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11.8 Proximate v. Fundamental Sources of Growth

In Temple’s (1999) survey of growth empirics he highlights the fact that one

of the important history lessons since 1960 has been that while some countries

have succeeded in ‘making a miracle’, other countries have been ‘growth

disasters’. When analysing the experience of the miracle economies, economists

need to ‘use these events to help in assessing economic policies that

may affect growth rates in other countries’ (Lucas, 1993). However, this

cannot be done without having theoretical structures in place that help researchers

make sense of the ‘mass’ of data that is now available to economists.

As Lucas argues, to be able to glean valuable lessons from the East Asian

experience, ‘One needs, in short, a theory’. Echoing this theme, Temple

(1999) reminds economists of what is perhaps the key issue: ‘Why have some

countries grown rich while others remain poor? It is hard to think of a more

fundamental question for economists to answer.’

In analysing developments in growth theory it is useful to begin by distinguishing

between proximate and fundamental causes of growth. The proximate

causes relate to the accumulation of factor inputs such as capital and labour,

and also to variables which influence the productivity of these inputs, such as

scale economies and technological change. The research of growth accountants

such as Denison (1967, 1974, 1985), Jorgensen (1996, 2001) and

Maddison (1972, 1987, 1995) has produced a useful taxonomy of the various

proximate sources of growth, and the neo-Keynesian, neoclassical and endogenous

growth theories tend to concentrate on modelling these proximate

variables. However, once we have considered the impact of these proximate

determinants of growth we are left with the deeper question: ‘Why are some

countries so much better than others at accumulating human and physical

capital and producing or adopting new ideas and knowledge?’ That is, we

need to investigate the fundamental determinants of growth (see Rodrik,


The fundamental or deep sources of growth relate to those variables that

have an important influence on a country’s ability and capacity to accumulate

factors of production and invest in the production of knowledge. For example,

Temple (1999) considers the following ‘wider’ influences on growth:

population growth, the influence of the financial sector, the general macroeconomic

environment, trade regimes, the size of government, income

distribution and the political and social environment. To this list Gallup et al.

 (1998) would add the neglected influence of geography. Moving from the

proximate to the fundamental causes of growth also shifts the focus of attention

to the institutional framework of an economy, to its ‘social capability’

(Abramovitz, 1986), ‘social infrastructure’ (Hall and Jones, 1997, 1999) or

‘ancillary variables’ (Baumol et al., 1994). There is now widespread acceptance

of the idea that ‘good’ governance and institutions and incentive structures

are an important precondition for successful growth and development (World

Bank, 1997, 2002).

In his historical survey of economic growth analysis, Rostow (1990) put

forward a central proposition that ‘from the eighteenth century to the present,

growth theories have been based on one formulation or another of a universal

equation or production function’. As formulated by Adelman (1958), this can

be expressed as equation (11.4):

Yt = f (Kt ,Nt , Lt , At ,St ) (11.4)

where Kt, Nt and Lt represent the services flowing from the capital stock,

natural resources (geography) and labour resources respectively, At denotes

an economy’s stock of applied knowledge, and St represents what Adelman

calls the ‘sociocultural milieu’, and Abramovitz (1986) more recently has

called ‘social capability’, within which the economy functions. More sophisticated

models distinguish between human and physical capital. Indeed, many

authors regard human capital as the key ingredient of economic growth

(Lucas, 1988; Galor and Moav, 2003). Heckman (2003), for example, argues

that China’s below average spending on investment in education compared to

physical capital accumulation is ‘a serious distortion’ of policy that is likely

to retard progress in China. Goldin (2001) has also attributed much of the US

economic success in the twentieth century to the accumulation of human


According to Rostow (1990), ‘something like the basic equation is embedded

equally in Hume’s economic essays, Adam Smith’s The Wealth of Nations,

the latest neoclassical growth model, and virtually every formulation in between’.

This universal equation encompasses both proximate and fundamental

causes of economic growth and Abramovitz drew attention to the importance

of these factors 50 years ago (see Nelson, 1997). Clearly, St contains the

influence of non-economic as well as economic variables which can influence

the growth potential and performance of an economy including the institutions,

incentives, rules and regulations that determine the allocation of

entrepreneurial talent (Baumol, 1990). Hence in recent years economists’

research into the ‘deeper’ determinants of growth has led some to stress the

importance of institutions and incentive structures (North, 1990; Olson, 2000),

trade and openness (Krueger, 1997; Dollar and Kraay, 2003) and the much598

neglected impact of geography (Bloom and Sachs, 1998). It is important to

note that Adam Smith had highlighted all three of these ‘deeper’ determinants

of growth over 200 years ago!

In sections 11.17–11.20 we will examine the ‘deeper’ determinants of

economic growth in more detail, but first, in sections 11.8–11.10, we survey

the three main waves of growth theory that have been influential in the

second half of the twentieth century to date. All three approaches emphasize

the proximate determinants of growth, namely:

1. the neo-Keynesian Harrod–Domar model;

2. the Solow–Swan neoclassical model; and

3. the Romer–Lucas-inspired endogenous growth models.

In each case the ideas developed represent interesting examples of multiple

discovery. The first wave of interest focused on the neo-Keynesian work of

Roy Harrod (1939, 1948) and Evsey Domar (1946, 1947). In the mid-1950s

the development of the neoclassical growth model by Robert Solow (1956)

and Trevor Swan (1956) stimulated a second, more lasting and substantial,

wave of interest, which, after a period of relative neglect between 1970 and

1986, has been reignited (Mankiw et al., 1992; Mankiw, 1995; Klenow and

Rodriguez-Clare, 1997a, 1997b). The third and most recent wave, initiated by

the research of Paul Romer (1986) and Robert Lucas (1988), led to the

development of endogenous growth theory, which emerged in response to

perceived theoretical and empirical deficiencies associated with the neoclassical

model (P. Romer, 1994a; Crafts, 1996; Blaug, 2002).