How New Is New Growth Theory?

How New Is New Growth Theory?Author(s): Richard NelsonSource: Challenge, Vol. 40, No. 5 (SEPTEMBER-OCTOBER 1997), pp. 29-58Published by: M.E. Sharpe, Inc.Stable URL: http://www.jstor.org/stable/40721855 .

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How New Is New Growth Theory? Richard Nelson

The author says that most of the basic premises of the "new" growth theory were well known more than a generation ago. And he is concerned that the current belief that growth theory must conform to a general equilibrium model may restrict what we know about how economies grow rather than expand our knowledge.

at least the late 1950s, most formal neo-classical models of economic growth have recognized technical advance as the key driving force. Thus, they have also been consis-

tent with a central conclusion of the empirical research on the sources of growth. However, most of the earlier formal models were mute or incoherent regarding the sources of technical advance. Recognition of this fact has led, over the past decade, to the development of a family of new formal neo-classical growth models - which make technological advance endogenous -

involving the profit-seeking investments of business firms (see Aghion and Howitt 1990; Grossman and Helpman 1989; and Romer 1990). These models capture in stylized form several

RICHARD NELSON is Henry Luce Professor of International Economy at Columbia University. A number of people made helpful comments on earlier versions of this article, and, without implicating them in any way, the author thanks the following individuals: Moses Abramovitz, Giovanni Dost, Zvi Griliches, John Kendrick, Theo van de Klundert, Franco Malerba, Paul Romer, and Robert Solow.

Challenge, vol. 40, no. 5, September/October 1997, pp. 29-58. © 1997 M.E. Sharpe, Inc. All rights reserved. ISSN 0577-5132 / 1997 $9.50 + 0.00. Challenge/ September-October 1997 29



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understandings about technical advance that for many years have been well documented by empirical scholars.1

To incorporate features that make research and development profitable for firms, these models depart from earlier ones in one or both of the following ways: First, firms are able to main- tain ownership of at least a portion of the value of the increased productivity or better product performance won through their research and development. Second, in accordance with the recognition that technology is to some degree proprietary, and also

Some models treat technical advance as a process of "creative destruction, " in which a new technology makes older ones obsolete.

that support of research and development is feasible only if price exceeds production cost by some margin, markets are assumed to be imperfectly rather than perfectly competitive.

Endogenizing technical advance in this way has been comple- mented by the incorporation of other features. For example, some models treat technical advance as a process of "creative destruction/' in which a new technology makes older ones obsolete. Others take into consideration "externalities" - additional ben- efits, so to speak, from research and development investments or from such other activities as education. Upfront research and development investments and, in some models, other factors can generate economies of scale.2

The characterization above does not do justice to the elegance of some of the new growth models, nor does it lay out the variety.3 First, these formal models are different than most of the earlier ones in ways that appear to make them more "realistic." They capture, in stylized form, at least some of the features of

30 Challenge/September-October 1997



How New Is New Growth Theory?

growth fueled by technical advance, long known to be important by many economists studying the topic empirically. Incor- poration of these features almost certainly makes it easier for formal growth theorizing to engage effectively with the empirical work of economists trying to come to terms with the puzzling features of economic growth.

However, second, this brief review also suffices to highlight the fact that the phenomena incorporated in the new formal models, and neglected in many of the old ones, scarcely repre- sent novel new insights or ideas. The basic notions - "technical change is largely endogenous"; "technology is at least somewhat proprietary"; "market structures supporting technical advance are not perfectly competitive"; "new technology often obsoletes old technology"; "growth fueled by technical advance involves externalities and economies of scale"; and "the investment rate may matter in the long run" - scarcely smack of nov- elty. All have been part of the body of understanding of those studying economic growth and technical advance for a long time. Indeed, Moses Abramovitz of Stanford put forth most of these propositions in his review article on the economics of growth, written in 1952.

The authors of the new models might respond that a causal argument is not well posed until it is articulated formally. But it is also important to note that, while the new models have incorporated understandings about technical change and economic growth won by economists who have studied the subject empirically, the models sometimes neglect or misspecify what seem to be equally important parts of those understandings. Thus, virtually all detailed empirical inquiry into major technological advance has highlighted the inability of the actors involved to foresee the path of development, even in broad outline, or the major surprises that often occurred along the path. In contrast, the new models assume perfect foresight or, if they admit less

Challenge/September-October 1997 31



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than that, that uncertainty about the future can be treated in terms of a well and correctly specified probability distribution of possible future events.

Several recent writers have argued that differences across nations in the organization and management of firms have significantly influenced firms7 economic growth performance. Thus Alfred Chandler (1990) and William Lazonick (1990) ascribe a good portion of the reason why the United States surpassed Great Britain in economic performance in the last part of the nineteenth century and the first part of the twentieth century to differences in management and organizational structure between

The new neo-classical growth models treat firms in a highly simplified way and barely address institutions, aside from the "competitive" (or monopolistically competitive) market.

American and British firms. A number of authors see the organization of Japanese firms in the post-World War II era as a major factor explaining Japan's extraordinary growth performance.4 The past decade also has seen a resurgence of interest by economists in differences in national institutions, such as financial systems (Gilson and Roe 1993) or universities (Nelson 1993), as important factors in national growth performance.

The new neo-classical growth models, in contrast, treat firms in a highly simplified way and barely address institutions, aside from the "competitive" (or monopolistically competitive) market. To the extent that f ormalization of important and previously unformalized understandings about technical change and economic growth defines an important part of the agenda for the new growth theorists, it seems useful to ask why certain ideas have been formalized and others not. The salience of the under-





standing certainly would seem to be an operative criterion. Thus, the incompatibility of the assumption of perfect competition with the facts of endogenous technical advance called attention to an obvious serious limitation of earlier formal growth models. But uncertainty also would seem highly salient to realistic modeling of economic growth fueled by technical advance.5 Why has imperfect competition been incorporated but not this kind of uncertainty or the other features mentioned above, from managerial differences to differences in educational and financial institutions?

The answer, I believe, is that another part of the agenda of the new growth theory, or a constraint on that agenda, is to hold the modeling as close as possible to the canons of general equilibrium theory Paul Romer (1990) states this explicitly, and the form of the models developed by others suggests that they too hold this as an objective or constraint. But it certainly is relevant to think a bit about what is gained and what is lost by operating under this constraint.

The central arguments of this essay are these: First, it does matter whether understandings of empirical scholars working in this area are incorporated in formal models. Therefore, second, it is consequential, and in my view unfortunate, that understandings of the sort I have mentioned above about technological advance, about firms, and about supporting institutions have not yet been incorporated into these formal models, or at least not in the formal models that now are in fashion. Third, con- straining formal growth theorizing to theorizing about equilibrium makes formalizing these understandings unnecessarily difficult.

Sidney Winter and I (1982) have argued that, perhaps because the subject matter and operative mechanisms in economics are so complex, theorizing tends to proceed at two levels at least. What we called "appreciative theorizing" tends to be close to empirical work. Mostly it is expressed verbally and is the




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analyst's articulation of what he or she thinks is actually happening. However, appreciative theory is very much an abstract body of reasoning. Certain variables and relationships are treated as important, and others are ignored. There generally is explicit causal argument. For all that, appreciative theorizing tends to stay quite close to the empirical substance.

In contrast, formal theorizing almost always proceeds at some intellectual distance from what is known empirically. Where it does appeal to data for support, the appeal generally is to "stylized facts" or reasonably good "statistical fits." If the hallmark of appreciative theory is storytelling that is close to the empirical details, the hallmark of formal theorizing is an abstract struc-

Formal theorizing almost always proceeds at some intellectual distance from what is known empirically.

ture set up to enable one to explore, find, and check proposed logical connections. Good formal theorizing is less likely than appreciative theorizing to contain logical gaps and errors. The logical inferences tend to reach farther. And there is greater self- consciousness about assumptions and analytic argument.

Winter and I proposed that, when the intellectual enterprise in economics is going well, empirical research, appreciative theorizing, and formal theorizing should work together. More explicitly, empirical work and appreciative theorizing should work together, and appreciative and formal theorizing should work together. Empirical findings or facts seldom influence formal theorizing directly. Rather, in the first instance they influence appreciative theorizing - that is, what the empirical researchers want to highlight and draw from their work. In turn, appreciative theorizing provides challenges to formal theory to encom- pass its understandings in stylized form. The attempt to do so





may identify gaps or inconsistencies in the verbal stories and suggest new mechanisms and connections to explore. In turn, the empirical and appreciative theoretical research enterprise may be reoriented.

Another important (and limiting) role of formal theorizing in contemporary economics is, somewhat paradoxically, to promote its understandings until they become the view of the profession. For whatever reasons, graduate training in economics emphasizes formal models. Compared to looser-form appreciative theoretic discussions, formal models in a specialized field, if they are analytically interesting, are also more commonly published in widely read economic journals, particularly if they are accompanied by some econometrics. The latter, therefore, tend to be read and known principally by specialists in a field.

For both of these reasons, the state of formal theory in a field serves as a constraint on as well as a help to appreciative theorizing. It is not simply that the state of formal theory limits the confident reach of appreciative theorizing. Formal theory provides the starting place and guide for young scholars entering a field of inquiry. And economists generally (not always) evidence unease when their appreciative theorizing takes them far outside what they can at least rationalize in the language of formal theory.

This brings our discussion to the basic arguments motivating this article.6 The new growth theory, while advertising its break from traditions, in fact, has stayed very close to the status quo ante. In the language of Abramovitz (1952), the new formal modeling is focused on the "immediate source of growth" and provides little help for appreciative theorizing aimed to understand the factors behind these immediate sources. Yet, in my view, this is where the most promising research avenues lie. Unfortunately, the new formal growth models pull attention away from these routes. Moreover, the type of formal theorizing that can facilitate these kinds of explorations very likely requires a focus on

Challenge/September-October 1 997 35



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variables and relationships that have been ignored or denied by neo-classical formal growth theory, new as well as old, and a break away from the canons of equilibrium theorizing.

Post- War Theorizing About Economic Growth

Economic growth was a central interest of Adam Smith and many of the classical economists of the nineteenth century. How- ever, during the first half of the twentieth century, the topic fell out of vogue, as microeconomic analysis increasingly came under the sway of partial and general equilibrium theory. With the Great Depression, macroeconomic analysis became obsessed with unemployment. After World War II, a number of economists again became interested in economic growth. The new surge of research on economic growth was not kindled by any arresting new theory in economics. On the other hand, much of the new research was designed to exploit the availability of new economic statistics, particularly the national income and product statistics, which Simon Kuznets pioneered and which for the first time enabled economists to measure growth at a national level.

In 1952, A Survey of Contemporary Economics was published, which attempted to assess the state of the discipline and con- tained the aforementioned article on the economics of growth by Abramovitz. Abramovitz was very much involved in this new research. There are two important features of his article. First, Abramovitz begins with a statement about the absence of any coherent modern growth theory to guide empirical research at that time: "Unlike most of the topics treated in the Survey, the problem with economic growth lacks any organized and genu- inely known body of doctrine whose recent development might furnish the subject of this essay/' Note that Abramovitz was writ- ing a few years before the publication of the works by Robert Solow (1956) and T.E. Swan (1956), which are reputed to have





established modern growth theory. The reader may also be tempted to take his statement as an indication that those latter articles filled an intellectual vacuum.

But the other noteworthy aspect of Abramovitz's essay is the up-to-date character, even by contemporary standards, of the issues and relationships that he discusses. It is as if most of formal neo-classical growth theory was already known. There is a clear statement of the logic behind modern growth accounting, a logic that was being used in the empirical work with which he was involved. Abramovitz notes that economists long have pro- fessed a theory that the level of output is determined by the quantity of inputs (land, labor, and capital) and factors that affect their productivity (the state of the arts, industrial and financial organization, the legal system, etc.). Therefore, at one level at least, economic growth can be understood as the result of changes or improvements in these "immediate determinants of output/7 Abramovitz also proposes that limiting analysis of growth to this level is not deep enough and that a satisfactory theory of growth must question the forces behind changes in the immediate determinants.

Abramovitz's essay goes on to analyze the forces affecting the expansion of the traditional factors of production (land, labor, and capital) and their contribution to growth. Among other features of his discussion, Abramovitz refers to the view, which is common in economics, that the marginal productivity of capital will be high or low depending on the ratio of capital to other factors and will diminish as capital grows relative to them -

clearly this characteristic of the "old" neo-classical growth theory did not come as news. But he then argues that increases in economic efficiency as the scale of output grows may offset diminishing returns - a feature built into some of the "new" neo-classical growth theories.

Abramovitz states that, in his view at least, "technical improve-




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ment" must account for "a very large share, if not the bulk, of the increase in output/7 Thus, before the discovery of the empirical evidence on growth accounting that later persuaded others in the economics community, Abramovitz would not have been surprised by these conclusions. Abramovitz clearly sees technical advance as "endogenous," resulting largely from investments aimed to create and exploit it, and anticipates the concept of "knowledge capital" as follows: "And insofar as new applied knowledge results from the deliberate direction of rev- enues to its discovery and use, the stock of knowledge is increased by a process identical with that which produces increases in the stock of material equipment." Referring to Joseph Schumpeter (1950), he observes, "With the development of industrial research departments of corporations . . . almost all engineering work is undertaken only in conjunction with the deliberate entrepreneurial decision." Some of the proponents of the new growth theory have argued that, until recently, ana- lysts of growth were focused on a growth theory that assumed perfect competition, but Abramovitz clearly did not have that problem. Abramovitz also recognized that title investments that yield new proprietary technology also generate externalities, at least with time, "as experience is gained and knowledge of the new art becomes widespread."

Abramovitz also highlights the interdependence of technical progress and the expansion of other factors as sources of growth. Vintage models would not have come as news to him. "The ac- tual exploitation of new knowledge virtually always involves some gross investment (in material equipment)."

Abramovitz had already focused on modern corporations as key actors in technical progress and investment in material equipment. He observed, "The role of enterprise has been slighted by traditional theory because of the theory's generally static character, which leads easily to assumptions about per-

38 Challenge/September^October 1997




feet knowledge, and rational calculation of profit/7 He goes on to suggest that, if one finds Schumpeter's analysis persuasive, one is compelled to recognize that "the marginal productivity of capital depends on enterprise to such a degree" that to neglect it is to miss the whole point of capitalist economic development. Here Abramovitz is far ahead of developments in even the "new" neo-classical growth theory, at least as that work has developed to date.

His discussion of the broader cultural and institutional factors surrounding and supporting enterprise is also pioneering. He states that the broader context is key and is concerned that, "The general conclusion suggested by this survey of the factors controlling the vigor of enterprise is that a vast deal of emphasis must be placed on forces that, in the ordinary conception of the bounds of economics, would have to be classed as political, psychological, or sociological." Abramovitz thus flags the challenge for economists and stresses that, to unravel the mysteries of economic growth, economists must delve into these issues. Mostly, of course, they have not. The focus of almost all research on economic growth since Abramovitz first wrote about it has been on what he terms the "immediate" determinants. Abramovitz was and is a remarkable scholar, but rather than write as if he had uncovered these ideas, he wrote as if they had already been part of an active dialogue.

Empirical Research on Growth During the 1950s and 1960s

In the early 1950s, a number of economists were hard at work doing empirical research on growth using the new National In- come and Product accounts and other new data. That research probed the immediate determinants of growth. These studies all reported that the growth of output experienced in the United

Challenge/September-October 1 997 39



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States had been significantly greater than reasonably could be attributed to input growth alone.7

In these papers, the contribution of total input growth was estimated by weighing the different inputs by their prices, a practice apparently considered so reasonable and obvious that few of the authors even bothered to rationalize it explicitly. The excess of output growth over input growth was attributed to a variety of factors: technological advance, increasing returns to scale, investments in human capital, the allocation of resources from lower to higher productivity activities. But these authors clearly put most emphasis on technological advance. Published after the studies noted above, Solow's 1957 piece was regarded by most economists who are not immersed in economic growth research as the seminal article in which the "residual" is calcu- lated and is interpreted as a measure of technological advance. The reason for the impact of Solow's piece is that his analysis was structured by a "formal" theory, whereas the earlier theories were more "appreciative" and therefore considered looser by the profession.

Edward Denison's research and writings, published starting in the early 1960s, elaborated and enriched the growth-accounting methodology and significantly increased our understanding of the sources of economic growth, at least at the level of Abramovitz's immediate determinants. Regarding growth in the United States, Denison's (1962) conclusions were basically con- sistent with those published earlier by the scholars cited above, and his contribution mainly involved an ingenious and pains- taking attempt to break down the sources of total factor productivity growth into the various components mentioned above. Other economists followed along the same track, developing other kinds of disaggregation and exploring different measures of factor marginal productivity.8

Work in other nations by Denison and others uncovered an-





other remarkable finding. The differences in inputs per worker could account for only a small share of the differences between American and European productivity levels. Apparently, Euro- pean nations, compared to the United States, were operating at significantly lower levels of "total factor productivity

" - the productivity of all factors, including capital, rather than simply the productivity of labor.

Studies of this sort caused a number of economists to turn their attention to the study of technological advance.9 The research by scholars working in this field covered a range of topics derived from Schumpeter: For example, do industries where the firms are large and have considerable market power experience more rapid technical advance compared to more frag- mented industries? Other topics included the analysis of inter-industry differences in technical advance, the connections between science and technology, and the difference between private and social returns to research and development, which seemed to be large. The point here is that most of the basic appreciative theoretical ideas that guided empirical analyses of growth already were there before Solow and Swan's articles.

On the other hand, some empirical research on technological advance seemed to signal that there was something wrong with the translation of those appreciative theoretic ideas into the formal neo-classical growth theory, which, after Solow's landmark work, was becoming broadly accepted as the right way to theo- rize about economic growth. Thus, Zvi Griliches's work on the diffusion of hybrid corn, Edwin Mansfield's work on the ad- vantages that innovation or early adoption of a productive new technology gave a firm, and the broad sweep of Nathan Rosenberg's work all raised questions about neo-classical assumptions that went into growth theory. While economists en- gaged in empirical research on technological advance debated about the kind of industrial structures associated with rapid tech-




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nological advance, the facts were clear that those structures often were oligopolistic and were almost never perfectly competitive. Why didn't these discrepancies with the assumptions of formal neo-classical growth theory cause major controversy, or at least wide discussion, about the "general competitive equilibrium" built into neo-classical growth theory? Of course, recognition of the latter discrepancy has strongly influenced the new formal neo-classical growth theorizing, but that development occurred with a lag of more than a quarter of a century

The reason was that the appreciative theory that interpreted and guided research on technological advance had a life of its own. What the formal theory said had only a minor influence on the empirical research and appreciative theorizing, and visa versa.

What, then, did the advent and development of formal neo- classical growth theory contribute to enterprises? In a few cases it added ideas and techniques that were distinctly new. Indeed, the basic proposition in Solow's first growth model - that if diminishing returns to capital are strong, the steady-state growth rate is independent of the savings rate - certainly came as a sur- prise to most economists, and many did not believe it. There are other examples. However, it is fair to say that, for the most part, formal growth modeling sharpened appreciative theoretic ideas that had been in the community for some time.

The most important contribution of the old neo-classical formal growth theory was that it made the research on economic growth more legitimate and thus attracted many young economists to its pursuit. Abramovitz's 1952 review piece has a tone of isolation from contemporary mainstream economics. It does not evoke the image of the surge of young economists coming into the field in the late 1950s and 1960s. It is quite possible that, absent Solow's 1957 article, which expressly grounded the empirical cal- culations in formal neo-classical growth theory, the empirical work





of Kendrick and Denison, which involved vastly more digging and calculating, would have received much less attention.

In any case, empirical studies conducted in the 1950s, 1960s, and early 1970s enormously increased our understanding of economic growth. Most of their findings have not been over- turned by subsequent studies. On the other hand, subsequent studies following the same line seemed to add little new information. By the early 1970s there are indications that research of the sort described above was experiencing sharply diminishing returns.

The most important contribution of the old neo-classical formal growth theory was that it made the research on economic growth more legitimate and thus attracted many young economists to its pursuit.

Sharp New Questions, Inadequate Answers

It seems fair to say that the research described above was driven partly by the development of new data on growth and partly by the excitment of many economists who found promise in a theory of growth that, if not new in many of its basic conceptions, pro- vided a formalization of some ideas. There were few nagging puzzles at the forefront of attention, crying out to be explained.

But by the early 1970s this had begun to change. Certain as- pects of economic growth experience were puzzling and de- manded explanation. First of all, there was the sharp falloff in growth rates in the United States and Western Europe that occurred in the late 1960s and early 1970s. Early in the era of slower growth, the problem was ascribed to the oil price shock and re- lated developments, but as growth continued slower than before, the search began for more systematic reasons.




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Research concerned with the economic growth slowdown in the United States, Western Europe, and later Japan soon identified another phenomenon that was interesting in its own right: The quarter-century after World War II was marked by a significant narrowing of the large productivity and income gap between the United States and the other advanced industrial nations, which had existed at the start of the period. While some economists first ascribed the original gap to the destruction caused by World War II, empirical studies soon made it evident that the United States had gained a significant productivity and income lead over the countries of Western Europe even before World War I. During the inter-war period that gap had, if any- thing, enlarged. The post-World War II era was marked by the appearance of strong "convergence." Attention turned to the twin questions: "What are the basic processes involved in convergence?" and "Why has convergence been so much stronger since World War II?"10

A closer inspection of the data raised another set of questions. While convergence seemed to be a phenomenon broadly appli- cable across the economies that had achieved significant technological sophistication as of World War II, some of these economies had grown significantly more slowly and others significantly faster than others of apparently comparable initial conditions. The sluggish performance of Great Britain attracted a lot of attention. On the other hand, Japan's economic growth performance was extremely impressive. By the middle 1980s, Japanese industry appeared actually to be forging ahead of American industry in a number of fields.

A closer empirical examination also revealed that the "convergence club" was relatively narrow. In particular, of the economies that could be regarded as "backward" after the war, only a few had achieved rapid sustained economic growth. Here Ko- rea and Taiwan stood out. A considerable body of research be-





gan to focus on the factors that seemed to lie behind the remarkable transformation of Korea and Taiwan, two very poor and backward economies as of the early 1960s. By the 1990s, they had more than quadrupled their per-capita incomes and were the home of companies that were quite capable of competing with firms from the United States, Europe, and Japan.

The collapse and reform of the communist economies in the late 1980s and early 1990s added another set of questions. For example, after having achieved rapid growth rates in the early post-war era, why did the communist economies prove unable

One can question how much useful understanding can be gained from studies that focus on the immediate determinants of growth but do not probe very far behind these.

to continue their catch-up with the West after 1970 or so? As it became evident that the economic transition was proving extremely difficult for these countries, economists sought to de- termine the features of the advanced capitalist countries that enabled them to achieve sustained economic growth.

Given the research traditions that had evolved during the 1950s and 1960s, it was natural for economists7 first attempts to answer these questions to focus on the immediate determinants of economic growth. One can question, however, how much useful understanding can be gained from studies that focus on the immediate determinants of growth but do not probe very far behind these.

Thus, it was well documented that the lion's share of the slowdown of economic growth in the United States was a result of a collapse of growth of total factor productivity. But this only raised questions about why the collapse occurred. Some economists, who interpreted total factor productivity growth as a measure




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of technical advance, claimed the reason was that technical advance had slowed down. In view of the technological revolution that obviously was occurring in electronics, as well as in other areas, this interpretation did not seem right. This evolved into the argument that the productivity impact of advancing technology had diminished. However, even if accepted, this interpretation only exposed the question of why the apparent spec- tacular advances in technology resulted in such a limited effect on economic growth.

Research on convergence made clear relatively quickly that the economies catching up with the United States most rapidly - for example, Japan - had achieved a combination of rapid growth of total factor productivity, relatively high rates of growth of the physical capital stock, and relatively high and growing investments in "human capital/' These three characteristics all seemed to be complementary features of economies that were rapidly and effectively incorporating advanced technologies, often pioneered in the United States. But this proposition only posed the deeper question of why some economies were able to put this package together and others were not.

In a similar vein, economists quickly came to recognize that Korea and Taiwan had unusually high rates of investment in physical and human capital. While there continues to be considerable argument about the contribution of growth of total factor productivity to the rapid development of these economies, everyone recognizes that the process has involved the pro- gressive incorporation of sophisticated technologies that were new to these countries, if not to the world. The question then becomes: How were these economies able to do this, while other economies have not been able to do so? And similarly, the collapse of total factor productivity growth during the 1970s and 1980s in communist countries and the failure of economic reform to boost total factor productivity may explain what has been

46 Challenge! September-October 1997




happening but mainly poses deeper questions about causality. The attempt to probe deeper leads inevitably to three topics

that continue to be repressed, or misspecif ied, in standard growth theory, including the new neo-classical growth models: technology as a body of understanding and practice, and the processes involved in mastering and advancing technology; the nature of the organizations, principally business firms, that employ technology and produce output; and the nature and role of a wide variety of economic institutions that establish the environment within which firms operate.

The question of what technology is and how it is advanced and mastered underlies all the analyses of the phenomena dis-

Questions about the nature of technology and how it is mastered come naturally to mind when one is trying to understand the processes of convergence.

cussed above. Questions about the nature of technology and how it is mastered come naturally to mind when one is trying to understand the processes of convergence - particularly the rapid growth of Korea and Taiwan or the stagnation in the Soviet Union and other ex-communist countries.

As Abramovitz noted in his 1952 article, searching for the understanding of technology and technical advance quickly leads to the need to understand the internal structure of business firms. Scholars from outside economics, seeking to understand the sources of Japanese economic strength, quickly focused on what they considered special features of Japanese firms. While economists have been slower to try to understand firms, in recent years the theory of the firm has become a lively topic. To date, however, very little of our growing understanding of firms has percolated into growth theory.




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Teachings of Appreciative Theorizing on Technology, Firms, and Economic Institutions

This section briefly highlights some of the more interesting and provocative appreciative theorizing regarding technology, firms, and institutions. These newly evolving theories provide the ba- sis for a more satisfactory growth theory.

As discussed in the preceding section, one limitation of analysis focused on the immediate sources of growth is that these seem to come in packages of activities. During the era when the U.S. economy was surging ahead of the European economy, U.S. investment rates were high, the U.S. education system was pro- ducing significant numbers of people capable of taking on managerial posts in the new industrial enterprises, and technological advance was proceeding at a rapid rate. In the post-World War II era, the countries that have moved toward the frontier most rapidly have been marked by a combination of high rates of physical investment, large investments in human capital, and rapid incorporation of superior technologies. Recognizing these interdependencies naturally leads to the deeper question: What generates or supports the cluster of activities that seems to be associated with rapid growth?

For many scholars the search for an answer to this question has led to research to deepen understanding of technology and technological change. Elaboration of this kind of argument, of course, sooner or later focuses on the question: What is technology? There are a few simple metaphors about that. One is that prevailing technology is like "a set of blueprints/' suggesting the conception of a "technology library/' albeit one with some of the "books" proprietary The notion that technology is knowledge also has been around for some time, suggesting something more embodied in human minds.

Research supports the idea that modern technology indeed is described in blueprints, texts, pictures, equations. However, in





many fields it takes a highly trained professional to make sense of the blueprints. Further, even for professionals in many technologies, the documents provide only the foundations of what it takes to make a technology work. A lot of hands-on learning is often required to gain real mastery of a technology. And it is increasingly apparent that for many technologies much of the knowledge that is needed to command a technology is know- how - that is, in the fingers as well as in the mind.

These elements of appreciative theory regarding command over technology carry over to understandings about how technical advances evolve. Scholars of technical advance have long known the importance of investments in research and development, generally involving the employment of professionals trained in the relevant underlying engineering and scientific disciplines, in the generation and development of new technologies. However, they also have long understood that many technologies seem to experience a continuing stream of improvements that reflect understandings gained and changes wrought through hands-on learning.

A number of studies now have documented how broad new technologies tend initially to be brought into practice in crude form, representing a bundle of potentialities, rather than being introduced in an operationally ready state.11 The automobile, the airplane, the transistor, the computer, and the laser - all sur- faced as new technologies of potentially wide applicability. But they required considerable work and ingenuity before they would be economically useful. It took a long time, a lot of investment, a lot of learning, and a lot of learning how to learn before these new technologies became major contributors to economic growth.

A common feature of the development paths of major new technologies is that quite unforeseen capabilities and uses are discovered along the route. Different new technologies often in-




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teract in complex and surprising ways. In the early days of the electronic computer no one foresaw the vast use by business that came later, partly because no one foresaw the advent of the transistor, the integrated circuit, and the microprocessor. AT&T, which in the early days had control of intellectual property rights to the laser, did not foresee its use in telecommunications through the vehicle of fiber optics. The evidence that technological advances today are significantly shaped by what has (and has not) been achieved earlier is very persuasive.

To a considerable extent, the rate and direction of technological advance is also shaped by the activities of business firms. Recent research has suggested that issues of firm organization and strategy are at least as important to technical advance as the quantity of their investments in research and development. Neo-classical economics is often disinterested in the firm, see- ing it more as a puppet that dances to the tune played by the market. However, under the appreciative theory sketched above, mastery of a technology is more like a learned skill, which most neo-classical theorizing is wont to admit. The entity that learns and practices is the firm. The practice of complex technologies inherently involves organization and management. The way a firm organizes to implement a common broad technology can make an enormous difference. This is a key finding of much of the recent work comparing U.S. and Japanese auto production. Chandler's pioneering historical work on the rise of the modern corporation (1962, 1977, 1990) has led to the development of a small body of writings that see key firm capabilities as dynamic, rather than static, involving the ability to learn, to adapt to changes in the environment, and to innovate, and not simply to perform well given prevailing practice and conditions.

There is also increasing recognition among economists that some entities, such as universities, do research that feeds into technical advance in industry and teach programs affecting the





supply of scientists and engineers, government agencies financ- ing certain kinds of research and development and others set- ting standards, banks and banking systems, and a variety of organizations and laws that affect labor supply and demand. Patent, regulatory, and liability law are part of the environment, as well as a variety of widely shared beliefs, values, and cus- toms that affect common expectations about what should be done and what will be done in a particular context.

This is an extraordinarily complex bag of items, and it may be foolhardy to give a name to the collection, but many scholars have called them all "institutions/7 One can question what is common about them. Some economists and other scholars have employed the language of game theory and have attempted to define institutions as "the rules of the game/' which, given the motivations of the players, constrain the way the game will be played. (See, for example, North 1990 and 1994.) Other economists, stressing that many repeated games have multiple equilibria, have proposed that the concept of "institutions" needs to include not only the formal rules of the game (the "law") but also the particular equilibrium or self-sustaining pattern of play that has evolved (the "custom"). (Schotter [1981] was among the first to argue this.)

Finally, it should be emphasized that, while recently there has been a surge of interest by economists in economic institutions, in fact, the interest is almost ancestral. Much of Adam Smith's The Wealth of Nations is about differences in institutional structures and how these differences explain the economic perfor- mances of nations. The new work examining the role of differences between the United States and Japan in financial institutions, and how these differences mold and support firm differences, is, in fact, a throwback to older forms of economic growth theory.

One conclusion is that national institutions are important for




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supporting the technological and organizational capabilities of business firms. Thus, historians have argued that an important reason why British industry did poorly in the new chemical prod- ucts industries of the late nineteenth century, and performed very unevenly in the new electrical equipment industries, was the failure of British universities to develop strength in the teach- ing of science and engineering. A recent study of my own com- pares the institutional structures supporting industrial technical advance in a number of different countries and argues that differences in the systems explain a lot about differences in national economic performance. Carlotta Perez (1983) has argued

While recently there has been a surge of interest by- economists in economic institutions, in fact, the interest is almost ancestral.

that, for rapid growth to proceed, a nation's institutions must be tuned to the dominant technologies of the era.

But, of course, institutions are not constant. They do change, albeit slowly. The question of how they change would appear to be a fundamental challenge for growth theory. In the 1970s a few intrepid economists put forth the hypothesis that "institutions evolve optimally/' Just how this would happen was never stated, however. Since that time more modern economists have become aware of major differences across nations in institutions - differences that seem to have a large impact - and thus have become more aware that in some countries the processes that guide the evolution of institutions seem to be more effec- tive than in other countries. They also have come to understand that these processes are very complex and poorly understood.

Acquiring a good understanding of institutions is going to be





harder than acquiring a better model of technological change, or firm capabilities and their dynamics, simply because institutions are so diffuse. But as Abramovitz said forty years ago, if we are to understand growth we will have to somehow understand institutions.

An Agenda for Growth Theory

As stressed in the foregoing discussion, the new formal growth models, like the earlier ones, focus on the immediate sources of growth and, to some extent, the factors just behind these. While they may give new life and power to exploration of these variables and their contribution to growth, there are strong reasons to believe that many of the important insights that can be gained by exploring this vein have been mined out, and the returns are much higher from research that examines the factors behind the immediate sources. There are three broad areas where returns from more research are likely to be high: the nature of technology and the processes driving technological advance, the factors influencing the behavior and effectiveness of firms and other organizations that employ technology and produce the goods and services that count as economic output, and the institutions that surround, support, and constrain firms. But the highest pri- ority is to develop a broad theory of growth capable of taking in and integrating the kinds of understanding about these variables described in the preceding section.

Actually, such a broad theory of growth already exists, at the appreciative level, and in fact has existed for a long time. Abramovitz's 1952 essay contains most of the key elements and traces their connections in a plausible way. The problem is in formal theory. And here, if the above arguments are on the mark, the developments that fall under the rubric of "the new neo- classical growth theory

" are of very limited help.




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The authors of the new neo-classical models clearly put "f ormalization" of presently unf formalized understanding high on their

agenda. However, further formalization of the kind proceeding in work on the new growth theory will buy little and actually may set back the cause of developing a formal theory capable of incorporating the relevant appreciative understandings.

In particular, there is a danger that the goal of formalization, per se, focuses efforts on understandings that are relatively easy to formalize or on f ormalizations of these understandings that are relatively easy but miss or deform important parts of those understandings. Earlier I referred to the treatment in the new formal growth models of uncertainty in technological advance as if it were calculatable risk. It is evident that the failure of the new neo-classical growth theorizing to open up the formal treatment of firms, or even to try to incorporate institutions, reflects that these are not easy to treat formally. This is especially so if the formal modeling is constrained by the canons of general equilibrium theory.

It is interesting that most of the formal theorizing that has interacted creatively with appreciative theorizing in the domains highlighted here has stood outside the arenas that have been

incorporated in the new neo-classical growth theory. Thus, the recent work of Paul Milgrom and John Roberts (1990) is sharp- ening intuitions regarding the implications of strong comple- mentarities in firm practice, identified by appreciative theorists. Recognition by game theorists of multiple equilibria and the sensitivity of the equilibrium to the vagaries of the dynamic time

paths has clarified the thinking about institutional evolution. And of course there has developed a rather extensive body of formal evolutionary modeling of technological advance that has been expressly motivated by the appreciative theorizing of em-

pirical scholars of the subject. But interaction between formal and appreciative theorizing





on the key topics on this agenda has been limited. This has been a problem not only because the former has not given much help to the latter. Perhaps even more important, because there is so little contact between most of the appreciative theory emanat- ing from research along these lines and formal theory, the broad economics community tends not to see this work and, when it does, to consider it "atheoretical." This discourages young scholars from working along these lines.

Useful formalization in these areas will require not only the treatment of variables and relationships that have seldom been considered in standard neo-classical theory but also a break from the canons of standard equilibrium theorizing.

The key intellectual challenge to formal growth theory - whether the basic dynamic structure is evolutionary or neo-classical - lies in learning how to formally model entities that are not easily reduced to a set of numbers, such as the character of a nation's education or financial system or the prevalent philoso- phies of management. But the gains here certainly seem to war- rant the effort.

More than forty years ago Abramovitz flagged technical advance, the role of the enterprise, and the broader cultural and institutional factors surrounding and supporting enterprise as the factors behind the "immediate" sources of growth and said that understanding all three was a challenge. It still is. But if the arguments about the relationships between appreciative theorizing and formal theorizing are on the mark, to be fully effec- tive appreciative theorizing needs help from formal theorizing. To provide that help, however, requires that formal theory try to break some new ground and shake loose from conventional constraints. A principal purpose of this essay has been to inform formal growth theorists as to where the most interesting and promising research on growth is located, in hopes of luring some to where the action is.




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Notes 1. For a good survey of these understandings, see Freeman (1982). 2. In some of these models, the rate of investment in new plant and equipment

affects the steady-state growth rate because of scale economies or externalities or both, whereas in the older generation of models the steady-state growth rate was independent of the investment rate.

3. For more extended and systematic reviews, see Romer (1991, 1994) and Verspagen (1992). However, it suffices to bring out several points.

4. See, for example, Womack et al. (1990). 5. "Uncertainty" here is in the sense of Knight (1921). 6. In Nelson (1994), I presented an earlier version of this case. 7. Studies by Schmookler (1952), Fabricant (1954), Kendrick (1956), and

Abramovitz himself (1956). 8. See, for example, Jorgenson and Griliches (1967). 9. This research proceeded within a number of different styles, from economet-

ric (Griliches [1957], Mansfield [1968], and Mansfield et al. [1971, 1977]) to historical (Rosenberg [1976, 1982] and Freeman [1982]). Jacob Schmookler (1966) did pioneering work using patents as a measure of inventive input.

10. See Abramowitz (1986); Nelson and Wright (1992); Baumöl, Nelson, and Wolff (1994).

11. See, for example, Enos (1962) and Nelson and Rosenberg (1993).

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. 1956. "Resource and Output Trends in the United States Since 1870." Ameri- can Economic Review 46 (May): 5-23.

. 1986. "Catching Up, Forging Ahead and Falling Behind." Journal of Eco- nomic History (June).

Aghion, P., and Peter Howitt. 1990. "A Model of Growth Through Creative De- struction." Econométrica (60): 323-51.

Baumol, William; Richard Nelson; and Edward Wolff. 1994. Convergence of Produc- tivity. Oxford: Oxford University Press.

Chandler, Alfred D. Strategy and Structure: Chapters in the History of the Industrial Enterprise. Cambridge: MIT Press, 1962.

. 1977. The Visible Hand: The Managerial Revolution in American Business. Cam- bridge: Belknap Press.

. 1990. Scale and Scope: The Dynamics of Industrial Capitalism. Cambridge: Harvard University Press.

Denison, Edward F. 1962. The Sources of Economic Growth in the United States and the Alternatives Before Us. New York: Committee for Economic Development.

Enos, John. 1962. "Invention and Innovation in the Petroleum Refining Industry."





In The Rate and Direction of Inventive Activity, ed. Richard R. Nelson. Princeton: Princeton University Press.

Fabricant, Solomon. 1954. Economic Progress and Economic Change. 34th Annual Re- port of the National Bureau of Economic Research. New York: NBER.

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Jorgenson, Dale W., and Zvi Griliches. 1967. "The Explanation of Productivity Growth." Review of Economic Studies 34 (July): 249-83.

Kendrick, John W. 1956. "Productivity Trends: Capital and Labor." Review of Eco- nomic Statistics 38 (August): 248-57.

Knight, Frank. 1921. Risk, Uncertainty, and Profit. Boston: Houghton Mifflin. Lazonick, William. 1990. Competitive Advantage on the Shop Floor. Cambridge: Harvard

University Press. Mansfield, Edwin. 1968. Industrial Research and Technological Innovation: An Econo-

metric Analysis. New York: W.W. Norton. Mansfield, Edwin; John Rapoport; and Anthony Romeo. 1977. The Production and

Application of New Industrial Technology. New York: W.W. Norton. Mansfield, Edwin; John Rapoport; and Jerome Schnee. 1971. Research and Develop-

ment in the Modern Corporation. New York: W.W. Norton. Milgrom, Paul, and John Roberts. 1990. "The Economics of Modern Manufactur-

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Theory?" In The Economics of Growth and Technical Change, ed. Gerald Silverberg and Luc Soete. Aldershot, UK: Edward Elgar.

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North, Douglass. 1990. Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press.

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. 1991. "Increasing Returns and New Developments in the Theory of Growth."




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In Equilibrium Theory and Applications, ed. William Barnett, Bernard Cornet, Jean d'Aspermont, and Andren Mas-Colell. Cambridge: Cambridge University Press.

. 1994. "The Origins of Endogenous Growth." Journal of Economic Perspec- tives (8): 3-22.

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. 1982. Inside the Black Box: Technology and Economics. Cambridge: Cambridge University Press, 1982.

, and Nathan Rosenberg. 1993. "Technical Innovation and National Systems," in National Innovation Systems, ed. Nelson. New York: Oxford University Press.

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. 1966. Invention and Economic Growth. Cambridge: Harvard University Press. Schotter, Andrew. 1981. The Economic Theory cf Social Institutions. Cambridge: Cam-

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World. New York: Macmillan.

To order reprints, call 1-800-352-2210; outside the United States, call 717-632-3535.




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