Nicholas Kaldor, increasing returns and Verdoorn's Law

Nicholas Kaldor made much of the Verdoorn's Law and the objective of this paper is to examine the validity of this alleged law and whether it justifies special treatment to manufacturing. This paper reviews the Smith-Young approach to increasing returns and shows that Kaldor was not much guided by this framework when it came to policy making. He was more guided by empirical observations with respect to the applicability of Verdoorn's Law. The paper also critically reviews Verdoorn's Law particularly in so far as Verdoorn himself was not fully convinced of its general applicability. The correspondence between Kaldor and Lauchlin Currie (and Roger Sandilands) is also highlighted in this regard and brings out their differing views on both agriculture and industry. The paper's main conclusion is that even if Verdoorn's Law is valid it does not call for a special treatment to manufacturing. The logic of favoring manufacturing at the cost of other sectors distorts intersectoral relationships, leads to adverse terms of trade for agriculture, and is likely to pose a demand constraint for industry itself. To undo one distortion (i.e., protection to industry), one has to match it with other distortions like price support and marketing board in agriculture, and dual exchange rates to promote exports. The whole economic system becomes an intricate maze with adverse consequences for growth and productivity for the whole economy.