Created 4/29/1996
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Endogenous Growth

Economic Theory and Faster Growth

J. Bradford DeLong
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 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 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:

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


Created 4/29/1996
Go to
Brad DeLong's Home Page

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