To Grow or Not to Grow: Why Institutions Must Make a Difference

This may not surprise you, but when I was a student of economics in the first half of the 1970s, we were taught that economic growth over long periods was always and everywhere a technological phenomenon. The theory of economic growth at the time taught that the rate of growth of national economic output per person in the long run must be equal to the rate of technological progress, which was taken to be outside the purview of economics. So, economic growth was “exogenous ” – that is, it was not supposed to react to economic forces. I. Two Views of Growth The theory that traced long-run growth to technological advance and nearly nothing else was one of the most elegant economic theories of all time. It was beautiful, and still is. It earned its main founder, Robert Solow of MIT, a well-deserved Nobel Prize in 1987. But even so, the implication of the theory, as it was understood at the time, that long-run growth was solely a matter of technology was not fully satisfying. I for one came from a country where high inflation was creating havoc: Icelanders at the time were busy emptying their bank accounts in order to spare their money holdings from the ravages of double-digit inflation, so domestic saving plunged before our eyes. I was concerned that a collapse in national saving woul