The Mystery of Growth

1.
The question of what causes economies to grow is theoretically interesting and practically important. If we could discover the secrets of economic growth —what causes income per person to increase over time—we might be able to make growth happen at will, abolishing poverty and creating a world of universal abundance.

Until about three hundred years ago, periods of economic growth had always been reversed, leaving long-term income levels unchanged: the standard of living of a European agricultural worker in the sixteenth century was little higher than it had been in Roman times. In his Essay on Population (1798) the Reverend T.R. Malthus explained why. Whenever food supply grew, population grew, but even faster. This meant that income per head—or food per person—was constantly being forced back toward subsistence levels. But fr om the late seventeenth century onward "perhaps for the first time in...history...both the Dutch and the British economies ...succeeded in increasing the per capita income of a growing population despite the continued pressure of diminishing returns in agriculture." [1] Malthus's population theory was by then explaining only past history. In the century after he wrote, emigration to the Americas, the Industrial Revolution, and falling birth rates banished, or at least postponed, his "problem" in the Western European countries of the world. Wealth could be made to grow faster than population.

Adam Smith, the founder of scientific economics, was the inventor of growth theory. The question he asked in The Wealth of Nations (1776) was: What laws, institutions, and public policies does a society need to experience economic growth? Smith had no doubt that "little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things." [2] Over fifty years later, and well into the Industrial Revolution, John Stuart Mill listed three requirements for the "less civilized and industrious" nations to catch up with the advanced ones: better government and property laws; the "decay of superstition" and "growth of mental activity"; and hospitality to "foreign arts" (technology) and foreign capital. [3]

Behind these economists' assertions lay the thought that economic growth is natural because, except for some monks and other ascetics, "love of gain" is universal. The main "obstacle to growth" was what Karl Marx called "ancient and venerable prejudices." However, these would yield to scientific knowledge. In this view, no change in human motives is needed to explain economic growth, merely a change in the circumstances in which the self-interested motives are translated into action. Prescriptively, "scientific" economics tries to tell you what the required circumstances are.

However, the economists' accounts left one huge question unanswered: Why has Western civilization been so much more successful than any other in removing the obstacles to economic growth? An equal love of gain cannot explain the highly unequal patterns of growth we have in fact observed. Sociologists argued that for growth to happen a prior shift of cultural values had to occur: the obstacles to growth were not prescientific prejudices, but cultural systems that frowned on moneymaking.

According to the sociologist Max Weber, this cultural shift was accomplished—uniquely in Western Europe —by Protestantism. Protestanism was the carrier of the "spirit of capitalism." Protestant countries, sociologists argued, developed a special aptitude for moneymaking. This explained their economic success; the lack of a Protestant ethic explained the failure of others. Seeing growth as culturally disruptive, sociologists were more sensitive to its costs. And they were less optimistic than were economists about the benefits growth would bring. In the sociological tradition, it is the obsession with growth, not resistance to it, which is irrational.

Post-1945 growth experience has given economics the edge over sociology. The classic sociological growth theories, associated with Max Weber, R.H. Tawney, Werner Sombart, and the Harvard scholar Alexander Gerschenkron, date from a time when Europe and its offshoots offered the only material for growth stories. So it made sense to explain economic growth according to Europe's exceptional, not readily reproducible, characteristics. This conclusion was, if anything, reinforced by early-twentieth- century attempts to force growth on the non-Protestant world by means of centrally directed "development strategies." These produced either monstrous aberrations, as in Soviet Russia and Communist China, or monuments to inefficiency and corruption, as in India, sub-Saharan Africa, and much of Latin America.

However, while these growth strategies were being tested, the Japanese economic "miracle" provided materials for an alternative story of development, based on export-led growth in a liberalizing world economy. Japan's success was the first real breach in the theory of European exceptionalism. In the 1970s and 1980s it was closely followed by a small cluster of East Asian "miracles" in South Korea, Taiwan, Singapore, and Hong Kong. Since 1960, according to Robert Lucas, the "entire human race [has been] getting rich, at historically unprecedented rates." This seemed to vindicate the insight of the classical economists that, if Western standards of good government prevailed, "love of gain" would do the rest.

2.
The two books under review, one written by the political sociologist Liah Greenfeld, the other by Nobel Prize– winning economist Robert Lucas, reflect the two main traditions for thinking about growth. To Liah Greenfeld, the explanation of growth belongs to the "history of ideas and the sociology of culture." For Lucas, growth is what happens automatically as knowledge accumulates.

Greenfeld denies the validity of naturalistic explanations of human behavior. Her key argument is that the emergence of the modern economy has to be understood "as a problem in the cultural construction of reality." Specifically, a desire for "continuous economic growth" is not natural for human beings, and for most of history it has been absent. "I am asking," Greenfeld writes, "why the historically exceptional inclination for ever-increasing gain...became defined, on the level of the individual, as rational self-interest...and on the level of society, as common good and paramount collective interest." The harnessing of greed to efficiency and ethical goals requires an explanation—a Factor X, as Lucas calls it.

Max Weber's Factor X was Protestantism. The Protestant ethic was required to convert natural, haphazardly satisfied greed into purposeful frugality. Calvinism abolished the distinction between the sacred and profane, generalizing the ascetic ideal of the monastic orders to secular life. Personal asceticism, in turn, favored the accumulation of capital. In this explanation of the origins of capitalism, Adam Smith's engine of accumulation —frugality—arises not from a natural desire for more wealth but from a heightened concern for one's immortal soul. But the rationality entailed by this concern became in time detached from the goal of salvation it was designed to serve. Capital accumulation became an end in itself.

Greenfeld accepts the need for a Factor X. Weber was right to see that the "spirit of capitalism" required a new morality. But the mechanism that brought this about, she argues, was nationalism, not Protestantism. By the seventeenth century, nationalism had emerged in Britain as "the cognitive and ethical framework which gave meaning to reality"—that is, consciousness of being a nation is what inspired the British to build up their wealth. Nationalism freed money from its subordination to religion and turned the accumulation of wealth into the summum bonum of life.

Britain's economic success made it a political superpower. This stimulated "many a reactive nationalism" in other countries, their focus on economics "greatly contributing to the formation of the modern 'economic civilization.'" Without nationalism, economic growth would have stopped earlier, the motives recognized by economists being insufficient to explain the sustained hunger for wealth. Greenfeld cites Holland as a counterexample of an economy which, after a great spurt, declined in the seventeenth century because it lacked a national consciousness.

Greenfeld believes that nationalism "necessarily promotes the type of social structure which the modern economy needs to develop." Because it is, at least in principle, egalitarian— membership in the nation confers equal rights on all—it encourages social mobility, frees labor, encourages market forces, and gives prestige to hitherto disparaged groups like merchants. Nationalism can also set up a system of international competition, committing societies "which define themselves as nations to a race with a relative and therefore forever receding finishing line." When international competition includes the economy, this presupposes a commitment to constant growth. "In other words, the sustained growth characteristic of modern economy is not self-sustained; it is stimulated and sustained by nationalism."

Greenfeld's book can be read both as an attack on economists and as a debate within sociology. Against the economists, she makes the good, though scarcely original, point that economic behavior is shaped by cultural values, and that growth-resistant cultures cannot simply be explained as products of ignorance and superstition. Within sociology, the question is whether nationalism offers a better explanation for economic growth than does Weber's Protestant ethic. I think not, for three reasons.

First, it is far from clear how nationalism is supposed to produce the individual behavior necessary for economic growth. Weber's theory of the Protestant ethic postulates a functional relationship between frugality (self-denial) and capital accumulation (though it was Keynes who famously remarked that "mere abstinence is not enough by itself to build cities or drain fens." [4] ) Why should nationalism make people more systematically frugal or, for that matter, enterprising—as opposed to more systematically warlike? Greenfeld herself admits it does not have to. Military conscription is as much a product of nationalism as is universal suffrage.

Secondly, the Protestant ethic, being transnational, at least explains why growth happened in some countries, whereas nationalism doesn't. Greenfeld treats the emergence of nationalism in one country after another as "an unconnected series of historical accidents." It is therefore incapable of explaining economic growth in any country but that in which the nationalism occurs. Apart from the vague musings I have mentioned on "reactive nationalism" (itself not original) no plausible mechanism is offered by which growth is transmitted from one "nation" to another.

Thirdly, nationalism hardly explains the origins of British capitalism. As a political doctrine, it dates from the French Revolution; but England had developed the core institutions of a capitalist market economy long before this. To save her argument, Greenfeld has to say that nationalism was "the preponderant vision" of British society by 1600. But this is nonsense, since, far from being egalitarian and democratic, England in 1600 was a hierarchical society, ruled by a hereditary monarch who held down the non-English parts of his dominion by force. What is true is that by 1600, the English had developed a strong sense of national identity (not nationalism). This was embodied in the "patriotic" Tudor monarchy, and underpinned by the sense of being a Protestant nation locked into semipermanent war with the Catholic powers of Spain and (later) France.

Greenfeld is right to see a link between national feeling and economic growth, but the connection has to be made in a historical context, and this she fails to provide. Historically minded sociologists have located the political foundations of capitalism in the failure of Europe to develop a single center of power after the collapse of the Roman Empire. [5] From the ruins of the Roman imperium emerged feudalism, a fragmented, overlapping system of jurisdictions and states held together by Christianity; parts of that system had by the early sixteenth century coalesced into intensely competitive national monarchies. Feudalism checked arbitrary rule, leaving space for the growth of free cities, pan-European markets, and private property rights; military competition between states stimulated national feeling and turned the attention of rulers to augmenting the stock of national wealth, because of the close connection between wealth and power. Thus national identity and the growth-minded "spirit of capitalism" can be seen as joint products of European rivalry among states. In economic jargon, nationalism is a dependent, not an independent, variable. It is connected to growth through the competition of states. Even so, we are left with no explanation of why some nationalistic states, like Russia, failed to develop the "spirit of capitalism." Weber's Protestant ethic hypothesis remains superior for explaining why the growth experience of parts of Europe diverged from elsewhere.

Greenfeld tries to demonstrate her key claim, that economic rationality on its own is incapable of generating a commitment to "continuous" growth without the support of nationalism, by reference to Holland. Holland had a hundred-year "golden age," roughly between 1580 and 1680, then declined. Greenfeld writes: "The Dutch of the seventeenth and eighteenth centuries did not choose to become modern. They did not make a fetish of ever-continued growth.... They remained economically rational.... In other words, they were not a nation." There is a simpler explanation for Dutch "retardation": Britain struck at the heart of Dutch prosperity with the Navigation Act of 1651, which excluded Dutch ships from carrying any goods that went through British ports. "What we want is more of the trade the Dutch now have," said the Duke of Albemarle. In any case, the Dutch did not do so badly even after their "decline" started. They were overtaken by the British, but the Dutch population continued to rise at an increased income per capita—that is, the Malthusian population cycle was broken. In 1820, Holland was just behind England as the richest country in Europe in per capita terms—not a bad record for a country lacking an "orientation" to sustained growth.

3.
To turn from Greenfeld to Lucas is like emerging from an old curiosity shop into a modern office. There is no clutter. Lucas is an economist's economist. Much of his work is mathematical—inaccessible to the nonspecialist reader. His method is to construct "a mechanical, artificial world, populated by...interacting robots..., that is capable of exhibiting behav-ior the gross features of which resemble those of the actual world...." This is not a sales pitch for a wide readership. However, with great effort, even a nonspecialist reader can get some benefit from his spare volume of lectures, since Lucas provides a lucid introduction and nontechnical summaries of his main ideas. And such a reader may even come to feel the excitement of Lucas's passionate quest for the solution to the mystery of growth. "If we know what an economic miracle is," Lucas writes, "we ought to be able to make one."

The first four chapters of the book are made up of lectures given in the years between 1985 and 1997, beginning with the Marshall Lectures, "On The Mechanics of Economic Development," delivered at Cambridge, England. These introduce the main theme: Lucas's dissatisfaction with conventional growth theory and his search for an alternative capable of giving a more satisfactory explanation of economic growth—one not just able to explain the actual growth experience of the modern world, but to do so by showing how it is based on rational individual behavior.

In the traditional (i.e., post-1940s) growth models, economic growth was associated with the accumulation of physical capital—plant and equipment. The more capital a given population had, the higher its standard of living would be. But physical capital (like land) is subject to diminishing returns: the more capital there is, the less each additional unit of it adds to output. This suggested that all countries would converge on the same growth path: countries with less capital per person would grow faster, those with more would grow slower, and, once they had the same ratio of capital to labor, they would all end up growing at the same rate. What this rate would be depends on what happens to population and technology.

Lucas rejected this theory on two grounds. First, it failed to explain the actual divergence of growth across countries, with the richest countries now having twenty-five times more income per person than the poorest ones. Secondly, it made long-run growth depend on two "exogenous," i.e., unexplained, factors: population and technology. Economists are always uncomfortable with variables that their models cannot explain.

Lucas's alternative is known to economists as "endogenous growth theory"—in which growth is explained within the theory and does not depend on something happening outside it. Endogenous growth theory distinguishes between physical and human capital. Human capital is the skill and knowledge embodied in the labor force. A person's human capital is measured by the present market value of the increase in productivity conferred on that person by the acquisition of skills or qualifications. (For example, the higher lifelong earnings accruing to a college graduate as compared to a blue-collar high school dropout are a measure of the increase in human capital associated with a college education.) Unlike physical capital, however, the accumulation of human capital for the whole society is not subject to diminishing returns, but leads to increasing returns. This is because human capital formation is a "social activity, involving groups of people in a way that has no counterpart in the accumulation of physical capital." (Italics in the original.) That is, it has external, or spillover, effects. We learn from each other: in acquiring a skill each member of a group raises not just his own productivity but the skill level, and thus average productivity, of the whole group, whether in a factory or in an office.

This approach allows Lucas to offset the diminishing private returns resulting from the accumulation of physical (and human) capital with increasing social returns resulting from the improvement of human capital. There is no need for diminishing returns to total capital formation, both physical and human. If this is so, initial inequalities between countries in income levels can persist. Endogenous growth theory improves on traditional theory in two ways. It explains the divergence of growth experience over long periods of time, and it "endogenizes" technological progress—explains how it happens within the growth model.

What this kind of model cannot explain, however, is the phenomenon of "catch-up," particularly the East Asian economic "miracle" (although it is now looking rather tarnished). How was it that a group of countries in East Asia managed to achieve Western income levels, starting with much lower human capital? Lucas wrestles with this question for three chapters of his book. He makes some progress. In his 1991 lecture "Making a Miracle," he assumes that some of the spillover effects of human capital accumulation in any one country are worldwide: "Productivity-related knowledge is pictured as though it floated across national boundaries, like acid rain or volcanic ash." Unfortunately it does not float to all places. Accordingly, economic growth rates can still diverge greatly between nations. Those nations lucky enough to be watered by the rain of productivity-related knowledge grow more quickly. Others, unaffected by this "volcanic ash," remain stagnant. Why this uneven spread?

In his chapter "The Industrial Revolution: Past and Future," Lucas turns to population as the clue to the riddle. Today's growth theories assume that technological change expands only incomes; Ricardo and Malthus assumed that its main effect was to increase population. To understand why some countries and not others have joined the modern world we have to combine both theories: "That is, we need to discover a more general theory of which the two we now have can be seen as special cases...."

This general theory follows Nobel Prize winner Gary Becker in treating decisions about how many children a family should have as economic decisions. A family that wants to take advantage of an increased return to investment in knowledge does so by reducing its number of children so as to devote more resources to each child. For individual family decisions to affect the growth of a nation enough families must change their views about the possibilities for the future to "reduce fertility across economic classes." The historical catalyst for this "change of view" was the Industrial Revolution. As factory work replaced agricultural labor, it made more sense for households to invest in quality rather than quantity of labor. Fertility declined and voluntary mass education started.

Lucas cites that "great novel of economic development," V.S. Naipaul's A House for Mr. Biswas, to illustrate his theme. Born in rural Trinidad, the grandson of immigrants who came to Trinidad as indentured servants, Mohun Biswas becomes a journalist in Port-of-Spain. By the time he dies, his oldest son, Anand, is a scholarship student at Oxford. "Between Anand and Mohun Biswas's parents is the entire 25–1 difference between living standards in India and living standards in Western Europe and the United States." By incorporating population as well as technology into his model, Lucas has generalized his theory of economic development. All that is needed for it to happen is that "people must experience changes in the possible lives they imagine for themselves and their children."

Lucas's conclusion, as we can see, is diametrically opposed to Greenfeld's. Greenfeld explains economic growth by European (and Japanese) exceptionalism, in particular the rise of nationalism. Because it is historically contingent, the search for the "universally applicable formula of economic growth is a wild goose chase; it can never be found." Lucas disagrees. By abstracting from historical contingency he can focus all his attention on the universal, long-run consequences of the Industrial Revolution—which, unexplained, is his own Factor X. "Full participation in the economic benefits of the industrial revolution," Lucas writes, "is open to countries of all races and cultural backgrounds." He believes that the enormous inequality of the postwar period is at its all-time peak, and will decline in the future until something like the more egalitarian relative incomes of 1800 are restored. Nothing but "unstable domestic politics and mercantilist trade policies"—surely a major qualification—can keep the rest of the world from "follow[ing] Japan." And all this is an immense boon. "The legacy of economic growth that we have inherited from the industrial revolution is an irreversible gain to humanity, of a magnitude that is still unknown.... The legacy of inequality, the concomitant of this gain, is a historical transient."

Lucas's book is an outstanding intellectual achievement. But its propositions are likely to be fully persuasive only to those who already inhabit his mental universe. These people will applaud his heroic attempt to derive the history and prospects of growth solely from attempts by households to maximize their well-being. Others will object to the use of overambitious, over-simplified generalizations to explain the complex behavior of the real world. The central question is: How long does Lucas expect his universal "catch-up" to take? There has been very little change in the ranking of nations in the last two hundred years— just an enormous increase in inequality. And Mr. Biswas's case is hardly typical. Members of his family moved from India to Trinidad to England in three generations. Most families remain stuck wh ere they started. In view of this, the question posed by Max Weber is not so easily disposed of. Suppose one succeeds in implanting Western institutions in traditional societies. How long before the implants take?

Lucas avoids any discussion of public policies that will quicken growth or reduce poverty, beyond the need for governments to dispense birth control information and to finance education. His conception of human capital also seems excessively narrow. If we take what people used to call "character" as an important aspect of human capital and "trust" as an external effect of "character," what are we to conclude about the size of these external effects today? Human capital can't just be measured by "skills."

4.
Occupying different intellectual terrains, both Greenfeld and Lucas help our thinking about economic growth. Greenfeld raises the question of whether an obsession with growth is rational. The problem is not to explain the desire of people to improve their lot, but the organization of modern societies for continuous growth. It is easy enough to understand why people in poor countries should wish to get richer. They have the examples of rich and powerful countries before them. It is not so clear why the already rich should want to go on getting richer.

An earlier generation of economists assumed that as people became more efficient at satisfying their wants, they would—and should as rational agents —work less and enjoy life more. This view seems to have been replaced by the view that human wants are insatiable. We are constantly being urged to work harder, and save more, in order to satisfy wants continuously being created by advertising, whose main effect is to enlarge the human capacity for envy. The evidence, moreover, suggests that increasing real income fails to make citizens of rich countries happier. In other words, Western societies remain organized around an objectless disposition to continuous wealth-creation—something that did not exist in earlier times, and that remains, in some sense, peculiar to them.

Lucas's discussion raises the question of what kind of public policies are needed for countries to break out of poverty. He himself seems to believe that little in the way of government intervention is required to carry us all to Nirvana. But this is not an inescapable conclusion of endogenous growth theory. The possibility of countries escaping poverty depends heavily on government policies with respect to taxation, law and order, education, health care, transport and other infrastructure, public services, intellectual property, regulation of international trade and financial markets, and so on. The Harvard economist Robert Barro acknowledges that "government therefore has great potential for good or ill through its influence upon the long-term rate of growth." [6] The problem is that the governments of many poor countries lack the social capacity to implement appropriate policies. For those not prepared to wait as long as Lucas is, endogenous growth theory prepares the intellectual ground for a new form of interventionism, in which Western countries take over some part of the development of "human capital" in the poorest countries. The current language of "failed" states is the embryonic language of the new imperialism.

Notes
[1] Douglass C. North and Robert Paul Thomas, The Rise of the Western World: A New Economic History (Cambridge University Press, 1973), p. 2.

[2] John A. Hall, Powers and Liberties: The Causes and Consequences of the Rise of the West (Penguin, 1985), p. 141.

[3] John Stuart Mill, Principles of Political Economy, Book 1, Chapter 13 (London, 1871), pp. 236–237.

[4] John Maynard Keynes, A Treatise on Money, Vol. 2 (Macmillan, 1930). Reprinted in The Collected Writings of John Maynard Keynes, Vol. 6 (Royal Economic Society, 1971), p. 132.

[5] See for example Jean Baechler, The Origins of Capitalism, translated by Barry Cooper (St. Martins, 1976), and Hall, Powers and Liberties.

[6] Robert J. Barro, Determinants of Economic Growth: A Cross-Country Empirical Study (MIT Press, 1997), p. 6.