Friday, December 3, 2010
Engines of Prosperity: Is There a Single Cause of Economic Expansion and Development?
Economic theory teaches that there are three contributing factors to economic expansion and development: the market division of labor, capital accumulation, and entrepreneurship. From time to time, however, different economists have sought to emphasize one of these three engines of prosperity over against the others in explaining economic progress.
Adam Smith, for example, placed great emphasis on the division of labor as the cause of national wealth. The classic Harrod-Domar model focuses exclusively on capital investment, while the Solow growth model uses a neo-classical production function to conclude that the important contributor to sustained economic progress is technology. This conclusion heavily influences the thought of William Easterly in his book The Elusive Quest for Growth.
It turns out, however, that we cannot neatly sever the components responsible for economic expansion from one another and find a single cause that explains economic progress. Certainly the division of labor has been a great boon to productivity and the standard of living. However, a highly developed division of labor would be impossible without the accumulation and use of capital goods.
Likewise, entrepreneurial activity presupposes an already existing division of labor and stock of capital to which entrepreneurs have access. As Rothbard and Salerno have noted, the entrepreneur must invest real property in the production process and if he errors in his market forecast, he can indeed reap large losses.
At the same time, we should never forget that capital per se never guarantees economic progress either, because it must be wisely utilized. One thing that will surely quickly shrink the capital stock is for it to be invested in wasteful production projects. Economic expansion and development is the result of all the contributors working together. It is the blessed result of a highly developed division of labor, taking advantage of a growing capital stock productively invested by entrepreneurs.