Chapter 8

Cypher & Dietz

Neoclassical Growth Models: the Solow Growth Model

Y(t) =A(t)K(t)1-a L(t)a where 0<a<1; in a perfectly competitive setting where each factor input is entitled

to a return equal to its own marginal product,a = income share of labor1-a = income share of capital.

This production function is such that K and L are subject to diminishing returns in the short term. production is subject to constant returns to scale in the long term.

y = Y/L = (s/n)a/1-a

where s=savings rate; n=exogenous population growth rate

Neoclassical Growth Models: the Solow Growth Model

Implications of the Neoclassical Growth Model for Developing CountriesThe Model predicts CONVERGENCE: Developing economies will sooner or later

catch up with developed economies. This result follows directly from the

assumption of diminishing returns to capital.

Convergence is based on two strong assumptions:

1. All countries have access to the same technology

2. All countries share similar savings (and investment) rates

from the Neoclassical Growth Model to Developmentalist Theories of DevelopmentSolow’s theoretical structure lent credence to

Developmentalist Theories → Growth depends on

expansion of industrial capital stock; and the rate of savings.

“the big push”; “balanced vs. unbalanced growth”, etc.

Both optimistic in development potential and eventual convergence (decreasing income gap)

The Income Convergence Controversy (Table 8.1)

The Income Convergence Controversy (Table 8.2)

The Income Convergence Controversy: An Institutionalist Economic Perspective

Path DependenceVicious circlesVirtuous circles

However, Path Dependence is not ultimately binding

Endogenous Growth Models as an Answer to the Income Convergence Controversy

Empirical research found that over 50% of the growth rate of a country can not be accounted for by changes in the use of capital and labor, leaving the unexplained Solow residual as the major determinant of growth rates.

ENDOGENOUS GROWTH Models emerge in the 1980s as an effort to account for the unexplained residual through a host of other factors such as education, R&D, technology and so on.

Endogenous Growth ModelsY = F(R,K,H)

Y= total output; R= research & development; K= physical K; H= human K

Let Kt = combined stock of human, physical and research capital; Assuming constant returns to scale as well as constant marginal returns to K stock, the EG Models suggest the so-called AK production function

Y = aKt

To capture the endogeneity of the growth process, the aggregate production function can be rewritten as

Y = A(Kt)Kt

A(Kt) = induced/endogenous tech. Change imparted to the economy by the stock of physical, human and research K particular to that country

Endogenous Growth ModelsEndogenous Growth Models are different from the

Neoclassical Growth Models in that No assumption of physical K to be the dominant determining

factor in spurring economic growth, other factors such as human K is integrated;

drop the assumption of diminishing returns to reproducible factors of production;

Technology is not assumed to be exogenous but rather endogenous.

As such in EG Models sustained growth is possible even without a change in the savings rate or an exogenous boost to technology

Therefore EG Models are able to explain the sustained or even increasing income gap between developed and developing economies.

An Endogenous Growth Production Function Figure 8.1

Some Empirical Findings on EG Models Table 8.3

Some Empirical Findings on EG Models Table 8.4