CHAPTER FOUR

HISTORIC GROWTH AND CONTEMPORARY DEVELOPMENT: LESSONS AND CONTROVERCIES

4.1 The Economics of Growth: Traditional and Modern

Approaches:
 Instead of summarizing the models and ideas presented so far, a
brief discussion of what we have learned from the models and
how they offer a useful perspective on world growth and cross-
country income differences.
What Have We Learned?
 Let us first summarize the most important aspects and take away

lessons of our analysis.

Growth as the Source of Current Income Differences:

 At an empirical level, the investigation of economic growth is

important not only for understanding the growth process, but
also because the analysis of the sources of cross-country
income differences today requires us to understand why some
countries have grown rapidly over the past 200 years while
others have not.
 The role of Physical capital, Human capital, and Technology:

 Cross-country differences in economic performance and

growth over time are related to physical capital, human
capital, and technology. Part of our analysis has focused on the
contributions of these factors to production and growth.

 One conclusion that has emerged concerns the importance of

technology in understanding both cross-country and over-time
differences in economic performance.
 Structural Changes and Transformations:

 Structural changes include changes in the composition of

production and consumption, urbanization, financial
development, changes in inequality of income and inequality of
opportunity, the transformation of social and living
arrangements, changes in the internal organization of firms, and
the demographic transition.
 Lack of structural transformation is not only a symptom of
stagnation but is also often one of its causes.
 Societies may fail to take off and benefit from the available
technology and investment opportunities, partly because they
have not managed to undergo the requisite structural
transformations and thus lack the type of financial relations, the
appropriate skills, or the types of firms that are conducive to the
adoption of new technologies.
Policy, Institutions, and Political economy:
 The reward structures faced by firms and individuals play a

central role in shaping whether they undertake the investments

in new technology and in human capital necessary for takeoff,
industrialization, and economic growth. These reward
structures are determined by policies and institutions.
 First, they directly determine the society’s reward structure,
thus shaping whether investments in physical and human
capital and technological innovations are profitable.
 Second, they determine whether the infrastructure and

contracting arrangements necessary for modern economic

relations are present. For example, modern economic growth
would be impossible in the absence of some degree of contract
enforcement, the maintenance of law and order, and at least a
minimum amount of investment in public infrastructure.
 Third, they influence and regulate the market structure, thus
determining whether the forces of creative destruction are
operational so that new and more efficient firms can replace
less efficient incumbents.

 Finally, institutions and policies may sometimes (or perhaps

often) block the adoption and use of new technologies to
protect politically powerful incumbent producers or stabilize
the established political regime.

 Thus to understand the process of modern economic growth,

we need to study the institutional and policy choices that
societies make.
INSTITUTIONS FOR HIGH-QUALITY GROWTH
 The comparative experience with economic growth
over the last few decades has taught us a number of
lessons. One of the more important of these is the need
for private initiative and incentives.
 All instances of successful development are ultimately
the collective result of individual decisions by
entrepreneurs to invest in risky new ventures and try
out new things.
 Investment decisions, agricultural production, and
exports turn out to be quite sensitive to price incentives,
as long as these are perceived to have some
predictability.
 It became clear that incentives would not work or
would generate perverse results in the absence of
adequate institutions.
 We need institutions that establish and protect
property right and enforce contracts.
 The rest of this section discusses five types of
market-supporting institutions, each responding to
one of these failures: property rights; regulatory
institutions; institutions for macroeconomic
stabilization; institutions for social insurance; and
institutions of conflict management.
TYPES OF MARKET-SUPPORTING INSTITUTIONS

Property Rights

 As North and Thomas (1973) and North and Weingast

(1989), among many others, have argued, the establishment
of secure and stable property rights has been a key element
in the rise of the West and the onset of modern economic
growth.
 It stands to reason that entrepreneurs do not have the
incentive to accumulate and innovate unless they have
adequate control over the return to the assets that are
thereby produced or improved. Note that the key word is
“control” rather than “ownership.” Formal property rights
do not count for much if they do not confer control rights.
 Regulatory Institutions
 Markets fail when participants engage in fraudulent or

anticompetitive behavior.
 They fail when transaction costs prevent the internalizing

of technological and other non pecuniary externalities.

 And they fail when incomplete information results in

moral hazard and adverse selection.

 Economists recognize these failures and have developed

the analytical tools required to think systematically about

their consequences and possible remedies.
 Theories of the second best, imperfect competition,

agency, mechanism design, and many others offer an

almost embarrassing choice of regulatory instruments to
counter market failures.
 In practice, every successful market economy is overseen
by panoply of regulatory institutions, regulating conduct
in goods, services, labor, assets, and financial markets.
 In fact, the freer are the markets, the greater is the burden
on the regulatory institutions.
 It is important to recognize that regulatory institutions
may need to extend beyond the standard list covering
antitrust, financial supervision, securities regulation, and
a few others.
 Recent models of coordination failure and capital market
imperfections make it clear that strategic government
interventions may often be required to get out of low-
level traps and elicit desirable private investment
responses.
Institutions for Macroeconomic Stabilization
 Since Keynes, we have come to a better understanding of

the reality that capitalist economies are not necessarily

self-stabilizing. He worried about aggregate demand and
the resulting unemployment. More recent views of
macroeconomic instability stress the inherent instability
of financial markets and its transmission to the real
economy.
 All advanced economies have come to acquire fiscal and

monetary institutions that perform stabilizing functions,

having learned the hard way about the consequences of
not having them. Probably most important among these
institutions is a lender of last resort—typically the central
bank—which guards against self-fulfilling banking crises.
 Institutions for Social Insurance
 A modern market economy is one where change is constant and

idiosyncratic (i.e., individual-specific) risk to incomes and

employment is pervasive.
 Modern economic growth entails a transition from a static economy

to a dynamic one where the tasks that workers perform are in constant
evolution, and movement up and down in the income scale is
frequent.
 One of the liberating effects of a dynamic market economy is that it

frees individuals from their traditional entanglements—the kin group,

the Church and the village hierarchy. The flip side is that it uproots
them from traditional support systems and risk-sharing institutions.
 Gift exchanges, the fiesta, and kinship ties—to cite just a few of the

social arrangements for equalizing the distribution of resources in

traditional societies—lose much of their social insurance functions.
 The huge expansion of publicly provided social insurance programs

during the twentieth century is one of the most remarkable features of

the evolution of advanced market economies.
Institutions of Conflict Management

 Societies differ in their cleavages. Some are made up of an

ethnically and linguistically homogeneous population
marked by a relatively egalitarian distribution of resources
(Finland). Others are characterized by deep cleavages along
ethnic or income lines (Nigeria).
 These divisions, when not bridged adequately, can hamper
social cooperation and prevent the undertaking of mutually
beneficial projects. Social conflict is harmful both because it
diverts resources from economically productive activities
and because it discourages such activities by the uncertainty
it generates.
 Healthy societies have a range of institutions that make such
colossal coordination failures less likely.
 The rule of law, a high-quality judiciary, representative
political institutions, free elections, independent trade
unions, social partnerships, institutionalized representation
of minority groups, and social insurance are examples of
such institutions.
 These arrangements function as institutions of conflict
management because they entail a double “commitment
technology”: they warn the potential “winners” of social
conflict that their gains will be limited, and assure the
“losers” that they will not be expropriated.

 They tend to increase the incentives for social groups to

cooperate by reducing the payoff to socially uncooperative
strategies.
Getting Institutions Right:
 There is now widespread agreement among economists

studying economic growth that institutional quality holds the

key to prevailing patterns of prosperity around the world.
 Rich countries are those where investors feel secure about

their property rights, the rule of law prevails, private

incentives are aligned with social objectives, monetary and
fiscal policies are grounded in solid macroeconomic
institutions, idiosyncratic risks are appropriately mediated
through social insurance, and citizens have civil liberties and
political representation.
 Poor countries are those where these arrangements are absent

or ill-formed. Of course, high-quality institutions are perhaps

as much a result of economic prosperity as they are its cause.
 We need to distinguish between stimulating
economic growth and sustaining it. Solid
institutions are much more important for the
latter than for the former. Once growth is set
into motion, it becomes easier to maintain a
virtuous cycle, with high growth and
institutional transformation feeding on each
other.
THE CONCEPT OF SOCIAL CAPITAL
 The term “capital”, according to the Merriam--Webster
Dictionary refers to “accumulated wealth, especially as used
to produce more wealth.” It is usually identified with
tangible, durable, and alienable objects, such as buildings
and machines, whose accumulation can be estimated and
whose worth can be assessed (Solow, 2000).

 As Field says, “in economic thought, the term ‘capital’

originally meant an accumulated sum of money, which
could be invested in the hope of a profitable return in the
future (Field, 2003).
 Bourdieu has argued that capital exists in three
fundamental forms:
 Economic capital that can be directly convertible

into money and institutionalized in the form of

property rights;
 Cultural capital that may be convertible into
economic capital and institutionalized in the form of
educational qualification; and
 Social capital, made up of social obligation that can

be convertible into economic capital and

institutionalized in the form of a title of nobility.
 So the different forms of capital are inter-convertible.
 Irrespective of disciplinary focus, there is growing consensus
among researchers that three leading figures, Bourdieu,
Coleman, and Putnam, have made great contributions.
 Bourdieu and Coleman emphasize the role of individual and
organizational social ties in predicting individual
advancement and collective action.
 By contrast, Putnam has developed the idea of association
and civic activities as a basis for social integration and well-
being (Edwards, 2001).
 Despite these differences, all three of these scientists argue
that social capital inheres in personal connections and
interpersonal interactions, together with the shared sets of
values that are associated with these contacts and
relationships.
 Lin (2001) refers to these connections as social networks
“the social relationships between individual actors, groups,
organizations, communities, regions and nations that serve
as a resource to produce positive returns.” The major
composition of network is size (the number of ties that a
person has in his personal network) and heterogeneity (the
tendency toward similar or diverse actors within a network).
 For Bourdieu social capital represented an “aggregate of the
actual or potential resources which are linked to possession
of a durable network.” He stressed that access to social
capital occurred via the development of durable
relationships and networks of connections especially those
among prestigious groups with considerable stocks of
economic and cultural capital.
 In many ways, his thinking on social capital was deeply
influenced by Marxist sociology. He argued that “economic
capital is at the root of all other types of capital” and that it
combined with other forms of capital to create and reproduce
inequality.
 For Bourdiue, inequality could be explained by the production
and reproduction of capital in obeisance to the social hierarchy.
 Sociologist James Coleman’s study of social capital has been
particularly influential. He incorporated his insights on
sociology and economics into a rational choice theory of social
capital.
 Based on his empirical studies of youth and schooling, he
defined the concept of social capital as a “variety of entities that
all consist of some aspect of social structures and facilitate
certain actions of actors—whether personal or corporate actors
—within the structure.” He highlighted the difference between
social capital and human capital.
 For Coleman, social structure becomes social capital when an
actor effectively uses it to pursue his interests. Both Bourdieu
and Coleman focused on individuals and their roles and
relationships with other individuals within a network as their
primary unit of analysis of social capital.
 The view that the actions of individuals and groups can be
greatly facilitated by membership in specific social networks,
is most common among sociologists.
 In contrast to the view that social capital exists as an external
factor, many sociologists and some political scientists believe
that social capital arises from the positive interactions that
occur between individuals in a network (Lesser, 2000).
 They consider social capital to be “a feature of the internal
linkages that characterize the structures of collective actors
and give them cohesiveness and its associated benefits.”
 Robert Putnam has played a leading role in popularizing the
concept of social capital. He defined it as “features of social
organizations, such as trust, norms and networks that can improve
the efficiency of society by facilitating coordinated actions.
 After studying American civil society, he modified his definition
of social capital to “features of social life—networks, norms, and
trust—that enable participants to act together more effectively to
pursue shared objectives.”
 He identified ‘participants’ instead of ‘society’ as the beneficiaries
of social capital. In his book Bowling Alone, Putnam (2000)
argued that “the core idea of social capital is that social networks
have value…social contacts affect the productivity of individuals
and groups.”
 He referred to social capital as “connections among individuals –
social networks and the norms of reciprocity and trustworthiness
that arise from them.
THE VIEW OF OTHER INTELLECTUALS
 Fukuyama has analyzed the link between trust,
social capital and national economic success. He
defined social capital as “the ability of people to
work together for common purposes in groups
and organizations (Fukuyama, 1995: 10).”
 He further expanded the definition of social
capital “as the existence of a certain set of
informal values or norms shared among members
of a group that permit cooperation among them.”
 Woolcock (1998) has referred to social capital as “the
information, trust, and norms of reciprocity inhering in
one’s social networks.”

 Nahapiet and Ghoshal (1998) have further elaborated

the concept and defined it as “the sum of the actual and
potential resources embedded within, available
through, and derived from the network of relationships
possessed by an individual or social unit.

 Social capital thus comprises both the network and the

assets that may be mobilized through that network.
KUZNET’S SIX CHARACTERSTICS OF MODERN ECONOMIC
GROWTH

 He defined Economic Growth as “a long term

rise in capacity to supply increasingly diverse
economic goods to its population, this growing
capacity based on advancing technology and the
institutional and ideological adjustments that it
demands.”
 Kuznet has isolated six characteristic features
manifested in the growth process of almost
every developed nation:
1. High rates of Growth of PC output and
population.
2. High rates of increase in Total Factor
Productivity.
3. High rates of Structural Transformation of the
Economy i.e., Agriculture to non -agriculture.
4. High rates of Social and Ideological
Transformation i.e., Modernization,
urbanization.
5. The propensity of economically developed countries to
reach out to the rest of the world for markets and raw
materials.
6. The limited spread of this economic growth to only a third
of the world’s population (15%)
 The six characteristics of modern growth reviewed here are

interrelated and mutually reinforcing. High rates of PC out

put result from rapidly rising levels of factor productivity.
High PC incomes in turn generate high level of PC
consumption, thus providing the incentives for changes in
the structure of production. Advanced technology needed
to achieve these out put and structural change causes the
scale of production and the characteristics of economic
enterprise units to change in organization and location etc.