NS4540 Winter Term 2016

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 • 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

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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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