International Monetary Fund. External Relations Dept.
Published Date:
January 1991
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Theorists of Economic Growth from David Hume to the Present

W.W. Rostow

Oxford University Press, New York, NY, USA, 1990, xx + 712 pp., $39.95.

The end of all production is consumption, and more is better. Philosophers and spiritualists may disagree, but economists will explain this dictum in terms of broadening choices and horizons, increasing opportunities and freedoms: in brief, having a more “fulfilled” life. What makes an economy grow, and its members more prosperous, is central to the discipline of economics.

Rostow’s new book is a delight: panoramic, rich, lucid, and enlivened by humor (a quality for which the “dismal science” is not especially noted). Readers can approach this work at many levels; as a work of reference, for the occasional deeper foray, or, for the true economic “crescophile,” to peruse from cover to cover. The contributions of the major economists (all the big names are here) on various aspects of growth are presented succinctly and within each one’s broader vision of society.

Only one chapter is devoted to development economics—the postwar academic phenomenon on which countless PhD theses were sacrificed, to say nothing of the forests that had to be cut down, the meetings and conferences that had to be suffered through, the institutes that had to be founded—all in the name of what? The assumptions (perhaps ideology would be a better word) on which this enterprise was based—that public policies (wholesale government intervention and planning, buttressed by foreign aid) could “solve” the problems of underdevelopment and accelerate the development process—have crumbled; noted development economists have been busy composing their mea culpas. One need shed no tears for economists (who have done quite well out of it all) but the sorry aspect of much development economics is the influence it exerted on economic “strategies,” in engendering policies that have, in many places, resulted in stunted, distorted, and stagnant economies.

We do not have a single, universal theory of economic growth: the process depends too much on noneconomic factors, which are diverse, changing, and impossible to theorize. Furthermore, the very idea of growth, or “growthmanship,” has come under renewed attack in recent years. An increment in GNP in itself means little unless due attention is paid to the quality of growth and to other issues such as environmental damage, depletion of resources, democracy, and liberty. Rostow alludes to all of this, but had his book been written a few years hence, he might have felt impelled to devote considerably greater space to the discussion of the noneconomic dimensions of growth. Also, history is not being kind to Rostow: several of the issues referred to in the penultimate chapter (the debate about economic systems, the appropriate role of government, the cold war) have been more or less settled—at least for now. And Soviet citizens may be comforted to know that, according to Rostow’s taxonomy (p. 446), they have been in the “high mass consumption” group of countries since the mid-1950s.

Rostow has performed a valuable service. His book is a major publication in the history of economic thought. He is a devotee (if not inventor) of the stages-of-growth approach; with this tome he reaches the highest stage.

Bahram Nowzad

The Road to a Free Economy

Janos Kornai

W.W. Norton, New York, NY, USA, 1990, 224 pp., $8.95.

Professor Kornai, the eminent East European economist, departs from his usual academic format to write a tract for the layman, focusing on specific Hungarian circumstances, but applicable to other planned economies moving toward a market system. Although written in nontechnical language, this is a detailed, tightly reasoned piece of economic analysis. Its main contribution is to demonstrate that the two main tasks of economic policy facing East European countries—namely, the creation of a market economy and macroeconomic stabilization—are closely related. While recognizing that the first of these tasks cannot be accomplished overnight, he also insists that strong measures to encourage the private sector at the outset are a precondition for a successful stabilization program, and that a middle road of “market socialism” is doomed to failure.

Kornai first discusses the details of transforming a system of socialist planning into a liberal market economy; then, against this background, demonstrates the chief measures that must be taken to eliminate inflation, minimize unemployment (which inevitably results from restructuring the economy), and maintain a viable balance of payments position. In discussing the creation of a market economy—in a chapter entitled simply “Ownership”—Kornai emphasizes a legal framework that enforces contracts and accords freedom to private economic units to acquire and sell property, set prices and wages, and engage in foreign trade and foreign currency transactions. State enterprises, he argues, can be privatized only gradually and should not be “sold to foreign countries at rock-bottom prices, as if at a liquidation sale.” The management of state enterprises therefore continues to be a problem: Kornai argues for an element of political control, to ensure, inter alia, that the private sector receives an adequate share of available credit.

In analyzing stabilization policies, Kornai places strong emphasis on halting inflation through tight fiscal and monetary policies: state enterprises should not be bailed out through either subsidies or easy credit. Fiscal deficits would be reduced by drastic reductions in consumption and production subsidies and by introducing a nonprogressive tax system based on consumption (e.g., value-added), payroll and profit taxes. The nonprogressive of these taxes is justified by the need to stimulate production and investment. To accomplish these ends, however, the tax measures must be accompanied by price liberalization, a uniform exchange rate, and liberalization of foreign trade and exchange transactions. Eventually, the central bank should establish a convertible forint, but until this is possible, free market transactions should be permitted. Western aid should be mobilized and foreign debts renegotiated. All these actions should be as simultaneous as possible: Kornai trenchantly demonstrates how failure in one area negates progress in another.

Throughout this analysis and in a final section, Kornai discusses social and political issues. While private enterprise must be encouraged, there needs to be “humanitarian aid” for the dislocated and poor; the fiscal consequences of this aid are not deeply explored. In arguing that his program should receive strong political support from a people tired of past failures, Kornai’s tone is as much hortatory as analytical.

Anthony Lanyi

The Age of Diminished Expectations

Paul Krugman

U.S. Economic Policy in the 1990s

MIT Press, Cambridge, MA, USA, 1990, xii + 204 pp., $17.95.

The Myth of America’s Decline

Henry R. Nau

Leading the World Economy into the 1990s

Oxford University Press, New York, NY, USA, 1990, 424 pp., $29.95.

The authors of both volumes agree that the US economy is not doing well and that, if present policies continue, the United States could fall behind in terms of economic power by the year 2000. There the similarity ends. Krugman’s theme is that the US public has come to accept a performance that is decidedly poor, certainly compared with what might have been expected some 20 years ago when the United States was enjoying a great postwar boom. Although the United States has had some economic successes since 1980, notably reduced inflation and increased job creation, the failures are profound. They are, of course, in the very areas that we all read, or hear about daily: a marked slowdown in productivity, a leveling off of a growth in real wages, increased inequality of income distribution, an increase in poverty in both extent and severity, a persistent trade deficit that has made the United States dependent on large capital inflows from abroad, gyrations in the value of the dollar, a huge seemingly intractable budget deficit, and mounting public debt. In addition, there is a savings and loan debacle, a Third World debt crisis, and numerous takeovers and leveraged buyouts of US corporations. Yet, maintains Krugman, there is amazingly little political demand that the economy do better. It is an “Age of Diminished Expectations.”

In this slim volume—a little gem—Krugman writes clearly, often engagingly, with 31 delightful simple charts (that he refers to at times as “pictures”). Rather than taking a particular standpoint, he explains the existing situation and the issues involved, as well as the alternative views of economists, well known for their differing opinions. On occasion, but with caution, he presents his own position. He ends with three possible scenarios of the eventual consequences of continuing present policies. The first is a “happy ending”—a renewed prosperity that makes today’s doomsayers seem foolish. The second is a severe crisis—a “hard landing”—brought on by the excesses of the 1980s. Krugman gives these scenarios a less than 30 percent probability. The third, which he considers virtually a forecast, is that the economy will continue to “drift.” While gloomy, this conclusion seems most realistic.

Henry Nau takes a more optimistic view. He argues that the United States can again be the leader of the world economy as it was from 1947 to 1967. What is required is for the country to take a dominant political position and to adhere to free market policies, with reduced levels of government spending, low income taxes, further rollbacks of government regulation, reliance on private enterprise and competition, and removal of international barriers to the free movement of products, labor, and capital.

Nau makes his case with a well-researched history of US policy since 1944. He finds only two periods of successful economic performance, the great postwar period starting with the Marshall plan and continuing through 1967, and the first Reagan administration, from 1981 to 1984. The first period was successful, in his view, because of US leadership and the pursuit by the Western world of conservative macroeconomic policies, little government regulation of the private sector, and reduction of trade and foreign exchange barriers, which led to low inflation and stable prices and exchange rates. The 1981-84 period was marked by a return to such conservative policies. Nau concedes that after 1984, the Reagan administration retreated, because of insufficient political will to stick to the policies as originally conceived in 1981.

But, as it turns out, many of the problems the US economy now faces can be laid at the doorstep of those very policies. Deregulation is largely responsible for the savings and loan failure; competition among commercial banks helped foster excessive lending to Third World countries and other risky overlending, which now threatens the solvency of the banking system; lowering of income taxes has brought the government near bankruptcy; and increased inequality of income is bringing about a class consciousness of rich and poor, now partly responsible for the political difficulties complicating resolution of the budget deficit. In addition, the US economic expansion of the 1980s was financed in large part by the savings of the rest of the world. Comparison with the successful Marshall Plan era is relevant, but not for the reasons Nau suggests. The United States, finding itself with a large share of the world’s gold reserves, was able and willing to provide assistance to Western Europe. Implementation of the Marshall Plan, moreover, is not an example of free market policies but rather of carefully planned coordinated government action. Nau’s optimism must thus be tempered with considerable skepticism.

Margaret Garritsen de Vries

Macroeconomic Policy

Robert J. Barro

Harvard University Press, Cambridge, MA, USA, 1990, 379 pp., $27.50.

This book is a collection of 13 papers written by one of the profession’s most prominent and widely read macroeconomic theorists. All but one of the papers have been published previously, and many of them will be familiar to anyone who has kept abreast of developments in macro theory and policy over the past decade. Among these, one would certainly include Barro’s work with David Gordon on the “rules-versus-discretion” controversy, and his more recent work on fiscal policies. Two very recent papers are also included in this volume, one on the issue of interest rate targeting and the other, a survey paper on the Ricardian approach to budget deficits.

The volume is divided into three main sections, which correspond to the broad themes of Barro’s writings over the past decade. Part I deals with the “rules-versus-discretion” debate and includes, in addition to the two papers with Gordon, a concise introductory chapter surveying the main issues. Part II deals with the role of money in the business cycle, while Part III focuses on fiscal policy issues.

In his joint work with Gordon, Barro analyzed a simple economy in which output responds positively to unexpected inflation. Their main objective was to formulate a positive theory of monetary policy that might be applicable under current monetary arrangements in the United States in which the Federal Reserve has broad discretion to set policy without having to follow formal rules. In addition to the prediction of relatively high inflation (relative, that is, to an equilibrium with rules), they used their model to predict how policy would react to various changes in the economic environment. They also examined the extent to which the reputation of the monetary authority (i.e., its past success at controlling inflation) might substitute for formal rules in controlling inflation.

From the three chapters that re-examine the role of money in business fluctuations, it is clear that Barro wishes to de-emphasize the real effects of monetary variables. This is a position he finds consistent with the available evidence.

In the fiscal area, the counterpart to monetary neutrality is the so-called Ricardian equivalence theorem, which contends that the method of financing a given deficit (by taxes or borrowing) is irrelevant. While there are many counter-arguments to the Ricardian view, Barro’s basic conclusion is that “like the Modigliani-Miller theorem in corporate finance—the Ricardian theorem is the right starting point for analyses of intertemporal government finance” (p. 4). In addition to an elegant survey of these issues, the final section also contains an exposition of Barro’s tax-smoothing model and some empirical tests of its main implications, as well as an investigation of the macroeconomic effects of government expenditures, both theoretically and empirically.

Barro’s contributions have covered many of the main issues of macroeconomic policy that are likely to occupy both the profession and policymakers for years to come. This book will therefore provide essential reading for anyone interested in formulating his own views on these questions.

Jonathan Ostry

Monetary Policy for a Volatile Global Economy

William S. Haraf and Thomas D. Willett (editors)

The AEI Press, Lanham, MD, USA, 1990, xiii + 198 pp., $24.95.

Economic literature is filled with articles and books on issues relating to the choice of exchange rate regimes and the conduct of stabilization policies in open economies. But these issues are important. This selected collection of six papers and four commentaries, prepared for a conference at the American Enterprise Institute, offers interesting perspectives on this broad theme.

How well can the choice of exchange rate regime be predicted by country characteristics or the nature of economic disturbances? Have floating exchange rates been excessively volatile? Does exchange rate variability significantly depress the volume of international trade? And how much wisdom on the choice of exchange rate regime has been acquired from simulation analysis with multicountry macroeconometric models? These are the questions addressed by Hali Edison and Michael Melvin in a fairly comprehensive survey of the empirical literature. It is highly recommended for those not yet convinced that empirical studies provide few, if any, clear answers on the appropriate choice of regime. The commentary by Morris Goldstein, who discusses some additional issues, including whether the choice of exchange regimes can have much effect on the authorities’ ability to discipline fiscal policy, is also highly recommended.

Thomas Willett and Clas Wihlborg challenge the popular view that international capital flows and exchange rate movements are primarily disruptive. The authors emphasize that capital flows can either aggravate or mitigate exchange rate fluctuations, domestic macroeconomic instability, and the international transmission of disturbances. More than half of the chapter is devoted to the subjects of exchange rate determination and the behavior of the US dollar during the 1980s. Additional and contrasting views on these topics are presented in the commentary by William Branson and in a subsequent paper and commentary by Alan Stockman and Jeffrey Frankel, respectively. The book also includes a chapter by Gottfried Haberler on the evolution toward economic and monetary union in Europe.

The final two papers provide insights on issues related to the external deficit and debt positions of the United States. Guido Tabellini argues that the accumulation of a large dollar-denominated net debt position could impair the commitment of the United States to combat inflation, with further implications for international monetary cooperation. His conclusion that “monetary cooperation… might weaken the incentives for the debtor country to correct its fiscal deficit (p. 144)” is not convincing, for reasons discussed in the penetrating commentary by Jacob Dreyer. Nonetheless, this is a paper many readers would find provocative.

Richard Cooper’s brief paper addresses the “unpleasant arithmetic” of eliminating the US current account deficit. The sobering conclusion is that, unless new mechanisms are established to help developing countries increase their imports substantially, the US deficit cannot be eliminated within a 5-year horizon if world recession is to be avoided.

Peter Isard

Principles of Budgetary and Financial Policy

Willem H. Buiter

The MIT Press, Cambridge, MA, USA, 1990, vii + 461 pp., $40.

In fiscal economics there is a marked gap between those specializing in the microeconomic theory of neoclassical public finance and those in the macroeconomic neo-Keynesian theory of stabilization policy. Willem Buiter is one of the pioneers who has attempted to forge links between the two, in skillfully formulating and analyzing the microeconomic foundations of our macro theories. The success of this approach is amply demonstrated in this collection of 13 papers, the majority of which were published over 1976-88.

Inevitably, many of these essays rely heavily on the short-hand of mathematics, placing the analysis beyond the reach of the layman. However, underlying Buiter’s elegantly formulated models is a discussion of some of the most pressing policy issues: How can economists explain the simultaneous occurrence of fiscal and balance of payments current account deficits? Must such a high fiscal deficit inevitably result in inflation? Does the expenditure underlying such a high deficit “crowd out” private saving and capital formation and lead to a deterioration in the balance of payments? The answers that economists have formulated to such questions, in turn, have determined the economic policies that directly affect the man in the street.

While at first glance this group of papers appears a little heterogeneous, four main themes can be discerned. First, the stabilization role of fiscal policy cannot be analyzed separately from its allocation and distribution roles. In many of these essays, Buiter clarifies how certain fiscal policy instruments adopted for stabilization purposes, in so much as they affect aggregate demand, alter relative prices and hence the distribution of resources. Second, the author forces us to realize that the way we measure things colors our understanding of the processes we are measuring. In particular, when attempting to measure public sector activity over time, the author stresses there are no “model-free” measures of fiscal stance and compels us to re-examine the models on which our conventional measures are based. Third, no analysis of fiscal policy can be complete without taking into account the relationship between public and private economic activity. While others have focused almost exclusively on the displacement of private economic activity by public economic activity, or “crowding out,” the author is at pains to point out that insofar as public sector activity is reinforcing or complementary, there could well be some “crowding in.” Fourth, and perhaps most controversial, is the author’s firmly held belief on the importance of the choice of alternative financing modes in affecting the fiscal impact on inflation, solvency, and crowding out.

Jack Diamond

Macroeconomic Consequences of Farm Support Policies

Andrew B. Stoeckel, David Vincent, and Sandy Cuthbertson (editors)

Duke University Press, Durham, NC, USA, 1989, xiii + 381 pp., $57.50.

The subject of international agricultural protection has been receiving increasing attention, particularly in the context of the Uruguay Round of trade negotiations. At the center of discussion has been the high level of such protection in the major trading countries and blocks. This is a provocative and well-written volume of ten research papers intended to spread awareness among the public and policy-makers of the macroeconomic costs and benefits of the policies in both industrial and developing countries.

An analysis of this multifaceted phenomenon would be incomplete if it were confined only to the agricultural sector. What is needed is an economywide analysis encompassing the second round (effects following the initial impact of a policy change) as well as indirect effects. This is exactly what researchers from different parts of the world do in their studies covering Australia, Japan, the Republic of Korea, and the United States, as well as the European Community (EC) and six representative developing countries.

The analyses brings out many powerful conclusions. Developing countries, even those exporting oil and importing food on a net basis, stand to gain from an estimated $26 billion increase in real income that would result from agricultural liberalization in the industrial countries (Loo and Tower, Chapter II). The economic position of the industrial countries would also be strengthened with the adoption of this policy. Agricultural protection has cost the German economy 200,000 to 400,000 jobs and a loss in real GDP of 3 percent, as higher prices have made industrial goods less competitive internationally (Dicke et al., Chapter III). The four largest countries in the EC have lost around four million jobs (Breckling et al., Chapter IV), and Japan’s export earnings have been lowered by 3 percent and higher agricultural prices have reduced the average real wage of workers by 2.5 percent (Vincent, Chapter V). Similar types of economic consequences would follow for newly industrialized countries such as the Republic of Korea (Vincent, Chapter VI). Australia, which taxes agriculture indirectly by affording protection to industry, would experience a decline in domestic prices and an improvement in international competitiveness if assistance to both sectors is withdrawn (Higgs, Chapter X).

Both the US government budget and the trade balance would improve and real income increase with the freeing of agriculture (Feltenstein, Chapter VII; Robinson et al., Chapter VIII) even if the United States liberalized unilaterally. A 5.5 percent reduction in the agricultural labor force would occur as a result (Hertel, Chapter IX), though the output adjustments within the agriculture would be uneven; sugar and dairy sectors will contract, while oil seeds will expand. Outputs of nonagricultural manufacturing and services will be higher by $18 billion, raising real income in the United States by $14 billion.

Clearly, these results are significant in the design of economic policy. However, a word of caution: the economywide (“computable” general equilibrium) models make various simplifying assumptions, rely extensively on externally estimated elasticities, and employ data of a given year assumed to be an “equilibrium” year. These results are very sensitive to the use of different elasticities or underlying assumptions and data. Nevertheless, these models possess sound microeconomic foundations, are internally consistent, and have the capability of providing detailed sectoral results, which enable policymakers to think about the mechanisms behind the results. In interpreting the results, one should perhaps then focus more on the direction, rather than the extent, of change.

Sanjeev Gupta

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