10. Endogenous Growth: Concluding Remarks and Policy Conclusions

Buchanan (1994), points out that Smith's pin-factory example has proved to be misleading. “Adam Smith's familiar illustration has been misleading because it draws attention away from the phenomenon of economy wide increasing returns and toward increasing returns to scale of operation within the single producing unit, in his case, the pin factory… The focus is shifted away from the limitless range of potentially advantageous specialization of inputs in a complex economic network and to the simple division of tasks among workers on something like an assembly line” (ibid., p. 5).

See, for example, Whitaker (2003, p. 145) who points out that joint stock companies constituted one tenth of the total business in the UK which “seems a remarkably small fraction”.

Marshall in a letter to Alfred William Flux, dated 7 March 1898, mentioned that “one of the chief purposes of my Wander-jahre among factories, etc., was to discover how Cournot’s premises were wrong”. See Whitaker (1996, II, pp. 227–28). According to Cournot, if a firm reaps economies of scale, it becomes a monopoly. Marshall on the other hand wanted to reconcile increasing returns with competition in an evolutionary framework.

Hart (2003, p. 171) points out that Marshall (1890) used the concept of free competition, and he identified perfect competition with the assumption of perfect knowledge. Therefore his definition of free competition excludes perfect knowledge. “Marshall’s treatment of competition was much closer to Adam Smith, where competition did not coincide with a particular ‘situation’ but represented an active process, than to that of his contemporaries” (Hart 2003, p. 171).

Some commentators take the view that Marshall failed in his project of combining evolution with the long-run equilibrium of industry. For example, Loasby (1991, pp. 15–16) writes: “Adam Smith’s explanation of economic progress linked development with co-ordination. Though he certainly used a concept of equilibrium, both development and co-ordination resulted from competitive processes (Richardson 1975). Marshall associated development with evolution and co-ordination with equilibrium, and attempted to incorporate both equilibrium and evolution within a single body of analysis; but he failed”. Hart (2003) calls the problem arising from Marshall’s analysis of increasing returns in Appendix H where he points to the limitations of static theory outlined in Book V as the “reconciliation problem”. “The reconciliation problem centres on the difficulties associated with representing, within an equilibrium framework, outcomes of ‘evolutionary’ processes identified directly with the increasing returns and thus the long-period industry supply schedule (derived from the representative firm)” (ibid., p. 168).

For a critical assessment of Kaldor’s growth ideas and his policies, see Chandra (2019) and Chandra and Sandilands (2021).

Smith stated that institutional arrangements should ensure two things—liberty and security. After analysing various systems of political economy, he came to the conclusion that these are best provided in a system of natural liberty where the government is confined to a few basic tasks it can do well. For Young, institutional development depended on the stage of society. The advent of war (WWI), monopoly capitalism, and business cycles meant that newer institutional mechanisms had to be created to deal with these. For example, an independent central bank was required to control credit—which he thought was an unstable component of money supply in line with Hawtrey—to moderate business cycles. Anti-trust laws and institutions were required to deal with the growth of monopoly. Advent of WWI meant that the state machinery had to be used not only to move men and materials for the war effort but also for post-war reconstruction. Also, the statistical machinery had to be created or strengthened for more effective steps in these directions. See Chandra (2021).

It is true that there may be a strong association between capital accumulation and growth (as, for example, noted by Sen 1983; DeLong and Summers 1991, 1992) but correlation does not prove causality. Considerable evidence suggests that the causation may be from economic growth to capital accumulation rather than from capital accumulation to economic growth. For this evidence see Chapter 6.

Young favoured reform of the patent system to avoid lasting domination and preemption of future improvements. “Reforms of the patent system are undoubtedly sorely needed. It should not be possible for any one company to secure lasting domination of an industry by getting control of so many patents that future improvements and inventions affecting the industry have no market and no value except to the one company already in control. A situation like this virtually perpetuates the life of patents long beyond the years which the law contemplates. It is likely that some day we shall have to come to a system by which the users of important patent rights shall be licensed by the government, which will administer the patent system in such a way as to eliminate the evils of artificial monopoly” (Young 1929; Mehrling and Sandilands 1999, p. 249). Today patents in most countries, including US and Europe, are for 20 years. Under the WTO framework, product patents have been instituted in addition to process patents, but poor countries can take recourse to compulsory licensing provisions under certain circumstances. In line with Youngian thinking, perhaps the time period of patents can be reduced, compulsory licensing provisions can be made more liberal (for example, in case of Covid vaccines), and further moves to making the system more stringent (for example, from process patents to product patents in the past) can be halted.

Thirlwall (2003) also points out that Kaldor’s explanation preserves a steady capital-output ratio, one of Kaldor’s stylised facts which any growth model has to satisfy.

Sandilands (2000) notes that in Romer’s (1989) “Marshall-Young-Romer” model, growth is made more rapid by giving investment subsidies when trade is restricted by transport and other barriers. This will be the case if the society chooses less consumption today, and saves and invests more. “But this could run up against another demand constraint. Why invest more when consumption is being restrained?” (Sandilands 2000, p. 319).

As noted by Quéré (2003, p. 192), Marshallian competition (Marshall 1919, p. 653) had three elements: “‘friendly emulation’ where the major purpose is to share resources with the aim of organizing co-operative agreements among companies and of making feasible the common discovery of new productive opportunities; ‘ordinary business competition’ corresponds to a context where the usual price competition mechanisms prevail; and ‘competition with destructive aims’ is a situation where the explicit purpose of companies is to establish a monopoly position and to drive the other incumbents from the market”. So competition in Marshallian conception is not always cut-throat or destructive; it has elements of cooperation as well.

Young was of the view that the case against monopoly was overstated and a monopolist did not charge as high a price as theory sometimes suggested. If a monopoly has cost curves where increasing returns exist, a monopolist takes a longer time period in view and does not maximize his net returns in the short term. The longer the time period he takes, the lower the price he will set. Also, a monopolist was not aware of his demand and supply functions, and this made him raise prices slowly, if at all. Moreover, he cared for public opinion and feared regulation by the government. See Chandra (2020, p. 134).

Becattini (2003, p. 22) sees Marshallian competition in the context of industrial districts as individual interest pursued within a group where every labourer engaged in social production has opportunities for moral and technical self-education. “The perception of individual interest as a part of a group interest can, under certain conditions, not only produce commodities but also foster the rise of a civic consciousness. And what is the district if not the ideal place for that self-educating process?”

In the Youngian conception even agriculture experiences increasing returns. The fact that it experiences the fruits of technical improvements and grows over time testifies to this. But since it has a lower demand elasticity, it grows slowly as compared to say manufacturing. So Young did not make a distinction between diminishing returns sectors and increasing returns sector (which are empty economic boxes anyway), only between those with lower and higher demand elasticities as their respective growth rates would differ. Because agriculture has lower demand elasticity, its relative share declines over time and productive resources (e.g., labour, land, food, and raw materials) are released for other uses.

Although the modern endogenous growth theory seeking to promote knowledge sectors claims to represent the ideas of the original authors of endogenous growth—Smith, Marshall and Young—with greater clarity, rigour and depth, it actually appears closer to Schumpeterian theory of creative destruction based on “innovation” and “monopoly profits” as noted by Aghion and Howitt (1992, 1998). For a brief discussion of the Schumpeterian theory see Chapter 1.

In any case, quantitative restrictions and exchange rate manipulation go against the current WTO framework, and therefore are a strict “no-no”.

Young thought that monopoly capitalism was not as widespread as it was thought to be. It was largely confined to a few sectors which were natural monopolies like railways and public utilities. Forces of competition were still strong and were growing. In any case the remedy for concentration did not lie in arbitrarily leveling down of fortunes but in ensuring “equality of competitive opportunity” through the democratic process. He was against discriminating privileges for the few; the system has to work for all. See Chandra (2020, pp. 160–61; 249–53).

See also Krueger (1990) for the argument that the state should not venture beyond its areas of comparative advantage.