The Determinants of Economic Growth Remain A Mystery

The quest for the key policies to help poor countries grow remains unfulfilled. New research by Daniel Henderson, Chris Papageorgiou and Christopher Parmeter, published in the March 2012 issue of the Economic Journal, suggests that a key reason for the seemingly impossible growth riddle lies in the highly nonlinear relationships between potentially effective policies and growth across countries and over time.

The results of the study, which uses frontier econometric methods to analyse data from more than 70 countries over a period of 40 years, suggest an important role for government but no ”one-size-fits-all” set of policies. As the authors conclude:

”While it is comforting to know that governments have a hand in promoting economic growth, there is not a fixed set of ground rules that any government can undertake to achieve a specific level of economic growth generically.”

The researchers note that thousands of academic papers have been written with the singular aim of identifying the main determinants of economic growth. Hundreds of possible growth determinants have been considered with the list becoming longer every year.

But previous work on the determinants of growth has typically assumed linear relationships. In contrast, the analysis in this new study shows that the assumption is highly problematic as many growth effects are highly nonlinear.

For example, while economists can agree that reducing inflation is good for economic growth, it is not clear that reducing inflation from 10% to 9% will have the same impact on economic growth of reducing inflation from 4% to 3%.

The authors comment:

”It is fascinating to observe how growth has accelerated in many sub-Saharan African countries over the last two decades and the convergence process that we see unfolding between several emerging markets – notably in Latin America and Asia – and the advanced economies in the west.

”What is even more fascinating though is the realisation that these dynamic economies have been successful by following very different growth paths, implementing different policies and under different institutional and political systems.”

The insights from this research imply that ”one-size-fits-all” policies to improve economic growth are likely to fail. And if one ignores nonlinearities, policy recommendations based on a specific growth theory may not offer the correct prescription.

In either setting, nonlinearities provide evidence about the underlying growth dynamics and ignoring their testimony may result in a mistrial when judging any specific growth theory.

The authors say that their new results should be interpreted with care: they are drawn from more than 70 countries over a period of 40 years (1965-2000). Therefore, there is no way of telling if a specific government initiative in any specific country will promote growth:

”It remains the case that governments can control how successful their countries are moving forward but mysteries still abound for any specific country.”

”Growth Empirics Without Parameters” by Daniel Henderson, Chris Papageorgiou and Christopher Parmeter is published in the March 2012 issue of the Economic Journal.

Daniel Henderson

State University of New York at Binghamton | +1-607-777-4480 | djhender@binghamton.edu

Chris Papageorgiou

International Monetary Fund | +1-202-623-7503 | cpapageorgiou@imf.org

Christopher Parmeter

University of Miami | +1-305-284-4397 | cparmeter@bus.miami.edu