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FUTUREINSIGHTWhat is the ultimate driver of growth?

July 2016

What is the ultimate driver of growth?

Summary

• macronomics has created the concept of the River of

Prosperity to help understand what ultimately drives long-

term economic performance.

• Imagine a river running upstream to downstream and

out into the ocean. The proximate causes of growth

are downstream, the ultimate drivers are upstream.

Upstream is culture, mid-stream is the role of institutions

(the so-called rules of the game) and downstream are

competitiveness and productivity.

• Conventional long-term economic analysis has focused

very much on downstream economic performance.

More recently this has been added to, with mid-stream

analysis on the role of institutions, most notably in the

work of Daron Acemoglu and James A. Robinson in their

international bestseller, Why Nations Fail: The origins of

power, prosperity and poverty.

• The mid and downstream contributors to long-term

economic performance remain critically important, but

they are not, in our view, the ultimate drivers. Institutions

shape productivity and competitiveness, but to understand

ultimate long-term causes, we need to understand what

shapes institutions. macronomics argues that the answer

is culture.

• Culture is not easy to define precisely. At times it’s akin to trying to nail jelly to a wall. But despite the challenges,

macronomics argues culture should play a much greater

role in long-term analysis by investors. It’s a hugely important topic, which has been neglected.

• Support for the culture first thesis comes from many sources, including, surprisingly, the economic performance

of the Nordic economies.

• This is not to deny that institutional change can occur

without a shift in culture, or that at times a change in

the direction of flow can occur, with institutional forces influencing culture. The culture first rule is not absolute.

F U T U R E I N S I G H T 2

PROFESSOR GRAEME LEACH

CEO and Chief Economist

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Introduction

One of the world’s leading economic historians, David Landes, wrote in his book, The Wealth

and Poverty of Nations that, “if we learn anything

from the history of economic development it

is that culture makes all the difference.” And

yet, economists have been largely dismissive

or neglectful of culture (see: Box A for an

explanation of culture) as a source of growth.

For most of the second half of the 20th

century growth economists tended to ignore

the role of culture in explaining cross-country

differentials in economic performance. Economists were reluctant to rely on culture as

a possible determinant of economic behaviour,

because the notion of culture is so broad, and

the channels through which it could operate

potentially so vague. As economic theory

increased its mathematical sophistication

economists tended to lose interest in culture.

They tended to see culture as an exogenous

influence like technology in the Solow Neo-Classical growth model. Culture was also

perceived as so slow-moving, capturing and

disentangling its effect empirically, would be a herculean task. But the neglect of culture

began to change in the mid 1990s, following

the work of Robert Putnam and Francis

Fukuyama.

Over recent years there has been something

of a renaissance in research on the impact

of culture on institutions (see: Box C for an

explanation of institutions) and economic

behaviour, with links from culture to savings

rates, from trust to trade and entrepreneurship,

and evidence that Judeo-Christian societies

are more opposed to re-distribution than non-

religious and atheistic societies. Extending

the basic Solow Neo-Classical growth model,

to incorporate social capital – defined as interpersonal trust – has also been shown to

be an important factor in explaining variations

in economic growth. So this is a growing area

of analysis.

“If we learn anything from the history

of economic development it is that culture makes all the

difference.”

F U T U R E I N S I G H T 3

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