Pmak Session3

Macroeconomics 2 (PMAK)
Discussion Session 3
Bopjun Gwak
Goethe University Frankfurt
May 16, 2018
Bopjun Gwak (Goethe University Frankfurt) PMAK - Discussion Session 3 May 16, 2018 1 / 25
Today’s Agenda
1 General Solow Model
2 Labor-augmenting technological progress
3 Growth and Levels Accounting
The steady state of the general Solow model
α
1−α α
1−α
ŷ¯ = s
δ+n+g ; ȳ = At s
δ+n+g
1 1
¯
1−α 1−α
s s
k̂ = δ+n+g ; k̄ = At δ+n+g
ĉ¯ = (1 − s)ŷ¯
Wage (per worker):

w̄ = At (1 − α)ŷ¯ = (1 − α)ȳ
Return on capital:
ŷ¯

ȳ n+g+δ
r̄ = α ¯ = α = α
k̂ k̄ s
Note: The solutions for the per worker variables (ȳ, k̄ ) boil down to the
one of the basic Solow model if g = n = 0 for B = A1−α .
Growth rates in the steady state
What is the growth rate of ŷ¯ in the steady state?

¯ ¯
Solution: ŷ¯ = k̂ α . Since k̂ is constant in SS, ŷ¯ is also constant in SS
(growth rate is zero).
What is the growth rate of ȳt (output per worker) in the steady state?

¯ ¯
Solution: ŷ¯ = k̂ α . Since k̂ is constant in SS, ŷ¯ is also constant in SS
(growth rate is zero).
What is the growth rate of ȳt (output per worker) in the steady state?
Solution:
yt+1 At+1 yt
yt+1 − yt At+1 At − At ŷ¯ (1 + g) − ŷ¯
= yt = =g
yt At ŷ¯
Alternatively,
Yt
ŷt = AYt Lt t = ALtt = Aytt . Since ŷt is constant in SS, yt must grow at the
same rate as At , i.e. at g.
What is the growth rate of Ȳt in steady state?

Yt+1 At+1 Lt+1 Yt
Yt+1 − Yt At+1 Lt+1 At Lt − At Lt ŷ¯ (1 + g)(1 + n) − ŷ¯
= =
Yt Yt
At Lt ŷ¯
= n + g + ng ≈ n + g
Alternatively,
ŷt = AYt Lt t . Since ŷt is constant in SS, then Yt must grow at the same
rate as At Lt , i.e. at n + g.

Yt+1 At+1 Lt+1 Yt
Yt+1 − Yt At+1 Lt+1 At Lt − At Lt ŷ¯ (1 + g)(1 + n) − ŷ¯
= =
Yt Yt
At Lt ŷ¯
= n + g + ng ≈ n + g
Alternatively,
ŷt = AYt Lt t . Since ŷt is constant in SS, then Yt must grow at the same
rate as At Lt , i.e. at n + g.
What is the growth rate of wages in steady state?
Long-run growth in the general Solow model
Can the general Solow model explain long-run growth?

Yes, GDP per capita (yt ) grows at a constant growth rate in the long
run (in the steady state).
What is the source of long-run growth in the general Solow model?


Technological progress (g).
Is the source of long-run growth explained inside the model?


Technological progress (g).
Is the source of long-run growth explained inside the model?

No, technological progress is an exogenous variable. The model does
not explain what determines g.
Balanced Growth path
Balanced Growth
Output per worker yt , capital per worker kt , consumption per worker ct , and
the real wage wt grow at the same constant rate g. Total output Yt = yt Lt ,
total consumption Ct = ct Lt , total investment It = St = syt Lt , and the total
capital stock Kt = kt Lt grow at the same constant rate g + n + gn ≈ g + n.
Kaldor facts
Yt
1 GDP per worker Lt grows roughly at a constant rate over time X
Kaldor facts
Yt
Kt
2 Capital per worker Lt grows roughly at a constant rate over time X
Kaldor facts
Yt
Kt
3 The share of capital income rtYKt t and the share of labor income wt Lt
Yt in
GDP are roughly constant over time X
Kaldor facts
Yt
Kt
Yt in
Kt
4 The capital-output ratio Yt is roughly constant over time X
Kaldor facts
Yt
Kt
Yt in
Kt
5 The return on capital rt is roughly constant over time X
Kaldor facts
Yt
Kt
Yt in
Kt
5 The return on capital rt is roughly constant over time X
6 The real wage wt grows over time X
Labor-augmenting technological progress
We assume that the production function
Yt = F (Kt , Lt , At )
has constant returns to scale in Kt and Lt
λYt = F (λKt , λLt , At ) λ > 0

1
We can then multiply both sides by Yt (= λ)
!
Kt 1
1=F , , At
Yt YL t
t
Why must techn. progress be labor-augmenting?
Consider
!
Kt 1
1=F , , At
Yt YL t
t
We know that KYtt is roughly constant over time, YLtt grows with a
constant rate g and At grows with a constant rate g.
Since the left-hand side of the equation above is constant, the inputs
on the right-hand side have to be constant too. This is only possible if
technological progress can be written as labor-augmenting in the
production function Yt = F (Kt , Lt , At ) = F (Kt , At Lt ).
Example 1
(the function cannot be written with labor-augmenting At ):
Yt = F (Kt , Lt , At ) = At Ktα Lt1−α

= Ktα (At Lt )1−α Aα
t 6= F (Kt , At Lt )
1
Multiply Yt by Yt
α !1−α
Kt At
1 = Yt
Aαt
|{z} Yt |{z}
const. | {z } | Lt {z } growing
const. const.
⇒ This equation is inconsistent with the stylized facts of economic

growth.
Example 2
(the function can be written with labor-augmenting At ):
Yt = F (Kt , Lt , At ) = A1−α
t Ktα L1−α
t
= Ktα (At Lt )1−α = F (Kt , At Lt )
1
Multiply Yt by Yt
α !1−α
Kt At
1 = Yt
|{z} Yt
const. | {z } | Lt {z }
const. const.
⇒ This equation is consistent with the stylized facts of economic

growth.
2. Growth accounting vs. levels accounting
Growth Accounting
Question: What is the rate of technological progress?

If output grows faster than inputs, the state of technology has
improved.
We can measure the rate of technological progress by measuring the
growth rate of output, the growth rate of the capital stock, the growth
rate of labor input, and the parameter α

At+1 Yt+1 Kt+1 Lt+1
(1 − α) ln = ln − α ln − (1 − α) ln
At Yt Kt Lt
Growth Accounting- some figures
Average annual growth rate of total factor productivity (in percent)
Country 1985-1999 2000-2015

Australia 0.8 0.4
France 1.2 0.4
Germany 1.4 0.7
Ireland 3.5 1.0
Italy 0.9 -0.3
Japan 1.5 0.7
Korea 4.1 2.3
Spain 0.7 -0.1
U.K. 1.1 0.7
U.S. 0.9 0.9
Data: OECD
Levels Accounting
Question: Why are some countries so much richer than others?

Production function of country i with human capital-augmented labor
input (Hi ):
Yi = Kiα (Ai Hi )1−α
α
1−α
Yi Ki Hi
How do we get Li = Yi Li Ai ? (Lecture 4, s.13)
α
Kiα (Ai Hi )1−α

Yi Ki Hi
= = Ai
Li Li Ai Hi Li
α
! 1−α α
Ki1−α
1−α
Hi Ki Hi
= Ai = Ai
(Ai Hi )1−α Li Kiα (Ai Hi )1−α Li
1−α α
Ki Hi
= Ai
Yi Li
Levels Accounting
Production function of country i: Yi = Kiα (Ai Hi )1−α

Human capital-augmented labor input:
Hi = eφ(Ei ) Li
where
I φ(.): a not yet specified function
I Ei : average years of schooling in country i
I Li : labor input in country i
If Ei = 0, then φ(0) = 0 and Hi = e0 Li = Li

Hi
hi = Li = eφ(Ei )
Levels Accounting
How do we specify φ(E)?
Production function of country i: Yi = Kiα (Ai eφ(Ei ) Li )1−α
Wages:
∂Yi
wi = = (1 − α)Kiα (Ai eφ(Ei ) Li )−α Ai eφ(Ei )
∂Li
= (1 − α)Kiα A1−α
i e(1−α)φ(Ei ) L−αi
Consider the wages of two workers (1,2) in the same country i with
different levels of education:
w1,i = (1 − α)Kiα Ai1−α e(1−α)φ(Ei,1 ) L−α
i ; w2,i = (1 − α)Kiα A1−α
i e(1−α)φ(Ei,2 ) L−α
i
w1,i
= e(1−α)[φ(E1,i )−φ(E2,i )] ⇔ ln(w1,i )−ln(w2,i ) = (1 − α)[φ(E1,i )−φ(E2,i )]
w2,i
⇒ We can compare wages of workers in one country to detect a
shape for φ(E).
Level Accounting
Hall and Jones (1998) describe φ(Ei ) as piecewise linear: For the first
4 years of education the rate of return is 13.4 %, for the next 4 years
10.1% and for education beyond 8 years 6.8 %.

0.134 Ei
 if 0 ≤ Ei ≤ 4
φ(Ei ) = φ(4) + 0.101(Ei − 4) if 4 < Ei ≤ 8

φ(8) + 0.068(Ei − 8) if 8 < Ei

1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Hall and Jones (1998) assume the same function φ(Ei ) for all
countries. Do you think this is plausible?
Levels Accounting
GDP per capita in country X relative to country Z can be decomposed

as follows α
yX (KX /YX ) 1−α hX AX
= α
yZ (KZ /YZ ) 1−α hZ AZ
where y is output per worker, K /Y is the capital-output ratio, h is
human capital-augemented labor (per worker) h = eφE , E are the
years of schooling, and A is the productivity level.
In log-differences:
α
ln(yX /yZ ) = ln(κX /κZ ) + φ(EX − EZ ) + ln(AX /AZ ),
1−α
KX KZ
where κX ≡ YX and κZ ≡ YZ .
Levels Accounting
Hall and Jones (1998) find that productivity differences are the most
important factor to explain the differences in the levels of output per
worker between countries.
Output per worker in the five rich countries is about 30 times higher
than in the five poorest countries (figures for 1988).
I Differences in capital intensity and educational attainment across
countries are only about 2 times higher in the rich countries compared to
the poor.
I Productivity over 8 times higher in the rich countries.
However, differences in education matter as much as capital intensity!
Does educationTHE
matter for economic growth?
EMPIRICS OF ECONOMIC GROWTH 425
(1). Test for unconditional convergence:
TABLE III
TESTS FOR UNCONDITIONALCONVERGENCE
Dependent variable: log difference GDP per working-age person 1960-1985
Sample: Non-oil Intermediate OECD

Observations: 98 75 22
CONSTANT -0.266 0.587 3.69
(0.380) (0.433) (0.68)
ln(Y60) 0.0943 -0.00423 -0.341
(0.0496) (0.05484) (0.079)
R2 0.03 -0.01 0.46
s.e.e. 0.44 0.41 0.18
Implied X -0.00360 0.00017 0.0167
(0.00219) (0.00218) (0.0023)
Note. Standard errors are in parentheses. Y60 is GDP per working-age person in 1960.
Table III from Mankiw, Romer and Weil (1992): ”A contribution to the empirics of economic
essentially zero. growth“,
There Quarterly
is no tendency
Journal of for poor countries to grow
Economics.
faster on average than rich countries.
Table III does show,
Bopjun Gwak (Goethe University Frankfurt)
however, that there is a significant
PMAK - Discussion Session 3 May 16, 2018 22 / 25
426 QUARTERLYJOURNAL OF ECONOMICS
Does education matter for economic growth?
TABLE IV
(2). Test for conditional convergence:
TESTS FOR CONDITIONALCONVERGENCE

CONSTANT 1.93 2.23 2.19
(0.83) (0.86) (1.17)
ln(Y60) -0.141 -0.228 -0.351
(0.052) (0.057) (0.066)
ln(I/GDP) 0.647 0.644 0.392
(0.087) (0.104) (0.176)
ln(n + g + 8) -0.299 -0.464 -0.753
(0.304) (0.307) (0.341)
R72 0.38 0.35 0.62
s.e.e. 0.35 0.33 0.15
Implied X 0.00606 0.0104 0.0173
(0.00182) (0.0019) (0.0019)
Note. Standard errors are in parentheses. Y60 is GDP per working-age person in 1960. The investment and
population growth rates are averages for the period 1960-1985. (g + 8) is assumed to be 0.05.
Table IV from Mankiw, Romer and Weil (1992)

Bopjun Gwak (Goethe University Frankfurt) PMAK - TABLE V 3
Discussion Session May 16, 2018 23 / 25
Does education matter forTABLE
economic
V
growth?
(3). Test for conditional convergence
TESTS FOR with education:
CONDITIONAL CONVERGENCE

CONSTANT 3.04 3.69 2.81
(0.83) (0.91) (1.19)
ln(Y60) -0.289 -0.366 -0.398
(0.062) (0.067) (0.070)
ln(I/GDP) 0.524 0.538 0.335
(0.087) (0.102) (0.174)
ln(n + g + 8) -0.505 -0.551 -0.844
(0.288) (0.288) (0.334)
ln(SCHOOL) 0.233 0.271 0.223
(0.060) (0.081) (0.144)
R2 0.46 0.43 0.65
s.e.e. 0.33 0.30 0.15
Implied X 0.0137 0.0182 0.0203
(0.0019) (0.0020) (0.0020)
Note. Standard errors are in parentheses. Y60 is GDP per working-age person in 1960. The investment and
population growth rates are averages for the period 1960-1985. (g + 8) is assumed to be 0.05. SCHOOL is the
average percentage of the working-age population in secondary school for the period 1960-1985.
Table V from Mankiw, Romer and Weil (1992)

Does education matter for economic growth?
What else could be relevant for economic growth?

Health (life expectancy)
Financial conditions (access to credit)
Institutions, democracy
Openness, Trade policies
...

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Macroeconomics 2 (PMAK)

Goethe University Frankfurt

May 16, 2018

1 General Solow Model

2 Labor-augmenting technological progress

3 Growth and Levels Accounting

Wage (per worker):

What is the growth rate of ŷ¯ in the steady state?

What is the growth rate of ŷ¯ in the steady state?

What is the growth rate of ŷ¯ in the steady state?

What is the growth rate of Ȳt in steady state?

What is the growth rate of Ȳt in steady state?

What is the growth rate of Ȳt in steady state?

What is the growth rate of wages in steady state?

Can the general Solow model explain long-run growth?

Can the general Solow model explain long-run growth?

What is the source of long-run growth in the general Solow model?

Can the general Solow model explain long-run growth?

What is the source of long-run growth in the general Solow model?

Is the source of long-run growth explained inside the model?

Can the general Solow model explain long-run growth?

What is the source of long-run growth in the general Solow model?

Is the source of long-run growth explained inside the model?

We assume that the production function

has constant returns to scale in Kt and Lt

λYt = F (λKt , λLt , At ) λ > 0

Yt = F (Kt , Lt , At ) = At Ktα Lt1−α

⇒ This equation is inconsistent with the stylized facts of economic

⇒ This equation is consistent with the stylized facts of economic

Question: What is the rate of technological progress?

Average annual growth rate of total factor productivity (in percent)

Country 1985-1999 2000-2015

Question: Why are some countries so much richer than others?

Production function of country i: Yi = Kiα (Ai Hi )1−α

If Ei = 0, then φ(0) = 0 and Hi = e0 Li = Li

GDP per capita in country X relative to country Z can be decomposed

Dependent variable: log difference GDP per working-age person 1960-1985

Sample: Non-oil Intermediate OECD

Dependent variable: log difference GDP per working-age person 1960-1985

Sample: Non-oil Intermediate OECD

Table IV from Mankiw, Romer and Weil (1992)

Dependent variable: log difference GDP per working-age person 1960-1985

Sample: Non-oil Intermediate OECD

Table V from Mankiw, Romer and Weil (1992)

What else could be relevant for economic growth?

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