Beyond the Solow Growth Model

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Beyond the Solow Growth Model
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Beyond the Solow Growth Model

• Three Reasons to Go Beyond the Solow Growth Model
  (SGM)
• The SGM doesnt fit facts too well
• Saving and Investment Dont Seem to Always Foster
  Growth
• Technology is only a residual in the SGM
  (technological change is not explained but taken
  as a fact-of-life).

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The SGM Doesnt Fit the Facts

• The SGM predicts
• that growth rates would decline as economies
  approached their steady states
• convergence - income per person of poor countries
  will catch up to that of rich countries
• Facts
• World growth rates have not declined
• Convergence hasnt happened

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SGM Predicts Rich Countries Grow More Slowly
than Poor Countries
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Growth in the United States
Period Annual Percent Change in Real GDP
per Person 1800-1840 0.58 1840-1880 1.44
1880-1920 1.78 1920-1960 1.68 1960-2000
2.20
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Comparisons of Income per Capita
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Saving and Investment Dont Always Foster Growth!

• The SGM suggests that saving and investing cause
  economies to grow
• The Soviet Union is an exception to the rule
• The Soviet Union saved and invested a tremendous
  amount of capital in its 80-year history
• Most of the countries in the former Soviet Union
  have income levels comparable to developing
  countries

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Explanations for Non-convergence(or conditional
convergence)

• Differences in the Quality of the Labor Force
• Education
• Health
• Sociological Aspects of Labor (Social capital)
• Differences in Institutions
• Increasing Returns to scale

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Differing Quality of Labor

• The adjustment for quality of labor makes
• capital per quality adjusted person smaller in
  developed countries with more productive labor
• the marginal product of capital in developed
  countries higher
• The expanded SGM predicts that a developed
  country will grow faster.

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Higher Education
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Education and Growth
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Differing Institutions

• Social capital is the set of institutions of a
  society, such as degree of trust, customs, laws,
  and civic and government organizations that
  positively affect growth.
• Social capital provides incentives to produce,
  invest, and innovate.
• Countries with more social capital generally have
  higher income (growth) levels.

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Institutions
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Corruption
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Rule of Law
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Foreign Aid and Social Capital
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Increasing Returns

• A production function shows increasing returns to
  scale when an increase in all inputs leads to a
  proportionately greater increase in output.
• Increasing returns production
• allows continual increases in income per person
• creates the possibility of a virtuous cycle in
  which growth creates more growth

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Production Function - Increasing Returns
Production function with increasing returns
Output
A Increasing returns
Income per person
B Constant Returns
Inputs
Time
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Why Increasing Returns Makes Sense

• Geographical effects of technology
• Areas where technology initially develops may
  have increasing returns
• Hollywood, the Tropics
• Learning by doing
• The more one does something, the more productive
  one becomes
• Textiles in Bangladesh, toys in China
• Agglomeration effects
• Concentration of similar firms increases the
  productivity for all area firms
• Silicon Valley, Liverpool

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New (Endogenous) Growth Theory

• New growth theory focuses on the role of
  technology in economic growth.
• In the Solow growth model, technology is a
  residual (exogenous parameter).
• In new growth theory technology is endogenous,
  explained by the model.

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Capital, Labor and RD

• Capital and labor in the technology production
  function are the amounts of capital and labor
  used in research and development.
• The more a society invests in research and
  development, the faster its economy will grow.

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Not-So-New Growth Theory
Adam Smith (18th century) Specialization and
Markets
Not-So-New Growth Theory
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Adam Smith
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Specialization and the Market

• Specialization of labor was the key to growth.
• Trade expands markets and encourages further
  specialization.
• Specialization increases output, which increases
  the market, and leads to more specialization.

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Joseph Schumpeter
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The Entrepreneur

• Entrepreneurs are individuals who see
  opportunities to produce and coordinate, manage,
  and assume the risk of production.
• Entrepreneurs create major technological changes
  and growth.
• The entrepreneurs industries are leading
  industries that pull the rest of the economy
  along with them.

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Potential Growth Policies (?)

• Promote innovation
• Encourage entrepreneurial activity
• Make education widely available
• Ensure political stability and good governance
• Establish well-defined property rights
• Protect intellectual property rights
• Promote aggregate demand policies

• Establish private enterprise zones
• Build industrial policies that promote
  technological innovation
• Lower tax rates
• Privatize government owned businesses
• Increase openness to international trade by
  reducing trade restrictions