What policies lead to economic growth?
Matthew McCartney, also writing in the Post-Autistic Economics Review, probes why economists know so little about economic growth when it comes to empirical research, and comes away skeptical about the merits of cross-country growth regressions:
This paper is concerned with how economic growth is analysed by economists. Over the last fifteen years an extremely common method has been through cross-country growth regressions. Section two shows how economic theory demonstrates that there should be a strong link between changes in economic policy and economic growth. Despite the implications of such theory empirical results using cross-country growth regressions remain disappointing. Section two demonstrates this using relevant empirical results in both a general manner and specifically those between economic growth and fiscal policy, investment, education and R+D.
The third section shows that the long-term averages typically used in cross-country growth regressions hide an important empirical reality of growth in developing countries. The medium-term growth averages used by cross-country regressions conceal the periods of stagnation, growth spurts, structural breaks, volatility and instability that actually characterise growth in developing countries. When confronted with these ‘empirical’ problems researchers typically stop and try to confront what they perceive as an empirical challenge. Researchers seek for better proxies for variables such as ‘education’, refine measures of ‘trade openness’ more precisely, and perhaps most commonly seek out longer and better data sets. Other methods have included the use of panel data and techniques such as ‘trimmed least squares’. Some researchers venture further realising that there may be more than an empirical problem at work, in particular that the theory relating growth and economic policy may be more complex than allowed for by simple cross-country regressions. If this is the case then the emphasis on improved data and technical refinements to the econometrics may be fruitless.
Section four explores a number of theoretical reasons why cross-country regressions may be an intrinsically poor method to isolate the link between changes in policy and changes in economic growth rates. Those analysed here are complementarity among policy variables, the relation between different theories of growth, hysteresis effects and dynamics. As demonstrated in this section, responses by researchers to these theoretical problems have been much more ad hoc.
Section five demonstrates the final problem of cross-country growth regressions that has rarely been faced by orthodox researchers. Far from being a positivist statistical exercise, cross-country growth regressions are bound to an underlying neo-classical assumption – that the growth process is universal. Each individual country in cross-section according to this view will provide evidence that can be used to elucidate the one underlying universal economic relation. An increase in openness for example is hypothesised to have the same effect on growth in all countries. There is a limited amount of evidence that can be teased out of existing cross-country growth regressions that suggests each growth experience should be treated as potentially unique, i.e. as a case study.
The last section concludes by suggesting that heterodox or post-autistic economists should open up the assumption of universalism to greater scrutiny and ask why the growth process may differ across time and space. In practical terms this would question the neo-classical assumption of universalism and with it the ‘one-size-fits-all’ programmes of liberalisation emanating from the World Bank, IMF and other institutions. A case study approach to economic growth would be justified on the assumption that growth processes are not universal. Comparative and historically informed case studies allow researchers to question the assumption of universality rather than be forced to assume it true a priori.