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JOHN VAN SICKLE, Economic Growth vs. “ Growth ” Economics - Ralph Raico, New Individualist Review [1961]

Edition used:

New Individualist Review, editor-in-chief Ralph Raico, introduction by Milton Friedman (Indianapolis: Liberty Fund, 1981).

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Economic Growth vs. “Growth” Economics

JOHN VAN SICKLE*

AS WORLD WAR II drew to a close, the prevention of massive unemployment was generally regarded in the West as the major continuing postwar problem. In the underdeveloped countries, however, it soon appeared that the number-one problem was growth, and not just any kind of growth, but industrial growth. At that time Russia’s forced growth convinced many in the West that some minimum rate was required for national survival, and that governments must see to it that this minimum rate is attained.

To old-fashioned liberals1 this concern for growth seems excessive. To them growth is a form of change and the only kind of change worthy of the name is one resulting from spontaneous changes in consumer tastes and preferences. If people want and can secure more leisure or more children rather than more material things, then that is growth. In brief, to the liberal, growth is only meaningful within the context of freedom.2

The liberal does not deny, of course, that in the world of today national survival does depend on growth in output per capita of goods people really want. But he believes that spontaneous forces can and will provide both freedom and adequate growth, in this more restricted sense, if government will but provide the proper framework. To him the best way to produce more of what people want is to work harder, save and invest more, and devise better tools and better methods of organizing production. Assuming as he does that human wants are virtually unlimited, he lays his bets on the enormous potentialities inherent in individual initiatives. He relies on free prices and competition to direct resources to all sectors of the economy in such proportions as to keep the returns to capital and to labor approximately equal at all margins. Out of the resulting abundance he would, of course, have the governments of the free world take whatever is needed for defense, urging only that the burden be so distributed as to maintain as fully as possible the incentives which free people must rely on to meet the Communist challenge.

The liberal is rationally as well as emotionally an internationalist. It is obvious to him that no national market is broad enough to yield the full potentialities that specialization offers. He is further convinced that only through free and private trading can national markets be peacefully and effectively integrated.

Properly speaking there is no single “new theory” of growth, but rather a family of theories, differing from one another in detail, but alike in their denial of the liberal concept and explanation of growth, and in their distrust of the spontaneous forces of the market. Common to all variants of the “new theory” is the conviction that growth must be in accordance with the overriding directives of a comprehensive plan. Just as the 1949 United Nations Report on Full Employment3 represents the “new look” at the employment problem, so its 1951 Report4 on ways of promoting the rapid development of poor countries represents the “new look” at the growth problem.5

A CHARACTERISTIC OF the new theories is the modest role assigned to agriculture. For a variety of reasons, some perfectly valid6 and some wholly fallacious,7 it is held that an appreciable proportion of the farm population in the underdeveloped countries could be withdrawn from that sector without any adverse effect on total output. Anything these workers could do elsewhere would represent a net gain. But they cannot be put to work without tools. Consequently investment in the non-farm sector of the economy is the key to growth, with industrial development given top priority.

It is further held that the needed rate of industrial development cannot be had by adherence to measures consistent with orthodox theory. Investment would be spread too thin. What is needed is such a massive concentration of capital on a relatively limited non-farm target as to enable the whole economy to “take off” and to “break through” the vicious circle of proverty and stagnation. Where a single factory might not pay, fifty plants properly brought together might prove highly profitable because they would provide each other with external economies and further justify the provision of the roads, power, ports, education, health services—the much-talked-of infra-structure—which would otherwise represent a waste of scarce resources.8

This variant of the “new theory” explicitly rejects the marginal-productivity principle. “Economic analysis,” we are told, “provides two general principles for the use of resources. One is the marginal principle.” Another, and a better one, to which no name is attached, “arises from the fact that large movements of resources within the economy will have effects which are disproportionately different. In consequence the planner must satisfy himself not only that further marginal movements would serve no useful purpose but also that there is nothing to be gained by larger movements of resources, amounting to a considerable alteration in the structure of the economy.” The new principle must be grasped intuitively. The planners “must soak themselves thoroughly in the facts of each particular case and must then use their best judgment.”9 Furthermore they must rely primarily on “direction” rather than on “inducement” despite the fact that direction requires a costly bureaucracy which is “liable to corruption,” “gives rise to black markets,” causes “great irritation and frustration” and “cannot be applied to new foreign resources to be attracted from abroad.”10

The immensity of the task assigned to the governments of the underdeveloped countries is revealed in the following list of public functions which the United Nations experts cite as representative rather than complete: market research; prospecting; establishment of new industries; creation of financial institutions “to mobilize savings and to channel them into desirable private enterprise”; operation of public utilities, of agencies for marketing agricultural produce, of factories for processing the output of small farmers: confiscation of “unearned increments” that arise in economic developments; land reform; “creating credit institutions and insurance schemes which satisfy the farmers’ legitimate needs for credit”; some compulsory standardization of products in particular industries; planning and organization of “industrial centers”; compulsory consolidation of land holdings; “influencing the movement of resources in directions which it considers to be more appropriate,” including the location of industry: control of new building by restrictive licensing; acting as guarantor for particular investments; licensing of new investment; and perhaps controlling the consumption of the rich.11

Governments of underdeveloped countries obviously cannot mobilize the talents needed to discharge this range of tasks. The Pakistani people were recently told just this by two distinguished German bankers who were invited to visit the country in the hope, of course, that they could help the Pakistani government find foreign capital. The visitors stated that “because of lack of experience, efficiency and discipline,” the administration was “incapable of running a system of physical controls.”12 Similarly a Mission sent by the International Bank to study economic conditions in India and Pakistan suggested very discreetly that “selective controls over industrial development present certain hazards in a country where administrative talent is spread so thin.”13

This is in brief the new theory. It denies that economic freedom alone will produce growth; it insists that government’s role in this area is critical, central and substantial. It is now in competition with orthodox theory for acceptance by policy-making bodies in all countries. Is it an improvement on the old?

THERE IS TRUTH in the new theory, but most of what is true is not new and most of what is new is of dubious validity. Indeed, the valid part of the theory is largely a restatement of two exceptions to the principles of “natural liberty” which have been recognized by economists from the days of Adam Smith on.

First, there is the infant-industry argument. Economists have always recognized the possibility of speeding up by temporary protection the development of industries for which an industrially young country possesses a potential comparative advantage. In so far as economic theorists reject the conclusion, it is on practical and political grounds.

Then there are what have come to be called “neighborhood effects.” Adam Smith’s third “duty of the sovereign” covers some of these; Professor Pigou has made us familiar with others. Whenever uncompensated benefits and uncompensated damages result from private actions, traditional theory recognizes the propriety, in principle at least, of public interventions of an encouraging or restraining sort, if returns to resources at all margins are to be kept equal. Here again the liberal’s scepticism is due to his doubts regarding the ability of governments to resist the pressures to carry investment far beyond the point indicated by marginal-productivity theory, and to handle satisfactorily the resulting administrative and fiscal problems.

Both these arguments slight the political and fiscal aspects of the problem. When a poor country invokes tariffs and subsidies in a large way, there is apt to be such a misuse of scarce resources as to seriously retard growth. Until a government can discharge tolerably well the first of Adam Smith’s “duties of the sovereign”—national defense and the maintenance of domestic tranquility—the undertaking of these optional and more difficult tasks is likely to create a situation in which growth with freedom becomes impossible.

Ambitious public programs call for large public expenditures. It is difficult to raise the required revenues entirely through indirect taxes. Consequently, governments are under pressure to impose heavy and sharply progressive direct taxes modeled on Western standards, or else to resort quite frankly to inflation. Both methods impede growth.

Inflation distorts investment decisions, creates balance-of-payments problems, works hardships on fixed-income groups, provokes flights of domestic capital and discourages the entry of foreign capital. Consequently investment via this route frequently explodes into galloping inflation with complete destruction of confidence in the nation’s money, or degenerates into “suppressed” inflation with its accompanying arsenal of detailed and paralyzing price and production controls, its black markets and the widespread “irritation and frustration” to which the United Nations’ experts referred.14

Progressive taxation is likely to be equally harmful to growth. In so far as the law is enforced, it slows down the rate of increase in precisely that resource which is most scarce and most needed for growth. In fact, of course, underdeveloped countries simply cannot enforce highly progressive taxes, but this does not mean that the attempt does not have unfavorable consequences. Administration is apt to be arbitrary, capricious, and corrupt, and the yield is sure to fall short of expectations. Hence, poor countries which attempt to finance grandiose development schemes through a modern progressive income tax are forced to fall back finally on either inflation or on indirect taxes. Neither is adequate to the task, but of the two, inflation is by far the more damaging.

The development plans called for by the new theory invariably require a greater investment than can be had from voluntary savings. Consequently, internal compulsions are recommended, though they are frequently spoken of as “inducements.” But it is also recognized that the “revolution of rising expectations” cannot be satisfied by any combination of voluntarism and compulsion. Foreign capital is essential and it is generally taken for granted that the underdeveloped countries neither can nor should be expected to pay the price needed to attract this capital from the private-capital markets of the West. The governments of the West are said to have a moral obligation to force the savings of their people into the service of the peoples of the underdeveloped countries roughly on the basis of need.

Is it wise to encourage this belief? Leaving aside the moral aspects of the problem, it is well to ask whether in fact the underdeveloped countries are likely to get more or less foreign capital by relying on compulsion rather than on voluntarism.

Unless the compulsions applied within the poor countries are extremely severe they defeat themselves by driving capital out of the country or into hiding. Success, therefore, will depend upon the willingness of the people of wealthy countries to tax themselves and to see their funds used year after year to keep in power regimes whose actions are in many respects at variance with the ideals which the aid is supposed to promote. Will the people of the West be willing to give enough and give long enough to enable all underdeveloped countries to grow in numbers and in wealth at rates corresponding to their several “expectations”? The amounts required are so gigantic that no responsible government in the West should give the impression that they will be forthcoming,15 and no responsible government among the underdeveloped countries should build its plans on the expectation that they will be forthcoming. Almost any underdeveloped country, on the other hand, can expect to see a very substantial inflow of foreign capital and foreign managerial skills, if it puts at the very center of its development plans the necessity for creating those social psychological, economic and institutional arrangements which represent the veritable infrastructure for voluntary growth.

NOTHING SAID SO FAR should be interpreted as a denial of the deep concern of all true liberals in the growth of freedom and well-being everywhere. What they object to is the method favored by the new theory. If the people of the West are really sincere in their protestations of concern with poverty in less-favored parts of the world, they must be prepared (a) to open on durable and reasonable terms their own markets to the products of the underdeveloped countries; and (b) to refrain both directly and through such agencies as the International Labor Organization from urging the governments of the underdeveloped countries to impose wage and welfare standards they cannot yet afford. And if the peoples of the underdeveloped countries really want growth with freedom, they must be prepared (a) to accept the disciplines of free markets; (b) to see to it that their governments discharge efficiently, adequately and honestly the “primary functions” that all governments must perform; and (c) to resist the natural and generous impulse to convert the high productivity which capital and modern know-how make possible too quickly into increased consumption. Development, whether planned or unplanned, is uneven in its timing and in its impact. It lifts productivity in narrow sectors of the economy far above that prevailing in the sectors where, for the time being, traditional methods persist.

When governments of poor countries call upon these narrow sectors to provide incomes to public officials and to the workers directly involved which are a multiple of those enjoyed by the vast majority of the people, a “domestic gap” is created which is probably more conducive to envy and more detrimental to growth than the international gap about which we hear so much. The high wages, whether imposed by minimum-wage laws or collective bargaining or industry commissions, create a “contrived scarcity” of labor where there is no real scarcity, and thus make it necessary for the private firms which are subject to these imposed costs to use more capital-intensive methods than would otherwise be the case. As a result the work force in the less-developed sectors of the economy is deprived of the simple tools which would contribute more to national output than the highly modern plant and equipment which planners in the underdeveloped countries delight in as evidence of progress.

To conclude, we can find no reason either in theory or in the historical record why governments of poor countries must play a larger role in economic affairs than the governments of wealthy countries. Development is an unending process. It is needed by poor and rich countries alike. The public policies which promote growth with freedom are much the same everywhere.

WHAT YOU CAN DO TO HELP NIR . . .

During the past year, the circulation and staff of NEW INDIVIDUALIST REVIEW has been expanding rapidly. This journal is now being sold at many local newsstands and at over 40 colleges and universities. Despite a few dissenting notes, the general reaction of libertarian and conservative leaders has been favorable. The author of “The Conservative Mind,” Prof. Russell Kirk, for instance, has said that NEW INDIVIDUALIST REVIEW is a work of “genuine intellectual power” and the editor of “National Review,” William F. Buckley, Jr. has called it “by far the best student magazine on our side of the fence.” If you agree that this is a useful magazine which ought to be read by more people, there are four things that you can do to further the growth of libertarian-conservative ideas.

(1) You can urge your college library or your local public library to subscribe. A library subscription makes an excellent donation since it may introduce the magazine to dozens of people.

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[* ] John Van Sickle is Professor Emeritus of Economics at Wabash College and co-author of the college textbook Introduction to Economics. This article is taken from his forthcoming book, A Framework for Freedom.

[1 ] The term “liberal” is used here and throughout this article in its original and proper sense.

[2 ] For an effective statement of this view of growth, see P. T. Bauer, Economic Analysis and Policy in Underdeveloped Countries, (Durham, North Carolina: Duke University Press, 1957), pp. 113-114.

[3 ]National and International Measures for Full Employment, United Nations, (New York, 1949).

[4 ]Measures for the Economic Development of Underdeveloped Countries, United Nations, (New York, 1951).

[5 ] There is little in the subsequent flood of interventionist literature that runs counter to the analysis and policy recommendations to be found in this 1951 report.

[6 ] For a clear statement of this sophisticated theory, see Economic Development in Latin America and Its Principal Problems. An analysis of this theory by B. A. Rogge appeared in the Spring, 1956, issue of Inter-American Affairs, (vol. 9, no. 4), pp. 24-49.

[7 ] For a perceptive discussion of this whole issue of the place of agriculture in a growing economy, see P. T. Bauer and B. S. Yamey, The Economics of Under-developed Countries (London and Chicago, 1957), Chapter XV. For actual evidence against this thesis, see H. T. Oshima, “Under-employment in Backward Countries,” Journal of Political Economy, June, 1958, and T. W. Schultz, “Latin-American Economic Policy Lessons,” American Economic Review, May, 1956.

[8 ]Measures for the Economic Development of Under-developed Countries, op. cit., parag. 185.

[9 ]ibid., parags. 148-151.

[10 ]ibid., parags. 216, 217. An item about Indonesia in Newsweek (February 14, 1960) strikingly confirms the reality of these dangers which the U.N. Report identifies and then dismisses: “Meanwhile, the art of government seems to elude Indonesia. Its vast mushrooming bureaucracy (more than I million Indonesians are on the public payroll) is riddled with twin ills: incompetence and corruption. More than anything else, these evils have got the nation’s economy into such a shambles that U. S. observers in Indonesia simply throw up their hands when the subject is brought up.

“Bribes and Bad Fish: Corruption is the normal way of business. One man recently paid a 50,000 rupiah bribe in order to be allowed to pay a 200 rupiah tax he’d forgotten; another was asked to pay 50,000 rupiahs for a residence permit to be allowed to live in his own house. (The rupiah itself, on the black market, has gone up as high as 750 to $1, though the legal rate is 45.) As for bureaucratic incompetence, government purchasing agents consistently buy bad rice and rotting fish; one importer recently bought 100,000 tons of Swedish cement and had to throw 30,000 tons into the ocean after it got wet because there was no place to store it.”

[11 ] The above list of duties and the ensuing comment borrows heavily from Ben A. Rogge, “The Role of Government in Latin-American Economic Development,” Inter-American Economic Affairs, (vol. 9, no. 3, Winter, 1959), p. 43.

[12 ] International Monetary Fund, International Financial News Survey, March 27, 1959, p. 298.

[13 ]ibid., April 28, 1960, p. 333.

[14 ] See Professor Karl Brandt’s The Threat of Inflation in the Underdeveloped World, at the Stanford Business Conference on Economic Growth and Inflation, held at Stanford University, Stanford, California, July 20, 1959 (mimeograph copy). A convincing statement of the case against inflation as a means of promoting growth will be found in an article by Gottfried Haberler, Galen L. Stone Professor of International Trade at Harvard University, Inflation: Its Causes and Cures (revised and enlarged edition, American Enterprise Association, Washington, D.C., June, 1961).

[15 ] Professor J. Spengler’s warning is very pertinent: “Unless population growth is reduced, the stork will gobble up capital faster than it can be introduced . . . in consequence per capita income will not be able to rise rapidly and America will be damned for having supplied a drop of water, when allegedly a bucket was needed, even though in the absence of a salutary change in the people’s habits, not even a barrel could have helped much in the long run.” This is from an address Professor Spengler gave at the Third Duke American Assembly, May 18-21, 1961. The whole address (“National Goals, Growth and the Principle of Economy”) deserves careful reading. It is an exceptionally convincing statement of the pitfalls involved in setting up national goals.