NS4053 Winter Term 2014

Modern Growth Theories

David Coates: Why Growth Rates Differ I

• Much of the difference between modern theories of growth lie in the assumptions about market based institutions as triggers to growth

• Orthodox theory of growth – neoclassical model – views growth as movement along a production function

• With capital and knowledge constant this involves;

• Intensifying labor practices

• Exploiting economies of scale

• Replacing labor by capital

• Over time with movements in the whole production function occur as

• Stock of knowledge increases

• Technical progress ensues

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David Coates: Why Growth Rates Differ II

• Neoclassical theory broadly assumes that the unregulated interplay of market forces is the best

• generator of growth, and

• at creating the convergence of growth paths between economies

• If growth does not occur one should focus on

• the location of inadequacies in either the supply or the quality of factors of production or

• the existence of barriers or blockages to their free interplay

• Neoclassical theory now challenged from different perspectives

• Schumpeterians

• Post-Keynesians

• New Growth Theorists – exogenous growth

• Marxists

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David Coates: Why Growth Rates Differ III

• Each of the alternative approaches questions:

• Whether the interplay of unregulated market forces automatically creates an optimal distribution of resources, or

• Eventually pulls economies to similar growth paths and levels.

• Marxists prefer to explain differential growth performance as the product of different

• class relationships and

• underlying structural conditions within the capitalist mode of production

• Debate around neoclassical growth theory• Originated with the work of Robert Solow at MIT• Wanted to improve on existing Harrod-Domar model

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David Coates: Why Growth Rates Differ IV

• Harrod-Domar had explained economic growth as consequence of interplay of three factors:• savings rate, -- result of preferences

• rate of growth in labor force – result of social demography and

• the capital output ratio – result of technology

• Implied that growth could increase as a result of increased savings alone• Rate of growth = saving rate X output/capital ratio

• Solow wanted to incorporate a more flexible production function with:• Straight labor

• Straight capital

• Residual technological change 5

David Coates: Why Growth Rates Differ V

• In Solow each economy had a unique and stable growth path determined by the growth of the labor force and technological progress

• Technological progress assumed to expand at a regular rate

• Diminishing returns encouraged capital to redeploy

• Problem with model is that it provided no explanation of its key variable -- technological progress

• Nor was its key prediction of convergence triggered by diminishing returns to capital seen in available evidence

• Another criticism of the neo-classicals is the absence of a linkage between technological progress, investment rates and growth rates

• These weaknesses stimulated range of “new growth theories.” – post-neoclassical endogenous growth theory

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David Coates: Why Growth Rates Differ VI

• In general, the new growth theories

• Highly mathematical

• Define capital more widely than normal in neoclassical model

• Emphasize endogenous sources of improved economic growth

• Lucas Model

• Stressed importance of investment in human capital as a trigger to growth

• Romer Model

• Emphasizes the way in which capital accumulation triggers learning,

• Which then spills out (beyond the investing company) to raise efficiency across the economy as a whole.

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David Coates: Why Growth Rates Differ VII

• Key idea in these models is that

• social rate of return higher than private rate of return and

• growth may go on indefinitely because returns to broadly defined capital do not necessarily diminish as economies develop

• Implications of new growth models

• Even between advanced capitalist economies growth trajectories can differ permanently

• Since technical progress can be created internally there are no automatic diminishing returns and

• no necessary convergence between growth paths

• State policy has a role to play in determining whether growth paths continue to diverge or to align

• none of the neoclassicals antipathy to the state

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David Coates: Why Growth Rates Differ VIII

• Other differences with new growth models• Institutions and policies have stronger effects on the growth

rate than what would have been predicted by traditional neoclassical model

• Thus a case can be made for subsidies or other policy interventions to raise investment or R&D or human capital to trigger the accumulation of knowledge

• New growth theorists not however advocates of

• extensive state planning or

• substantial public investment in specific industries or sectors• Would like a more nuanced and more targeted form of

industrial policy largely confined to

• limited injections of pubic resources to R&D,

• education and training and

• the reform of institutional structures in labor and capital markets.

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David Coates: Why Growth Rates Differ IX

• Schumpeterian (supply side) Theories of Growth

• Schumpeterian economies – stress different efficiency than neoclassicals

• Neoclassicals focused on

• Preto-type efficiencies -- allocation efficiencies (diagram)

• Short run, static criteria

• Schumpeterians prefer my dynamic and long term criteria of efficiency

• Not competitive pressures per se but the possibility of replacing competitive relationships with oligopolistic ones which provides the incentive for investment

• Investment looked at as endogenous

• Key to growth is risk taking or entrepreneurship

• Focuses on institutional structures likely to generate innovation 10

David Coates: Why Growth Rates Differ X

• Post-Keynesian theories of growth• Stresses demand, increasing returns and dynamic

differences between sectors of the economy• Emphasis on the special role of manufacturing as

an engine of growth• Tendency of a fast rate of growth of exports and

output to set up a cumulative process –

• virtuous growth thorough link between output growth and productivity growth

• At hart of post-Keynesian analysis is the notion of cumulative causation

• To post Keynesians, economies once weakened and if left to themselves weaken further

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David Coates: Why Growth Rates Differ XI

• Poor profit level generates low investment, low investment produced diminished competitiveness, diminished competitiveness guarantees poor profits and the cycle begins

• The resulting balance of payments deficits require high interest rates to hold foreign capital and high interest rates deter domestic investment eventually to produce further balance of payments deficits of a more serious nature

• Contrary to neoclassicals,

• market forces will not break cumulative, self sustaining cycles of underperformance

• Will not trigger either economic growth or convergence

• What post-Keynesians have added is the importance of

• profits in in triggering growth and preventing cumulative decline

• conditions in product markets, and profits in setting off patterns of expansion or contraction

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