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# Economic Growth

Mark Weder
August 2008
Mark Weder (Adelaide) Economic Growth August 2008 1 / 68
World’s Economic History in one picture
Mark Weder (Adelaide) Economic Growth August 2008 2 / 68
Convergence and the World Income Distribution
The Convergence Hypothesis:
Fact: Enormous variation in incomes per worker across countries
Question: Do poor countries eventually catch up?
Convergence hypothesis: They do, in the right sense!
Main prediction of convergence hypothesis (and the Solow model): Poor
countries should grow faster than rich countries.
Mark Weder (Adelaide) Economic Growth August 2008 3 / 68
Solow Model and Convergence
Solow model without technological change
Mark Weder (Adelaide) Economic Growth August 2008 4 / 68
Solow Model and Convergence
Fundamental di¤erence equation of Solow Model with technological
progress (and Cobb-Douglas production function):
¯
k
t+1
=
1
(1 + n)(1 + g)
(s
¯
k
α
t
+ (1 ÷δ)
¯
k
t
)
Production function
Y
t
= K
α
t
(A
t
L
t
)
1÷α
= ¯ y
t
=
Y
t
A
t
L
t
=

K
t
A
t
L
t

α
=
¯
k
α
t
.
Income per worker is y
t
= ¯ y
t
A
t
and A
t
= (1 + g)
t
A
0
. Solow equationn
¯
k
t+1
÷
¯
k
t
=
1
(1 + n)(1 + g)
(s
¯
k
α
t
+ (1 ÷δ)
¯
k
t
÷(1 + n)(1 + g)
¯
k
t
)
=
1
(1 + n)(1 + g)
(s
¯
k
α
t
÷(δ + n + g + ng)
¯
k
t
).
Mark Weder (Adelaide) Economic Growth August 2008 5 / 68
Solow Model and Convergence
Convergence towards steady state – diagram uses: s
¯
k
α÷1
t
¯
k
t+1
=
1
(1 + n)(1 + g)
(s
¯
k
α
t
+ (1 ÷δ)
¯
k
t
).
Mark Weder (Adelaide) Economic Growth August 2008 6 / 68
Solow Model: comparative statics
Convergence towards steady state – diagram uses:
¯
k
t+1
÷
¯
k
t
¯
k
t
=
1
(1 + n)(1 + g)
(s
¯
k
α÷1
t
÷(δ + n + g + ng)).
Suppose economy in steady state: what happens if savings rate goes up?
Initially
¯
k
t+1
÷
¯
k
t
¯
k
t
= 0 =
1
(1 + n)(1 + g)
(s
¯
k
α÷1
t
÷(δ + n + g + ng)).
Then: s
¯
k
α÷1
t
÷(δ + n + g + ng) > 0 and growth rate is positive. Peters
out as economy goes back to new steady state.
Mark Weder (Adelaide) Economic Growth August 2008 7 / 68
Solow Model: steady state
0 =
1
(1 + n)(1 + g)
(s
¯
k
α÷1
t
÷(δ + n + g + ng))
= s
¯
k
α÷1
= δ + n + g + ng
=
¯
k
+
=

δ + n + g + ng
s
1
α÷1
and from ¯ y
t
=
¯
k
α
t
¯ y
+
=

δ + n + g + ng
s
α
α÷1
.
Further, output per worker is given by
y
+
t
= A
t

δ + n + g + ng
s
α
α÷1
.
Mark Weder (Adelaide) Economic Growth August 2008 8 / 68
Solow Model: steady state empirics
Let’s take logs on both sides of
y
+
t
= A
t

δ + n + g + ng
s
α
α÷1
lny
+
t
= lnA
t
+
α
α ÷1
ln

δ + n + g + ng
s

= lnA
t
+
α
1 ÷α
ln

s
δ + n + g + ng

= lnA
t
+
α
1 ÷α
[lns-ln (δ + n + g + ng)]
First of two important relationships of Solow model: given A
t
state prediction of model is that y
+
t
should depend on
lns-ln(δ + n + g + ng) and this realtionship should be linear with positive
slope since
α
1÷α
> 0. Slope should be around 1/2.
Mark Weder (Adelaide) Economic Growth August 2008 9 / 68
Solow Model: steady state empirics
Heroric assumption that all countries are in (or very close) to their steady
state in 2000 and that they had same technology in that year. OLS
regression estimation of
lny
i
2000
= lnA
t
+
α
1 ÷α

lns
i
-ln

δ + n
i
+ g + n
i
g

s
i
average investment rate 1960-2000. δ + n
i
+ g + n
i
g = 0.075 (and we
neglect n
i
g). Now:
lny
i
2000
= γ
0
+ γ
1

lns
i
-ln

n
i
+ 0.075

÷ lny
i
2000
= 8.8 + 1.47

lns
i
-ln

n
i
+ 0.075

R
2
= 0.55, t = 10.2
Estimate of slope, γ
1
, is 1.47 and model seems to be in accordance with
data. However, this is "too large" – we would need a α = 0.6 to match
this!
Mark Weder (Adelaide) Economic Growth August 2008 10 / 68
Solow Model: convergence
... the second important relationships of Solow model.
Countries with same s, n, α, δ...
... eventually same growth rate of output per worker and same level of
output per worker (absolute convergence).
Countries starting further below the balanced growth path (poorer
countries) should grow faster than countries closer to balanced growth
path.
... seems to be the case for the sample of now industrialized countries.
Mark Weder (Adelaide) Economic Growth August 2008 11 / 68
Solow Model and Convergence
Mark Weder (Adelaide) Economic Growth August 2008 12 / 68
Solow Model and Convergence
Mark Weder (Adelaide) Economic Growth August 2008 13 / 68
But:
Countries with same g but potentially di¤ering s, n, α, δ...
... countries have di¤erent balanced growth path (BGP).
Countries that start further below their balanced growth path (countires
that are poor relative to their BGP) should grow faster than rich countries
(relative to their BGP). This is called conditional convergence...
Mark Weder (Adelaide) Economic Growth August 2008 14 / 68
Convergence in Solow model
Recall transition equation (in generic form)
¯
k
t+1
=
1
(1 + n)(1 + g)
(s
¯
k
α
t
+ (1 ÷δ)
¯
k
t
) = G(
¯
k
t
).
¯
k
+
= G(
¯
k
+
). Linearize transition equation around the
steady state (local dynamics!)
¯
k
t+1
÷
¯
k
+
= G
/
(
¯
k
+
)

¯
k
t
÷
¯
k
+

.
A (linear) …rst order di¤erence equation in
¯
k
t
. Term G
/
(
¯
k
+
) is given by
G
/
(
¯
k
+
) =
1
(1 + n)(1 + g)
(sα
¯
k
+α÷1
+ 1 ÷δ)
=
1
(1 + n)(1 + g)
(sα
δ + n + g + ng
s
+ 1 ÷δ)
=
1
(1 + n)(1 + g)
(α (δ + n + g + ng) + 1 ÷δ)
Mark Weder (Adelaide) Economic Growth August 2008 15 / 68
Convergence in Solow model
¯
k
t+1
=
1
(1 + n)(1 + g)
(s
¯
k
α
t
+ (1 ÷δ)
¯
k
t
) = G(
¯
k
t
).
0 < G
/
(
¯
k
+
) < 1, hence stable equation (and
¯
k
t
÷
¯
k
+
as t ÷∞).
Mark Weder (Adelaide) Economic Growth August 2008 16 / 68
Convergence in Solow model
Convert transition equation into changes in natural log-values rather than
absolute changes.
Note that ln
¯
k
t
÷ln
¯
k
+
-
¯
k
+
1/(
¯
k
t
÷
¯
k
+
).
¯
k
t+1
÷
¯
k
+
= G
/
(
¯
k
+
)

¯
k
t
÷
¯
k
+

=
¯
k
+

ln
¯
k
t+1
÷ln
¯
k
+

= G
/
(
¯
k
+
)
¯
k
+

ln
¯
k
t+1
÷ln
¯
k
+

= ln
¯
k
t+1
÷ln
¯
k
+
= G
/
(
¯
k
+
)

ln
¯
k
t+1
÷ln
¯
k
+

.
With Cobb-Douglas production function
¯ y
t
=
¯
k
α
t
=ln¯ y
t
÷ln¯ y
+
= α

ln
¯
k
t
÷ln
¯
k
+

last equation becomes (…rst order equation in ¯ y
t
)
ln¯ y
t+1
÷ln¯ y
+
= G
/
(
¯
k
+
) (ln¯ y
t
÷ln¯ y
+
) .
Mark Weder (Adelaide) Economic Growth August 2008 17 / 68
Convergence in Solow model
Rate of convergence
ln¯ y
t+1
÷ln¯ y
t
= G
/
(
¯
k
+
) (ln¯ y
t
÷ln¯ y
+
) ÷ln¯ y
t
+ ln¯ y
+
= ln¯ y
t+1
÷ln¯ y
t
=

1 ÷G
/
(
¯
k
+
)

(ln¯ y
t
÷ln¯ y
+
)
Let’s de…ne λ = 1 ÷G
/
(
¯
k
+
), where 0 < λ < 1 :
ln¯ y
t+1
÷ln¯ y
t
= λ (ln¯ y
t
÷ln¯ y
+
)
In words, relative change in ln¯ y
t
is the fraction λ of the current relative
deviation between ¯ y
t
and its long run equilibrium (the remaining gap).
λ is time-invariant measure of rate at which ln¯ y
t
converges to ln¯ y
+
("rate
of convergence").
Say if λ = 0.02, then every year two percent of gap will be closed.
Growth rate of ln¯ y
t
larger (in absolute terms) the further away economy
Mark Weder (Adelaide) Economic Growth August 2008 18 / 68
Convergence in Solow model
λ = 1 ÷G
/
(
¯
k
+
) = 1 ÷
1
(1 + n)(1 + g)
(α (δ + n + g + ng) + 1 ÷δ)
=
(1 + n)(1 + g) ÷(α (δ + n + g + ng) + 1 ÷δ)
(1 + n)(1 + g)
- (1 ÷α)(n + g + δ)
For realistic parameters, α - 1/3 and n + g + δ - 0.075, the convergence
rate, λ, is about 5 percent.
ln¯ y
t+1
= λln¯ y
+
+ (1 ÷λ)ln¯ y
t
Let’s solve this …rst order di¤erence equation.
Mark Weder (Adelaide) Economic Growth August 2008 19 / 68
Convergence in Solow model
ln¯ y
t+1
= λln¯ y
+
+ (1 ÷λ)ln¯ y
t
1. Particular solution (a time path that solves equation for every year):
ln¯ y
t+1
=ln¯ y
+
.
2. Homogenous solution (set constant term zero):
ln¯ y
t+1
÷(1 ÷λ)ln¯ y
t
= 0 =ln¯ y
t
= (1 ÷λ)
t
C C is arbitrary constant.
3. Complete solutions (sum of 1. and 2.):
ln¯ y
t
= ln¯ y
+
+ (1 ÷λ)
t
C.
4. For solution to be compatible with initial value, ¯ y
0
, we must have
C =ln¯ y
0
÷ln¯ y
+
.
Therefore, unique solution
ln¯ y
t
= ln¯ y
+
+ (1 ÷λ)
t
(ln¯ y
0
÷ln¯ y
+
)
=

1 ÷(1 ÷λ)
t

ln¯ y
+
+ (1 ÷λ)
t
ln¯ y
0
.
Mark Weder (Adelaide) Economic Growth August 2008 20 / 68
Convergence in Solow model
For speci…c year T:
ln¯ y
T
=

1 ÷(1 ÷λ)
T

ln¯ y
+
+ (1 ÷λ)
T
ln¯ y
0
= ln¯ y
T
÷ln¯ y
0
=

1 ÷(1 ÷λ)
T

(ln¯ y
+
÷ln¯ y
0
) .
Using ln¯ y
t
=lny
t
÷lnA
t
:
lny
T
÷lny
0
T
=
lnA
t
÷lnA
0
T
+
1 ÷(1 ÷λ)
T
T
(lnA
0
+ ln¯ y
+
÷lny
0
) .
Mark Weder (Adelaide) Economic Growth August 2008 21 / 68
Convergence in Solow model
Recall output per worker was given by
¯ y
+
=

δ + n + g + ng
s
α
α÷1
then
ln¯ y
T
÷ln¯ y
0
T
- g +
1 ÷(1 ÷λ)
T
T

lnA
0
+
α
1 ÷α
[lns-ln (δ + n + g + ng)] ÷lny
0

.
This is the convergence equation of Solow model. Left hand side is
average (annual) growth in GDP per worker from zero to T. Sums of two
terms: steady state growth rate and term that increasingly depends on
initial relative gap between steady state growth path and the actual GDP
per worker, y
0
.
Mark Weder (Adelaide) Economic Growth August 2008 22 / 68
Empirical convergence
Assume countries are technologically similar (same g and A
0
), regression
across countries
g
i
T,0
=
lny
i
T
÷lny
i
0
T
- β
0
+ β
1
lny
i
0
+ β
2

lns
i
-ln

n
i
+ 0.075

.
Sample over 90 countries 1960-2000.
g
i
T,0
= 0.063 ÷ 0.006
(0.0015)
lny
i
0
+ 0.02
(0.0025)

lns
i
-ln

n
i
+ 0.075

R
2
= 0.40.
(Assumption of same access to technology not too far fetched.)
β
1
is equal
1÷(1÷λ)
T
T
implying λ = 1 ÷(1 ÷Tβ
1
)
1/T
. With T = 40,
λ = 0.007.
Annual rate of convergence is 0.7 percent ...
... data for full sample lend support to conditional convergence.
If we limit to OECD countries, rate is 2 percent.
Mark Weder (Adelaide) Economic Growth August 2008 23 / 68
Convergence of the rich
Mark Weder (Adelaide) Economic Growth August 2008 24 / 68
Convergence of the rich
Mark Weder (Adelaide) Economic Growth August 2008 25 / 68
No convergence
Mark Weder (Adelaide) Economic Growth August 2008 26 / 68
No convergence (and that’s persistent)
Mark Weder (Adelaide) Economic Growth August 2008 27 / 68
No convergence and the Solow model
The Basic Solow Model...
... o¤ers a nice account of a number of growth facts. However:
1. leaves unexplained factors that make countries leave (or not attain)
their BGP.
2. leaves unexplained why certain countries have higher s, n than others.
3. leaves unexplained technological progress, the source of growth.
4. More importantly it insu¤ciently accounts for long run per capita
di¤erences in output.
Mark Weder (Adelaide) Economic Growth August 2008 28 / 68
No convergence and the Solow model
So what could be missing?
There are insu¤cient di¤erences in inputs to account for the huge
di¤erences in outputs that we observe.
So what is needed is a theory of di¤erences in z.
Institutions, schooling, taxation, corruption, red tape, ine¤cient use of
technologies.
Imagine (in the context of the Solow model without technical progress)
that all countries share the same technology but they they di¤er in τ how
much of output is wasted.
Mark Weder (Adelaide) Economic Growth August 2008 29 / 68
No convergence and the Solow model
Now output is
Y = (1 ÷τ)zK
α
N
1÷α
in per capita terms
Y
N
= y = (1 ÷τ)zk
α
The steady state condition was
k
+
=
1 ÷δ
1 + n
k
+
+ szf (k
+
) =(n + δ)k
+
= szf (k
+
).
Hence
k
+
=

sz(1 ÷τ)
n + δ

1
1÷α
Then
y
+
= (1 ÷τ)z(k
+
)
α
= (1 ÷τ)z

zs(1 ÷τ)
n + δ

α
1÷α
= (1 ÷τ)z
1
1÷α

s(1 ÷τ)
n + δ

α
1÷α
Mark Weder (Adelaide) Economic Growth August 2008 30 / 68
No convergence and the Solow model
Assume α = 0.36, s = 0.2, δ = 0.05, n = 0.02 and z = 1, then

s
n+δ
α
1÷α
= 1.81.
If τ = 0,
y
+
=

s(1 ÷τ)
n + δ

α
1÷α
= 1.81
If τ = 0.36 then (1 ÷τ)
1
1÷α
= 0.50:
y
+
= (1 ÷τ)
1
1÷α

s(1 ÷τ)
n + δ
α
1÷α
= 0.90
For a …fty percent di¤erence in income, the distortion τ needs to be
greater than 35 percent (easy to cook up more extreme numbers).
So large di¤erences in τ are needed to account for the data.
Mark Weder (Adelaide) Economic Growth August 2008 31 / 68
How
How?
Mark Weder (Adelaide) Economic Growth August 2008 32 / 68
How
Education?
Mark Weder (Adelaide) Economic Growth August 2008 33 / 68
Human capital
Education levels are very di¤erent across countries.
Rich countries tend to have higher educational levels than poor countries.
We have the intuition that education (learning skills) is an important
factor in economic growth.
Mark Weder (Adelaide) Economic Growth August 2008 34 / 68
Mankiw, Romer & Weil (1992)
Their workhorse: Cobb-Douglas augmented Solow model. Suppose that
Y
t
= K
β
t
H
α
t
(A
t
L
t
)
1÷α÷β
where α, β _ 0, α + β _ 1. Y is total output, H is human capital, L is
labor and A is labor-augmenting technological change.
(1) Constant returns to scale.
(2) Elasticity of substitution between three factors is unitary.
(3) All technical progress is labor-augmenting.
(4) Human capital is taken to be a di¤erent factor of production rather
than simply labor augmenting.
Mark Weder (Adelaide) Economic Growth August 2008 35 / 68
Mankiw, Romer & Weil (1992)
Transform variables in per capita e¤ective units:
k =
K
AL
h =
H
AL
y =
Y
AL
then
y = Ak
β
h
α
Population grows at rate n. Common technology advances at zero rate (to
make my point, not in paper, set A = 1).
Countries di¤er in technology level, but they share the same common
technology growth rate µ = 0. In absence of this assumption, world
income distribution would become more and more dispersed. Constant
savings rates for physical and human capital
K
t+1
= s
k
Y
t
÷(1 ÷δ
k
)K
t
and
H
t+1
= s
h
Y
t
÷(1 ÷δ
h
)H
t
where δs are constant depreciation rates.
Mark Weder (Adelaide) Economic Growth August 2008 36 / 68
Mankiw, Romer & Weil (1992)
Then
K
t+1
= s
k
Y
t
÷(1 ÷δ
k
)K
t
H
t+1
= s
h
Y
t
÷(1 ÷δ
h
)H
t
become
k
t+1
÷k
t
= s
k
y
t
÷(n + δ
k
)k
t
h
t+1
÷h
t
= s
h
y
t
÷(n + δ
h
)h
t
Mark Weder (Adelaide) Economic Growth August 2008 37 / 68
Mankiw, Romer & Weil (1992)
Dynamics very complicated (two di¤erence equations to be solved at the
same time) so let’s look at the BGP.
k
t+1
÷k
t
= 0 = s
k
k
β
t
h
α
t
÷(n + δ
k
)k
t
h
t+1
÷h
t
= 0 = s
h
k
β
t
h
α
t
÷(n + δ
h
)h
t
From …rst equation
s
k
k
β
h
α
= (n + δ
k
)k
= h =
¸
(
n + δ
k
s
k
)k
1÷β
¸1
α
Mark Weder (Adelaide) Economic Growth August 2008 38 / 68
Math
Now use
s
h
k
β
h
α
= (n + δ
h
)h
and insert
h =
¸
(
n + δ
k
s
k
)k
1÷β
¸1
α
into it
s
h
k
β
(
n + δ
k
s
k
)k
1÷β
= (n + δ
h
)(
n + δ
k
s
k
)
1
α
k
1÷β
α
= s
h
(
n + δ
k
s
k
)k = (n + δ
h
)(
n + δ
k
s
k
)
1
α
k
1÷β
α
= s
h
k = (n + δ
h
)(
n + δ
k
s
k
)
1
α
÷1
k
1÷β
α
= s
h
= (n + δ
h
)(
n + δ
k
s
k
)
1
α
÷1
k
1÷β
α
÷1
Mark Weder (Adelaide) Economic Growth August 2008 39 / 68
Math
s
h
k
β
(
n + δ
k
s
k
)k
1÷β
= (n + δ
h
)(
n + δ
k
s
k
)
1
α
k
1÷β
α
...
= s
h
= (n + δ
h
)(
n + δ
k
s
k
)
1
α
÷1
k
1÷β÷α
α
= s
h
= (n + δ
h
)(
n + δ
k
s
k
)
1
α
÷1
k
1÷β÷α
α
= s
h
= (n + δ
h
)(
n + δ
k
s
k
)
1
α
÷1
k
1÷β÷α
α
Mark Weder (Adelaide) Economic Growth August 2008 40 / 68
Still going
into it
...
= s
h
= (n + δ
h
)(
n + δ
k
s
k
)
1
α
÷1
k
1÷β÷α
α
= k
÷
1÷β÷α
α
=
n + δ
h
s
h
(
n + δ
k
s
k
)
1
α
÷1
= k
÷
1÷β÷α
α
=
n + δ
h
s
h
(
n + δ
k
s
k
)
1÷α
α
= k
÷
1÷β÷α
α
=
1
s
h
(
1
s
k
)
1÷α
α
(n + δ
k
)
1
α
= k =

1
s
h
(
1
s
k
)
1÷α
α
(n + δ
k
)
1
α

÷
α
1÷β÷α
= k =

¸
s
h

s
k

1÷α
α
(n + δ
k
)
1
α
¸

α
1÷β÷α
= k =

s
h

α

s
k

1÷α
n + δ
k

1
1÷β÷α
Mark Weder (Adelaide) Economic Growth August 2008 41 / 68
Human capital
k
+
=

s
h

α

s
k

1÷α
n + δ
k

1
1÷β÷α
and some algebra yields
h
+
=

s
h

1÷β

s
k

β
n + δ
k

1
1÷β÷α
The central issue for growth is the value of α.
If α = 1/3 we have that small di¤erences in {s
h
, s
k
, n, δ} can account for
(relatively) large di¤erences in output per capita across countries.
According to Jones di¤erences in k account for a factor of 2 di¤erences in
output, di¤erences in educational attainment account ro 2.2 (using
educational attainment di¤erentials and the return to schooling). The
reminder is still 7 or 8 times that have to be imputed to di¤erences in TFP.
Mark Weder (Adelaide) Economic Growth August 2008 42 / 68
Human capital
Substituting back in (2) and taking logs, we obtain for a country j
ln y
ss
j
= ln A
j
+ gt +
α
1 ÷α ÷ β
ln

s
h
j
n
j
+ g + δ
h

+
β
1 ÷α ÷ β
ln

s
k
j
n
j
+ g + δ
k

(a) This can be estimated using cross-country data, if we have measure of
s
h
j
. Proxy they use: fraction of working age population enrolled in school,
(b) δ
k
= δ
h
, (c) s
k
j
investment rates (averages), (d) Common technology:
A
j
= A, (e) δ + g = 0.05.
Mark Weder (Adelaide) Economic Growth August 2008 43 / 68
Human capital
They estimate (standard errors in parenthesis); g + δ = .05
ln y
j
= 5.48
(1.59)
+ 1.42
(0.14)
ln s
k
j
÷ 1.97
(0.56)
ln(n
j
+ g + δ)
R
2
= 0.59 implied capital share = 0.60!
ln y
j
= 6.89
(1.17)
+ 0.69
(0.13)
ln s
k
j
÷ 1.73
(0.41)
ln(n
j
+ g + δ) + 0.66
(0.07)
ln(SCHOOL
j
)
R
2
= 0.78 implied capital share = 0.31
SCHOOL = average percentage of the working age population in
secondary school. Mankiw et al. estimate α - 1/3, β - 1/3 and
R
2
- 0.78. Strong support of augmented Solow model: α is capital share
(at right ballpark) and almost 80 percent of di¤erences in income can
be explained by investment decisions (in physical and human
capital). If human capital is not included in regression, the coe¢cient on
s
k
j
is estimated ”too high” (typically around 2/3) and R
2
is signi…cantly
less (0.59).
Mark Weder (Adelaide) Economic Growth August 2008 44 / 68
Human capital
Problems with the Mankiw et al. approach:
(1) Common technology assumption too strong. When A
j
varies across
countries, it will be plausibly be correlated with s
k
j
and s
h
j
. Thus, omitted
variable bias to overestimate of α, β and exaggeration of R
2
(that is, the
regression picks up something that is spurious). In fact, substantial
correlations across countries: ln(H
i
/L
i
) and ln(A
i
) ρ = 0.52 and
ln(K
i
/L
i
) and ln(A
i
) ρ = 0.25.
Mark Weder (Adelaide) Economic Growth August 2008 45 / 68
Human capital
Problems with the Mankiw et al. approach:
(2) The coe¢cient on s
h
j
is too large. Implications: Fraction of working
age population in enrolled in school ranges from under 1 to over 12 in
sample. Their estimates imply that a country ”with 12” should have
income per capita 6 times that of a country with s
h
j
= 1 (ceteris paribus) –
0.66 (ln(12) ÷ln(1)) - 1.8 and exp(1.8) - 6. Labor literature suggests
that additional years of schooling is associated with a 6 to 10 percent
increase in individual earnings. From Mincer regression
ln w
i
= X
/
i
γ + φE
i
where X
/
i
is a set of demographic controls and E
i
is years of schooling.
φ-estimates range typically around 0.06.
÷ So a country with 12 more years of schooling should be at most three
times as rich not 6 times as rich (exp(0.06 + 12) - 2)!
Mark Weder (Adelaide) Economic Growth August 2008 46 / 68
Human capital
To understand the point, consider the following: Each …rm has technology
y = k
1÷α
(Ah)
α
Firms face interest rate, r . Human capital is fraction of schooling with
standard exponential form
h
i
= exp(φE
i
)
(standard means labor-economics literature). First-order condition implies
r = (1 ÷α)(Ah/k)
α
All workers, irrespective of their level of schooling, will work with at the
same physical to human capital ratio. Wages are equal to
w = y ÷rk = αk
1÷α
(Ah)
α
Mark Weder (Adelaide) Economic Growth August 2008 47 / 68
Human capital
Then
k =

1 ÷α
r
1
α
Ah
implies
w(h) = αk
1÷α
(Ah)
α
= α(1 ÷α)
1÷α
α
Ar
α÷1
α
h
Mark Weder (Adelaide) Economic Growth August 2008 48 / 68
Human capital
w(h) = αk
1÷α
(Ah)
α
= α(1 ÷α)
1÷α
α
Ar
α÷1
α
h
so wages are linear in human capital (from constant returns). Taking logs
gives the standard wage equation:
log w
i
= c + φE
i
Consider two economies with same technology and interest rate but
di¤erent schooling. They will have same physical to human capital ratio.
From
Y
j
= K
1÷α
j
(AH
j
)
α
and
K
j
=

1 ÷α
r
1
α
AH
j
we obtain
Y
j
= (1 ÷α)
1÷α
α
Ar
α÷1
α
H
j
= (1 ÷α)
1÷α
α
Ar
α÷1
α
exp(φE
j
)
Mark Weder (Adelaide) Economic Growth August 2008 49 / 68
Human capital
log Y
2
÷log Y
1
= φ(E
2
÷E
1
).
So if economy has on average on year more schooling, income should be 6
to 10 percent higher. Data (1985), there are much larger di¤erences
log Y = c + 0.313
(0.027)
E
which is too strong given micro evidence. Not simply explained by
di¤erences in interest rate (as control)
r = (1 ÷α)
Y
K
Taking logs of
Y
j
= (1 ÷α)
1÷α
α
Ar
α÷1
α
exp(φE
j
)
gives
log Y
j
= c ÷
1 ÷α
α
log r + φE
j
or = c
/
÷
1 ÷α
α
log
Y
K
+ φE
j
Mark Weder (Adelaide) Economic Growth August 2008 50 / 68
Human capital
Estimate equation leads to
log Y = c + 0.266
(0.033)
E + 0.408
(0.178)
log
Y
K
so there is still a large e¤ect of education on income (coe¢cient on Y/K
should be near 1/2). Relationship may re‡ect human capital externalities
(Mincer equations private returns)...
... or everything is captured in A : An alternative interpretation is that
there are di¤erent patterns in technology, A, and these are correlated with
human capital di¤erences.
Mark Weder (Adelaide) Economic Growth August 2008 51 / 68
Hall & Jones
That’s what Hall & Jones (1999) try to tackle. Assume
Y
j
= K
α
j
(A
j
H
j
)
1÷α
with H
j
e¢ciency units of labor given by Mincer-type relationship
H
j
=

E
exp¦φ(E
j
)¦L
j
(E)
where φ(E
j
) is return to schooling, and L
j
(E) is number of individuals
with schooling years E. Microeconomic studies suggest that the
percentage increase in earnings from additional schooling falls as amount
of schooling rises. φ(E
j
) is piecewise linear function with slope 0.134 for E
below 4 years, 0.101 for E between 4 and 8 years and 0.068 for E above 8
years (this follows work by Psachropoulos (1994) and the numbers are a
bit larger than in the mentioned Mincer regressions – yet, higher values
will make human capital more important in the analysis below and we will
see that it is not.).
Mark Weder (Adelaide) Economic Growth August 2008 52 / 68
Hall & Jones
One can rewrite production function in per capita termsOne can rewrite
production function in per capita terms
Y
j
= K
α
j
(A
j
H
j
)
1÷α
= Y
1÷α
j
=
K
α
j
Y
α
j
(A
j
H
j
)
1÷α
= Y
j
=

K
j
Y
j
α
1÷α
A
j
H
j
=
Y
j
L
j
=

K
j
Y
j
α
1÷α
H
j
L
j
A
j
Hall & Jones (1999) use this equation to estimate contributions to output
per worker in each country. Average output per worker in …ve richest
countries (USA, Luxembourg, Canada, Switzerland, Australia) exceeds
average in poor group (Burundi, Malawi, Burkina Faso, Myanmar, Niger)
by factor 31.7 (based on geometric average).
Mark Weder (Adelaide) Economic Growth August 2008 53 / 68
Hall & Jones
Now, the di¤erence in (Hall & Jones set α = 1/3)

K
Rich
Y
Rich
α
1÷α

K
Poor
Y
Poor
α
1÷α
is 1.8. The di¤erence in
H
Rich
L
Rich
H
Poor
L
Poor
is 2.2. And the di¤erence in
A
Rich
A
Poor
8.3 (that makes 1.8 2.2 8.3 = 31.7). Thus most of the gap
between richest and poorest countries is due to the residual, A.
... with no di¤erence in A the output di¤erence would be only 3.96
(= 1.8 2.2). Why?
Mark Weder (Adelaide) Economic Growth August 2008 54 / 68
Hall & Jones
Because:
Investment rates are relatively similar. Moreover, the di¤erence gets raised
to the power 1/2:

K
j
Y
j
α
1÷α
=

K
j
Y
j
1/3
1÷1/3
=

K
j
Y
j
1
2
.
Similarly, the average educational attainment in the …ve richest countries
is about 8.1 years greater. The di¤erence gets reduced when converted
into an e¤ect on output (via Mincer return to schooling assumption).
Mark Weder (Adelaide) Economic Growth August 2008 55 / 68
Hall & Jones
To sum up, Hall & Jones …nd that
(1) Di¤erences in physical and human capital matter but
(2) there are also signi…cant productivity di¤erences.
Mark Weder (Adelaide) Economic Growth August 2008 56 / 68
Endogenous Growth
Models so far: no sustained long-run growth; relatively little to say about
sources of technology di¤erences.
Models in which technology evolves as a result of …rms’and workers’
decisions are most attractive in this regard (and we will discuss these).
But sustained economic growth is possible in the neoclassical model as
well: AK model prevents diminishing returns to capital.
Capital accumulation could act as the engine of sustained economic
growth.
Neoclassical version of the AK model: Very tractable and applications in
many areas.
Shortcoming: capital is essentially the only factor of production,
asymptotically share of income accruing to it tends to 1.
Mark Weder (Adelaide) Economic Growth August 2008 57 / 68
Ak model
Rebelo (1991)
Y
t
= AK
t
A > 0
Does not depend on labor, thus w
t
will be equal to zero. De…ning
k
t
= K
t
/N
t
as the capital-labor ratio
y
t
=
Y
t
N
t
= A
K
t
N
t
= Ak
t
Notice output is only a function of capital, and there are no diminishing
returns. But introducing diminishing returns to capital does not a¤ect the
main results in this section.
Mark Weder (Adelaide) Economic Growth August 2008 58 / 68
Ak model
More important assumption is that the Inada conditions are no longer
satis…ed
lim
k÷∞
f
/
(k) = A
In fact, The marginal product of capital is alwyas equal to A.
Mark Weder (Adelaide) Economic Growth August 2008 59 / 68
Ak model
Capital accumulates as
k
t+1
÷k
t
= ÷δk
t
+ sy
t
= ÷δk
t
+ s (w
t
+ r
t
k
t
) = ÷δk
t
+ sr
t
k
t
= ÷δk
t
+ sAk
t
thus
k
t+1
÷k
t
= ÷δk
t
+ sAk
t
=
k
t+1
÷k
t
k
t
= ÷δ + sA
If sA ÷δ > 0 economy grows endogenously (ie with exogenous
technological change).
No transitional dynamics: growth rates of consumption, capital and output
are constant and given in last equation.
Mark Weder (Adelaide) Economic Growth August 2008 60 / 68
Ak model and policy
Suppose there is an e¤ective tax rate of τ on the rate of return from
capital income.
The e¤ective marginal return to capital will be (1 ÷τ)Ak. Repeating the
analysis above this will adversely a¤ect the growth rate of the economy,
now:
k
t+1
÷k
t
k
t
= ÷δ + s(1 ÷τ)A
Since saving rate is constant, di¤erences in policies will lead to permanent
di¤erences in the rate of capital accumulation.
Even small di¤erences in τ can have very large e¤ects.
Mark Weder (Adelaide) Economic Growth August 2008 61 / 68
Endogenous Growth via learning by doing and externalities
Romer (1986), Arrow (1962), Sheshinski (1967)
Romer (1986): model the process of “knowledge accumulation”.
Di¢cult in the context of a competitive economy.
Solution: knowledge accumulation as a byproduct of capital accumulation.
Technological spillovers: arguably crude, but captures that knowledge is a
largely non-rival good.
Non-rivalry does not imply knowledge is also non-excludable.
But some of the important characteristics of “knowledge” and its role in
the production process can be captured in a reduced-form way by
introducing technological spillovers.
Mark Weder (Adelaide) Economic Growth August 2008 62 / 68
Endogenous Growth via learning by doing and externalities
No population growth (we will see why this is important). N
t
= 1.
Production function with labor-augmenting knowledge (technology) that
satis…es Assumptions on Continuity, Di¤erentiability, Positive and
Diminishing Marginal Products, and Constant Returns to Scale and the
Instead of working with the aggregate production function, assume that
the production side of the economy consists of a set i ÷ [0, 1] of …rms.
The production function facing each …rm i is
y
i ,t
= Ak
α
i ,t
κ
γ
t
n
1÷α
i ,t
0 < γ < 1
κ
t
stands for aggregate stock of capital.
Mark Weder (Adelaide) Economic Growth August 2008 63 / 68
Endogenous Growth via learning by doing and externalities
Key assumption: Firms take κ
t
as given, but this stock of technology
(knowledge) advances endogenously for the economy as a whole.
κ
t
=

t
÷∞
I (v)dv
Extreme assumption of su¢ciently strong externalities such that κ
t
can
grow continuously at the economy level. Motivated by “learning-by-doing”:
"each new machine produced and put into use is capable of
changing the environment in which production takes place, so
that learning takes place with continuous new stimuli." (Arrow,
1962, 157)
Alternatively, could be a function of the cumulative output that the
economy has produced up to now.
Mark Weder (Adelaide) Economic Growth August 2008 64 / 68
Endogenous Growth via learning by doing and externalities
Pro…t maximization subject to
y
i ,t
= Ak
α
i ,t
κ
γ
t
n
1÷α
i ,t
yields
αAk
α÷1
i ,t
κ
γ
t
n
1÷α
i ,t
= r
t
(note that this is the private not social marginal product!).
In symmetric equilibrium
αAk
γ+α÷1
t
n
1÷α
t
= r
t
and
(1 ÷α)Ak
γ+α
t
n
÷α
t
= w
t
Mark Weder (Adelaide) Economic Growth August 2008 65 / 68
Endogenous Growth via learning by doing and externalities
αAk
η+α÷1
t
= r
t
and
(1 ÷α)Ak
η+α
t
= w
t
Then per capita output is given by
w
t
+ r
t
k
t
= (1 ÷α)Ak
η+α
t
+ αAk
η+α÷1
t
k
t
= Ak
η+α
t
and capital evolves as
k
t+1
÷k
t
= ÷δk
t
+ sAk
η+α
t
Mark Weder (Adelaide) Economic Growth August 2008 66 / 68
Endogenous Growth
Capital evolves as
k
t+1
÷k
t
k
t
= sAk
η+α÷1
t
÷δ.
Increasing returns to scale not su¢cient for endogenous growth! We need
very increasing returns such that η + α = 1:
k
t+1
÷k
t
k
t
= sA ÷δ.
Mark Weder (Adelaide) Economic Growth August 2008 67 / 68
Endogenous Growth
Romer (1987)
Researchers
Mark Weder (Adelaide) Economic Growth August 2008 68 / 68

World’ Economic History in one picture s

Economic Growth

August 2008

2 / 68

Convergence and the World Income Distribution

The Convergence Hypothesis: Fact: Enormous variation in incomes per worker across countries Question: Do poor countries eventually catch up? Convergence hypothesis: They do, in the right sense! Main prediction of convergence hypothesis (and the Solow model): Poor countries should grow faster than rich countries.

Economic Growth

August 2008

3 / 68

Solow Model and Convergence Solow model without technological change Mark Weder (Adelaide) Economic Growth August 2008 4 / 68 .

yt = e = At Lt e = ktα . = = Mark Weder (Adelaide) 1 e e e (s k α + (1 δ)kt (1 + n)(1 + g )kt ) (1 + n)(1 + g ) t 1 e e (s k α (δ + n + g + ng )kt ). (1 + n)(1 + g ) t Economic Growth August 2008 5 / 68 . Solow equationn e e kt +1 e kt = Ktα (At Lt )1 α Yt .Solow Model and Convergence Fundamental di¤erence equation of Solow Model with technological progress (and Cobb-Douglas production function): e kt +1 = Yt 1 e (s k α + (1 (1 + n)(1 + g ) t Kt At Lt α Production function e δ)kt ) Income per worker is yt = yt At and At = (1 + g )t A0 .

Mark Weder (Adelaide) Economic Growth August 2008 6 / 68 .Solow Model and Convergence e Convergence towards steady state – diagram uses: s ktα e kt +1 = 1 e (s k α + (1 (1 + n)(1 + g ) t 1 e δ)kt ).

e Then: s ktα 1 (δ + n + g + ng ) > 0 and growth rate is positive.Solow Model: comparative statics Convergence towards steady state – diagram uses: e e kt +1 kt 1 e = (s k α et (1 + n)(1 + g ) t k 1 (δ + n + g + ng )). Mark Weder (Adelaide) Economic Growth August 2008 7 / 68 . Peters out as economy goes back to new steady state. Suppose economy in steady state: what happens if savings rate goes up? Initially e e kt +1 kt 1 e =0= (s k α et (1 + n)(1 + g ) t k 1 (δ + n + g + ng )).

output per worker is given by yt = At Mark Weder (Adelaide) y = e δ + n + g + ng s α α 1 . August 2008 8 / 68 . k = δ + n + g + ng s 1 α 1 Further. δ + n + g + ng s Economic Growth α α 1 . s k α 1 = δ + n + g + ng 0 = e and from yt = ktα e e .Solow Model: steady state 1 e (s k α 1 (δ + n + g + ng )) (1 + n)(1 + g ) t e .

Mark Weder (Adelaide) Economic Growth August 2008 9 / 68 . the steady state prediction of model is that yt should depend on lns-ln(δ + n + g + ng ) and this realtionship should be linear with positive slope since 1 α α > 0. Slope should be around 1/2.Solow Model: steady state empirics Let’ take logs on both sides of s yt = At δ + n + g + ng s α α α 1 α 1 α α 1 α α 1 lnyt = lnAt + = lnAt + = lnAt + ln ln δ + n + g + ng s s δ + n + g + ng [lns-ln (δ + n + g + ng )] First of two important relationships of Solow model: given At .

Solow Model: steady state empirics Heroric assumption that all countries are in (or very close) to their steady state in 2000 and that they had same technology in that year. However.47 lns i -ln ni + 0.075 R2 i ! lny2000 = 8.6 to match this! Mark Weder (Adelaide) Economic Growth August 2008 10 / 68 .2 Estimate of slope.8 + 1. t = 10. Now: i lny2000 = γ0 + γ1 lns i -ln ni + 0.075 = 0. γ1 .55.47 and model seems to be in accordance with data. OLS regression estimation of i lny2000 = lnAt + α 1 α lns i -ln δ + ni + g + ni g s i average investment rate 1960-2000. is 1.075 (and we neglect ni g ). δ + ni + g + ni g = 0. this is "too large" – we would need a α = 0.

. seems to be the case for the sample of now industrialized countries.. δ.. . eventually same growth rate of output per worker and same level of output per worker (absolute convergence)..Solow Model: convergence . . α. Countries starting further below the balanced growth path (poorer countries) should grow faster than countries closer to balanced growth path.. Mark Weder (Adelaide) Economic Growth August 2008 11 / 68 .. Countries with same s... the second important relationships of Solow model. n.

Solow Model and Convergence Mark Weder (Adelaide) Economic Growth August 2008 12 / 68 .

Solow Model and Convergence Mark Weder (Adelaide) Economic Growth August 2008 13 / 68 .

.. α. This is called conditional convergence.But: Countries with same g but potentially di¤ering s. Mark Weder (Adelaide) Economic Growth August 2008 14 / 68 . n.. Countries that start further below their balanced growth path (countires that are poor relative to their BGP) should grow faster than rich countries (relative to their BGP).. countries have di¤erent balanced growth path (BGP).. δ.. .

Convergence in Solow model Recall transition equation (in generic form) 1 e e (s k α + (1 kt +1 = (1 + n)(1 + g ) t e e δ)kt ) = G (kt ). . Term G 0 (k ) is given by 1 e e G 0 (k ) = (sαk α 1 + 1 δ) (1 + n)(1 + g ) 1 δ + n + g + ng = (sα + 1 δ) (1 + n)(1 + g ) s 1 (α (δ + n + g + ng ) + 1 δ) = (1 + n)(1 + g ) Mark Weder (Adelaide) Economic Growth August 2008 15 / 68 e e e k = G 0 (k ) kt e k . e e In steady state k = G (k ). Linearize transition equation around the steady state (local dynamics!) e kt +1 e e A (linear) …rst order di¤erence equation in kt .

Mark Weder (Adelaide) Economic Growth August 2008 16 / 68 . hence stable equation (and kt ! k as t ! ∞). e kt +1 = 1 e (s k α + (1 (1 + n)(1 + g ) t e e δ)kt ) = G (kt ).Convergence in Solow model e e e 0 < G 0 (k ) < 1.

k e e = G 0 (k ) kt With Cobb-Douglas production function e yt = ktα ) lnet e y lnet +1 y e . lnkt +1 e e e lnk = G 0 (k ) lnkt +1 e lne = α lnkt y e lnk e k . last equation becomes (…rst order equation in yt ) e Mark Weder (Adelaide) e lnk lne ) .Convergence in Solow model Convert transition equation into changes in natural log-values rather than absolute changes. e e Note that lnkt lnk e kt +1 e k e e k 1/(kt e lnkt +1 e k ). y August 2008 17 / 68 e lne = G 0 (k ) (lnet y y Economic Growth . e e = G 0 (k )k e lnkt +1 e lnk e lnk e .

Mark Weder (Adelaide) Economic Growth August 2008 18 / 68 In words. lnet +1 y Let’ de…ne λ s 1 lnet = 1 y λ is time-invariant measure of rate at which lnet converges to lne ("rate y y of convergence"). Say if λ = 0.Convergence in Solow model Rate of convergence lnet +1 y lnet y e = G 0 (k ) (lnet y lnet +1 y lne ) y lnet + lne y y e G 0 (k ) (lnet y lne ) y lne ) y .02. relative change in lnet is the fraction λ of the current relative y deviation between yt and its long run equilibrium (the remaining gap). e e G 0 (k ). Growth rate of lnet larger (in absolute terms) the further away economy y from steady state. then every year two percent of gap will be closed. where 0 < λ < 1 : lnet = λ (lnet y y .

is about 5 percent.075. lnet +1 = λlne + (1 y y Let’ solve this …rst order di¤erence equation. α 1/3 and n + g + δ rate. λ.Convergence in Solow model λ = 1 1 (α (δ + n + g + ng ) + 1 (1 + n)(1 + g ) (1 + n)(1 + g ) (α (δ + n + g + ng ) + 1 δ) = (1 + n)(1 + g ) (1 α)(n + g + δ) e G 0 (k ) = 1 δ) For realistic parameters. s 0. the convergence λ)lnet y Mark Weder (Adelaide) Economic Growth August 2008 19 / 68 .

y0 . For solution to be compatible with initial value. y y = lne + (1 λ)t (lne0 lne ) y t y y = 1 (1 λ) lne + (1 λ)t lne0 . y y 2.Convergence in Solow model lnet +1 = λlne + (1 y y λ)lnet y 1. we must have e C =lne0 lne . Homogenous solution (set constant term zero): lnet +1 y λ )t C λ )t C . y y Therefore.): lnet = lne + (1 y y 4. (1 3. Economic Growth August 2008 20 / 68 . Particular solution (a time path that solves equation for every year): lnet +1 =lne . and 2. Complete solutions (sum of 1. unique solution lnet y Mark Weder (Adelaide) λ)lnet = 0 ) lnet = (1 y y C is arbitrary constant.

y = lnAt T lnA0 + (1 λ )T y (lnA0 + lne T lny0 ) . Mark Weder (Adelaide) Economic Growth August 2008 21 / 68 .Convergence in Solow model For speci…c year T : lneT y = . lneT y Using lnet =lnyt lnAt : y lnyT T lny0 h 1 (1 i λ)T lne + (1 λ)T lne0 y y h i y lne0 = 1 (1 λ)T (lne y 1 lne0 ) .

Convergence in Solow model Recall output per worker was given by y = e lne0 y T g+ 1 δ + n + g + ng s α α 1 then lneT y (1 λ )T T α lnA0 + [lns-ln (δ + n + g + ng )] 1 α lny0 . Sums of two terms: steady state growth rate and term that increasingly depends on initial relative gap between steady state growth path and the actual GDP per worker. y0 . Left hand side is average (annual) growth in GDP per worker from zero to T . Mark Weder (Adelaide) Economic Growth August 2008 22 / 68 . This is the convergence equation of Solow model.

02 i (0. (Assumption of same access to technology not too far fetched. (0.. data for full sample lend support to conditional convergence.075 i . .0025 ) lns i -ln ni + 0. rate is 2 percent.0 = 0. 1 (1 λ )T T implying λ = 1 (1 T β1 )1/T . If we limit to OECD countries.) β1 is equal λ = 0.Empirical convergence Assume countries are technologically similar (same g and A0 ).0 = i lnyT i lny0 β0 + β1 lny0 + β2 lns i -ln ni + 0. Annual rate of convergence is 0..7 percent .063 i gT .007.. Mark Weder (Adelaide) Economic Growth August 2008 23 / 68 . regression across countries T Sample over 90 countries 1960-2000.40. With T = 40.0015 ) 0. i gT .006 lny0 + 0..075 R 2 = 0.

Convergence of the rich Mark Weder (Adelaide) Economic Growth August 2008 24 / 68 .

Convergence of the rich Mark Weder (Adelaide) Economic Growth August 2008 25 / 68 .

No convergence Mark Weder (Adelaide) Economic Growth August 2008 26 / 68 .

No convergence (and that’ persistent) s Mark Weder (Adelaide) Economic Growth August 2008 27 / 68 .

3. leaves unexplained why certain countries have higher s. o¤ers a nice account of a number of growth facts. n than others. More importantly it insu¤ciently accounts for long run per capita di¤erences in output. the source of growth. However: 1.No convergence and the Solow model The Basic Solow Model. 4. leaves unexplained technological progress. leaves unexplained factors that make countries leave (or not attain) their BGP.... . 2.. Mark Weder (Adelaide) Economic Growth August 2008 28 / 68 .

Mark Weder (Adelaide) Economic Growth August 2008 29 / 68 . schooling. corruption. Institutions. ine¤cient use of technologies. So what is needed is a theory of di¤erences in z. Imagine (in the context of the Solow model without technical progress) that all countries share the same technology but they they di¤er in τ how much of output is wasted. red tape.No convergence and the Solow model So what could be missing? There are insu¤cient di¤erences in inputs to account for the huge di¤erences in outputs that we observe. taxation.

(n + δ)k = szf (k ). 1+n sz (1 τ ) n+δ zs (1 τ ) n+δ Economic Growth 1 1 α α 1 α τ )z = (1 τ )z 1 1 α s (1 τ ) n+δ 30 / 68 Mark Weder (Adelaide) August 2008 .No convergence and the Solow model Now output is Y = (1 in per capita terms Y = y = (1 N The steady state condition was k = Hence k = Then y = (1 τ )z (k ) = (1 α τ )zK α N 1 α τ )zk α 1 δ k + szf (k ) .

90 For a …fty percent di¤erence in income.2.81 = 0.36. n = 0. So large di¤erences in τ are needed to account for the data.02 and z = 1. Mark Weder (Adelaide) Economic Growth August 2008 31 / 68 .50: τ) 1 1 α y = (1 s (1 τ ) n+δ α 1 α = 0. n +δ If τ = 0. s = 0. δ = 0. then s 1 α = 1.36 then (1 τ) 1 1 α s (1 τ ) n+δ α 1 α = 1. the distortion τ needs to be greater than 35 percent (easy to cook up more extreme numbers).No convergence and the Solow model Assumeα α = 0. y = If τ = 0.05.81.

How How? Mark Weder (Adelaide) Economic Growth August 2008 32 / 68 .

How Education? Mark Weder (Adelaide) Economic Growth August 2008 33 / 68 .

We have the intuition that education (learning skills) is an important factor in economic growth. Mark Weder (Adelaide) Economic Growth August 2008 34 / 68 . Rich countries tend to have higher educational levels than poor countries.Human capital Education levels are very di¤erent across countries.

α + β 1. Y is total output. Mark Weder (Adelaide) Economic Growth August 2008 35 / 68 . (4) Human capital is taken to be a di¤erent factor of production rather than simply labor augmenting. L is labor and A is labor-augmenting technological change. β 0. (1) Constant returns to scale. Suppose that Yt = Kt Htα (At Lt )1 β α β where α.Mankiw. Romer & Weil (1992) Their workhorse: Cobb-Douglas augmented Solow model. (3) All technical progress is labor-augmenting. (2) Elasticity of substitution between three factors is unitary. H is human capital.

but they share the same common technology growth rate µ = 0. Constant savings rates for physical and human capital Kt +1 = s k Yt and Ht +1 = s h Yt (1 δ k ) Kt δ h ) Ht August 2008 36 / 68 (1 where δs are constant depreciation rates. Countries di¤er in technology level.Mankiw. Common technology advances at zero rate (to make my point. In absence of this assumption. set A = 1). world income distribution would become more and more dispersed. Romer & Weil (1992) Transform variables in per capita e¤ective units: H Y K h= y= k= AL AL AL then y = Ak β hα Population grows at rate n. Mark Weder (Adelaide) Economic Growth . not in paper.

Mankiw. Romer & Weil (1992) Then Kt +1 = s k Yt Ht +1 = s h Yt become kt +1 ht +1 kt = s k yt ht = s h yt (1 (1 δ k ) Kt δ h ) Ht (n + δk )kt (n + δh )ht Mark Weder (Adelaide) Economic Growth August 2008 37 / 68 .

s kt +1 ht +1 From …rst equation s k k β hα α kt = 0 = s k kt ht β α ht = 0 = s h kt ht β (n + δk )kt (n + δh )ht (n + δk )k " n + δk . h = ( k )k 1 s = β #1 α Mark Weder (Adelaide) Economic Growth August 2008 38 / 68 . Romer & Weil (1992) Dynamics very complicated (two di¤erence equations to be solved at the same time) so let’ look at the BGP.Mankiw.

Math Now use s h k β h α = (n + δh )h and insert n + δk h = ( k )k 1 s into it shk β( n + δk 1 )k sk β " β #1 α = (n + δh )( n + δk 1 1 β )αk α sk n + δk n + δk 1 1 β )k = (n + δh )( k ) α k α sk s n + δk 1 1 1 β . sh( Mark Weder (Adelaide) Economic Growth August 2008 39 / 68 . s h k = (n + δh )( k ) α k α s n + δk 1 1 1 β 1 . s h = (n + δh )( k ) α k α s .

s h = (n + δh )( k ) α s n + δk 1 . s h = (n + δh )( k ) α s n + δk 1 .Math shk β( n + δk 1 )k sk β n + δk 1 1 β (n + δh )( k ) α k α s . n + δk 1 .. s h = (n + δh )( k ) α s = 1 k k k 1 β α α 1 1 β α α 1 1 β α α Mark Weder (Adelaide) Economic Growth August 2008 40 / 68 ..

.Still going into it . Mark Weder (Adelaide) α β α August 2008 41 / 68 . . s h = (n + δh )( .. .. . n + δk 1 1 1 β )α k α sk 1 β α n + δh n + δk 1 1 α k = ( k )α sh s 1 β α n + δh n + δk 1 α α k ( k ) α = sh s 1 β α 1 1 1 1 α α = h ( k ) α (n + δk ) α k s s 1 1 1 1 1 α k= ( ) α (n + δk ) α h sk s α 0 11 β α 1 α h sk α s A k=@ 1 (n + δk ) α ! 1 α 1 α 1 β α Economic k Growth h α .

di¤erences in educational attainment account ro 2. The reminder is still 7 or 8 times that have to be imputed to di¤erences in TFP. If α = 1/3 we have that small di¤erences in {s h . s k .Human capital sh α k = and some algebra yields h = sk 1 α n + δk 1 β !1 !1 1 β α sh sk β 1 β α n + δk The central issue for growth is the value of α. n.2 (using educational attainment di¤erentials and the return to schooling). Mark Weder (Adelaide) Economic Growth August 2008 42 / 68 . δ} can account for (relatively) large di¤erences in output per capita across countries. According to Jones di¤erences in k account for a factor of 2 di¤erences in output.

(d) Common technology: Aj = A. if we have measure of sjh . (b) δk = δh . we obtain for a country j ! sjh α ss ln yj = ln Aj + gt + ln 1 α β nj + g + δh ! sjk β + ln 1 α β nj + g + δk (a) This can be estimated using cross-country data. (c) sjk investment rates (averages). (e) δ + g = 0.Human capital Substituting back in (2) and taking logs. Mark Weder (Adelaide) Economic Growth August 2008 43 / 68 . Proxy they use: fraction of working age population enrolled in school.05.

14 ) (0. If human capital is not included in regression.89 + 0.05 ln yj = 5.69 ln sjk (1.48 + 1.60! 1. Mankiw et al.17 ) implied capital share = 0. g + δ = .78 (0. Strong support of augmented Solow model: α is capital share (at right ballpark) and almost 80 percent of di¤erences in income can be explained by investment decisions (in physical and human capital).41 ) implied capital share = 0.56 ) 1.42 ln sjk (1.59). β 1/3 and R 2 0. Mark Weder (Adelaide) Economic Growth August 2008 44 / 68 .78.59 ) (0.Human capital They estimate (standard errors in parenthesis).13 ) 2 (0.66 ln(SCHOOLj ) (0. estimate α 1/3.97 ln(nj + g + δ) R 2 = 0.73 ln(nj + g + δ) + 0. the coe¢ cient on sjk is estimated ”too high” (typically around 2/3) and R 2 is signi…cantly less (0.07 ) R = 0.31 SCHOOL = average percentage of the working age population in secondary school.59 ln yj = 6.

Mark Weder (Adelaide) Economic Growth August 2008 45 / 68 .Human capital Problems with the Mankiw et al.52 and ln(Ki /Li ) and ln(Ai ) ρ = 0. When Aj varies across countries. approach: (1) Common technology assumption too strong.25. omitted variable bias to overestimate of α. substantial correlations across countries: ln(Hi /Li ) and ln(Ai ) ρ = 0. it will be plausibly be correlated with sjk and sjh . Thus. the regression picks up something that is spurious). In fact. β and exaggeration of R 2 (that is.

06. From Mincer regression ln wi = Xi0 γ + φEi where Xi0 is a set of demographic controls and Ei is years of schooling. ! So a country with 12 more years of schooling should be at most three times as rich not 6 times as rich (exp (0.8 and exp (1. Their estimates imply that a country ”with 12” should have income per capita 6 times that of a country with sjh = 1 (ceteris paribus) – 0.06 12) 2)! Mark Weder (Adelaide) Economic Growth August 2008 46 / 68 . Implications: Fraction of working age population in enrolled in school ranges from under 1 to over 12 in sample. φ-estimates range typically around 0.8) 6. approach: (2) The coe¢ cient on sjh is too large.66 (ln(12) ln(1)) 1.Human capital Problems with the Mankiw et al. Labor literature suggests that additional years of schooling is associated with a 6 to 10 percent increase in individual earnings.

Wages are equal to w =y Mark Weder (Adelaide) rk = αk 1 Economic Growth α (Ah)α August 2008 47 / 68 . r . will work with at the same physical to human capital ratio. consider the following: Each …rm has technology y = k1 α (Ah)α Firms face interest rate. irrespective of their level of schooling.Human capital To understand the point. First-order condition implies r = (1 α)(Ah/k )α All workers. Human capital is fraction of schooling with standard exponential form hi = exp(φEi ) (standard means labor-economics literature).

Human capital Then k= implies w (h) = αk 1 α 1 r α 1 α Ah 1 α α α 1 α (Ah)α = α(1 α) Ar h Mark Weder (Adelaide) Economic Growth August 2008 48 / 68 .

Taking logs gives the standard wage equation: log wi = c + φEi Consider two economies with same technology and interest rate but di¤erent schooling. From Yj = Kj1 α (AHj )α and Kj = we obtain Yj = (1 Mark Weder (Adelaide) 1 α α α 1 α w (h) = αk 1 α 1 α α 1 1 r α 1 α AHj 1 α α α 1 α α) Ar Hj = ( 1 Economic Growth α) Ar exp(φEj ) August 2008 49 / 68 .Human capital (Ah)α = α(1 α) α Ar α h so wages are linear in human capital (from constant returns). They will have same physical to human capital ratio.

313 E (0.Human capital log Y2 log Y1 = φ(E2 E1 ) . there are much larger di¤erences log Y = c + 0. income should be 6 to 10 percent higher. Data (1985). Not simply explained by di¤erences in interest rate (as control) Y r = (1 α ) K Taking logs of 1 α α 1 Yj = (1 α) α Ar α exp(φEj ) gives log Yj = c Mark Weder (Adelaide) 1 α α log r + φEj or = c 0 Economic Growth 1 α α log Y + φEj K August 2008 50 / 68 . So if economy has on average on year more schooling.027 ) which is too strong given micro evidence.

266 E + 0.Human capital Estimate equation leads to log Y = c + 0.. Relationship may re‡ect human capital externalities (Mincer equations private returns). and these are correlated with human capital di¤erences. or everything is captured in A : An alternative interpretation is that there are di¤erent patterns in technology.033 ) (0...178 ) Y K so there is still a large e¤ect of education on income (coe¢ cient on Y /K should be near 1/2).. Mark Weder (Adelaide) Economic Growth August 2008 51 / 68 . . A.408 log (0.

101 for E between 4 and 8 years and 0. 0. Microeconomic studies suggest that the percentage increase in earnings from additional schooling falls as amount of schooling rises.).Hall & Jones That’ what Hall & Jones (1999) try to tackle. Mark Weder (Adelaide) Economic Growth August 2008 52 / 68 . and Lj (E ) is number of individuals with schooling years E .134 for E below 4 years.068 for E above 8 years (this follows work by Psachropoulos (1994) and the numbers are a bit larger than in the mentioned Mincer regressions – yet. Assume s Yj = Kjα (Aj Hj )1 α with Hj e¢ ciency units of labor given by Mincer-type relationship Hj = ∑ expfφ(Ej )gLj (E ) E where φ(Ej ) is return to schooling. higher values will make human capital more important in the analysis below and we will see that it is not. φ(Ej ) is piecewise linear function with slope 0.

Luxembourg. Niger) by factor 31. Mark Weder (Adelaide) Economic Growth August 2008 53 / 68 . Yj = .Hall & Jones One can rewrite production function in per capita termsOne can rewrite production function in per capita terms Yj = Kjα (Aj Hj )1 α . Myanmar. Yj1 α = Kjα Yjα (Aj Hj )1 α 1 α α . Canada. Switzerland.7 (based on geometric average). Average output per worker in …ve richest countries (USA. Burkina Faso. Yj = Lj Kj Yj Kj Yj Aj Hj α 1 α Hj Aj Lj Hall & Jones (1999) use this equation to estimate contributions to output per worker in each country. Australia) exceeds average in poor group (Burundi. Malawi.

Hall & Jones
Now, the di¤erence in (Hall & Jones set α = 1/3)
K Rich Y Rich K Poor Y Poor
α 1 α

α 1 α

is 1.8. The di¤erence in

H Rich L Rich H Poor L Poor

is 2.2. And the di¤erence in

ARich APoor

8.3 (that makes 1.8 2.2 8.3 = 31.7). Thus most of the gap between richest and poorest countries is due to the residual, A. ... with no di¤erence in A the output di¤erence would be only 3.96 (= 1.8 2.2). Why?
Mark Weder (Adelaide) Economic Growth August 2008 54 / 68

Hall & Jones

Because: Investment rates are relatively similar. Moreover, the di¤erence gets raised to the power 1/2: Kj Yj
α 1 α

=

Kj Yj

1/3 1 1/3

=

Kj Yj

1 2

.

Similarly, the average educational attainment in the …ve richest countries is about 8.1 years greater. The di¤erence gets reduced when converted into an e¤ect on output (via Mincer return to schooling assumption).

Economic Growth

August 2008

55 / 68

Hall & Jones

To sum up, Hall & Jones …nd that (1) Di¤erences in physical and human capital matter but (2) there are also signi…cant productivity di¤erences.

Economic Growth

August 2008

56 / 68

Capital accumulation could act as the engine of sustained economic growth. asymptotically share of income accruing to it tends to 1. Mark Weder (Adelaide) Economic Growth August 2008 57 / 68 . But sustained economic growth is possible in the neoclassical model as well: AK model prevents diminishing returns to capital.Endogenous Growth Models so far: no sustained long-run growth. Models in which technology evolves as a result of …rms’ and workers’ decisions are most attractive in this regard (and we will discuss these). Shortcoming: capital is essentially the only factor of production. relatively little to say about sources of technology di¤erences. Neoclassical version of the AK model: Very tractable and applications in many areas.

thus wt will be equal to zero. De…ning kt = Kt /Nt as the capital-labor ratio yt = Kt Yt =A = Akt Nt Nt Notice output is only a function of capital.Ak model Rebelo (1991) Yt = AKt A>0 Does not depend on labor. Mark Weder (Adelaide) Economic Growth August 2008 58 / 68 . But introducing diminishing returns to capital does not a¤ect the main results in this section. and there are no diminishing returns.

The marginal product of capital is alwyas equal to A. Mark Weder (Adelaide) Economic Growth August 2008 59 / 68 .Ak model More important assumption is that the Inada conditions are no longer satis…ed lim f 0 (k ) = A k !∞ In fact.

δkt + sAkt kt +1 kt = kt δ + sA If sA δ > 0 economy grows endogenously (ie with exogenous technological change).Ak model Capital accumulates as kt +1 kt = = δkt + syt = δkt + sAkt δkt + s (wt + rt kt ) = δkt + srt kt thus kt +1 kt = . Mark Weder (Adelaide) Economic Growth August 2008 60 / 68 . No transitional dynamics: growth rates of consumption. capital and output are constant and given in last equation.

Ak model and policy Suppose there is an e¤ective tax rate of τ on the rate of return from capital income. Mark Weder (Adelaide) Economic Growth August 2008 61 / 68 . The e¤ective marginal return to capital will be (1 τ )Ak. now: kt +1 kt = δ + s (1 τ )A kt Since saving rate is constant. Repeating the analysis above this will adversely a¤ect the growth rate of the economy. di¤erences in policies will lead to permanent di¤erences in the rate of capital accumulation. Even small di¤erences in τ can have very large e¤ects.

Endogenous Growth via learning by doing and externalities Romer (1986). Arrow (1962). But some of the important characteristics of “knowledge” and its role in the production process can be captured in a reduced-form way by introducing technological spillovers. Di¢ cult in the context of a competitive economy. Sheshinski (1967) Romer (1986): model the process of “knowledge accumulation”. Solution: knowledge accumulation as a byproduct of capital accumulation. Technological spillovers: arguably crude. Mark Weder (Adelaide) Economic Growth August 2008 62 / 68 . Non-rivalry does not imply knowledge is also non-excludable. but captures that knowledge is a largely non-rival good.

Production function with labor-augmenting knowledge (technology) that satis…es Assumptions on Continuity. 1] of …rms. Mark Weder (Adelaide) Economic Growth August 2008 63 / 68 . The production function facing each …rm i is yi . and Constant Returns to Scale and the Inada conditions. Instead of working with the aggregate production function. assume that the production side of the economy consists of a set i 2 [0. Positive and Diminishing Marginal Products.t γ 0<γ<1 κ t stands for aggregate stock of capital. Nt = 1. Di¤erentiability.Endogenous Growth via learning by doing and externalities No population growth (we will see why this is important).t = Akiα κ t ni1.t α .

Motivated by “learning-by-doing”: "each new machine produced and put into use is capable of changing the environment in which production takes place. 1962." (Arrow.Endogenous Growth via learning by doing and externalities Key assumption: Firms take κ t as given. could be a function of the cumulative output that the economy has produced up to now. but this stock of technology (knowledge) advances endogenously for the economy as a whole. so that learning takes place with continuous new stimuli. κt = Z t ∞ I (v )dv Extreme assumption of su¢ ciently strong externalities such that κ t can grow continuously at the economy level. Mark Weder (Adelaide) Economic Growth August 2008 64 / 68 . 157) Alternatively.

t = Akiα κ t ni1.t α . In symmetric equilibrium αAkt and γ+α 1 1 α nt = rt α (1 α)Akt γ+α nt = wt Mark Weder (Adelaide) Economic Growth August 2008 65 / 68 .t γ (note that this is the private not social marginal product!).t γ yields αAkiα 1 κ t ni1.Endogenous Growth via learning by doing and externalities Pro…t maximization subject to yi .t α = rt .

Endogenous Growth via learning by doing and externalities αAkt and η +α 1 = rt = wt (1 α)Akt η +α Then per capita output is given by wt + rt kt = (1 and capital evolves as kt +1 kt = δkt + sAkt η +α α)Akt η +α + αAkt η +α 1 kt = Akt η +α Mark Weder (Adelaide) Economic Growth August 2008 66 / 68 .

Endogenous Growth Capital evolves as kt +1 kt η +α = sAkt kt 1 δ. Increasing returns to scale not su¢ cient for endogenous growth! We need very increasing returns such that η + α = 1: kt +1 kt = sA kt δ. Mark Weder (Adelaide) Economic Growth August 2008 67 / 68 .

Endogenous Growth Romer (1987) Researchers Mark Weder (Adelaide) Economic Growth August 2008 68 / 68 .