Wednesday, February 6, 2008

Comment on economics of economic growth

New Economist's entry on the sensitivity of growth regressions to data revisions reminded me of this critique by Lant Prichett:

First, growth regressions never satisfactorily resolved the "symptoms versus syndromes" problem. They could establish the relationship between particular observable empirical variables ("symptoms") and growth but could only rarely move convincingly from those observed associations to specific recommendations on how to tackle the underlying causes of the emergence of the symptoms. For example, suppose one finds that a high black market premium is associated with lower growth. Is this an indicator that trade policy was awry, that there were macroeconomic imbalances, or that the country was unable to respond to adverse trade shocks? Or was it just an indicator of general dysfunction? Hence, although it was clear that there was something about a country's external policies that affected growth and triggered a syndrome of misguided inward orientation, even two decades into trade liberalization, prominent scholars are still debating exactly what that something is and how best to address it.

Second, growth regressions were widely seen as producing estimates of gains from policy reform that were orders of magnitude larger than the microeconomic estimates of those gains—without any particularly convincing economic explanation. As trade theorists like T.N. Srinivasan and Jagdish Bhagwati consistently pointed out, the justification of trade reform based on growth regressions was a dubious exercise indeed, compared with the firmer groundings in theory and microeconomic empirics such reforms already had. The growth regression literature in field after field (trade, tax and expenditure, and finance) has had a very difficult time reconciling micro and macro evidence.

Third, growth regressions have a tough time dealing with the huge differences in country experiences. Establishing a correlation between economic output and some variable, say, corruption, on average across countries is only the very beginning of wisdom. Is the effect proportional to corruption as measured? Or does it follow a different relationship? Is the effect stronger in democracies than in nondemocracies? In poorer than in richer countries? In more open than in less open countries? In reality, the growth regression is only a crude approximation that indicates the average impact of corruption, but it does not provide the information policymakers really want—the specific impact in a particular country. This inability to tackle country differences head-on led to differing results about one set of growth determinants (for example, external orientation) depending on sample, period, technique, and the other variables included—creating a general skepticism about the reliability of all growth regressions.

It's possible that economists have been misled by the Solow model and its variants and its search for determinants of steady state growth rates. Perhaps there is no such thing as steady state growth rates as noted by Pritchett in the article (not cited here).

... Solow could write that everything that could be said with his growth model had been said. And what was said was not that nothing could be said with certainty but that, with certainty, nothing could be said by the model. In the model (and all its variants), equilibrium or steady-state growth rates of per capita output were driven by technical progress—but these models, as constructed, could say nothing about the determinants of technical progress.

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