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The MIT Press Cambridge, Massachusetts London, England
with the collaboration of Leonardo Bursztyn
Preface xvii Why This Book? xvii For Whom? xviii Outline of the Book xix
Why This Book?
To learn about economic growth you need formal theory, for organizing the facts, clarifying causal relationships, and drawing out hidden implications. In growth economics, as in other areas of economics, an argument that is not disciplined by a clear theoretical framework is rarely enlightening. Our experience with graduates and undergraduates at Brown and Harvard has taught us, however, that the theory needed to understand the substantive issues of economic growth is much simpler than what is found in most modern text- books. You do not need to master all the subtleties of dynamic programming and stochastic processes in order to learn what is essential about such issues as cross- country convergence, the effects of financial development on growth, and the consequences of globalization. The required tools can be acquired quickly by anyone equipped with elementary calculus and probability theory. These considerations are what motivated us to write The Economics of Growth. We believe that what is going on at the frontiers of research on economic growth can also be made accessible to undergraduates, as well as to policy makers who have not been to graduate school for many years, even though gaining this access requires learning some basic tools and models. Although there are many other excellent books on growth economics,^1 those that focus on theory are either too removed from policy and empirical applications or too involved with formal technicalities to be useful or interesting to the uninitiated reader wanting to learn about the substantive issues, while other books that focus on substantive issues are not as concerned with formal models as is necessary. None of them present the main facts and puzzles, propose simple tools and models to explain these facts, acquaint the reader with frontier material on growth—both theoretical and empirical— or initiate the reader into thinking about growth policy. What follows is our attempt to fi ll this gap. To bring the reader up to date on the frontiers of the subject, we have had to write a comprehensive book. In the first part we introduce all the major growth paradigms (neoclassical, AK, product-variety, and Schumpeterian), and then in subsequent chapters we show how these paradigms can be used to analyze various aspects of the growth process and to think about the design of growth policy. The
xix
access to frontier material, and hopefully it should spur many new research ideas. The second target group is intermediate or advanced undergraduate students. In particular, the first four chapters of the book have been conceived so as to make the basic growth paradigms fully accessible to students who have no more background than elementary notions of calculus (derivatives, maximization) and a very basic knowledge of economic principles. One can then complete the undergraduate course or sequence by using some of the other chapters of the book—for example, the chapters on stages of growth, finance, convergence, institutions, education, and volatility. The more advanced material, which can be skipped at the undergraduate level, is put in starred sections and problems. (Prob- lems with two stars are the most diffi cult.) The third audience is that of professional economists in government or in international financial institutions who are involved in advising governments on growth and development policies. With parsimonious use of models and equa- tions, the book provides them with the basic paradigms (part I), and also with the tools (chapters 11–18), to think about the design of growth policy. More generally, this book can be used by any reader with a basic mathematical background who is interested in learning about the mechanics of growth and development.
Outline of the Book
The book comprises three parts. Part I presents the main growth paradigms: the neoclassical model (chapter 1), the AK model (chapter 2), Romer’s product- variety model (chapter 3), and the Schumpeterian model (chapter 4). Chapter 5 concludes part I by introducing physical capital into a growth model with endog- enous innovation, in order to provide a theoretical framework for interpreting the results of growth accounting. Part II builds on the main paradigms to shed light on the dynamic process of growth and development. Chapter 6 analyzes the relationship between financial constraints, innovation, and growth, and then the relationship between financial constraints, wealth inequality, and growth. Chapter 7 analyzes the phenomenon of “club convergence,” in other words, why some countries manage to converge to growth rates of the most advanced countries whereas other countries continue to fall further behind. Chapter 8 introduces the notion of directed technical change and uses it to analyze wage inequality or to explain persistent productivity
Preface
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differences across countries. Chapter 9 introduces the notion of general-purpose technology and explains why new technological revolutions can produce both temporary slowdowns and accelerating wage inequality. Chapter 10 analyzes how an economy can evolve from a stagnant Malthusian agricultural economy into a persistently growing industrial economy, or from an economy that accumulates capital to an innovating economy, or from a manufacturing to a service economy. Chapter 11 discusses the role of institutions in the growth process, and introduces the notion of appropriate growth institutions to understand why different institu- tions or policies can be growth enhancing in countries at different levels of development. Part III focuses on growth policies. Chapter 12 analyzes the growth effects of liberalizing product market competition and entry. Chapter 13 analyzes the growth effects of education policy. Chapter 14 focuses on the relationship between risk, financial development, and growth. Chapter 15 discusses the effects of trade liber- alization. Chapter 16 analyzes how growth can be sustained in an economy with environmental or resource constraints. And Chapter 17 investigates the relationship between democracy and growth. Chapter 18 concludes the book by summarizing the main conclusions from previous chapters and then by linking growth to culture and to modern develop- ment economics. Finally, the appendix acquaints the reader with basic notions of econometrics, so that without any prior knowledge this chapter should allow her to read and understand all the empirical sections and tables in the book.
Preface
xxii
Steven Durlauf, William Easterly, Ricardo Hausmann, Martin Hellwig, Andreu Mas-Colell, Jean Pisani-Ferry, Ken Rogoff, Dani Rodrik, Andre Sapir, Nicholas Stern, and Federico Sturzenegger. We have greatly benefited from our association with the Institutions, Organiza- tion and Growth (IOG) Group at the Canadian Institute for Advanced Research. There, we particularly benefited from continuous feedback from Elhanan Helpman, George Akerlof, Tim Besley, Daniel Diermayer, James Fearon, Patrick Francois, Joel Mokyr, Roger Myerson, Torsten Persson, Joanne Roberts, Jim Robinson, Ken Shepsle, Guido Tabellini, and Dan Trefler. The encouragement and support of Daron Acemoglu, Kenneth Arrow, Robert Barro, Olivier Blanchard, Oliver Hart, Martin Hellwig, Edmund Phelps, Mark Schankerman, Robert Solow, Jean Tirole, and Fabrizio Zilibotti over the years have been invaluable to us. The book would never have been completed on time without the active col- laboration of graduate students at Harvard. Here our biggest debt is to Leonardo Bursztyn, who worked with us on the literature reviews, provided the background notes for the econometric appendix, collaborated with us on the environment chapter, produced all the fi gures, proofread the material, and coordinated the team that produced the problem sets and solutions. In this endeavor, Leonardo worked with David Hemous, Dorothée Rouzet, Thomas Sampson, and Ruchir Agarwal. We owe special thanks to John Covell from MIT Press, who managed the tour de force of getting the book to be ready on time in spite of initial delays in deliv- ering the manuscript, and provided us with all the support we needed along the way to completion. In particular, Nancy Lombardi did an outstanding job in supervising the copyediting of the manuscript and then handling the page proofs until the book was ready to print. Sarah Chaillet did us an immeasurable favor by offering one of her paintings for the book cover. Philippe Aghion is infinitely thankful to Benedicte Berner whose sense of humor, “joie de vivre,” and continuous faith in this project have been so essential for its completion. Peter Howitt’s biggest debt is to Pat Howitt for the loving support, lively spirit, and uncommonly good sense that contributed more than words can describe.
Acknowledgments
I.1 Why Study Economic Growth?
Economic growth is commonly measured as the annual rate of increase in a country’s gross domestic product (GDP). Why should anyone care about this dry statistic instead of focusing on more specific welfare, consumption, or happiness indicators? Perhaps the most compelling reason is that economic growth is what mainly determines the material well-being of billions of people. In economically advanced countries, economic growth since the industrial revolution has allowed almost the entire population to live in a style that only a privileged handful could have afforded a hundred years ago, when per capita GDP was a small fraction of what it is today. Indeed, growth in some sectors of the economy, especially the medical and pharmaceutical sectors, has allowed almost everyone to live a longer and healthier life than could have been expected by anyone in the 19th century, no matter what position a person held on the economic ladder. In contrast, the lack of economic growth in the poorest countries of the world has meant that living conditions for hundreds of millions of people are appalling by the standards of rich countries; per capita income levels in many 21st-century countries are much lower than they were in 19th-century Europe. To understand why the human race has become so much wealthier and why our wealth is shared so inequitably among the inhabitants of the world, we need to understand what drives economic growth.
I.2 Some Facts and Puzzles
Our first goal is to provide the reader with analytical tools to understand the growth process. The basic theoretical paradigms are laid out in part I. Then part II analyzes various facts and puzzles raised by world growth history. The follow- ing subsections present some examples of these facts and puzzles.
I.2.1 Growth and Poverty Reduction
A number of economists argue that growth is the best way to achieve massive reduction in poverty. For example, table I.1 summarizes a study by Deaton and Dreze (2002), showing a substantial reduction in the fraction of Indian population below the poverty line. The reduction is particularly important for urban areas (from 39.1% in 1987–88 to 12% in 1999–2000). At the same time, table I.2 from Rodrik and Subramanian (2004) shows a marked acceleration in GDP growth between the 1970s and the 20 years that