ARNOLD HARBERGER: Policy Economics, Creative Destruction and the Economic Growth Process by Ihering Guedes Alcoforado

HARBERGER: An approach the study of growth — I try to approach the study of growth working up from the tangible basics. I guess that is part of my trademark in economics. Economic growth comes in part from a growing labor force, and/or one whose quality is improving, in a human capital sense. It also comes as a result of investment in physical capital. Finally, growth comes from improvements in total factor productivity. I prefer to use the term “real cost reduction” rather than “total factor productivity” because it’s something that every businessman in the world recognizes. This element of real cost reduction certainly has been an extremely important part of the growth process and something that we have known about and studied since the 1950s.[HARBERGER & LEVY, 1999]

The “breakdown of growth” analysis that I’m talking about really came into the forefront of economics in the 1950s. People like Abramowitz, Schultz and Kendrick. Many people identify it with Bob Solow, who was the first to build new theory on this base, but others were working on it empirically before that time. Indeed, Tinbergen and Stigler had the basic idea in the 1940s, before others brought it to center stage.[HARBERGER & LEVY, 1999]

One of the things that I find very puzzling is once you realize that the increment of the labor force is one source of growth; that the improvement in education (i.e., the quality of the labor force), is another; that the rate of investment in physical capital is still another; that the productivity of that physical capital is another source of growth; and that real cost reduction is yet another, why does 99 percent of the literature on growth not study these things one by one? They deserve to be studied one by one because they depend on such different elements. You can see Asian countries saving 30 and 40 percent of their GDP. That explains quite a lot of their growth. Why not zero in on that and try to study what leads to high and low savings rates, rather than nearly always run regressions just for the overall growth rate? Countries with rapid population growth will have rapid labor force increments. That doesn’t come from some endogenous growth model, it comes from the fact they have a lot of babies, which those models don’t talk about. So let’s get down to earth and try to understand what we observe.[HARBERGER & LEVY, 1999]

Now I feel that in this breakdown of growth we understand reasonably well the parts that have to do with the productive factors, labor and capital. The one that is the most difficult for us to fully “internalize” is the element of real cost reduction. I think we need to do a great deal more work studying that term. We need to try to get a much clearer picture of the elements that seem to make it bigger or smaller at different points in time. We have been moving in this direction in some of our recent work here at UCLA.[HARBERGER & LEVY, 1999]

HARBERGER: A Vision of the Growth Process — “In my 1998 American Economic Association presidential address called “A Vision of the Growth Process,” one of the things I emphasized was what I called, in another context, the juxtaposition of “yeast vs. mushrooms.” Yeast makes the bread rise kind of evenly, the way a balloon blows up. If real cost reduction were like that, we’d have similar improvement in productivity in shoeshines, in laundromats, in carwashes, in the auto industry, in pharmaceuticals — everything would grow evenly all through the economy. The mushroom analogy comes from the fact that it is very hard to predict where mushrooms are going to pop up — here, there or another place. And that’s what we see. Real cost reduction is extremely uneven across industries and activities. It is very hard to predict in advance how strong it will be and where it will occur.[HARBERGER & LEVY, 1999]

I focused on this around 1990, and subsequently I was struck by yet another fact: Not only is this real cost reduction uneven, but in nearly every data set broken down by industries within an economy or by firms within an industry, you have some with falling real cost (rising productivity) and others with rising real cost (falling productivity) per unit. This juxtaposition is something that I’m fascinated by right now and that I want to pursue, because if only we could do something to reduce the incidence of rising real cost we could gain a lot. Indeed as we study different periods, we find that the good periods are those with low incidence of cases of falling productivity, while the bad periods show a high incidence of such cases. This differential incidence explains most of the difference between good and bad results. I think we should focus our energies on studying and understanding this phenomenon of rising real cost, especially in light of how much difference it makes.[HARBERGER & LEVY, 1999]

This has led me to the “vision of the growth process” that I tried to convey in my presidential address. Firms are the locus where growth takes place. Entrepreneurs and other decisionmakers within the firms are the people who are the agents of this process. Somebody out there finds some way to make a dramatic reduction in real cost, does so, expands output, reduces prices, prospers. What happens to competitors? They’re driven back along their average cost curves, and they end up having increased average costs, which is what we measure. So those with negative real cost reductions are the losers in the competitive battle.[HARBERGER & LEVY, 1999]

HARBERGER & SCHUMPETER: Creative Destruction as the process of growth in a market economy — “ Schumpeter used the term “creative destruction” for the process of growth in a market economy. I pick up on that and say that here we have a lot of evidence. Creativity brings about the positive real cost reductions in the winning firms, but for a period of time the losing firms suffer an opposite force so that the net gain for the economy is not as great as what you’re seeing in the winners alone. Yet the losers are either going to adapt, in which case the consumers will gain all over the place, or they’ll go out of business, in which case consumers will gain as they shift their demand to the winners. That’s my line of thinking. [HARBERGER & LEVY, 1999]

HARBERGER AND ECONOMIC POLICY: to make it easier for people to perceive opportunities for real cost reduction — In policy we have to try to make it easier for people to perceive opportunities for real cost reduction. We have to fight against inflation, which blurs their perceptions, and against market distortions, which send them false signals about real costs. We have to fight for more open markets and freer competition, both within and among nations. This speeds the process of implementing real cost reductions and bringing their benefits to consumers. And we have to provide an institutional framework (laws, contracts, property rights, etc.) and a macroeconomic policy environment (stable and broadly predictable) that fosters a rapid adjustment of capital stocks in response to changing circumstances.[HARBERGER & LEVY, 1999]

“ HARBERGER AND THE REAL COST REDUCTION: A Vision of the Growth Process. “In my 1998 American Economic Association presidential address called “A Vision of the Growth Process,” one of the things I emphasized was what I called, in another context, the juxtaposition of “yeast vs. mushrooms.” Yeast makes the bread rise kind of evenly, the way a balloon blows up. If real cost reduction were like that, we’d have similar improvement in productivity in shoeshines, in laundromats, in carwashes, in the auto industry, in pharmaceuticals — everything would grow evenly all through the economy. The mushroom analogy comes from the fact that it is very hard to predict where mushrooms are going to pop up — here, there or another place. And that’s what we see. Real cost reduction is extremely uneven across industries and activities. It is very hard to predict in advance how strong it will be and where it will occur. HARBERGER in Levy, David. 1999. “Interview with Arnold Harberger,” The Region Mazgazine (Federal Reserve Bank of Minneapolis), 13 (1): 18–21, 36–40

HARBERGER: Is Growth Yeast or Mushrooms?

“Economic growth would be a socially easier process if it was smooth and even across society: that is, if most people could just get steady raises for doing their same jobs a little better each year. When growth benefits some and not others, or even benefits some while imposing losses and costs of transition on others, then controversies arise.” [TAYLOR, 2016]

Arnold Harberger offered a nice metaphor thinking about this difference in his Presidential Address to the American Economic Association back in 1998, entitled “A Vision of the Growth Process” and published in the March 1998 issue of the American Economic Review. Harberger discusses whether economic growth is more likely to be like “mushrooms,” in the sense that certain parts of a growing economy will take off much faster than others, or more like “yeast,” in the sense that economy overall expands fairly smoothly overall. “ He argues that “mushroom”-type growth is more common. Harberger writes:

“The analogy with yeast and mushrooms comes from the fact that yeast causes bread to expand very evenly, like a balloon being filled with air, while mushrooms have the habit of popping up, almost overnight, in a fashion that is not easy to predict. I believe that a “yeast” process fits best with very broad and general externalities, like externalities linked to the growth of the total stock of knowledge or of human capital, or brought about by economies of scale tied to the scale of the economy as a whole. A ‘’mushroom’’ process fits more readily with a vision such as ours, of real cost reductions stemming from 1001 different causes, though I recognize that one can build scenarios in which even 1001 causes could work rather evenly over the whole economy. Personally, I have always gravitated toward the “mushrooms” side of this dichotomy. I remember being impressed, when I first saw some early industry estimates of TFP [total factor productivity] improvement, by their tendency to industry concentration.” [Apud TAYLOR, 2016]

HARBERGER. GROWTH AND “MUSHROOM” PROCESS — The real cost reduction uneven — “I focused on this around 1990, and subsequently I was struck by yet another fact: Not only is this real cost reduction uneven, but in nearly every data set broken down by industries within an economy or by firms within an industry, you have some with falling real cost (rising productivity) and others with rising real cost (falling productivity) per unit. This juxtaposition is something that I’m fascinated by right now and that I want to pursue, because if only we could do something to reduce the incidence of rising real cost we could gain a lot. Indeed as we study different periods, we find that the good periods are those with low incidence of cases of falling productivity, while the bad periods show a high incidence of such cases. This differential incidence explains most of the difference between good and bad results. I think we should focus our energies on studying and understanding this phenomenon of rising real cost, especially in light of how much difference it makes.HARBERGER in Levy, David. 1999. “Interview with Arnold Harberger,” The Region Mazgazine (Federal Reserve Bank of Minneapolis), 13 (1): 18–21, 36–40

VISION OF HARBERGER OF THE GROWTH PROCESS: The Firms as Locus of Growth. “This has led me to the “vision of the growth process” that I tried to convey in my presidential address. Firms are the locus where growth takes place. Entrepreneurs and other decisionmakers within the firms are the people who are the agents of this process. Somebody out there finds some way to make a dramatic reduction in real cost, does so, expands output, reduces prices, prospers. What happens to competitors? They’re driven back along their average cost curves, and they end up having increased average costs, which is what we measure. So those with negative real cost reductions are the losers in the competitive battle.HARBERGER in Levy, David. 1999. “Interview with Arnold Harberger,” The Region Mazgazine (Federal Reserve Bank of Minneapolis), 13 (1): 18–21, 36–40

SCHUMPETER, CREATIVE DESTRUCTION AND POSITIVE REAL COST REDUCTION. Schumpeter used the term “creative destruction” for the process of growth in a market economy. I pick up on that and say that here we have a lot of evidence. Creativity brings about the positive real cost reductions in the winning firms, but for a period of time the losing firms suffer an opposite force so that the net gain for the economy is not as great as what you’re seeing in the winners alone. Yet the losers are either going to adapt, in which case the consumers will gain all over the place, or they’ll go out of business, in which case consumers will gain as they shift their demand to the winners. That’s my line of thinking.HARBERGER in Levy, David. 1999. “Interview with Arnold Harberger,” The Region Mazgazine (Federal Reserve Bank of Minneapolis), 13 (1): 18–21, 36–40

POLICY AS REAL COST REDUCTION: An Institutional Framework

“In policy we have to try to make it easier for people to perceive opportunities for real cost reduction. We have to fight against inflation, which blurs their perceptions, and against market distortions, which send them false signals about real costs. We have to fight for more open markets and freer competition, both within and among nations. This speeds the process of implementing real cost reductions and bringing their benefits to consumers. And we have to provide an institutional framework (laws, contracts, property rights, etc.) and a macroeconomic policy environment (stable and broadly predictable) that fosters a rapid adjustment of capital stocks in response to changing circumstances.” HARBERGER in Levy, David. 1999. “Interview with Arnold Harberger,” The Region Mazgazine (Federal Reserve Bank of Minneapolis), 13 (1): 18–21, 36–40

TIMOTHY TAYLOR: A supportive institutional environment for innovation“To put this another way, a lot of the policies for encouraging economic growth — like investing in human capital, technology, infrastraucture, and a supportive institutional environment for innovation — seem to suggest the possibility of broadly shared economic gains. But the economic growth that results will often be often mushroom-like and disruptive, affecting certain industries, localities, and kinds of workers more than others. [TAYLOR, 2016]

Paul Romer, who recently accepted the position of Chief Economist at the World Bank, recently offered on his blog a summary of the social problem that then arises in a pithy aphorism: “Everyone wants progress. Nobody wants change.” [TAYLOR, 2016]

BIBLIOGRAFIA

HARBERGER, Arnold C., A vision of the Growth Process, IN The American Economic Review, 1988, v. 88, n.1, pp. 1–32

HARBERGER, Arnold., Studying the Growth Process: A Primer” in Capital Formation and Economic Growth, Michael J. Boskin, editor, the Hoover Institution.

TAYLOR, Timothy, Arnold Harberger: Is Growth Yeast or Mushrooms? IN CONVERSABLE ECONOMIST, 20 OCT, 2016

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