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Social capability and long-term economic growth
ELSEVIER
Journal of DevelopmentEconomics Vol. 54 (1997) 195-197
JOURNAL OF Development ECONOMICS
Book review Bon Ho Koo and Dwight H. Perkins, eds., Social Capability and Long-Term Economic Growth (St. Martin's Press, New York), pp. x + 356. 'Social capability' sounds as if it were something important, but I did not quite know what it meant; and so it was curiosity that led me to read this book. The blurb on the inside jacket fuelled the curiosity (while at the same time imparting in me a sense of shame for my ignorance) as it declared that " T h e authors argue that a nation's social capability to manage human resources efficiently is a crucial ingredient for sustaining growth", thereby giving the impression of a group, like the scientists at Los Alamos, making a concerted effort to find the key to long-term growth and actually finding it. Economics typically does not yield such magic answers and as one reads through the chapters it becomes evident that this book is no exception. Moreover, it becomes clear that, contrary to the assertion in the blurb, the authors have not collectively worked towards a single thesis. This is made amply clear by Perkins and Koo in their introductory essay when they write: " T h e closest thing to a consensus in these essays is that government policy must be outward- or exportoriented" (p. 6). This is initially a disappointment because of the expectations built up, but eventually the book turns out to be very interesting for reasons very different from the ones advertised. The book grew out of a conference organized to celebrate the twentieth anniversary of the Korean Development Institute. The authors were given the brief, one gathers, to reflect on the role of "social absorption capability" and development, including the actual performance of developing economies, especially those of Asia. The authors include several economists of eminence, and as usually happens with such brief, most authors begin by paying lip-service to "social absorption capability" (with some exercising the economy of confining this to the title of the paper) and then push it aside, veering out instead in a more open-ended fashion to comment on the economics of development in general. And that is what turns out to be the strength of the book. One finds in its pages the reflections of some first-rate theorists on the causes of economic development and 0304-3878/97/$17.00 Published by Elsevier Science B.V. PII S0304-3878(97)00036-9
196
Book rer'iew
growth. No single thesis emerges but, nevertheless, there seems to be some consensus on some important matters. Thus most authors agree that institutions matter, that markets often fail, that government has an important role to play in providing the structure within which the market can function efficiently, that human capital is important, that openness helps, that the legal environment can be crucial for economic progress. As the editors put it in the introduction: "Governments provide the legal and regulatory framework in which markets operate... Markets do not come into being entirely through natural forces." These ideas emerge from very different kinds of enquiries: Kenneth Arrow on the role of information and knowledge, Joseph Stiglitz on externalities and multiple equilibria, Leonid Hurwicz on market failures and the role of government, Masahiko Aoki on the experience of Japan, and Dwight Perkins on China and Vietuant The book also includes papers by Moses Abramovitz, Carl Dahlman and Richard Nelson, Vito Tanzi, Bon Ho Koo, Stanislaw Gomulka, Fernando Fajnzylber, Linsu Kim, Deepak Lal and Lawrence Krause. The two central theoretical ideas - - increasing returns and externalitites - - on which much of our developmental concerns are based are developed in the initial essays on economic theory. In the first of these Arrow draws our attention to the important fact that the cost of creating a new idea or invention does not depend on the scale on which the invention will be used. But the benefit derived from the new idea depends on the scale of its application. Thus, for instance, the cost of inventing a new machine for making chapatis, or bread, is independent of how many people will use it, but its benefits multiply as more and more people use it. It follows that a country will be willing to spend more on research and development the larger the size of the market. Hence, once a country begins to grow, there can be a spiralling affect upwards with more new ideas being generated and that, in turn, spurring on growth. Also, globalization and openness can help enlarge the market and boost the pace at which new ideas are generated even if the nation concerned is small. Stiglitz dwells at length on externalities, stressing how these are ubiquitous rather than special cases. He argues that unlike in standard neoclassical models externalities give rise to "positive feedback systems", whereby heightened activity of one kind enhances the returns to some other activity. This is very similar to the idea of supermodularity in game theory which tends to give rise to multiple equilibria. In such an environment, the theory cannot predict which equilibrium will arise. The actual equilibrium into which an economy settles is therefore determined by history, the beliefs of the people, and even culture. Also, the legal set-up and governmental institutions can be used to steer the economy into the better equilibrium some of these arguments, especially in the context of financial institutions, get reinforced by Aoki in his analysis of the Japanese experience. How important is the role of banks and financial institutions in the process of development? There is now an increasing feeling that it is much more important than traditional development economics recognized. There is little to go by
Book review
197
theoretically on the subject but Aoki's discussions in terms of the Japanese experience can provide some of the building blocks. While the book is supposed to be on long-term growth its one virtue is that it does not make the mistake of equating growth theory with development economics. Much of growth theory is concerned with what happens on the technological frontiers of an economy, whereas development has to deal with political institutions, micro incentives, and the possibility of failure of both markets and governments which tend to cause economies to stagnate or get caught in poverty traps. The move away from the mechanistic models of neoclassical economics, which treat institutions as largely irrelevant to economic processes, is not new. Such opinion has been gathering strength over the last one or two decades. The rise of game theory has played a role in this shift, as has the growing literature on development economics and its invasion into mainstream economics. So novelty is not the strong point of the book nor its comprehensiveness. What is nice about this book is that in it these views about the role of institutions in development find reinforcement from some leading economists of today, including some who have not previously worked in the area of development economics; and that makes up for the fact that at the end of the book one remains as befuddled about the meaning and role of social capability as at the beginning. Kaushik Basu Department of Economics Uris Hall Cornell University Ithaca, NY 14853 Fax: 607 255 2818; Email: [email protected]
Journal of DevelopmentEconomics Vol. 54 (1997) 195-197
JOURNAL OF Development ECONOMICS
Book review Bon Ho Koo and Dwight H. Perkins, eds., Social Capability and Long-Term Economic Growth (St. Martin's Press, New York), pp. x + 356. 'Social capability' sounds as if it were something important, but I did not quite know what it meant; and so it was curiosity that led me to read this book. The blurb on the inside jacket fuelled the curiosity (while at the same time imparting in me a sense of shame for my ignorance) as it declared that " T h e authors argue that a nation's social capability to manage human resources efficiently is a crucial ingredient for sustaining growth", thereby giving the impression of a group, like the scientists at Los Alamos, making a concerted effort to find the key to long-term growth and actually finding it. Economics typically does not yield such magic answers and as one reads through the chapters it becomes evident that this book is no exception. Moreover, it becomes clear that, contrary to the assertion in the blurb, the authors have not collectively worked towards a single thesis. This is made amply clear by Perkins and Koo in their introductory essay when they write: " T h e closest thing to a consensus in these essays is that government policy must be outward- or exportoriented" (p. 6). This is initially a disappointment because of the expectations built up, but eventually the book turns out to be very interesting for reasons very different from the ones advertised. The book grew out of a conference organized to celebrate the twentieth anniversary of the Korean Development Institute. The authors were given the brief, one gathers, to reflect on the role of "social absorption capability" and development, including the actual performance of developing economies, especially those of Asia. The authors include several economists of eminence, and as usually happens with such brief, most authors begin by paying lip-service to "social absorption capability" (with some exercising the economy of confining this to the title of the paper) and then push it aside, veering out instead in a more open-ended fashion to comment on the economics of development in general. And that is what turns out to be the strength of the book. One finds in its pages the reflections of some first-rate theorists on the causes of economic development and 0304-3878/97/$17.00 Published by Elsevier Science B.V. PII S0304-3878(97)00036-9
196
Book rer'iew
growth. No single thesis emerges but, nevertheless, there seems to be some consensus on some important matters. Thus most authors agree that institutions matter, that markets often fail, that government has an important role to play in providing the structure within which the market can function efficiently, that human capital is important, that openness helps, that the legal environment can be crucial for economic progress. As the editors put it in the introduction: "Governments provide the legal and regulatory framework in which markets operate... Markets do not come into being entirely through natural forces." These ideas emerge from very different kinds of enquiries: Kenneth Arrow on the role of information and knowledge, Joseph Stiglitz on externalities and multiple equilibria, Leonid Hurwicz on market failures and the role of government, Masahiko Aoki on the experience of Japan, and Dwight Perkins on China and Vietuant The book also includes papers by Moses Abramovitz, Carl Dahlman and Richard Nelson, Vito Tanzi, Bon Ho Koo, Stanislaw Gomulka, Fernando Fajnzylber, Linsu Kim, Deepak Lal and Lawrence Krause. The two central theoretical ideas - - increasing returns and externalitites - - on which much of our developmental concerns are based are developed in the initial essays on economic theory. In the first of these Arrow draws our attention to the important fact that the cost of creating a new idea or invention does not depend on the scale on which the invention will be used. But the benefit derived from the new idea depends on the scale of its application. Thus, for instance, the cost of inventing a new machine for making chapatis, or bread, is independent of how many people will use it, but its benefits multiply as more and more people use it. It follows that a country will be willing to spend more on research and development the larger the size of the market. Hence, once a country begins to grow, there can be a spiralling affect upwards with more new ideas being generated and that, in turn, spurring on growth. Also, globalization and openness can help enlarge the market and boost the pace at which new ideas are generated even if the nation concerned is small. Stiglitz dwells at length on externalities, stressing how these are ubiquitous rather than special cases. He argues that unlike in standard neoclassical models externalities give rise to "positive feedback systems", whereby heightened activity of one kind enhances the returns to some other activity. This is very similar to the idea of supermodularity in game theory which tends to give rise to multiple equilibria. In such an environment, the theory cannot predict which equilibrium will arise. The actual equilibrium into which an economy settles is therefore determined by history, the beliefs of the people, and even culture. Also, the legal set-up and governmental institutions can be used to steer the economy into the better equilibrium some of these arguments, especially in the context of financial institutions, get reinforced by Aoki in his analysis of the Japanese experience. How important is the role of banks and financial institutions in the process of development? There is now an increasing feeling that it is much more important than traditional development economics recognized. There is little to go by
Book review
197
theoretically on the subject but Aoki's discussions in terms of the Japanese experience can provide some of the building blocks. While the book is supposed to be on long-term growth its one virtue is that it does not make the mistake of equating growth theory with development economics. Much of growth theory is concerned with what happens on the technological frontiers of an economy, whereas development has to deal with political institutions, micro incentives, and the possibility of failure of both markets and governments which tend to cause economies to stagnate or get caught in poverty traps. The move away from the mechanistic models of neoclassical economics, which treat institutions as largely irrelevant to economic processes, is not new. Such opinion has been gathering strength over the last one or two decades. The rise of game theory has played a role in this shift, as has the growing literature on development economics and its invasion into mainstream economics. So novelty is not the strong point of the book nor its comprehensiveness. What is nice about this book is that in it these views about the role of institutions in development find reinforcement from some leading economists of today, including some who have not previously worked in the area of development economics; and that makes up for the fact that at the end of the book one remains as befuddled about the meaning and role of social capability as at the beginning. Kaushik Basu Department of Economics Uris Hall Cornell University Ithaca, NY 14853 Fax: 607 255 2818; Email: [email protected]