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Dismissing industrial policy because 'governments cannot pick winners' is counter-productive. This Element studying selected major innovations illustrates the fact that virtually all major new technologies have been developed by a synergetic cooperation between the public and the private sectors, each doing what it can do best. By examining how R&D is financed, rather than where it takes place, the authors show that the role of the public sector is much more pronounced than is often thought. The nature of the cooperation − who does what − varies with the nature of each innovation so that simple, one-size-fits-all, rules about what each sector should do are suspect. These results are particularly important because they challenge the scepticism in the United states and elsewhere about the importance of industrial policy, a scepticism that threatens to undermine the long-term, and necessary cooperation, between the public and private sectors in promoting growth-inducing innovations.

This paper reviews some of the myriad, often complex, ways in which the private and public sectors interact in the invention and innovation of the new technologies that are a major driver of economic growth. Several terms have been used to describe the public sector’s activities in these matters: technology enhancement policy, innovation policy, industrial policy, and national systems of innovation. We use the term Industrial Policies to cover all the public sector’s activities that, either directly or indirectly, encourage technological advance. We first outline some important concepts and definitions: two views of the place of the public sector in technological advance; the definition of technology and the facilitating structure; the main public sector organizations that encourage technological advance; the four evolutionary trajectories of a new technology: invention, efficiency, applications and diffusion; the growing importance of science in technological advance; and an overview of a successful industrial policy. In Section II we study 13 important technologies developed over the last century and a half, showing the extent that the public sector has provided finance for the various trajectories of these technologies. In Section III we consider nine public policies designed to encourage technological advance in general. Then in section IV, we discuss over 20 cases in which the government has attempted to pick and encourage specific winners, some of which were successes while others were failures. After each of our case studies in our three main sections, we offer at least one tentative lesson concerning the conditions that favor success and/or that tend to lead to failure. Section V offers a few concluding remarks ending with the statement that “The cases considered here reveal that those who would dismiss industrial policy with statements such as ‘Governments cannot pick winners’ are relying on an empty slogan to avoid detailed consideration of the actual complicated, multifaceted relationship between the private and public sectors in encouraging the inventions and innovations that are the root of economic growth.”

We examine the sources of the finance that has enabled technological evolution, distinguishing between sources in the private, or for-profit, sector (FPS) and sources in the public or not-for-profit sector (NPS). We investigate the roles that agents in each sector have played, both directly and indirectly, in financing the creation and evolution of twelve major technologies that were innovated between the late 19th and early 21st centuries, many of which have been labelled GPTs. To document this, we describe the development of our selected technologies in some considerable detail. Although much of this is already well known, what has not been done, to the best of our knowledge, is to emphasise for all these developments the extent to which agents in the NPS and FPS provided the supporting finance. Studies of the physical location of R&D, inventions and innovations typically give heavy weight to the FPS and much less to the NPS. However, when we study the sources of the finance that enabled these technological developments, this greatly increases the relative weight attached do the NPS compared with that of the FPS. We distinguish four trajectories in the evolution of any new technology: the invention trajectory covers the scientific and technological developments that precede the emergence of an identifiable technology; the efficiency trajectory is the time path of the cost of producing a unit of the service provided by the technology; the applications trajectory is comprised of the technological products, processes, and forms of organization that depend on it; the diffusion trajectory is the spread of the technology to uses in other places and other times, both nationally and internationally. For each of these trajectories in each of our 12 technologies we indicate which developments were financed mainly by the NPS, mainly by the FPS, or by some combination of both. We divide our technologies into five main groups (groups that were discerned after completing our case studies rather than being imposed a priori): Group 1, little NPS support except for the applications trajectory, the internal combustion engine; Group 2, NPS support mainly for the invention trajectory, refrigeration; Group 3, NPS support mainly for the efficiency and applications and diffusion trajectories, railways, automobiles, aircraft and agriculture; Group 4, NPS support mainly for the invention and efficiency trajectories, the iron steam ship; Group 5, NPS Support for all trajectories, electricity, computers, the Internet, and lasers. After reporting on each of our 12 technologies, we suggest lessons that are drawn from them and are appropriate to industrial policy. For example, when there is much uncertainty about the technology early on, as it is so often and was with refrigeration, certain practical components of it need to be demonstrated by agents in the NPS before those in the FPS can foresee profitable investments in the technology. In such cases NPS support is needed early in the invention trajectory. After completing our case studies, we draw several lessons that seem appropriate to most or all of them. Two examples follow. First, the more does a technology depend on science, the larger the place for NPS support for the relevant trajectories. Second, major technologies have significant co-evolutionary complementarities amongst themselves. As a result, NPS support in the development trajectories of any one technology has significant positive and often difficult-to-foresee, impacts, on the development trajectories of other technologies, including some that were not directly supported by NPS themselves. NPS investments can also help to create positive feedbacks through these indirect impacts by creating further complementarities that subsequently operate on the originally supported technology. Thus, calculations of the “return to NPS support” for a particular technology typically underestimate that return, unless they take account of the impact on the entire interconnected, complementary system. The work concludes that dismissing industrial policy with statements such as ‘governments cannot pick winners’ relies on an empty slogan to avoid detailed consideration of the actual complicated, multifaceted relationships between the private and public sectors in encouraging the inventions and innovations that are the root of economic growth.

Distinguishing characteristics of General Purpose Technologies (GPTs) are identified and definitions discussed. Our definition includes multipurpose and single-purpose technologies, defining them according to their micro-technological characteristics, not their macro-economic effects. Identifying technologies as GPTs requires recognizing their evolutionary nature, and accepting possible uncertainties concerning marginal cases. Many of the existing ‘tests’ of whether particular technologies are GPTs are based on misunderstandings either of what GPT theory predicts or what such tests can establish. The development of formal GPT theories is outlined, showing that only the early theories predicted the inevitability of GPT-induced showdown and surges. More recent GPT theories, designed to model the characteristics of GPTs, do not imply the necessity of specific macro effects. We show that GPTs can rejuvenate the growth process without causing slowdowns or surges. We conclude that existing criticisms of GPT theory can be resolved and that the concept remains useful for economic theory.

Second-best theory established that a policy's effect on community welfare (or any other objective function) varies with its specific context. In contrast, Ng argues that fulfilling first-best conditions piecemeal is optimal whenever the policy-maker's information is insufficient to determine the direction of the change in the variable under consideration that will raise welfare, irrespective of the conditions in that market. It is argued in the present paper: (i) that Ng's own assumptions imply not that first-best conditions should be established under these circumstances, but that the status quo should be maintained; (ii) that when Ng's key assumption is altered to be empirically relevant, all policy decisions become fully context-specific; and (iii) that Woo's argument for accepting Ng's conclusions in spite of point (ii) is incorrect. The conclusion discusses valid uses of piecemeal welfare theory in spite of second best.

This paper contrasts the static neoclassical and the evolutionary views of the economy and economic policy. It responds to Ng's comments on Lipsey's original criticism of third‐best theory. Under a relevant definition of informational poverty and Ng's other assumptions, the expected value of any policy‐created divergence from the status quo is negative: If there is not enough known to determine what to do, nothing should be done, rather than establishing first‐best conditions as Ng's analysis has it. It is argued that Ng's analysis of his two other information states adds little to what common sense suggests. To address Ng's argument that policies using context‐specific objective functions lack the required welfare basis, the present paper studies how economic policy is actually pursued absent guides provided by welfare economics. Policies that follow from evolutionary economic theory imply that many things that are seen as ‘distortions’ in welfare economics are actually desirable forces that drive economic growth.

In this final piece to the symposium for a special issue of Pacific Economic Review on the theories and applications of second‐best and third‐best theories, Richard Lipsey and Yew‐Kwang Ng provide their final comments to the debate. Several issues of agreement and disagreement are discussed. Most importantly, while both agree on the formal correctness of both the second‐best and third‐best theories, Lipsey believes the main proposition of third‐best theory (following the first‐best rules under Informational Poverty) is applicable only to a situation (status quo) where the first‐best rule (such as taxing a pollution at the marginal damage of $N) is already being followed; Ng regards it as applicable whether or not the first‐best rule is currently being followed. This also partly explains their difference on the practical policy relevance and the importance of that theory.

An early post-WWII debate concerned the most desirable demand and inflationary pressures at which to run the economy. Context was provided by Keynesian theory devoid of a full employment equilibrium and containing its mainly forgotten, but still relevant, microeconomic underpinnings. A major input came with the estimates provided by the original Phillips curve. The debate seemed to be rendered obsolete by the curve’s expectations-augmented version with its natural rate of unemployment, and associated unique equilibrium GDP, as the only values consistent with stable inflation. The current behavior of economies with the successful inflation targeting is inconsistent with this natural-rate view, but is consistent with evolutionary theory in which economies have a wide range of GDP-compatible stable inflation. Now the early post-WWII debates are seen not to be as misguided as they appeared to be when economists came to accept the assumptions implicit in the expectations-augmented Phillips curve.

The main thrust of this Element is a critical assessment of the theory and evidence concerning the sources of scale effects. It is argued that the analysis of static scale effects is important because scale effects are embedding in our world, and new technologies associated with an evolving economy often allow their exploitation when they cannot be exploited in less technically advanced and smaller economies. So, although static equilibrium theory is not a good vehicle for studying economic growth, showing how scale effects operate when output varies with given technology helps us to understand the scale effects that occur when output rises as a result of economic growth, even though that is typically driven by technological change.

This paper discusses the influence on my research and writings of several methodological principles that we, the members of the LSE Staff Seminar on Methodology, Measurement and Testing learned directly from Joseph Agassi and indirectly from Karl Popper. It begins with the origins of the seminar and my text book, An Introduction to Positive Economics. It goes on to cover methodological issues that arose in my subsequent papers including: the importance of having empirical content in economic theories, the poverty of theories that are built only to pass sunrise tests, why non-robust assumptions need to be tested, the concept of refutability, the fussy distinction between normative and positive statements, the impossibility of giving purely positive policy advice, the testing of existential statements, fallacious attempts to deduce empirical propositions from definitional identities, the distinction between internally and externally driven research programs, the poverty of modern welfare economics as a guide to policy and the possibility of deriving policy advice without such guidance. It concludes with a short discussion of the revolutionary implications of accepting technological change as being generated endogenously under conditions of genuine uncertainty rather than measurable risk.

Advocates of green-growth policies and those who advocate policies to stop growth both accept that the world faces serious environmental problems. They disagree on and debate about appropriate remedies. Green-growth advocates argue that it is possible to create a green economy compatible with sustained growth. The no-growth advocates argue that the whole growth process must be stopped if the planet is to be saved from catastrophe. This short paper argues that choosing the optimal policy for dealing with these serious problems does not require deciding which group is right. Instead it is argued that the optimal policy is to act as if the green-growth advocates are right and only if they are proved wrong by the failure of their policies to do the job, should no-growth policies be attempted.

The evolutionary vision in which history matters is of an evolving economy driven by bursts of technological change initiated by agents facing uncertainty and producing long term, path-dependent growth and shorter-term, non-random investment cycles. The alternative vision in which history does not matter is of a stationary, ergodic process driven by rational agents facing risk and producing stable trend growth and shorter term cycles caused by random disturbances. We use Carlaw and Lipsey’s simulation model of non-stationary, sustained growth driven by endogenous, path-dependent technological change under uncertainty to generate artificial macro data. We match these data to the New Classical stylized growth facts. The raw simulation data pass standard tests for trend and difference stationarity, exhibiting unit roots and cointegrating processes of order one. Thus, contrary to current belief, these tests do not establish that the real data are generated by a stationary process. Real data are then used to estimate time-varying NAIRU’s for six OECD countries. The estimates are shown to be highly sensitive to the time period over which they are made. They also fail to show any relation between the unemployment gap, actual unemployment minus estimated NAIRU and the acceleration of inflation. Thus there is no tendency for inflation to behave as required by the New Keynesian and earlier New Classical theory. We conclude by rejecting the existence of a well-defined a short-run, negatively sloped Philips curve, a NAIRU, a unique general equilibrium, short and long-run, a vertical long-run Phillips curve, and the long-run neutrality of money.

We address two interrelated issues: structured technology and non-stationary equilibrium growth. We do this by modelling multiple, co-existing, non-identical general purpose technologies (GPTs). Three sectors producing pure and applied research and consumption goods, employ different, evolving, technologies. Agents within each sector operate under conditions of Knightian uncertainty and path dependence, employing technologies that differ in specific parameter values. This behaviour produces a non-stationary (non-ergodic) growth process. Important characteristics of structured technology, previously only described historically, are successfully modelled, including co-existing GPTs some of which compete with each other while others complement each other in varying degrees. Because changes in technology are partial causes of, but not contemporaneous with, GDP changes, their separate evolutions can be studied.

This paper argues that technological advance is a necessary condition for sustained economic growth. Technologies and institutions co-evolve in a system of mutual causation. Although some institutions inhibit growth while others encourage it, no single institution is either necessary or sufficient to produce sustained growth. However, some non-unique bundle of encouraging institutions is necessary. Sustained growth began with the Industrial Revolutions that did not just ‘fall out of the blue’ but were instead the culmination of three trajectories of technological advance in steam power, electric power, and the mechanization of textile manufacturing. These stretched over several centuries. Growth then became sustained when the West ‘invented how to invent’. A necessary condition for the Industrial Revolutions was Western science whose roots lie as far back as the scholastic philosophers and the medieval universities. Its absence elsewhere is a sufficient reason why no other place developed its own indigenous industrial revolution.

This paper criticizes three Robbinsian positions still often found in modern economics: (1) the methodology of intuitively obvious assumptions; (2) treating facts as illustrations rather than as tests of theoretical propositions; (3) assuming that theory provides universally applicable generalizations independent of the characteristics of individual economies and so are independent of specific historical processes. Two corollaries of point (3) are that theory cannot assist in explaining unique historical events such as the emergence of sustained growth in the West and that economists need not interest themselves in the details of the technologies that produce the nation's wealth.

Seven years after Helpman's (1998) book on general purpose technologies (GPTs), there is a dearth of subsequent models. Early models employed technically complex dynamic optimising techniques which limited further development. We present a model in which sustained growth is driven by a succession of GPTs that is technically simpler than the early models yet captures stylised facts that were omitted from them. Ours has diminishing returns to inputs, and endogenous, incremental technological changes from R&D, interrupted by the occasional introduction of new GPTs. GPTs are themselves developed endogenously with payoffs that are subject to uncertainty in magnitude and timing.

TFP is interpreted in the literature in different, mutually contradictory ways. Changes in TFP are shown to measure not technological change, only the super-normal returns to investing in such change – returns that exceed the full opportunity cost of the activity. Thus, in the limit, technological change can proceed with unchanged TFP. Measuring the effects of technological change instead requires counterfactual estimates. Reasons why changes in TFP are imperfect measures of super normal returns are also studied – reasons connected with the timing of output responses, the treatment of R&D in the national accounts, the omission of resource inputs, and two types of aggregation. La productivite totale des facteurs et la mesure du changement technologique. La productivite totale des facteurs (PTF) est interpretee dans la litterature de manieres differentes et mutuellement contradictoires. On montre que les changements dans la PTF ne mesurent pas le changement technologique, mais seulement les rendements supra-normaux sur les investissements dans de tels changements – des rendements qui depassent le plein cout d’opportunite de cette activite. Donc, a la limite, le changement technologique peut proceder sans que la PTF change. Mesurer les effets du changement technique reclame des evaluations d’hypotheses de rechange. Les raisons pour lesquelles les changements dans la PTF sont des mesures imparfaites des rendements supra-normaux sont aussi etudiees – raisons connectees avec la reponse des niveaux de production, le traitement de la R&D dans les comptes nationaux, l’omission des intrants de ressources, et deux types d’agregation.

The relationship between productivity, technology and economic growth has been debated extensively in the endogenous growth, growth accounting, New Economy and policy literature. This paper briefly surveys the literature on total factor productivity (TFP) calculations – the various techniques and problems associated with it. We argue that TFP is not a measure of technological change and only under ideal conditions does it measure the supernormal profits associated with technological change. The critical driving force of economic growth is not the super normal profits that technological change generates but rather the continuous creation of opportunities for further technological development. Six illustrations of when TFP fails to correctly measure these super normal profits are provided. A version Carlaw and Lipsey’s (2003b) model of endogenous general purpose technology- driven growth is then utilized to make some progress toward answering Prescott’s (1998) call for a theory of TFP. The model is used to simulate artificial data and connect theoretical assumptions of returns to scale and resource costs to the conditions under which TFP miss-measures the actual growth of technological knowledge.

Externalities as conventionally defined miss many of the spillovers that are both causes and consequences of the technological changes that underlie economic growth. We introduce a much wider concept called technological complementarities. New general purpose technologies (GPTs) rejuvenate the growth process by creating technological complementarities, which are adequately measured neither by total factor productivity (TFP) nor by externalities. There would be major gains from technological change even if the returns on capital invested in innovation never exceeded the returns on investing in existing technologies so that there were neither externalities nor positive changes in TFP.

LAURENCE S. Moss [*] I Samuelson on Harry, the Full Achiever IN THE BRITISH ACADEMY OBITUARY OF Harry, James Tobin called ours the Age of Johnson. That was a bit of a stretch, but admissible in an eulogy where, as Dr. S. Johnson observed, one is not under strict oath. Undeniably our Johnson did penetrate into every nook and corner of post-1940 mainstream economics. He was certainly among the most prolific of our clan. Indeed, although he died at age 54, the intensity at which he lived added up to at least two normal lifetimes. Harry seemed a driven man--self-driven. Articles bubbled out of him like songs from Franz Schubert and varied melodies from Mozart. He would travel 3,000 miles to attend a meeting, whittle away while the program droned on, polish off a nightcap quart of scotch, and then on the plane trip back home compose a paper dealing with some aspect of the subjects discussed. Before the word processor amplified scholars' capacity for good or ill, Harry's little portable typed out print-ready copy. Johnson surfaced in big-time science at Harvard following the war's end. He was born on a Toronto street where (I believe) Lone Tarshis, Harold Somers, A. F. W. Plumptre, and a number of other eminent Canadian economists had lived. Like Jacob Viner in an earlier Montreal generation, Harry had a distinguished physician brother. During the war itself Harry did have a brief sojourn in the Other Cambridge. Unaccountably, he did not at Harvard stand out remarkably in comparison with the several hundred post-war graduate students in economics. At MIT, three miles away, I would hear tales about Bob Solow, Jim Tobin, Carl Kaysen, and Tom Schelling. However, when Harry called on me at my office (along with a forgotten second face), I was obtuse enough to regard him as just another competent student. However, Sidney Alexander alerted me to Harry's unusual versatility and speed. Needing a grader to handle examination books, Alexander hired the first to volunteer, namely H. J. Later that day the books came back expertly graded and ranked. Since the normal expected time was three blue books per hour, Sidney was suspicious of a slovenly job. Checking, he reported to me, "They were optimally evaluated. Clearly we deal here with an extraordinary talent." Fellow editors were later to learn the same lesson. John Chipman was surprised to find out how prolific Pareto had been: his words of publication exceeded those of Keynes and Ricardo put together. When I mentioned this to the late, erudite Alexander Gerschenkron, I was told that Eli Heckscher, Bertil Ohlin, and Luigi Einaudi put Pareto to shame. Like him they wrote often for newspapers and general magazines; a book merely listing Einaudi's bibliography made a volume thicker than Marshall's Principles. Johnson, by contrast, concentrated on learned journal publishing. Certainly he was aiming for a lifetime total of more than 1,000 scientific articles. Given a normal life span of the Bible's three score and ten, he would surely have reached that goal. It was said that at Johnson's death he had 18 articles in proof. I wager that there wasn't a dud in the whole lot. The classical scholar and poet A. E. Housman was asked by a colleague about an item he had not included in his collected papers: "Did you think it not good?" Housman answered, "I thought it good. But no t good enough for me." I doubt that Harry let the wet rag of doubt kill off many of his plane-ride progeny. Friedrich Lutz said of a super-productive Harvard professional contemporary, "That man Seymour Harris can't hold his ink." A similar case was the mathematician Richard Bellman: he wrote important innovative analyses, but he may have written too much-so much that readers were not always sure whether they had or had not already read the Bellman result that arrived in the morning mail. (The same can never be said about the mathematician Paul Erdos, who died recently in his 80s, having authored or co-authored highly respected mathematical articles in excess of 4,000. …

While acknowledging the successes of modern economics, this paper concentrates on some shortcomings. Many are traced to a single source: the great insights of economics are all qualitative. Economics does not have a theoretical structure that is tightly related to a rich body of data and those seeking to contribute to its ideas operate on widely divergent levels of theoretical and empirical sophistication with little communication between those who operate at different levels. One consequence is that anomalies are tolerated on a scale that would be scandalous in any natural science. Another is that theories tend to be developed in unconstrained ways that are empirically relevant only by accident. Elegant error is often preferred to messy truth. Theoretical tractability is often preferred to empirical relevance. Economists often prefer theories that produce unambiguous policy results over theories that do not, irrespective of their relative evidential bases.

In Governance, Multinationals and Growth, leading scholars celebrate and build upon the pioneering work of Edward Safarian on multinational enterprises and foreign direct investment. The book explores the linkages among multinationals and foreign direct investment, corporate and public governance, and economic growth. The contributors pay particular attention to emerging policy issues that include the behavior of individual governments, intergovernmental organizations and civil society. In addition, they address linkages among MNEs, their governance and economic growth, and generic policy realities (and innovations) in a small-to-medium-sized economy.

To make the argument that the behaviour of modern industrial economies since the 1990s is inconsistent with theories in which there is a unique ergodic macro equilibrium, the paper starts by reviewing both the early Keynesian theory in which there was no unique level of income to which the economy was inevitably drawn and the debate about the amount of demand pressure at which it was best of maintain the economy: high aggregate demand and some inflationary pressure or lower aggregate demand and a stable price level. It then covers the rise of the simple Phillips curve and its expectations-augmented version, which introduced into current macro theory a natural rate of unemployment (and its associated equilibrium level of national income). This rate was also a NAIRU, the only rate consistent with stable inflation. It is then argued that the current behaviour of many modern economies in which there is a credible policy to maintain a low and steady inflation rate is inconsistent with the existence of either a unique natural rate or a NAIRU but is consistent with evolutionary theory in which there is perpetual change driven by endogenous technological advance. Instead of a NAIRU evolutionary economies have a noninflationary band of unemployment (a NAIBU) indicating a range of unemployment and income over with the inflation rate is stable. The paper concludes with the observation that the great pre- Phillips curve debates of the 1950s that assumed that there was a range within which the economy could be run with varying pressures of demand, and varying amounts of unemployment and inflationary pressure, were not as silly as they were made to seem when both Keynesian and New Classical economists accepted the assumption of a perfectly

Regional trade liberalizing agreements are placed within the context of multilateral trade liberalization. While the EU is a trading block, neither NAFTA nor the proposed Western Hemisphere Free Trade Area (WHFTA) is such a block because they establish neither a common external trade policy nor a bureaucracy to administer it. The self‐interest of the non‐US member countries should prevent NAFTA/WHFTA from evolving into such a block. Thus the outward‐looking effects of a NAFTA should dominate the inward‐looking effects, making NAFTA, rather than the EU, a model for trade liberalizing agreements in the Asia Pacific area.

This paper discusses twenty five methodological issues covering selected areas of both micro and macroeconomics. Included on the micro side are issues related to modelling the price system, assessing its efficiency, competing models of competition, modelling technological change and economic growth, dealing with risk and uncertainty, and policies related to R&D support, picking winners, and support of infant industries. Included on the macro side are issues related to the alleged refutation of old fashioned Keynesian economies by the stagflation of the 1970s, the use of the Dixit Stiglitz model of monopolistic competition in macro models, the current imperative that all the micro behaviour underling macro relations be based on dynamic inter-temporal optimization, the downplaying of fluctuations in aggregate demand as a driver of cyclical fluctuations, and the interpretation of the economy’s recent behaviour.

Recent studies have indicated that the number of firms engaged in R&D has been significantly underestimated, which has hampered the evaluation of the impact of government S&T policies and programs on individual firms. The results of a study reported here suggest there is a need to supplement R&D data collected according to Frascati Manual standards to include information on ‘part-time’ R&D performers. Copyright , Beech Tree Publishing.

One of the most neglected issues in modern economics concerns the consequences of technological change that is ubiquitous and endogenous. To address these we need to model technology as more than a scalar value in an aggregate production function, dealing with technological change in its messy micro economic details. This paper illustrates these points by considering the policy implications of some alternative economic theories that treat technology differently. The first section contrasts the policy implications of neoclassical and evolutionary economics with respect to the evaluation of the efficiency of the price system, policies with respect to 'distortions,' policies to discourage monopolies, to encourage economic growth in general, and infant industries and specific technological advances in particular. The second section contrasts New Classical and various versions of Keynesian economics with respect to micro behavioural underpinnings of macro relations, the place of technology as a driving force of economic change, and aggregate demand as both a source of fluctuations and a variable to be manipulated by policy makers.

The theory of second best established that the effect on community welfare of any one policy change varies with the specific context in which that change occurs. In paper that has been frequently quoted to justify specific policies, Ng argues that fulfilling firstbest conditions piecemeal is an optimal policy under quite general conditions when neither full first nor second best optima are achievable. This paper first argues that Ng's conclusion does not follow from his own assumptions, which imply instead that the status quo should be maintained, whatever it might be. Next it gives one illustrative example showing how much damage can be caused by following Ng's advice. It then argues that when Ng's key assumption is replaced by one that is closer to the facts, there is no general a priori presumption for adopting any specific policy, including maintaining the status quo. The paper closes with some observations on the usefulness of welfare economics even when the full implications of second best theory are accepted.

I am honoured to be invited to give this lecture before so distinguished an audience of development economists. For the last 21/2 years I have been director of a project financed by the Canadian Institute for Advanced Research and composed of a group of scholars from Canada, the United States, and Israel.I Our brief is to study the determinants of long term economic growth. Although our primary focus is on advanced industrial countries such as my own, some of us have come to the conclusion that there is more common ground between developed and developing countries than we might have first thought. I am, however, no expert on development economics so I must let you decide how much of what I say is applicable to economies such as your own. Today, I will discuss some of the grand themes that have arisen in my studies with our group. In the short time available, I can only allude to how these themes are rooted in our more detailed studies. In doing this, I must hasten to add that I speak for myself alone; our group has no corporate view other than the sum of our individual, and very individualistic, views.

We summarise salient developments in the interaction of the multilateral trading system and multilateral trading agreements (MTAs) on the one hand and regional trading agreements (RTAs) on the other. We then consider the economic effects of RTAs, comparing customs unions with free trade agreements. We argue, contrary to much received wisdom, that either may produce more economic benefits than the other, depending on the specific context in which they are introduced. There follows a discussion of the political economy effects of RTAs. Some of these have unfavourable, some neutral and some favourable effects on the progress of further MTAs. We conclude that the case against RTAs as eroding the MTS and inhibiting further MTA negotiations, as expounded by such economists as Krueger and Bhagwati, is not well founded. There remain grounds for optimism that the process of competitive liberalisation in RTAs will lead eventually to further multilateral liberalisation.