Conversation with Paul Romer, senior fellow, Stanford Institute for Economic Policy Research

Kedrosky: We're here with Paul Romer, an economist at Stanford who is going to talk to us for the next … we're going to talk for maybe the next 30 minutes or so about some of the things he's involved in, specifically as an entrepreneur and that is the charter cities movement. But, thanks very much for doing this Paul.

Romer: Yeah, glad to be here.

Kedrosky: So, let's sort of maybe go backwards before we talk about some of the stuff you're involved with right now with the charter cities effort, but let's talk a little bit about Paul Romer, entrepreneur, and get away from this whole economist stuff. So, you're a tenured economist at Stanford back when. You get out to become an entrepreneur. How exactly did that happen?

Romer: Yeah, well I worked on innovation and this theory of growth in the first phase in my career. I perceived as a young economist pushing some new ideas the problems of old economists who were hanging around defending their old ideas, and so I made a commitment to myself early on that I wasn't going to persist working on the same area of growth for more than about ten years. So once I had worked as just the theorist of growth for that period of time, I started looking around for what to do next. One of the big puzzles for me was why technology, which we saw having this transformative effect on the rest of the economy, why it wasn't being used in higher ed. So, I decided as a … just as kind of an experiment to try and start a company that could provide the technology that I wanted in the classroom just to try and demonstrate that technology really could be used in higher ed just like it's used in every other industry. So, I met a programmer, and we started working writing software for things I wanted in the classroom and eventually got some funding and started a company.

Kedrosky: So, you know, you make it all sound so straightforward, but we don't exactly see, you know, truck loads of tenured Stanford economists or other economists leaping out to start companies, so what was different in your case?

Romer: Well, I guess that's a good question because, you know, it obviously matters for the Foundation and for policymakers who think about entrepreneurship. I think being here in the Valley probably plays a role. It's an environment where people are very supportive of the idea of doing startups, and you clearly get the sense that it's not a high risk activity in terms of how people will perceive you. I could try to start off and, if it hadn't succeeded, that really would not have been a black mark against me. That's very strongly reinforced out here.

Kedrosky: Yeah. Did you have friends or others who had, you know, colleagues, acquaintances? You sort of said, you know, I'm not nearly … I'm at least as clever as that fellow, and I could do this too.

Romer: Well, I'm trying to think. I don't know of any colleagues who had started a business.

Kedrosky: I guess LTCM doesn't really qualify. When you create companies [inaudible] the world, maybe that doesn't count.

Romer: Yeah, that's true actually. Quite a few. This is something that maybe should be a concern, but quite few economists get involved in finance. I think that's perhaps not a healthy thing because I think it means that as a whole the profession isn't totally unbiased when we talk about financial reform, but that's a whole ‘nother conversation.

Kedrosky: Yeah but that's an interesting point because, you know, as you say, it becomes an invested interest. So, let's talk a little bit, though, a little deeper about your experience as an entrepreneur. What was easier than you expected? What was harder than you expected? What did you walk away with having spent … how long exactly were you …?

Romer: Yeah, so I was on leave from Stanford for five years and then back half time towards the end of the company for two years. I sold the company to a large publishing firm after about seven years, so that was the involvement. So, seven year involvement in the company.

Kedrosky: Okay, and so as you think back on it or as you thought about it at the time, what … let's sort of think about it in terms of things that were different from your expectations. What was easier than you expected? What was harder than you expected? You know that kind of thing.

Romer: One surprise for me was how important sales, or marketing, or communication, however you want to describe that activity, is relative to writing good software. In retrospect, it's more obvious than it was as I was going into it, but everyone is incredibly busy these days, especially say professors who were the people we were trying reach. So, competing for their time, getting a little bit of their time to try something and see how it works or to learn about something is quite difficult. So this kind of attitude of build it and they'll come and use it really misses how scarce time is and how difficult it is to get people to do a little bit of investment to learn about something before they know if it's going to be worthwhile for them.

Kedrosky: Now how about the fundraising part? How did that go?

Romer: Yeah, we had an unusual fundraising experience. We didn't have a traditional venture capitalist who had invested in us. It was actually a large financial services firm from Sweden, and we were very lucky because they were very hands off. That meant that we didn't have some insane pressures, for example, for an early exit and for, you know, kind of sizzle rather than substance. We had time to really build substance. I was just lucky.

Kedrosky: What did you … I mean I suppose the softball question is do you think it made you a better economist? But maybe a better way of backing into that is, you know, what did you find most pleasurable about the experience of kind of creating something and trying to take it out to people who you thought might need it?

Romer: I really enjoyed the experience of working with a growing group of people. We were up to about 40 employees when I sold the company. I really enjoyed working with this group that we were building. We were all committed to a vision that was partly to make the world a better place. We really believed that we could help students learn economics. Our initial foray was in college level economics. We thought we could help students learn economics better and that the world would be a slightly better place if we did that and that kind of the process of forming this team committed to that vision and carrying it out was very satisfying. That doesn't make me necessarily a better economist, but it does … I guess in an indirect way, it does. It made me think in I think with more precision about some subtle issues which I'm now thinking about with new cities which is how do you sustain a group of people working towards sort of mutual benefit for everyone there. The role of norms and kind of the subtle motivations that go beyond the direct monetary motivations that usually take center stage in an economic analysis. People are motivated by much more complicated sets of potential rewards, and their behavior is influenced by a much more subtle set of influences than just payoffs, fines and kind of formal rules that you think about as an economist.

Kedrosky: That's a great point, and those subtleties really only show up through that kind of thick quasi sort of ethnographic experience of having actually lived there with the same incentives in many ways.

Romer: Yeah, yeah. Like one of the interesting things was to watch how this vision that I had which was that if we set about helping students learn more effectively then things would take care of themselves in some sense. You saw the real problem in the world and the business model follows and it works. So, we were really very committed to teaching. It's been fascinating to watch how that organization maintained that commitment even after I was gone because what happened is we attracted people who were committed to that idea. They kind of socialized each other into a stronger commitment to that idea. As new people were brought on board; they either were kind of socialized in and bought that vision, or they left the organization. So, it's taken on this life of its own, but it has this persistence which is both kind of gratifying, but also, intellectually fascinating to watch.

Kedrosky: Let's kind of step across, I guess, to some of what you're working on now. And maybe you started to make the bridge already, but before getting you to kind of sort of define the whole charter cities movement, I suppose, and what you're trying to do, how did you get there? What was sort of the steps that took you to thinking from, you know, you sort of talked about sort of how the entrepreneurial connection was made to the charter cities movement? But, I think I saw somewhere where there was a connection with respect to a paper you were writing on [inaudible] I think. Just try to make sort of the intellectual path forward from growth theory through entrepreneurship on to charter cities.

Romer: Sure. When I was looking around … before I started the company, when I was looking around at what I wanted to do next, the biggest puzzle, the biggest gap it seemed to me in economics was understanding political decision making. I now interpret that more broadly as, how is it that collections of people change the rules which govern how they interact with each other? So if you think about politics, what you're thinking about is formal rules like laws and regulations. I think when I was at the company I realized that the informal rules, the things that are codified in people's norms about right and wrong, are at least as important as the formal rules. But even before I had started the company, I was thinking about this question of how do societies change the rules that govern how the people work together, and in particular, why is it that large collections of people can get stuck with rules that are so transparently inefficient, but yet they can't seem to change them? That was the puzzle. Went off and started the company and then once I sold the company decided to return to that with a specific application to development. The places where rules are doing the most damage are of course the least developed countries in the world where countries are not going through the kind of rapid catch up growths that we now see in a place like India and China, but where they could if they changed their rules.

Kedrosky: Just …

Romer: Can I just close one more kind of gap there?

Kedrosky: Sure.

Romer: What I concluded was that the best way to change rules is through something I'm now calling the startup dynamic which is instead of taking an existing large collection of people and trying to compel or persuade change within the whole large collection, one of the most effective ways to do it is to create an opportunity for a subset of those people who believe in a new set of rules to go off, set up a new community or organization based on those new rules, and by demonstrating how well they can work in the startup, you can eventually attract people from the existing organization and ultimately transform the whole society, or community, or industry. So, it's a dynamic we see at lots of different scales, but right now it's not operating at the level of nation states or cities. That's where I'd like to see if we can bring it back to life.

Kedrosky: Is there kind of path … I mean you sort of implied it. That's sort of implicit in a lot of this discussion, but there seems to me there's kind of a path dependency argument in here as well. Is there in terms of, you know, I often point out to people that in the average city, in a normal average city, in a normal developed country and a large city like a Los Angeles, or a Toronto or Chicago, that something like only about 12 or 13 percent of all calls, calls for a fire department, are actually about fires, which usually comes as a huge surprise to people because they think the fire department fights fires. Of course, the answer is the fire department used to fight fires, but now it's kind of got this institutionalized friction. We've got this group that no longer has fires to fight and yet still exists, and so we're tied up in this kind of … at a political level and very much it's sort of a path dependency kind of problem.

Romer: Yeah, yeah. So, the way I frame this right now is to draw this distinction between technologies and rules. We're sort of used to thinking about the dynamics of technologies, but the questions we're talking about now are about the dynamics of the rules. The rules involves organizations, structures, agreements about what a fire department does. Also, just understandings about things like is it okay to jaywalk; is it not okay to jaywalk? So, there's this whole range of things that are captured under this dynamic of rules. As you suggest, there is this path dependence and also this tendency for stability. Any given system of rules tends to be very stable so that as the world changes, rules that were once well suited to the environment can become increasingly poorly suited to this changing environment. And, the big question is how do you move from a stable but no longer useful set of rules to a better set of rules.

Kedrosky: So, this sounds like a good point to sort of maybe define terms a bit. So, what exactly is a charter city, and maybe how does it fit into this problem that you've sort of identified and I think all of us see it represents a solution for, at least in your mind.

Romer: Yeah. Well, I mean rather than define it let me just kind of operationalize it.

Kedrosky: Sure.

Romer: So, what would it take to start a charter city? It requires first just a piece of unoccupied land and then one or more political jurisdictions that are willing to set up a new set of formal rules that would describe how this new … a new city that would emerge on this land operate. So, that's the role of a charter. It sets some formal rules. Now, what that does is that the formal rules attract a certain type of people. The selection will go in the direction people believe in those formal rules, so they'll bring with them norms that are consistent with those formal rules and typically will be very different from the norms of the existing equilibrium.

If those formal rules and informal norms and rules work better, as I think they surely would, these kind of cities will survive … not just survive, but they'll thrive and they'll start to attract more people based on just the narrow economic benefits that they confer. But, they'll also socialize the new arrivals in the city into this new set of informal rules that make the place work. It's a social mechanism. It's just exactly like the startup dynamic for firms, but the key difference here is one of scale. These cities should be … the land required is roughly on the order of a thousand square kilometers, so 33 by 33 kilometers that the scale, one, I think should aim for would be something like ten million people. The reason for this is that a city of that scale can be largely self sufficient so you can redo all of the rules in a city like that and not have it be dependent on dysfunctional rules in the surrounding environment that you can't change.

So, a city on that scale can have it done. Our system of transport networks, legal arrangements, social arrangements and … can be dramatically different from what operates around it. Of course, the historical example that looks most like this is Hong Kong which has a completely different system of organization compared to the surrounding Chinese mainland.

Kedrosky: Right, right. So, a bunch of different sort of thoughts as I kind of sort of think it through, but give me some examples. Maybe let's start off by making it more specific, so as you think about formal and informal rules in the context of a charter city, you've alluded to some in various interviews that I've read. But, give some examples of the sorts of things you might imagine happening.

Romer: So, you're asking like what would be different?

Kedrosky: Yeah, what's different? I mean, you know, I think I saw a … I think it may have been on the “Freakonomics Blog” where you were talking about these rules … the trouble in Paris with convincing them to stop urinating in public as a kind of a … as an aside. But, I mean the point being that these societies develop norms there either positive, you know, positive ones you want to reinforce or negative ones you want to get rid of. Give us some examples of what are some of the emergent rules that you might imagine popping up in a charter city that would be something you would try to promote and enhance.

Romer: Well, if you look at successful cities around the world and you notice how people interact, what you'll see is that there's a collection of things that would … we just take for granted that don't exist in many other places. So, there's certain kinds of norms about sort of courtesy and kind of respect for other people, norms about a lack of predatory behavior compared to other people, kind of a notion of inclusion and fair dealing with a very broad range of people rather than some very narrow group like my family, or my clan, or my tribe. These are subtle things, but they're very important to the underpinnings of a modern market economy. But also, just underpinning kind of reasonable quality of life, so if you're going to have low levels of crime, low levels of pollution, low levels of, you know, littering and compliance with basic public sanitation and so forth, you need a set of norms that make people pretty much automatically follow the rules that let them all live and work in these high density urban environments. We're so used to just taking those rules for granted that it's hard for most of us from the western world to even imagine what it's like when they aren't present. This is why I use this illustration just public urination in Paris because it kind of catches people off guard. It's hard to even imagine why would you need police to give tickets to stop someone.

Kedrosky: Right.

Romer: But, if you extrapolate from Paris to, you know, Haiti, there's, you know, a thousand things or a million things that go way beyond public urination where the norms about right and wrong that currently prevail don't support the kinds of things that we just take for granted as being right and wrong. There's nothing different as people for Haitians, as opposed to Parisians, as opposed to, you know, people anywhere else. But, the local norms that people take on board are determined partly by local behavior, so you get these stable equilibria where what's common in terms of behavior establishes the local norms which reinforces the common behavior. You just need to change from old norms and equilibria there were perhaps better suited to a time when we didn't live in such dense urban areas to this very different set of norms and assumptions about how we treat each other.

Kedrosky: So then, the norms in a developed country in terms of trying to change how people behave in a city like Paris is one thing. Obviously, one of the things that I'm sure many people have brought up before but it strikes me as you think about trying to have a charter city inside of a developing country is that the border between the charter city and the rest of the country is that the border between the charter city and the rest of the country, you know, in a sense it's a permeable barrier or semi-permeable barrier. To a country that's obviously got all kinds of developmental issues, maybe graft, bribes, whatever else, how do you in the absence of sort of surrounding charter cities in developing countries with the equivalent of kind of black water, how do you deal with the issue of this barrier and it being geo located inside of a country that's got issues that you don't want to have across the barrier?

Romer: Well, you look at the history of Hong Kong. I think there's lots of lessons about how to manage this. There were political reasons why there were pretty sharp barriers that separated Hong Kong from the surrounding area. You could recreate those kinds of barriers both through physical barriers as well as … those physical barriers might partly be determined by geography, so you know, it could be an island. It could be a location in a very arid region where there's no longer say coastal location that's in a very arid region where there's very little economic activity outside the city itself. It could also be the separation could be enforced partly by things like customs controls, border controls, immigration controls, but it is the case. If you want to create a new entity that operates differently from a surrounding entity, you do need some kind of a like a cell membrane that establishes the border between the new entity and the surrounding region.

Kedrosky: So this kind of brings up, at least I'm sure to some, sort of this specter of, it feels like there's an aspect of imperialism or colonialism 2.0 in here somewhere. What's sort of your response to that criticism that I'm sure comes up?

Romer: Yeah, the first thing to observe is that the process here for setting up a charter city turns on choice, voluntary choice, at each stage. So no nation would volunteer land for one of these cities under duress, and that would have to be a voluntary choice, because they see it as being beneficial to create such an entity. No other nation that might participate as a partner would do it except under voluntary terms. The people who go live there would all choose to go rather than have some new system forced on them. This is why it's very important to start within an unoccupied piece of land. So, most colonial ventures in the past involved some degree of coercion, both at the national level and even at the level of the, kind of the citizens or residents. And that, I think, was why they often ran into problems about legitimacy and resistance. Hong Kong is interesting because it was very different in that sense, that virtually everybody who lived under British rule in Hong Kong chose to go there. There was essentially nobody, it was just a tiny fishing village when the British took it over. So voluntary choice is a critical distinguishing feature.

But the other thing that's worth keeping in mind is this notion of a startup city on unoccupied land does not necessarily have to involve other nations, especially other developed nations. When China set up Shenzhen as basically a brand new city in China, it didn't involve any foreign participation. So you could have charter cities that look like Hong Kong or charter cities that look like Shenzhen. But either way, it's the startup dynamic which is driving things, not so much necessarily the participation of other units of government.

Kedrosky: Okay. So I'm curious, and I think one of my Kauffman colleagues has been talking to you about this idea as well. But as you sort of think about that idea and you think about it, you talk about it in the context of unoccupied land and so on, but obviously within this occupied land known as the United States, we've got cities that we'd love to see reenergized and even resurgent. And you think about a city like Detroit. Is there anything you can take away from what you're thinking with respect to charter cities into some of the cities that are currently having their own troubles in the U.S. today?

Romer: Yeah. Well, I think it's actually very informative to exploit the analogy between cities and firms. So what I'm talking about is a startup dynamic and applying it in a developing world where cities are very scarce. The developing world needs urban environments for billions of people in the next incoming decades. The United States is quite different in the sense that we've largely urbanized, so you don't need a whole lot of new urban space. And what we're dealing with more are questions like, you know, what's the analogy for a workout mechanism when a city gets into a position where it's in effect in a form of political or economic bankruptcy? And we don't have good mechanisms to do a workout. We don't have anything like takeovers and we should be thinking about those, I think, rather than a startup part of the process for dealing with most of the problems with [inaudible]. But the two illustrations of things that are a bit like a workout are in New York City, there was a reform agency set up by New York State when the City was going through serious financial difficult and that was part of a key turnaround in New York. Just by historical accident, Washington D.C. is under the formal control of the Congress, so when Washington D.C. got in a position that was, you know, as bad or maybe worse even than Detroit, the Congress basically just imposed a kind of workout process on D.C. as well. So I think we should really be thinking about basically the analogue of bankruptcy and takeover as a way to deal with assets that are trapped in cities where the current leadership and organization is not succeeding.

Kedrosky: But to press that a little bit further, and I buy that analogy, is part of the issue though then, and to bring back in the startup idea a little bit, that cities, as strange historically as it might seem, maybe they don't fail often enough and part of the problem is they live on long past their sort of economic and political usefulness and we, for institutional reasons, try to find ways to continue to keep them there like Frankenstein on the slab? And maybe the answer is that we need to find a way, not even past workout, to let cities in some sense fail?

Romer: Yeah. Remember what bankruptcy does for firms. I mean, it doesn't like blow up the assets of the firm. It just reuses them. It just puts them under a kind of control and redeploys them. So you do have these valuable fixed assets like infrastructure which ideally you would efficiently repurpose and reuse. So it's probably not efficient to think about like putting up a chain link fence around, you know, some city and just saying, “Okay, nobody go there. It's a dead zone.”

Kedrosky: Right.

Romer: We really should be thinking about how do we do in effect a kind of an organizational change that can use the existing assets more effectively.

Kedrosky: And this may be getting outside the sort of thing you follow. But I don't know if you've been tracking what's been going on with respect to one attempt here in California to do something like that in the context of the bankruptcy or the attempt at bankruptcy, the city of Viejo, California up in the San Francisco – well, up in your area – which I think declared bankruptcy a little over a year ago and it's been trying to go through a workout process and a judge trustee process, and it's been very interesting to watch. And one of the main things, pace your comments, that it's kind of revealed is that we don't have a process at all for doing any of this.

Romer: Yeah. I think it's really a big gap in our legal and political structure that there isn't some way to trigger something like, you know, like a voluntary reorganization. I mean, you know, just hypothetically, imagine that the residents in some city had the option to vote through, say, a referendum process to place the entire city political structure under the control of some, you know, like reorganization authority. You know, it could be a state authority, it could even be national. And suppose that authority also had the ability to just rewrite every, you know, every contract, every obligation of the city. So at some point, the residents of the city had the option not just to change who's the mayor or who sits on the city council, but basically to pitch the whole control structure for the city to this other entity. You know, maybe there's even a couple of competing reorganization authorities that, you know, manage workouts of these cities.

Kedrosky: So – and we've just got a minute or two left, a couple of minutes left. But as sort of an, and I'm guessing we both know the answer. It's the same answer for all sorts of fresh ideas. But what's been the response maybe both in the policy, but also in sort of the economic community to some of the ideas you're proposing around charter cities? Shock, amazement?

Romer: No, actually, the response, both from policymakers and from academics, has been, you know, quite – there's quite a lot of interest in rethinking some of these things that we've just taken for granted and haven't examined before. So universally people have said, you know, this is a new idea and it's interesting and we should be asking these questions. Now, a long side of that response, there's a very common response which is, oh, but this is just not going to be politically feasible. And there, I think people are too kind of trapped by what's familiar. It's a very common fallacy. This is one of the things the entrepreneurs are the ones who kind of see through this. But most people are trapped by the kind of the fallacy that if something's unfamiliar, then it's impossible. And you know what the entrepreneur sees is, well, it's something unfamiliar and something new, but it's perfectly feasible, so we could do it. So I think people have been overly skeptical about the practical possibilities of something like this. And ultimately when this happens, everybody's going to update and revise and say, “Oh yeah, you know, this actually could happen.” But still what's been gratifying is how receptive people are to saying the questions you're raising are very important questions and we should be thinking much more broadly about these questions and how to achieve this goal of basically transforming systems of rules that trap people.

Kedrosky: Well, thanks very much, Paul. This is fascinating stuff. We're kind of reaching the end of our time, so I'll stop it here. But thanks again. I really enjoyed it.

Romer: Okay. Well, we'll have another chat after one or two of these things gets up and running.

Kedrosky: Look forward to it. Thanks, Paul.

Romer: Take care.

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