Beyond the Beyond the Solow Growth Solow Growth ModelModel

Beyond the Solow Growth Beyond the Solow Growth ModelModel

Three Reasons to Go Beyond the Solow Growth Model (SGM)

The SGM doesn’t fit facts too wellSaving and Investment Don’t Seem to Always Foster GrowthTechnology is only a residual in the SGM (technological change is not explained but taken as a fact-of-life).

The SGM Doesn’t Fit the The SGM Doesn’t Fit the FactsFacts

The SGM predicts:that growth rates would decline as economies approached their steady statesconvergence - income per person of poor countries will catch up to that of rich countries

FactsWorld growth rates have not declinedConvergence hasn’t happened

SGM Predicts Rich Countries Grow More Slowly than Poor Countries

Growth in the United StatesGrowth in the United States

Period Annual Percent Changein Real GDP per Person

1800-1840 0.58%1840-1880 1.44%1880-1920 1.78%1920-1960 1.68%1960-2000 2.20%

Comparisons of Income per Comparisons of Income per CapitaCapita

Saving and Investment Don’t Always Foster Growth!

The SGM suggests that saving and investing cause economies to growThe Soviet Union is an exception to the rule

The Soviet Union saved and invested a tremendous amount of capital in its 80-year historyMost of the countries in the former Soviet Union have income levels comparable to developing countries

Explanations for Non-Explanations for Non-convergenceconvergence(or conditional convergence)(or conditional convergence)

Differences in the Quality of the Labor Force

EducationHealthSociological Aspects of Labor (Social capital)

Differences in InstitutionsIncreasing Returns to scale

Differing Quality of Differing Quality of LaborLabor

The adjustment for quality of labor makes

capital per quality adjusted person smaller in developed countries with more productive laborthe marginal product of capital in developed countries higher

The expanded SGM predicts that a developed country will grow faster.

Higher Education

Education and GrowthEducation and Growth

Differing InstitutionsDiffering 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.

Institutions

Corruption

Rule of Law

Foreign Aid and Social Capital

Increasing ReturnsIncreasing 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

Production Function - Increasing Production Function - Increasing ReturnsReturns

Production functionwith increasing returns

B: Constant Returns

Inputs

Ou

tpu

t

Inco

me

per

per

son

Time

A: Increasing returns

Why Increasing Returns Makes Why Increasing Returns Makes SenseSense

Geographical effects of technologyAreas where technology initially develops may have increasing returns

Hollywood, the Tropics

Learning by doingThe more one does something, the more productive one becomes

Textiles in Bangladesh, toys in China

Agglomeration effectsConcentration of similar firms increases the productivity for all area firms

Silicon Valley, Liverpool

New (Endogenous) Growth New (Endogenous) Growth TheoryTheory

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.

Capital, Labor and R&DCapital, Labor and R&D

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.

Not-So-New Growth TheoryNot-So-New Growth Theory

Not-So-NewNot-So-NewGrowth TheoryGrowth Theory

Joseph Schumpeter (early 20th century) Entrepreneurs

Developed From

Adam Smith(18th century)Specialization and Markets

Adam Smith

Specialization and the Specialization and the MarketMarket

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.

Joseph Schumpeter

The EntrepreneurThe 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.

Potential Growth Policies (?)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