Where growth comes from: Nobelists stress pragmatism and progress culture

What is economic growth, and from what does it emerge? Is it simply an accumulation of more material, more inputs, more natural resources, and more labour and capital? Is it a product basically of technological progress, or is there something even more subtle at work?

 

That should be a core question for the discipline of economics, but surprisingly few Nobel Prizes have been awarded to those who ask it. When Joel Mokyr, Philippe Aghion, and Peter Howitt were given the prize this year, they joined a very short list. Only Simon Kuznets in 1971 and Robert Solow in 1987 have been explicitly rewarded for their work on the theory and accounting of growth. 

 

Kuznets is remembered most for his observation that inequality within an economy initially increases with growth, and then decreases — the “inverted-U” curve that bears his name. But this observation is actually a subset of his broader insight that growth is never simple, but contains within it an enormous restructuring of the productive relations within any economy undergoing it. And, as head of the United States’ National Bureau of Economic Research’s project on national income accounting, he advanced more than anyone the concept of a “gross domestic product” (GDP) that is so ubiquitous today. 

 

Solow, meanwhile, created the relatively simple model that underlies how all GDP growth today is measured and analysed. GDP is created by combinations of inputs — capital and labour, primarily. If you chose to save and invest, you grew faster. When put together with labour-enhancing technological progress, the Solow model shows the growth rate of output per worker is determined essentially by the rate of technological change. 

 

But, while useful when it comes to predicting and decomposing growth, given a country’s endowments of capital and labour, the Solow model’s theoretical insights were always considered a little unsatisfactory. These technological shifts that provided sustained growth seemed a little too magical for comfort. If they were central to growth, where in turn did they come from? Surely there were differences between economies in how they were discovered, distributed, or disseminated?  

 

That is what, in the years after Solow’s prize, led to what is called “endogenous” growth theory — in which, instead of being exogenous or provided from somewhere outside, technical progress was modelled as emerging from the economy’s internal organisation and mechanics. It is for writing one of the seminal papers in this field of endogenous growth theory that Professors Aghion and Howitt have been awarded this year’s Nobel. 

 

They are not the only people who worked to examine the sources of growth in that period. Robert Lucas, who won the Nobel for his work on the foundations of macro-economics, introduced human capital to the model, and Paul Romer, who really should have won at some point by now, first incorporated a role for patent protection and research. 

 

Why has it taken so long to recognise this field, and why is it happening now? As is always the case with economics, what work is celebrated is a reflection of the anxieties and concerns of real-world policymakers. 

 

The notion that growth is created through constant innovation, or through cutting-edge research, or even through increases in human capital, seemed a little too distant from policymakers’ experiences in the past decades. The People’s Republic of China was the world’s growth champion, and it seemed to be accomplishing that through a simple reorganisation of its economy towards productive manufacturing sectors, forcing a high savings rate, and deploying ever increasing amounts of capital. Some revolutionary work by economists like Alwyn Young in the 1990s seemed to prove that even its high-growth predecessors, the Asian Tigers like Korea and Taiwan, achieved world-beating growth by simply increasing their capital deployments, their workforce sizes by employing women, and their human capital through education. 

 

Today’s world, however, is different. After an extraordinary run, China’s growth seems to have hit a ceiling. The sources of the next wave of growth, whether in the developed or developing world, are difficult to discern. And, at the moment, growth, investment, and equities are being driven by sectors that in turn are dependent on high rates of research and innovation. Almost all of US GDP growth in the first two quarters of this calendar year came from investment in AI (artificial intelligence) infrastructure. It has suddenly become urgent once again to understand what about economies makes them hospitable to technological change, and how that converts into real GDP growth.

 

This year’s Nobel laureates have provided two answers to those questions. Profs Aghion and Howitt say: Be pragmatic. And Joel Mokyr says: Be progressive. 

 

Pragmatic how? By accepting that growth means that some sectors, technologies, and companies must die for new ones to grow. Emerging processes substitute obsolescent ones, new companies replace the old. Inventors and entrepreneurs must be granted super-normal profits for them to do their job of creating new technologies, and those technologies must be allowed to displace inefficient ones for growth to occur.  

If you try to hold on to, or recreate the past, you will not achieve growth. Voters and politicians in America and elsewhere looked at decayed industrial areas such as the midwestern Rust Belt and said: “Let us recreate that, and then we will have growth again.” But, according to the Aghion-Howitt model, that is not possible. 

 

The very act of looking back, according to their fellow-laureate Prof Mokyr, is dangerous. His many books on economic history share a similar theme: Whether innovation and investment are allowed to take hold in a country, and therefore whether economic growth occurs, is shaped by cultural factors. In The Lever of Riches, in 1990, he argued that while technological progress determines the possibility of growth, whether it is allowed to act depends upon cultural and institutional factors. In a later book, he says that countries with “built-in mechanisms that protected the status quo and resisted further innovation” will always face limits on both growth and geopolitical ambitions. 

 

He illustrates this with a compelling thought experiment: “As late as 1700, there was no discernible difference between the scientific and technological achievement of Britain and India. One might ask … why was there no ‘Western Europe Company’ set up in Delhi that would have exploited the deep political divisions within Europe to establish an Indian Raj in London?”

It’s a question that we should continue to ask ourselves today.