Policy Implications of Endogenous Growth Theory

Abstract

Harrod-Domar Growth Theory sanctioned the overriding importance of capital accumulation in the quest for enhanced growth. Since budgetary surpluses could substitute for domestic savings, fiscal policy became identified as the primary growth instrument. Government had a role to play. The influence of Harrod-Domar economics was far reaching. Development agencies, gave great prominence to the need to raise savings ratios. In doing so, they were reflecting the spirit of contemporary development doctrine. Lewis (I954, I958), Rostow (I960) and Fei and Ranis (I964) had pinpointed the raising of the savings ratio as the key to understanding the process of development and the 'take-off' into sustained growth. In advanced market economies concerned with the apparent success of Soviet economic growth, similar sentiments were expressed and the 'strict fiscal easy money' prescription for economic growth was frequently advocated. The introduction of the Neo-classical growth model, especially in the contributions of Solow (I956) and Swan (I956) provided the necessary antidote to the excessive claims made for capital accumulation. In Neoclassical one sector models, the ultimate determinant of the growth rate is shown to be the autonomously determined rate of population expansion. Fiscal policy is thus rendered an irrelevancy in the pursuit of higher growth per se, although it may still have a part to play in the more esoteric pursuit of Golden Rules to achieve Golden Ages. What the early Harrod-Domar and Neo-classical formulations of growth theory possessed in common was the belief that the third ingredient in growth, namely technical progress, was an exogenously determined, fortuitous and costless occurrence descending like manna from the heavens. Even though it was recognised that technical progress could be the dominant element in the growth equation, especially following the publication of Solow (I957), there was no satisfactory account of the determinants of technical change. Indeed, in the Neo-classical growth model with exogenous population expansion and exogenous technical change there was virtually no role for government to play. Discussion turned to the rather sterile issue of whether government intervention could speed up the process of adjustment in the event of some temporary disturbance from the steady state path. But there was no growth policy as such. This essentially unsatisfactory position has continued until very recent times. The present paper offers an attempt to detail recent contributions which seek to rectify this situation and to draw out the more important implications for economic policy.