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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
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%
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.
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.
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
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.
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