The mystery of economic growth

THE MYSTERY OF ECONOMIC GROWTH

THE MYSTERY OF ECONOMIC GROWTH

ELHANAN HELPMAN

t h e b e l k n a p p r e s s o f harvar d univ er sity pr ess Cambridge, Massachusetts, and London, England

2004

Copyright © 2004 by the President and Fellows of Harvard College All rights reserved Printed in the United States of America Library of Congress Cataloging-in-Publication Data Helpman, Elhanan. The mystery of economic growth / Elhanan Helpman. p. cm. Includes bibliographical references and index. ISBN 0-674-01572-X (alk. paper) 1. Economic development. 2. Saving and investment. 3. Production (Economic theory) I. Title. HD82.H435 2004 338.9—dc22 2004042217

To Limor and Liat whose miraculous growing up has been a ceaseless source of joy, with love

CONTENTS

Preface

ix

1. Background

1

2. Accumulation

9

3. Productivity

19

4. Innovation

34

5. Interdependence

55

6. Inequality

86

7. Institutions and Politics Glossary Notes References Index

111 145 153 185 209

PREFACE

or centuries economists have been preoccupied with the growth of nations, and they have studied this subject continually since the days of Adam Smith. This effort has produced a better understanding of the sources of economic growth. But the subject has proved elusive, and many mysteries remain. Two recent waves of research have changed our views on the subject. One wave started in the mid-1950s and lasted until the early 1970s. The second started in the mid-1980s and continues to this day. Both led to major revisions of the theory and empirics of growth. I participated as a researcher in the second wave, and I have closely followed its unfolding. This short book describes what I have learned. This book provides a nontechnical description of growth economics in order to arrive at summary conclusions about what we know, what we do not know, and what it is that we need to learn in order to improve our understanding of a subject that affects, in major ways, the well-being of billions of people across the

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globe. But in undertaking this project I had no intention of writing a survey of the literature. The book presents my personal views and assessments and reflects my personal biases. I feel that it is important to present these research findings to a broad audience, consisting of not only economists with technical expertise but also other economists, social scientists who are not economists, policymakers, and other interested readers. The subject is not only important; it is also intellectually fascinating and absorbing. The scientific literature, consisting of both theoretical and empirical studies, is huge. Nevertheless, important messages can be extracted from this vast research, and they can be summarized and explained in (almost) plain English. Here I attempt to do just that. My tale of growth economics is organized around four themes. First, the accumulation of physical and human capital is important, but it explains only part of the variation across countries in income per capita and its rate of growth. Technological and institutional factors also affect the rate of accumulation of these capital inputs, and they are in some sense more fundamental. Second, total factor productivity is at least as important as accumulation. (For a brief explanation of total factor productivity and other economic terms, see the Glossary.) To understand its determinants we need to understand what shapes the accumulation of knowledge and, in particular, the incentives for knowledge creation. This leads us naturally to explore the effects of research and development, learning-by-doing, externalities, and increasing returns. It also leads us to examine the institutional factors that encourage or discourage knowledge creation. Third, growth rates of different countries are interdependent, because knowledge flows across national borders, and

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foreign trade and investment affect the incentives to innovate, to imitate, and to use new technologies. Fourth, economic and political institutions affect the incentives to accumulate and to innovate, and they also affect the ability of countries to accommodate change. A recent surge of research on the effects of institutions and politics on economic growth has convincingly shown the importance of these elements of social structures. But as of now, we understand these channels of influence less well than some of the others discussed in this book. If I were to write this book five years from today, I probably would write the same book except for the chapter on institutions and politics, because I believe that much progress will be made in this area in the next few years. Since this is not a survey, I have omitted certain topics from my story. Important among them is endogenous population growth. The omission of a topic, however, does not imply that I consider it to be unimportant. Rather it implies that—on the basis of my understanding of the literature—I am not able to coherently fit the topic into my tale. Part of this reflects my ignorance. Another part reflects my differences of opinion with other scholars. To all those who labor on topics that I have ignored, my apologies. I have been fortunate to be a member of the Economic Growth and Policy Program and the Institutions, Organizations and Economic Growth Program of the Canadian Institute for Advanced Research (CIAR). This unique Canadian institution has given me the opportunity to study economic growth for a prolonged period of time, and in the process to interact with some of the world’s most distinguished scholars. My participation in these programs has been an intellectual feast, where true scholarship has been practiced with comradeship and zeal. Fraser

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Mustard, the founder of the CIAR, is a man of vision and a great believer in the power of ideas. His initial support of the unorthodox approach to economic growth taken by myself and others was critical for the launching of our first program. In addition, I would like to thank the National Science Foundation for its support of my research. The epigraph is reprinted from the Journal of Monetary Economics, 22, Robert E. Lucas, Jr., “On the Mechanics of Economic Development,” p. 5, copyright 1988, with permission from Elsevier. I have also been blessed with friends and colleagues who took the time to read the manuscript and who gave me wise advice on a host of issues. They saved me from errors and encouraged me to carry on with this project. They are Daron Acemoglu, Philippe Aghion, Alberto Alesina, Pol Antràs, Michael Aronson, Francesco Caselli, Zvi Eckstein, Harry Flam, Oded Galor, Avner Greif, Gene Grossman, Peter Howitt, Dale Jorgenson, Lawrence Katz, Torsten Persson, Assaf Razin, Kenneth Shepsle, Andrei Shleifer, Guido Tabellini, Manuel Trajtenberg, and Daniel Trefler. Although I did not always follow their advice, I always carefully considered their suggestions. For their contributions to this book I will remain forever grateful. Finally, my gratitude to Jane Trahan for editing the manuscript. She patiently converted Hebrew-tainted verses into proper English.

The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else. Robert E. Lucas, Jr.

1 BACKGROUND

hat makes some countries rich and others poor? Economists have asked this question since the days of Adam Smith. Yet after more than two hundred years, the mystery of economic growth has not been solved. Living standards differ greatly across countries. So do the rates at which these standards change. Some countries grow richer quickly, others slowly. And in some of the poorest nations the standard of living has declined over prolonged periods of time. Economists use real income per capita to measure how well off people are. Obviously, people care about income. But they also care about other issues, such as political freedom, education, health, the environment, and the degree of inequality in their societies. For this reason a good measure of living standards has to account for many factors. But most of them are hard to measure. And it is even harder to decide how much weight to give each one. As a result, real income per capita is often used as a rough measure of a country’s standard of living.1

W

t h e

m y s t e r y

o f

e c o n o m i c

g r o w t h

2

30,000 25,000

Dollars

20,000 15,000 10,000 5,000

M oz am bi N que i Pa geri ki a s Se tan n Uk egal ra i Ch ne i Jo na rd an Pe Po ru la M nd e Ur xic o Cz Ar ugu ec ge ay h nt Re in pu a bl i C c Sw hile ed en Ca UK na Au da st Sw Ja ria itz pa er n la nd US

0

Figure 1.1

Real GNP per capita, 1996. Data from Summers and Heston, PWT 5.6.

Today income per capita differs across countries much more than it used to. Such differences were small up until the nineteenth century. They started to widen with the Industrial Revolution, and they expanded most during the last hundred years.2 Moreover, although differences in income per capita among rich countries have declined in the post–World War II period, the disparity between rich and poor countries has widened. At the same time, the number of middle-income countries has dwindled. We now have two polarized economic clubs: one rich, the other poor.3 Figure 1.1 describes income per capita in a sample of countries.4 It demonstrates the disparities that existed in 1996. In that year income per capita in Canada was more than twice as high as in Argentina and about thirteen times higher than in Pakistan. Even larger gaps existed between Canada and a number of African countries. Canada’s income was, for example, about forty-

B a ckg ro un d 3

25,000

Dollars

20,000 15,000 10,000 5,000

Switzerland Japan Canada Sweden UK Argentina Czechoslovakia Mexico Poland China Pakistan Nigeria

0 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 Figure 1.2

Real GNP per capita in 1992 compared with the historical record of the United States. Data from Maddison (1995).

three times higher than Mozambique’s. And Canada was not the richest country in 1996. These differences are mind boggling. Another measure of income disparity is displayed in Figure 1.2. It depicts the real income per capita of thirteen countries in 1992. One of them is the United States, for which the figure also shows the evolution of income since 1870. We can pick out from this figure the years in which the United States had the same income level as each one of the remaining countries had in 1992. According to these data, in 1992 Argentina’s income per capita was comparable to the income per capita of the United States around World War II, while Pakistan’s was lower than U.S. income in 1870. These very long lags suggest that it will take many years before Argentina and Pakistan catch up to the current standard of living in the United States. Economic growth is measured by the rate of change of real income per capita. A country with a growth rate of 1 percent per

t h e

m y s t e r y

o f

e c o n o m i c

g r o w t h

4

30

1960–1972 1974–1990

Number of countries

25 20 15 10 5

< − 4% < − 3% < − 2%