NS4053 Winter Term 2014 Modern Growth Theories

1. NS4053 Winter Term 2014Modern Growth Theories

2. 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 • Double inputs, double outputs • Factor prices determine combinations of labor and capital • Firms search for most efficient means of production • Over time with movements in the whole production function occur as • Stock of knowledge increases • Technical progress ensues

3. 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

4. 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

5. 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

6. 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

7. 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.

8. 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

9. 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.

10. 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

11. 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

12. 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