Journal of International Economics 33 (1992) 383-395.

North-Holland

Book reviews
Gene M. Grossman and Elhanan Helpman, Innovation and Growth in the
Global Economy (The MIT Press, Cambridge, Mass., 1991) pp. xiv+ 359,
$34.95.

It is customary in public policy debates to dismiss the classical theory of

trade based on the principle of comparative advantage as an outdated
doctrine, ill-suited to describe international competition among industrialized
countries in a rapidly changing world. One might say, a nation’s comparative
advantage is not inherited, it needs to be created through education, R&D,
and industrial policies. Recently, Gene Grossman and Elhanan Helpman
have proved that such a verdict is unwarranted. In a series of articles, they
have developed an analytical framework that links economic growth and
foreign trade, and demonstrated that much of the insight into classical theory
remains valid and consistent with dynamic competition and product inno-
vation. Their new book, Innovation and Growth in the Global Economy,
synthesizes their earlier results and offers some new ones. As public debates
on productivity slowdown and international competitiveness become the
national pastime (or paranoia) in the United States, the book should be on
the shelf of anyone interested in the subjects.
Grossman and Helpman focus of the R&D activities pursued by protit-
seeking firms as the engine of long-run productivity growth. Following the
lead of Arrow and Romer, the authors stress that industrial research not
only generates specific and proprietary technical information that allows a
firm to produce new products, but also contributes to general scientific
knowledge, which can be exploited by other firms to develop even better
products. They argue that some forms of technological externalities in R & D
activities are essential to keep innovation and growth moving.
To demonstrate this idea, they develop two alternative models of technolo-
gical competition; innovation takes the form of expanding product variety in
one model (chapter 3) and of quality upgrading (and inevitable product
obsolescence) in the other (chapter 4). Both models are quite elegant,
capturing the basic idea in a theoretically parsimonious manner, and will no
doubt serve as the prototypes in the field for many years to come.
In the remainder of the book the authors themselves extend these models
in a variety of directions. Throughout these extensions, the interactions
between growth and trade are central to their analysis. The authors show
how the country with a relatively rich endowment of human capital obtains
a dynamic comparative advantage in high-tech industries through its more

0022-1996/92/$05.00 0 1992-Elsevier Science Publishers B.V. All rights reserved

384 Book reviews

active R&D activities (chapter 7); they show how foreign trade can
accelerate or slow down the nation’s economic growth (chapter 9) and
examine the impacts of various government policies both at home and
abroad (chapter 10). Grossman and Helpman also demonstrate the possibi-
lity of uneven development when technological spillovers across the national
borders are limited (chapter 8). As a final exercise (chapters 11 and 12), they
consider the effect of technology catch-up by newly industrialized economies
through imitation activity, generating what look like product cycle patterns.
The wide range of issues they address demonstrates the usefulness of their
analytical framework. At the same time, however, I do have some reserva-
tions. It is true that some forms of externalities are necessary to produce
sustainable growth; otherwise innovation would run into diminishing returns.
Also, the complementarity across R&D activities is perhaps most amenable
to a formal modelling. Unfortunately, that does not necessarily mean that it
is the most important kind of complementarity in practice. And much of
their results seems critically dependent upon the particular nature of the
complementarity modelled.
For instance, they show that a production subsidy to high-tech products
would slow down the rate of innovation, while a production subsidy to
traditional goods would accelerate it (chapter 10). This result is dictated by
the resource constraint, but the absence of any feedback from manufacturing
and consumption of the high-tech goods to future development is also
critical. It seems plausible, at least in commercial R&D, that researchers
learn more about desirable characteristics of new products or new produc-
tion processes through feedbacks from the assembly line, the dealer, and the
customer, than through scientific journals and reverse engineering. (To give
an example, the ‘competitive advantages’ of Japan’s automobile and electro-
nics industries are often attributed to the effective use of such feedbacks in
their product development.) To the extent that testing products at actual
shopfloors and marketplaces generate information vital to future product
development, the effects of subsidies may be reversed.
The lack of any feedback from the consumption side also makes their
framwork incapable of capturing the role of local demand conditions, the
factor that is viewed as the major source of dynamic comparative advantages
by many writers, such as Staffen Burenstam Linder, Raymond Vernon, and
more recently Michael Porter. Given that they focus exclusively on technolo-
gical externalities, I am puzzled with their reference to Vernon’s product
cycle hypothesis.
The advantage of being close to lucrative markets in product development
would also provide a convincing reason for geographical localization of
externalities. On the other hand, the authors offer languages and the limited
international mobility of technical workers as possible explanations of
nation-specific knowledge capital. The two formulations, despite their similar-
 Book reviews 385

ity, may lead to very different empirical implications. The former would
suggest agglomeration economies and thus population density as the key
determinant of the growth rate, while the latter suggests pure scale econo-
mies and therefore the total population of the country becomes the more
relevant variable. Another limitation of their framework arises from the
single type of knowledge capital accumulated in each economy. If economies
can invest in knowledge along a variety of dimensions, then endogenous
changes in technology leadership may occur.
In terms of policy analysis, I am rather disappointed since they only look
at the policy instruments that are commonly analyzed in the trade literature,
i.e. Pigovian taxes and subsidies and tariffs. These tools are certainly
important, but there are many other policy options that are relevant in the
context of product innovation and dynamic competition, such as antitrust
policies, patent policies, and the enforcement of intellectual property rights.
They never discuss coordination of R& D efforts nor ask to what extent
R & D activities should be conducted in the public rather than private sector.
These are the most critical questions repeatedly asked in policy discussions.
Finally, the authors movtivate the book at the beginning by referring to
the poverty of African nations and citing the evidence on cross-country
variation in growth performances, which includes 114 countries, ranging from
Chad and Ghana to Switzerland and the United States. Nevertheless, their
framework seems more natural in the context of industrialized countries. The
models are formulated so as to generate a balanced growth path. In
particular, preferences are assumed to be homothetic both intratemporally
and intertemporally. This assumption rules out any analysis of structural
transformation and the stages of economic development, and makes it
impossible to address the critical question of balanced versus unbalanced
growth. Many other problems that allegedly plague developing countries,
such as food supplies, saving shortage, and the secular decline of terms of
trade, would never arise under this assumption. Those who hope to find
some insights on economic development may be disappointed. This is even
true in the chapter on North-South trade. The authors themselves seem to
find it a little bit awkward; in the end, they describe the model as a two-
region world economy between an industrialized North and ‘a middle-
income South’ (p. 306).
These reservations should not be viewed as a criticism against the efforts
of the authors; no single book can possibly address such a diverse set of
issues on economic growth and trade. Rather, they are meant to be a caution
to the reader that the book hardly offers the final words on the subject. Or
perhaps, these reservations testify more than anything else to the potential
significance of their contribution. For the first time they have demonstrated
that the issues of R&D competition, growth, and trade are amenable to
rigorous analysis. Now that they have presented a coherent theoretical
386 Book reviews

framework or a sort of paradigm, we can start disagreeing about specific

details and speculating about possible extensions. This book should thus
serve as a useful launching pad for any future work on the subject. It is my
hope, which I believe is shared by the authors, that many researchers in the
field will learn from this book and go on to develop new and better
analytical frameworks, so that this book will quickly become obsolete, just as
one of their models predicts.

Kiminori Matsuyama
Hoover Institution and Northwestern University

Matthew B. Canzoneri and Dale W. Henderson, Monetary Policy in

Interdependent Economies (The MIT Press, Cambridge, Mass., 1991) pp.
x + 171, $27.50.
The classic work of Koichi Hamada in a 1976 issue of the Journal of
Political Economy was the first to apply game theory to issues of internatio-
nal monetary policy coordination. Hamada was primarily concerned with an
interdependent world characterized by a regime of fixed nominal exchange
rates. In such a world monetary policies have immediate spill-over effects,
because the global rate of inflation is a weighted average of the excess of
national domestic monetary growth rates over growth rates in real income
plus the growth in international reserves. The monetary approach to the
balance of payments then says that the balances of payments of the various
countries are each other’s mirror image and that a country’s balance of
payment is in surplus when the rate of growth in domestic credit falls short
of the global inflation rate. Hence, domestic credit expansion induces on the
one hand higher inflation in all countries and on the other hand a deficit
which is mirrored by surpluses elsewhere. Hamada contrasted non-
cooperative and cooperative outcomes when central banks care about
inflation and the balance of payments. Absence of international policy
coordination leads to a too high (low) inflation rate when the increase in
international reserves exceeds (falls short of) the weighted average of the
desired increase in international reserves. Excessive expansion of world
reserves leads countries to defend themselves against reserve accumulation by
expanding domestic credit and thus increasing world inflation above the
desired level. Hence, when there is excessive expansion of world reserves,
international policy coordination implies that central banks must reduce
their rates of expansion in domestic credit. Clearly, in the classical view of
the economy adopted by the monetary approach there is no need for
international monetary policy coordination under a regime of floating
exchange rates. Under such a regime there are no international spill-over
effects and each country can conduct an independent monetary policy,