The most basic challenge for economics is to understand the nature and causes of economic progress. But what exactly is to be explained? What are the facts? One very striking fact is historical--the rapid acceleration in the rate of economic progress since the early 1800s. Another is geographical the huge differences in levels of economic progress in different parts of the world today. The questions virtually ask themselves. Why did economic progress accelerate? Why is it not universal? On the whole, these two questions have been addressed by two different specialized fields within economics. Economic history has addressed the question of change over time, and development economics has addressed the question of contemporary differences across countries.
The theory that until recently guided work in both fields--the Ricardian theory--measures economic progress in terms of the quantity of output produced by the economy. It sees the economy as a kind of machine that transforms inputs (labor, natural resources, capital) into output: the amount of inputs and the technology of the machine determine the quantity of output. If output increases more rapidly, it is either because of larger amounts of inputs or because of better technology. If output is low in some countries, it is because inputs or technology are lacking. Since Solow (1957) showed that increases in physical inputs explain only a small part of observed changes or differences in output, Ricardian theory has focused primarily on the nonphysical in explaining growth--on technological change and on increases in human capital in the form of skills and knowledge (Lucas 2002, Galor 2005).
The Deficiencies of the Ricardian Theory
The Ricardian theory of growth has been found wanting both by economic historians and by development economists. The problem for economic historians is that the Ricardian theory offers no explanation for why the accumulation of human capital and technological progress accelerated in the West in the early 1820s. There have been attempts at purely Ricardian explanations: Pomeranz (2000) has suggested that it was the discovery of new resources in the Americas and in England's coalfields that did the trick; Clark (2007a), that human evolution in England came to favor human capital accumulation and technological progress. However, both of these explanations have been challenged on the facts, and neither has achieved wide acceptante (Broadberry 2007, Broadberry and Gupta 2006).
The problem for development economies, a more practical field, is that the Ricardian theory has proven itself to be a treacherous guide to policy. For decades after World War II, development economists advocated a series of dirigiste policies for the less developed countries (LDCs) aimed at making up perceived deficiencies in resources and technology: physical capital, technology, and human capital all had their day. The results, to put it mildly, were disappointing: Lal (2000) and Easterly (2001, 2006) have documented the sorry record.
The failings of the Ricardian theory have caused economists to look further afield for explanations of growth and development. In particular, many have come to challenge a fundamental assumption of the Ricardian theory--that an economy's potential, defined by its resources and technology, is fully realized. To development economists in particular this assumption has seemed increasingly farfetched: surely, the problem of the LDC economies is not a lack of potential but an inability to achieve that potential (see de Soto 2000, Parente and Prescott 2000, and Guest 2004). The obstacle to their development is not a lack of resources or technology, but a failure to exploit the resources and technology available. In development economies and in economic history, attention has therefore shifted to how and to what degree economies succeed in realizing their potential. Grantham (1999) has labeled this approach--more in the spirit of Adam Smith than of David Ricardo--Smithian. …