- Email: [email protected]
Development theory and the economics of growth
Book reviews
559
could somehow cure it with immediate effect, so that the growth rates of resource-rich countries jumped instantaneously to the average rate achieved by the resource-poor. The same must be true for the additional cumulative future costs of failing to break this link. On the third and fourth questions, the contributors to this volume are very positive that the adverse link is not ‘deterministic’, that much of the blame rests with systematically worse policy choices by resource-rich countries, that this differential is explicable in terms of the socio-political concomitants of resource abundance, but that this last link is not necessarily a tight one. As noted above, this insight is persuasive, and indeed shared by many in this field. However, it is far from clear that we know how to fix the problem, or how to prevent potential solutions from being blocked. David L. Bevan Department of Economics, University of Oxford, Manor Road, Oxford OX1 3UQ, UK E-mail address: [email protected] 2 October 2002 doi:10.1016/S0304-3878(02)00113-X
Development theory and the economics of growth By Jamie Ros (Ann Arbor: University of Michigan Press, 2000) 429 pp. Not many development economists are also rigorous growth theorists, and not many growth theorists possess a deep understanding of development economics. Jamie Ros belongs to that select band of economists who feel comfortable, and excel, in both fields. He wants to blend the insights of classical development theory with the recent contributions of modern growth economics to answer the basic, but elusive, question of why some countries are richer, and grow faster, than others. The task is a daunting one, and the result is the most rigorous development economics text written for a generation. Those who believe that development economics is a soft option should think again. The starting point, and recurring theme, of the book is that the standard one-sector neoclassical growth model simply cannot explain different steady-state levels of per capita income (PCY) across countries, or deviations from the steady state. Parts of the world may be ‘converging’, but not the world as a whole, and many countries still seem to be trapped in a ‘low-level equilibrium’. Moreover, lack of support for the neoclassical model does not necessarily provide support for new (endogenous) growth theory. In Ros’ words ‘new growth theory does not pose a serious empirical challenge to the augmented neoclassical models [. . .] the empirical assessment of the theory proves to be rather disappointing.’ The dilemma for new growth theory, of course, is the knife-edge problem. If the assumption is made of increasing returns to capital, the model generates infinite output in finite time. If
560
Book reviews
diminishing returns to capital is assumed, we are back to the neoclassical model. Constant returns to capital (the AK model) would be a coincidence, and turns out to be the old Harrod –Domar growth equation. In this case, all that new growth theory is doing is attempting to explain differences in the productivity of capital across countries controlling for the share of investment in GDP [see Hussein, K. and A.P. Thirlwall (2000), ‘The AK model of ‘new’ growth theory is the Harrod – Domar growth equation: investment and growth revisited,’ Journal of Post Keynesian Economics, Spring]. The puzzle for Ros (and he is not alone) is why modern growth theory, in trying to understand patterns of growth across the world, has largely ignored the classical development insights of such luminaries as Rosenstein – Rodan, Nurkse, Prebisch, Hirschman, Leibenstein, Lewis and others, relating particularly to increasing returns to scale and elastic supplies of labour. Ros argues that classical development models are much richer and more realistic than the neoclassical and new growth theory models because they can explain the existence of multiple equilibria and development traps, and why divergence at low levels of income can be followed by convergence at high levels of income, which is what we observe in the real world. Ros believes that development theory drifted away from the insights of the early development models partly because of the normative implications concerning government intervention to achieve a ‘big push’; partly because later development economists shifted their focus to particular constraints on development such as nonoptimising agents, lack of demand, inelasticities of supply and demand, technological weaknesses, etc., and partly because old theories were misinterpreted as only applicable to closed economies. Trade and capital mobility would overcome obstacles to sustained development. To merge the old insights of classical development theory, based on elastic supplies of labour and increasing returns to scale, with the new insights of modern growth theory, Ros starts by taking the long-run growth model of Solow, and then in successive chapters drops its key assumptions one by one: that is, no surplus labour, constant returns to scale, perfect competition in the goods and factor market, no international trade, and no constraints on demand (Say’s Law). Before the theory, however, Chapter 1 outlines the stylised facts of growth and development across approximately 60 countries in recent decades. Simple descriptive statistics and correlations can reveal a lot when used in competent hands. There is observed a strong relation between the level of PCY and (i) capital per head, (ii) number of years of schooling, (iii) market size, (iv) share of trade in GDP and (v) industrial employment. There is also a strong relation between the growth of PCY and (i) the growth of capital per worker and (ii) the rate of change of the share of industrial employment in total employment. Investment and industrial structure matter for long-run growth performance. In the Solow model, there are two sources of country differences in PCY: different steady-state levels of PCY and disequilibrium differences in the capital – labour ratio. According to Ros’ calculations, differences in the steady-state levels of PCY are relatively small, and very much smaller than actual differences, which implies that poor countries are much further away from their steady-state levels than rich countries. The question is why? The answers come as the assumptions of the neoclassical model are dropped. First, a non-capitalist sector with surplus labour a` la Lewis is introduced and the steadystate properties of the Solow and Lewis models are compared. It is the existence of this sector, and its characteristics, which accounts in large part for the empirical shortcomings
Book reviews
561
of the neoclassical model. Lewis in his model assigns an important role to savings out of capitalist profits. Ros looks at this issue empirically and finds a close association between the domestic savings ratio and the share of manufacturing profits in GDP (except in some Latin American countries). Ros then combines surplus labour with externalities associated with training and learning by doing, and shows how this combination of characteristics can produce vicious or virtuous circles, or more precisely, divergences between countries at low levels of income and convergence at high levels of income, depending on a critical level of capital accumulation. The model is confirmed by the author’s own empirics, which includes initial PCY squared in a standard cross-country regression equation. The assumption of perfect competition is also dropped by introducing scale economies and pecuniary external economies. This model also generates multiple equilibria, and the complementarity between the agricultural and industrial sector of the economy now becomes important so that the market for industrial goods is large enough to reap economies of scale. The classical development models of Rosenstein – Rodan and Nurkse come into their own, and the model is also reminiscent of ideas in Kaldor’s two-sector agriculture –industry model (see Kaldor, N., 1996, The causes of growth and stagnation in the world economy: The Raffaele Mattioli Lectures, Cambridge: Cambridge University Press). Ros contrasts his modelling with the popular AK model of new growth theory which cannot explain why divergence takes place at low levels of income and convergence at high levels of income. There are three chapters which open up the economy to trade. There are two main channels through which the pattern of international specialisation can affect capital accumulation and growth. The first is higher investment because of a higher rate of return in increasing returns activities, and the second is a higher productivity of capital. It was true historically that resource-rich countries were richer than resource-poor countries, but this is not true today. Ros’ modelling allows natural resources to facilitate development at low levels of income, while increasing returns activities dominate at high levels of income. On the other hand, he shows how economies with land-based activities and surplus labour can find themselves stuck in a low-level equilibrium trap, and would be better off with protection. The important distinction is made between natural and acquired comparative advantage, and Ros concludes from his rigorous modelling ‘that it is hard to see how, without policy interventions [. . .] a market driven development model could have produced such extremely high growth rates in East Asia as well as, although growth was slower, the rapid economic development in a few Latin American countries from 1940 to the early 1990s.’ Empirical analysis takes the Chenery – Syrquin index of trade orientation which measures the importance of manufactures in total exports adjusted for a country’s size and income. The index of trade orientation, investment and growth are all correlated across 34 countries over the period 1960 –1990. The message is plain, that the structure of trade matters for growth. Not all countries, however, experience rapid growth in the middle-income phase, and Ros demonstrates how inequality traps can lead to a slowdown of growth. The frame of reference here is the Kuznets curve and the two-way relation between growth and inequality. It appears, however, that deviations from the Kuznets curve are more important than the curve itself (i.e. the level of PCY) in explaining patterns of inequality. For example, greater inequality at a given level of income can lead to faster population growth,
562
Book reviews
lower rates of investment in education and greater political and social instability, and this seems to have affected some Latin American countries adversely compared to countries in South East Asia with a much greater degree of equality. Finally, demand constraints are introduced into the model, both domestic and foreign. The model used here is an open economy extension of Kalecki’s two-sector agriculture – industry model in which there is a food constraint and a foreign exchange constraint in the spirit of Chenery’s two-gap model. To explain the significant slowdown of growth in Africa and Latin America in the 1980s, a third gap, or investment constraint, is also added, associated with internal and external indebtedness. Paradoxically, however, in this section of the book, the role of foreign exchange is highlighted more from the supply-side than the demand-side, and more recent models of balance of payments constrained growth are not considered at all. Ros’ book is a tour de force by any standards. What it tells us is that while the preoccupations of new growth theory can enrich the insights of classical development theory, they cannot replace the fundamental features of the early classical models for an understanding of the different phases of the growth and development process, and why some countries stay poor while others forge ahead. Those who have the stamina to stay the course will be richly rewarded. Robert Lucas once said that when one starts thinking about economic growth ‘the consequences for human welfare are simply staggering [. . .and] it is hard to think of anything else’. I felt the same when I finished this difficult but fascinating book. A.P. Thirlwall University of Kent, UK E-mail address: [email protected] 18 September 2002 doi:10.1016/S0304-3878(02)00126-8
559
could somehow cure it with immediate effect, so that the growth rates of resource-rich countries jumped instantaneously to the average rate achieved by the resource-poor. The same must be true for the additional cumulative future costs of failing to break this link. On the third and fourth questions, the contributors to this volume are very positive that the adverse link is not ‘deterministic’, that much of the blame rests with systematically worse policy choices by resource-rich countries, that this differential is explicable in terms of the socio-political concomitants of resource abundance, but that this last link is not necessarily a tight one. As noted above, this insight is persuasive, and indeed shared by many in this field. However, it is far from clear that we know how to fix the problem, or how to prevent potential solutions from being blocked. David L. Bevan Department of Economics, University of Oxford, Manor Road, Oxford OX1 3UQ, UK E-mail address: [email protected] 2 October 2002 doi:10.1016/S0304-3878(02)00113-X
Development theory and the economics of growth By Jamie Ros (Ann Arbor: University of Michigan Press, 2000) 429 pp. Not many development economists are also rigorous growth theorists, and not many growth theorists possess a deep understanding of development economics. Jamie Ros belongs to that select band of economists who feel comfortable, and excel, in both fields. He wants to blend the insights of classical development theory with the recent contributions of modern growth economics to answer the basic, but elusive, question of why some countries are richer, and grow faster, than others. The task is a daunting one, and the result is the most rigorous development economics text written for a generation. Those who believe that development economics is a soft option should think again. The starting point, and recurring theme, of the book is that the standard one-sector neoclassical growth model simply cannot explain different steady-state levels of per capita income (PCY) across countries, or deviations from the steady state. Parts of the world may be ‘converging’, but not the world as a whole, and many countries still seem to be trapped in a ‘low-level equilibrium’. Moreover, lack of support for the neoclassical model does not necessarily provide support for new (endogenous) growth theory. In Ros’ words ‘new growth theory does not pose a serious empirical challenge to the augmented neoclassical models [. . .] the empirical assessment of the theory proves to be rather disappointing.’ The dilemma for new growth theory, of course, is the knife-edge problem. If the assumption is made of increasing returns to capital, the model generates infinite output in finite time. If
560
Book reviews
diminishing returns to capital is assumed, we are back to the neoclassical model. Constant returns to capital (the AK model) would be a coincidence, and turns out to be the old Harrod –Domar growth equation. In this case, all that new growth theory is doing is attempting to explain differences in the productivity of capital across countries controlling for the share of investment in GDP [see Hussein, K. and A.P. Thirlwall (2000), ‘The AK model of ‘new’ growth theory is the Harrod – Domar growth equation: investment and growth revisited,’ Journal of Post Keynesian Economics, Spring]. The puzzle for Ros (and he is not alone) is why modern growth theory, in trying to understand patterns of growth across the world, has largely ignored the classical development insights of such luminaries as Rosenstein – Rodan, Nurkse, Prebisch, Hirschman, Leibenstein, Lewis and others, relating particularly to increasing returns to scale and elastic supplies of labour. Ros argues that classical development models are much richer and more realistic than the neoclassical and new growth theory models because they can explain the existence of multiple equilibria and development traps, and why divergence at low levels of income can be followed by convergence at high levels of income, which is what we observe in the real world. Ros believes that development theory drifted away from the insights of the early development models partly because of the normative implications concerning government intervention to achieve a ‘big push’; partly because later development economists shifted their focus to particular constraints on development such as nonoptimising agents, lack of demand, inelasticities of supply and demand, technological weaknesses, etc., and partly because old theories were misinterpreted as only applicable to closed economies. Trade and capital mobility would overcome obstacles to sustained development. To merge the old insights of classical development theory, based on elastic supplies of labour and increasing returns to scale, with the new insights of modern growth theory, Ros starts by taking the long-run growth model of Solow, and then in successive chapters drops its key assumptions one by one: that is, no surplus labour, constant returns to scale, perfect competition in the goods and factor market, no international trade, and no constraints on demand (Say’s Law). Before the theory, however, Chapter 1 outlines the stylised facts of growth and development across approximately 60 countries in recent decades. Simple descriptive statistics and correlations can reveal a lot when used in competent hands. There is observed a strong relation between the level of PCY and (i) capital per head, (ii) number of years of schooling, (iii) market size, (iv) share of trade in GDP and (v) industrial employment. There is also a strong relation between the growth of PCY and (i) the growth of capital per worker and (ii) the rate of change of the share of industrial employment in total employment. Investment and industrial structure matter for long-run growth performance. In the Solow model, there are two sources of country differences in PCY: different steady-state levels of PCY and disequilibrium differences in the capital – labour ratio. According to Ros’ calculations, differences in the steady-state levels of PCY are relatively small, and very much smaller than actual differences, which implies that poor countries are much further away from their steady-state levels than rich countries. The question is why? The answers come as the assumptions of the neoclassical model are dropped. First, a non-capitalist sector with surplus labour a` la Lewis is introduced and the steadystate properties of the Solow and Lewis models are compared. It is the existence of this sector, and its characteristics, which accounts in large part for the empirical shortcomings
Book reviews
561
of the neoclassical model. Lewis in his model assigns an important role to savings out of capitalist profits. Ros looks at this issue empirically and finds a close association between the domestic savings ratio and the share of manufacturing profits in GDP (except in some Latin American countries). Ros then combines surplus labour with externalities associated with training and learning by doing, and shows how this combination of characteristics can produce vicious or virtuous circles, or more precisely, divergences between countries at low levels of income and convergence at high levels of income, depending on a critical level of capital accumulation. The model is confirmed by the author’s own empirics, which includes initial PCY squared in a standard cross-country regression equation. The assumption of perfect competition is also dropped by introducing scale economies and pecuniary external economies. This model also generates multiple equilibria, and the complementarity between the agricultural and industrial sector of the economy now becomes important so that the market for industrial goods is large enough to reap economies of scale. The classical development models of Rosenstein – Rodan and Nurkse come into their own, and the model is also reminiscent of ideas in Kaldor’s two-sector agriculture –industry model (see Kaldor, N., 1996, The causes of growth and stagnation in the world economy: The Raffaele Mattioli Lectures, Cambridge: Cambridge University Press). Ros contrasts his modelling with the popular AK model of new growth theory which cannot explain why divergence takes place at low levels of income and convergence at high levels of income. There are three chapters which open up the economy to trade. There are two main channels through which the pattern of international specialisation can affect capital accumulation and growth. The first is higher investment because of a higher rate of return in increasing returns activities, and the second is a higher productivity of capital. It was true historically that resource-rich countries were richer than resource-poor countries, but this is not true today. Ros’ modelling allows natural resources to facilitate development at low levels of income, while increasing returns activities dominate at high levels of income. On the other hand, he shows how economies with land-based activities and surplus labour can find themselves stuck in a low-level equilibrium trap, and would be better off with protection. The important distinction is made between natural and acquired comparative advantage, and Ros concludes from his rigorous modelling ‘that it is hard to see how, without policy interventions [. . .] a market driven development model could have produced such extremely high growth rates in East Asia as well as, although growth was slower, the rapid economic development in a few Latin American countries from 1940 to the early 1990s.’ Empirical analysis takes the Chenery – Syrquin index of trade orientation which measures the importance of manufactures in total exports adjusted for a country’s size and income. The index of trade orientation, investment and growth are all correlated across 34 countries over the period 1960 –1990. The message is plain, that the structure of trade matters for growth. Not all countries, however, experience rapid growth in the middle-income phase, and Ros demonstrates how inequality traps can lead to a slowdown of growth. The frame of reference here is the Kuznets curve and the two-way relation between growth and inequality. It appears, however, that deviations from the Kuznets curve are more important than the curve itself (i.e. the level of PCY) in explaining patterns of inequality. For example, greater inequality at a given level of income can lead to faster population growth,
562
Book reviews
lower rates of investment in education and greater political and social instability, and this seems to have affected some Latin American countries adversely compared to countries in South East Asia with a much greater degree of equality. Finally, demand constraints are introduced into the model, both domestic and foreign. The model used here is an open economy extension of Kalecki’s two-sector agriculture – industry model in which there is a food constraint and a foreign exchange constraint in the spirit of Chenery’s two-gap model. To explain the significant slowdown of growth in Africa and Latin America in the 1980s, a third gap, or investment constraint, is also added, associated with internal and external indebtedness. Paradoxically, however, in this section of the book, the role of foreign exchange is highlighted more from the supply-side than the demand-side, and more recent models of balance of payments constrained growth are not considered at all. Ros’ book is a tour de force by any standards. What it tells us is that while the preoccupations of new growth theory can enrich the insights of classical development theory, they cannot replace the fundamental features of the early classical models for an understanding of the different phases of the growth and development process, and why some countries stay poor while others forge ahead. Those who have the stamina to stay the course will be richly rewarded. Robert Lucas once said that when one starts thinking about economic growth ‘the consequences for human welfare are simply staggering [. . .and] it is hard to think of anything else’. I felt the same when I finished this difficult but fascinating book. A.P. Thirlwall University of Kent, UK E-mail address: [email protected] 18 September 2002 doi:10.1016/S0304-3878(02)00126-8