THE ASSESSMENT: NEW APPROACHES TO ECONOMIC GROWTH

OXFORD REVIEW OF ECONOMIC POLICY. VOL 8, NO. 4

THE ASSESSMENT:NEW APPROACHES TO ECONOMICGROWTH

ANDREA BOLT/HOMagdalen College, Oxford

GERALD HOLTHAMLehman Brothers International and London Business School

I. INTRODUCTION

Until recently, economics had little of interest to sayabout economic growth. Now this is changing.

So began an article devoted to the growth themepublished not long ago in the London magazine TheEconomist (4 January 1992, p. 17). The presentissue of the Oxford Review of Economic Policy isdevoted to this change. It explores several newapproaches to the question of economic growth andprovides a survey (see the article by van der Ploegand Tang) of an expanding body of literature thatgoes under the name of 'endogenous growth'.

This assessment addresses four main questions:

(i) What are the major empirical issues that anytheory of economic growth should try to tackle?(ii) What interpretations have been given in the paston these issues?(iii) What new and/or additional insights are pro-vided by the theories of endogenous growth?(iv) What policy implications arise from both theold and the new literature?

II. THE ISSUES

Economic growth as it is understood today, i e .almost uninterrupted increases, decade alter dec-ade, in a country's total and per capita output, is aphenomenon that would seem to date from the

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OXFORD REVIEW OF ECONOMIC POLICY, VOL 8, NO. 4

industrial revolution. Tentative estimates of growthrates in die preceding millennium suggest that, inEurope at least, growth in this sense was virtuallyunknown (Maddison, 1982, p. 6). The single mostimportant reason for a take-off at around the turn ofthe 18th century is both simple and widely ac-cepted—die pace of technological progress accel-erated and this allowed sustained growth in theproductivities of growing inputs of capital andlabour.

That simple explanation, combining innovationand accumulation, has remained with us. The mostbasic approach to economic growth in any macro-economic textbook still stresses the joint impor-tance of factor inputs and, especially, technology.The canonical model, as presented by Solow (1956),obtains the well-known result that, on conventionalassumptions, an economy has a unique and stablegrowth path determined by the growth of the labourforce and of technical progress, with the latterusually assumed to expand at a regular, if unob-served, rate.l This last assumption is not inevitable.Schumpeter, for instance, saw inventions, and theirassociated innovations, occurring in pulses whichled to investment booms and creative 'gales ofdestruction'. But this integration of growth andtrade-cycle theory has not generally been incorpo-rated into mainstream analysis which has ratherdealt with equilibrium steady states.

The mainstream model also underlay the 'growthaccounting' literature (e.g. Denison, 1967), whichattempted to quantify the role of various proximateinfluences on growth. The results of this literatureare equally well-known—the growth of outputcould not nearly be accounted for by the growth ofinputs. Hence the appearance of a substantial 're-sidual' which was attributed to technical progress(though efforts were made to decompose it intodifferent elements, such as education, which hadnot been captured by the conventional measure-ment of factor inputs).

The major difficulty about this traditional approach,as underlined by the quotation from The Economistcited above, is that it provides no explanation forwhat causes technical progress, the most importantdeterminant of growth. Moreover, its depiction of

a stable steady state bears no resemblance to the realworld. Actual profits, investment, and growth rateshave exhibited long-term accelerations anddecelerations, tending neither asymptotically toapproach such a steady state nor even to progresssmoothly along a trend provided by the technologi-cal deus ex machina. Nor has the world economyshown strong tendencies towards convergence inper capita incomes, contrary to what neoclassicalgrowth and international trade theories would haveled one to expect

To be convincing, a theory of growth should be ableto provide answers to several basic issues that arisefrom the economic history of the last century or so.Kaldor (1961) was probably the first to set out a listof empirical observations with which any theoryhad to be consistent (for a slightly modified versionof his 'stylized facts', see the article by King andRobson in this issue). Among these were the pur-ported long-run constancies of factor shares and ofthe capital-output ratio, neither of which seems tobe borne out by the data. Factor shares have shownlong-run trends in a number of countries (Kravis,1959; Kuznets, 1959; Hill, 1979), and capital-output ratios have tended to rise in all the majoreconomies over the last century, bar the UnitedStates (Maddison, 1991). Yet, some of Kaldor'sfacts are true. The following brief selection drawsboth from Kaldor and from other work in this area:

(i) Why have countries, or groups of countries, beenable to grow for decades in succession with noapparent tendency to slow down, despite risingcapital-labour ratios?(ii) Why has convergence in per capita incomesacross the world seemingly failed to materialize?(iii) Why have countries, or groups of countries,generally exhibited medium- to long-term acceler-ations or decelerations in their growth?

First, comes the basic issue of why growth could besustained for a century or more in the presence ofrising capital-labour ratios which, according to theorthodox theory at least, should have induced fall-ing marginal productivities of capital. Evidence onlong-term growth for a sample of developed econo-mies for which sufficient data are available isprovided in Table 1. As was noted in a similar

1 The Harrod-Domar model, with its almost opposite result that 'an equilibrium growth rate will exist only by chance—ifthe natural rate is equal to the "warranted rate"1 (King and Robson, this issue), was also popular, but only for a time.

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Table 1Growth in Per Capita Incomes and in the Capital-Labour Ratio inSelected Countries, 1900-79 (Average Annual Percentage Changes)

GermanyItaly1

JapanUnited KingdomUnited States

GDPper capita

2.22.53.11.41.8

Non-residentialcapital stock

per employed

2.42.82.61.41.5

Note: • 1900-78.Sources: Maddison (1982,1991).

context: 'Output per worker and the capital-labourratio move one-for-one with each other in the realworld* (Baldwin, 1989, p. 256), contrary to atraditional theory that limits the latter's contribu-tion to usually only 30 per cent and assigns theresidual 'to conveniently unobservable technologi-cal progress' (ibid.). Dissatisfaction with this con-

clusion, which was basically seen as a 'confessionof ignorance' (Arrow, 1962, p. 155), was a majorstimulus to endogenous growth theory.

Data throwing light on the second question arepresented in Table 2 whichshows levels and growthrates of per capita incomes from the beginning of

Table 2Levels and Growth Rates of Per Capita Real Income

(1980 Dollars and Average Annual Percentage Changes)

OECD CountriesUnited StatesEurope1

JapanSoviet UnionEastern EuropeLatin America0

ArgentinaBrazil

Asiad

ChinaIndia

Africa (Sub-Saharan)

Pre-Second

Level1900

1.9502,9101,830

680800

6401,280

440400400380

••

World War

Growth1900-38

1.31.01.21.91.91.5"1.51.01.70.20.20••

Post-Second

Level1950

3,9306,7003,0901,1202,270

1.3802,3201,070

380340360

••

World War

Growth1950-89

3.62.03.26.02.73.22.50.63.03.64.61.90.8

Notes: * Sample of 12 countries.b 1913-38 (or 1925-38 for Poland andRomania). 'Sample of 6 countries,d Sample of 9 countries.Sources: IMF, World Economic Outlook, May 1992; Maddison (1989); OECD, National Accounts,1960-1989; Worid Bank, World Development Report, 1991, Oxford, Oxford University Press.

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Table 3Selected Episodes of Accelerations or Decelerations in GDP Growth

(Average Annual Percentage Changes)

Accelerations Decelerations

Western Europe

Eastern Europe

Soviet Union

Japan

NICs-

China

2.54.7

2.74.8

1.96.8

2.89.1

3.38.0

5.38.9

1922-371953-73

1925-371950-73

1870-19131925-37

1870-19371953-73

1900-381953-89

1956-791979-89

Western Europe

Eastern Europe

Soviet Union

Japan

Latin America

4.72.3

4.82.0

5.02.3

9.13.9

5.31.6

1953-731973-89

1950-731973-89

1950-731973-89

1953-731973-89

1953-791979-89

Note:' South Korea and Taiwan only.Sources: Bairoch (1976); IMF, International Financial Statistics (Yearbook); Maddison (1989,1991).

this century in a number of selected areas. It will bereadily seen that evidence for convergence anddivergence co-exists in parallel. Thus, Japan andWestern Europe were able to catch up on the higherincome levels of the United States, slowly in thepre-Second World War period, but rapidly since1950. The same seems to have occurred in EasternEurope and the former Soviet Union, despite thedoubtful quality of those countries' statistics.2

The picture for the developing world, however, ismuch less favourable. Before the Second WorldWar, Asian standards of living hardly rose at all,while Latin America's process of convergence cmthe richer countries was minimal at best Since theSecond World War, Latin America actually re-gressed relative to the OECD area while Asia'sconvergence was far from uniform—though rapidin the East, it was slow or non-existent in theSouthern part of the Continent. Africa's plight istoo well known to require emphasis.

A further important growth phenomenon has beenthe occasional presence of 'trend accelerations' ordecelerations in selected countries or areas (Table3). The single best-known example of such anupward spurt occurred during the so-called' GoldenAge' of the 1950s and 1960s in Japan and Europe(both East and West). In the two decades from theend of post-war reconstruction to 1973, growthrates nearly doubled in Europe and more mantrebled in Japan, relative to their longer-term trends.An even more marked acceleration appears to havetaken place in the Soviet Union after the Bolshevikrevolution. Turning to developing countries, theEast AsianNICs clearly provide a startling exampleof arapid take-off in the early 1950s, as does Chinain the 1980s.

Conversely, a number of areas have also shownsharp growth decelerations that went well beyondperiods of normal cyclical slowdown. The post-1973 near halving of growth rates in the OECD area

1 Though the data on Eastern Europe and the Soviet Union shown in Tables 2 and 3 arc Western estimates which avoid someof the known biases of the official data, the adjustments made may still be insufficient in the light of recent revelations aboutthe extent of earlier statistical misreparting.

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(including, on this occasion, also the United States)is well known, as are the Eastern European andLatin American slowdowns of the 1980s.

There is the question, of course, whether suchchanges in trend are inherent in the growth process,in which case they should be encompassed by anadequate theory, or whether they are the result ofspecific, and in some sense random, events. Agrowth theory that tried to account for the bulk ofobserved fluctuations in growth rates would almostcertainly be attempting too much. There must be arole for historical accidents. Nevertheless, the ex-perience of varying growth, or even growth cycles,is so clearly widespread that a theory which predictsit has a strong appeaL Schumpeter's notion ofpulses of innovation has already been mentioned.Similarly, in models like those of Arrow (1962), orin some of the more recent literature looked atbelow that stress the role of capital formation,growth can clearly fluctuate with the rate of invest-ment, which is notoriously unstable in practice.This instability is, however, ignored in most mod-els.

III. EARLIER EXPLANATIONS

The knowledge that traditional theory could notprovide a convincing explanation for the 'convul-sive structural, technological, and social changes'(Nordhaus and Tobin, 1972, p. 2) which havecharacterized the growth experience of the worldeconomy over the last century or more was, ofcourse, widespread well before the birth of endog-enous growth models. Some economists explainedthis by recognizing that growth theory was equilib-rium theory and much in the real world was adisequilibrium phenomenon: 'General economicgrowth as we have known it is not a balancedsteady-state affair, . . . the historical process ofgrowth... may best be viewed as part of a sequenceof technologically induced traverses, disequilibriumtransitions between successive growth paths'(Abramovitz and David, 1973, p. 429).

While older approaches were not always expressedin the formal language of more recent models, theydid attempt to, and in a number of cases succeededin, shedding light on some of the issues highlightedabove. Indeed, a significant number of ideas used

by endogenous growth models can be found in theearlier literature.

(i) Long-term Growth

The issue as to why growth has continued for wellover a century in most industrialized countries at arate that may even have accelerated slightly has, onthe whole, received little attention. Applied econo-mists have worried about growth-rate differencesacross countries and between time-periods, buthave usually left alone the long-run sweep of his-tory. In this area, the neoclassical paradigm, relyingon exogenous technological progress, has ruledalmost unopposed.

Unorthodox theories were few and far between anddo not seem to have been tested empirically. Afairly complete survey is presented in Scott (1989)and work stressing 'learning by doing' (Arrow,1962), or endogenizing human capital formation(Uzawa, 1965) and technical progress (Conlisk,1969), is looked at in the article by van der Hoegand Tang. Of these approaches, Arrow's contribu-tion is one that comes near to the recent literature'spreoccupations. In Arrow's 'endogenous theory ofthe changes in knowledge' (Arrow, 1962, p. 155),growth results from a learning process which isitself the product of experience. The latter, in turn,is a function of cumulative gross investment 'aseach new machine . . . put in use is capable ofchanging the environment in which productiontakes place, so that learning is taking place withcontinually new stimuli' (ibid., p. 157).

The links between Arrow's model and those ofmore recent vintage are drawn further below. Anelement that seems missing from the formulation isthe recognition that, in an uncertain world, optimalinvestment cannot be presupposed. In practice, it islikely that fixed investment will be encouraged bythe experience of growth itself. A formulation thatspecified the latter feedback, while avoiding the adhoc nature of simple accelerator models, wouldreinforce the endogeneity of the growth path.

(ii) Convergence

Research on 'why growth rates differ' has, on theother hand, a long history which predates and goeswell beyond the growth-accounting exercises car-

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ried out within the confines of neoclassical theory(Denison, 1967). The idea that poorer countriesshould catch up on richer ones was advanced al-ready in the 19th century to explain ContinentalEurope's convergence with Britain In die 1960sone of its most persuasive advocates wasKindleberger (1967), with his well-known adapta-tion of the Marx-Lewis model of abundant laboursupplies explaining the divergent growth experi-ence in Western European countries. Relative back-wardness and abundant labour supplies are simi-larly crucial in stimulating growth in the writings ofKaldor (1966) since they allow expansion in the all-important manufacturing sector and hence the reap-ing of static and dynamic scale economies. Andscale economies also feature importantly in 'ex-port-led' growth models, in which, for example, afavourable/unfavourable exchange rate at the out-set confers lasting advantages/disadvantages asdemand and supply interact in virtuous or viciouscircles (Beckennan, 1962).

The accent that Kaldor put on 'Verdoorn's Law'and on economies of scale clearly foreshadowssome of the new growth literature. So too doapproaches that stress the technology gap betweencountries (Gomulka, 1971). In a variation on thistheme, however, stress has also been put on re-search at the frontier and not merely on the catch-upof the backward economies (Fagerberg, 1987). InSchumpeterian fashion, growth differences are seenas: "The combined result of two conflicting forces:innovation which tends to increase technologicalgaps, and imitation or diffusion which tends toreduce them' (ibid., p. 92).

A third set of explanations has stressed the role ofpolicies and institutions. In this category one canfind the modified physiocratic view that rapidexpansion of the non-market (or public) sectorretards growth because of the various financingburdens it imposes on the private economy (Baconand Eltis, 1976). Also very influential has been theapproach folio wed by Olson (19 82), in which youngsocieties grow more rapidly than mature ones, sincethey are not (yet) slowed down by the actions of'distributional coalitions' (ie. rent-seeking pres-sure groups such as oligopolies, fanners' associa-tions, trade unions, etc.).

While the empirical testing of some of these ap-proaches has been limited, the convergence hy-pothesis has been subject to numerous investiga-tions (e.g. Gomulka, 1971; Cornwall, 1977; Bau-moL 1986; Dowrick and Nguyen, 1989). The find-ings have suggested that convergence has occurredamong industrialized countries, though possiblydisturbed by the incidence of innovation in themore advanced economies acting in the oppositedirection to imitation (Fagerberg, 1987). Conver-gence between developed and developing countrieshas, however, been largely absent. Indeed, some ofthe more recent empirical investigations suggestthe presence of several 'growth clubs', e.g. rich,middle-income, and poor countries, within whichconvergence occurs, but between which it may not(Baumol, 1986; Dowrick and GemmelL 1991; andthe article by Chatterji in this issue).

An early explanation for widening gaps betweenNorth and South, that anticipates some aspects ofthe endogenous growth school, stressed that:'Economic development is a process of circular andcumulative causation which tends to award itsfavours to those who are already well endowed andeven to thwart the efforts of those who happen tolive in regions that are lagging behind' (Prebisch,1962, quoted in Meier, 1964, p. 345). The divergentexperience of the developing world over the lastdecades, with some areas losing ground, but othersgrowing rapidly, has made for a more differentiatedset of explanations (some of which also foreshadowstrands in the recent literature). Cumulativecausation is still possible. Its reasons, however, areto be found not so much in the workings of theinternational trading system, as had been arguedby, for instance, Nurkse (1961) or Griffin (1974),but in initial domestic conditions: 'A country'spotential for rapid growth is strong not when it isbackward without qualification, but rather when itis technologically backward but socially advanced'(Abramovitz, 1986, p. 388). And this 'socialcapability'is,mtum,unportanttyrmked to educationand hence human capital, as underlined by a recentempirical investigation that stresses the crucial roleof schooling in explaining the divergent growthexperience of a very large sample of countries(Barro, 1991).

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(iii) Accelerations/Decelerations

While relative backwardness and rising social ca-pability may explain the presence or absence ofconvergence, they are unable to throw much lighton why countries, or groups of countries, experi-ence sudden medium-term accelerations (orslowdowns) in their growth rates. Writings in thisarea have drawn relatively little on formal theoriesof growth and have relied mainly on ad hoc expla-nations, tending to stress the role of economicpolicies or of specific disturbances to 'the institu-tional policy-mix... usually initiated by some sortof "system shock"' (Maddison, 1991, p. 85).3

Hie post-Second World War growth accelerationsin Western Europe and Japan are more interestingthan first appears. They did, of course, owe a gooddeal to the catch-up factors usually cited, but moremust have been at work, given that significant gapsvis-a-vis United States productivity levels (as wellas even more elastic labour supplies) had existedsince the beginning of the century and had notgenerated similarly rapid growth before 1950.

Two possible explanations for this accelerationlook at almost opposite factors. In one, the stress ison the return to unfettered market forces, resultingfrom the disappearance in many countries of thespecial interest groups of the pre-war era (Olson,1982). In the other, the accent is on policy changes,some of which (e.g. freer international trade) madefor a more liberal order (Crafts, 1992), but others(e.g. demand management) went in the direction ofgreater government interference in the economy(Boltho, 1982; Bombach, 1985). It is likely that thecombination of greater competition and greaterbusiness confidence, instilled by the self-fulfillingbelief that intervention in the economy could stabi-lize/promote growth, strongly contributed to the'system shock' that raised 'animal spirits' anddoubled investment ratios in the period. And shocksprovide, of course, at least a proximate explanationfor the slowdown that has occurred since the early1970s.

'Animal spirits' play no role in any explanation ofthe Eastern European acceleration in the 1950s and1960s (and of that of the Soviet Union already in the1930s). Yet, the stress on economic policies re-mains. While the shortcomings of central planningin the context of more mature societies are obvious,for less advanced countries it was an effectivemechanism for mobilizing resources through forcedsavings and investment This experience also pro-vides some evidence in favour of the standardmodel's argument that increases in investmentratios are unable to permanently raise an econo-my'sgrowthratemtheabsenceoftedinicalprogress.The huge investment efforts of the last few decadesseem to have generated progressively smaller re-turns, since they occurred in a system that basicallydiscouraged innovation. Yet, while illuminatingthe importance of technical progress, this explana-tion also shows that the latter is not fully exogenousbut depends importantly on the legal and institu-tional framework.

Turning to developing countries, the idea that ex-ogenous (or partly exogenous) events are crucialin explaining turning points in the growth of percapita incomes receives strong confirmation fromthe experience of forty-one countries since the mid-19th century: 'First, the turning point is almostalways associated with some significant politicalevent . . . Second, [it] is usually associated with amarked rise in exports' (Reynolds, 1983, p. 963).And the conclusion that policy changes can becrucial would seem broadly to fit the recent experi-ence of East Asia. Despite a sharp world economicslowdown, both the NICs and China were able tomaintain, or even raise, their growth tempos. InChina's case this clearly reflected a gradual retreatfrom central planning. And in the two larger AsianNICs there was a move away from earlier policiesof intervention which had contributed to rapidgrowth in the 1950s and 1960s (Wade, 1990).Finally, Latin America's deceleration in the 1980sowes much to the shock that came from the debtcrisis, though inappropriate policies no doubt alsoplayed a role.

1 An alternative explanation has stressed the appaieut regularity of such changes in trends (Mandel, 1980; Freeman, 1983;Van Duijn, 1983). In this view, a variety of factors (of which the most plausible is that of discontinuous technical progress),has led to long-term waves, h la Kondratieff. Yet, neither the regularity nor the causal mechanisms of Kondratieff cycles seemvery convincing (Chesnais, 1982; Rosenberg and Frischtak, 1983).

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IV. THE NEW LITERATURE

The theoretical literature on growth had little to sayon these issues. Indeed, it had increasingly becomeentangled with disputes in capital theory over thelegitimacy of aggregating inputs into 'factors' ofproduction, or of aggregating production functionsthemselves. The theory had also become morecomplex with the development of multi-sectoralmodels or models with capital goods disaggregatedeither by sector or by 'vintages'. Nor could thelimited dataavailable discriminate among the manyvariations on the standard model. Diminishingreturns in terms of general results appeared to haveset in. And while practitioners, aware of the mod-els' limitations, searched for alternative explana-tions of the 'stylized facts', growth theory from the1970s onwards went into a state of hibernation.

From this it emerged in the mid-1980s. Two ele-ments seem to have been important in explainingthe recent revival. One was the 're-discovery' of awell-known fact—convergence of per capita in-comes across countries was either limited or absentin the world economy. Yet, if exogenous technicalprogress could be thought of as falling like mannafrom heaven, should not standards of living tend toconverge, especially given the increasing mobilityof capital internationally? As illustrated above, theabsence of convergence had long been a datum fordevelopment economists and economic historians,but only recently have growth theorists becomeaware of it.

The second element was not so much a fact asdissatisfaction with existing models arising from aform of intellectual imperialism. If something calledtechnical progress accounted for the steady-stategrowth rate, and for the bulk of observed growthaccording to the growth accountants, was it notregrettable that economists had nothing to sayabout what determined therateoftechnical progress?Economic tools were being used to explain manydecisions previously thought to be non-economic;there was an economics of crime and punishment,of marriage and parenthood; surely, the origins ofthe wealth of nations could not be left to be colo-nized by historians of science or social psycholo-gists. Schumpeter's dictum that economic causes

should be sought for economic phenomena is themotto of the endogenous growth theorists.

The latters' contribution is as yet at an early stageof development, particularly in dealing with the'facts' that need explaining. So farthe new writingshave remained largely theoretical. Their main com-mon element is to provide a broader view of whatconstitutes capital. This is at the heart of Scott'sexplanation of growth (in his article in mis issue),an explanation that is not usually linked to the(largely American) endogenous growth literature,butthatboth predates it (inaseries of earlier papers)and is virtually alone in providing empirical tests(Scott, 1989). And a broadening of the concept ofcapital is similarly what brings together the litera-ture surveyed by van der Ploeg and Tang. Theyidentify four different views which emphasize vari-ous aspects of the process: learning by doing,human capital, research and development (R&D),and public infrastructure, and also stress the poten-tial for international spillovers in some of theseareas.

As Artus (1992) has pointed out, these endogenousgrowth models can be further grouped into one oftwo broad types. Both imply that the aggregateproduction function exhibits increasing returns toscale. Increasing returns, although espoused bysome earlier theorists, notably Kaldor, had beengenerally shunned as being incompatible with com-petitive markets and stable equilibrium.

Modern theory has escaped this dilemma by build-ing some form of externality into the model. Indi-vidual enterprises face constant returns to scale atany time, but due to some positive productionexternality increasing returns are encountered at theaggregate leveL In the first class of models, theelasticity of output with respect to aggregate capitalis unity, implying increasing returns to capital andlabour together. Though individual firms still facea conventional (constant returns) production func-tion, their overall efficiency level is a function ofthe aggregate stock of capital in the economy. Theprincipal interpretation (Romer, 1986), is that capi-tal accumulation results in learning which cannotbe internalized and emulation then raises efficiencyin the economy as a whole.

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As King and Robson also point out, this model isakin to Arrow's model of 'learning by doing'(Arrow, 1962). Arrow supposed that technicalprogress was a function of accumulated invest-ment, but with an elasticity below one. The impli-cation was that in the end growth depended on theexpansion of the labour force. With a stationarypopulation, ultimately decreasing returns to invest-ment limited growth. The steady-state growth ratewas the growth of the labour force times a factorwhich depended on the rate of learning by doing.

Romer broke the link between output and popula-tion growth by making the learning parameter equalto at least one. Growth can now proceed indefi-nitely with capital accumulation even in the pres-ence of a stationary labour force. This type of modelis simple and may well be indirectly empiricallytestable. A limitation is that it depends on a strongassumption about the value of the learning expo-nent—if tins is one epsilon below one, growth fallsback to the Arrow solution; if it is marginally aboveone, growth accelerates without bounds.

Though van der Ploeg and Tang point out thatRomer has produced 'rudimentary evidence' thatworld growth has accelerated over the past twocenturies, continuous acceleration is, of course,implausible. Yet, the two authors also point out thatHicks (1950) had dealt with this problem by posit-ing some 'ceiling'. Locally explosive propertiesplus ceilings and floors lead to models with limitcycles, which have a long tradition in economics(e.g. Kondratieff waves). Indeed, on the basis ofcasual empiricism, cycles would seem more plau-sible than steady states. It is true that there is adifficulty with endogenously generated repeatedcycles—surely forward-looking 'agents' wouldlearn to anticipate mem and thereby smooth themout? The force of this objection has, however, beenweakened by the realization that non-linearitiesmay lead to chaotic quasi-cycles that, though deter-ministic, are unpredictable. Moreover, the longerthe cycle, the less likely is it to be rationallyanticipated and therefore eliminated by finite-livedindividuals. Perhaps, a learning exponent fraction-ally above one is not impossible after all.

The second class of endogenous growth modelsposits the existence of a specific growth factorwhich raises the total productivity of the other

factors of production. Increasing the supply of thespecial growth factor diverts labour and/or capitalfrom ordinary production. Crucially, however, not'only do inputs into the growth factor enhanceoverall productivity, but they are themselves sub-ject to a form of dynamic and external increasingreturns to scale. Several of the specific modelsreviewed by van der Ploeg and Tang fall into thiscategory.

The growth factor may consist of human capital(Lucas, 1988; Romer, 1989), or of a stock ofknowledge from R&D (Romer 1990a; 19906). Inthe latter case, R&D's contribution may take theform of creating new inputs (which improve pro-ductive efficiency), or new consumer goods (whichraise consumer welfare). In these models, finalproduction takes place in a perfectly competitivesector, while the R&D sector is monopolisticallycompetitive. Firms and households maximize prof-its and utility in an inter-temporal framework, sothat resource allocation across the two sectors isendogenized along with the growth rate. In a differ-ent model, the growth factor is represented bypublic infrastructure supplied by a government thatraises distortionary taxes to finance i t The govern-ment, therefore, faces a trade-off and is assumed tofind the optimal rate of taxation and public goodsprovision (Barro and Sala-i-Martin, 1990).

Most endogenous growth models have a commonimplication—owing to the presence of externali-ties, a Pareto optimum is not achieved. In the firstclass of models efficiency would be greater withmore investment, but part of the benefit cannot beappropriated by the private investor who, therefore,ignores it in his calculations. In the second class ofmodels, the producers of the growth factor (e.g.R&D) can charge for the contribution their output(e.g. a patent) makes, but they cannot appropriatetiie external benefit obtained from the patent byother growth-factorproducers. Forexample, Romer(19906) in effect supposes that a company engagedin R&D can patent the result of its research, butcannot prevent its own patent making it subse-quently easierforother researchers to produce morepatents.

Empirical implementation of these models dependson identifying a specific growth factor (e.g. publicinvestment, human capital, or R&D), and finding

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measures or proxies for it. Unfortunately, the rightdata are not often available and certainly not intime-series form. Most empirical work has con-sisted of cross-country correlations between changesin labour or in total factor productivity and someparticular growth factor. Such tests are evidentlyweak, if only because the proxies are generallyinadequate—not all patents are of equal value,human capital is not well captured by the number ofyears spent in school, etc. A particular problem isthat the tests do not encompass each other. What ifmore than one of the plausible growth factors isplaying a role?

Results so far have thus been disappointing. In asurvey of some of the empirical findings, Crafts(1992) reports that Romer himself has concludedthat his 1986 model did not dominate the neoclas-sical one. Such evidence as we have suggests thatArrow's learning exponent is less than one. Capi-tal's output elasticity certainly seems to exceed theshare of profits in national income, but most at-tempts to estimate it find it substantially less thanone (ibid.). More sophisticated models are muchharder, perhaps fatally harder, to test Moreover, noone has subjected to empirical tests the hypothesisthat the process of generating the chosen growthfactor is subject to increasing external returns toscale.

Scott's approach is similar, in mat he also broadensthe concept of capital, yet different in a number ofother important aspects. In particular, he argues thathistorical observation and case studies show thatthe distinction between innovation and repetition isblurred. Hence, trying to find a subset of investmentresponsible for technical advance is a hopelesstask.4 What matters for growth is the 'learningexternality' obtained from cumulative investment(defined as all past expenditures devoted to chang-ing existing arrangements).

Scott argues that it is inappropriate to subtractscrapping from estimates of the capital stock whenmeasuring the latter's contribution to production.

With fixed costs sunk, capital is retired from pro-duction only when its marginal product is zero (orless than the wage of complementary labour). Thiseconomic obsolescence, not physical decay, is thereason for most of the scrapping that takes place.Such scrapping, therefore, subtracts nothing frompotential output which is bound to be stably relatedto cumulated investment. Only when part of thatpast investment is wrongly excluded as scrapped, isit necessary to posit some process of technicalprogress independent of the successive acts ofinvestment

Some of Scott's insights are pursued by King andRobson, who specify anon-linear 'technicalprogressfunction' that relates the rate of productivity growthto the rate of investment This embodies the famil-iar proposition that capital accumulation generatesspillovers due to 'learning by watching'.5 Theimportant difference in this model is that the proc-ess is non-linear. This results from the intuitivelyplausible (but empirically unsubstantiated) ideathat the technical progress function has first in-creasing and then decreasing returns. Returns de-cline eventually because there is a limit to the rateat which ideas can be assimilated (and they do notsurvive to be exploited later). The S-shaped curveleads to a model with multiple equilibria, of whichtwo are stable.

If an economy is in the vicinity of a stable equilib-rium, it may be resistant to shocks. But if it hasstrayed or is at an unstable equilibrium, variousshocks, including policy changes, can have power-ful effects, moving the system away from a lowgrowth to a high growth equilibrium or vice versa.Similarly, identical economies can be on high orlow growth paths, entirely due to past history oraccidents. These results are intuitively plausibleand have two implications. First, they call intoquestion simple cross-country correlations designedto test 'growth theories', particularly when thevariables are averaged over short time periods.Second, they provide an explanation fbrhow' catch-up* can become 'overtaking'. Thus, countries such

4 Hence his lack of surprise at the difficulties that are faced in implementing 'growth factor' type models.5 What differentiates the model from Scott (or Romer) is mat the spillover effects are immediate since output growth depends

an the contemporaneous change in the capital stock rather than on cumulated past investment In practice, little would seemto hinge on this distinction because authors of the latter type of models never specify any lags on the learning function nor dothey suppose it to be stochastic. The individual Gfm's production function in the Romer (1986) model, for example, could bedifferentiated to yield a linear technical progress function.

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as Germany or Japan, following war-time destruc-tion, may have moved on to a high investment pathand consequently from a low to a high growthequilibrium.

Multiple equilibria also raise the possibility thateven in a world with free trade, free capital move-ments, and international dissemination of knowl-edge, countries may cluster into 'growth clubs'.Chatterji in the final article further examines thispossibility and finds some evidence for the exist-ence of such mutually exclusive groupings—onefor the 'rich* and one for the 'poor' countries.

Overall, however, both the articles surveyed in thisissue and the broader literature on endogenousgrowth provide only few empirical answers to thequestions posed in section II above. Differences inthe strength of various growth factors can accountfor lack of convergence (a conclusion already an-ticipated in the earlier literature), and differences inpast investment efforts can throw light on changesin growth trends. But the reasons for such differ-ences are usually unexplored or left to unpredict-able shocks. As for continuing long-term growth,this can occur, provided, however, mat certaincrucial parameters are equal to unity—somethingso far not confirmed by the empirical evidence.

More generally, many of the models have appeal-ing but also arbitrary features. The King and Rob-son model is a good case in point It illustrates acontinuing feature of growth theory: moderatechanges in assumptions can yield a model thatgenerates very different results from the standardones but which can also 'explain' some real worldphenomena. Yet, the task of arbitrating betweenthis model and others is almost impossible giventhe data sets available. Even if one model appearsto have more empirical support than another, noclaim for generality can be sustained. Perhapsanother model would have fitted better for othertimes or places.

V. POLDCY ORflPLIICATniOMS

The conclusion just reached on the robustness ofthe existing models of endogenous growth clearlylimits their usefulness for economic policy-mak-

ing. In principle, of course, a number of policyimplications can be drawn from them, in stark.contrast to the earlier neoclassical view of the^growth process which implied that policy had nolong-run effects on growth. Thus, if specific growthfactors can be shown to improve productivity, andgiven the implication in all these models of adivergence between private and social costs, a casecan be made for subsidies, or other policy interven-tions, to raise investment, or R&D, or humancapital (or, perhaps, all together).

Oddly, the authors of some of these models appearto be rather reluctant to draw the strong policyconclusions that apparently flow from their writ-ings. One reason, no doubt, is mat any governmentaction carries dangers of its own. First, governmentborrowing or taxation may be required to financenew policies. Taxation is bound to be distortionary,reducing efficiency in the system. Hence, govern-ments may face a trade-off between the beneficialeffects of subsidies (or higher public investment)and the injurious effects of higher taxes. At least thenew models allow many of the live issues in publicfinance theory to be set in a growth context

Second are the public-choice problems emphasizedby the Buchanan school. The authors are well awareof the fact that 'the beneficial effects of governmentexpenditures are conditional on a benevolent andefficient government' (Ehrlich, 1990, p. S8). Canthe authorities be expected to make the correctchoices and is this consonant with the interests ofbureaucrats and politicians? And would not discre-tionary action lead to 'rent-seeking' behaviour?Scott, despite his stress on the growth-promotingrole of capital formation, is particularly wary of thedanger mat pressure groups will hijack in theirfavour any policy that might help investment

In addition, there is the fact that the authors of thesemodels may be less than wholly confident that theyare adequate representations of reality. After all,there are many candidates for a 'growth factor'—investment 'that changes the way of doing tilings'according to Scott; investment in know-how andeducation; investment in public infrastructure, etc.Should all of these receive preferential treatment orsubsidy and, if so, how much? Given the potentialcosts to government action, some idea of the rela-

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tive importance of the different growth factors andof their effects on growth is necessary in framingpolicy.

In this context, the failure of endogenous growthmodels unambiguously to dominate empiricallytheir predecessors is disquieting. Moreover, teststhat rigorously seek to distinguish among the dif-ferent growth factors or to rank them in order ofimportance have yet to produce results that com-mand general credence or assent (Levine and Renelt,1992). The literature is largely at the stage ofillustration—showing how various factors couldhave an influence on growth—rather than of dem-onstration—showing how some factors do havesuch an influence. Nor does the literature touchupon the institutional and legal framework which,according to Crafts (1992), is very important inexplaining cross-country differences in growth rates.Governments thinking about reforms of the regula-tory environment receive virtually no support fromthe formal theory.

The discussion of policies so far has mainly lookedat the supply side and atmeasures designed to affectresource allocation. The development of models,such as King and Robson's, in which the equilib-rium growth rate itself is path dependent, means,however, that a wider range of policies potentiallyaffects growth. Macroeconomic instruments, forinstance, by influencing the level of aggregatedemand, could raise investment and thereby thegrowth rate. Such 'dashes for growth' had beenadvocated in the 1950s and 1960s, for example, inthe context 6f various Kaldorean models of increas-ing returns to scale. The experience of high infla-tion in the 1970s has, however, discredited not onlythe idea of 'dashes for growth' but Keynesiandemand management itself.

Nowadays economists shy away from the idea thatdemand changes can have any durable impact ongrowth. If only macroeconomic policy can avoidshocking the system, it is commonly argued, theeconomy would in due course settle at a 'natural'rate of unemployment. Yet, the experience of thelast decade suggests that recession has had perma-

nent effects on the rate of unemployment in manyEuropean countries. And the last five years or sohave also seen a considerable investment cycle inEurope and Japan that seems to owe little to macro-economic policy (though deregulation in financialmarkets has played a part).

It is plausible to think that if policy could preventsuch swings it could raise the growth rate. Cer-tainly, in models with non-lineartechnical progressfunctions, a steady rate of investment encourageslearning by doing and diffusion of new ideas betterman a more erratic investment path, even if onaverage the rate is the same. However, the bestmeans of stabilizing demand remains a controver-sial issue. The endogenous growth literature, withits equilibrium models and absence of independentinvestment functions, has, like the neoclassicalone, ignored problems of instability. Yet, maintain-ing an adequate level of demand and confidence sothat productive investment occurs has, in practice,been a significant objective of policy in manycountries.

More broadly, and surveying what governmentsthe world over have done to promote growth, one isinevitably struck by the fact that so many of themeasures taken have not only attempted to stabilizedemand, but have, in fact, encouraged preciselythose 'growth factors' that the new literature justreviewed has highlighted. Theory seems finally tobe catching-up with practice. Education and expen-ditures on R&D have been subsidized almost uni-versally. Public infrastructure has inevitably beenan area in which governments have been veryactive. Most importantly, capital formation hasgenerally received help and incentives throughoutthis century, in total disregard of neoclassical con-clusions that suggested only very low returns to i tIn the light of recent results showing strong positivecorrelations between output growth and variousdefinitions of investment (Scott, 1989; De Longand Summers, 1991, Levine and Renelt, 1992), thepolicy-makers may nothave been that wrong. Whileeconomists may not trust politicians, it would seemthat politicians have not trusted economists ei-ther—and perhaps with at least as good a reason.

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Documents

THE ASSESSMENT: NEW APPROACHES TO ECONOMIC GROWTH