"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
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:
First, that it is very hard to continue to believe in the
conclusions of the 1950s literature--that the bulk of growth
over the timespan of even a generation is due to total factor
productivity growth that springs from pure research and development
outside the economic system, and that national economies' savings
and investment efforts have some impact on relative levels but
little impact on relative long-run growth rates. This does not
mean that some do not try to reestablish the major positions
of the 1950s tradition: Greg Mankiw, for example, tries to interpret
the cross-country pattern of growth as supporting a dominant
role for disembodied total factor productivity growth. Robert
Barro, for example, tries to find evidence for "conditional
convergence"--that even though countries have not been growing
at roughly the same rate, and even though differences in investment
have not been primarily associated only with differences in relative
levels of prosperity, that these conclusions of the 1950s will
soon come to pass as the world moves out of the current "transitional"
stage to achieve its "steady-state" relative income
and productivity distribution.
The problem is that in order to rescue any one particular
piece of the 1950s set of conclusions, practically all of the
other assertions have to be thrown overboard.
The second lesson is that rapid total factor productivity
growth is not unconnected with but closely connected with economic
factors: without high levels of investment and without good government,
increases in productivity associated with the progress of science
and technology and the diffusion of better organizations and
techniques simply do not happen.
The third lesson is that untangling exactly which particular
components of investment promise the greatest benefits in terms
of boosting productivity growth is very hard. Practically everyone
agrees that high rates of investment in machinery and equipment
are a crucial channel through which developing economies assimilate
the high-productivity modern technologies of the industrial revolution--but
some doubt that already-industrialized economies would see similar
boosts in productivity growth from higher machinery investment,
and claim that the growth-machinery correlation in already-rich
economies arises primarily because fast growth creates many investment
opportunities, and triggers high investment. Practically everyone
agrees that a public sector that fails to provide and maintain
infrastructure can cripple private-sector productivity--but some
doubt that modern governments have the competence to direct additional
infrastructure dollars to high-value uses. Practically everyone
agrees that research and development expenditures have had very,
very high social rates of return. But research and development
expenditures are and are almost surely destined to be only small
components of investment.
The natural conclusion is that--when we do not truly know
which components of investment are the most crucial ones, but
have strong reason to believe that many types of investment generate
healthy rates of return for society, and that some types of investment
trigger enormous benefits in faster productivity growth--good
government policy involves placing eggs in many baskets: boosting
the different components of investment along a very broad range.
The fourth lesson is that the factors that have in the past
led to the conclusion that a good government takes steps to boost
investment are growing stronger, not weaker, as time passes.
Improvements in communication and in the speed of technological
diffusion imply that there are growing "wedges" between
the private and the social returns to investments that create
new knowledge and new organizations that can effectively utilize
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:
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
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
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
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 can
guide thinking about the design of a good economic growth agenda.
In my view the policies to be extracted from the principles were:
Support pure research. Repair the damage done to public support
of civilian science and technology during the 1980s budget stringency,
and expand the federal government's commitment to basic research
and technological infrastructure.
Provide true public goods. Restore government investment in
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 and training.
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.
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
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
But we can do better...