- Growth theory
The part of economic theory that seeks to explain (and hopes to predict) the rate at which a country's economy will grow over time. Economic growth is usually measured as the annual percentage rate of growth in one or another of the country's major national income accounting aggregates, such as Gross National Product or Gross Domestic Product (almost always with appropriate statistical adjustments to discount the potentially misleading effects of price inflation). Just about any country's economy will show sizable year-to-year and quarter-to-quarter fluctuations in its economic growth rate, but economic growth theorists tend to concentrate their efforts on analyzing and explaining the smaller variations in the longer-term trend or average rate of economic growth over periods of a decade or more. They leave explanation of the shorter-term fluctuations around the longer-term trend to specialists in business cycle theory because investigation has shown that the predominant influences on short-term growth rates seem to differ in important ways from the determinants of an economy's long term average growth performance. It might also be added that the political effects of variations in long range economic growth rates tend to be substantially different from the political effects of the booms and busts of the business cycle.
The short term ups and downs of the business cycle have dramatic effects on popular perceptions of the country's economic well-being. In a recession, hundreds of thousands or even millions of people may become unemployed and suffer dramatic declines in their incomes for the duration of the crisis -- usually for a period of somewhere between six months and one-and-a-half years before more normal economic conditions return again. Yet over the long haul, even rather small increases or decreases in the trend rate of economic growth will have much more profound and enduring effects on economic production and hence on the material living standards of the population. As an illustration, consider the following: During the period since the end of World War II (1946 to 1999-I), the growth rate of GDP for the United States (corrected for inflation) has averaged about 3.3% per year. Assuming that the typical undergraduate student reading this text was born in 1979, the growth rate of the US economy over his or her lifetime has averaged a slightly lower 2.7% per year - a difference of "only" 0.6 percentage points per year. But if the US had been able to maintain the same average growth rate from 1979 to 1999 that it had enjoyed during 1946 to 1978 (about 3.6%), 1998 GDP would have reached 9.152 trillion 1992 dollars worth of goods and services instead of the 7.552 trillion dollars of production actually achieved. That means that the income of the average American household in 1998 (and every single year thereafter) could have been more than 20% higher than it actually turned out to be if only a way could have been found to prevent this seemingly slight decline in the trend rate of economic growth. And if the US economy had somehow managed to average the slightly higher growth rate of an even 4% for the whole postwar period, the income of the average American household from 1998 on could have been about half again as much over what was (and will later be) at their disposal.
Explaining differences between countries in their long term economic growth rates is a complex matter, and the scientific literature on the subject is filled with controversies both technical and ideological in nature. Many of the theoretical determinants of long term growth rates are difficult to measure very adequately and many of the least imperfect measurements available for testing the various theories have been systematically collected in much of the world only for a relatively recent historical period -- roughly the last 20 to 30 years. Nevertheless one eminent scholar's recent survey of the published professional literature came up with over sixty different variables that have been put forward by theorists as enhancing or retarding long term economic growth and that also actually showed significant evidence of real explanatory power in one or more systematic statistical tests using a broad range of 20th century historical data. There is broad support in virtually all empirical studies for a strong positive impact on economic growth by the investment rate (especially the rate of investment in plant and equipment) and by various measures of human capital (such as the literacy rate, school enrollment ratios, and average life expectancy). Although it is difficult to measure separately from investment and improvement of human capital, there is also substantial support for the positive contribution of continuing technological innovation and improvement in sustaining the process of economic growth by improving productivity. A majority of the other variables that have been brought into economic growth theory are conceived of as influencing growth rates mainly in an indirect fashion by affecting either the volume or the efficiency in utilization of investment and/or of human capital and/or technological progress. There is also substantial and robust support in the empirical literature for the hypothesis of "conditional convergence" - that is, because of diminishing returns to capital, the lower a country's level of real GDP per capital at the beginning of a given historical period, the faster the country's subsequent growth rate tends to be (an initial advantage of less developed countries that in practice has been all too often offset by counterproductive governmental policies and by disruptive conditions such as frequent coups, lawlessness, warfare and civil strife that tend to retard savings and investment rates and to destroy or drive out a lot of human capital).
Various kinds of public policy variables also seem to make a difference in growth rates. Countries with relatively "open" economies (that is, those which allow relatively free movement of goods and capital in and out of the country without high tariffs, protectionist import quotas, foreign exchange controls or major restrictions on foreign investment) have tended to maintain higher growth rates than countries with more restrictive policies. Countries that allow extremely rapid expansion of their money stocks and thus bring on high rates of inflation (about 20% per year seems to be a critical threshold) have tended to experience sharply lower economic growth rates than countries with low or moderate rates of inflation. Countries whose legal systems provide relatively reliable enforcement of private contracts and relatively secure protection for private property rights have tended to grow more rapidly than countries whose legal systems are bogged down by corruption, arbitrary judicial decision-making, frequent radical changes in basic legal principles, ex post facto legislation and/or just plain lack of prompt and effective enforcement of the law.
Some of the most emotion-laden and ideologically-tinged debates on economic growth theory deal with two questions on which no broad consensus seems likely in the near future: What sort of mixture of government planning and control versus the free market is most conducive to economic growth? And what are the effects of different cultures (especially differences in religious and ethical values) on promoting or retarding economic growth?
Taking the second question first, it should be noted that many of the earliest theories about what causes economic growth were largely cultural in nature. Adam Smith, David Ricardo, Thomas Malthus and many others (even Karl Marx) laid great stress on the importance to economic growth of such culturally conditioned values or attitudes as thrift, the value of diligence and hard work, ambition for a better material standard of living, respect for other people's property rights, the sense of obligation to honor agreements and contracts, inventiveness, willingness to adopt new ways of doing things and so on. Many of these values are fostered and reinforced (or possibly denigrated and condemned) in different measure within different cultural traditions, and an especially important role in this is played by organized religion. It is not surprising then that nowadays we still see a lot of more or less informed speculation about the role of this religion or that in fostering or inhibiting economic growth, especially in less developed regions of the world. (Max Weber's classic essay on "The Protestant Ethic and the Spirit of Capitalism" is one of the best known and most closely reasoned classic examples of this tradition in the social sciences.) Two or three decades ago, the prevalence of Roman Catholicism in southern Europe and Latin America and its alleged anti-commercial social and economic values were often invoked as a part of the explanation for the relative economic backwardness of these regions compared to mainly Protestant northern Europe and North America. In much more recent times, the influence of Islam in fostering fatalistic attitudes and anti-commercial or anti-materialist values (such as the condemnation of all lending at interest) is often invoked as part of the explanation for the relative economic backwardness of the Moslem countries, despite the huge advantages many of them enjoy in the form of rich endowments of natural resources like petroleum. The conservative anti-materialist and fatalistic elements of Hinduism are often put forward as an explanation for India's backwardness. Weber believed that Confucianism greatly hindered China's economic development over the centuries, but ironically the same Confucian heritage is today more often invoked as an explanation for the rapid commercial development of such places as Hong Kong, Taiwan, and Singapore. The problem with such explanations is that all major religious traditions contain some elements that can encourage economic activity along with other elements that inhibit it, and determining which influences will predominate in any particular place and time is a game that tends to be played with far too many wild cards, with the theorist opportunistically seizing upon whichever elements of the local religious tradition best seem to fit with what he already knows has been happening lately. It is hard to deny that cultural values matter for economic development and that religion plays an important role in fostering the people's values, but correlating changes in people's values with changes in economic growth performance requires much better measurement than is possible by simplistic references to which particular religious faith has predominated in the particular country for centuries. A more promising approach is for researchers to go out periodically and directly sample the distributions of particular "pro-growth" and "anti-growth "attitudes among the populations of various countries (perhaps by survey research polling methods) rather than simply assuming the presence of these values and attitudes on the basis of formal religious doctrines. Only then does it make sense to begin gingerly pronouncing upon how the prevalence or lack of particular values correlate with actual long-term economic growth performance in subsequent years.
As to the first question, socialist and communist economists used to argue that a totally government controlled and planned economy would enjoy more rapid economic growth than a capitalist economy, primarily basing their case on the idea that a planned economy would maintain a steadier and higher rate of investment, free of the periodic slowdowns of investment caused by periodic financial crises in the capitalist business cycle. It was also assumed that a more egalitarian socialist educational policy would be much more successful in promoting widespread education for the masses, greatly enhancing the supply of what we would today call human capital. Economists more favorably inclined toward the free market system acknowledged that the total amount of investment in both non-human and human capital was indeed very important to rapid economic growth but cautioned that the efficiency with which these resources were allocated was also of extreme importance. A capitalist economy , they argued, has a much better system of incentives for encouraging the most efficient allocation of economic resources, whereas the socialist economy would tend to get bogged down in bureaucratic waste and misallocation of resources that would lead to even more waste than the "anarchy of the market."
It is now reasonably clear from the historical record of the last thirty years or so that the closer to capitalist the economy has been, other things being equal, the more successful it has been in achieving higher long term rates of economic growth. During that same period, countries at the extreme socialist end of the scale, especially the countries of the Communist bloc and their third world client states, have seen their initially fairly high rates of economic growth dwindle away gradually to zero and then plunged rapidly into full-scale economic collapse in the late 1980s. Since then, only those relatively few former Communist countries that moved most rapidly and radically to adopt capitalistic institutions and practices have resumed respectable rates of economic growth (such as Poland, Hungary, the Czech Republic, Estonia), while the vast majority of them have stagnated for about a decade in a kind of Never-never land where government bureaucrats have largely lost their power to plan, finance and administer state-owned enterprises but most of the legislation necessary to legalize and unleash private business still remain on hold. Many of the non-Communist countries of the world that formerly had relatively large public sectors and extensive government controls over the economy have enacted reforms to privatize some of their state-owned enterprises and to open up their economies to more foreign trade and outside investment - and most (but not all) of them have since experienced at least modest improvements in their economic growth rates (although it is still too soon to tell whether these improvements represent changes in the long term trend or only temporary cyclical upswings).
Clearly the advocates of the free market have been scoring a lot of points in the debates over the past decade or two and have won over some of the skeptics, but their remaining opponents have by no means lost all of their intellectual ammunition. Die-hard advocates of full-scale socialism can (and do) still argue that socialism has not failed economically because "true" socialism has never been fully implemented (the Soviets and their former comrades in Eastern Europe and the Far East went ideologically wrong somewhere in the beginning) - and if it were really to be tried in the future , surely it would painlessly combine social justice, perfect democracy and the most rapid possible economic progress. Less fanciful socialists can argue that there have actually been at least a few relatively successful growth stories in countries that retain many of the trappings of old fashioned state socialism (mainland China being the most telling example, since about one-third of the human species lives and works there). Some elements of the political left (including the economists among them) reluctantly accept the idea that more government control of the economy might lead to somewhat slower economic growth but then go on to say that low (or no) growth in GDP would be worth it if it was required in order to promote greater social justice. Still others on the left, especially the "Greens," believe that an end to economic growth would be a positive good because people should reject excessively materialistic consumerist values and because it seems to them to be necessary in order to save the planet from environmental catastrophe. More conventional moderate socialists and social democrats more often take the line that they now accept the importance of retaining many elements of the market economy but still insist that a "middle way" with considerably larger amounts of government ownership, regulation and control than now exist in the United States or much of Western Europe could maintain or even improve upon present economic growth rates if done carefully and in the right way. Only a few of these arguments are susceptible to proof or disproof by reference to numbers in the historical record since they contain value judgments as well as empirical assumptions. And it must be acknowledged that the limited amount of data we have amassed over just the past few decades is still a very long way from what one would like to have for decisively resolving even the more tractable empirical disputes over just how economic growth rates get determined.