival column, the government pays
for basic research and gives away the results. This arrangement ischosen partly because dissemination of these goods is so important.
(Think, for example, of the polio vaccine.) In addition, because of theefforts of Vannevar Bush and people like him, the institution of peer

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review of competitive research grants is now available. It offers areasonably good solution to the problem of selecting which projects to
fund.
For nonrival goods at the top of the column, there is little prospectof setting up a government body that could make the right decisions
about what to provide. No one would take seriously the suggestion thatthe government should extensively subsidize the production of popular
music recordings, movies, or the design of new kinds of microprocessors so that these goods can be sold at marginal cost. Instead, society
relies on market mechanisms to make those decisions and accepts thelimits on dissemination and the monpoly distortions that the use of themarketentails. The monopoly markups on compact disks, movies, andmicroprocessors cause relatively small welfare losses, and selecting
which goods to produce poses an institutional design problem thatdwarfs the problem faced in basic research.
The existing arrangement with government provision of basic research and market provision of final goods seems to work reasonably
well for nonrival goods at the top and bottom of the column. It is theintermediate zone where the most important opportunities may now be
missed. This region includes what Richard Nelson has called genericresearch. As he argues on the basis of case studies in different industries, this area may offer particularly large returns from investment inresearch.5 It includes goods such as the principles of chemical engineering, the insights behind the design of computer interfaces, and thefundamentals of program design. It is this region that my proposal tries
to address through its mixture of government and private sector mechanisms. Without trying to identify in advance what these areas are andwhat the specific opportunity for collective action is, the proposal seeks
to create a mechanism that combines the government's efficiency atsolving free-rider problems with the market's effectiveness in selecting
practical problems that offer the highest rates of return. Market participants can then make the right decisions about where the returns on
investment are highest for the industry.
More is at stake here than just the rate at which knowledge is transferred from basic research to commercial application. These areas playa special role as the intermediaries between the basic research com5. Nelson (1983).

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munity and the final users of technological knowledge in an economy.
Better communication here is important not just for commercial outcomes, but for the vitality of the basic research endeavor. Without somepoint of contact with the practical opportunities and challenges of theworld, basic science risks drifting into irrelevancy. The recent trend
toward closer contacts between individual firms and universities avoids
the problem, but firms pay for research only if they get proprietarycontrol over the results. These arrangements therefore tend to undermine the traditions of open dissemination of ideas that have made ouruniversities so successful. The proposal outlined here could provide amechanism for connecting industry with universities, without jeopardizing the traditional role of the university.

Economic Magnitudes
Economists have uncovered a great deal of evidence suggesting the
economic importance of nonrival goods. In his very useful survey ofthe econometric work on spillovers from R&D, Zvi Griliches describes
one of the first attempts to compute a social rate of return on investments
in R&D.6 T. W. Schultz computed the total resources saved by technological change in agriculture, compared the savings to total expenditure
on R&D, and found a high ratio of benefit to cost.7 In his refinementof this calculation, Griliches himself found that the social rate of returnon public investment in research on hybrid corn had a rate of return of
about 40 percent, a number illustrative of the magnitude of returns on
investment in R&D that has been found in many subsequent investigations.8 A sample of discoveries has been used to make this kind of
calculation both in agriculture and in manufacturing.9 It has also been
made in agriculture, in manufacturing, and at the national level bymeans of regression analysis using data on total factor productivity.
Three conclusions emerge from this large body of work. The first isthat the social rate of return to investment in the broad class of nonrival
goods is quite high, on the order of 30-50 percent. This level of return
6. Griliches(1992).
7. Schultz (1953).
8. Griliches(1958, p. 425).
9. Mansfieldand others (1977).

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confirms the claim made above that these are in some sense the mostimportant kinds of investments that can be made. Second, the researchdemonstrates that the social rates of return are significantly higher thanthe private rates of return. This gap can arise because firms that produce
new nonrival goods have only weak control or property rights overthem. Alternatively, it can arise because property rights are strong;monopoly pricing then induces its own wedge between private andsocial values. The third conclusion is that economists cannot estimate
the ex post rate of return in any one industry or area of economic activity
with anything like the precision required if econometric estimates alone
were to be used to make decisions about where to direct research dollars. This literature offers no support for the idea that academics orbureaucrats will be able to read the numbers and pick winners.
The calculation by Griliches suggests that the difference between
private and social benefits from research is important for more than the
microeconomic details. The macroeconomic effects of this difference
can be quite large. Using the calculated social rates of return to investments in R&D, he can explain the majority of the total factor productivity growth at the national level as the result of measured spending
on R&D. And this kind of calculation must lead to an underestimate of
the importance of nonrival goods because it cannot capture the kind ofinnovation that led, for example, to discount retailing in the UnitedStates. Wal-Mart no doubt does not show up as a big player in the R&D
statistics but has nevertheless helped transform an extremely importantsector of the economy, significantly lowering costs in the retail sector.
Griliches' calculation is also consistent with the recent cross-country
regression estimates by Lichtenberg and by Coe and Helpman suggesting that social returns to R&D, measured at the national and international level, are still very high. '0

Principles of Political Action
Having made the case that there are important opportunities for collective action to encourage the production of nonrival goods, especiallyin areas of practical importance, I now evaluate the potential costs of
10. Lichtenberg(1992); Coe and Helpman(1993).

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trying to undertake collective action. In doing so several general principles suggest themselves. Other observers would no doubt add to thelist and might change the emphasis, but the generalizations listed below
should not be particularly controversial.
Reaction
Every policymaker operates in an environment characterized by competition among many different independent policymakers. A government of divided powers, such as ours, has a number of policymakers,
and every government in the world must take account of the actions ofother governments.
In this setting any change in policy can induce a reaction from otherpolicymakers. A good working hypothesis is that policymakers operate
in a strategic environment characterized by tit-for-tat and in which thedetails of what others are doing are sometimes hard to discern. Thissuggests a sequence of tests in evaluating any policy initiative:* Self-interest. Would a policy be worth adopting if no other policymaker changed policy in response?

* Reflection. Would a policy be worth adopting if other policymakers responded by adopting the same policy?

* Robust reflection. Would a policy be worth adopting if other policymakers responded by adopting similar but more pernicious policies?
These tests reflect increasingly sophisticated views of strategic behavior. The self-interest test applies when there are no other players orin a one-time strategic interaction. The reflection test applies in casesof repeated interaction-what economists call a repeated game. The
robust reflection test applies in cases of repeated strategic interaction if
the actions or motivations of other players are difficult to observethat is, in a repeated game with asymmetric information. In both of thereflection tests, the implicit model of the policy equilibrium is basedon trigger strategies in which all parties defect as soon as one does.
One example that bears directly on technology policy and that suggests the importance of the robust reflection test can be cited. I In the
11. This account is based on Crease (1991) and Office of Technology Assessment(1991).

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early 1980s George Keyworth, then the science advisor to President
Reagan, invented the concept of a "Presidential Initiative" and simply
put a $140 million item in the Department of Energy budget to support
funding for a National Center for Advanced Materials (NCAM), bypassing all of the usual mechanisms of peer review.
Suppose for the purposes of argument that this project represents agood investment in science and technology and thus passes the selfinterest test. Suppose also that it passes the reflection test in a policy
game between Congress and the executive branch. If both sides begin
to use the special initiative process to fast-track high priority scienceand technology projects that are truly in the national interest, the net
effect would be positive.
What Keyworth did not anticipate was that Congress would behave
differently from the way he did because members of Congress face
incentives that are different from his. They used the freedom from peer
review to fund projects of dubious scientific value. At the same timethat Congress rejected Keyworth's attempt to bypass the traditional
procedures with his presidential initiative (which was eventually funded
afterundergoing peer review), it approved two congressional initiatives
that also bypassed all peer or agency review and that had no apparent
justification in terms of national interests. For example, one initiative
gave Columbia University $24 million to renovate its chemistry building. (In a play on Keyworth's words, this was referred to as the National
Center for Chemical Research.)
These actions marked the end of the traditional consensus that basic
research funding had to pass peer review and would not be eligible forcongressional earmarking. Universities began to hire their own lobbying firms and compete actively for earmarked funding. Senators andrepresentatives now compete to provide resources for their constituents.
Since 1982 earmarked research funds have grown from $9 million ayear to $470 million in 1991 and $707 million in 1992.12 For comparison, the annual budget for the entire National Science Foundation isabout $2 billion.
Almost everyone concedes that much of the congressionally earmarked funding represents pure pork-barrel spending. The academic
community, the executive branch, and the defenders of traditional sci12. Savage (1992, p. 8, table 1).

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ence in Congress have tried to put the genie back in the bottle but to noavail. For example, when the Bush administration tried to rescind funding for specific examples of pork-barrel science, Congress threatened
an extended battle of tit-for-tat by canceling funding for thirty-one
specific research grants for the National Science Foundation and the
National Institutes of Health. The Clinton administration initially said
the right things but has subsequently backed down and gone along with
the intentions of Congress.
One can always argue that Congress would eventually have developed a high level of earmarked pork-barrel funding on its own, but the
specific sequence of events and the testimony of participants suggeststhat Keyworth's initiative played a crucial role in the shift from the old
equilibrium to the new one. If so, it did not pass the robust reflection
test.
Delegation
The dissatisfaction with congressional earmarking as a mechanism
for allocating funds to universities reflects a general principle. Successful decisionmaking on matters of science and technology policy
requires that responsibility for specific spending decisions be delegatedto a body that is not under the direct control of members of Congress.
For example, delegation is the key element in the success of the peer
review system. It is the mechanism whereby members of Congresscommit to each other that they will refrain from pursuing special advantage for their constituents as long as everyone else refrains as well.
The lack of delegation is at the heart of the failure of many science andtechnology projects that must, because of their large dollar cost, be
directly funded by Congress. The summary by Cohen and Noll of theresults from six case studies of large commercialization projects (thesupersonic transport, satellite technology, the space shuttle, the Clinch
River breeder reactor, the synfuels project, and the photovoltaics commercialization program) is illustrative. "The overriding lesson from thecure market
case studies is that the goal of economic efficiency-to
failures in privately sponsored commercial innovation-is so severely
constrained by political forces that an effective, coherent national commercial R&D program has never been put in place," they wrote. 13
13. Cohenand Noll (1991, p. 378).

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The problem with direct political control of large discretionary
spending projects is one of incentives, not ethics. Members of Congress
are rewarded in large part for providing services and benefits to constituents. This creates strong incentives to select projects for reasonsthat do not have much to do with economic efficiency or even institutional missions. For example, the only possible explanation for the factthat the National Aeronautics and Space Administration (NASA) has
been authorized to build the Christopher Columbus Center of Marine
Research and Exploration in Maryland, a project the agency did not
request, is that the senator who chairs the panel that writes the NASAappropriationis from Maryland. Even if the ultimate goal of this or any
other senator is to do the very best job possible of promoting iiational
science and technology objectives, the first priority is to build a strong
local power base to ensure reelection.
From an institutional point of view, the problem is further compounded, because what Congress can delegate, it can also take back.
A consensus that everyone should refrain from seeking narrow advantage in some area of government activity can easily break down if theopportunitypresents itself and the temptation becomes too large. Some
proponentsof direct government funding for specific kinds of commercial innovation point to the former Defense Advanced Research Projects
Agency (DARPA) as an agency comparable to the National Science
Foundation, able to make independent decisions free from congressional interference. This may have been true in the past, when its
activities were clothed in secrecy and were not widely understood. But
lawmakers from Michigan inserted $25 million into the fiscal 1993
defense budget to fund purchases by what is now called ARPA of flat
panel display screens. (To emphasize the increased importance that thisagency is to place on technologies that have both civilian and military
applications, the new administration has taken "defense" out of thename.) It will come as no surprise that the legislation was written sothat the company best positioned to fill the request happened to belocated in Michigan. 14 Officials at ARPA reportedly disapproved, butthey know where their funding comes from. They wrote a request for
proposals that favored the Michigan firm and are now negotiating a final
purchase contract.
14. Carey(1993).

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Inertia and Competition

A thirdgeneralprincipleis that large organizationsare very difficult
to change. They seem to adapt to changing circumstancesonly whenconfrontedwith serious competitive threats.This generalizationseems
to applyequally well to private and public sector organizations.Large
companiessuch as Ford and Chrysler, which are now two of the lowcost, high-qualityautomobilemanufacturersin the UnitedStates, began
the majorreorganizationsthat transformedtheir operationsonly after
beingfaced with the serious prospectof bankruptcy.(Some economists
point to the government's interventionto save Chrysleras a success.
Perhaps,however, the governmentshould have demonstratedits willingness to let a big-three automakerfail. If it had, Ford and especially
GM might have begun to change much sooner.) Similarly, while therestof the Soviet economy fell furtherandfurtherbehindWesternlevelsof outputand technology, the Soviet arms industry-propelled by theintensepressuresgeneratedby militarycompetition-managed to manufacturefighteraircraftthat were roughly on a par with those made in
the United States.
This suggests a role for competition that is quite differentfrom theone economiststeach to students. Competitionin this sense has nothing
to do with price-takingand tangency conditions. Instead, it affects thepowerthatthe leadersof a large hierarchicalorganizationhave to overcome the incentive and monitoringproblems that tend to plague these
institutionsundernormalcircumstances.
Reaction, delegation, and organizationalinertiaare general considerationsthatpolicy analysis in any countryof the world shouldaddress.
The next two issues are somewhatmore specific to the currentpoliticaland institutionalcontext in the United States.
Pay as You Go

In the currentbudget climate in the United States, no large new
spending program can be undertaken unless it includes a funding
source. The magnitude of the change in spending priorities that an
aggressivetechnology policy might contemplatemakes the importanceof this observationclear. The substantialdifference between the socialand privaterates of returnto investment in nonrival goods and theirrelatively small share of total investment suggests that it would bePaul Romer

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reasonableto consider an increase in annual spending on R&D of as
muchas 1 percentof gross domestic product, or roughly $60 billion ayear. This is not an impossible amountto contemplatein a $6 trillion
economy,but it is a very large amountto raise in new taxes in the midstof the currentbudget climate in Washington.
Divided Government

The Americansystem of governmentwas intentionallydesigned tolimit the ability of any one part to take decisive, unilateral action.
Subsequentdevelopments, such as the recent erosion of the seniority
systemandpartydiscipline in Congressandthe expansionof the powersof the judiciary have probablypushed the system even furtherin thisdirection.The governmentis not an actor. It is a game with a very large
numberof players, many of whom can veto, or at least delay, any
proposal.The equilibriathat result are quite different from those thatemerge, for example, undera parliamentarysystem.
To see the relevance of divided governmentfor technology policy,
considertwo examples. First, ARPA (and before it, DARPA) has explicitly encouraged technological development of massively parallel
supercomputers.It picked particularfirms that it aided duringthe developmentof prototype machines. Firms that were not favored have
objectedto the perceived favoritismand have managedto instigate, nodoubtthroughtheir local congressionalrepresentatives,a GeneralAccountingOffice investigationof ARPA thatwas critical of its supposedfavoritism.
Set aside the question of whether ARPA is right that massively
parallelcomputingis an importantareaof technology. (It almost surelyis.) Also set aside the more problematicquestion of whetherARPA isableto pick the most promisingfirmsin this area. The relevantpoint isthatany agency directly answerableto Congressis increasinglyunable
to exerciseany independentjudgmentaboutimportanttechnicalissues.
Soon, the selection of technology projects at ARPA will look like therestof militaryprocurement.
Militaryprocurementis, of course, a familiarwhippingboy. The Air
Force,for example, has been trying to buy a large quantityof desktop
computersfor years now under its new "expedited" bidding process.
Thewinnerhas been announcedtwice, only to be overruledwhen losing

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biddersprotestedto the GeneralServices Administrationboardof contractappeals.As JamesQ. Wilson has emphasized,the inflexible, ruledriven,excessively bureaucraticnatureof procurementis an inevitableoutcome of a process in which a losing party has access to multiple
bodies-members of Congress, other agencies, or the courts-to question the integrity and professionalism of the person who made the decision to give the bid to someone else.'5

Evaluating the Self-Organizing Industry Boards
The economic case for creating the industryinvestmentboardshas
alreadybeen made. The opportunityfor collective action is a logicalconsequenceof the existence of nonrivalgoods. (So, for thatmatter,isthe potentialfor economic growth.) The privatesector-governmenthybridproposedhere would use the tax system to share the cost of producingnew nonrivalgoods, and it would use marketforces to solve theselection problem of deciding how the funds could best be invested.
Private, for-profitfirms would make the decisions about the relative
importanceof variousindustry-specificpublic goods andwhethertheseinterestsare sufficient to justify any funds at all. In addition, both theindustryboards and the organizations, such as research universities,
researchlabs, and training schools, that they might supportwould beforced to compete for funds. Thus, both private sector incentives andcompetitivepressurescan be broughtto bear on the selection process.
If it succeeds, this mechanismcould supportinvestmentsthat span
the gap between the most general forms of basic research and the
productdevelopmentactivities of individualfirms. Duringthe past few
decadesnew discoveries in this gap have been fundedonly if they bearon the health care or military missions of the federal government.
Becauseotherpracticalareashave been neglected and because support
for health- and defense-related research is likely to contract in the
coming years, it is particularlyimportantto find a new way to selectthe practical problems that motivate good fundamentalresearch andcreateeconomic value. A new source of funds to supportworkon these
problemsmust also be found.
15. Wilson (1989).

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Another, more subtle advantage of this kind of proposal is that it
addressesbroaderissues thanthose typically consideredin the technology policy debate. As Henry Ergas has emphasized, explicit governmentpolicies affecting procurement,subsidies for firms, diffusion, orthe educationalsystem take place within a broadereconomic and institutionalcontext that crucially determinestheir effectiveness.'6 Implementationof this proposal can empower firms in various industriesto
change some of the basic features of this larger context. They canchange, for example, the patterns of interaction between university
researchersand those in industry.They can change the system of training at the postgraduateor vocational level. They can create new institutions for setting standards. In so doing, they can enhance theeffectivenessof the policies that governmentsnow take (too often withlittlesuccess)to encouragethe commercialapplicationof new technology.
Some of the details of the proposal could be debated but are ofsecondaryimportance.For example, the primaryeffects of selecting a
specifictax will come from investing the revenue in an area with large
disparitiesbetween private and social returns. The distortionsassociated with different kinds of taxes will be second-ordersmall. The decisive issue in selecting the tax will come not from the conventional
analysis of elasticities and deadweight losses, but from the costs ofcollectionand enforcement. Industryparticipantswould have the rightincentivesto minimize these costs and should thereforebe given wide
latitudeto propose their own enforcementmechanisms.
The political case for this particularproposal is somewhat more
complicated.This system was explicitly designed to survivethe robustreflectiontest. If every country decided to compete internationallyby
creatingprivatesector initiatives thatsupportindustry-specificversionsof Bell Labs, or open versions of SEMATECH, or new schools of
biotechnicalengineering, everyone would benefitfrom the discoveries
thatresult. The federal governmentwould certainlywant to insist that
othercountriesoffer the same treatmentto U.S. firmsthatthey offer todomesticfirms. If such a system were adoptedin anothercountry, theU.S. governmentwould also insist thatthe spendingmustbe transparent
andthat it not be used to offer continuing subsidies to domestic firms
in anindustry.If differentialtreatmentor directsubsidieswere possible,
16. Ergas (1987).

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thereis a real risk that even if the United States did not abuse this kindof arrangement,other countries could and would.
This proposalis also designed to ensure an adequatedegree of delegation. The only effective way to do this is to make sure that thedecisionmakerscan operate without having to go throughthe congressional appropriationsprocess each year. (This is why the FederalReserve Boardis independentin a way that no other quasi-governmental
entityis.) Absentthis freedom, the kindof interferencethatis beginningto occur at ARPA is sure to arise here as well. Finally, the provisions
specifyingfree entryof new industryboardsare designedto ensurethat
the inertiathat typically saps the effectiveness of any complacentorganizationwill not affect prospects for an entire industry-or for thenationas a whole.
In more parochial terms, the proposal is obviously designed to be
self-financingand is tailoredto keep any new financingarrangedunder
this proposal isolated from the ongoing and protracteddebates about
federalbudgetprioritiesand deficit policy. As the example of the FDA
fees suggests, it is not entirely unrealisticto believe that firmsin someindustrieswould be willing to back the requiredtaxes if they could
controlhow the proceeds are used. Finally, this kind of system, unlike
any governmentagency, would be capable of decisive action because
it would be free from interferencefrom the legislative and executive
branchesof government.
One of the most serious (and certainlythe most frequent)complaint
about this proposal is that it may not work for all industries, perhaps
not even for very many of them. Comparedwith a multibilliondollar
programthat puts control of innovation into the hands of some technology bureaucrats,this proposalis indeed less aggressive. But if one
believes thatthe risks from careless interventionby the governmentare
potentiallyvery large, this built-in conservatismis an advantage,not a
weakness. The imperativein policy design, as in medicine, should beto do no harm. In its currentform, this proposalwill be exploited only
in industrieswhose participantsperceive benefitsthat are large enoughto justify the costs to them of the tax (which may in fact be small) andthe costs of setting up and administeringthe system (which may belarge). Whereit is implemented, society will very likely derive important gains. Where it is not, the case for other, strongermeasuresmust

Paul Romer373

be viewed as open in principle, but with a very strongburdenof proof
on those who call for more explicit governmentintervention.Surely,
the right way to proceed in formulatingpolicy is to try the less risky,less intrusivemeasuresfirstand save the measuresfavoredby advocatesof aggressivegovernmentinterventionfor later.
If this criticismis right, this mechanismwill be implementedin few
places. If so, there is less to be gained by creating this process, butlittleriskin trying. And the criticismmay well not be correct.For many
areastheopportunitiesseem to be large, andthe mechanicsof collecting
the tax straightforward.For example, the telephone and cable TV industriescould agree to a common, 1 percent revenue surchargethat
would be used to supportresearch and training on new digital communicationsand the interface between computing and imaging.'7 In
effect, these industries could recreate the source of funds that once
supportedthe rich interactionbetween practical problem-solvingand
fundamentalresearchthattook place at Bell Labs. Given the increasing
likelihoodthat the "Baby Bells" will end up directly competing witheach other(for example, throughlinks with cable firmsthat operatein
the serviceareaof anotherphone company), the existing arrangements
thatsupportBellCore may erode. In any case, BellCore, the partof theoriginalBell Labs now controlled by the telephone operatingcompanies, probablycould benefit from being exposed to a more competitive
researchenvironment.
Onecould imagine an industryinitiativeby semiconductormanufacturers,witha tax of, say, 20 cents per million transistorson all domestic
chip sales. If a firm in the semiconductormanufacturingindustrybelieves thatthe SEMATECHconsortiumdeserves support,it could use
17. After this paper was written, I learned of a research organization called
CableLabsin Boulder, Colorado, that collects a voluntarycharge of 2 cents per subscriberper month from the operatorsof cable television systems. Contributingfirms
cover 85 percentof the subscribersin the United States and about 70 percentof subscribersin Canada.CableLabsemploys a small numberof scientists and contractsout
muchof its researchto universities, public and privateresearchlaboratories,and someequipmentsuppliersto the industry.It is currentlyworkingon problemssuch as digitalcompressionanddigital transmissionof cable signals.
The fact that an organizationvery close to the one describedhere could come into
existenceeven withoutthe supportof legislationthatsolves free-riderproblemssuggests
theexistenceof a muchlargerunmetdemandfor the kind of collective industry-specificinvestmentactivitythanskeptics have realized.

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its funds to ensure supportonce ARPA withdrawsits funding, as it is
now scheduled to do. SEMATECHcould compete with universities
for funding from an industry-controlledresearch board, provided it
operatedaccording to the open disclosure and equal access rules requiredunderthe new system. If the researchboarddid not believe that
SEMATECHwas a good investment, it could use its funds to support
basic researchat universities or the national labs. Otherboards could
supportgraduate training fellowships, worker training, or whateverotherneed they perceived to be most pressing.
One could also imagine initiatives in machinetools or in automobile
assemblyanddesign. Moreprosaiceconomic areassuch as construction
might also be covered, perhapsin subsegments such as single-family
home construction, an area that seems to have been conspicuously
lackingin technologicalprogress.18A new initiativefor electricalpower
utilities might compete with EPRI in areas such as electricity storage.
Biotech firms could use their funds to create a school of biotechnicalengineeringthat could do for them what chemical engineeringat MIT
did for the petroleum and chemical industries in the United States.'9
Softwarefirmscould tax shrink-wrappedsoftwareto help pay for basic
researchin computerscience or to establishbettercurriculumstandards,
testing, and teaching at the junior college and undergraduatelevel.
Software firms might also benefit from the creation of a software
engineeringdiscipline separatefrom the pure researchactivities of existing computer science programs. These schools could support thesystematizationof private sector knowledge about principles of software engineering and could train skilled professionals for software
productionratherthan for university research, just as chemical engineering serves these functions for the petroleumand chemical industries. This kind of change in the institutionalinfrastructurecould prove
to be far moreimportantfor an industrythanany particulargovernment
programof subsidies or attemptsto pick winners.
In any industrycomplicateddetails of administrationand tax collec18. See Nelson (1983) for a discussionof previousattemptsto transferthe successesof the extensionservice in agricultureto the homebuildingindustry.At least partof the
problemin previousinitiativeshas been the attemptto implementthe programfrom the
top down, ratherthan meeting needs that were perceivedby industryparticipants.
19. Rosenbergand Nelson (1993).

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tion would have to be workedout. For example, if a tax of 20 cents per
million transistorswere levied on semiconductorchips, some decision
would have to be made concerning the level at which tax obligations
would be calculated and monitored. Typically, firms try to avoid responsibilityfor taxes, but underthis proposal, controlof how the funds
are spent comes along with responsibilityfor collecting the tax. A tax
pertransistorcould be levied when a semiconductormanufacturersuch
as Intel sells one of its chips. Intel would be responsiblefor reporting
its total sales of transistorsand would be able to decide which industry
researchboardwould get its taxes. WhenToshibaexportsmemorychips
to the United States, it could be responsible for reportingsales andcouldallocateits tax obligationsamongdifferentboards.Alternatively,a firm such as Dell Computersthat buys semiconductorchips from
Toshibawould be responsible for reportingits purchasesof transistors
not alreadycovered by a tax payment and could decide how these tax
obligationswould be allocated. One could even leave the choice of who
pays the tax and controls the revenue up to the firmsinvolved. Toshiba
couldsell some chips on which the tax has alreadybeen paid if it wanted
to control some of the tax revenue. It could also sell some chips onwhichtaxes have not been paid if Dell or anotherpurchaserwantedto
pay the tax and control the proceeds. All that would be requiredis thatsomeonepay the tax before the goods move into the handsof the final
purchaser.
A little thoughtwould be needed to resolve the practicaldetails, suchas implementinga system for keeping track of the chips on which tax
paymentshave alreadybeen made and those on which they have not.
This problem is the kind that a government agency might find very
difficultto solve or might solve by imposing large costs on the private
firmsthat have to comply with its rules. But private firms routinely
solve all kinds of difficult logistical, contractual,and monitoringproblems. Dairy cooperatives make sure that fresh milk is always on the
shelf in the grocery store. Railroadskeep trackof freight cars that are
shuttledamong different trains operatedby different companies. Employersmake sure that workersactually do theirjobs in the absence ofeffective legal enforcementof employment contracts. Policy analysts
shouldnot underestimatethe ingenuityof privatefirmsin solving monitoring, enforcement, and tax collection problems in their industryif

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they perceive it to be in their interest to do so. And if firms do not
perceive this programto be in their interest, it will not even be attempted.
Perhapsthe biggest risk inherent in this proposal is that existing
firmsin an industrymight use it to protect themselves from new competition. For this to take place, some degree of collusion between existing firms and the governmentwould almost certainly be necessary.
Therequirementsfor openness andthe oversightpowersof the secretaryof commerce would make it very difficult for existing firms to limit
competitionwithoutat least tacit governmentapproval.Unfortunately,cases in which the governmentwould collude with the threatenedfirms
in an industryare not hardto imagine. For example, the United Steelworkershave proposed a surchargeof $5 a ton on all importedanddomesticsteel to cover unfundedpension and healthcare obligationsat
large steel firms. This is a clear attemptto tax the new, innovative,
nonunionminimill steel producersand subsidize the existing firmsand
theirworkers.The United Auto Workersare also consideringthis kindof arrangementfor the automobile industry. Because the government,
throughits Pension Benefit GuaranteeCorporation,is faced with large
potentiallosses on the pension obligations of the largest steel and auto
firms,it might be willing to go along with this kind of scheme.
NothingpreventsCongress from passing this kind of surchargeas aseparatemeasure,but it could not be imposed surreptitiouslyunderthe
structureof the industry investment boards. The enabling legislation
would specifically prohibit any kind of spending activities by boards
thatwould shift costs from or transferresourcesamong existing firms.
The ultimateprotection, however, comes from the freedom that firms
in an industryhave to createalternativeboardsandto controlhow funds
arespent. Even if the establishedsteel producers,becauseof theirsize,
could impose an industry-widetax thatminimill operatorsdo not want,
the establishedproducershave no way to coerce the minimill operators
to fundan IndustryPensionBoard.The minimilloperatorscould merely
establisha separateboarddevoted to researchon new technologies forminimillsand refuse to contributeto any boarddominatedby the old,
integratedproducers.
The freedom to create new boards and to choose among competingboards is so importantthat any proposal that did not include thesePaul Romer

377

provisions would have an entirely different character.Without these
protections,the political risks would loom very large comparedwith
the potentialeconomic benefits.

Alternative Technology Policy Proposals
The criteria listed above can be used to evaluate other technology
policy proposals.
Increased Funding for Basic Research at Universities

Funding for basic university research has until recently received
broadsupportfrom economists and politicians, partlybecause the economic advantagesof free disseminationof basic scientific discoveries
are so obvious. In addition, the delegation problem has largely beensolved. Peer review delegates resources to the scientific community,
whichdecides whatissues to pursuewithinbroadguidelinesestablishedby the fundingagencies. (But as noted above, this delegationfunction
is increasinglythreatenedby direct congressionalearmarksthatbypass
peer review.)
Moreand more policymakers, however, are realizing that the existing arrangementsolves only one partof the broaderselection problem
of decidingwhich areas deserve additionalresearchsupport.Spending
is concentratedon pure scientific researchandon practicalproblemsin
the areas of health and defense, but too few resources are devoted toareasof basic researchand trainingthat are motivatedby the commercial opportunitiesfaced by private firms. Because policymakers are
beginningto emphasize the commercialrelevance of researchand becausebudgetaryand geopolitical changes may reducemission-oriented
basicresearchin health and defense, the amountof supportuniversities
receivefor basic researchmay soon decline substantially.Froma practical point of view, the relevant question is not how much government
supportfor basic science at universities can be increased, but whether
the currentlevel can be preserved.
To understandhow a system of industry investment boards could
protectthe existing level of support for pure research at universities

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and at the same time addressthe reasonableconcerns of policymakers
for a commercialpayoff from some kinds of research, it is useful tolook at the history of universities in the United States. As Nathan
Rosenbergand RichardNelson demonstrate,the university system in
the United States has always paid a great deal of attentionto practicalproblemsand has contributedenormouslyto their resolution.20But thenatureof those practical problems has changed dramaticallyover theyears.
BeforeWorldWarII universitiesprimarilyaddressedpracticalproblems faced by commercial interests. The land grant universities weredevoted to agriculture and "the mechanic arts." Farming, railroadtransportation,electrical generation and transmission, and chemical
processingall requiredtheir own specific kinds of technical research
andtraining.Europeanssneered at the vocationalorientationof higher
educationin the United States during the nineteenthcentury and thefirst part of the twentieth century, but Americans derived importantnationaleconomic benefits from a responsive university system. To
illustrate that responsiveness, Rosenberg and Nelson describe theemergenceof programsof electrical engineering. In 1882-the same
year thatEdison opened the first electrical station in New York-MIT
introducedits first electrical engineering courses. Cornell followed in
1883. By the 1890s schools of electrical engineeringwere the primary
suppliers of skilled professionals for the electrical industry, having
supplantedunsuccessful attemptsby firmsto trainengineers in house.
Thisexperiencewas not unique. Universitiestrainedpeople for workin many areas of commercial importance and developed bodies ofknowledgethat could be used there. They did not do this, one can be
sure, entirelyout of patriotismor dedicationto nationaleconomic success. Universitieswere attentiveto privatesector opportunitiesbecause
the privatesector paid the bills.
Duringand immediatelyafterWorldWarII, the federalgovernment
becameby far the largest patronof researchand advancedtrainingat
universities.This shift in funding accompanieda shift towardsolving
practicalproblems in health and defense and pursuing more abstract
problems. The Departmentof Defense and departmentswith related
20. Rosenbergand Nelson (1993).

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379

missions(Energyand NASA) provide the majorityof all researchsupportin the engineeringdisciplines. The total expenditureat the National
Institutesof Health is five or six times larger than the budget at the
NationalScience Foundation.
There is a continuing debate about whether this postwar shift inemphasishas been beneficial for the business sector. Many observers
say thatthe commercialspin-offs frommilitaryresearchhave decreased
in recentyears. The typical interpretationof this findingis thatcivilian
and military technologies are diverging for exogenous technologicalreasons. An alternativeexplanationis that the initial surge in funding
fromthe governmentin the immediatepostwaryears stimulateda system that for historical reasons was still attentiveto commercialapplications and opportunities. As the system evolved in the 1960s and1970s, however, its connections to the civilian business sector atrophied. The increasing divergence may therefore reflect the delayed
effects of incentives and funding ratherthan exogenous technologicaldevelopments.
However this debate is resolved, the end of the Cold War clearlymeans that defense-related support for research will be substantiallyreducedin the next decade. Moreover, the enthusiastic support fortechnologicaladvance in medicine and health may increasingly comeunderattackas the nation tries to come to terms with the rapidlyescalatingcost of medicalcare. Some policy analystsarealreadysuggesting
thatbecausenew healthtechnologies are not being pricedand allocatedcorrectly,slowing the rate of technological advancewould be the best
way to control health care expenditures.
Stagnation,or even real cuts in governmentfunding for university
research,is thus a distinct possibility. Moreover, demandswill growfor more direct commercial payoffs from research. This pressure isreflected,for example, in the controversialplanning process that DirectorBernadetteHealy tried to impose on biological researchfundedby the National Institutes of Health in 1992. Respondingto congressional pressure, she tried to adjust the decision process and prioritiesof the traditionalpeer-reviewed,basic researchprogramto give greater
emphasisto commercialobjectives. In the currentinstitutionalenvironment,this pressurecould underminethe strengthsof the existing basic
researchsystem withoutgeneratingthe hoped-forcommercialbenefits.

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TheNationalInstitutesof Health, the NationalScience Foundation,and
the Departmentof Defense are unlikely to be the best institutionsfor
assessing commercialopportunities.
A more productive response to politicians and voters who ask forresearchand training that have closer economic payoffs would be toagreeto a division of labor. Basic science agencies such as the National
Institutesof Healthandthe NationalScience Foundationcould continue
to fund the most adventurousand forward-lookingresearch at their
existing levels, and an independentsource of funds could be created
for the commerciallyrelevantresearchthat should be underthe controlof people in the privatesector who are knowledgeableaboutthe opportunities. These funds could fill in part of the gap that would open if
mission-orientedfunding in defense and healthis cut back. Such a dual
system could both restore the strengthsof the pre-World War II connections between universities and the private sector and preserve theadvantagesof the more abstractbasic researchsystem that developed
afterthe war. It might also provide more total fundingthanis currently
available. The system of industry investment boards would establish
this more balancedarrangement.
It is importantto recognize (as Rosenberg and Nelson do) that anincreasedemphasison practicalproblemsis completelyconsistentwith
a division of labor in which universitiesconcentrateon basic research,where free dissemination of knowledge is most important,and firms
concentrateon R&D activities over which propertyrights should bestrong. It would be very unwise for university researchersto perform
proprietaryresearchfor privatefirms, yet manycollaborationsbetween
business firms and universities or teaching hospitals are now taking
preciselythatdirection. Universitiesin searchof additionalfundingare
increasinglyseeking out arrangementsunderwhich they give up someof the traditionsof open science and in effect become researchsubcontractorsemployed by private firms. Because the industry investmentboardscan solve, or at least mitigate, the free-riderproblem, they can
supportuniversitiesand help set the researchagendawithoutendangering the free exchange of ideas.
Closerinteractionbetween firmsconfrontedwith practicalproblems
and researcherspursuing fundamentalquestions may lead not just to
biggereconomic benefitsbut also to betterbasic science. For example,
solid state physics was enormously stimulatedby an attempt at BellPaul Romer

381

Labs to solve a reliability problem with vacuum tube amplifiers. Thelabs had scientists on staff who knew some of the basic propertiesof
semiconductorsfrom solid state physics. They used this knowledge asa basis for their experimentsleading up to discovery of the transistor.
This discovery fed back into the basic researchand trainingactivities
of solid state physicists and completely transformedthe field. Hightemperaturesuperconductorsand opto-electronic devices are just twoof the manyunderexploitedopportunitiesthatpose as manychallenges
forbasic scientistsas they do for practicalproblemsolvers. These areas
are at least as promising for the pursuitof basic knowledge as is thesearchin high energy physics for "the God particle," using ever more
expensiveparticleaccelerators.
In summary, issuing the perennial call for a massive increase infederalsupportfor existing basic researchprogramsat universitiesis atotally unrealisticapproachto a technology strategy. It is politicallyunrealisticand would not by itself generate much in the way of economicbenefits.It might not even producebetterbasic science. The real
challengewill be to keep government supportfor basic science fromfalling. At the same time, universities will feel growing pressure tocontributemore directly to economic performance.Unless these pressuresare channeledin a constructiveway, they could underminemuchof the strengthof the basic research system, without achieving thedesiredpracticalbenefits.
R&D Tax Credit

On efficiency groundsthe optimal R&D tax credit would be so generousin its definition of R&D activity that no corporationwould pay
any income tax. Because of the widely acknowledgeddistortionsthatarise from the double taxation of capital income (once as corporate
income,then as individualincome), the efficiency gains from abolishing the corporateincome tax would be large.
The United States has a corporateincome tax for political reasons,not on groundsof economic efficiency. The potential for substantial
increasesin the generosity of the R&D tax credit is thereforelimitedby the lack of substitutefunding sources and sensitivity to the politicalrisksof giving "tax preferencesto corporationsinstead of people." Ifpoliticians continue to insist on raising revenue from the corporate382

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income tax, an argumentcan be made, in principle, for taxing R&D
capital less heavily than physical capital because R&D has a higher
social rate of return. In practice, the crucial issue is whether the tax
authoritiesare able to distinguish R&D spending from other kinds ofspending. Corporationswill surely get better at redefiningwhat theycall R&D in response to bigger tax incentives for doing so. Over time,
the revenue cost of each additional dollar of new R&D generated
throughthis mechanismwill grow. As a result, serious practicallimits
will be placed on the size of the subsidy that can be provided in thisway as long as substantialrevenue is collected throughthe corporate
income tax.
Comparedwith other, more specific technology policies, the R&D
tax creditis relatively safe politically, which no doubtexplains why it
has attractedbroaderpolitical supportthan direct subsidies to firms. In
effect, the tax credit specifies an aggregatelevel of subsidies for R&D,
and then it solves the delegation problem by letting individual firms
select their own R&D projects.
Whateverthe decision on the constrained, second-best level of thecorporatetax rate and the R&D tax credit, it should be clear that R&D
spendingby privatefirms(like government-fundedpurebasic scientificresearch)is a complementto the kind of industry-specificpublic goods
that the industry investment boards would proivide. Taken together,
thesethreemechanisms(privateR&D in firms, governmentsupportfor
basicresearch,and industrysupportfor industry-specificpublic goods)
would cover most of the spectrumof new ideas illustratedin the nonrival column in table 1.
Infrastructure

Increasedfunding for infrastructureas a technology policy has atleasttwo serious strikesagainstit. First, no economic case can be madefor infrastructureas a good that requirescollective action. Very little
infrastructure
is a nonrivalgood. At best infrastructureis whatis calleda club good in public finance, and these goods can be efficiently provided by decentralized action in markets. Except for the bargaining
problemover rights-of-way that is readily solved by the powers ofeminentdomain, no collective action is needed to provide infrastructure.(The statecould use its powers of eminentdomainto assist in landPaul Romer

383

acquisitionwhere necessary but still rely on private sector decision
processesin all other areas.) If anything, governmentsshould be moving awayfromgovernment-subsidizedinfrastructureandtowardgreater
reliance on market-like mechanisms such as congestion charges onroads and competition among providers of basic telephone service.
Localities or even private firms should be allowed to select and fundinfrastructure
projects.
The second problem is that federal funding for infrastructureis rifewith the kind of waste inherent in a system that lacks any degree ofdelegationin project selection and funding. The governmentcontinues
to provide supportfor "mass transit" that defies all economic logic.
(My favorite example is the subsidy for the buses in Vail, Colorado,thattake skiers throughtown and between ski lifts.)
The dollars at stake in decisions on popularinfrastructureprojects
aretrulyfrightening. A plausible estimate for the cost of roadbedconstructionfor magneticlevitationtrainsis $60 million a mile. Justputtingin the trackfor a trainthat runs from Boston to Chicago could cost $60
billion, or aboutthirtyyears worth of funding for the National Science
Foundation.
Dual-Use Technology

Manyadvocatesof a moreaggressivetechnologypolicy havepointed
to the apparentsuccesses at DARPA as a model for a more activist role
for the government.This approachshould set off all kinds of warningbells aboutserious political risks. The most importantproblemspertain
to funding,delegation, divided government,selection, inertia, and therobustreflectiontest.
The funding problem is self-explanatory. Budget constraintsmean
thatthe federalgovernmentis highly unlikely to makeavailableenoughfundsto undertakea technology policy initiative thatcould makemuch
differenceon a nationalscale. The delegationproblemhas alreadybeen
notedin the discussion of the contractfor researchon flat panel display
screens.ARPAwill be underincreasingpressureto conformto congressional demands,especially if its budget grows. ARPA projects would
thenofferthe best opportunityfor every memberof Congressto provide
an identifiablelocal project. ARPA projects would soon look like infrastructure,earmarkedpork-barrelscience projects, and militarypro-

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curement. Asymptotically, every technology project would have partof its spending located in every congressional district, and the selection
process for projects would become increasingly rule-bound and bureaucratic.
In its proposal on technology policy, the National Academy of Sciences Panel on the Government Role in Civilian Technology proposedthat an independent civilian technology corporation be created with a
one-time grant from the government of $5 billion.21 This proposal reflects the panel's appreciation of the importance of the delegation anddivided government problems, but it cannot be regarded as a true
solution. A private corporation would in principle be free to makeindependent decisions and would not be subject to vetoes and secondguessing by multiple actors in the government. But the proposed $5
billion initial grant is far too small to make a permanent contribution
to a national technology policy. (This relatively low figure was presumably selected in the hope that Congress would fund it. Even at this low
level, funding now seems extremely unlikely.) The interest income on$5 billion would be about $250 million a year. Compare this with the$5 billion or more that IBM and GM each spend on R&D annually.
Surely, the proponents of the Civilian Technology Corporation are assuming that if the corporation succeeds, it could go back for more funds.
But that means the corporation would have to be highly responsive tothe wishes of members of Congress from the start.
The comparison with IBM and GM also raises a caution about the
selection problem and institutional inertia. Some proponents of the
ARPA, or government planning, approach argue that industry leaders
are not competent to make the right decisions about technology in theway a few key people at DARPA are alleged to have done. The countervailing argument is that putting all of the public's technology resources into a single hierarchical, bureaucratic structure leaves noprotection if that organization stops producing valuable results. Noneof the existing proposals put any competitive pressure on ARPA or an
independent technology corporation. If the entire auto and computerindustries had depended on GM and IBM for all of their innovation,
cars and computers would now be much less useful than they are. That
21. Panel on the GovernmentRole in Civilian Technology(1992, p. 94).

Paul Romer385

is true even though the research staffs in both corporations are highly
talented and even though some discoveries of real value have emerged
from both institutions (for example, catalytic converters from GM andhigh temperature superconductors at IBM.) There is no substitute forcompetitive pressure on any such organization.
Even if all of the other objections could be met, the technology
agency approach is probably not the kind of policy that passes thereflection or robust reflection tests. It is all too easy to imagine that an
ARPA or a well-funded civilian technology program could be used tosubsidize something like the European Airbus program, which Americans now find so objectionable. Mechanisms for direct government
subsidies to firms may not be something that the United States wants
to encourage in other countries.
Research Joint Ventures
Interest in the United States in research joint ventures seems to havebeen motivated primarily by the success of the VLSI (very large scale
integration) joint venture among semiconductor firms in Japan, an example that is now understood to have been unusually successful andnot representative of the typical outcome. Research joint ventures sufferfrom the obvious economic problem that they cannot solve the freerider problem and achieve free dissemination of the results at the sametime. What has been attempted in the United States, for example at
SEMATECH, is a mixture of some degree of insider advantage that ispromised to participants in the joint venture together with federal
matching funding to sweeten the pot. One half of SEMATECH funding
was provided by DARPA, so if this model were to be adopted more
widely, all of the concerns about delegation and divided governmentthat apply to DARPA would extend to the government-assisted joint
venture.
But if government funds are not used, in any instance where several
firms in an industry find it in their interest to work together on a research
project, they presumably will be motivated to do so by the availabilityof important special advantages that accrue only to members of the joint
venture. Such cases should raise serious concern that collusion in research will lead to product market collusion. A research joint venture386

Brookings Papers: Microeconomics2, 1993

could, for example, become the vehicle for preventingnew entry into
an industryor for reducing total industryexpenditureson research.22
Comparedwith the proposal outlined above, in which all joint effort
has to be directedat activities that are freely availableto any currentor
futureparticipantin the industry, the researchjoint venture seems toholdout muchgreaterrisk of reducedtotal researchandproductmarket
competitionthan do industryinvestmentboards.
Managed Trade: Import Restrictions

Managedtradecomes in two flavors, importrestrictionsand market
access requirements.Importrestrictionshave the appeal that they are,in effect, self-financing. Importquotas, for example, can generateadditionalrevenue for protected firms without imposing an explicit tax.
Importrestrictionssuffer from almostevery otherconceivableproblem.
Some firmswill supportthis option out of naked self-interest, but virtuallyno economist is willing to try to make a serious intellectualcase
for these measures.
Managed Trade: Market Access Requirements

Proposalsthat the U.S. governmentdemandadequateaccess to foreign marketsare more problematic. The purely economic case here isstrongerthan many economists who supportfree trade would like toadmit. Marketaccess is a necessary condition for effective protectionof intellectual property rights. Suppose, for example, that a foreigncountryenforces a ten-yearquarantineon all importedforeign softwareto check for softwareviruses. (Sounds plausible, right?)Domestically
producedversionsof word-processingsoftware, spreadsheetprograms,
and other kinds of applications that are close copies of the versions
availableon world marketswould no doubt be writtenand sold in thiscountry.The effect for U.S. software firms would be as if the foreign
firmssimply sold bootleg versions of theirprograms.Formalcopyrightprotectionis worth nothing if a firm is deprivedof the right to sell its
goods.
It is not clear that market access restrictionswould be in the selfinterestof the foreign country. It depends on how costly the copying
22. For a discussionof these issues, see Katz and Ordover(1990).

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387

process is and on what effects the protection has on domestic incentives.
The experiences in Brazil, with its failed computer industry, and inJapan, with its (allegedly) protected personal computer industry, do not
speak well for the long-run success of this strategy. If a protected
domestic market were truly the key to export success, NEC and theBrazilians should have taken over the market for personal computers in
the United States, but they have not. For internal political reasons,many countries may nevertheless restrict market access. The UnitedStates must therefore decide how it should respond to these restrictions.
Some advocate unilateral punitive measures, but this approach fails
the robust reflection test. If market access requirements were given thesame status as intellectual property rights and were monitored and enforced through a multilateral body, they would be beneficial. But a
unilateral decision by the United States to adopt punitive measures as
it sees fit could ultimately have very serious negative affects on theinstitutions that now support free trade. This would effectively condone
the principle that countries can take unilateral action when they are
unhappy with trade outcomes. Many other countries would soon start
instituting punitive measures that are supposedly intended to punish
marketrestrictions elsewhere but that are, in fact, pure income transfers
to powerful domestic groups.
Moving ahead with unilateral punishments would be like announcing
an intent to drive through red lights whenever no cars are coming on
the cross street. We may believe that no harm will come from ouractions if we use our new powers judiciously, and we may even be
willing to let others do what we do if they promise to be as responsible
as we are. The ultimate outcome is nevertheless likely to be one that
we regret.
A useful comparison would be to contemplate the consequences ofrepealing the interstate commerce clause in the U. S. Constitution andletting individual states take punitive action whenever another state
restricts market access. (Many state governments in the United Statescurrently do try to give the same preference to local firms that theJapanese government apparently gives in procurement.)
Economists would almost universally agree that giving each state thepower to interfere with interstate commerce would not be the way todeal with market access problems within the United States. The same
argument presumably suggests that the United States should work to388

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strengthenthe General Agreementon Tariffs and Tradeand the available multilateralinstitutionsin the hope of moving tradeamong countries closer to the substantial,but not quite perfect, freedom that now
prevailsamong the states of the United States.
Nevertheless, attackson restrictedmarketaccess will continueto bea very attractivepolitical strategy for the federal government. Suchattackscan be used to aid a small numberof firmswith high visibility.
They do not require budget expenditures, they typically raise little
domesticpolitical opposition, and a confrontationwith bad guys fromanothercountryalways plays well in politics. (The war over the Falkland Islands may indeed have been like two bald men fighting over acomb, but it did wonders for the popularityof the Thatchergovernment.) Of all the policies described here, saber rattling and punitive
measuresdesigned to open foreign marketsare the most likely candidates for a technology strategyin coming years.

Conclusions
In one of the last things he wrote, the late George Stigler concluded
an essay on monopoly with these words: "The merits of laissez-fairerest less upon its famous theoreticalfoundationsthan upon its advantages over the actual performanceof rival forms of economic organization."23 Any discussion of technologypolicy shouldtakethese words
as both a warning and a challenge. The warning is that even after
admittingall of the deficiencies of economic markets, one must acknowledgewhat experience has so clearly demonstrated-that most of
the familiarpolitical alternativesare far less efficient mechanismsforallocatingresources than the marketis. The challenge for economists
is to understandwhy marketsperformwell and then to build upon theirstrengths.The problemwith the classical descriptionof laissez-faire isits suggestion that the best of all possible arrangementsfor economic
affairs has already been discovered and that it requires no collective
action. The lesson from economic growth is that collective action isvery importantand that everything, including institutions, can always
be improved.
23. Stigler (1993, p. 402).

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389

The reality of economic life is that the pure individualisticmarket
exchange invoked in the usual defense of laissez-faire has been supplantedby many institutions that allow collective action and improveon pure individualisticmarketexchange. Perhapsthe most importantsuch institutionis the limited liability corporation,an invention thatwould not have been viable without the emergence of supportingregulatoryandlegal institutions.Otherexamplesof institutionalinnovation
includeprivateuniversities, copyrightsand patents, corporateresearchlaboratories,and peer-reviewedcompetitive grantsfor research.
Eachof these institutionsrepresentsan attemptto take advantageof
the opportunitiesfor mutually beneficial coordinatedaction that arepresentedby the world in which we live. Each is consistent with theoperationof marketsand supportssuccess in the marketas the finaltest
of economic activity. Each builds on or emulates at least some of thestrengthsof the market:the pushto do betterthatcomes fromcompeting
against rivals, the pull that comes from opportunitiesfor individual
gain, the diversity that comes from having many different individuals
andorganizationsworking in parallel to achieve a given end, and thediscipline that comes from clearly enforced criteria for success andfailure. From this broaderperspective, the "theoretical foundations"to which Stigler attached relatively little importance-the notions ofprice taking and tangency conditions-are only one small part of thepicture.
This paperhas tried to place the discussion of technology policy inthis largercontext. It has tried to shift the discussion away fromnarrowquestionsaboutwhetherthe marketor the governmentis better. It has
avoidedconjecturesabout which sectors should be given government
supportor about what are the most important"critical technologies."
Instead,it has suggested that the debate focus on the underlyingprocesses that lead to effective institutionalarrangements.
To a large extent, market competition has become a process forselectingever bettercorporateinstitutionsthatcan channelthe energies
of large numbersof people toward the productionof ordinaryprivate
goods. This paperdescribes a parallelprocess for selecting ever better
institutionsthat can channel the energies of large numbersof people
toward the production of the new discoveries that drive economic
growth.
Theprocessoutlinedabove combinesgovernment-likeaspects (man-390

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datory taxes that solve free-rider problems) with market-like mechanisms (free entry, competition among different institutions, anddecisionsthat are ultimately groundedin opportunitiesfor profit). It is
designedto fill the gap between private and public supportfor R&D.
The essence of the proposalis to empowerthe firmsin differentindustries, giving them the tools needed to solve the collective action problems inherentin providingindustry-specificpublic goods. The proposal
protectsproductmarketcompetitionamong firmsand encouragescompetitionamong the organizationsthat would provide industry-specificpublicgoods such as researchor training.The argumentis premisedon
the idea that long-rungrowth depends on our ability to discover innovative ways to arrangethe limited stocks of objects. It concludes thatthe prospectsfor growth could be enhanced by searchingfor equally
innovativeways to arrangeour institutions.

Comments
and Discussion
Comment by Zvi Griliches: This is an exciting paper. It is nice to see
somebody young tackling big policy issues. The paper builds on an
analysisof the past, but it is basically aboutthe future. It is suggesting
new mechanismsandnew institutionsto solve pressingeconomic problems. It takes as its historical example the "invention" of land grantcolleges and the developmentof Bell Labs. It sees unlimitedopportunities for investment in both basic and applied researchand is looking
for mechanismsthat could provide the financingthat would launchthe
next expeditions into the wide unknown.
The two basic assumptionsof the paper are, first, that the research
opportunitiesare out there and, second, that without new financing
institutions,we may not get there. I believe thatRomeris righton bothcountsbut that the evidence for the first is not as overwhelmingas heassumesit to be and that the particularinstitutionalinnovationmay notworkas well as advertised-but nothing ventured, nothing gained.
I will focus on the second point first. I see two difficulties with
Romer'sproposal. The first deals with the incidence of benefits fromand the costs of technical change in an industry. Implicitly, a highelasticityof demandis assumed for the productsof the various industries. Because the benefits from this researchwill be public, they arelikelyto be competedaway andnot redoundto the benefitof the original
investorsin these boards. Moreover, if demand were inelastic, as inagriculture,such technical change could reduce the rents to the scarce
resourcesin these industriesand might be counterproductivefrom theprivatepoint of view. Thus, industriesmight not vote for such a levy
if they see throughit.
391

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Second, if there are several boardsand I am a small producer,I may
choose to contribute my share to a peculiar board, specializing, forexample,in supportingeconomic researchat the Universityof Chicago,on the assumptionthat the big guys will give to the importantresearch
purposesanyway and that my contributionto those boardsis unlikely
to affect the industry's fate by much. In other words, allowing foralternativeboards and for freedom of choice among them may stillleave free-riderproblems, even within this framework.Nevertheless,the proposal may be worth trying. People may not be as selfish as
economistssay they should be.
The more difficult notion is the one of the "endless frontier," theabsenceof diminishingreturnsto research. Because I have been worrying aboutthis lately, I will focus the rest of my remarkson what we
do not know about it.
One can ask two relatedquestions aboutthis. Are our recent "slowgrowth"problemscaused by a shortfallof researchand development?
Andwill encouragingmore R&D be helpful here?I don't thinkthatthe
sharprecession of the mid-1970s and the subsequentslow growthwere
the resulteitherof the decline in the rateof aggregateR&D investmentthat occurred in the late 1960s and early 1970s or of a fall in the"potency" of these expenditures. The timing and magnitudesare all
wrong.' It is probablya good thing to pursuemore R&D in any case,for reasons of long-term growth, but not as a solution to our current
problems.(Of course, Romer is not saying that his proposalwill solvethese problems, but it is the currenteconomic situationthat gives his
proposalits resonance.) We are not currentlyconstrainedby our production possibilities frontier. Much existing knowledge is not being
used yet. Much more diffusion of computersand learningabout themis still in store. And the economy could be made much more efficientby eliminating a variety of barriersto its functioning. Nevertheless,
R&D is one of the relevant margins, and we should be exploring it.
But before we encourage more R&D by creating new institutions,
we have to face the crude evidence of diminishingreturnsto it. Figure
1 plots the ratio of patents to company-financedR&D for the last seventy years. If patentsare taken as an indicatorof inventiveoutput,thenthe news is not all that good. Bronwyn Hall's paper in this volume
1. See Griliches(1988) for an elaborationof this argument.

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Figure 1. Domestic Patent Applicationsper Company-FinancedR&D in Industry(1972 dollars) and per Scientist and Engineer, 1921-92.
Log scale, scientists

Log scale, dollars

11

14

10

-

-

-

Patents/R&D
Patents/scientist

13

9

12

8

11

7

10

6

9

5
i

4
1920

1930

I

1940

1950

1960

1970

Ii
1980

7

X
1990

Source: Bureau of the Census, Historical Statistics of the United States, Colonial Times to 1970, pt. 2 (Department ofCommerce, 1975), chap. W; Patent andTrademarkOffice, TechnologyAssessment andForecasts (Departmentof Commerce,
March 1977), app. A; National Science Board, Science and Engineering Indicators, 1991, NSB 91-1 (Washington); andPatent and TrademarkOffice releases. Number of applications by residence of inventor for 1940-59, unpublished memorandumof P. F. Fredrico, Patent and TrademarkOffice, January 18, 1961; for 1960, Journal of the Patent Office Society,
44 (February 1964), p. 168; for 1961-62, Commissioner of Patents and Trademarks,Annual Report, 1966, p. 26; for 196391, Patent and Trademark Office releases; extrapolated back, before 1940, by the number of total applications. Data on
company R&D and the number of scientists and engineers in industry from the same sources, updated from NSF Reports
92-307, 92-330, and 92-331. Deflated by R&D price index from Griliches, "Comment on Mansfield," in R&D. Patents,
and Productivity, (University of Chicago Press, 1984) p. 149, and Bronwyn H. Hall and others, "The R&D Master File
Documentation," Technical Paper 72 (NBER, December 1988), updated.
Note: Left scale is the log of the number of domestic patent applications per 1,000 R&D scientists and engineers. Rightscale is the log of the number of domestic patent applications per $1 million of company-financed R&D (in 1972 dollars).

shows a significantdecline in the market's recent valuationof R&D.
Evidence claiming to show exhaustion of inventive opportunitywas
presentedby Baily and Chakrabartiat these same meetings some years
ago, andEvenson looks at the internationalevidence on patentingand
comes to similarconclusions.2
I myself do not think these facts need to be interpretedso pessimistically, but before we urge significantadditionalinvestmentsin R&D,
2. Baily and Chakrabarti(1988); Evenson (1993).

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we need to convince ourselves that this would be a good investment.
My own optimistic reading of these same data is based on scatteredevidencethatthe economic "meaning" of patentshas changed. This is
the only reasonableway to interpretthe fact that ratios of patents to
R&Dhave been falling consistently, until quite recently, throughgood
times and bad. If we did not worry about it in the 1950s and 1960s,
whentotal factorproductivitygrowth was rapid, why should we worry
now? Moreover,even while-according to Hall's estimates the market's valuationof new R&D was falling sharply, firmswere expanding
theirR&D investmentsat ratesnot seen since the 1950s! Did companies
know something that the marketdid not, or were they all lemmings?
At the momentwe face two contradictoryfacts: domestic patentapplications startedgrowing sharply in the late 1980s, indicating some revival of inventive activity, while the growth in companies' real R&D
expendituresslowed to a crawl and may have actuallyturnednegative.
But overall, if the numbersare to be believed, we are not investing lessin R&D today, relative to the size of the economy, than we did in the
peakyears of the 1960s. It is a puzzlement.
An argumentcan be made that precisely because we may have been
facing the exhaustionof inventive opportunities,we need more R&D,
but R&D of a special kind, the basic kind, the kind that would "recharge" the pool of knowledge and increase the effectiveness of therestof it, which is spent on "D," ratherthan "R." We need additional
investmentin science and basic research to make the run-of-the-millcompany'sR&D more productive. In this sense, Romer's new institutions, specializing in basic and "generic" industrialR&D may be justwhatthe doctor ordered. But what we want is basic researchand basic
resultsthat will not be appropriatedby individualfirms, and I am notsure that we will succeed in convincing such firms to tax themselves
for the public good.
I do want to dissent from Romer's view that the fact the molecules
can be arrangedin an infinity of ways implies an "endless" frontier
for R&D exploration. It may not be feasible to discover the work of a
new Shakespearein the randomtyping of monkeys, even if it is there.
Moreseriously, the notion that there may be no diminishingreturnsto
researchin the long run, and the associated notion of a permanent
exponentialgrowthof real income per capita, is a dreamfull of hubris,the notion that man is God-like and not subject to serious constraints

Paul Romer

395

or hardchoices. Many years ago, in commentingon the "old" growththeory,Arrowremarkedthat "eternalexponentialtechnologicalgrowthis just as unreasonableas eternal exponentialpopulationgrowth.'3
The fact that the frontier may not be endless need not be taken
pessimistically. First, we are still very far from being there. And,second, much is left to do to improve the situation as it is, including
the diffusionof already-knowntechnologies and the dismantlingof themanymanmadebarriersto economic efficiency. Technologicalchange
is still endogenous,even if it is not endless, and althoughthe outcomesof science and researchare largely out of our hands, better economic
understandingstill has much to contribute.Schmookler, in one of thelast things he wrote, complained about the state of this field: " . . . it

may leave scientific and technological progressunexplained,which isunsatisfactory;alternatively, it explains scientific and technologicalprogressas self-generated, which is dreadfully wrong. Such a viewis wrongboth scientifically and morally. It is wrong scientifically because . . . it is simply not true. It is wrong morally . . . because it

deprivesman generally of any sense of responsibilityfor the course ofsocial and economic development. For if [technologicalchange is endogenous], then all men must accept some measure of responsibility
for what happens next. 4 It is admirablethat Romer is willing to dojust that.
General Discussion: In evaluating the potential of the author'splan,
severalparticipantsraisedexamplesof pastexperiencewith cooperative
researchefforts. Pointing out that few firmshave formedresearchjoint
venturesin the decade since it first became permissibleunderantitrust
laws, Timothy Bresnahan wondered if there really is an unfulfilled
demandfor more cooperative research. He also noted that existing
cooperativeinstitutions in the form of standardscommittees (such as
ANSI) are abandonedby many in informationtechnology industries
when these committees attemptto coordinatethe directionof technological progressthroughanticipatorystandardsetting. Bresnahanconsideredthe rules imposed by standardscommittees to be quite modest
and arguedthat the author's seemingly more restrictive institutional
could prove even less popular.
arrangements
3. Arrow(1969, p. 34).
4. Schmookler(1972, p. 84).

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Brookings Papers: Microeconomics2, 1993

In contrast,Albert Link said that experience with SEMATECH,thecooperativeresearchventureof the semiconductorindustry,shows thatcooperationcan yield importantbenefits. Despite others' criticisms ofthat organization,Link said, it has ensured that Americancompanies
are competitive in their production of semiconductormanufacturing
equipment,such as wafer polishing tools.
Link, however, questionedwhetherthe author'sproposalwould succeed in increasingbasic scientific research.He maintainedthatexisting
cooperativearrangementswith universities are becoming more commerciallyorientedand now almost mirrorresearchthat is performedat
private firms. Link nonetheless praised the proposal's concern with
providinga forumfor the more efficient evolution of standards,saying
thatthis could lead to a more rapiddiffusion of technology throughout
a given industry.
LindaCohen arguedthat the coercive part of the author'sproposal
mightmake it more viable than existing forms of noncoercive cooperativearrangements.She maintainedthatnoncoercivecooperativeagreements work well only in regulated and monopolistic industries(and,for unique reasons, in agriculture), and that they tend to break down
undercompetitiveconditions. She noted that when the electric industry
becamemorecompetitive, SouthernCaliforniaEdison, one of the largest and most innovative utilities, dropped out of the Electric Power
ResearchInstitutebecause the utility no longer wanted to share technology. Using SEMATECHas an example, she arguedthat when noncoercive cooperationinvolves the public sector, the results of the researchare forced to be more public, allowing many firmsto opt out of
the arrangementand get a free ride. In competitive markets, she concluded, coercion forcing 100 percent of participationmay be the only
feasible way to bring about sustainedcooperativeresearch.
Michael Katz argued that the governmentrole in the author's proposed arrangementwould end up being far more intrusive than theauthorassumes. He said that government would become integral indeterminingwhich firms fall within an industryand which do not. He
also suggested that the author'sproposalto make importedgoods subject to the mandatoryindustrytaxes could lead to abuse if other countriesadoptedthis proposalas well. If his plan were effected in a country
such as France, Katz said, nationalizedFrench firms might be able to
avoidpayingtheirtaxes throughoffsetting governmentsubsidies, plac-

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397

ing Americanand other foreign firms subjectto the tax underan unfair
burden.
Severalparticipantsdiscussed the author'spresumptionthat almost
limitless potential gains can be had from pushing out the knowledge
frontier.RobertGordon argued that diminishing returnspresent a seriousconstraintto the benefits of technical progress. He suggestedthat
such diminishingreturnscan be observed by looking at the effects ofthe technologicalchanges of the past century. Such changes have beentransformingdaily life over this period, but the rate of transformation
has been slowing down. Martin Baily, in contrast, argued that thesignificantexternalities connected with additional investments in researchanddevelopmentmake a strongcase for pushingout the knowledge frontier.
RobertHall disagreed with the author's contention that providing
extremelystrong property rights over nonrival goods would lead toinefficienciesand lost opportunitiesfor additionaltechnological progress. Using the computer industry as an example, he noted that IBM
hasbeenliberallygrantedlicenses for the use of its key patents.Bresnahanconcurredwith Hall's assessment and added that for the commercializationof informationtechnology, the most importantmechanism
for coordinationand reuse is the appointmentof a monopoly vendor.

398

Brookings Papers: Microeconomics2, 1993

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