1.1 The Scope for Optimality in Economic Growth
âJusticeâ, or more accurately an equitable distribution of the fruits of development, is a key notion in theoretical economics and policy-making. Indeed, âno society can surely be flourishing and happy, of which the greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloth and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, clothed, and lodgedâ, an argument put forward by Smith (1776, p. 88) [emphasis added]. The importance of âequityâ in theoretical economics and policy can hardly be challenged. It has been suggested, for example, that the elimination of poverty and the achievement of greater equality in income distribution should at least supplement, if not replace, aggregate growth as a target of development policies (Stewart and Streeten 1976). âTaking it for granted that a more equal distribution of wealth is to be desiredâ, as Marshall (1907) argues, âhow far would this justify changes in the institutions of property or limitations of free enterprise even when they would be likely to diminish the aggregate wealth?â (p. 4). This particular quotation raises a more general question with clear policy implications: the conflict between the aims of improving the distribution of income (equity) and increasing wealth of the economy as a whole (aggregate efficiency). When a conflict of choice arises, a move towards one objective can be attained only at the expense of moving away from other objectives. All economics, according to Winch (1971), is concerned with is âchoiceâ and choices in economics always involve conflicts.1 Conflicts are not uncommon in macroeconomic analysis.2 As macroeconomic analysis became accepted, Ford (1971) notes,
governments were not slow to realise that it offered them useful guidelines for managing their economies in the short run at least. For they could now devise economic policies to help them achieve some diverse objectives or targets as reduction of excessive unemployment, control of inflation and the avoidance of price increases, the elimination of gold losses by balance of payments adjustment, and the mitigation or elimination of economic instability. However, they have come to realise that certain objectives may conflict and that they may have to compromise by âtrading offâ the level of unemployment against price increases.3 (p. 153) [emphasis added]
A case of particular interest is the consumption-saving trade-off implied in the model by Ramsey (1928). According to this approach, the consumerâs lifetime utility depends on the time path of consumption, and the aim of dynamic optimisation is to determine the time path of consumption that maximises the consumerâs lifetime utility. At each point in time, the consumer faces an inter-temporal trade-off because immediate consumption reduces future consumption by lowering capital accumulation and output growth. This trade-off is linked with the idea of optimal economic growth.4
Economic growth has been seen as a solution to a variety of economic problems. Thus, for example, it is frequently argued that âeconomic growth, rather than the redistribution of income or wealth, provides the only hope of alleviating or eliminating povertyâ (Jones 1975, p. 2). Dissatisfaction, however, with the âmarket solutionâ to the problem of income distribution led economists to look more closely into the character of growth paths based on an ethically explicit criterion function over time. Optimal growth theory, according to Dasgupta and Hagger (1971), recognises the importance of ethical judgments by formulating them explicitly in a âsocial welfare functionâ, as proposed by Arrow (1951). In the case of the policy issues which arise in connection with the growth objective, ethical judgments can hardly be avoided. More specifically, âgrowth policy is inextricably bound up with the choice of a rate and pattern of investmentâ (Dasgupta and Hagger 1971, p. 364) [emphasis added].
The analysis in this study is structured upon the notion of optimality in investment activity, which, undeniably, acts as a catalyst in the process of economic growth. The existing literature employs input-output analysis or Keynesian macroeconomic models. Nevertheless, neither Leontiefâs multi-sectoral input-output analysis nor Keynesâ aggregate theory is in- and by itself capable of providing optimal solutions to those investment problems which involve alternatives and constraints (Kurihara 1964). In several theoretical models and empirical applications, optimal investment is examined from a âsectoralâ perspective. This resulted to a variety of frameworks in which the aggregate (national) economy is of primary interest (e.g. Koopmans 1965; Bose 1968; Dasgupta 1969; Weitzman 2005). As a result most policy analysis has focused mainly on aggregate efficiency rather than equity.5 Investment choices are themselves bound up with the question of distribution of consumption between generations and the personal distribution of income, an issue of particular significance in mainstream economic analysis (e.g. Dalton 1920; Pigou 1912, 1949). Spatial inequality is an important determinant of interpersonal income inequality. However, little theoretical work in this direction seems to have been done as yet.
Chinitz (1966) argues that certain frameworks designed for the analysis of national growth problems might âvery logically and necessarily want to have a significant regional componentâ (p. 1) [emphasis added]. Furthermore, competition is increasing between regions, rather than countries, particularly in a context of economic and social restricting stemming from the globalisation of the economy. In an environment of rapid technological change combined with market liberalisation and deregulation, investment is more mobile. Regional investment policy, consequently, can be considered as an indistinguishable element of the overall development policy. It is of critical importance, therefore, to examine the issue of optimality in regional investment activity and its implications for regional policy.
1.2 Optimality in Regional Policy
An idea which has been much bandied around by politicians and the news media is that of economic development. An explicit concern over the existing levels of economic development across the world runs through a special field in economics, termed as development economics. Krugman (1995) defines this field as âa branch of economics concerned with explaining why some countries are so much poorer that others, and with prescribing ways for poor countries to become richâ (p. 6). Some economists consider that this is a natural outcome, or at least the global-capitalist order of things: the rich get richer and so do the poor, but without even catching up (Hurst et al. 2000). As argued by Stewart and Streeten (1976), however, policies that emphasise greater equality within low-income countries may widen the gap of incomes between rich and poor countries, while policies that aim at reducing the international gap often widen the domestic one.
Economic development refers mainly to social welfare. Differences in economic development, according to Cox (1972), connote differences in social welfare and therefore conflict both between nations and between regions within a nation (p. 349) [emphasis added].
Regional disparities often cause political and ethnic tensions, which undermine social cohesion and economic stability. The strongest argument in favour of regional policies lies in the long-run persistence and even widening of regional disparities. In the European Union (EU), for example, despite substantial expenditure, at national and community level,6 regional dispa...