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Over at Equitable Growth: "Convergence": Daily Focus

NewImageOver at Equitable Growth: When I read this piece, it struck me that the stakes were unusually large--that what Lant Pritchett and Larry Summers were really trying to do was to reopen questions of how to think about long-run economic growth that had been largely settled back in the 1950s and 1960s, with the intellectual victory of Robert Solow and company over incremental-institutionalists like Walt Rostow...

Lant Pritchett and Lawrence Summers: Growth Slowdowns: Middle-Income Trap vs. Regression to the Mean: No question is more important for the living standards of billions of people or for the evolution of the global system than the question of how rapidly differently economies will grow over the next generation. We believe that conventional wisdom makes two important errors.... READ MOAR

First, it succumbs to the extrapolative temptation and supposes that, absent major new developments, countries that have been growing rapidly will continue to grow rapidly, and countries that have been stagnating will continue to stagnate.... Past is much less the prologue than is commonly supposed. Second, conventional wisdom subscribes to the notion of a ‘middle-income trap’.... What is often ascribed to the middle-income trap is better thought of as growth rates reverting to their means....

First, we find it difficult to understand the meaning of the ‘middle-income trap’ when it is used to discuss countries that range from Latin American countries to Russia to China to Indonesia to India to Vietnam to Ethiopia.... Second... rapid growth [is] a much more powerful predictor of the likelihood of a deceleration than level of income.... Third... the impact of the current growth rate on the likelihood of deceleration is large, significant, and important... whereas the effect of the ‘middle-income trap’ is small....

Sustaining growth is not a ‘middle-income’ problem... [but] the fundamental challenge... at all stages...

Ever since Solow (1956) set forth his Solow growth model, the key concepts in neoclassical economic growth theory have been "convergence" and the "steady-state growth path". The theory's underlying ideas are four:

  1. An economy's political-economic and sociological institutions determine where, relative to the world's best-practice most-prosperous frontier, its long-run steady-state neoclassical growth path is.

  2. Habits of thrift and demography-driven population growth, rule of law and vulnerability to corruption, the technological system of invention and adaptation, and the provision of education and infrastructure are the most powerful aspects and channels of what we call political-economic and sociological institutions.

  3. Substantial institutional changes can produce large shifts in the location of its long-run steady-state neoclassical growth path.

  4. When a country's economy is away from its long-run steady-state neoclassical growth path, it tends to "converge" toward that path with a 1/e time measured in decades.

This theory predicts that:

  1. If a country has been growing very fast for reasons unrelated to resource booms, almost surely it is because it is converging to its LRSSNGP from below, and is almost sure to continue to grow rapidly--unless something goes badly wrong with its institutions.

  2. If a country has been growing very slowly for reasons unrelated to resource booms, almost surely it is because it is converging to its LRSSNGP from above, and is almost sure to continue to grow slowly--unless something goes wonderfully right with its institutions.

  3. A big institutional change is likely to be followed by a growth acceleration or deceleration, and such acceleration or deceleration is likely to persist for some time.

Lant Pritchett and Larry Summers are now trying to blow this up: to say that just as the neoclassical aggregate production function is a very bad guide to understanding the business cycle, as the generation-old failure of RBC models tells us, so the neoclassical aggregate production function and the Solow growth model built on top of it is a bad guide to issues of growth and development as well.

I am going to have to think hard to decide what I think of all this--especially as Larry was one of the people who taught me the Solow growth model in the first place...

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