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KEYNESIAN THEORIES OF GROWTH

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6. Keynesian Theories of Growth
Pasquale Commendatore, Salvatore
D’Acunto, Carlo Paico and Antonio Pinto

6.1. INTRODUCTION

This paper outlines the content of a Keynesian approach to the theory of

growth. While for other established traditions it is possible to talk of a theory
of growth described by some specified models and contributions,1 for the
Keynesian tradition it is only possible to identify several lines of
development, which share the view that the economic system does not tend
necessarily to full employment and that the different components of demand
may affect the rate of growth of the economy.
As far as we know, there is no essay in the recent literature which seeks to
reconstruct the content of a Keynesian approach to growth by describing the
lines of research, which have historically emerged. In what follows an
attempt will be made to do so. This attempt outlines a unified framework that
can deal with the influence of the different components of aggregate demand
on the rate of growth of an economic system that does not tend necessarily to
full employment. The specification of this unified framework makes it
possible to preserve the diversity of the ideas proposed by Keynesian authors
on what can be considered the most relevant factors at work.2 Moreover, it
shows Keynesian growth theorists as a homogeneous crew, sharing a positive
theoretical standpoint on the role of aggregate demand, rather than a group of
authors united by a critical attitude towards orthodoxy, but unable to present
a systematic challenge to the dominant theories.3
The paper is organised as follows. Section 6.2 aims to derive a unifying
framework for Keynesian theories of growth from the analyses proposed by
the founder of modern growth theory, Roy Harrod. Sections 6.3, 6.4 and 6.5
deal with the analyses underlining the influence on growth of three
components of effective demand, coming from the Government sector, the
private sector, in the form of autonomous investment (i.e. investments not
directly generated by savings), and the foreign sector. Section 6.6 draws
some conclusions.

100
 Keynesian theories of growth 101

6.2. HARROD AND THE FORMATION OF A

KEYNESIAN FRAMEWORK FOR GROWTH
THEORY

According to Varri (1990, p. 9), Harrod‘s contributions to growth have

received less attention than they deserve. Recently, however, Young (1989)
and Besomi (1999) have reconsidered his writings, taking advantage of the
availability of his papers at the Chiba University of Commerce in Ichikawa
(Japan) and clarifying the extent to which some of his writings have been
misrepresented. They have refuted, in particular, the view that Harrod‘s
efforts to develop a theory of growth and dynamics were stimulated by his
work on imperfect competition and his dissatisfaction with the Austrian trade
cycle theory put forward by Hayek (cf. Kregel, 1980, p. 98; 1985, pp. 66–7).
Moreover, they have confirmed the limits of the widespread belief that
Harrod developed his analysis of growth by assuming absence of monetary
influences and fixed technical coefficients and saving propensity, in order to
establish the famous ‘knife-edge problem’ (Solow, 1956, 1970; for the
opposite interpretation, see Eisner, 1958, Asimakopulos and Weldon, 1965,
Kregel, 1980, Asimakopulos ,1985).
In opposition to the first view, Young (1989, pp. 15–50) clarified that
Harrod‘s efforts to develop a theory of growth and dynamics were mainly
stimulated by his contacts with Keynes. These began in 1922, when Keynes
invited Harrod to study economics in Cambridge under his supervision
(Phelps Brown, 1980, pp. 7–8). One year later, having read A Tract on
Monetary Reform,

Harrod took up Keynes‘s call for deeper research into the problems of the ‘credit
cycle’, and over the next few years produced a number of essays on the subject. In
these Harrod focused on the theoretical basis for – and policy options related to –
issues raised by Keynes in the Tract (Young, 1989, p. 16).

According to Young, in these essays, some of which were never published,

Harrod dealt with a problem that was central to Keynes‘s and other works of
the time. Moving on from the idea that the economic system is stable and
that negative influences on fluctuations only come from monetary and credit
factors, attempts were made to identify a ‘neutral’ policy, i.e. a policy that
can prevent monetary and credit disturbances from amplifying the
fluctuations of the economy.
In those years Harrod also focused on Keynes‘s proposals for
Government interventions.4 According to Phelps Brown (1980, pp. 13 and
18), Harrod first heard Keynes‘s proposals at the Liberal Summer School of
August 1924.5 From then onwards, he closely followed Keynes‘s intellectual
102 The Theory of Economic Growth: a ‘Classical’ Perspective

activity on this subject6 and after the Great Depression he actively supported
Keynes’s proposals.7 By that time, Harrod had come to recognise the need
for deep political and theoretical changes.8 As Young (1989, pp. 30–8)
points out in an unpublished paper written in 1933, Harrod stated that the
Great Depression had posed a new problem to economists and politicians.
The previous recessions had not led the economy too far from full
employment, nor had they cast doubts on the belief that the economy is able
to return to it. The severity of the Great Depression had changed this
situation. It had jeopardised political stability and raised the problem both of
a new political approach and of a new economic theory able to clarify
whether market forces can lead the economy towards full employment or
Government intervention is required to restore it.
As an initial contribution to these problems in 1933 Harrod published
International Economics. This book, as Young (1989, pp. 38–9) points out,
sets the lines of analysis that Harrod developed in the following years. In
International Economics and in his 1936 The Trade Cycle, he moved from
Keynes‘s Treatise (Young, 1989, pp. 48–50), to focus on the cyclical
fluctuations of the economy around a line of steady growth. His aim was to
point out that competitive market forces may widen the gap between actual
and equilibrium growth, independently of the destabilising influences of
monetary and credit factors, which had been underlined by the literature up
to that time. In his 1939 essay on dynamics, again stimulated by the
discussions with Keynes (Collected Writings, Vol. XIV, pp. 150–79)9,
Harrod focused instead on the equilibrium paths of the economy and on the
factors determining the ‘warranted’ and the ‘natural’ rates of growth. This
study represented ‘a preliminary attempt to give an outline of a “dynamic”
theory’ (Harrod, 1939, p. 254) and ‘a necessary propaedeutic to trade–cycle
study’ (Harrod, 1939, p. 263).
It moved from the condition of equilibrium in the commodities’ market.
In the most simplified case, that of an economic system without Government
intervention and closed to non-residents, this condition is represented by the
equality between saving and investment decisions. In the formal presentation
of his analysis, the saving propensity was taken as given. Yet Harrod (1939,
p. 276) made some reference to the influence of the interest rate on the
propensity to save and, in his following writings, he recalled the possibility
of using Ramsey‘s intertemporal approach to on which to base this part of his
analysis.10 The equation relative to investment, which introduces, according
to Sen (1970, pp. 11 and 23) and Asimakopulos and Weldon (1965, p. 67),
the major difference with other traditions, assumes that investment decisions
are taken independently of saving decisions and are not generated by them.
They depend on the ‘acceleration principle’ and on the degree of utilisation
of capital equipment, along the following lines:
 Keynesian theories of growth 103

i = k g* + f ( g − g−*1 ) (1)

with f (0) = 0 and df /dg > 0

where:

i represents the ratio between investment and the net output of the
economy;
*
g the current period expected rate of growth of output;
g−*1 the previous period expected rate of growth;
g the current period rate of growth;
k the equilibrium capital/output ratio.

Harrod used his analysis to study the ‘warranted’ rate of growth (gw), defined
as that equilibrium rate which allows the normal utilisation of capital
equipment.11 He assumed that, along the warranted equilibrium path,
expectations are realised (g−*1 = g) and the expected rates of growth are equal
to the warranted rate (g* = g−*1 = gw ) . The following equations were thus used
for the analysis of the warranted rate:

s = k gw (2)

k = k (r) (3)
with dk /dr ≤ 0
r = r0 (4)
where:

s represents the average propensity to save of the economy;

r the rate of interest.

The introduction of equation (3) and (4) points out, in opposition to a

widespread view, that Harrod did not develop his analysis of growth by
assuming absence of monetary influences and fixed technical coefficients.
Equation (4) assumes that the rate of interest depends on the conduct of
monetary policy, which, according to Harrod, operates by stabilising this rate
at some specified level.12 Equation (3) recognises the possibility of
substitution between factors of production. Harrod admitted the existence of
decreasing marginal returns,13 but considered that this kind of substitution
was low, following the results reached by the Oxford Research Group, in
which he actively participated.
From equation (2) one can derive
104 The Theory of Economic Growth: a ‘Classical’ Perspective

s
g= (5)
k

The study of the ‘warranted’ rate was for Harrod a preliminary part of the
analysis of the dynamic behaviour of the economy, which in 1939 was
presented through the following steps.
The first step dealt with the forces that start to operate as soon as the
economy gets out of equilibrium and expectations are not realised.
According to Harrod (1939, pp. 263–7), when the rate of growth differs from
the equilibrium warranted rate, some centrifugal forces operate. If the former
exceeds the latter, capital equipment is utilised above its normal level,
inducing entrepreneurs to increase their investment decisions, as pointed out
by equation (1). In the opposite case, capital equipment is utilised below its
normal level, inducing entrepreneurs to reduce investment decisions. In both
situations, the rate of growth will be pushed further away from the warranted
level. This description was considered by Harrod (1939, pp. 263–4)
equivalent to that developed by static theory when it is assumed that the
market price exceeds (is lower than) the equilibrium price and the
appearance in that market of an excess supply (an excess demand) tends to
restore equilibrium. These descriptions, unlike the ‘cobweb’ analysis in the
traditional supply and demand theory, do not represent a dynamic analysis of
disequilibrium. They just point out in an informal way that some centrifugal
or centripetal forces come into operation as soon as disequilibrium occurs.
Most literature has interpreted this part of Harrod‘s work as the outcome
of a dynamic analysis of stability. Sen (1979, p. 14), for instance, after
pointing out that Harrod‘s analysis only deals with the initial elements of this
problem and can be compatible with different analytical developments,
criticised his conclusions.

There are many other ways in which Harrod‘s somewhat incomplete model can be
completed. Some confirm instability, while others either eliminate it or make it
conditional on certain actual circumstances. In general, it will be fair to say that
Harrod‘s instability analysis over-stresses a local problem near the equilibrium
without carrying the story far enough, and extensions of his model with realistic
assumptions about the other factors involved tend to soften the blow (Sen, 1970,
p. 14).

Already in 1939, however, Harrod had stated that his analysis did not give a
complete account of the problem, suggesting some lines along which a
dynamic analysis of the behaviour of the system can be developed.
 Keynesian theories of growth 105

Space forbids an application of this method of analysis to the successive phases of

the trade cycle. In the course of it the values expressed by the symbols on the
right-hand side of the equation undergo considerable change. As the actual growth
departs upwards or downwards from the warranted level, the warranted rate itself
moves and may chase the actual rate in either direction. The maximum rates of
advance or recession may be expected to occur at the moment when the chase is
successful (Harrod, 1939, pp. 271–2).

Moreover, in the subsequent years, Harrod (1948, p. 99) first claimed that he
was reluctant to enter the field of the dynamic analysis of disequilibrium
without developing the analysis of the equilibrium warranted path which,
according to him, had a higher degree of generality.14 He then rejected the
view that his aim had been to raise a ‘knife-edge problem‘15 confirming that
he had only tried to underline the existence of some centrifugal forces
coming into play as soon as the economy gets out of equilibrium. The
reference to these forces did not exclude the existence of other forces,
producing stabilising effects, which have to be analysed by considering,
according to Harrod, that the ‘natural’ rate of growth represents the ‘ceiling’
limiting the expansion of the economy.
The second step of the analysis proposed by Harrod (1939) to study the
dynamic behaviour of the economy considered the existence of forces
pushing the ‘warranted’ rate of growth towards the ‘natural’ rate. This part of
Harrod‘s work was based on his assumptions on substitution between factors
of production and on the determination of the interest rate. As stated above,
introducing equations (3) and (4), Harrod did not deny the existence of
substitution between factors of production, but considered that it occurred to
a small extent. After 1939, this idea was often restated: he claimed, with
increasing emphasis, that he was skeptical on the possibility of reaching full
employment through reduction of the interest rate.16 Moreover, he confirmed
that the rate of interest tends to show some rigidity, since it depends on the
conduct of monetary policy, which, according to Harrod (1948, pp. 99–100;
1973, p. 67), operates by stabilising this rate at some specified level. This
view of the interest rate, which also took into account the attempts of the
monetary authorities to maintain the equilibrium of the balance of payments
(Harrod, 1969, pp. 178 and 191; 1973, p. 75), raises the problem of the links
between the theory of growth and that of distribution, since it was associated
in Harrod‘s writings with the idea that a persistent change in this rate leads to
a similar variation in the rate of profit.17 The analysis of this problem,
however, was little developed by the Oxford economist, who focused instead
on the conclusion that one cannot rely on the belief that the spontaneous
operation of market forces always leads the economic system towards full
employment.
106 The Theory of Economic Growth: a ‘Classical’ Perspective

This conclusion led to the third step of analysis relative to the role of
effective demand and Government policy on growth. Harrod (1939) pointed
out that the warranted rate could be influenced by three different components
of effective demand coming from the Government sector, the private sector,
in the form of autonomous investment, and the foreign sector. Harrod (1939,
pp. 269–74) gave some initial formal account of how these three sources of
demand can affect the equilibrium path of the economy. Then, he focused on
the Government sector and considered how policy can be used to stabilise
the economy and to achieve higher growth and employment.
To sum up, the recent studies on Harrod‘s papers clarify that his seminal
work on growth theory and dynamics was conceived as an extension of
Keynes‘ analysis to a long-period context.18 It developed the view that the
economic system does not tend necessarily to full employment and that the
different components of aggregate demand may affect the rate of growth of
the economy. His theory can be considered a prototype of a Keynesian
approach to this problem: it outlines a framework that much literature within
this tradition has subsequently adopted.

6.3. THE INFLUENCE OF THE GOVERNMENT

COMPONENT OF AGGREGATE DEMAND

The need to take into account the influence of Government activity on

growth was pointed out by Harrod (1939, pp. 269–70 and 275), who also
gave some initial formal account of how this source of demand can affect the
equilibrium growth path of the economy. For him, Government policies have
to be used both to stabilise the economy and to achieve higher growth.

Policy in this field is usually appraised by reference to its power to combat

tendencies to oscillations. Our demonstration of the inherent instability of the
dynamic equilibrium confirms the importance of this. But ... in addition to dealing
with the tendency to oscillation when it occurs, it may be desirable to have a long-
range policy designed to influence the relation between the proper warranted rate
of growth and the natural rate (Harrod, 1939, p. 275).

In 1939 Harrod claimed that both fiscal policy and variations in the long-
term interest rate have to be used to pursue this long-range objective, adding
that the latter are more appropriate than the former to this aim. The bank rate
policy can be used instead to combat the runaway forces of the economy.

If permanent public works activity and a low long-term rate availed to bring the
proper warranted rate into line with the natural rate, variations in the short-term
 Keynesian theories of growth 107

rate of interest might come into their own again as an ancillary method of dealing
with oscillations (Harrod, 1939, p. 276).19
This position was maintained in Harrod (1948, pp. 74–5 and 117–22), where
he again identified fiscal policy with ‘public works’. In the subsequent
writings these ideas were revised, claiming that it was advisable to rely on
fiscal, rather than on monetary policy, to affect the equilibrium warranted
path of the economy, so as to bring it close to the natural path, and to
conduct fiscal policy by changing the tax rates while keeping Government
expenditure constant.
This new position was clearly presented in Harrod (1964 and 1973),
where he also recalled that the conduct of policy is difficult owing to the
complexity of the objectives to be achieved (Harrod, 1964, pp. 913–15) and
to the fact that

even if the authorities had succeeded in maintaining a steady growth rate ... for a
substantial period of time – a state of affairs not yet realised – and there was
general confidence that their success would continue, this would not relieve the
entrepreneur of his major uncertainties ... Entrepreneurs usually have to cast their
bread upon the water (Harrod, 1964, p. 907).

He proposed to use the equilibrium condition of the commodity market to

study how Government policy has to be applied and suggested dealing with
this equation by taking the natural rate of growth as given, i.e. as the
objective that the long-term policy has to pursue. Harrod (1973, p. 45)
considered Government intervention necessary, arguing that this view was
becoming increasingly popular.

In the spectrum of countries ranging from individualism to socialism, the U.S.A.

may be regarded as being at or near the individualist end. But even in that country
‘monetary’ and ‘fiscal’ policies are regarded as legitimate weapons of
government, including the central bank. These policies serve to doctor the saving
ratio and to provide enough, neither more nor less, to maintain reasonably full
employment and growth in accordance with the growth potential of the economy
(Harrod, 1973, pp. 28–9; see also 1964, p. 906).

He also underlined that the traditional position, which confines the use of
these policies only ‘to ironing out the business cycle’, ‘implies too narrow a
view of the duties of the authorities’ (Harrod, 1973, p. 29).
Finally, Harrod (1964, p. 906; 1973, pp. 102–3, 173 and 177) claimed that
fiscal policy was appropriate to achieve this long-term objective. It should be
used by varying the tax rates while keeping government expenditure constant
(Harrod, 1973, p. 107). Monetary policy was appropriate instead to deal with
108 The Theory of Economic Growth: a ‘Classical’ Perspective

what he defined the short-term policy objective of correcting the divergence

of the actual rate from the warranted rate and stabilising the fluctuations of
the economy. Temporary variations in the short-term rate of interest operate
through their effects on the availability of credit in the markets (i.e. credit
rationing) (Harrod, 1964, pp. 912–3; 1973, pp. 178–9). On the other hand,
permanent variations in the interest rate tend to be more effective in causing
similar variations in the rate of profit than in changing the capital–output
ratio (Harrod, 1973, pp. 44, 78 and 111).
The formal analysis used by Harrod to deal with these views was limited.
It can be developed as done in equation (3.1) below, which follows his
proposal to study how to apply Government policy by using the equilibrium
condition of the commodities’ market, which in this case takes the form
‘saving plus taxation is equal to investment plus Government expenditures’.

s (1 – t + rbb) + t = kg + h + rbb (6)

where:

s is the private sector’s propensity to save (0 < s < 1);

t is the average tax rate, defined in terms of the net output of the economy
(0 < t < 1);
rb is the interest rate on Government bonds;
b is the amount of Government bonds in circulation, measured in terms of
the net output of the economy (b ≥ 0);
k is the capital–output ratio (k > 0);
g is the rate of growth of the economy;
h is the amount of Government‘s expenditure on goods and services,
measured in terms of the net output of the economy (h ≥ 0).

As Harrod suggests, this equation can be used either to study the factors
affecting the warranted rate of growth (in this case, g is taken as unknown,
while r and the policy parameters t and h are taken as given) or to analyse
how fiscal policy has to be applied to maintain reasonable full employment
or growth in accordance with the potential of the economy (in this case, g is
taken as given at its natural level, while one policy parameter, say t, is
considered unknown).
From equation (6) one can derive

s(1 − t + rb b) + t − h − rb b
g= (7)
k

where dg/dt > 0.

 Keynesian theories of growth 109

It can be noticed that variations in the tax rate keep affecting growth even
in the simplified case of a balanced Government budget and absence of
Government bonds (t = h > 0 and b = 0), when equation (7) becomes
s(1 − t )
g= (8)
k

where dg/dt < 0.

This effect does not depend on the influence of variations in t on the
propensity to save and on the capital–output ratio.20
The presence of Government debt and the interest rate in equation (7)
raises the problem of the relationships between growth and distribution and
between monetary and fiscal policy. Only the former problem is known to
occupy a central place in the original development of the post Keynesian
theory of growth and distribution.21 Kaldor‘s 1958 Memorandum to the
Radcliffe Committee, however, considers both problems simultaneously.
The Memorandum describes how Government policy can affect stability
and growth. It argues that monetary policy has to stabilise the short-term
interest rates in order to avoid some ‘undesirable consequences’. The
instability of the interest rates enhances financial speculation and reduces the
ability of the markets to convey financial resources towards productive
enterprises. Moreover, it raises the risk premium to be paid on loans of
longer maturity and leads to higher long-term interest rates. Higher long-term
interest rates, in turn, make the management of Government debt difficult.
Moreover, they increase the probability that firms may not be able to pay
back their loans, making lending institutions and financial markets more
fragile. Finally, they tend to cause economic stagnation.
To justify the tendency to stagnation Kaldor made explicit reference to his
theory of growth and distribution and to what is known as the ‘Cambridge
equation’.

In a steadily growing economy the average rate of profit on investment can, in the
first approximation, be taken as being equal to the rate of growth in the money
value of the gross national product divided by the proportion of profit saved … To
keep the process of investment going, the rate of profit must exceed the (long-
term) interest rates by some considerable margin (Kaldor, 1958, pp. 137–8)

A monetary policy causing unstable interest rates raises the long-term rates
to a level considered by investors too high to keep accumulation going.
Under these circumstances, stagnation prevails, unless the rate of profit is
raised too. According to Kaldor, this can be done through fiscal policy.
110 The Theory of Economic Growth: a ‘Classical’ Perspective

If the rate of interest were higher than [the level that keeps investment going], the
process of accumulation would be interrupted, and the economy would relapse
into a slump. To get it out of the slump it would be necessary to stimulate the
propensity to consume – by tax cuts, for example – which would raise the rate of
profit and thus restore the incentive to invest (Kaldor, 1958, p. 138).22

The post Keynesian theory of growth and distribution, to which Kaldor

greatly contributed, differs from Harrod‘s growth theory for the introduction
of the saving propensities of different income groups and for the role
attributed to distributive shares in restoring equilibrium conditions.
According to some literature, this part of Kaldor‘s work departs from the
Keynesian tradition, since it does not reject the idea that market economies
tend to full employment.
Kaldor‘s Memorandum to the Radcliffe Commission does not confirm
this allegation (Kaldor, 1958, pp. 135–7 and pp. 141–2). It shows many
similarities with the views proposed by Harrod and the rest of Keynesian
tradition on the role of Government policy. First of all, Kaldor considered
Government policies necessary to pursue stability and growth. Secondly,
thought that Government policies have to deal with a complex set of
objectives, which are interrelated – and often incompatible – among them.
Thirdly, for Kaldor , monetary policy is the appropriate tool against the
fluctuations of the economy, while it is advisable to use fiscal policy to
pursue the long-range objective of sustained growth. Fourthly, when he
advocated fiscal policy, Kaldor referred to variations in the tax rate, rather
than to variations in the level of Government expenditure. Finally, like
Harrod, Kaldor proposed to use the equilibrium condition of the
commodities’ market to deal with these problems and referred to it either to
determine the growth path of the economy (considering the rate of growth as
unknown and the interest rate, the tax rate and Government expenditure as
given) or to determine the intensity of fiscal policy appropriate to the
achievement of a specific rate of growth (considering one policy parameter –
the tax rate – as unknown and the rate of growth as given).
Kaldor did not present his positions on the role of Government policy in a
formalised way. Nor can such a treatment be found in other literature of that
time. His reference to the Cambridge equation must then be considered, as he
himself stated, a first approximation rather than the result of a thorough
treatment of this problem. The first formal presentation of the post
Keynesian theory of growth and distribution, which explicitly introduced the
Government sector, was provided by Steedman (1972). This article proved
that in an analysis that assumes a balanced Government budget and no
outstanding bonds, the Cambridge equation holds in a larger number of cases
than the ‘dual theorem’ of Modigliani and Samuelson. Some years later,
 Keynesian theories of growth 111

Fleck and Domenghino (1987), who challenged the validity of the

Cambridge equation when the Government budget is not balanced stimulated
an intense debate on this subject. The debate has examined a large number of
cases, showing when the Cambridge equation holds and confirming the
conclusion that Steedman had previously reached.23
The results of the debate show how the views on the role of Government
policy that Kaldor presented in the Memorandum to the Radcliffe
Commission can be formally developed and clarify some features of his
proposals. Let us consider the case examined by Denicolò and Matteuzzi
(1990), in which the Cambridge equation holds. It refers to a closed economy
with two classes (workers and capitalists)24, where the Government sector
finances its budget through the issue of bonds and the private sector finances
its productive activity through the sale of shares to other components of the
private sector. Capitalists do not work: they earn their income through the
returns of their wealth. Moreover, the two classes have different saving
propensities, can invest their wealth in shares representing real capital and in
Government bonds, and have the same portfolio structure (for the case of
different portfolio structures, see Panico, 1993). To study what are the
conditions allowing steady growth, we must specify the equilibrium
condition in the commodities’ market, the dynamic equilibrium conditions
between the savings of the two classes and the growth of their wealth, and
the dynamic equilibrium condition between the Government budget and its
debt. These conditions can be written as follows:

sc(1 – t) α (rbb + rkk)+ s (1 – t) [1 + rbb – α (rbb + rkk)] + t = gk + h + rbb (9)

sc (1 – t) α (rbb + rkk) = g α (b + k) (10)

g b = h + rb b – t (11)

where:
sc is the propensity to save of the capitalist class (0 < sc < 1);
t the tax rate (0 < t < 1), which is assumed to be the same on all forms of
income;
α the quota of wealth owned by the capitalist class (0 ≤ α ≤ 1);
sw the propensity to save of the working class (0 < sw < sc);
rb the rate of interest on bonds;
b the stock of Government bonds measured in terms of the net output of the
economy (b ≥ 0);
g the rate of growth;
k the capital/output ratio (k > 0);
112 The Theory of Economic Growth: a ‘Classical’ Perspective

h Government expenditure on goods and services, measured in terms of net

output (h ≥ 0);
rk the rate of return on real capital.

If we assume rb = rk = r, equation (10) produces:

sc (1 – t)r = g (12)

where dg/dt < 0 and dt/dr > 0.

This confirms the validity of the Cambridge equation, taking into account
the role of t, and allows one to calculate the value of t compatible with steady
growth at the rate of interest fixed by the monetary authorities.
Equations (9)–(12) thus show how to develop in a formal way the views
proposed by Kaldor in his Memorandum to the Radcliffe Commission, where
the lack of a formal analysis of how Government intervention can affect
growth and distribution led the author to refer to a version of the Cambridge
equation which, unlike equation (12), does not include the tax rate. As a
consequence, Kaldor conceived the influence of tax variations on growth in
terms of their effect on the propensities to save. The analysis presented
above, instead, clarifies how Government intervention can affect demand and
growth independently of changes in the propensities to save and in the
capital–output ratio. We may thus further elaborate Kaldor‘s attempt to
describe how fiscal policy can be used to maintain steady growth conditions.
Finally, the results of the recent debate on the role of the Government
sector in the post Keynesian theory of growth and distribution clarify some
other common elements of the classical and the Keynesian traditions. They
allow reconciliation of two approaches to distribution, which have always
been considered alternative (see Moss, 1978, p. 306; Vianello 1986, p. 86;
Nell , 1988; Pasinetti, 1988; Pivetti, 1988; Wray, 1988; Abraham–Frois,
1991, pp. 197 and 202). These are the approach proposed by Kaldor and
Pasinetti in their theory of growth and distribution and that implied by
Sraffa‘s suggestion in Production of Commodities to take the rate of profit,
rather than the wage rate, as the independent variable in the classical theory
of prices and distribution (for an analysis of this point, see Panico 1997,
1999).

6.4. THE INFLUENCE OF AUTONOMOUS

INVESTMENT

The introduction of an autonomous investment function is often considered

what differentiates a Keynesian theory of growth from other approaches.
 Keynesian theories of growth 113

There is, however, no agreement in the literature on what characterises a

Keynesian investment function and several investment-led growth theories
have been proposed. The first type of theory (labelled neo-Keynesian) was
proposed by Joan Robinson (1956, 1962) and Kaldor (1957 and 1961). They
are characterised by full capacity utilisation of plants, flexible income shares
and a functional relationship between the rate of capital accumulation and the
rate of profits.25 A second group of theories (labelled Kaleckian) was
inspired by the works of Kalecki (1971) and Steindl (1952). They assume
that firms under-utilise their productive capacity and apply mark-up
procedures in determining prices. Moreover, capital accumulation is driven
by profitability (through the rate of profits) and by effective demand
(through the degree of capital utilisation). These investment-led growth
theories have been further elaborated in the literature. In what follows, an
attempt is made to compare the alternative lines of development of
investment-led growth within the Keynesian tradition by introducing a
homogeneous set of equations which can be modified to take account of the
assumptions relating to capital utilisation, income distribution and
investment determinants.
Let’s assume (i) a closed economy with no government intervention; (ii)
two factors of production, labour and capital, with a fixed coefficient
technology; (iii) flexible labour supply; (iv) absence of technological
progress and capital depreciation; (v) identical physical composition of
capital and product; (vi) homogeneous firms. The following equations can
then be written
1 = wal + rkk (13)

1  l 1
= min  ,  (14)
k  al ak 

ak
u= (15)
k

min(wπ, wω) ≤ w ≤ max(wπ, wω) (16)

s = sc rk k (17)

i
= γ (rk, u, g) (18)
k

s=i (19)
where:
114 The Theory of Economic Growth: a ‘Classical’ Perspective

k represents the capital/output ratio;

w represents the real wage rate;
rk represents the rate of profits;
l represents the labour/capital ratio;
al represents the labour coefficient of production;
ak represents the capital coefficient of production;
u represents the degree of capacity utilisation;
wπ represents the wage firms are prepared to pay;
wω represents the wage workers are prepared to accept;
s represents the ratio between saving and output;
i represents the ratio between investment and output;
g represents the rate of growth of income;
sc is the capitalists’ propensity to save, with 0 < sc ≤ 1.

According to equation (13) output (normalised to one) is distributed between

wage and profit recipients. Following expression (14), which describes a
fixed-coefficient (Leontief) type technology, the elastic labour supply
guarantees that the labour/output ratio always coincides with the
corresponding technical coefficient, al = lk. Conversely, capital is not
necessarily fully utilised. It follows that output is not necessarily the
maximum technologically possible, 1/k ≤ 1/ak. Expression (14) leaves open
the determination of the degree of capacity utilisation, defined in expression
(15) as the ratio between current demand and full capacity output. It is
possible to envisage two cases. In the first, capacity is fully utilised, that is,
the equality u = 1 (1/k = 1/ak) holds. In the second, some capacity is left idle
with the degree of capacity utilisation settling in any period at some level
which does not necessarily equal one, that is, u ≤ 1 (1/k ≤ 1/ak). Expression
(16) also leaves the wage rate open to two possible determinations. In the
first case, workers’ and firms’ claims over the shares of income (in real
terms) are not inconsistent, wω ≤ w ≤ wπ. If follows that distribution and
growth are simultaneously determined. In the second case, workers and firms
lay conflicting claims over income shares, wπ ≤ w ≤ wω (and wω ≠ wπ). The
distribution between profits and wages depends on the relative power of
workers and firms. The way in which distribution is in fact determined
depends on the institutional setting. Equation (17) clarifies that saving
propensities differ between classes. According to expression (18), investment
demand depends on profitability (through rk), on the demand level (through
u) and on demand growth (through g). Keynesian approaches to investment-
led growth differ inasmuch as they do not assign to each of the determinants
of investment the same prominence. Finally, equation (19) represents the
equilibrium condition saving equal to investment. The model (13)–(19) has
 Keynesian theories of growth 115

three degrees of freedom. The way in which it is closed differentiates the

Keynesian approaches to investment-led growth.
The neo-Keynesian position is represented by the following equations
derived from expressions (13)–(19) by assuming full capacity utilisation,
u = 1(k = ak); endogenous income distribution, wω ≤ w ≤ wπ; and disregarding
the role of the rate of growth of demand in the investment function:
1 = wal + rkak (20)

s = scrak (21)

i
= γ 0 + γ 1rk (22)
k

s=i (23)
By rearranging (20), one obtains the following expression

1 a
rk = −w l (24)
ak ak

which describes the traditional long-term negative relationship between r and

w. Following Joan Robinson (1962), investors’ ‘animal spirits’ (encapsulated
in the constant coefficients γ 0 and γ 1) are prompted by expected profitability
and favoured by the availability of internal finance. This explains the
relationship between desired investment and the rate of profits of equation
(22).
The model (20)–(23) is similar to that proposed by Marglin (1984a,
1985b) to describe the contributions of Joan Robinson and Kaldor to growth
theory. By imposing the equilibrium growth condition according to which all
the variables have to grow at the same rate, i/k = g, the solutions are
univocally determined:26

γ0
rk = (25)
sc − γ 1

γ0
g = sc (26)
sc − γ 1

There are three major features of the neo-Keynesian analysis. The first is
that distribution and growth are simultaneously determined. The second is
the transposition to the long run of the so-called ‘paradox of thrift’,
according to which an increase in the propensity to save induces a reduction
116 The Theory of Economic Growth: a ‘Classical’ Perspective

in the rate of growth and in the equilibrium rate of profits. Indeed, by

differentiating expressions (25) and (26) with respect to sc one obtains

drk γ0
=− <0 (27)
dsc (sc − γ 1 )2

dg γ 0γ 1
=− <0 (28)
dsc (sc − γ 1 )2

The third is the negative relationship between g and w. From (21), (23)
and (24), taking into account the equilibrium condition i/k = g, it follows that

dg sa
=− c l <0 (29)
dw ak

Lower levels of the wage rate correspond to higher accumulation. Profit

leads growth.
If the equilibrium solution w lies outside the interval wω ≤ w ≤ wπ, the
neo-Keynesian analysis becomes overdetermined. When the left constraint is
binding, w = wω > w and rk < rk , the economy suffers inflationary pressures,
because investment demand permanently exceeds saving, gak > i > s . Joan
Robinson (1962) acknowledged this possibility by referring to an
‘inflationary barrier’ (also named ‘real wage resistance‘), which represents
the minimum level of the real wage rate organised labour is prepared to
accept without opposing rises in monetary wages. 27 Conversely, when the
right constraint is binding, w = wπ < w and rk > rk , the economy is
stagnating since investment is too low (or saving is too high) for full capacity
growth, s > i > gak . This constraint may become operational when,
following Kaldor (1957), firms are – regardless of demand – not prepared to
lower prices below that level which guarantees a minimum profit margin π,
which determines wπ = (1/al) − π/al and depends on the Kaleckian ‘degree of
monopoly’. Note that the discrepancy between s and i can be reduced by
varying sc or (in the opposite direction) γ 0 and γ 1.
Unlike the neo-Keynesian approach, some economists (e.g. Rowthorn
1981; Dutt, 1984, 1987, 1990; Nell 1985; Amadeo, 1986a, 1986b, 1987 and
Lavoie, 1992, 1995), inspired by the works of Kalecki and Steindl,
developed analyses in which firms are allowed to operate under long-run
under-utilisation of production plants . In Kaleckian analyses demand affects
capital accumulation through changes in the degree of capacity utilisation.
They assume, moreover, oligopolistic markets and conflicting claims over
income distribution, wω > wπ. This position can be represented by the
 Keynesian theories of growth 117

following equations derived from expressions (13)–(19) by assuming an

endogenous degree of capacity utilisation, u ≤ 1; exogenous income
distribution, w = wπ; and disregarding the role of the rate of growth of
demand in the investment function:

1 = wal + rkk (30)

ak
u= (31)
k

w = wπ (32)
s = sc rk k (33)

i/k = γ 0 + γ 1 rk + γ 2 u (34)
s=i (35)
According to expression (32), income distribution is determined outside
the model according to the Kaleckian theory of distribution. It is assumed
that firms, independently of workers’ wage resistance, fix prices through a
mark-up procedure securing profit margin π, wage rate wπ = (1/al) – π/al and
profit share rkk = 1 – wπal = π.28 Moreover, using (31), a relationship may be
expressed between the rate of profits and the degree of capacity utilisation,

πu
rk = (36)
ak

according to which rk is not univocally determined by income distribution as

it was, according to expression (24), in the neo-Keynesian model. Equation
(34), a linear form of (18), postulates a relationship between capital
accumulation, the rate of profits and the degree of capital utilisation,
specified by the constant coefficients γ 0, γ 1 and γ 2.29 In Kaleckian writings
the current rate of profits is relevant for investment decisions for two main
reasons. It represents a proxy for expected profitability and also a source of
internal financing.30 The level of capacity utilisation affects investment
decisions both indirectly (acting through the rate of profits) and directly by
reflecting the state of demand.31
By imposing the equilibrium growth condition i/k = g, the solutions of
equations (30)–(35) are univocally determined:

γ 0 ak
u= (37)
(1 − wπ al )(sc − γ 1 ) − γ 2 ak
118 The Theory of Economic Growth: a ‘Classical’ Perspective

γ 0 (1 − wπ al )
rk = (38)
(1 − wπ al )( sc − γ 1 ) − γ 2 ak

scγ 0 (1 − wπ al )
g= (39)
(1 − wπ al )(sc − γ 1 ) − γ 2 ak

Note that the paradox of thrift is preserved, as shown by differentiating

expressions (38) and (39) with respect to sc,

drk γ 0 (1 − wπ )2
=− <0 (40)
dsc [(1 − wπ al )(sc − γ 1 ) − γ 2 ak ]2

dg γ (1 − wπ al )[γ 1 (1 − wπ al ) + γ 2 ak ]
=− 0 <0 (41)
dsc [(1 − wπ al )(sc − γ 1 ) − γ 2 ak ]2

The negative relationship between growth and the real wage rate, instead,
disappears. Equations (30)–(35) generate the so-called ‘paradox of costs’,
according to which an increase in costs, in the form of a higher wage rate,
implies higher profits and growth rates (see Rowthorn, 1981, p. 18 and
Lavoie, 1992, p. 307). By differentiating expressions (38) and (39) with
respect to wπ, one obtains

drk γ 0γ 2 ak al
= >0 (42)
dwπ [(1 − wπ al )(sc − γ 1 ) − γ 2 ak ]2

dg scγ 0γ 2 ak al
= >0 (43)
dwπ [(1 − wπ al )(sc − γ 1 ) − γ 2 ak ]2

The paradox of costs is caused by the fact that investment expenditures

are more sensitive to changes in effective demand (reflected by the degree of
capacity utilisation) induced by changes in distribution (reflected by the
wage share) than to changes in costs induced by changes in the wage rate
(and in the profit margin).
The analytical condition indicating when the paradox of costs occurs is
given by the value of the elasticity ξ(u, π) < – 1. This elasticity measures the
sensitivity of effective demand to changes in distribution. From (36), in fact,
the inequalities drk/dπ < 0 and dg/dπ < 0 (and, therefore, drk/dwπ > 0 and
dg/dwπ > 0) imply ξ(u, π) < – 1. For the model (30)–(35), this condition
always holds since, from (37),
 Keynesian theories of growth 119

π (sc − γ 1 )
ξ (u , π ) = − < −1
π (sc − γ 1 ) − γ 2 ak
Note finally that, when the wage rate exceeds the value

γ 2 ak
wπ > 1 − ,
sc − γ 1

the equilibrium solution u does not satisfy the condition u ≤ 1 and the
Kaleckian analysis becomes overdetermined. When the constraint u = 1 is
binding, firms cannot expand production to accommodate further rises in
demand. The disequilibrium between demand and supply, i > s > gak u ,
persists unless prices and profit margins rise and the wage share falls (see
Rowthorn, 1981, p. 10). The neo-Keynesian adjustment mechanism is thus
restored.
Moving on from the relationship between the rate of profits and the
degree of capacity utilisation (36), rk = πu/ak, Bhaduri and Marglin (1990)
amended the Kaleckian theory taking into account that investment reacts
differently to similar changes in profitability. In particular, at the same rate of
profit investment decisions differ when profit margins are low and capacity
utilisation high and profit margins are high and capacity utilisation low.
Firms may not be willing to expand further productive capacity when excess
capacity is already extensive. Consequently, equation (34) has to be replaced
by the following

i/k = γ 0 + γ 1 π + γ 2 u (44)

The solutions of the model (30)–(33), (35) and (44), considering that
π = 1 – wal, are
[γ + γ (1 − wπ al )]ak
u= 0 1 (45)
sc (1 − wπ al ) − γ 2 ak

(1 − wπ al )[γ 0 + γ 1 (1 − wπ al )]
rk = (46)
sc (1 − wπ al ) − γ 2 ak

sc (1 − wπ al )[γ 0 + γ 1 (1 − wπ al )]
g= (47)
sc (1 − wπ al ) − γ 2 ak

By differentiating expressions (46) and (47) with respect to wπ, one

obtains
120 The Theory of Economic Growth: a ‘Classical’ Perspective

drk [γ 2 uak − γ 1 (1 − wπ al )al ]al

= (48)
dwπ sc (1 − wπ al ) − γ 2 ak

dg s [γ ua − γ (1 − wπ al )al ]al
= c 2 k 1 (49)
dwπ sc (1 − wπ al ) − γ 2 ak
The sign of the derivatives (48) and (49) depends on the parameters of the
model. It follows that the model modified with the investment function (44)
is able to generate two alternative growth regimes. A wage-led growth
regime, characterised by drk dwπ > 0 and dg dwπ > 0 ( drk dπ < 0 and
dg dπ < 0 ), prevails when u > γ 1π al γ 2 ak . The wage-led regime is
characterised by great responsiveness of effective demand to changes in
distribution, ξ (u , π ) < −1 . The overall effect of an increase in the wage rate
on growth is positive because the positive effect of demand (induced by the
distribution in favour of workers) is greater than the negative effect of higher
costs (generated by the increased wage rate or decreased profit margin). The
paradox of costs holds. Conversely, a profit-led growth regime, characterised
by drk dπ > 0 and dg dπ > 0 ( drk dwπ < 0 and dg dwπ < 0 ), prevails
when u < γ 1π al γ 2 ak . The profit-led regime is characterised by little
responsiveness of effective demand to changes in distribution ξ (u , π ) > −1 .
Growth is enhanced by increases in the profit margin because the negative
effect of changes in the wage share on demand is more than compensated by
the inducement to invest caused by lower costs (lower wage rates). The
negative relationship between w and rk and g holds as in the neo-Keynesian
model.
A recent attempt has been made to develop an approach (labelled neo-
Ricardian) to investment-led growth in line with the Classical theory of
prices and distribution (see Vianello, 1985, 1989, 1996; Ciccone 1986, 1987;
Committeri 1986, 1987; Kurz 19861992; Garegnani 1992; Serrano, 1995;
Trezzini 1995, 1998; Garegnani and Palumbo, 1998; Ciampalini and
Vianello 2000; Park, 2000; and Barbosa–Filho, 2000). In this approach the
‘normal’ income distribution, that is, the distribution corresponding to the
degree of capacity utilisation desired by entrepreneurs (which is also labelled
‘normal‘),32 is determined by conventional or institutional factors.33
Moreover, the rate of growth of demand may affect investment decisions, as
a result of firms’ constant attempts to match productive capacity to expected
demand. This feature is not explicitly taken into account in neo-Keynesian
and Kaleckian analyses. Neo Ricardians also object that the Kaleckian
approach has no adjustment mechanism between the current and normal
degree of capacity utilisation.34 However, they allow that these two
magnitudes may differ for long periods of time.35
 Keynesian theories of growth 121

An attempt to clarify the neo Ricardian position is made by introducing

the following equations derived from expressions (13)–(19) by assuming an
endogenous degree of capacity utilisation, u ≤ 1; an exogenous income
distribution, w = wω; and disregarding the role of expected profitability in the
investment function:36
1 = wal + rkk (50)
1  l 1
= min  ,  (51)
k  al ak 
a
u= k (52)
k

w = wω (53)
s = sc r k k (54)

i
= u – 1 + gu (55)
k

s=i (56)
Equation (53) assigns a conventional nature to the wage rate. Unlike the
neo-Keynesian analysis, exemplified by equation (24), normal distribution,
and in particular the normal rate of profits, is independent of accumulation.
rn = 1/ak – wω(al/ak) represents the normal rate of profits.37 According to
equation (55), investment expenditure is driven by an accelerator
mechanism. This mechanism involves the entrepreneur’s attempt to adjust
productive capacity towards the planned degree (here corresponding to full
capacity) and to install capacity to adjust to the growth of (expected)
demand.
From (50)–(56), by imposing the equilibrium growth condition u = 1, one
obtains the solutions:

rk = rn (57)

g = sc rn (58)

According to expressions (57) and (58), in equilibrium, the rate of profits

coincides with its normal value and the rate of growth is governed by that
level of saving, scrn, which corresponds to normal capacity utilisation or
‘capacity saving’. From this analysis it follows that, along the equilibrium
path, effective demand does not affect growth.
122 The Theory of Economic Growth: a ‘Classical’ Perspective

To re-assign a role to demand the neo Ricardian literature has taken two
routes. The first introduces in the equilibrium condition of the commodity
market a component of demand that is independent of the level of income
and its rate of change (Serrano, 1995; Park, 2000; and Barbosa–Filho,
2000).38 The second abandons the use of equilibrium growth analysis and
suggests the adoption of empirical and historical analyses, which are case-
specific, in order to identify the influence of the various components of
demand in different historical phases (see Garegnani, 1992; Ciampalini and
Vianello 2000; and, for an example of historical analyses, Garegnani and
Palumbo, 1992).

6.5. THE INFLUENCE OF THE EXTERNAL

COMPONENT OF AGGREGATE DEMAND

The analysis of the influence of the external components of demand is

mainly based on the contributions of Harrod, Kaldor and Thirlwall, which
point out that the rate of growth of an open economy may be constrained by
its trade performance. Some insights into the role of external demand can
already be found however in Keynes’s writings on the British return to gold.
In The Economic Consequences of Mr. Churchill (1925), Keynes claimed
that the return to the pre-war parity would have had a negative influence on
the British trade, making a sharp reduction of money wages necessary to
restore the competitiveness of the national industry on overseas markets. The
wage adjustment, however, would not have been painless: in the absence of a
fall in the cost of living, workers’ resistance to wage reductions had to be
overcome ‘by intensifying unemployment without limits’ (Keynes, 1925, pp.
211 and 218).
At the time, the theory of international trade was dominated by ‘classical’
thinking, according to which the balance of payments automatically adjusts
through gold flows and consequent relative price movements: countries
experiencing a trade deficit would lose gold, causing an internal price
deflation which would induce a rise in exports and a fall in imports such as to
restore equilibrium. According to Keynes, however, gold flows may fail to
restore the balance of payments equilibrium if wages and prices react slowly
to changes in the quantity of money: in these cases, the ‘classical’
mechanism would not work, and interest rate adjustments have to come into
play to ensure capital inflows sufficient to compensate for the trade deficit,
with the inevitable adverse effect of discouraging capital accumulation and
slackening economic activity.
In the following years, Keynes restated this view on various occasions. In
the evidence addressed to the Macmillan Committee, he went so far as to
 Keynesian theories of growth 123

advocate protectionism as a remedy against recession, a provocative

suggestion in a laissez-faire oriented environment (Keynes, 1929, pp. 113–
7). The proposal testifies to the relevance Keynes attributed to the constraint
that the balance of payments can set to domestic prosperity. In his view, as
long as monetary policy was sacrificed to the achievement of external
equilibrium, Britain was inevitably condemned to stagnation (Keynes, 1929,
pp. 56–7). To ‘release’ monetary policy from this task the British
competitive performance in overseas markets had to be improved. This view
also emerges in the General Theory.

In an economy subject to money contracts and customs more or less fixed over an
appreciable period of time, where the quantity of domestic circulation and the
domestic rate of interest are primarily determined by the balance of payments, as
they were in Great Britain before the war, there is no orthodox means open to the
authorities for countering unemployment at home except by struggling for an
export surplus and an import of the monetary metal at the expense of their
neighbours (Keynes, 1936, p. 348).

The idea that the trade performance of a country may affect its level of
activity was restated by Harrod in his 1933 International Economics. Like
Keynes, Harrod analyzed the case of an economy with sticky wages, where
the gold outflows caused by a trade deficit cannot affect relative prices, so
that the ‘classical’ adjustment process does not work. In this case, the gold
outflows would cause ‘real’ effects, and a poor trade performance may
therefore become a constraint to domestic activity and employment (Harrod,
1933, pp. 118 and 125). This view is formally depicted through the so-called
‘foreign trade multiplier’ (Harrod, 1933, pp. 119–23), that is a causal
relationship going from exports to domestic output. Consider an economy
with no Government sector and no saving and investment. In this case,
income (Y) is spent either on home-made consumption goods (C) and
imports (M):
Y=C+M (59)
The total national income is derived from the sale of goods at home (C)
and exports (X):
Y=C+X (60)
If the country spends on imported commodities a stable fraction µof its
income,

M=µY (61)
124 The Theory of Economic Growth: a ‘Classical’ Perspective

substituting (61) in (60) and equating (59) and (60), we get:

1
Y= X (62)
µ

The link with Keynes’ insights into the influence of international trade on
domestic prosperity is straightforward: when deterioration of the trade
performance of a country, whether a reduction of exports or an increase in
the import propensity, occurs, the commodity market equilibrium is restored
through a reduction of output. Thus, the country’s trade performance may
constrain economic activity and employment.
Harrod’s analysis of the dynamic adjustment of output following an
external shock also reflects Keynes’ line of reasoning: in the case of a current
account disequilibrium, the gold outflows would cause pressures on interest
rates, thus affecting investment in fixed and working capital and giving rise
to changes in domestic output (Harrod, 1933, pp. 135–7).
Harrod noted that, under the simplified assumptions of the model, the
commodity market equilibrium automatically implies X = M (Harrod, 1933,
p. 120). He also clarified that the relationship between foreign trade
performance and domestic ouput still holds in a more general model taking
into account saving and investment, even if in this case the output
adjustments may no longer be sufficient to assure balanced trade.
Other contributions to the study of the role of the external component of
aggregate demand in growth theories can be found in the 1960s with
Kaldor’s work on growth rate differentials, where this analysis was
intertwined with that of cumulative causation.39 In these works, which had a
great impact on development studies and on the subsequent birth of the
‘evolutionary literature‘40, Kaldor claimed that orthodox theory fails to
explain the divergence in growth rates among economies, which ‘are largely
accounted for by differences in the rates of growth of productivity’ (Kaldor,
1966, p. 104). The latter, in turn, are mainly due to the economies of scale
occurring within the industrial sector, whose rate of growth shows an
‘extraordinarily close correlation’ (Kaldor, 1978a, p. XVIII) with the rate of
growth of GDP and productivity.
In order to describe the actual performance of the economies, Kaldor
(1966; 1967; 1970; 1972) used the notion of ‘circular and cumulative
causation’, introduced by Myrdal (1957), considering the dynamics of the
industrial sector as the ‘engine of growth’. Following Young, Kaldor (1966
and 1967) described growth as a process generated by the interaction
between demand and supply: the rate of growth is positively related to the
ability of supply to accommodate variations in demand and to the reaction of
demand to changes in supply. Moreover, he clarified that economies move
 Keynesian theories of growth 125

through different stages of economic development. In an early stage, the

demand for consumption goods plays the leading role in the growth process.
In the later stages, the leading forces are, respectively, the export of
consumption goods, the demand for capital goods, and, finally, the export of
capital goods (Kaldor, 1966, pp. 112–4).
In his subsequent essays, Kaldor underlined other aspects of the growth
process. In 1970 he examined how growth depends on the rate of change of
exports, by applying Hicks’ (1950) analysis of the ‘super-multiplier’ to an
open economy and considering exports as the leading force, and
consumption and investment as induced components. The rate of growth of
exports, in turn, was assumed to depend on an external cause, the world rate
of growth of demand, and on a domestic cause, the rate of change of
production costs. An increase in world demand raises exports and domestic
production through the super-multiplier. The presence of increasing returns
in the export sector increases productivity and reduces costs, unless a
proportional rise in wages occurs. The reduction in costs further increases
exports, setting up a cumulative process, which tends to broaden the gaps
with other regions.41
For Kaldor, therefore, the demand coming from the foreign sector plays a
primary role in setting in motion the growth process, while the domestic
sources of demand mainly influence the competitiveness of the economy and
the intensity with which the external stimulus is transmitted to the rate of
growth.
In 1975 Dixon and Thirlwall tried to embody in a formal model the view
presented by Kaldor in his 1970 article. According to them, the working of
the growth process in an open economy may be so depicted:

g = γ xˆ (63)

xˆ = ηx ( pˆ − pˆ f − eˆ ) + ε x g f (64)

pˆ = wˆ − aˆl + πˆ (65)

aˆl = a0 + λ g (66)

where g is the rate of growth of the economy, x̂ the rate of growth of

exports, p̂ , pˆ f and ê are rates of change of domestic prices, foreign prices
and exchange rates respectively, g f is the rate of growth of world income,
ŵ , aˆl and πˆ are rates of change of wages, labour productivity and mark-up
factor respectively.
126 The Theory of Economic Growth: a ‘Classical’ Perspective

Equation (63) specifies Kaldor’s idea that the rate of growth of the
economy is directly related to the growth of exports42. Equation (64) is the
dynamic formulation of a conventional multiplicative export function
relating the rate of growth of exports to the rates of change of relative prices
and world income, with ηx and εx being constant price and income
elasticities. Equation (65) describes the rate of change of domestic prices as
depending on changes in the unit labour costs and on changes in the mark-up
factor. Finally, equation (66) describes the relation between the rate of
change of productivity and the rate of growth of output known in the
literature as the Verdoorn’s Law.43
The equilibrium solution of equations (63)–(66) is

γ [ηx (wˆ − a0 + πˆ − pˆ f − eˆ) + ε x g f ]

g= (67)
(1 + γηx λ )

Dixon and Thirlwall (1975) also presented the model in terms of finite
difference equations, deriving equation (67) as the steady growth solution.44
This equation can be used to describe the evolution of the rates of growth of
different countries or of different regions within the same country. If one
assumes a given mark-up in each region and given and equal values of pˆ f ,
gf, and ŵ in all regions45, the differences in the rates of growth depend on
the regional values of λ, γ, ηx, εx, and a0.
Owing to its ‘aggregate’ structure, the model (63)–(66) neglects the role
of the sectoral composition of the economy and, therefore, it does not
adequately depict the richness of Kaldor’s views on growth, based on the
idea that the productive structure affects the overall rate of growth of
productivity. Yet, the relevance of these ‘composition effects’ may be easily
taken into account by analysing how the sectoral composition of the
economy affects the parameters of the model.
As to λ, Kaldor (1971) argued that it mainly depends on the composition
of demand and on the weight of the capital goods sector in the productive
structure. High investments and a large capital goods sector enhance
productivity and the competitive performance of the economy in the world
markets.46 According to Kaldor (1966; 1967; 1971), the influence of the
composition of demand on productivity is due to the presence of variable
returns in the different sectors of the economy. The intensity of the effect on
productivity thus crucially depends on the sectors towards which the demand
for consumption and investment is directed, since increasing returns mainly
occur in the capital goods sector. Moreover, the extent to which this sector is
able to accommodate demand is also important. High quotas of investment to
output and of the capital goods sector in the productive structure enhance
productivity changes, which, in turn, improve the international performance
 Keynesian theories of growth 127

of the economy setting up and intensifying cumulative processes.

Kaldor (1971) referred to the role of composition of demand on long-term
growth in his policy analyses too. He distinguished between the concepts of
‘consumption-led’ and ‘export-led’ growth, arguing that the latter is more
desirable than the former: consumption-led growth tends to have negative
long-run effects on productivity, since it tends to raise the weight of non-
increasing return sectors in the productive structure of the economy. This
tends to worsen the international performance of the economy. Hence, as
stated in section 3 above, Kaldor claimed that Government intervention
should avoid the use of fiscal policy to increase the rate of growth and reduce
unemployment. By making growth more dependent on the demand for
consumption, this policy generates the undesired consequences previously
recalled. In this case, he said, the authorities should intervene on the
exchange rate, rather than through fiscal measures.47
Kaldor’s writings also hint at the factors affecting the parameter γ, which
depends on the quotas and elasticities of the various components of domestic
demand to the net output of the economy48. The elasticity of the demand for
consumption is influenced by productivity growth through the introduction
of new products of large consumption (Kaldor, 1966, p. 113; 1981, p. 603;
and Rowthorn, 1975, p. 899). When this occurs a higher value of γ and a
more intense effect of a given rate of growth of exports come about. For
Kaldor (1971) tax reduction too has a positive influence on γ, through its
effect on consumption.49 Yet, any stimulus to the latter variable has long-run
negative consequences, as stated above, since it makes the growth process
consumption-led. Finally, the elasticity of imports depends on the degree of
coincidence between the composition of demand and the productive structure
of the economy. In 1966 Kaldor related the degree of coincidence of the
productive structure to demand to the stage of development reached by a
country. The more a country can rely on a large capital goods sector, the
lower will be the elasticity of imports, the higher the value of γ and the more
stimulating the effect of a given rate of change of exports. A country that has
reached a stage of development which allows it to be a net exporter of capital
good can enjoy ‘explosive growth’, since ‘a fast rate of growth of external
demand for the products of the ‘heavy industries’ is combined with the self–
generated growth of demand caused by their own expansion’ (Kaldor, 1966,
p. 114).
An important and controversial issue concerns the factors affecting ηx and
εx. Kaldor (1971) considered price competitiveness the most important factor
at work. In Kaldor (1978c) this position was abandoned, on account of the
fact that the worst performing countries in terms of relative prices after the
2nd World War proved to be the best performing in terms of exports
(McCombie and Thirlwall, 1994, pp. 262–300). Kaldor (1981) then
128 The Theory of Economic Growth: a ‘Classical’ Perspective

concluded that the rate of growth of exports mainly depends on income

elasticity, which in turn depends on the innovative capacity of a country, that
is, the capacity of a country to differentiate its products. This innovative
capacity gives the economy a privileged position in foreign markets.
In their 1975 paper, Dixon and Thirlwall also tested their model on United
Kingdom data, but the model gave rise to unsatisfactory approximation
between fitted and actual values over the period 1951–66, since higher than
actual growth rates were systematically predicted. According to Thirlwall
(1998, p. 194) this discrepancy could be explained by the neglect of the
balance-of-payments constraint, in that period a severe hurdle to Britain’s
growth performance. To make up for this failure, in 1979 Thirlwall worked
out an analytical model incorporating the external equilibrium condition,
described by the following equation:
p X + F = pf M e (68)
where p is the export price index, pf the import price index, e the exchange
rate and F the value of net capital flows measured in domestic currency.
Expressing (68) in terms of rates of change, we get:

θ ( pˆ + xˆ ) + (1 − θ ) fˆ = pˆ f + mˆ + eˆ (69)

where m̂ and f̂ denote respectively the rate of growth of imports and the
rate of change of net capital flows , while θ and (1 – θ) are respectively the
value of exports and capital inflows as a percentage of imports. If we specify
the demand for imports and exports through the conventional multiplicative
functions with constant elasticities, we may express the rate of change of
exports through equation (64) and the rate of change of imports by:

mˆ = ηm ( pˆ − pˆ f − eˆ) + ε m g (70)

where ηm and ηm are price and income elasticities respectively.

Substituting (64) and (70) in (69) and rearranging, we get:

[θε x g f + (1 − θ )( fˆ − pˆ ) + (1 + θηx + ηm )( pˆ − eˆ − pˆ f )]
gB = (71)
εm

where gB is the rate of growth consistent with equilibrium in the balance of

payments. Basing his work on the extensive empirical evidence showing
long-run stability in the terms of trade50, Thirlwall assumed that the
contribution to economic growth of the price term in (71) is likely to be
small. If for simplicity’s sake it is assumed to be zero, equation (71) reduces
 Keynesian theories of growth 129

to:

[θε x g f + (1 − θ )( fˆ − pˆ )]
gB = (72)
εm

If we also assume that a country cannot finance its trade deficit through
capital inflows for a considerable length of time, the long-run equilibrium
requires that θ = 1 (McCombie, 1998, pp. 229–32). This transforms equation
(72) into

εx
gB = gf (73)
εm

which represents the dynamic version of Harrod’s foreign trade multiplier.

The economic meaning of equation (73) is that a poor trade performance
constrains a country to grow at a slower pace than that allowed by the growth
of internal demand and by resource availability. If g > gf, imports would
grow quicker than exports, thus worsening the country’s trade account and
forcing policy-makers to intervene. When for various reasons (real wage-
resistance and subsequent transmission of exchange rate variations on
domestic prices, product differentiation leading to small price elasticity of
demand for tradable goods, etc.) exchange rate devaluations prove
ineffective, the balance of payments adjustment takes place through internal
demand deflation, which slackens the pace of growth (Thirlwall, 1979, pp.
279–80). Analogously, if g < gf and the country is able to expand internal
demand, the pressure of demand upon productive capacity may raise the
capacity growth rate up to the ceiling represented by equation (73)
According to this approach, indeed, capital and labour availability does not
constrain growth, being to a large extent ‘endogenous’ to the economic
system.51
The theoretical relevance of equation (73) lies in the fact that it supplies a
simple and attractive explanation of why growth rates differ among
countries. An increase in world income generates a rate of growth that
depends on the value of each country’s εx/εm ratio. Since there are significant
international differences in this ratio (Houthakker and Magee, 1969), the
same increase in the world income gives rise to different growth rates among
countries.
A relevant question, to which this strand of literature has not yet given a
conclusive answer, is what determines the εx/εm ratio. In some contributions,
Thirlwall (1979, p. 286 and 1991, p. 26) claims that the differences in this
ratio mainly reflect those in the patterns of productive specialization. This
way of interpreting the dynamic foreign trade multiplier has striking
130 The Theory of Economic Growth: a ‘Classical’ Perspective

implications for the theory of uneven development. For example, assume a

simplified world where some countries only produce manufactured goods
and others only produce primary goods. As the income elasticity of the
demand for manufactured goods, due to Engels’ Law, is higher than income
elasticity of the demand for primary goods, it would be εx/εm > 1 for countries
producing manufactured goods and εx/εm < 1 for those producing primary
goods. According to this view, therefore, the pattern of specialisation is the
source of a process of cumulative divergence in GDP levels: countries
producing primary goods would be unable to grow at the same rate as those
producing manufactured goods, owing to their tighter balance-of-payments
constraint.
Although attractive, this way of interpreting the foreign trade multipliers
has been poorly supported on empirical grounds52., inducing Thirlwall to
return to the topic and clarify that, for industrial countries, income elasticities
must also be made to depend on the supply characteristics of the goods
produced, such as their technical sophistication and quality (see Thirlwall,
1991, p. 28 and 1998, p. 187). With this revision, the ‘cumulative
divergence’ view rooted in the post-Keynesian tradition may be extended
even to growth differentials among industrial countries: in Thirlwall’s view,
indeed, an initial discrepancy in growth rates sets in motion the negative
feedback mechanisms associated with Verdoorn’s Law, which ‘will tend to
perpetuate initial differences in income elasticities associated with “inferior”
productive structures on the one hand and “superior” industrial structures on
the other’ (Thirlwall, 1991, p. 27).53
Thirlwall’s 1979 analysis has been subsequently extended to take into
account the role of international capital flows. Thirlwall and Hussain (1982)
used equation (72), instead of (73), to capture the experience of some
developing countries running persistent current account deficits, financed by
foreign investment. In some more recent contributions (Moreno Brid, 1998–
99, McCombie and Thirlwall, 1999), however, the use of equation (72) has
been considered inappropriate for a steady-state analysis without imposing
any restriction on the evolution path of foreign capital inflows, as the lack of
this restriction may generate a path of foreign debt unsustainable in the long
run. According to Moreno Brid (1998–99), international credit institutions
impose on developing countries borrowing restrictions based on some index
of their expected ability to repay the foreign loans. He therefore proposes a
different specification for the balance-of-payments constraint based on the
requirement of a constant ratio between the current account deficit and the
GDP, interpreted as a measure of a country’s creditworthiness. When this
restriction is added to the model, the dynamic foreign trade multiplier may
assume a value higher or lower than the standard one, depending on the
initial current account position of the country concerned. This revision has
 Keynesian theories of growth 131

considerable implications for empirical analysis, clarifying that estimates of

the εx/εm ratio may be significantly biased if they do not take into account the
countries’ initial export/import ratio.
To sum up, the balance-of-payments constraint approach provides some
important insights into the analysis of the relationship between external
demand and growth. While on theoretical grounds the relevance of the
cumulative causation mechanism embodied in the model (63)–(66) cannot be
denied, the empirical evidence seems to show that the simpler formula
described by equation (73) suffices to capture the main ‘stylised facts’
relating to growth.54 As the analysis of the factors affecting the εx/εm ratio
seems to suggest, however, the balance-of-payments constraint approach
does not obscure the peculiar role played by the interaction between
‘external’ and ‘internal’ factors underlined by Kaldor in his writings.

6.6. CONCLUSIONS

Harrod’s seminal work on growth theory was conceived as an attempt to

extend Keynes’s analysis. It moved from the Keynesian ideas that the
economic system does not tend necessarily to full employment and that
aggregate demand may affect the rate of growth of the economy. In
subsequent years, Keynesian economists developed this approach along
several lines, focussing on the different components of aggregate demand
and on their role in the growth process, by using several descriptive and
analytical methods. As stated above, this multiplicity of ideas and analyses
shows, according to some authors, the fertility of this line of thought.
Conversely, an external observer may judge the lack of a unified framework
a weakness, considering the Keynesian literature a disorderly set. By
reconstructing the content of a Keynesian approach to growth and describing
the lines of development that have historically emerged, this paper has tried
to underline the wealth of this tradition. At the same time, it has sought to
outline the existence of some unifying elements which, while preserving the
diversity of ideas and analyses, reduces the risk of interpreting the Keynesian
literature as a disorganised set.

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NOTES

1. The model proposed by Solow (1956) describes the neoclassical theory of growth. For the
classical tradition one can refer to the analyses proposed by Pasinetti (1960) and by
Samuelson (1978). The analyses presented by Barro and Sala-i-Martin (1995) give the main
elements of the New Growth Theories.
2. This multiplicity of ideas and analyses is, according to some authors (e.g. Dow, 1985;
Hamouda and Harcourt, 1989; and Chick, 1995), a great merit of the Keynesian literature,
since it adds to the richness of this line of thought.
3. See Rochon (1999, pp. 64–9) for a collection of these criticisms against Keynesian
economics, raised by authors like Solow, Backhouse, Dornbusch, Fisher, Felderer and
Homburg.
4. ‘During the twenties many of us were deeply interested in Keynes‘s advocacy of measures
to promote fuller employment‘ (Harrod, 1967, p. 316).
5. Harrod (1951, ch. IX, par. 3) recalls however Keynes’s article in the Nation, May 24, where
the Cambridge economist presented for the first time his proposals for public works.
6. According to Phelps Brown, Harrod constantly followed Keynes‘s work for the Liberal
Party, with his contributions to the Yellow Book of 1928 and the defense of Lloyd George‘s
proposal for public works. At the same time, Phelps Brown says, he closely followed
Keynes‘s academic work, as he did in summer 1926, when he spent a fortnight with
Maynard and Lydia at Tilton, while Keynes was working on the galleys of the Treatise.
142 The Theory of Economic Growth: a ‘Classical’ Perspective

7. Phelps Brown (1980, p. 19) points out that since 1932, Harrod wrote several letters to The
Times, in favour of Keynes‘s proposals.
8. Young (1989, p. 30) quotes Harrod (1971, p. 77) to claim that 1933 marked a turning point
in the theoretical work of the Oxford economist on this subject.
9. ...............................
10. See Harrod (1948, p. 40; 1964, pp. 903 and 905–6). The similarity between Harrod‘s and
Ramsey‘s analysis of saving is underlined by Asimakopulos and Weldon (1965, pp. 66).
Harrod (1973, p. 20) also clarifies that ‘what each person chooses in regard to saving is
governed by various institutional arrangements, which differ from country to country and
from time to time. There is the question of what the State will provide for future
contingencies – old age, ill health, unemployment, etc. – by current transfer payments as and
when they arise. The more ground that the State covers, the less will the individual feel it
incumbent to provide for himself by saving. Personal saving will also be affected by the
degree the education of one‘s children is subvented by the public authorities’.
11. According to Harrod (1939, p. 264), the warranted rate is the rate that, if it occurs, leaves
producers satisfied, in the sense that for them ‘stock in hand and equipment available will be
exactly at the level they would wish to have them’.
12. Harrod (1948, p. 83) points out that his analysis of the warranted rate assumes the rate of
interest constant. He referred to the realism of Keynes‘s view on the behaviour of the
interest rate (pp. 64–5), agreeing that this rate may be rigid (pp. 56–7) and unable to
decrease in such a way as to lead to full employment (pp. 70–1; 83–4; 97; 99).
13. See Harrod (1939, pp. 258, 259 and 276). On page 276, in particular, Harrod explicitly
referred to an inverse relationship between k and r. In the Thirties the neoclassical
assumption of decreasing marginal returns was generally accepted. Sraffa‘s critique of the
neoclassical theory of capital had not yet been presented. Within Sraffa‘s papers, the first
written evidence of this critique is dated 1942. (See Panico, 1998, p. 177, fn. 55; and Panico,
2001, pp. 300 and 308–9 fn. 59, 60 and 61). As is well known, it was published in 1960 and
discussed at length in the following decade.
14. Dealing with his analysis of the equilibrium warranted path, Harrod claimed: ‘I know of no
alternative formulation, in the world of modern economic theory, of any dynamic principle
of comparable generality. We must start with some generality however imperfect. We shall
never go ahead if we remain in a world of trivialities or fine points. It is useless to refine and
refine when there are no basic ideas present at all’ (Harrod, 1948, pp. 80–1).
15. As to the ‘knife-edge problem’ Harrod stated: ‘Nothing that I have ever written (or said)
justifies this description of my view’. Harrod (1973, p. 31; but see also pp. 31–45).
16. See Harrod (1948, pp. 132–3, 137–8 and 144; 1960, pp. 278–9, 283 and 285; 1964, pp. 910–
13; 1973, pp. 68, 78, 80, 102). It should be noted too that, after 1960, Harrod thought that
the major influence of the interest rate on investment is through the availability of finance,
owing to the fact that the credit markets are imperfect (information are asymmetrically
distributed) and tend to react to the shortage or availability of credit (see Harrod, 1960, pp.
278–9 and 292; 1964, pp. 912–13; 1973, pp. 44, 61, 179).
17. ‘Sustained low interest will presumably in the long run reduce the normal profit rate’
(Harrod, 1973, p. 111). And again: ‘If the market rate of interest rises considerably and stays
up for a substantial period, ... that may cause firms to increase the mark-up’ (Harrod, 1973,
p. 44, but see also, p. 78).
18. The studies recently made on Harrod‘s papers thus also clarify why he claimed that time will
prove that Keynes‘s greatest contribution to economics is that of generating the dynamic
theory of growth which the Oxford economist had proposed since 1939.
19. Harrod (1964, p. 908) gave a somewhat different account of this point: ‘In the concluding
pages of my first “Essay” I did recognise that there were two distinct problems of policy,
 Keynesian theories of growth 143

namely: (i) the short-term one of preventing deviations from a steady growth rate, and (ii)
the long-term one of bringing the warranted rate into line with the natural growth rate. I
recognised that, if the warranted rate was not equal to the natural rate – and there is no
reason why it should be – difficulties would inevitably arise. Thus, policy was required to
bring them together. My remarks on this subject were admittedly very sketchy. I suggested
that the long-term interest rate might be used to make the warranted rate adhere more closely
to the natural rate, while “public works” (nowadays “fiscal policy”) and the short-term rate
of interest should be used to deal with short-term deviations. All this was very loose. The
existence of the double problem was, however, recognised’.
20. Some recent contributions to the New Growth Theories consider, instead, the influence of
Government intervention on growth, be it a change in taxation or in expenditure, through its
effect on the propensity to save and on the capital–output ratio (see Barro, 1990).
21. In his seminal contribution Kaldor (1955–56, p. 98) explicitly recognised the need to deal
with the State in the analysis of steady growth conditions. Yet, like other authors, he failed
to do so in most of his later work.
22. According to Kaldor (1958, pp. 136–7), the drawback of this solution is that in times of
inadequate demand the Government gradually transforms the economy into one of high
consumption and low investment, with the undesirable consequences on long-run growth,
which will be described in Section 6 below.
23. In this debate, Pasinetti (1989a; 1989b) and Dalziel (1989; 1991a,b; 1991–92) examine the
validity of the Cambridge equation by introducing into the analysis the Ricardian
debt/taxation equivalence. Denicolò and Matteuzzi (1990) and Panico (1992; 1993; 1997;
1999) consider the same topic by introducing into the analysis the existence of financial
assets issued by the Government. Commendatore (1994; 1999a), instead, compares the
limits of validity of the dual and the Pasinetti theorem.
24. Denicolò and Matteuzzi (1990) deal with the so-called ‘personal’ version of the post
Keynesian theory of growth and distribution. It may be noted, however, that the debate has
considered different versions of the post Keynesian theory of growth and distribution: the
personal version, in terms of classes, the functional version, in terms of income groups, and
the institutional version, in terms of sectors of the economy (see Panico, 1997 and
Commendatore, 1999a, 1999b).
25. Kaldor (1955–56) and Pasinetti (1962), instead, assume that investment is exogenous. Their
models are characterised by full employment. According to some authors this assumption
cannot be considered Keynesian (see Marglin, 1984a, p. 533–4 and Kurz, 1991, p. 422). In
section 3 above, however, we have pointed out that for Kaldor, full employment growth can
be achieved through suitable policy interventions. In the absence of government
interventions, the economy does not necessarily grow at the full employment rate. Pasinetti,
on the other hand, explicitly investigates the conditions of steady growth at full
employment. For a survey of the subsequent developments of the neo-Keynesian theory, see
Baranzini (1991) and Panico and Salvadori (1993).
26. The introduction of a non-linear form for expression (22) could generate multiple solutions,
some of them unstable. This is the case of Joan Robinson’s (1962) well-known ‘banana
diagram’ which gives rise to two equilibria, one stable and one unstable.
27. Marglin (1984a, 1984b) solved this type of overdetermination by introducing in the analysis
a new variable, the rate of inflation, depending on the discrepancy between s and i.
According to this author, ‘equilibrium can be characterised in terms of investment, saving,
and conventional wages, but to do so we must abandon the static characterisation of
equilibrium in favour of a dynamic one. Using the disequilibrium dynamics of the two
systems, we can synthesise Marxian and Keynesian insights into a just-determined model in
144 The Theory of Economic Growth: a ‘Classical’ Perspective

which investment, saving, and the conventional wage jointly determine equilibrium.’
(Marglin, 1984b, pp. 129–30)
28. Dutt (1987 and 1990) presented a more sophisticated resolution mechanism of conflicting
claims between firms and workers which could generate a value of the wage rate between wπ
and wω.
29. In the Kaleckian literature these coefficients are not univocally interpreted. According to
Dutt (1984, p. 28), γ 0 and γ 1 accounts for the (constant) entrepreneurs’ desired degree of
capacity utilisation. Lavoie (1992, 1995), instead, interpreted γ 0 as firms’ expected rate of
growth of sales, which is not necessarily constant.
30. These are the same reasons invoked by Joan Robinson (1962). See above.
31. According to Steindl (1952), firms plan a reserve of excess capacity facing uncertainty. This
is to avoid the permanent loss of market share owing to the temporary inability to fulfil
unexpected demand. Other reasons, invoked by the literature to justify firms’ planned excess
capacity, are: (i) seasonal fluctuations of demand; (ii) expected growth in demand; (iii)
costly use of overtime work and night shifts or shifts involving unordinary hours or days;
(vi) indivisibility of plants and equipment. For a short review on this argument, see Lavoie
(1992, pp. 124–6).
32. The normal degree of capacity utilisation, un, is ‘the degree of utilisation of capacity desired
by entrepreneurs, and on which, therefore, they base their investment decisions about the
size of a new plant relative to the output they expect to produce’ (Garegnani, 1992, p. 55).
33. In particular, income distribution can be determined either by referring to some
‘conventional standard of life’, which affects the wage rate, or, alternatively, by the level of
the money interest rates, which affects the rate of profits, as suggested by Sraffa (1960,
p. 33) and envisaged by Vianello (1996).
34. On the absence of an adjusting mechanism between u and un, Committeri warned that if ‘the
“equilibrium” utilisation degree does not coincide with its normal level, and hence
producers’ expectations are not being confirmed by experience … as the economy moves
away from the steady path, the model has nothing to say about the long-run tendencies of
capital accumulation’ (Committeri, 1986, p. 175). See also Ciampalini and Vianello (2000).
35. According to Garegnani (1992), ‘the entrepreneurs will certainly attempt to bring about,
through investment, a capacity which can be used at the desired level. And the degree of
their success will depend on how well they will be able to forecast the outputs which it will
be convenient for them to produce. But given the initial arbitrary level of capacity that
success will show only in shifting, so to speak, backward in time the deviation of the
utilization of capacity from the desired level. Even correct foresight of future output will not
eliminate average utilization of capacity at levels other than the desired one’ (Garegnani,
1992, p. 59)
36. Neo-Ricardians consider the normal rate of profits, rn, a more suitable variable than the
current rate of profits, r, to capture the role of expected profitability in investment decisions.
See on this point Vianello (1996, p. 114).
37. We maintain the simplifying assumption that normal and full capacity utilisation coincide,
un = 1.
38. The independent component of aggregate demand can come from any sector of the
economy. Notice that this analysis only shows that effective demand can affect the
adjustment path towards equilibrium even if along this path u = 1 (see Park, 2000, pp. 11–16
and Barbosa-Filho, 2000, p. 31). As to the conclusion that equilibrium growth is governed
by capacity saving, Park (2000, p. 8) and Barbosa-Filho (2000, p. 31) showed the existence
of two solutions of this analysis. The first, which is locally stable, confirms that growth is
governed by capacity saving. The second, which is unstable, implies that income grows at
the same rate as the independent component of demand, if the latter has certain properties.
 Keynesian theories of growth 145

39. For a detailed analysis of Kaldor’s views on growth and cumulative causation, see Thirlwall
(1987) and Ricoy (1987; 1998). These contributions describe several aspects of Kaldor’s
position, including the role of technical progress and structural change, and his idea of
growth as a path-dependent process. In what follows, we mainly focus on the role of demand
in the growth process, paying less attention to other equally relevant aspects of his vision of
the topic.
40. This is the literature that moves from the contributions of Nelson and Winter (1974, 1977,
1982), examined by Santangelo’s essay in this volume.
41. In 1972 Kaldor further integrated Young’s analysis with the Keynesian principle of effective
demand, examining the role played by the demand for investment and focusing on the
conditions allowing self-sustained growth. In this contribution, he argued that growth is a
fragile process. In order to work it requires that several things simultaneously occur:
investors must have confidence in the expansion of the markets; the credit and financial
sectors have to accommodate the needs of trade; the distributive sector has to bring about
price stability. According to Kaldor, after the 1930s, Government intervention secured the
smooth working of the process by demand-management policies (Kaldor, 1972, p. 1252).
42. As stated above, Kaldor borrowed this relationship from Hicks’ super-multiplier. Following
standard notation, I + X = S + M is the commodity market equilibrium condition for an open
economy without public sector. If we assume that S = sY, I = κY and M = µY, the
equilibrium level of income is given by Y = αX, where α = 1/(s – κ + µ) is Hicks’ super-
multiplier. Rewriting this equation in terms of rates of change, we get g = α ( X / Y ) xˆ . Since
α = dY/dX and, by definition, γ = (dY/dX) (X/Y), the rate of change of income simply reduces
to (63).
43. Dixon and Thirlwall (1975, pp. 208–10) point out that a0 is determined by the autonomous
rate of disembodied technical progress, by the autonomous rate of capital accumulation per
worker and the extent to which technical progress is embodied in capital accumulation. λ is
instead determined by the induced rate of disembodied technical progress, by the degree to
which capital accumulation is induced by growth and the extent to which technical progress
is embodied in capital accumulation.
44. The stability condition of the model isγηxλ < 1, which, in their opinion (1975, p. 208),
may be plausibly assumed to hold. As a consequence, since ηx < 0, in equation (5.9) g is
related positively to γ, a0, pˆ f , ê , εx, gf and λ, and negatively to ŵ and πˆ . The effects of
variations of ηx are not determined. Notice too that recently Setterfield (1997) has presented
an analysis, similar to that of Dixon and Thirlwall (1975), in order to study the movements
of the economy out of equilibrium.
45. See Dixon and Thirlwall (1975, p.209). Notice however that, unlike Dixon and Thirlwall,
Kaldor (1966, p. 147) assumes that the differences in the rate of change of money wages of
different regions do not counter-balance the reduction in costs due to the different rate of
change of productivity.
46. To empirically estimate the influence of the composition of demand on productivity, Kaldor
(1966) also used an expression, which differs from our equation (4) only in introducing, as
an additional variable, the ratio of investment to output. His analysis showed that this
variable explained the divergence of the rate of change of productivity from the trend
determined by the original equation (4). It explains the residual change in productivity, not
explained by increasing returns.
47. In the subsequent years, Kaldor changed this position too: ‘In this respect I now feel I was
mistaken. Events since 1971 have shown that the exchange rate is neither as easy to
manipulate nor as rewarding in its effect on the rate of growth of net exports as I have
thought’ (Kaldor, 1978a, p. XXV).
 146 The Theory of Economic Growth: a ‘Classical’ Perspective

48. Let Y = D + X, where Y is income, D is the demand for domestic products and X is exports.
By definition γ = ω x ( d D + d X ) / d X , where ωx is the ratio of exports to income. Since
( d D / d X ) ω x = ( d D / d Y ) ( d Y / d X ) ω x = ( d D / d Y ) γ and ωx = 1 – ωD, we can write
γ = ( 1 – ω D ) / ( 1 – d D / d Y ) . Finally, from the definition of the income elasticity of
demand for domestic products ε D , we get γ = ( 1 – ω D ) / ( 1 – ω D ε D ) .
49. This view was already presented in Kaldor (1958), as stated in Section 3 above.
50. See Wilson (1976), Ball, Burns and Laury (1977). Long-run stability in the terms of trade
may alternatively rely either on arbitrage or on wage-resistance forcing domestic prices to
move equiproportionately to exchange rate depreciations so that pˆ − pˆ f − eˆ = 0 (Thirlwall,
1979, p. 283).
51. According to McCombie and Thirlwall (1994, 233), there are a number of possible
mechanisms through which capacity growth may adjust to demand growth: ‘the
encouragement to invest which would augment the capital stock and bring with it
technological progress; the supply of labour may increase by the entry of the workforce of
people previously outside or from abroad; the movement of factors of production from low
productivity to high productivity sectors, and the ability to import more may increase
capacity by making domestic resources more productive’. On this point, see also Thirlwall
(1986, pp. 48–9) and McCombie (1998, pp. 238–9).
52. See McCombie (1993, p. 481), who quotes extensive empirical evidence showing that
income elasticities are not related to the differing product mixes of the exports of the various
countries.
53. It is worth noting that alternative ways of interpreting the foreign trade multipliers may lead
to less pessimistic conclusions. Bairam (1993), for example, shows the existence of a
statistically significant inverse relationship between the εx/εm ratio and the stage of economic
development of the country, proxied by per-capita output. Such a relationship implies that
developing countries are less balance-of-payments constrained than developed countries,
and therefore provides some support for the ‘catching-up’ hypothesis: if developing
countries are able to grow quicker than developed ones, GDP levels will inevitably converge
in the long-run.
54. See McCombie and Thirlwall (1994, 434). Kaldor himself (1981, p. 602) admitted the utility
of the simplified model. In the same essay, Kaldor assumed that the sum of the marginal
propensities to consume and invest is equal to unity. This assumption transforms Hicks’
supermultiplier into Harrod’s multiplier. If we also assume ηx = 0, equation (67) collapses to
the dynamic foreign trade multiplier. Note that the assumption c + κ = 1 has also been used
in the Cambridge Economic Policy Group model. On this point see also Targetti (1991).

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