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close this bookExporting Africa: Technology, Trade and Industrialization in Sub-Saharan Africa (UNU, 1995, 434 pages)
close this folderPart I. Exporting Africa: an analysis
close this folder2. Trade theory: relevance and implications for African export orientation
View the documentIntroduction
View the documentConventional trade theory: essence and relevance
View the documentCritics and extensions of conventional trade theory
View the documentTrade theory and accumulation effects: introducing new growth theories
View the documentSome implications of new trade theories for Africa

Trade theory and accumulation effects: introducing new growth theories

Accumulation effects in the medium term can be derived from the neoclassical models of growth. The neoclassical model without exogenous shocks (e.g. productivity increases or population changes) presents a steady state capital-labour ratio determined by equating the real marginal product of capital and the discount rate. Any policy which raises the marginal product of capital will also raise the steady state capital-labour ratio, inducing output to grow faster in the medium term as capital accumulation takes place at a higher level (Solow, 1956; Baldwin, 1993).25 In the neoclassical model, medium-term growth results from the connection between trade and the marginal productivity of capital. Recent developments have augmented the Solow model by including human capital as a separate factor along with physical capital and unskilled labour (e.g. Mankiw et al., 1992).26 In this case, any policies (e.g. streamlining licensing procedures or easing foreign exchange restrictions) which would raise the marginal product of physical capital or human capital accruing to investors (e.g. by reducing the difficulty and expense of making investments) will also raise capital accumulation and growth in the medium term.

Although in the neoclassical growth models, continual accumulation takes the form of productivity-boosting knowledge, the rate of productivity growth is taken as given (determined exogenously). One contribution of the new growth theory is to endogenize the rate of productivity growth itself. A distinguishing feature of endogenous growth models (endogenizing investment) is that continuous accumulation requires that the return to accumulation does not fall as capital stock rises. Endogenous growth models have differed as to the type of factor which is thought to play a dominant role in the accumulation process: physical capital, human capital or knowledge capital.

The Marshallian concept, of increasing returns which are external to a firm but internal to an industry, was most widely used in static models, presumably because of the technical difficulties presented by dynamic models (Romer, 1986).27 Following Smith and Marshall, most authors explained the existence of increasing returns on the basis of increasing specialization and the division of labour, but these cannot rigorously be treated as technological externalities.

Evidence from observations made over almost three centuries, from 1700 to 1979, shows that productivity growth rates have been increasing for the Netherlands, UK and US (Romer, 1986). Similar evidence has been found for individual countries over shorter periods. Other evidence coming from growth accounting exercises and the estimation of aggregate production functions shows that the growth of inputs alone does not fully explain the rate of growth of outputs. Interest in dynamic models of growth driven by increasing returns was rekindled by Arrow's work on learning by doing (1962),28 in which increasing returns are supposed to arise from the new knowledge generated in the course of investment and production.

Some studies, closely related to the analysis of long-term growth, have focused on patterns of trade and their linkages with the patterns of innovation across countries, across sectors and over time. These studies have found some robust evidence regarding the impact of innovation on international competitiveness and on growth. This trend also relates to those neo-technology models which have attempted to endogenize technical progress within equilibrium open-economy development models (Krugman, 1979; Spencer, 1981) 29 Krugman's modelling of the technology gap between the North and the South and Spencer's analysis of the learning curve have contributed to bringing out some dynamic considerations in the discussions of international trade theory. Such approaches can be reduced to analyses of either learning curves or the generation of new intermediate inputs under monopolistic competition.

New growth theories which take technical progress as the driving force have extended Solow's insights by endogenizing technical progress. In the earlier models in this category, the rate of return to investment was prevented from falling due to technological spill-overs in production (Romer, 1986). The evidence on productivity growth over time coupled with the inadequacies of previous growth models motivated Romer (1986) to present a competitive equilibrium model of long-run growth with endogenous technological change, and with knowledge as an input which has increasing marginal productivity. In his model, long-run growth is primarily driven by the accumulation of knowledge by forward-looking, profit-maximizing agents. Knowledge is accumulated by devoting resources to research. New knowledge is assumed to be a product of research technology and this research exhibits diminishing returns. Romer combined three elements (externalities, increasing returns in the production of output and decreasing returns in the production of new knowledge) to constitute his competitive equilibrium model of growth. His model deviates from the Ramsey-Cass-Koopmans model and the Arrow model by assuming that knowledge is a capital good with an increasing marginal product.

A major problem with analyses undertaken in the equilibrium framework is their assumption of the existence of price- and/or quantity-based adjustment mechanisms which ensure clearing of all markets and the attainment of equilibrium in that sense. The assumptions based on the presence of maximizing agents become an inadequate representation of the general behaviour of agents when fundamental features of technological change (uncertainty and various irreversibilities) are invoked (Nelson and Winter, 1982; Dosi et al., 1990; Cooper, 1991).30 As North (1994) has suggested, the problem here reflects on the neoclassical body of theory. A theory of economic dynamics comparable to general equilibrium theory would be ideal for understanding economic change, but we do not have such a theory. The neoclassical theory is inappropriate for analysing and prescribing policy measures that will induce development. It is concerned with how markets operate rather than how they develop. Even when it attempts to take account of technological development and human capital investment, it still ignores the incentive structure, embodied in institutions, that influences societal investment in those factors.

Attempts to correct this deficiency have been based on more evolutionary micro foundations, whereby firms with different technologies and organizational traits interact under conditions of persistent disequilibrium. The essential aspects of Schumpeterian competition are highlighted, especially the diversity of firm characteristics and experience and the cumulative interaction of that diversity. Contributions in this category have focused more explicitly on the micro foundations of innovation by addressing firm-level decisions to invest in product or process innovations. The ceaseless search for better product quality and for cost-lowering process innovations continuously leads to productivity improvements. What Schumpeter referred to as 'creative destruction' is a process whereby the impulse coming from new products, new processes and new markets revolutionizes the economic structure from within, destroying the old one and creating a new one.

Contributors in this strand are more heretical and heterogeneous in nature and scope and their models are not always thoroughly formalized. Following Dosi et al. (1990), they may be classified into four broad groups: post-Keynesians (e.g. Posner, Vernon, Kaldor), structuralists in development economics (e.g. the dependency school), institutional economists such as Douglass North, and economic historians (e.g. Kuznets, Gerschenkron, Balough). Much of the management literature focusing on firm-level capabilities may be included in this approach (e.g. Porter, 1990). Studies which follow this approach agree on several points: that international differences in technology levels and innovative capabilities are crucial in explaining the trade flows and incomes of countries, that the general equilibrium mechanisms of international and inter-sectoral adjustment are relatively weak, that technology is not a free good and that allocation patterns induced by international trade have dynamic implications in the long term. The questions have implications regarding the causes of industrial development and growth, the linkages between these processes and their micro foundations, and the understanding of the on-going transformations and restructuring of world industry.

The evolutionary theory of economic change attempts to provide a formal theory of economic activity, driven by industrial innovation (consistent with the Schumpeterian view). It seeks to understand technical change, its sources and its impacts at micro and macro levels (Nelson and Winter, 1982). Evolutionary theory consists of heterogeneous modelling efforts which emphasize various aspects of economic change, such as the responses to market conditions of firms and industries, economic growth and competition through innovation. Many of its underlying ideas can be traced back to classical political economy (e.g. Smith, Marx, Schumpeter). In addition, contributors in this field have adopted tools of analysis from other fields. For instance, from the managerialists they have taken over a more realistic description of the motives that directly determine business decisions. From the behaviouralists they have taken an understanding of the limits of human rationality which make it unlikely that firms can maximize over the whole set of conceivable alternatives. The linkage of a firm's growth and profitability to its organizational structure, capabilities and behaviour is adopted from industrial organization (e.g. Coase, Williamson). The view that the histories of firms matter, because their previous experience influences their future capabilities, and that firms adapt to changing conditions is largely adopted from evolutionary theorists (e.g. Darwin, Lamarcker, Alchian) and economic historians berg. Rosenberg, David).

The version of evolutionary theory presented by Nelson and Winter (1982) questions two pillars of neoclassical theory. First, the maximization model of firm behaviour is questioned with respect to the way it specifies the objective function and the set of things that firms are supposed to know how to do. In addition, evolutionary theory objects to the way firms' actions are viewed as resulting from choices which maximize the degree to which the objective is achieved, given the set of known alternatives and constraints. Second, objections are raised to the concept of equilibrium which is used to generate conclusions about economic behaviour within the logic of the model.31 The general term that Nelson and Winter use for all the regular and predictable behavioural patterns of firms is 'routine'. Routine consists of well-defined technical routines for producing things, procedures (e.g. for hiring and firing, ordering new stocks), policies (e.g. for investment, R&D, advertising) and business strategies (e.g. on diversification, overseas investment). These routines are categorized into the operating characteristics governing short-run behaviour, those determining investment behaviour (period-to-period changes in the firm's capital stock) and those which operate to modify over time certain aspects of the operating characteristics (e.g. market analysis, operations research, R&D). There are also aspects of the behavioural patterns of firms which are essentially irregular and unpredictable. These are regarded as stochastic elements in the determination of decisions and decision outcomes. Evolutionary theory attempts to model the firm as having certain capabilities and decision rules and choice sets (through which the main objective is pursued). These choice sets are not well defined and exogenously given. The core concern of evolutionary theory is with the dynamic process by which firm behaviour patterns and market outcomes are jointly determined over time.

The emerging theory of dynamic firm capabilities is presented by focusing on three related features of a firm (Nelson, 1991):32 its strategy (a set of broad commitments made by a firm that define and rationalize its objectives and how it intends to pursue them), its structure (how a firm is organized and governed and how decisions are actually made and carried out) and its core capabilities (core organizational capabilities, particularly those which define how lower-order organizational skills are coordinated, the higher-order decision procedures for choosing what is to be done at lower levels, and R&D capabilities, particularly regarding innovation and how to take on-going economic advantage of innovation). Since the real world is too complicated for the firm to understand in the neoclassical way, firms will choose somewhat different strategies which will lead to their having different structures and different core capabilities.

When a new and potentially superior technology comes into existence in a relatively mature industry, the evidence suggests that what happens depends on whether the new technology is able to conform to the core capabilities of specific firms (competence enhancing) or requires very different kinds of capabilities (competence destroying) (Nelson, 1991). A change in management, and presumably a major change in strategy, is often necessary if an old firm is to survive in the new environment. Organizational change must be seen as the handmaid of technological advance and not as a separate force behind economic progress (Tidd, 1991; Nelson, 1991).33 In the long run, what has mattered most has been the organizational changes needed to enhance dynamic innovative capabilities. However, there is little in the way of tested and proven theory for predicting the best way of organizing a particular activity, and there is considerable disagreement about what features of a firm's organization are responsible for certain successes and/or failures. These can only be unveiled in concrete situations through empirical studies which seek to understand firm-level strategies, structures and capabilities and the environment in which they are operating.

Attempts to model the way allocation patterns of international trade influence the long-term dynamics of an economy have been made, incorporating the main ideas from the two-gap models and hypothesizing that world growth is determined by asymmetrical patterns of change in technological and demand structures (e.g. Kaldor, 1970, 1975; Pasinetti, 1981; Dosi et al., 1990).34 The locus of these approaches has largely been on the relationship between trade, levels of activity and growth.

It has been pointed out that the neoclassical premise of efficient markets is undermined by the existence of transaction costs, which create a need for institutions to define and enforce contracts. If trade is to prosper, certain informational and institutional requirements become necessary. Market institutions are expected to induce the actors to acquire information that will lead to the correction of their subjectively derived models. But if institutions shape the incentive structure of society, the learning process which occurs in the interaction between institutions and organizations shapes the institutional evolution of an economy (North, 1994). Institutions may be the rules of the game but organizations and entrepreneurs are the players. While the bulk of the choices made by players are routine, some involve altering existing contracts and some may even lead to alterations in the rules of the game. Thus the most fundamental long-run source of change is learning by the players.