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Policy distortions, size of government, and growth

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Author Info
Easterly, William R.

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

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  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. [Downloadable!] (restricted)
  2. Findlay, Ronald, 1989. "Is the new political economy relevant to developing countries ?," Policy Research Working Paper Series 292, The World Bank. [Downloadable!]
  3. Robert J. Barro, 1989. "A Cross-Country Study of Growth, Saving, and Government," NBER Working Papers 2855, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  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. [Downloadable!]
  5. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Larry E. Jones & Rodolfo E. Manuelli, 1993. "Growth and the Effects of Inflation," NBER Working Papers 4523, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Larry E. Jones & Rodolfo E. Manuelli, 1990. "Finite Lifetimes and Growth," NBER Working Papers 3469, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Wacziarg, Romain, 2000. "Measuring the Dynamic Gains from Trade," Research Papers 1654, Stanford University, Graduate School of Business. [Downloadable!]
    Other versions:
  4. Matías Berthelon, 2004. "Growth Effects of Regional Integration Agreements," Working Papers Central Bank of Chile 278, Central Bank of Chile. [Downloadable!]
  5. 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. [Downloadable!]
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