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Abstract

This paper analyzes the structural relationship between policies that distort resource allocation and long-term growth. It briefly reviews the Solow model in which steady-state growth depends only on exogenous technological change, but finds it unsatisfactory as a model of long-term growth. The author proposes an increasing-returns model in the spirit of the new literature on economic growth. With increasing returns, endogenous economic variables - and thus policy - will affect the steady-state rate of growth. This model gives output as a linear function of total capital, but a decreasing function of each of two types of capital. The distortion is defined as a policy intervention that increases the cost of using one of the types of capita. The results suggest that simple linear relationships between distortions and growth, or between size of government and growth, are untenable. Easterly's model shows that reducing the distortions does not have an equal effect on growth in all circumstances. The effect depends on how flexible the economy is, how large the share of the factor being penalized in production is, and how high the distortions are initially. Small changes in either very low or very high levels of initial distortions have a minimal effect on growth.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 344.

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Date of creation: 31 Dec 1989
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Handle: RePEc:wbk:wbrwps:344

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Keywords: Economic Theory&Research; Economic Growth; Economic Conditions and Volatility; Environmental Economics&Policies; Achieving Shared Growth;

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References

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1. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 1002-37, October.
2. Robert J. Barro, 1991. "A Cross-Country Study of Growth, Saving, and Government," NBER Chapters, in: National Saving and Economic Performance, pages 271-304 National Bureau of Economic Research, Inc.
   
   • Robert J. Barro, 1989. "A Cross-Country Study of Growth, Saving, and Government," NBER Working Papers 2855, National Bureau of Economic Research, Inc.
3. Findlay, Ronald, 1989. "Is the new political economy relevant to developing countries ?," Policy Research Working Paper Series 292, The World Bank.
4. Easterly, William R. & Wetzel, Deborah L., 1989. "Policy determinants of growth : survey of theory and evidence," Policy Research Working Paper Series 343, The World Bank.
5. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.

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Cited by:

1. Jones, L.E. & manuelli, R.E., 1994. "The Sources of Growth," Working papers 9428, Wisconsin Madison - Social Systems.
   
   • Jones, Larry E. & Manuelli, Rodolfo E., 1997. "The sources of growth," Journal of Economic Dynamics and Control, Elsevier, vol. 21(1), pages 75-114, January.
   • Larry E. Jones & Rodolfo E. Manuelli, 1994. "The Sources of Growth," GE, Growth, Math methods 9410002, EconWPA, revised 05 Mar 1999.
   • Larry E. Jones & Rodolfo E. Manuelli, 1994. "The Sources of Growth," Macroeconomics 9411002, EconWPA, revised 05 Mar 1999.
2. Larry E. Jones & Rodolfo E. Manuelli, 1990. "Finite Lifetimes and Growth," NBER Working Papers 3469, National Bureau of Economic Research, Inc.
   
   • Jones, Larry E. & Manuelli, Rodolfo E., 1992. "Finite lifetimes and growth," Journal of Economic Theory, Elsevier, vol. 58(2), pages 171-197, December.
3. Wacziarg, Romain, 1998. "Measuring the dynamic gains from trade," Policy Research Working Paper Series 2001, The World Bank.
   
   • Wacziarg, Romain, 2000. "Measuring the Dynamic Gains from Trade," Research Papers 1654, Stanford University, Graduate School of Business.
4. Matías Berthelon, 2004. "Growth Effects of Regional Integration Agreements," Working Papers Central Bank of Chile 278, Central Bank of Chile.
5. Devarajan, Shantayanan & Swaroop, Vinaya & Heng-fu, Zou, 1996. "The composition of public expenditure and economic growth," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 313-344, April.
   
   • Shantayanan Devarajan & Vinaya Swaroop & Heng-fu Zou, 1996. "The composition of public expenditure and economic growth," CEMA Working Papers 77, China Economics and Management Academy, Central University of Finance and Economics.
6. Devarajan, Shantayanan & Swaroop, Vinaya & Heng-fu Zou, 1993. "What do governments buy? The composition of public spending and economic performance," Policy Research Working Paper Series 1082, The World Bank.
7. Larry E. Jones & Rodolfo E. Manuelli, 1993. "Growth and the Effects of Inflation," NBER Working Papers 4523, National Bureau of Economic Research, Inc.
   
   • Jones, Larry E. & Manuelli, Rodolfo E., 1995. "Growth and the effects of inflation," Journal of Economic Dynamics and Control, Elsevier, vol. 19(8), pages 1405-1428, November.
8. Solimano, Andres, 1991. "Inflation and growth in the transition from socialism : the case of Bulgaria," Policy Research Working Paper Series 659, The World Bank.

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