How Economics Try to Explain Modern Economic Growth

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The Gare St. Lazare by Claude Monet (1877)

Modern Economic Growth (MEG) is a concept that copes with the patterns of growth in economies in which sustained growth is observable, notably among nations that went through critical overturns in their socioeconomic structures. For Simon Kuznets (1973), “economic growth may be defined as a long-term rise in capacity to supply increasingly diverse economic goods to its population, this growing capacity based on advancing technology and the institutional and ideological adjustments that it demands.”

Prior to 1800, per capita wage income, output, and consumption did not grow (Hansen, 1998). The industrial revolution was “a watershed in world economic development after which sustained growth started’ (Pereira, 2003), a crucial moment for the transition from Malthusian Economies[1] to Modern Economies. From this point on, GDP per capita increased, carried by the augment in total factor productivity; being preceded or accompanied by significant institutional transformations, capable of driving the agents towards economic prosperity. Economists have endured to explain and summarize the most remarkable facts about economic growth. However, there are still voids to be filled.

To try and explain this process, in this essay, we base our analysis on the “Kaldor facts” (Kaldor, 1964) and on the “Kuznets facts” (Kuznets, 1973), since the development process of the industrialized countries during the last century satisfies these two types of stylized facts (Stijepic and Wagner, 2010). For the Kaldor facts, we complementary address the “new Kaldor facts” (Romer and Jones, 2010) as a basis to analyze the productivity factors and some of the proposed growth models. Then, for the Kuznets facts we approach the revisited characteristics presented by Broadberry (2016) to focus on the remarkable characteristics of MEG. Finally, we bring up considerations reached by Acemoglu (2012).

Current literature confluence on the assertion that sustained growth can only be achieved with an increase in total factor productivity. Keynesians and Neoclassical theorists focused mainly on two factors: labor and physical capital. For the neoclassicals, the exogenous technology variable was added, mainly responsible for sustained growth, as can be seen in the Solow model. For the Keynesians models, as are Kaldor facts structured after, growth is directly connected to the endogenous variable of investment.

Models are designed to, more or less generally, explain facts, and economists use them to formulate logical suppositions. So did Kaldor when he formulated what would then originate the term “stylized facts”. These “are empirical observations used as a starting point for the construction of economic theories. A stylized fact must be true in general, but not necessarily in every case” (Black, 2009).

He declared that some aggregate measures remain stable during economic growth, especially the capital to output ratio (facts four and five), while labor productivity and capital per worker grow at a sustained rate (facts number one and two) (Kaldor, 1964).

The neoclassical growth theory captures the first five of the six Kaldor’s facts (Romer and Jones, 2010). However, this model assumes decreasing marginal returns to capital. Therefore, the Harrod-Domar model was used as a basis for Kaldor’s assumptions. With this, he introduced the endogenous variable (investment) as directly associated with growth.

Later, his study was updated under the light of more complex data and methods. Modern growth theorists, such as Jones and Romer (2010) go farther and consider other endogenous state variables, such as ideas, institutions, population, and human capital. The ‘new Kaldor facts’, proposed by them are:

“1. Increased flows of goods, ideas, finance and people; 2 Accelerating growth; 3. Variation in modern growth rates; 4. Large income and TFP cross-country differences; 5. Increases in human capital per worker; 6. Long-run stability of relative wages.” (Jones and Romer, 2009)

Facts one and two are directly connected with the concept of human capital. This concept implies that consumers supply labor and accumulate human capital (stock of skills and education) (Williamson, 2002, p. 310). Thus, more output is produced the higher is the human capital, and, simultaneously, even more human capital can be generated. Being a non-rival good, human capital is spread faster and is more largely used, free of the scarcity of factors like physical capital and land. As a result, facts five and six come to light.

Simon Kuznets also enlisted a series of characteristics of modern economic growth. He divided his characteristics in three main groups: 1. aggregate growth; 2. Structural Transformations and 3. International Spread. These got to be revisited by Broadberry, who focused especially on how more recent literature and methods were able to differently understand some of the aspects of Modern Economic Growth.

For the first group, Kuznets enlisted “high rates of increase in per capita product, accompanied by substantial rates of population growth and high rates of increase in productivity” (Kuznets, 1973). On the other hand, Broadberry enlightened that sustained growth happened mainly due to the elimination of negative growth periods. That means the economy would not shrink in periods of slump (Broadberry, 2016). Also, growth during the early stages of the Industrial Revolution was not as fast as once thought. Moreover, it is true that during the industrial revolution there was a process of discontinuity in the driving forces of economic growth (Pereira, 2003).

In this sense, Kuznets emphasizes that expressive structural transformations are observable during the development of an economy. One of his facts is focused on the shift from agriculture to industry and services as part of these high degree structural transformations. Kuznets places more importance on industrialization for the early stages of MEG, and services being accounted only further in time. Evidence, however, suggests that the shift from agriculture to industry and services was more gradual than Kuznets supposed. As a matter of fact, labor productivity growth grew more rapidly in agriculture than in industry during the industrial revolution (Broadberry, 2016).

Concerning international spread, Kuznets predicted that Western Europe and its offshores in the “new world” would slowly build a productivity lead over the rest of the world (Broadberry, 2016). Broadberry, however, states that further data presented by economists such as Pomeranz (2000) underlined the existence of rich and poor countries both in Europe and Asia. This confrontation is empirically observable nowadays, as we can see by looking at the current economic condition of some Asian countries, such as South Korea, Japan, and China.

Both Kaldor and Kuznets explain decently growth in “central economies”, such as the U.S.A. and western European nations. But they fail to encompass singularities arising from historical minuteness. The Solow model, for instance, strongly predicts the convergence of rich and poor countries. Convergence was, indeed, observable, but among the wealthiest nations (Williamson, 2002).

The posterior endogenous models, for their turn, try to encompass the idiosyncrasy caused by endogenous factors. However, for these models, a direct implication of the Human Capital is that there will be no convergence unless there are differences in initial level of human capital (Williamson, 2002), falling, again, in generality.

A model is useful, and it has been, to account for certain situations and to be extended for predictions and forecasts. However, it still lacks the capability to account for so many outliers. A more heterodox approach might be helpful to explain why some nations grew, while others stagnated.

Acemoglu tries to explain the spread between nations as being distinctly connected to their institutions. “Countries differ in economic success because of their different institutions, the rules influencing how the economy works, and the incentives that motivate people” (Acemoglu, 2012). One might wonder what causes such institutions to behave in particular ways. The author states that they are determined by the country’s politics and its political institutions, mainly. And, nonetheless, “the patterns of nowadays institutions are deeply rooted in the past because once society gets organized in a particular way, this tends to persist” (Acemoglu, 2012). In this sense, inclusive economic institutions promote economic growth through the development of technology and education, while extractive economic institutions go the other way around.

It is, howbeit, a crucial challenge for nowadays economists to find theories and models able to rationalize the well-known complexity of human behavior and social structures. Current economic models are constantly improving. It seems, however, that trying to enclose many samples into a broad list of characteristics has limitations. We have observed that both Kaldor and Kuznets factors encompass reality especially for quantitative variables and usually fails when it tackles qualitative ones.

There are, indeed, remarkable facts about economic growth, namely the ones concerning the increase in total factor productivity, which represent the most tangible factor of growth. However, for this to happen, other subtle factors must come to action, expanding themselves into a broader set of particularities. When trying to predict, the models stumble on the unpredictability of human action. By adding more variables, they take risk of “overfitting”. We can know which factors are relevant, but asserting how they will behave, that is, the consequential facts, is a more complicated task.

References:

ACEMOGLU, D. and ROBINSON, J.A. (2012). “Why Nations fail: The Origins of Power, Prosperity and Poverty”,

BROADBERRY, S. (2016), “The Characteristics of Modern Economic Growth Revisited”, Nuffield College, Oxford.

BLACK, J. HASHIMZADE, N. and MYLES, G. (2009), Dictionary of Economics, Oxford University Press

CRAFTS, N.F.R (1985) “British Economic growth During Industrial Revolution”, New York: Oxford University Press

DURLAUF, S.N. and BLUME, L.E. (2008), “The New Palgrave Dictionary of Economics”, 2nd edition

HANSEN, G.D. and PRESCOTT, E.C. (2002) “Malthus to Solow”, American Economic Review

LUCAS, R.E. (1988) “On the Mechanics of Economic Development”, American Journal of Monetary Economics

JONES, CHARLES, I., and ROMER, P.M. (2010) “The New Kaldor Facts: Ideas, Institutions, Population, and Human Capital.” American Economic Journal: Macroeconomics

KUZNETS, S. (1973), “Modern Economic growth: Findings and Reflections”, American Economic review.ays on the origins of modern economic growth

KALDOR, N. (1964) “Capital Accumulation and Economic Growth”, MacMilan, London

PEREIRA, A.S. (2003) Essays on The Origin of Modern Economic growth, Simon Fraser University

POMERANZ, K. (2000), “The great divergence: China, Europe, and the making of the modern world economy”. APA

STIJEPIC, D. and WAGNER, H (2010)., “The Kuznets-Kaldor-Puzzle and Neutral Cross-Capital-Intensity Structural Change”, University of Hagen

WILLIAMSON, S.D. (2002). “Macroeconomics”, Boston: Addison Wesley

[1] See DURLAUF, S.N. and BLUME, L.E. (2008), “The New Palgrave Dictionary of Economics”, 2nd edition.