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What Does the Economics of Growth Have to Say About Public Policy?

J. Bradford De Long
University of California at Berkeley
October 1996
 

ABSTRACT

 

"Growth economics" began in the 1950s--created in large part by M.I.T.'s Robert Solow. It was reborn, with somewhat different aims and emphases, in the 1980s.

The 1950s growth economics tradition led economists to take up and hold on to two sets of positions. The first set was empirical: the bulk of economic growth in living standards and material prosperity appeared to be due not to investment--not to capital formation that "deepened" the quantity and value of the capital available to amplify the productivity of each worker--but instead to disembodied "total factor productivity growth". This "total factor productivity growth" was seen in large part as due to the background progress of science and technology, and as determined by factors outside of--hence hardly influenced by--the economy.

The second set of positions led to by the 1950s growth economics tradition was theoretical: that differences in national economies' rates of investment and savings would, in the long run, lead to some differences in levels of output per worker but not to permanent differences in growth rates: countries would array themselves in order, with the highest investment countries having the highest productivity levels and living standards at any single point in time. But all would see roughly the same rate of output-per-worker growth: all would grow together.

The 1980s rebirth of growth economics in large part sprang from dissatisfaction with these two sets of positions that had been the conclusions of the 1950s growth economics tradition.

First, the theoretical conclusion that all national economies should, in relatively short order, find themselves with approximately the same rate of output-per-worker growth appeared to be false: there was little sign that in the post-World War II period the different national economies of the world had been "growing together". Second, the empirical conclusion that the bulk of output-per-worker growth came from disembodied "total factor productivity growth"--and was, hence, largely determined by factors outside the scope of political economy--appeared unattractive as well: good government, free trade, and high investment appeared to have much stronger links to rapid economic growth than the first round of growth economics had suggested.

The new growth economics tradition has now been at work for more than a decade. For more than a decade the--largely technical, frequently over-mathematical, frequently obscure--written literature in the "new growth economics" tradition has been developing. Yet the overall lessons to draw from this tradition have not been widely disseminated: "what it all means" is obscure to those outside the relatively small circle of largely-academic initiates--and is, if truth be told, obscure even to many inside the relatively small circle of largely-academic initiates.

This essay takes a look at the "new growth economics" tradition, and tries to outline what those making economic policy should take from the tradition. There are four lessons: There is still an enormous amount that remains unsettled in the literature of the "new growth economics." But these four lessons appear clear--and clear enough to begin to guide applications to economic policy.


Long-Run Economic Growth

Compare America's standard of living today to 1870. The inflation-adjusted productivity of American workers, real wages, and real GDP per head are all now some ten times what they were then according to official statistics--and there is good reason to think that official statistics substantially understate growth.

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 American 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 50% of America's--150% of Italy's--GDP per capita in 1950 to less than 30% 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 knowledge?

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.


Economic Policy

What about economic policy? To some extent the principles derived from economists' theories of knowledge and growth can guide thinking about the design of a good economic growth agenda. In my view the policies to be extracted from the principles were: This growth agenda is bipartisan. For Democrats, it urgency is underlined 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. Democrats who value that social insurance 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. Republicans who fear that the New Deal puts too great a burden on the private economy similarly recognize that only faster growth will diminish the relative size of the social insurance state, and reduce the potential economic drag.

Over the past four years a proportion of this economic growth agenda has been put into operation. Trade expansion--yes. Deficit reduction--yes (and deficit reduction has paid dividends in higher investment and lower interest rates perhaps twice as great as even optimistic projections had forecast). But support for research and development--no. Increases in public investment as opposed to redistribution--no. Making it easier for America's workers to invest in themselves--largely no.

Because perhaps half of a pro-growth agenda has been enacted, America's trend productivity growth rate is perhaps higher than it would otherwise have been by some 0.2 percentage points of growth per year or so. While masked in the short term by the business cycle, in the long term such a boost to trend growth mounts up: by 2010 there will be perhaps an extra $400 in annual U.S. GDP.

But we can do better.


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
delong@econ.berkeley.edu
http://econ161.berkeley.edu/