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Economic Theory and Faster Growth
J. Bradford De Long
April 29, 1996
Associate Professor of Economics
601 Evans, University of California at Berkeley
Berkeley, CA 94720
(510) 643-4027 phone
(510) 642-6615 fax
Long-Run Economic Growth
Compare Britain's standard of living today to 1870. The inflation-adjusted
productivity of British workers, real wages, and real GDP per head are all
now some five times what they were then. A small part of this enormous amplification
of material prosperity comes from committing a somewhat greater share of
production to investment: perhaps 20%. Another part of the past century's
growth comes from committing a larger share of production to education,
boosting the skills and competencies of British workers: perhaps 30%.
But the main engine of economic growth has been the advance of economically-useful
knowledge: better ways of making machines, better ways of using machines,
better ways of organizing production and communication, and better ways
of using limited natural resources. The advance of knowledge woul dhave
generated a three-fold multiplication in productivity, even if the shares
of national product invested in human and physical capital had not risen.
No one sane thinks that the economically-useful knowledge in the brains
of workers and the standard operating procedures of organizations advances
at a steady pace, unrelated to the rest of the economy and the polity. Even
the purest and most abstract of pure sciences depend on the number of and
the resources devoted to cosmologists, elementary partical physicists, and
paleontologists. The applied science and organizational practices that boost
the productivity of workers and businesses are closely tied to the rest
of economic life.
So there is no reason to think that the trend rate of productivity growth--a
function of the rates of investment and of the advance of economically-useful
knowledge--is a fixed constant. After World War II continental Europe grew
rapidly as it built its capital stock and worker skills back to pre-WWII
levels. But continental Europe did much better than simply return to its
pre-WWII growth trend: today it has output per capita levels more than forty
percent above what you would have expected from simple extrapolations of
pre-WWII trend growth.
On the eve of WWII Argentina was a wealthy member of the first world, perhaps
fourth in the world among nations in automobile ownership per capita and
higher in estimated GDP per capita than Germany, Italy, or France. Yet Argentina
has gone from 76% of Britain's--and 150% of Italy's--GDP per capita in 1950
to less than 45% today. There is no basis for the often-heard claim that
countries must learn to live with rather than try to change their long-run
growth trend, and every reason to think that pro-growth policies can nurture--and
anti-growth policies destroy--long-term economic growth.
Knowledge and Growth
But how about the argument that market forces will generate the "right"
amount of economic growth? We let market forces decide the number of books
relative to CD's to produce, and even to switch from analog LP to digital
CD systems. Why not let market forces decide how much of society's collective
work time and effort to devote to pursuing advances in economically-useful
The answer is that there is good reason to think that the Invisible Hand
will do a bad job. The Invisible Hand is very good at directing economic
activity when resources are scarce--either I have it or you have it--and
property rights are straightforward. But economically-useful knowledge is
not scarce in this sense: just because I am making use of it doesn't mean
that you cannot use the same piece of knowledge. And information wants to
be free: it is very, very hard to keep people from making full use of whatever
they know no matter who holds formal title to the "intellectual property."
The libertarian science fiction writer Robert A. Heinlein once set out the
principles of a [fictional] Fifth Socialist International: "Private
where private belongs, public where it's needed, with an admission that
circumstances alter cases." The nature of knowledge-as-commodity guarantees
that it is a broad and important area of the economy where public involvement
is needed: reliance on pure laissez-faire will not produce good outcomes.
To date the "endogenous growth theories" of economists are signposts
that point to problems and unresolved issues. They may provide a few principles
for how to think about the relationship between public policy, the advance
of knowledge, and economic growth. They do not provide settled directives,
or comfort for the dogmas of old ideologies. But political movements that
refuse to think about such issues are certain to become more and more irrelevant.
For the advance of knowledge continues to become--as it has been doing since
the eighteenth-century industrial revolution--a more and more dominant component
of modern economies.
What about economic policy? To some extent the principles derived from economists'
theories of knowledge and growth did guide thinking during the design
of the Democratic economic growth agenda in the U.S. for the 1992 election
cycle. In my view the policies extracted from the principles were:
- Support pure research. Repair the damage done to public support
of civilian science and technology during the 1980s, and expand the federal
government's commitment to basic research and technological infrastructure.
- Provide true public goods. Restore government investment in
economic infrastructure to its pre-1980s levels.
- Boost private investment. Sharply reduce the federal deficit
to lower interest rates, boost investor confidence, and thus stimulate
a high rate of investment in machinery and equipment that is such an important
embodiment of technological knowledge.
- Make it easier for people to invest in themselves--through "making
work pay" so that joining the labor force will always seem a more
attractive option, through diminishing the cost of student loans, through
making it easy for individuals to invest in themselves through more education
- Expand markets by expanding world trade, because private investments
in knowledge are more valuable the greater is the size of the marketplace
over which they can be leveraged.
The urgency of this growth agenda was strengthened by the recognition
that the United States' social insurance system was designed for the pre-1973
rapid rather than the post-1973 slow pace of growth. Those of us who value
that system--who think that equality of opportunity and social insurance
are better principles than the perpetuation of privilege and the multiplication
of poverty--recognize that without faster long-term growth America's social
insurance system will be dead in two decades.
Only a proportion of this economic growth agenda was put into operation.
Trade expansion--yes. Deficit reduction--yes (and has paid dividends in
higher investment and lower interest rates perhaps twice as great as even
optimistic had forecast). Robert Reich's plans to invest in America's workers--no.
Gene Sperling's well thought-out proposals to restore public investment--eviscerated
and left for dead on Pennsylvania Avenue.
But more than half the agenda was enacted. America's trend productivity
growth rate is higher than it would otherwise have been. Perhaps the boost
is only 0.2 percentage points of growth per year. Perhaps--if the policies
do manage to generate not only more investment but also a truly faster pace
of advance of economically-useful knowledge--the boost is 0.4 percentage
points per year. While masked by the business cycle, in the long term such
a boost to trend growth mounts up: by 2010 there will be perhaps an extra
250 billion pounds to annual U.S. GDP.
And this boost would not have been forthcoming had policy design been driven
exclusively by short-run political advantage and the dogma that governments
must learn to live with rather than try to boost their economies' long-run
rates of growth.
Shadow Chancellor of the Exchequer Gordon Brown's thoughts on the
British Labour Party's Medium
Term Growth Strategy, from the Guardian
Robert Shapiro on New
Democrats and New Growth Theories, from the Financial Times
Go to Brad De Long's Home
Associate Professor of Economics Brad De
Long, 601 Evans
University of California at Berkeley; Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax