Sunday, February 18, 2007

Growth Regressions and Policy Advising

A student emails me some questions:

Hi Prof. Mankiw

I am a student of Economics at the University of Oslo. And as part of my reading list I come across a paper you wrote in 1995--The Growth of Nations. I must say it is one of the best articles I have read on the issue. But up on completing the article I am left with two important questions.

First, though you have emphasized the limitations of cross country regressions in answering most of the important questions growth theories are supposed to address, there appears to be an influx of such empirical works until recently. So my question here is: How much do you think such works have solved the problems you mentioned empirical works are subjected to.

Second, on page 309 of this same paper you said that ''the implications of recent work on economic growth for policy makers are far from clear.'' My question with this regard is: Do you think later studies (studies after 1995) have come up with a somewhat clearer policy implications? If not I wonder what policy advisers are being paid for.

Thank you in advance for your answers.

[name withheld]

I have long been skeptical about how much one can learn from cross-country growth regressions. In the early 1990s, I wrote one paper in that literature, coauthored with David Romer and David Weil, and to my surprise, it turned out to be my most cited paper by a very large margin. In a subsequent paper, The Growth of Nations, I tried to spell out the reasons for my skepticism. I emphasized three problems, which I called the simultaneity problem (it is hard to disentangle cause and effect), the multicollinearity problem (most of the potential determinants of growth are correlated with each other and imperfectly measured, making it hard to figure out which is the true determinant), and the degrees-of-freedom problem (there are more plausible hypotheses than data points). To some extent, the subsequent literature addresses some of my concerns. For example, there is more attention now to trying to find exogenous differences across countries, but the task is inherently difficult, so one should not expect to find definitive answers about the causes of growth from this literature.

That does raise the question: If such empirical work is so far from definitive, what are economic policy advisers paid for? (Actually, "paid for" is the wrong phrase--being a policy adviser is not lucrative and sometimes, as in the case of my role in the Romney campaign, not compensated at all.) Economists come up with policy advice not because a single regression yields a particular coefficient but because they have weighed a large variety of evidence from different sources, together with the insights from theory, and reached some educated judgments about the effects of alternative policies. No doubt, political bias can at times affect those judgments as well. In light of this process, it is no surprise that different economists reach different judgments about policy. They differ about which evidence they find most compelling and about which theoretical assumptions are most plausible, and they bring different biases to the task. On some issues--international trade, rent control--economists speak with a high degree of consensus. On other issues--income redistribution, health policy--economists are more divided. The fact that definitive conclusions are difficult in economics makes the field both frustrating and challenging.

Cross-country growth regressions are part of the process by which economists figure out how the world works, but they constitute only one patch of a large quilt of theory and empirics.