Institutions and growth, an introductory essay

Abstract

The revival of interest in growth theory and empirics is now about ten years old. Some indicators of the permanence of this revival are the volume of publications (including at least one new textbook), the incorporation of much of the new theory and empirical work into basic graduate courses in macroeconomics, the increased supply of advanced courses on economic growth, and the promising start of this new journal. The initial excitement centered on theories in which the long-term growth rate was determined endogenously. The first models were standard except that capital was broadened to include human components and to allow for spillover effects (Romer [1986], Lucas [1988], Rebelo [1991]). In these settings, the absence of diminishing returns meant that the accumulation of capital could sustain growth indefinitely, although the rates of growth and investment might not be Pareto optimal. Subsequent analyses argued that technological progress generated by the discovery of new ideas was the only way to avoid diminishing returns in the long run. In these models, the purposive behavior that underlay innovations hinged on the prospect of monopoly profits, which provided individual incentives to carry out costly research (Romer [1990], Aghion and Howitt [1992], Grossman and Helpman [1991, Chs. 3, 4]). Again, the equilibria need not be Pareto optimal, and there were some intriguing implications for policy, notably for subsidies to basic research. Despite these breakthroughs, the recent empirical work on growth across countries and regions has not received its main inspiration from the new theories. Rather, the standard applied framework derives more from the older, neoclassical model, as extended to include government policies, accumulation of human capital, fertility choice, and the diffusion of technology. In particular, the neoclassical model's central idea of conditional convergence receives strong support from the data. Theories of basic technological change are most important for understanding why the world as a whole and, more specifically, the economies at the technological frontier can grow in the long run. But these theories have less to do with the determination of relative rates of growth across economies; that is, with the relations studied in cross-country or cross-region statistical analyses. It is surely an irony that one of the lasting contributions of endogenous growth theory is that it stimulated empirical work that demonstrated the explanatory power of the neoclassical growth model. The economic growth program has organized conferences since 1989, and the most recent meeting took place at the Universitat Pompeu Fabra in Barcelona in April 1995. l The Barcelona meeting focused on the effects of political institutions on the growth process.