So Solow argues that the driver of growth is exogenous and that is technological progress and that the government, being endogenous, can do nothing.
Well the Soviet system of planning is totally different, the key difference is that they like to plan, specifically investment.
Economic planning can be defined as "a component of public policy that controls economic activities", inherent in this you can see the argument for an interventionist state.
Klosterman argues that in general terms there are four key social functions of planning:
1. To allocate and provide public goods such as street lighting (a good which is non-excludable and non-rivarlrous).
2. To manage social marginal costs i.e. externalities that the market does not take into account.
3. To manage information asymmetries, another form of market failure and;
4. To ensure that growth and development is equitable, so practically managing the route of the surplus.
The idea is that investment should be planned with a bias towards capital goods and machinery. The idea originates from the Fel'dman model and was used as the Soviet method of growth. This is crucial case study as the Soviet Union was looking to compete with the Western World and their alternative classical method of development.
Y = aV, a being the proportion of capital investment and V being productivity of capital.
The First Five Year Plan, which included strict quotas and soft budgets, was very much an application of the Fel'dman model. They allocated resources in the capital industry so as to ensure a steady stream of consumption. The First Five Year Plan, did not result in the results accepted and so it led to similar ad hoc plans before the Soviet Union declined in the 1970s and dissolved in 1991.
How did the Soviet model decide how much to invest, Elleman lays at three methods that economic planner use:
1. Utility Maximisation i.e. you maximise utility u(x) by delaying consumption
The problem with this method is that it deals with what the planners face as opposed to answering the normative question of how much they should invest.
2. Descriptive Approach
This suggests that moderate figures of investment are derived from negotiations between planners and politicians.
This again does not answer the normative question.
3. The Growth Maximisation strategy.
This was first suggested by Horvat and suggests that investment should happen where the "absorptive capacity of the economy" is met, and by this he means where the marginal productivity is equal to zero.
The problem with this is that it directs investment towards wasteful means.
When look at the method of how we should investment in the capital sector, then Dobb-Sen provide the answer, they argue for a capital instensive technique to be used as this is the way in which the surplus is going to get maximised.
A quick summary of the Dobb-Sen model;
In an economy where; the share of investment is sub-optimal and all profit is invested and all wage is consumed, investment should be invested should be invested in capital intensive projects as that is how the surplus can be maximised.
In a capital intensive technique, the MP (of labour) = Wage, so surplus is maximised as wage is more accurate.
In a labour intensive technique, the MP (of labour) = 0 and so output is maximised as opposed to surplus.
Kalecki criticised this saying this capital intensive methods result in a loss of employment and output, in the shot-run, delaying the transition of the economy into a fully developed one.
Mao, despite China originally accepting the Soviet model, went on to criticism and differentiate their model of growth as they suggest the best way to grow is on "two legs" i.e. investing in both the light and heavy industry.
Furthermore, in developing countries, they often lack the technological capacities to do this and cannot delay consumption as the famine levels are so high.
There are three main theories proposed for why the Soviet Union declined:
1. The extent of state planning did not forsee technological failure i.e. that there was a lack of competition and efficiency in the production, teamed with the autarkic nature of the model, the producitivity was not efficient and thus failed. Perhaps, this is an evidence for the Solow model?
2. The model assumed there was no diminshing returns to capital, this is unlike that what can be perceived in reality.
3. There were errors in investment, e.g. was spending 15-17% of budget on defence sensible?
A Contrasting case study....
The journey of the Washington Consensus
The WC is a neo-classical model which unlike the Soviet style of planning centres on free markets and interest rates.
They believed the reason why countries are poor to be a lack of financial capital and consumption and thus trade liberalisation goes some way to deal with this.
There are two key defining features of the WC and those are (i) belief in individual freedoms - i.e. the role of state is to regulate exclusionary rights and uphold law and order not intervene otherwise and (ii) the strict manner in which the policies are dictated.
However, this is a questionable mode of development as South Korea believed to be an example of WC-led growth did not privatise or immediately open up to trade liberalisation. However, many economist including Buchanan still hold that government failure is by far still greater than market failure.
Post-Washington Consensus, this is the New Institutional Economics
- Institutions as dictated by North are the "rule of the game"
- For a market to operate properly there is a requirement that the right institutions exists e.g. a regime of property rights.
- This is the notion that growth prescription to focus on strategies which reduce poverty not just the rate of industrialisation.