The Nature of Economic Growth: An Alternative Framework for Understanding the Performance of Nations

Citation

Carlos Moreno‐Brid, J. (2005), "The Nature of Economic Growth: An Alternative Framework for Understanding the Performance of Nations", International Journal of Social Economics, Vol. 32 No. 11, pp. 1011-1013. https://doi.org/10.1108/03068290510623816

This book presents the lectures given by Professor Tony Thirlwall to graduate students at the National Autonomous University of Mexico (UNAM) a couple of years ago. It puts forward, in a concise and well‐written form, an analytical perspective on the determinants of economic growth – one that contrasts with the neoclassical view so much in vogue today. Its publication is most welcome, and the book should be recommended reading to students and economists interested in understanding the constraints and causes of economic growth.

The first two chapters give a historical review of the key contributions to growth theory. They show how the key insights of Adam Smith, and their extensions by, inter alia, Allyn Young and Nicholas Kaldor lead to an interpretation of economic growth as a cumulative process caused by the interaction of the division of labor, the effect of increasing returns on productivity, and of market expansion. It shows how Malthus, Ricardo and Marx, based on a nonsanguine assessment of the relevance of increasing returns, built analytical models characterized by an inherent tendency towards stagnation and crisis. Harrod's analysis of the warranted growth rate, the natural growth rate and the actual growth rate is introduced and relied upon to succinctly explain the Cambridge controversy that marked the debates on economic growth between the 1950s and 1980s.

The neoclassical theory of economic growth, both in its old version put forward by Solow and in its “new” version triggered by Paul Romer and Robert Lucas, is put to task and found wanting. On the one hand, the book claims that this theory has a tendency to “reinvent the wheel”, borrowing insights from non‐mainstream economists but not always giving them due recognition. In this sense, it is striking that Allyn Young and Nicholas Kaldor are usually ignored by mainstream economists notwithstanding that some of their contributions predated key results of the New Growth Theory.

On the other hand, the book argues that the neoclassical approach – in both its old and modern vintages – is fundamentally flawed. Its assumptions that, in the long run, price changes clear all markets and thus, labor and capital must be fully utilized are considered far from adequate. They ultimately force an interpretation of economic growth as determined by the supply of inputs and technological progress, with no role whatsoever played by demand. But such assumptions and – much more importantly – the neoclassical theory's belief about a unidirectional causation from the supply of factors to long‐term growth, is at odds with the empirical evidence. In fact, growth episodes in developing countries are typically interrupted and even derailed by demand constraints that become binding way before capacity and labor are fully utilized; i.e. long before supply constraints start to operate.

The rest of the book is devoted to presenting the alternative theoretical framework that Thirlwall and his associates have developed in the last thirty years. The relevance of their assumptions and the adequacy of their application to empirical analysis is assessed. For this alternative perspective, long‐term economic growth is driven by demand. One premise of this approach is that economic growth depends on the dynamism of activities subject to increasing returns as well as on their interactions with the other branches of economic activity. A second premise is that, in small open economies, long‐term growth must be accompanied by a sustainable path of foreign indebtedness.

Following Veerdorn and Kaldor, the alternative framework places manufacturing as the engine of growth, given that its expansion pushes up total productivity. Such expansion is due to the effects of increasing returns in manufacturing as well as the positive externalities that it generates by absorbing surplus labor – unemployed or that engaged in low productivity activities. The book argues that at early stages of development, growth of manufacturing requires a dynamic domestic market. At later stages, its growth is sustainable if and only if it is driven by a strong expansion of external demand. In other words, it will be sustained only if it is “export‐led”. It is precisely in building relevant export‐led growth models that Thirlwall has made his seminal contributions.

His original theoretical model was introduced in the late 1970s, and rests on the assumption that the current account deficit cannot be indefinitely financed. In its most simple interpretation it concludes that the long‐term rate of economic growth is determined by the ratio of the income elasticities of demand for exports and for imports. The model is elaborated to include capital flows, but its main conclusions are still valid: long‐term growth is determined by the rate of expansion of exports relative to the income elasticity of demand for its imports.

The last chapter tests the hypothesis of the endogeneity of the supply of factors relative to their demand. It concludes that, within relevant ranges, the natural rate of growth is actually dependent on the actual rate of growth of the economy. Such a conclusion questions, once again, the neoclassical school's assertion that the availability of resources is the binding constraint on economic growth.

The alternative approach put forward in this book has important implications for the design of economic policy, particularly in developing countries. It shows that exports may be an engine of growth only if their dynamism is not compensated by the expansion of import penetration. This simple, but important, insight tends to be overlooked by advocates of free trade. Indeed, in many Latin American countries, trade liberalization was accompanied by a rise in the income elasticity of demand for their imports that more than compensated the increase in their exports drive.

It highlights the need to monitor the balance of payments trade and current account deficit. And, consistent with its Keynesian roots, it concludes that long‐term trade or current account deficits will not be corrected by fluctuations in exchange rates. These deficits reflect structural problems that, to be corrected, require greater investments to improve infrastructure, to modernize and expand the capital stock of machinery and equipment, combined with sectoral policies that improve the competitiveness of domestic producers in local and global markets. These policy conclusions run against the Washington Consensus‐based recommendations that identified low inflation, minimal fiscal deficits, trade liberalization and the availability of supply factors as necessary and sufficient conditions for long‐term growth.

Many of this book's analyses and conclusions are contentious to economists trained in the mainstream approach and it will require much more empirical evidence to convince them. But, the book will certainly broaden their perspectives and, perhaps, incline some of them to question the relevance of the contributions made by the new vintage of the neoclassical approach. For instance, it would help in understanding the persistent and recurrent failure of many developing nations, characterized by conspicuous level of unemployment, informal employment and spare capacity, in their quest to enter a path of long and sustained economic growth. Hopefully, not only students, but also policymakers, will read this well‐written and intellectually stimulating book.