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Book Review: Determinants of Economic Growth

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Determinants of Economic Growth: A Cross-Country Empirical Study
by Robert J. Barro (Cambridge, Mass.: The MIT Press, 1997); 145 pages; $22.50.

The London School of Economics regularly hosts a Lionel Robbins lecture series. Lord Robbins, who in the 1930s was a vigorous and articulate proponent of Austrian economics, was a master in the history of economic ideas. In 1952, he published a study entitled The Theory of Economic Policy in English Classical Political Economy. Lord Robbins pointed out:

“It is the specific contribution of the Classical Economists that for the achievement of [the maximum material wealth for the greatest number of people in society] they recommended . . . the System of Economic Freedom. Given a certain framework of law and order and certain necessary government services . . . they conceived that the object of economic activity was best attained by a system of spontaneous cooperation. . . . It is the impersonal mechanism of the market which, on this view, brings about that the interests of the different individuals are harmonized . . . The idea of freedom. . . inspired their crusade against what they considered to be abuses of [political] authority.”

For the 1995-1996 academic year, the guest lecturer for the Lionel Robbins series was Harvard University economist Robert J. Barro. His lectures have now been published under the title Determinants of Economic Growth: A Cross-Country Empirical Study. They focus on the institutional factors that have been most conducive and most harmful for growth and rising standards of living in more than 100 countries around the world since 1960. An adherent of the quantitative approach to economic analysis, Professor Barro focuses on the statistical correlations between institutional influences and average rates of economic growth in various countries.

Professor Barro’s study can be considered an attempt at a statistical corroboration of the theoretical and historical conclusions reached by the classical economists, beginning with Adam Smith. His empirical hypothesis is the idea of “conditional convergence.” If all national economies were basically the same except for the respective amounts of capital with which they were endowed, then the hypothesis suggests that the countries with smaller amounts of capital would experience higher annual per capita rates of real growth than countries with larger endowments of capital. The long-run tendency, therefore, is for poorer countries to catch up with richer countries in terms of per capita Gross Domestic Product (GDP).

The convergence hypothesis is “conditional” because it depends upon various factors in each country, among which the central ones are: the rate of savings, the growth rate of population, the marginal productivity of labor, and, Barro says, “especially . . . government policies with respect to levels of consumption spending, protection of property rights, and distortions of domestic and international markets.” Investment in “human capital” in the form of secondary and higher education are highly significant in their effects on potential rates of growth. The better and more highly trained the work force, the more productive it will be in helping to enhance the rate of annual real output in a society. At the same time, the lower the rate of population increase relative to the rate of growth in the capital supply, the more capital can be invested per worker to increase the average output of each member of the work force.

And after looking at various types of government policies and their effects on economic growth in the surveyed countries, Barro concludes: “The growth rate tends to be higher if the government protects property rates, maintains free markets, and spends little on nonproductive consumption.” For example, his statistical results suggest that the practice of the rule of law — respect for individual rights, sanctity of contracts, security of property rights, low or minimal political corruption — can increase the average annual rate of growth by as much as 0.5 percent. Compounded over many years, that can have a dramatic effect on the standard of living in countries practicing the rule of law.

His next topic is the statistical relationship between democracy and economic growth. He points out that a dictator need not be an economic collectivist; he can respect or even try to stimulate free-market activities by minimizing various forms of government intervention and income redistributions. But, in general, Barro argues that “dictatorship is a form of risky investment” because you run the risk that the dictator might soon reverse his respect for the market and impose various forms of controls and confiscations.

Barro’s studies suggest that democracy within any country will rarely be stable or long-lasting if it is imposed from the outside by either a colonial or conquering power. If democratic forms of government are going to work, in other words, they must be homegrown. And they will tend to be homegrown only after a level of education and middle-class income status have been achieved by a certain percentage of the population.

The establishment of democratic institutions will tend to accelerate the rate of economic growth. At first, the advocates of democracy will demand protections for “negative” freedoms, i.e., rule of law, individual rights, respect for property, and various civil and personal liberties. But as democratic decision-making begins to encompass a growing number of issues that can be decided through the political process, the emphasis shifts to “positive” freedoms, i.e., privileges, subsidies, redistributions, regulations, and controls to benefit various individuals and groups at the expense of others in the society. Interventionist policies, invariably, slow down the rate of economic growth in the society as the free market is weakened or strangled by the growth of government.

Professor Barro’s third and last topic is the relationship between inflation and economic growth. Using statistical data for 64 countries, he finds that high and variable rates of price inflation have significant negative effects on economic growth. For example, a 10 percent increase in the average annual rate of inflation can reduce the growth rate in real per capita GDP by 0.3 percent to 0.4 percent per year. Over a 30-year period, this would mean a country’s real output would be 6 percent to 9 percent less than it might have been without such an inflation policy by government.

Especially interesting, Professor Barro found that the rate of inflation experienced by these countries was not significantly influenced by whether or not they had “independent” central banks, i.e., central banks supposedly insulated from direct political manipulation by their governments. Thus, the frequently heard arguments that all that is needed for monetary stability is to ensure that the central bankers are free from the immediate control of the government does not stand the test of the statistical evidence.

If space permitted, I would raise, from the perspective of the Austrian school of economics, a number of methodological questions about the uses of the statistical approach that Professor Barro has chosen to adopt. But in an age in which economists and public-policy makers are mesmerized by the quantitative method and statistical results to the fifth decimal point, it remains pragmatically valuable that the empirical aggregates and averages can be used to reinforce the wisdom of the classical economists and their case for economic freedom.

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).