Proximate v. Fundamental Sources of Growth
In Temple’s (1999) survey of growth empirics he highlights the fact that one
of the important history lessons since 1960 has been that while some countries
have succeeded in ‘making a miracle’, other countries have been ‘growth
disasters’. When analysing the experience of the miracle economies, economists
need to ‘use these events to help in assessing economic policies that
may affect growth rates in other countries’ (Lucas, 1993). However, this
cannot be done without having theoretical structures in place that help researchers
make sense of the ‘mass’ of data that is now available to economists.
As Lucas argues, to be able to glean valuable lessons from the East Asian
experience, ‘One needs, in short, a theory’. Echoing this theme, Temple
(1999) reminds economists of what is perhaps the key issue: ‘Why have some
countries grown rich while others remain poor? It is hard to think of a more
fundamental question for economists to answer.’
In analysing developments in growth theory it is useful to begin by distinguishing
between proximate and fundamental causes of growth. The proximate
causes relate to the accumulation of factor inputs such as capital and labour,
and also to variables which influence the productivity of these inputs, such as
scale economies and technological change. The research of growth accountants
such as Denison (1967, 1974, 1985), Jorgensen (1996, 2001) and
Maddison (1972, 1987, 1995) has produced a useful taxonomy of the various
proximate sources of growth, and the neo-Keynesian, neoclassical and endogenous
growth theories tend to concentrate on modelling these proximate
variables. However, once we have considered the impact of these proximate
determinants of growth we are left with the deeper question: ‘Why are some
countries so much better than others at accumulating human and physical
capital and producing or adopting new ideas and knowledge?’ That is, we
need to investigate the fundamental determinants of growth (see Rodrik,
2003).
The fundamental or deep sources of growth relate to those variables that
have an important influence on a country’s ability and capacity to accumulate
factors of production and invest in the production of knowledge. For example,
Temple (1999) considers the following ‘wider’ influences on growth:
population growth, the influence of the financial sector, the general macroeconomic
environment, trade regimes, the size of government, income
distribution and the political and social environment. To this list Gallup et al.
(1998) would add the neglected influence of geography. Moving from the
proximate to the fundamental causes of growth also shifts the focus of attention
to the institutional framework of an economy, to its ‘social capability’
(Abramovitz, 1986), ‘social infrastructure’ (Hall and Jones, 1997, 1999) or
‘ancillary variables’ (Baumol et al., 1994). There is now widespread acceptance
of the idea that ‘good’ governance and institutions and incentive structures
are an important precondition for successful growth and development (World
Bank, 1997, 2002).
In his historical survey of economic growth analysis, Rostow (1990) put
forward a central proposition that ‘from the eighteenth century to the present,
growth theories have been based on one formulation or another of a universal
equation or production function’. As formulated by Adelman (1958), this can
be expressed as equation (11.4):
Yt = f (Kt ,Nt , Lt , At ,St ) (11.4)
where Kt, Nt and Lt represent the services flowing from the capital stock,
natural resources (geography) and labour resources respectively, At denotes
an economy’s stock of applied knowledge, and St represents what Adelman
calls the ‘sociocultural milieu’, and Abramovitz (1986) more recently has
called ‘social capability’, within which the economy functions. More sophisticated
models distinguish between human and physical capital. Indeed, many
authors regard human capital as the key ingredient of economic growth
(Lucas, 1988; Galor and Moav, 2003). Heckman (2003), for example, argues
that China’s below average spending on investment in education compared to
physical capital accumulation is ‘a serious distortion’ of policy that is likely
to retard progress in China. Goldin (2001) has also attributed much of the US
economic success in the twentieth century to the accumulation of human
capital.
According to Rostow (1990), ‘something like the basic equation is embedded
equally in Hume’s economic essays, Adam Smith’s The Wealth of Nations,
the latest neoclassical growth model, and virtually every formulation in between’.
This universal equation encompasses both proximate and fundamental
causes of economic growth and Abramovitz drew attention to the importance
of these factors 50 years ago (see Nelson, 1997). Clearly, St contains the
influence of non-economic as well as economic variables which can influence
the growth potential and performance of an economy including the institutions,
incentives, rules and regulations that determine the allocation of
entrepreneurial talent (Baumol, 1990). Hence in recent years economists’
research into the ‘deeper’ determinants of growth has led some to stress the
importance of institutions and incentive structures (North, 1990; Olson, 2000),
trade and openness (Krueger, 1997; Dollar and Kraay, 2003) and the much
neglected impact of geography (Bloom and Sachs, 1998). It is important to
note that Adam Smith had highlighted all three of these ‘deeper’ determinants
of growth over 200 years ago!
In sections 11.17–11.20 we will examine the ‘deeper’ determinants of
economic growth in more detail, but first, in sections 11.8–11.10, we survey
the three main waves of growth theory that have been influential in the
second half of the twentieth century to date. All three approaches emphasize
the proximate determinants of growth, namely:
1. the neo-Keynesian Harrod–Domar model;
2. the Solow–Swan neoclassical model; and
3. the Romer–Lucas-inspired endogenous growth models.
In each case the ideas developed represent interesting examples of multiple
discovery. The first wave of interest focused on the neo-Keynesian work of
Roy Harrod (1939, 1948) and Evsey Domar (1946, 1947). In the mid-1950s
the development of the neoclassical growth model by Robert Solow (1956)
and Trevor Swan (1956) stimulated a second, more lasting and substantial,
wave of interest, which, after a period of relative neglect between 1970 and
1986, has been reignited (Mankiw et al., 1992; Mankiw, 1995; Klenow and
Rodriguez-Clare, 1997a, 1997b). The third and most recent wave, initiated by
the research of Paul Romer (1986) and Robert Lucas (1988), led to the
development of endogenous growth theory, which emerged in response to
perceived theoretical and empirical deficiencies associated with the neoclassical
model (P. Romer, 1994a; Crafts, 1996; Blaug, 2002).
In Temple’s (1999) survey of growth empirics he highlights the fact that one
of the important history lessons since 1960 has been that while some countries
have succeeded in ‘making a miracle’, other countries have been ‘growth
disasters’. When analysing the experience of the miracle economies, economists
need to ‘use these events to help in assessing economic policies that
may affect growth rates in other countries’ (Lucas, 1993). However, this
cannot be done without having theoretical structures in place that help researchers
make sense of the ‘mass’ of data that is now available to economists.
As Lucas argues, to be able to glean valuable lessons from the East Asian
experience, ‘One needs, in short, a theory’. Echoing this theme, Temple
(1999) reminds economists of what is perhaps the key issue: ‘Why have some
countries grown rich while others remain poor? It is hard to think of a more
fundamental question for economists to answer.’
In analysing developments in growth theory it is useful to begin by distinguishing
between proximate and fundamental causes of growth. The proximate
causes relate to the accumulation of factor inputs such as capital and labour,
and also to variables which influence the productivity of these inputs, such as
scale economies and technological change. The research of growth accountants
such as Denison (1967, 1974, 1985), Jorgensen (1996, 2001) and
Maddison (1972, 1987, 1995) has produced a useful taxonomy of the various
proximate sources of growth, and the neo-Keynesian, neoclassical and endogenous
growth theories tend to concentrate on modelling these proximate
variables. However, once we have considered the impact of these proximate
determinants of growth we are left with the deeper question: ‘Why are some
countries so much better than others at accumulating human and physical
capital and producing or adopting new ideas and knowledge?’ That is, we
need to investigate the fundamental determinants of growth (see Rodrik,
2003).
The fundamental or deep sources of growth relate to those variables that
have an important influence on a country’s ability and capacity to accumulate
factors of production and invest in the production of knowledge. For example,
Temple (1999) considers the following ‘wider’ influences on growth:
population growth, the influence of the financial sector, the general macroeconomic
environment, trade regimes, the size of government, income
distribution and the political and social environment. To this list Gallup et al.
(1998) would add the neglected influence of geography. Moving from the
proximate to the fundamental causes of growth also shifts the focus of attention
to the institutional framework of an economy, to its ‘social capability’
(Abramovitz, 1986), ‘social infrastructure’ (Hall and Jones, 1997, 1999) or
‘ancillary variables’ (Baumol et al., 1994). There is now widespread acceptance
of the idea that ‘good’ governance and institutions and incentive structures
are an important precondition for successful growth and development (World
Bank, 1997, 2002).
In his historical survey of economic growth analysis, Rostow (1990) put
forward a central proposition that ‘from the eighteenth century to the present,
growth theories have been based on one formulation or another of a universal
equation or production function’. As formulated by Adelman (1958), this can
be expressed as equation (11.4):
Yt = f (Kt ,Nt , Lt , At ,St ) (11.4)
where Kt, Nt and Lt represent the services flowing from the capital stock,
natural resources (geography) and labour resources respectively, At denotes
an economy’s stock of applied knowledge, and St represents what Adelman
calls the ‘sociocultural milieu’, and Abramovitz (1986) more recently has
called ‘social capability’, within which the economy functions. More sophisticated
models distinguish between human and physical capital. Indeed, many
authors regard human capital as the key ingredient of economic growth
(Lucas, 1988; Galor and Moav, 2003). Heckman (2003), for example, argues
that China’s below average spending on investment in education compared to
physical capital accumulation is ‘a serious distortion’ of policy that is likely
to retard progress in China. Goldin (2001) has also attributed much of the US
economic success in the twentieth century to the accumulation of human
capital.
According to Rostow (1990), ‘something like the basic equation is embedded
equally in Hume’s economic essays, Adam Smith’s The Wealth of Nations,
the latest neoclassical growth model, and virtually every formulation in between’.
This universal equation encompasses both proximate and fundamental
causes of economic growth and Abramovitz drew attention to the importance
of these factors 50 years ago (see Nelson, 1997). Clearly, St contains the
influence of non-economic as well as economic variables which can influence
the growth potential and performance of an economy including the institutions,
incentives, rules and regulations that determine the allocation of
entrepreneurial talent (Baumol, 1990). Hence in recent years economists’
research into the ‘deeper’ determinants of growth has led some to stress the
importance of institutions and incentive structures (North, 1990; Olson, 2000),
trade and openness (Krueger, 1997; Dollar and Kraay, 2003) and the much
neglected impact of geography (Bloom and Sachs, 1998). It is important to
note that Adam Smith had highlighted all three of these ‘deeper’ determinants
of growth over 200 years ago!
In sections 11.17–11.20 we will examine the ‘deeper’ determinants of
economic growth in more detail, but first, in sections 11.8–11.10, we survey
the three main waves of growth theory that have been influential in the
second half of the twentieth century to date. All three approaches emphasize
the proximate determinants of growth, namely:
1. the neo-Keynesian Harrod–Domar model;
2. the Solow–Swan neoclassical model; and
3. the Romer–Lucas-inspired endogenous growth models.
In each case the ideas developed represent interesting examples of multiple
discovery. The first wave of interest focused on the neo-Keynesian work of
Roy Harrod (1939, 1948) and Evsey Domar (1946, 1947). In the mid-1950s
the development of the neoclassical growth model by Robert Solow (1956)
and Trevor Swan (1956) stimulated a second, more lasting and substantial,
wave of interest, which, after a period of relative neglect between 1970 and
1986, has been reignited (Mankiw et al., 1992; Mankiw, 1995; Klenow and
Rodriguez-Clare, 1997a, 1997b). The third and most recent wave, initiated by
the research of Paul Romer (1986) and Robert Lucas (1988), led to the
development of endogenous growth theory, which emerged in response to
perceived theoretical and empirical deficiencies associated with the neoclassical
model (P. Romer, 1994a; Crafts, 1996; Blaug, 2002).
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