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«What makes some countries rich and others poor? Economists have asked this question since the days of Adam Smith. Yet after more than two hundred ...»

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The Enduring Elixir of

Economic Growth

Xavier Sala-i-Martin on the wealth

and poverty of nations

Brian Snowdon

What makes some countries rich and others poor? Economists have asked this

question since the days of Adam Smith. Yet after more than two hundred years,

the mystery of economic growth has not been solved.

Elhanan Helpman (2004)

If we want to understand why countries differ dramatically in standards of living we have to understand why countries experience such sharp divergences in long-term growth rates…. Economic growth is the part of macroeconomics that really matters.

Robert Barro and Xavier Sala-i-Martin (2003) Introduction Xavier Sala-i-Martin is widely recognised as one of the world’s leading economists in the field of economic growth. Since 1990, he has made numerous theoretical and empirical contributions to growth analysis, recognised by numerous awards, fellowships, and research grants.1 He is also the co-author, with Robert Barro, of Economic Growth (2003), the leading graduate textbook in the field.

Xavier Sala-i-Martin is Professor of Economics, Columbia University, USA. Brian Snowdon is Principal Lecturer in Economics at Newcastle Business School, Newcastle upon Tyne, UK.

Details of Professor Sala-i-Martin’s publications and professional activities can be found at his personal (and magnificently entertaining!) webpage: http://www.columbia.edu/~xs23/home.html.

WORLD ECONOMICS • Vol. 7 • No. 1 • January–March 2006 73 Xavier Sala-i-Martin interviewed by Brian Snowdon Educated at the Universitat Autònoma de Barcelona, and Harvard University, Professor Sala-i-Martin has taught at Yale (1990–96), and Columbia (1996–to date), where he is currently Professor of Economics.

He is also a Visiting Professor at Barcelona’s Universitat Pompeu Fabra (1994–2005), and was Visiting Professor at Harvard University in 2003–04.

Among his many professional activities, Professor Sala-i-Martin has been a consultant to the IMF and World Bank (since 1993), and Senior Economic Advisor to the World Economic Forum (since 2002). In 2002 he founded the ‘Umbele Foundation: A Future for Africa’. Professor Sala-iMartin is a Research Fellow at the Centre for European Policy Research, London, the Institute for Policy Research, Washington D.C., and the National Bureau of Economic Research, Cambridge, Massachusetts. He is also Associate Editor of the prestigious Journal of Economic Growth.2 In the interview that follows, I discuss with Professor Sala-i-Martin several important issues relating to economic growth and development. First, to provide some background to the interview, I review the historical context of recent research.

The elixir of economic growth The power and importance of economic growth in raising living standards is perhaps best illustrated by the history of the twentieth century. Despite two devastating World Wars, the Great Depression and collapse of international integration during the interwar period, and the rise and fall of the communist experiment, the majority of the world’s population are better off than their parents and grandparents in terms of income per capita ($PPP). If the worldwide dramatic gains in life expectancy are also taken into account, there has been a remarkable improvement in welfare (see Maddison, 2001; Becker et al., 2003; Crafts, 2003; Komlos and Snowdon, 2005).

In McCloskey’s (1994) words:

No previous episode of enrichment approaches modern economic growth; not China or Egypt in their primes, not the glory of Greece or the grandeur of Rome.

The Journal of Economic Growth, first published in 1997, is designed to serve as the main outlet for theoretical and empirical research in economic growth and dynamic macroeconomics.

–  –  –

Economic growth, not redistribution, is the single most powerful mechanism for generating long-term increases in income per capita. It will also act as the main source of divergences in living standards if growth rates differ across the regions and countries of the world. Over very short time horizons, the gains from moderate economic growth are often imperceptible to the beneficiaries, but the gains in the long run are highly visible. It is hardly surprising, then, that for many economists, to understand the causes of economic growth is far more important than gaining a better understanding of business cycles. As Barro and Sala-i-Martin (2003) argue, ‘If we can learn about government policy options that have even small effects on long-term growth rates, we can contribute much more to improvements in standards of living than has been provided by the entire history of macroeconomic analysis of countercyclical policy and fine tuning’. Although Keynes (1930) is normally associated with his work on short-run macroeconomic issues, at the beginning of the Great Depression, the worst business cycle in the history of capitalism, we find him reminding contemporary observers that they should not be blind ‘to what is going on under the surface—to the true interpretation of things…the power of compound interest over two hundred years is such as to stagger the imagination’.

Modern economic growth in historical perspective: extensive vs. intensive growth As Maddison’s data (Table 1) show, prior to the modern era living standards for the vast majority of the World’s population progressed at a glacial pace. Reflecting on the ‘Economic Possibilities of Our Grandchildren’,

Keynes (1930) commented that:

From the earliest times of which we have record… there was no very great change in the standard of life of the average man living in the civilised centres of the earth…This slow rate of progress, or lack of progress, was due to two reasons—to the remarkable absence of important technical improvements and to the failure of capital to accumulate.

As the numerous growth models reviewed by Barro and Sala-i-Martin (2003) show, capital accumulation and technology play a central role in the analysis of the causes of growth.

–  –  –

Since an increase in real GDP can either be absorbed by an increase in population, or lead to an increase in per capita income, it is important at the outset to distinguish between extensive and intensive growth. Extensive growth is a situation where an increase in GDP is fully absorbed by population increase, with no upward trend in per capita income (see Figures 1 and 2). Galor and Weil (2000) refer to this as a ‘Malthusian Growth Regime’. The pre-modern world economy was not characterised by persistent stagnation. The fact that for thousands of years the world’s population increased, even if ‘glacially slowly’, is evidence of extensive growth.

If we assume that for the vast majority of people, subsistence living was the norm, then a larger population is only possible if total output also rises (Kremer, 1993). So extensive growth has been ‘fairly common’ throughout human history.

In contrast, intensive growth is where GDP growth exceeds population growth, allowing a sustained rise in living standards as measured by real income per capita. Periods of intensive growth have usually been preceded by a long period of extensive growth, often lasting several centuries, and the significant ‘turning point’ for any economy is the period of transition from extensive to intensive growth. However, throughout most of human history the possibilities for sustained intensive growth in predominantly agrarian (organic) economies were extremely limited. The availability and productivity of land determined the amount of extensive growth, but once the supply of suitable agricultural land was exhausted, diminishing returns set in. When these forces are combined with Malthusian population dynamics it is hardly surprising to find that many classical economists predicted the inevitability of a long-run stationary state involving subsistence standards of living for the vast majority of humanity.

Eric Jones (1988) distinguishes between two forms of intensive growth, namely, ‘Smithian growth’ and ‘Promethean growth’. Smithian intensive growth relies on the gains to productivity that can be made from the division of labour, specialisation and trade. Such growth must eventually run into diminishing returns, as there are limits to the gains from resource reallocation. In contrast, Promethean intensive growth is sustainable, being driven by technological progress and innovation, and lies at the heart of the ‘capitalist growth machine’ (Baumol, 2002). It was in the latter part of the eighteenth century that we begin to see the emergence of Promethean WORLD ECONOMICS • Vol. 7 • No. 1 • January–March 2006 77 Xavier Sala-i-Martin interviewed by Brian Snowdon intensive growth in Britain with the coming of the Industrial Revolution.

Why did Promethean growth first emerge at this specific point in history, and, in this specific geographical location, i.e., Britain? This is the billiondollar question that many economists and economic historians have tried to answer (see, for example, Landes, 1998; Pomeranz, 2000; Jones, 2001;

Mokyr, 2006).

The phenomenon of intensive Promethean growth represents a distinctive ‘regime change’ and several economists have recently argued that any story of the growth process, in addition to accounting for the modern experience of sustained intensive growth, should also be able to account for the long period of Malthusian stagnation (see Snowdon and Vane, 2005).

Since the middle of the eighteenth century, human history has been dominated by the emergence and impact of the first ‘Industrial Revolution’. In the eighteenth and nineteenth centuries, economic growth was largely confined to a small number of countries, but gradually, modern economic growth spread from its origins in Great Britain to Western Europe, and initially to ‘Western Offshoots’ (overseas areas settled by European migrants; Maddison, 2001). As Figures 1, 2 and 3 indicate, even though world population has exploded during the last 250 years, average world living standards, measured by GDP per capita, have shown a marked improvement, and this achievement is due to the dramatic acceleration of world growth rates of per capita GDP. However, because the diffusion of the modern economic growth regime during the last 250 years has been highly uneven, and, in some cases, such as sub-Saharan Africa, negligible, the result is a current pattern of income per capita differentials between the richest and poorest countries of the world that almost defies comprehension. For example, the most recent World Bank data for 208 economies show that in 2004, Luxembourg (Rank 1) had a Gross National Income per capita (PPP) of $61,220, the USA (Rank 2) had $39,710, and the UK (rank 13) had $31,460. At the other end of the scale, Nigeria (Rank

193) had a GNI per capita (PPP) of $930, Ethiopia (Rank 200) had $810, and Malawi (Rank 208) had $620! Such huge disparities in living standards are a recent historical phenomenon.

But it is not all bad news. Sala-i-Martin’s recent research demonstrates that, especially during the last twenty-five years, significant improvements in living standards via growth have now spread to other heavily populated

–  –  –

Figure 2: World per capita GDP over time 8,000 7,000 6,000 5,000 4,000 $ 3,000 2,000

–  –  –

Figure 3: World per capita GDP over time: growth rates % –1 0–1000 1000–1500 1500–1820 1820–1870 1870–1913 1913–1950 1950–1973 1973–2000

–  –  –

Source: Based on Maddison’s data, http://www.ggdc.net/Maddison/ parts of the world, most significantly to China and India (two countries with a combined population of 2.3 billion people). This is now having a dramatic impact on reducing world poverty and inequality (see Sala-iMartin, 2002a, 2002b, 2002c, 2006). The main tragedy remains subSaharan Africa and ‘there should be no doubt that the worst economic disaster of the twentieth century is the dismal growth performance of the African continent’ (Artadi and Sala-i-Martin, 2003).

The importance of economic growth as a basis for improvements in human welfare and poverty reduction cannot be overstated, and is confirmed by numerous empirical studies (Dollar and Kraay, 2002). There is no better demonstration of this fact than the impact on living standards since 1960 of the comparative growth experiences of the ‘miracle’ East Asia economies with those of the majority of sub-Saharan African economies. Growth theory suggests that poor countries have enormous potential to ‘catch up’ through rapid growth. So, in many ways, the ‘miracle’ rapid growth of East Asia is much less of a puzzle to economists that the stagnation of sub-Saharan Africa.

WORLD ECONOMICS • Vol. 7 • No. 1 • January–March 2006 The Enduring Elixir of Economic Growth Developments in growth theory and empirics The classical economists, inspired by Adam Smith’s Wealth of Nations (1776), gave prominence to the issue of economic growth. An important message from Smith is that ‘little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and tolerable administration of justice’. In contrast, the growth models of Thomas Robert Malthus and David Ricardo, each for different reasons, generated pessimistic conclusions with respect to the possibility of long-term growth of living standards. Karl Marx’s model of capitalist development also predicted doom and gloom for the working classes. But, as Maddison’s data confirm (see Table 1), Smith was right concerning the capacity of successful capitalist market economies to generate sustained increases in living standards. The real income and life style of the working classes in the leading capitalist economies has been transformed beyond belief (see Clark, 2005).

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