GROWTH STORIES
Before we get to that, it is worth pointing out something the careful reader might have already noted: as soon as we started talking about the theory of economic growth, the conversation just got a whole lot more abstract.
Both Solow and Romer are telling stories about what happens to entire economies over long periods of time. To do so, they are telescoping an incredible amount of real-world complexity into as few building blocks as possible. Solow, for example, gives a central role to the idea of economy-wide diminishing returns. Romer, for his part, puts his money on the flows of ideas between firms, but we never get to see the ideas themselves, just their supposed benefits at the level of the entire economy. Given the sheer diversity of occupations, enterprises, and skills that constitute an economy, it is very hard to get a feel (let alone an empirical counterpart) for any of these very broad concepts. Solow wants us to think of what happens in an economy when the total capital available to it goes up. But economies typically don’t accumulate capital; individuals do. Then they decide what to do with that capital: whether to lend it out, start a new bakery, buy a new house, and so on. Each such decision changes many things; house prices may go up, bread prices may come down, good pastry chefs may become harder to come by. Solow wants to reduce all that complexity to one change: the change in the availability of labor relative to capital. Likewise, when a city gets an influx of tech people, many things change—you get better espresso, for one, and many low-income residents get pushed out—but Romer highlights just one key thing: the exchange of ideas. Both Romer and Solow may well be right in their guesses about what really matters, but it is difficult to map their abstractions into the real world.To make matters worse, the data, which has been our main recourse so far, cannot help us very much here.
Because the theories operate at the level of entire economies, our tests will need to compare different economies (countries or, at best, cities) rather than individual firms or people. As we discussed in the chapter on trade, this is always a challenge since economies tend to be different from each other in any number of ways, making them hard to compare.Moreover, even if we were willing to draw conclusions from the comparison of entire economies to each other, it is not clear what we would learn. Take the idea of diminishing returns at the level of the economy. We want to test whether capital is less productive in a country that ends up with some extra capital. The problem once again is that countries don’t accumulate capital, individuals do. Those individuals may then invest that capital in firms. Those firms buy machines and buildings and so on, and then try to hire workers to make use of their newly installed capital. This increases competition in the labor market, forcing the firms to settle for fewer workers than they would want, which is what depresses productivity of capital. Now suppose we do observe that an inflow of capital made capital less productive. How can we be sure that the reason this happened is the one Solow has in mind? After all, it could be that the capital was invested in the wrong place and that is what made it unproductive. Or that it was never invested at all. Perhaps if it were invested properly, the return on capital would actually go up (and not down as Solow would have it).
Finally, a lot of the claims in growth economics are about what happens in the long run. In the long run, growth slows down in Solow’s world; it does not in Romer’s. But how long is long enough? Is it enough to observe a slowdown? Or could that just be a temporary blip, a piece of bad luck to be reversed soon enough?
So at the end of the day, although we will try to stitch together the best evidence for these theories, the result will be tentative. We have already seen that growth is hard to measure. It is even harder to know what drives it, and therefore to make policy to make it happen. Given that, we will argue, it may be time to abandon our profession’s obsession with growth. The most important question we can usefully answer in rich countries is not how to make them grow even richer, but how to improve the quality of life of their average citizen. It is in the developing world, where growth is sometimes held back by an egregious abuse of economic logic, that we may have something useful to say, though, as we will see, even that is very limited.