Capital fundamentalism, economic development, and economic growth

Few economic ideas are as intuitive as the notion that increasing investment is the best way to raise future output. This idea was the basis for the theory"capital fundamentalism."Under this view, differences in national stocks of capital were the primary determinants of differences in levels of national product. Capital fundamentalists viewed capital accumulation as central to increasing the rate of economic growth. Evidence to support this view was based mostly on case studies of less developed countries. Neoclassical growth theory and growth accounting research indicated that differences in patterns of investment and capital formation were not the main factors that led nations to be rich or poor, fast-growing or slow. Technology, rather than capital accumulation, appeared to drive improvements in living standards in the long run. Evidence to support this view was based mostly on data from advanced countries. Recent research on growth and development has lent support to two conclusions that capital fundamentalists would find attractive: that differences in national patterns of physical capital accumulation can explain many differences in levels of national product, and that increases in national investment rates can produce major increases in rates of economic growth. The authors find that although the capital-output ratio varies positively with the level of per capita income, there is little support for the view that capital fundamentalism should guide the agenda for research and policy advice. Extending standard growth accounting procedures to a broad sample of 105 countries, they find: 1) differences in capital-per-person explain few of the differences in output-per-person across countries; 2) growth in capital stocks account for little of output growth across countries; and 3) the ratio of investment to Gross Domestic Product is strongly associated with economic growth - but there is more reason to believe that economic growth causes investment and savings than investment and savings cause economic growth.