Ask someone what should be the number one question of macroeconomics. Chances are high that the answer concerns economic growth: what causes economic growth, can government policies adjust it, and can we count on it staying with us for, say, the next hundred years? But, quite surprisingly, economic science has not been able thus far to come up with straight and clear answers. Instead, plenty of answers exist, many of which are sometimes difficult to reconcile. On top of that, while research produces new answers to these questions, old answers are not thrown away. Consequently, our picture of the determinants of economic growth seems to be becoming increasingly blurred over time.
our picture of the determinants of economic growth seems to be become increasingly blurred over time
Let me try to bring in some structure by defining three views on economic growth. The first view is what I call the supply-side view. According to this view, supply factors like the input of production factors and the invention and adoption of new technologies drive economic growth. The second view, the demand-side view, points to effective demand as the primary determinant of economic growth. Third is the view I will denote, for lack of a better name, the non-economic view. This view stresses the role of non-economic factors like culture, geographical and institutional factors.
What does the supply-side view tell us? That economic growth stems from the combination of production factors and technology. It points to the success of newly industrialising economies like South-Korea and Taiwan to stress that growth might be the result of increasing the number of workers, providing better education to workers, and accumulating large stocks of physical capital. It refers to the industrial revolution as the primary example of the role of innovative technologies. It holds the ICT revolution responsible for the growth that occurred prior to the current economic crisis. What is the role for government policies, according to the adherents of the supply-side view? That is to promote investments, innovation, research and development, and the spirit of free enterprise, which often translates to a call for low taxes and little regulation.
The demand-side view is in many aspects the opposite of the supply-side view. The demand-side view tells us that, by definition, economic growth means an increase in the demand for goods and services. This view then looks at the development of spending categories like consumption, investment and exports to explain economic growth. It leaves a big role for government policies. As a consumer of products, the government can quite directly steer the development of effective demand. But the indirect role for public policies may be even more important — to increase consumption and investment by reducing the taxes that consumers and firms have to pay, for example. In addition, the demand-side view leaves a role for monetary policies. In general, lowering interest rates through monetary expansion may help to foster economic growth; the current episode in economic history may be a bit of an exception.
the current episode in economic history may be a bit of an exception
The supply-side view is more associated with the long term and the demand-side view more with the short term. Also, academics seems to embrace more the supply-side view, whereas the popular press seems to be led more by the demand-side view. These two observations might be related. Academics naturally take a longer-term perspective, whereas the popular press is more occupied by day-to-day problems. This suggests that both academics and the popular press could learn from each other, as both supply-side factors and demand-side factors play a role. This is even more important as supply-side factors sometimes operate on a short term and demand-side factors on a longer term. The rises in oil prices in the seventies are an example of the former, the Great Depression and the current economic crisis an example of the latter.
Completely different is the non-economic view. This view stresses the role of factors that create the conditions under which economic development and economic policies take place. The view is as old as the supply-side and demand-side views but sounds younger, as influential writers have recently embraced the view. The non-economic view stresses the role of institutions, of geographical factors and of norms and values. Illustrative for the role of norms and values is the idea of the sociologist Max Weber that the Protestant ethic contributed to industrial development in Western Europe. Geography refers to the location of countries on the globe. In particular, countries that are between the tropics of Cancer and Capricorn suffer from tropical diseases like malaria and from soils that cannot easily be used for agriculture. People such as biologist Jared Diamond and economist Jeffrey Sachs hold these factors responsible for the failure of many of the tropical countries to achieve structural economic growth. Democratic institutions (or rather the lack of them) are seen as an explanation of why former colonies in Latin America have witnessed miserable economic growth, whereas the United States has shown remarkable growth. According to the advocates of the latter view, Daron Acemoglu and James Robinson, the strategies chosen by former colonists — to establish extractive or inclusive institutions — explain all the economic developments since the times of colonisation.
If the demand-side view focuses on the short term and the supply-side view on the long term, the perspective adopted by the non-economic view is clearly ultra-long. The non-economic view has a clear value added: it helps to explain the broad patterns of economic development of countries and regions throughout the world. However, it has little to nothing to say about the growth prospects for a few years ahead. Still, to the extent that it is true, the message the non-economic view sends out is reassuring. Forget about monetary, fiscal or tax policies, and make sure you continue to have inclusive political and economic institutions. Then there will be economic growth, although not necessarily each and every year.
forget about monetary, fiscal or tax policies and make sure you continue to have inclusive political and economic institutions
As yet, economics does not give us a clear-cut story about the role of the three views. That might be disappointing, but maybe it is the best that a science that is hindered by a lack of data and natural experiments can achieve. But there is more. None of the three views on economic growth is outspoken about the role of the financial sector. Its importance does not need to be explained here. This might be the best illustration that economists still have some way to go to come up with a general theory of economic growth.
Yet, I am optimistic about the progress that we might see in future years. And, although this may sound a little strange, in a sense I am happy the world has been hit by an economic crisis. It is another experiment that researchers can use to come up with new theories, to improve existing theories, and to distinguish between theories that work and do not work. Furthermore, I am happy because the crisis has increased the popularity of macroeconomics in universities. Actually, the crisis has helped to spread the idea that economics is too important to leave to political decision makers. In a sense, that is a blessing in disguise.
economics is too important to leave to political decision makers