Background

The 18th and 19th centuries saw, along with the rise of economics, an unprecedented explosion of economic growth, where people consistently became richer and saw improved living standards. This historically enormous rate of growth has continued to the present day. One of the earliest focuses of economics was what causes growth and how it can be promoted.

Mercantilism, 1500-1800

Mercantilists held that economic growth would arise from maintaining a positive balance of payments, and therefore that the government should support exports and restrict imports in order to maintain this. If a country exported more than it imported, it would receive large amounts of gold and silver from other countries; some early thinkers believed that such metals were the only source of value in the economy. This contradicts our current beliefs that any product can be a source of value for the economy. However, there is some logic to the mercantilist viewpoint, as discussed by Keynes in his General Theory: in a society where the currency is entirely gold-based, increasing the quantity of precious metals is the only way to increase the money supply; a money supply that does not grow with the real economy will cause deflation, which could depress real growth. However, this justification for mercantilist ideas on growth was not fully understood by mercantilists themselves, and their understanding of the sources of value and growth for an economy was poor. 4

Physiocrats, 1750-1800

Physiocrats such as Francois Quesnay also had theories of economic growth. In his Tableau Economique, Quesnay argued that all value and economic growth was derived from agriculture. He referred to the expenditures in the manufacturing sector as "sterile expenditures", which did not produce any value; he believed that only agriculture produced a surplus (more than necessary to provide for the workers). Agricultural production and expenditure, however, would circulate through the economy to produce an increase in income for everyone. This again contradicts the modern notion that any increases in production constitute economic growth. However, Quesnay was the first to develop the idea of the circular flow of income; that is, that the proceeds from economic growth would circulate through the economy to benefit everyone. This was visually illustrated in the Tableau.5

Classical econonomics, 1775-1850

The Classical theory of economic growth was developed by the leading Classical economists: Smith, Malthus and Ricardo. The first difference from the Physiocrats was that Classical economists generalised their principle of surplus to apply to all industries, not just agriculture. They believed that this surplus could generally be used for the accumulation of capital, which would contribute to growth by allowing more division of labour and greater productivity. They identified two other factors of production: land and labour. However, Ricardo noted that land was ultimately in limited supply; it cannot be created. This means that land growth could not contribute significantly to economic growth. Malthus' ideas on labour were also influential; he argued that population growth was dependent on economic growth, rather than a cause of it. As accumulation of capital produced higher incomes, people would be able to afford to have more children, and would therefore do so in accordance with their natural instincts. This would cause the higher income to be distributed among a larger population, so in practise GDP per capita would never increase significantly, in the long run. Technological progress was noted as a cause of growth, but was not given much attention; this is likely to be because the authors were writing before the progress of the Industrial Revolution had become obvious (Malthus was the last of the three to die, in 1834) and there had been no great leaps in productivity due to technology in recent history in Britain; furthermore, they believed that technological progress required capital, so the accumulation of capital remained the most important factor. They believed, in addition, that all of these factors of production and causes of growth were subject to diminishing returns. As a result, they thought that the economy would eventually reach a "stationary state", where both economic growth (and therefore population growth) had stopped. The theory of the stationary state was developed by John Stuart Mill.6, 7

Marx, 1850-1890

Marx's approach to economic growth theory was not revolutionary - he developed the Classical growth theory, rather than attempting to replace it. Having the advantage of writing later in the Industrial Revolution, he placed more focus on the role of technological progress in creating economic growth - and, indeed, on the role of entrepreneurs in causing this progress. He rejected the Malthusian idea that population would inevitably increase to match economic output, calling it "a libel on the human race" - in this he is supported by history. He also drew more attention to the affect that distribution and demand might have on growth; he observed that, if workers were paid too little, there would be less demand for products and therefore fewer profitable investments to makes, stifling economic growth.7

Schumpeter, 1920-1930

The Marginal Revolution shifted attention from macroeconomics to microeconomics, and theories of economic growth subsequently fell by the wayside. Joseph Schumpeter, writing in the 1920s and 30s, elaborated on Marx's points about the importance of innovation, technological progress and entrepreneurs to economic growth; he believed that innovation, and economic growth, required a process of "creative destruction", where old, failing business models are destroyed to make room for the new ones created by technology. He also thought that some degree of monopoly would benefit innovation and economic growth, as monopolies have extra funding with which to fund research and development that is not accessible when the same service is provided by lots of small firms.7, 8

Modern theory, 1945 -

After World War II, various more formal models of economic growth were created. The Harrod-Domar model proposed that economic growth depended on the marginal productivity of capital, the savings rate, and the rate of depreciation of capital. However, this focus on only capital was limiting, and the model made some unrealistic assumptions, such as that there were no diminishing marginal returns on capital. The model was later extended by Solow and Swan, who assumed diminishing returns, allowed for shifts in the use of capital and labour, and more explicitly included technological progress in the model. The Solow-Swan model thus mathematised most of the views on growth from past history, and remains the basic standard for economic growth models. However, it did not have an explanation for the causes of technological progress, but simply assumed this would take place; it also predicted that without technological progress, economic growth would eventually stop, as predicted by Classical Economists. In the 1980s, Paul Romer and Robert Lucas attempted to solve this problem by trying to create a model that included technological progress, trying to explain technological innovation and education; this is often referred to as "endogenous growth theory", endogenous meaning "included in the model". The implications of this model are that the best way to promote growth is to create an environment where innovation and new ideas can be created and adopted easily. It also suggests that developing countries can grow faster than developed countries because they are able to "catch up" by adopting technologies that were already created in developed countries, rather than having to create new ones, and that countries that resist new technologies will have slower growth. The approach is based on microfoundations - creating a model from microeconomic knowledge of human behaviour rather than starting by looking at the whole economy.18

The future

Over the last two centuries, we have developed a fairly clear idea of what causes economic growth. Population growth will tend to cause economic growth, but this will not make people better off since GDP per capita will not increase. The accumulation of capital is clearly important, as this raises productivity. Innovation, which depends on education, is also a highly important factor. Endogenous growth models go some way towards explaining how to promote innovation, but there is more room for development in this field, since these models still do not fit the empirical data we have on growth differences as well as might be hoped. Recent research on the role of political and social institutions may help to explain another important factor affecting long-run growth.