The economics of ideas and the ideas of economists.

• Author: Johnson, William R.
• Position: 2005 Presidential Address

1. The Importance of the Market for Ideas

   On college campuses across the country, and on millions of home computers too, young adults download from each other digital files containing recorded music and films for their entertainment. The owners of that copyrighted material pursue the downloaders and the software services that facilitate it with legal action. Napster, a free file-sharing Internet site, was shut down in 2001, and the Supreme Court has recently ruled that a successor file-sharing service, Grokster, engaged in copyright infringement by providing an easy way for individuals to exchange files. The amount of file-sharing activity is not trivial; Paul Romer (2002) estimates that Napster users were downloading at the rate of 1.5 billion downloads per month before Napster was shut down and that the consumer surplus generated by downloading roughly equaled the revenues of the recording industry.

   At the other end of the demographic spectrum, many of these college students' grandparents seek to buy patented prescription drugs from Canada, where prices are lower than in the United States. The pharmaceutical manufacturers and the Food and Drug Administration (FDA) try to restrict that crossborder trade, but the grandparents flex their political muscle to keep their supply routes open.

   These two phenomena have something in common: both represent attempts by consumers to use intellectual property without compensating the owners of that property. Public sympathy probably lies more with the grandparents than the downloading twenty-somethings, but the owners of intellectual property are often viewed, if not by the public, at least by the consumers at issue, as wealthy entities undeserving of further enrichment.

   The prominence of these two recent episodes--along with such issues as the pricing of HIV drugs in Africa and the pirating of copyrighted material in Asia--underscores the importance of intellectual property issues in contemporary life. My goal today is to outline both some of the contributions economists have made to understanding these problems and a few areas we have failed to pin down. I have three major themes:

   First, the market for ideas, broadly conceived, is more important today than in the past for reasons that are primarily economic in origin. Second, intellectual property rights are not an absolute, and the appropriate boundaries of those property rights depend both on behavioral responses and on the state of technology. Rapid changes in technology likely change the efficient intellectual property boundaries. Third, economists so far have made little headway in understanding the crucial empirical magnitudes on which optimal intellectual property policies depend. One of these magnitudes is the elasticity of supply of new ideas.

   That information or knowledge is of crucial importance to modern economies is a cliche that can easily be overstated, as it undoubtedly was in the late 1990s when the dot corn boom convinced some that we were well on our way to a digital economy in which bits of information would be the central commodity in trade. Obviously this is an exaggeration, but there is good reason to think that information and ideas take an unprecedented place in contemporary advanced economies.

   The growth of income per capita in the world was negligible from the eleventh through the eighteenth centuries. In the nineteenth century, however, per capita income roughly tripled, while in the twentieth century it increased eightfold. Accounting for this unprecedented acceleration of real incomes is, of course, a crucial question for economists. My reading of the empirical literature is that much of the growth over time is attributable to technological change rather than the accumulation of capital. I do not mean to neglect the role of institutions such as private property, markets, and the rule of law, which appear to play an important role in explaining differences in growth across countries and are a necessary precursor to the growth explosion of the twentieth century. But the economic historian Joel Mokyr (2002) contends that one distinctive feature of the nineteenth and twentieth centuries was the development of systematic ways of creating basic scientific knowledge and using it to advance technology. Technology had advanced before (think of Gutenberg), but haphazardly. Once science became the foundation for technical change, the rate of technical change accelerated, as the production of new ideas was systematized. Now, of course, we have whole sectors of the economy devoted to basic science and the development of useful technology. Information production has come to play a central role in modern advanced economies because we have learned to develop ideas more productively.

   A second feature distinguishes advanced economies from those of the rest of the world. The bulk of new ideas, at least expressed by patents, are generated by the advanced economies. Globalization and the specialization induced by world trade has, to some extent, made the advanced economies of Europe, North America, and East Asia the generators of new ideas and technologies and the rest of the world the users of those technologies. Or, to put it another way, these economies generate most of the world's useful ideas because they have a comparative advantage in the production of ideas.

   Ideas contribute to welfare both by reducing the cost of existing goods through process innovation and by creating new goods through product innovation. Of course, sometimes it is difficult to distinguish the two: Is the DVD a product innovation or is it a cheaper way to produce visual entertainment? While the latent demand for process innovation has presumably always existed (because we always want more), a third reason for the growth of the production of ideas emphasizes the increasing demand for product innovation for which ideas are crucial. Where has this increased demand come from? Let's look at Robert Fogel's (1999) estimates of the shares of total consumption in the United States comprised of food, clothing, shelter, health, education, and leisure in 1875 compared with 1995. If we take health, education, and leisure to be the relatively idea-intensive categories of consumption, we see that the share of spending on these idea-intensive categories has quadrupled over the past 120 years, from only 20% then to 80% now. Most of that increase is in leisure. Economic growth has been accompanied by an explosion of leisure time. Looking only at the time available after sleeping and eating, Fogel estimates that Americans spent 18% of that time on leisure a century ago, with the rest taken up by market and household work. The figure today is 67%. Some, maybe much of that time, is filled with the entertainment hardware and software of contemporary life. The software--movies, musical recordings, television programs, computer games, and, for at least a few of us, books--that fills much of this free time requires creativity.

   One way to think of this is that as our biological wants can be satisfied with less effort (because of the advances in production technology), we increasingly demand consumption that is idea intensive. This may stem from the income elasticity of the demand for variety. There are actually two quite distinct senses in which the demand for variety rises. The first is the demand for variety over time by a single consumer. Underlying this income elasticity may be the durable nature of many of these consumption goods. At low levels of income, I eat to get calories to exist. The calories are quickly burned and I need to eat again to acquire more calories. My demand for cheap calories trumps my interest in cuisine, variety, etc. At high levels of income, eating becomes more than intake of fuel. It becomes an experience with long-lasting effects. We remember the experience of the meal well after the calories from the meal have been burned. Similarly, the memory of a movie or song or vacation lingers. To some extent, the durability of these memories engenders a demand for variety in the experiences that create them. And ideas contribute to producing the variety we demand. The connection is clearest in the creative arts, such as composing, movie making, literature, and so on, but also extends to fields such as cuisine where innovative chefs devise new dishes with new combinations of flavors. Or, at a more prosaic level, a clever entrepreneur conjectures that the American middle class will want to eat steaks and deep fried onions in a vaguely Australian-themed restaurant.

   The second sense in which variety may have...