What Determines Economic Growth? - Economic Review, Second Quarter 1993 - Dallas Fed

S ince 1973, per capita income growth in the United States and other advanced countries has slowed to 2.2 percent a year, or almost half the 3.9-percent annual rate of the preceding quarter century. If the United States had maintained the level of growth experienced in the 1950s and 1960s, real per capita income today would be about 11 percent ($2,200 in 1987 dollars) greater than it actually is. In contrast, it has been estimated that eliminating the variability in U.S. consumption since World War II would be equivalent to boosting current real consumption by only about 4.8 percent ($420 in 1987 dollars). If the choice is between long-term growth policies and further short-term stabilization policies, long-term growth policies clearly have the potential for vastly higher benefits. Perhaps the reason why economists have neglected long-run economic growth is that, for a long time, the profession relied on a theory that offered little scope for policy to influence important sources of growth. According to traditional growth theory, the main determinants of long-run economic growth are not influenced by economic incentives. Recently, however, the study of economic growth has been reinvigorated by new developments in theory and empirical findings that suggest growth is in the sphere of policy. This new literature, referred to as endogenous growth theory, helps to explain movements in long-term growth and why some countries grow faster than others. Because long-term economic growth is the fundamental determinant of whether our grandchildren will have better lives than ours or whether the poor nations will catch up with or fall further behind the rich nations, this article attempts to summarize what economists have learned about economic growth and applies recent empirical findings to the above issues. The first section examines the long-term growth record, focusing on the extent of growth variations across countries and across decades. The second section presents the traditional growth model and recently developed endogenous growth models. The next section discusses whether poor countries are catching up with richer nations or whether the rich are getting relatively richer. The fourth section examines factors that have been found to influence long-run economic growth, and the last section presents lessons for the future.