1. The Importance of Understanding Economic Growth
Inside the Black Box: Policies for Economic Growth2
This paper assumes that the central objective of economic policy is to achieve and sustain high and increasing levels of material well being for New Zealanders.3 The paper abstracts from a wide range of related issues, such as income distribution, to focus sharply on this material well-being objective4.
Increasing income per capita is a good proxy for increasing material well-being of New Zealanders. And increasing output per hour worked (labour productivity) is by far the most important way to achieve increased income per capita. Countries can become richer in the short term by increasing the proportion of their population that works, or encouraging those in the workforce to work longer hours or harder. But these approaches have clear limits, which New Zealand is approaching. Over the longer term, the only sustainable way to grow income per head is to increase the level of productivity.
To design policy in pursuit of material wellbeing, we need a clear understanding of what causes productivity growth. Achieving this is quite a challenge. Economic growth has been studied intensively for centuries, leading to a good understanding of some of the causes of economic growth, and of appropriate policies to promote it. However, there is much that remains uncertain (Easterly 2001). In particular, the "Washington Consensus", which described the then broadly agreed policy prescription, has been undermined by dissatisfaction with the results of applying it, and more "first principles" approaches are being proposed instead (World Bank 2005 page xiii, Rodrik 2006, Rodrik forthcoming). The analysis here, which attempts to push the boundaries of what we know about the causes of productivity growth and how to promote it, will therefore be open to debate.
Despite this, to give analytically robust and falsifiable policy advice, we do need a view about the causes of economic growth and appropriate policy to promote it. This paper proceeds in two stages. The first stage outlines the way I think about economic growth and how it occurs. The second, more normative, stage assesses the implications of this understanding of economic growth for policy.5
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