Growth Theory and Economic Structure

Abstract

New growth theory endogenises growth, but neglects aggregate demand and distributional shifts in output and employment. A model incorporating demand and structural change is introduced to assess the effects of greater integration of the EC. The analysis shows that (i) the new growth model overstates the long run implications of integration, and (ii) identical effects on productivity growth can be achieved by reducing unemployment. It is argued that the benefits of lower unemployment are more certain of achievement than those expected from reduced barriers to trade and resource movement, and that stronger demand is a pre- requisite for realization of the latter. With the rise of the new growth theory (Romer 1986), many economists foresee the end of the long dominance of neoclassical growth theory. New growth theorists make the general point that within their framework the rates of growth of productivity and per capita income (and changes in these growth rates) are endogenously explained. Their main criticism of neoclassical growth theory is that it attributes these growth rates to exogenous determinants, and that this is not an explanation. New growth theory is to be commended for its efforts to endogenize growth, but it none the less retains two shortcomings in common with neoclassical growth theory: it neglects the effects of (1) distributional shifts in output and employment and (2) aggregate demand. In this paper we argue that these must be included in order to develop a research strategy that permits reasonable measures of the impact of policy on growth rates. To support this view, we first outline the way in which neoclassical and new growth theory analyse and quantify the effects of increased competition and market size, using in illustration the 1992 programme for greater economic integration of the EC. We then introduce a model that is free of the defects of both approaches, and use it to provide a clearer view of the static and dynamic effects of the 1992 changes. These are then compared with the effect of policies to reduce unemployment. The results show that (1) the new growth model overstates the long-run implications of the 1992 measures, and (2) identical effects on productivity growth can be achieved by a programme to reduce unemployment. We conclude by arguing that the benefits of lower unemploy- ment are more certain of achievement that those expected to flow from reduced barriers to trade and resource movement, and that stronger demand is a pre- requisite if the latter are to be realized. We do not attempt to make quantitative estimates of the economic gains from 1992 (or from reduced unemployment), whether for the short, medium or long run. Rather, our paper can be seen as outlining a research strategy for