R.E. Lucas, Jr, On the mechanics of economic development Krueger and Harberger document are of evident importance, but they seem me to pose a real paradox to the neoclassical theory we have, not a confirma- tion of It The main contributions of the neoclassical framework, far more important an its contributions to the clarity of purely qualitative discussions, stem from its ability to quantify the effects of various influences on growth Denison's monograph lists dozens of policy changes, some fanciful and many others seriously proposed at the time he wrote, associating with each of them rough upper bounds on their likely effects on U.S. growth. 0 In the main,the theory adds little to what common sense would tell us about the direction of each effect it is easy enough to guess which changes stimulate pr roduction, hence savings, and hence(at least for a time) economic growth. Yet most such changes, quantified, have trivial effects: The growth rate of an entire economy not an easy thing to move around. Economic growth, being a summary measure of all of the activities of an entire society, necessarily depends, in some way, on everything that goes on in a society Societies differ in many easily observed ways, and it is easy to identify various economic and cultural peculiarities and imagine that they are keys to growth performance. For this, as Jacobs(1984)rightly observes, we do not need economic theory: ' Perceptive tourists will do as well. The role of theory is not to catalogue the obvious, but to help us to sort out effects that are crucial, quantitatively, from those that can be set aside. Solow and Denison's work shows how this can be done in studying the growth of the U.s economy, and of other advanced economies as well. I take success at this level to be a worthy objective for the theory of economic development 3. Neoclassical growth theory: Assessment It seems to be universally agreed that the model i have just reviewed is not a heory of economic development. Indeed, I suppose this is why we think of growth'and'development' as distinct fields, with growth theory defined as those aspects of economic growth we have some unders development defined as those we dont. i do not disagree with this judgment, but a more specific idea of exactly where the model falls short will be useful in thinking about alternatives e to attempt he Solow -Denison framework to account for the diversity in income levels and rates of growth we observe in the world today, we would begin, theoretically, by imagining a world consisting of many Denison(1961, ch, 24). My favorite example is number 4 in this 'menu of choices available to crease the growth rate: 0.03 points [i.e, 0.03 of one percentage point] maximum potential Eliminate all crime and rehabilitate all criminals. This example and many others in this chapter are pointed rebukes to those in the 1960s who tried to advance their favorite(and often worthy
R.E. Lucas, Jr, On the mechanics of economic development economies of the sort we have just described, assuming something about the way they interact, working out the dynamics of this new model, and compar ing them to observations. This is actually much easier than it sounds(there isn't much to the theory of international trade when everyone produces the same, single good! ) so let us think it through The key assumptions involve factor mobility: Are people and capital free to move? It is easiest to start with the assumption of no mobility, since then we can treat each country as an isolated system, just like the one we have just worked out. In this case, the model predicts that countries with the same preferences and technology will converge to identical levels of income and asymptotic rates of growth. Since this prediction does not accord at all well with what we observe if we want to fit the theory to observed cross-country variations, we will need to postulate appropriate variations in the parameters (P, o,A, B and u)and /or assume that countries differ according to their initial technology levels, A(O). Or we can obtain additional theoretical flexibil ity by treating countries as differently situated relative to their steady-state paths. Let me review these possibilities briefly Population growth, A, and income shares going to labor, 1-B, do of cours differ across countries, but neither varies in such a way as to provide an account of income differentials. Countries with rapid population growth are not systematically poorer than countries with slow-growing populations, as the theory predicts, either cross-sectionally today or historically. There are,cer- tainly, interesting empirical connections between economic variables(narrowly defined)and birth and death rates, but I am fully persuaded by the work of Becker(1981)and others that these connections are best understood as arising from the way decisions to maintain life and to initiate it respond to economic conditions. Similarly, poor countries have lower labor shares than wealthy countries, indicating to me that elasticities of substitution in production are below unity(contrary to the Cobb-Douglas assumption I am using in these examples), but the prediction(9)that poorer countries should therefore grow more rapidly is not confirmed by experience The parameters p and o are as observed earlier, not separately identified but if their joint values differed over countries in such a way as to account for income differences, poor countries would have systematically much higher (risk-corrected)interest rates than rich countries. Even if this were true, I would be inclined to seek other explanations. Looking ahead, we would like also to be able to account for sudden large changes in growth rates of ndividual countries. Do we want a theory that focuses attention on sponta neous shifts in people's discount rates or degree of risk aversion? Such theories are hard to refute, but i will leave it to others to work this side of the street Consideration of off-steady-state behavior would open up some new poss bilities, possibly bringing the theory into better conformity with observation but i do not view this route as at all promising. Off steady states, (9)need not hold and capital and output growth rates need not be either equal or constant
R E. Lucas, Jr, On the mechanics of economic development but it still follows from the technology(2 )that output growth(gyu, say) and capital growth(gkn, say), both per capita, obey gy=Bgk+μ But 8y and gkr can both be measured, and it is well established that for no value of B that is close to observed capital shares is it the case that gyt-pgki is even approximately uniform across countries. Here Denison,s Law works against us: the insensitivity of growth rates to variations in the models underlying parameters, as reviewed earlier, makes it hard to use the theory to account for large variations across countries or across time. To conclude that even large changes in'thriftiness'would not induce large changes in U.S growth rates is really the same as concluding that differences in Japanese and U.S. thriftiness cannot account for much of the difference in these two economies' growth rates. By assigning so great a role to technology'as a urce of growth, the theory is obliged to assign correspondingly minor roles to everything else, and so has very little ability to account for the wide diversity in growth rates that we observe Consider, then, variations across countries in ' technology'-its level and rate of change. This seems to me to be the one factor isolated by the neoclassical model that has the potential to account for wide differences in income levels and growth rates. This point of departure certainly does accord with everyday usage. We say that Japan is technologically more advanced than China, or that Korea is undergoing unusually rapid technical change, and such statements seem to mean something(and I think they do). But they canno mean that the 'stock of useful knowledge[in Kuznets's(1959)terminology] is higher in Japan than in China, or that it is growing more rapidly in Korea than elsewhere. 'Human knowledge' is just human, not Japanese or Chinese or Korean. I think when we talk in this way about differences in 'technol across countries we are not talking about 'knowledgein general, but about the knowledge of particular people, or perhaps particular subcultures of people. If so, then while it is not exactly wrong to describe these differences b an exogenous, exponential term like A(t) neither is it useful to do so. We want a formalism that leads us to think about individual decisions to acquire knowledge, and about the consequences of these decisions for productivity The body of theory that does this is called the theory of human capital,, and I going to draw extensively on this theory in the remainder of these lectures the moment, however, I simply want to impose the terminological conven tion that 'technology'-its level and rate of change- will be used to refer to something common to all countries, something pure' or 'disembodied,, some thing whose determinants are outside the bounds of our current inquiry In the absence of differences in pure technology then, and under the assumption of no factor mobility, the neoclassical model predicts a strong tendency to income equality and equality in growth rates, tendencies we can
R.E. Lucas, Jr, On the mechanics of economic developmen observe within countries and, perhaps, within the wealthiest countries taken as a group, but which simply cannot be seen in the world at large. When factor mobility is permitted, this prediction is very powerfully reinforced. Factors of production, capital or labor or both, will flow to the highest returns, which is to say where each is relatively scarce. Capital-labor ratios will move rapidly to equality, and with them factor prices. Indeed, these predictions survive differ- ences in preference parameters and population growth rates. In the model as stated, it makes no difference whether labor moves to join capital or the other way around. (Indeed, we know that with a many-good technology, factor price equalization can be achieved without mobility in either factor of production. The eighteenth and nineteenth century histories of the Americas, Australia and South and East Africa provide illustrations of the strength of these forces for equality, and of the ability of even simple neo-classical models to account for important economic events. If we replace the labor-capital technology of the Solow model with a land-labor technology of the same form, and treat labor as the mobile factor and land as the immobile, we obtain a model that predicts exactly the immigration flows that occurred and for exactly the reason- factor price differentials -that motivated these historical flows Though this simple deterministic model abstracts from considerations of risk and many abstraction is evidently not a fatal one her elements that surely played a role in actual migration decisions thi In the present century, of course, immigration has been largely shut off, so it is not surprising that this land-labor model, with labor mobile, no longer gives an adequate account of actual movements in factors and factor prices. What is surprising, it seems to me, is that capital movements do not perform the same functions. Within the United States, for example, we have seen southern labor move north to produce automobiles. We have also seen textile mills move from New England south(to'move'a factory, one lets it run down and builds its replacement somewhere else: it takes some time, but then, so does moving families)to achieve this same end of combining capital with relatively low wage labor. Economically, it makes no difference which factor is mobile,so long as one is Why, then, should the closing down of international labor mobility have slowed down, or even have much affected the tendencies toward factor price equalization predicted by neoclassical theory, tendencies that have proved to be so powerful historically? If it is profitable to move a textile mill from New England to South Carolina, why is it not more profitable still to move it to Mexico? The fact that we do see some capital movement toward low-income countries is not an adequate answer to this question, for the theory predicts that all new investment should be so located until such time as return and real wage differentials are erased. Indeed, why did these capital movements not take place during the colonial age, under political and military arrangements that eliminated (or long postponed) the 'political risk'that is so frequently