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Economic growth

The whole issue of economic growth has seen a regeneration of interest in

recent years and many prominent economists like Robert Barro and Xavier

Sala-i-Martin [1995] regard it as the part of macroeconomics that really

matters. There seems to have been a neglect of Nobel Prize awards in this

area, so do you anticipate that this relative neglect will be rectified in the

future given the importance of growth for human welfare?

Well, I would not describe it as a relative neglect. I think that what looks like

neglect is actually something quite different. They started the Nobel Prize

awards in Economics in 1969, and, unlike Physics or Chemistry, which had

been going for years, there was a long backlog of people who were clearly of

that calibre, if you have that kind of prize. Therefore it was only natural to

start picking them up in turn. There are exceptions. Some people came out of

order; for example Ken Arrow (deservedly) came early in the awards but even

he was paired with John Hicks who was old by then. In 1987 when I got the

award nobody born later than me had yet been given the prize, so in a way it

is still just rolling up the carpet from the old end. My view is that if growth

theory, the empirical analysis of growth, and ideas connected with them,

continue to be popular, the subject will attract the best people in the profession.

And yes, there surely will be more awards in this area. By the way, I do

not know how you count Arthur Lewis and Ted Schultz, who were interested

in economic development – Ted Schultz in a very different way – but Arthur

Lewis contributed that famous 1954 paper on ‘Economic Development with

Unlimited Supplies of Labour’. So I would not say that there has been a

neglect; I would say the timing has been natural. There are likely to be more

surprises, coming at a slightly greater rate than the past, because we are now

getting up to contemporary people, to economists who were doing their work

fairly recently. Since 1987 there has been a real outburst of work on growth

so there will be more awards in that area.

Your 1956 and 1957 papers have clearly had a profound impact on the

direction of research in the area of economic growth. Can you tell us what

were the main influences which led you into that research and which generated

those papers?

Yes, I do recall what led me to that research. I became interested in growth for

three main reasons. First, in the early 1950s everybody was interested in

economic development, for the obvious reason that most of the population of

the world was living in poor economies. I was passively interested in economic

development, but I have never been actively interested – in a research way – in

what happens in underdeveloped countries. But I got to thinking about development

issues and I had read Arthur Lewis. I knew I was not going to work on

development issues, but it did get me interested in the general area of economic

growth. Then Paul Samuelson and I had started thinking about what later

became Dorfman, Samuelson and Solow [1958], the book on Linear Programming.

That was the second factor. In the course of that research we thought

about the Von Neumann and Ramsey models. So from the optimization and

linear programming end and the idea of using programming theory to deal with

intertemporal optimization, I also got interested in growth. The third influence

was my reading of the work of Harrod and Domar; but I guess my reaction to

their ideas was a little different from some other economists. I was suspicious

of the Harrod–Domar model for reasons which I have occasionally explained.

It occurred to me that if the world works in the way suggested by their model,

then the history of capitalism would have been much more erratic than it has

been. If Harrod–Domar was a good macro model for the long run, then it is

impossible to explain, to my mind, how contained economic fluctuations have

been, how you can draw a trend and look at fluctuations around that trend, and

how those fluctuations stay 3–4 per cent either side of trend, except for a few

major depressions. I thought that there must be a way of modelling growth that

does not have the knife-edge property of the Harrod–Domar model. Those

were the influences which led me to the 1956 paper.

You mentioned Arthur Lewis in your answer. His model was described as a

classical rather than neoclassical model. Do you think that the classical

economists made any important lasting insights on the issue of economic

growth?

When you say classical economists do you mean Smith, Ricardo and Mill

and so on?

Yes.

If so, that is not where I got any intellectual help, for a number of reasons.

First, I am not very well read in the history of economic thought. I know the

potted versions of Smith, Ricardo and Mill, but I would never trust myself to

have a deep thought about classical economics. I have looked back to see if

there was anything that I missed, and I would say that apart from Mill on the

stationary state, and Ricardo to a certain extent as Mill’s predecessor, I did

not find much there other than vague ideas. They were obviously interested in

the long run but that does not butter any parsnips really. The relationship of

diminishing returns to the stationary state, especially in Mill, obviously has

some relationship to the work I was doing in the mid-1950s. That paid off a

lot. On the other hand the obvious thing on the negative side is that Ricardo at

the beginning, and Mill a little later on in the course of the Industrial Revolution,

were thinking about the long run and yet the notion that growth can be

maintained by technological improvements did not seem to occur seriously to

either of them.

Was your 1956 paper accepted for publication straight away?

Yes. I can pinpoint when I was working on it; it was in 1955. I sent it to the

Quarterly Journal of Economics and they accepted it right away. Writing

papers is very hard for me; and so throughout my whole career I have only

written papers when I thought that either I had something really serious to

say, or I had to produce a paper for a Festschrift or something like that. In the

latter case anything intellectually respectable would do. But the papers that I

write of my own free will are usually pretty serious, otherwise it is not worth

the effort, because I really do not like doing it.

Earlier you mentioned the growth of interest in development economics which

took off as a research area during the 1950s. Why did development economics

emerge during this period as a separate branch of economics from growth

theory?

Why did it happen that way? Well, I am going to offer a suggestion but it is

not original to me. I guess it comes originally from Paul Krugman of MIT.

On the whole the personality types in the profession who became interested

in economic development were not model builders. They were collectors of

data and generalizers from rough empirical data, like Simon Kuznets; or they

were like Ted Schultz, really deeply into underdeveloped agriculture, or they

were people interested in history and backwardness for its own sake. That

sort of temperament is not suited to model building. Growth theory, par

excellence, yielded to model building. So even Arthur Lewis, whom I mentioned

earlier, thought of his 1954 paper as a minor sideline to his book The

Theory of Economic Growth [1955]. The people who got interested in the

theory of economic growth were interested in model building.

When we talked to James Tobin in 1993 he remarked that the really good

papers in economics always contain a surprise. Were you surprised to find

that the steady state rate of growth is independent of the saving rate?

Oh yes. I wrote that up right away and wanted to publish it in spite of my

dislike of writing papers. I thought it was a real shocker. It is not what I

expected at all, and by the way, when I did the 1957 paper on technical

change I also expected a different answer from the one that I found. I

expected that the main source of growth would be capital accumulation

because that is what everyone talked about and I had heard that all my life as

a student. Those were both real surprises.

That 1957 paper inspired a vast literature on growth accounting, with contributions

from economists such as Denison, Kendrick, Jorgenson, Maddison

and others. After 40 years of work, what have we learned about the sources

of economic growth?

I think we have learned a great deal, not compared with what might be

learned, but compared to what we have learned in other areas of macroeconomics.

The notion that technical change or the residual accounts for much

more of growth than you would expect, much more of productivity increase

than capital accumulation, has stood up. Where it has not stood up – as in

the work of Alwyn Young [1995], Jong Il Kim and Larry Lau [1994], Sue

Collins and Barry Bosworth [1996] on the four Asian Tigers – it has been

fascinating and you actually learn a great deal (assuming it is all true, of

course); they have recorded staggeringly rapid growth but not in the same

way as the historical capitalist economies. That basic distinction between

capital accumulation and the residual has proved to be very informative. We

have also learned a lot about the importance of human capital, as distinct

from tangible capital, but the relative importance of each is still not settled.

You still find what look like perfectly sound empirical papers which come

up with conflicting results about the importance of human capital, depending

on the time period, the model and other factors, especially the way

‘human capital’ is measured. I was delighted to learn after the fact that in

my 1957 paper, at the very beginning, I said that what I called technical

change included a lot of things such as human capital, although I did not

have that language then. But the work on growth accounting, beginning

with Edward Denison and then continuing on, has taught us a great deal

about the nature of growth. I would say that the fact that the growth of the

current advanced industrial economies only owes a little to the exploitation

of natural resources is very interesting and this too has come out of growth

accounting methods.

In 1970 the first edition of your book, Growth Theory: An Exposition, was

published. Following that, for the next 16 years, the interest of macroeconomists

in the issue of economic growth, or more accurately growth theory, went into

relative decline. Why do you think that happened?

I think it happened because the profession ran out of ideas and you cannot

maintain interest in any subject simply on the basis of looking more and more

closely into the existing ideas. Edward Denison was still writing his books

during this period, all of which I read and admired. But there were no new

ideas. The merit of the contributions from Paul Romer [1986] and Bob Lucas

[1988] – I do not know how to divide it up between them – is that they

renewed interest in the subject by bringing in new ideas. That always attracts

people to any branch of economics, and I presume the same thing is true of

chemistry. So it was just a case of intellectual diminishing returns. Around

1970 we simply ran out of new ideas.

The first paper on endogenous growth in the new phase of interest in economic

growth was Paul Romer’s [1986] ‘Increasing Returns and Long-Run

Growth’. What do you think inspired the new research? Was it the convergence

controversy issue which also emerged about the same time with the

contributions of Abramovitz [1986] and Baumol [1986]?

Well, you are going to have to ask Lucas and Romer that question.

OK, we will ask Paul Romer that question when we interview him tomorrow.

I would have said, just from the second-hand evidence of reading their

papers, that the convergence issue was more of a stimulus to Bob Lucas than

it was to Paul Romer. It may have influenced Paul Romer as well, but I do not

remember anything in that 1986 paper which suggests that, though I could

easily have forgotten. I am inclined to think that Paul Romer had an idea,

found it exciting and followed it. But Lucas gave more signs of having been

fascinated by the international comparisons.

What are your views on the convergence issue? Your 1956 model predicts

conditional convergence and this prediction seems to fit reasonably well to a

group of countries, a ‘convergence club’. Yet there are other poor countries

which are showing little sign of catching up with the rich industrialized

countries.

I have no independent thoughts on this at all. I just read the literature, not all

of it because there is so much. But I read enough of it to develop opinions and

these go roughly like this. First of all I am at heart very suspicious of all this

international cross-section research. I read it, sometimes it is interesting and

sometimes it is not, but in the back of my mind there is always a question as

to whether I should believe it. The fundamental reason why I am dubious

about it is that there is no solution to the inverse causation issue. The more

right-hand-side variables that go into those regressions, the more they seem

to me to be just as likely the consequences of success or failure of long-term

economic growth as the cause. The second reason I am suspicious is that I

learned from Ross Levine at the World Bank a long time ago that most of

those results are not robust. They do not stand up if you make minor variations.

The third reason I am suspicious is that I keep asking myself, do I

really believe that there is a surface out there in space whose axes are labelled

with all the things Robert Barro and company put on them? Do I believe that

there is such a surface, and countries or points on that surface could in

principle move from one place to another on it and then move back to where

they began by changing their form of government or by having more or fewer

assassinations? A small voice says maybe, but I would not bet anything on

the existence of that surface. So I am dubious about that whole line of

research. If you look at it as a pure time series problem, the way Danny Quah

(1993) does, if you look at conditional convergence – and conditional convergence

is the only version of this that makes sense – then the evidence does

look more or less as if there really is something to the distinction between

growth and development. There is a group of countries, which for one reason

or another do not catch on to the railroad train as it goes by and I am inclined

to attribute that to their lacking some institutional infrastructure, some sociological

infrastructure, whatever. If I had to throw in my lot with one camp or

the other I would support the convergence club.

Another factor which has contributed to the reawakening of interest in the

growth issue has been the so-called productivity slowdown which began in

the late 1960s/early 1970s. Do you believe there was a productivity slowdown

and, if so, what were the possible causes?

Yes, I do believe that there was a productivity slowdown. All the debate

about price indices does not seem to me to produce a convincing case

against the observation that there has been a productivity slowdown. There

is no reason to suppose that if you made the same corrections on price

indices before 1970 you would not have at least as much overstatement of

inflation. So I think there was a productivity slowdown, I think it had an

international character, it happened as much in Japan as it did in the USA,

and I think that as far as anyone can tell at least half or more of it is a

mystery still. But when I say mystery I think we should distinguish between

two senses of the word inexplicable (or mystery, for that matter).

When I say something is inexplicable or a mystery I could mean that I

cannot pin down in detail the causes of the phenomenon. But inexplicable

may also mean that it is utterly shocking! How could such a thing happen? I

think the productivity slowdown is inexplicable only in the first of those

two senses. There is nothing in any piece of growth economics, theoretical

or empirical, which says that the rate of growth of the residual is an

invariant, that it cannot change from one period of time to the next. We

know by the usual backward extrapolation that there cannot have been

productivity growth at 1 or 2 per cent a year forever or else Oliver Cromwell

would have been crawling around in skins. By the way, this goes back to a

significant analytical issue. When I say that in my work in the 1950s I

treated technical change as exogenous, that does not mean that I really

believed at the time that it had no internal economic causes. In the very

same papers I always treated population growth as exogenous, but I did

know about Malthus, and there is clearly a connection between economic

development and demographic patterns. What I meant by saying something

is exogenous was that I do not pretend to understand this; I have nothing

worthwhile to say on this so I might as well take technical change as given

for reasons which are inexplicable in the first sense I mentioned before. I do

not know what the determinants of technical change are in any useful

detail. But technical change is not inexplicable in the second sense. I am

not shocked to learn that productivity growth after 1973 is slower than

before 1973, nor would I have been shocked in this sense if it had been

higher.

If we take a longer-term view, going back a hundred years or so, perhaps the

bigger puzzle is the above trend productivity performance of the post-war

period up until the 1970s.

Exactly. I do believe that. It is a hypothesis that makes sense to me; and I can

even tell a story that makes sense to explain it. But keep in mind that I am, so

to speak, estimating one parameter with one degree of freedom, so there is no

real test being made. The story I tell myself is as follows: from 1930 to 1947

or so, a certain amount of technological change and other improvements in

productive knowledge were taking place, but could not be incorporated into

the real economy, first because of the Great Depression and then because of

the war. So beginning around 1950 the world had a 20-year backlog of

technological improvements to incorporate into practice. After 1950 this

began to happen. That seems to make perfectly good sense; but I do not

believe that it is possible to test the hypothesis because there is nothing to

compare it with.

Are there any strong theoretical or empirical reasons for believing that moderate

inflations of less than 10 per cent have any significant adverse effects

on economic growth?

I am not up on all the literature on this topic. But what I have gathered is that,

at least empirically, the evidence is that rapid inflation is unconditionally bad

for economic growth, but relatively slow inflation, even perhaps averaging 10

per cent annually, has no visible correlation with economic performance. I

doubt that theory compels that view; but I can easily imagine that theory

would be compatible with that view.

The modern phase of endogenous growth theory has now been with us for

just over ten years. What do you think have been the most important developments

or insights which have emerged from this research programme? Have

we learned anything useful?

Less than I had hoped. My own opinion, which I think is now shared by Paul

Romer, is that the early developments – the so-called AK models which

simply amounted to saying let us assume that there are exactly constant

returns to the collection of accumulatable factors of production, human and

physical – all that led nowhere because it was not robust theory. It is very

unlikely that growth could happen that way. If you adopt the AK view, it is

the simplest thing in the world to say: I can show you how reducing a tax on

capital will increase the growth rate, or I can show you how making leisure

less attractive will increase the growth rate. But that sort of stuff went nowhere

and added no real insights because it rested entirely on a linearity

which is so unlikely to be true. But then when you start asking questions

about what does govern the accumulation of technical knowledge, how could

you model the accumulation of human capital, then you begin to get into

really interesting issues. That is what I like about all that literature.

The current crisis involving the so-called ‘Asian Tiger’ economies is making

big news. Their success in the past has been identified with, among other

factors, export performance. What in your view is the relationship between

foreign trade and growth? Has the East Asian growth ‘miracle’ been exportled?

Well, I am uncertain about the relationship between trade and growth. Empirically

there does seem to be a relationship. I have lots of friends who have

worked on this empirically and while their results differ, and some of them

come up empty-handed, it appears that openness to trade favours economic

performance. It is a bit less clear, at least in the literature I have read, what

the source of that relationship is. The very important distinction needs to be

made between factors that have growth effects and factors that have level

effects. Imagine exponential growth as a linear trend on semi-log paper. You

can ask: are there forces that take a country’s trend line and lift it without

changing its slope, a level effect, shifting the trend roughly parallel? It is

clear that anything that improves economic efficiency can do that. So trade

which increases economic efficiency can almost certainly do that. If what you

are looking for is something that will change the slope of the trend line, the

rate of growth, then sheer efficiency gains from trade cannot do that except

temporarily, not over a very long period of time. The only way you can make

sense of trade having an effect on the long-term growth rate is not so much

whether the country is export-led, but whether the country is in contact with

the rest of the world.

So the important factor for growth is the degree of openness of an economy?

Yes, openness in general and especially the will and the capacity to pick up

new technology and new ideas from the rest of the world. I am absolutely

clear that a positive impact from trade on efficiency and the level of output

happens, and that those countries that went in for export-led growth rather

than import substitution integrated themselves with the world economy and

learned things. Some of it they learned from transplants, from direct foreign

investment and multinationals. But whether or not there are any cases of

really long-term changes in growth rates as a consequence of trade is I think

very uncertain. I can easily imagine a country breaking out from being an

underdeveloped stagnant economy and getting on the growth train as a result

of trade. That I can easily see. But whether a country that is already growing

at the same sort of rate as the OECD economies can improve its growth rate

over a period of many decades by virtue of openness or trade, that seems to

me to be unproved.

There were some interesting papers published in the first issue of the Journal

of Economic Growth [1996] by Robert Barro, Alberto Alesina and others on

the relationship between democracy and economic growth, and political

instability and economic growth. Barro, for example, suggests that the best

way we can help poor countries is to export our economic system to them and

if, as a result, their economies improve, they will tend to become more

democratic. In other words economic freedom, by promoting economic growth,

will eventually lead to more democratic outcomes in today’s poor countries.

Have you looked at this literature and developed any ideas on these issues?

That gets into questions that are too big for little old me [laughter]. But my

reaction to that kind of literature has always been as follows. I can easily see

that if you compare a democratically organized country with a country which

is really tightly oligarchically organized, then the democratically organized

economy is going to tap the bigger store of entrepreneurship, whereas the

oligarchs in the non-democratic countries pretty soon give up any entrepreRobert

neurial pretensions they ever had in favour of wine, women and song or

whatever [laughter]. There is also the question of whether you can run a

modern economy in a tightly authoritarian regime or whether these are incompatible.

What happens next in China is going to be the big example of

this dilemma. I can understand this kind of difference. But the notion that if

you could take roughly democratic countries and order them on a scale from

zero to one, that going from 0.5 to 0.6 on a measure of democracy gets you a

big or detectable difference in growth rate or even the level of output, that

seems to be much less likely.

The greens and environmentalists are always warning everyone that the costs

of economic growth will eventually outweigh the benefits. Do you ever worry

about the environmental consequences of growth? Can the world sustain

OECD levels of output per capita for China, South Asia, Africa and Latin

America?

Yes, I worry first of all that rapid population growth will begin to encroach on

the possibilities of improving productivity and on the environment. Furthermore,

one of my sons is interested in these issues professionally; he likes to

say that China is made of coal, that China is just one large coal deposit. Now

if they were simply to burn that coal, while it might not have any effect on the

growth rate of GDP as we measure GDP, it would certainly have a big effect

on the growth of some rough welfare equivalent of GDP. Yes, of course I

worry about these things. I worry more about that than I do about resource

exhaustion, simply because we seem to be a lot further from resource exhaustion.

By the way, I do think that the issue of the relationship between economic

growth and the environment is, to put it crudely, probably going to boil down

to a race between technology and pollution. We do not have much of a grip

on the likely outcome of that issue and possibly cannot get much of a grip on

it. It is foolish to be a fatuous optimist on these issues, but it is equally foolish

to believe that we have come to the end of our capacity to overcome resource

limitations technologically.