Beyond the Basic Solow Growth Model, Part 1 Agenda. The Basic Solow Growth Model. The Basic Solow Growth Model. The Basic Solow Growth Model

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1 Beyond the Basic Solow Growth Model, Part genda The. Shortcomings The Growth ccounting Formula. The The : depends on v, n-dot, δ, and. Changes in v, δ, and lead to changes in the level of but they affect y-dot only during the transition period. The The ssumes countries have similar technology. The production function, v, δ, n-dot, and will be similar. ssumes is fixed; a-dot = 0. Implies differences in are only explained because of differences in. The The Basic Solow Model Predicts that: Persistent growth in stops at the steady state. Growth slows as the steady state is approached. Higher v always implies higher. Poor countries always grow faster than rich ones. ll countries converge to the same. Prediction #: Once the steady state has been achieved, there is no persistent growth in. () Solow Growth Model 5 () 6

2 persistent growth in has continued. Long-run Economic Growth 7,000BCE 0 500CE Prediction #: For any country, growth rates should decline over time as economies approach their steady states. () () H () L Solow Growth Model 9 () L () H() 0 Growth rates have actually accelerated. Long-run Economic Growth,000BCE 0 500CE

3 Increase v Prediction #: higher v always raises. nd promotes faster y-dot during the transition period. () B () () B () B () () B Higher saving and investment don t always foster faster growth. If capital is misallocated, it can even lower. Investments must be effective. India in the 950s. Housing, booms in non-productive assets. Prediction #: Poor countries should always grow faster than rich countries. There should be an inverse correlation between (an initial) and (subsequent) y-dot. 5 6 verage nnual Growth Rate Over Period. Poor countries have NOT always grown faster than rich ones. Real Income per Worker in Start Year. 7 8

4 Prediction #5: ll countries converge to the same. This is known as The Convergence Hypothesis. lso known as bsolute Convergence. 9 0 The Convergence Hypothesis () () R () P Convergence hasn t happened everywhere. Income per capita as % of US has not narrowed. () R () () P Failures of the : Does NOT explain accelerating growth rates. Does NOT explain persistent growth. Does NOT explain why increasing v does not always lead to higher. Does NOT explain why poor countries don t always grow faster than rich countries. Does NOT explain non-convergence.

5 Moving Beyond the We must think more broadly about how growth rates are determined and what can be done to increase them. We do this through the Growth ccounting Formula. 5 Growth ccounting Formula From the production function Y = * f( N, K ) = * N x * K (-x) y-dot = a-dot + x * n-dot + ( x ) * k-dot n-dot and k-dot are weighted by the factor s relative importance in production Where x is labor s share of output (70%) nd x is capital s share of output (0%) Independent of the form of the production function 6 Growth ccounting Formula Growth ccounting Formula Growth accounting formula y-dot = a-dot + x * n-dot + ( x ) * k-dot y-dot depends on a-dot, n-dot, and k-dot Identifies the contributions of N, K, and to y-dot 7 If y-dot = a-dot + x * n-dot + ( x) * k-dot Then a-dot = y-dot x * n-dot ( x) * k-dot Since y-dot, n-dot and k-dot can be measured, a-dot can be calculated. Indirect measurement of a-dot. a-dot is a residual, called the Solow residual. 8 Contribution in Percent per Year Historical Growth ccounting Sources of Growth Technological Change Capital Labor 5 Growth ccounting Formula a-dot accounts for a significant portion of growth, and fluctuations in growth, in developed countries. To permanently increase y-dot must permanently increase a-dot

6 Growth ccounting Formula If a-dot = 0 nd n-dot = k-dot = % Then y-dot = % y-dot = 0% * % + 0. * % = % This is a balanced growth path. Steady state position Growth ccounting Formula If a-dot = % nd n-dot = k-dot = % Then y-dot = % y-dot = % * % + 0. * % = % Even though is constant, increases. Production function has shifted upward. Exogenous Technological Change Nonfarm Business Productivity constant a-dot > 0 is better than a-dot = 0 The Solow growth model does not show rising unless a-dot > 0. Cannot adequately explain long-run growth without explaining the determinants of a-dot Challenge is to explain changes in a-dot Slowdown in a-dot in Speed up in a-dot since 995. Percent per nnum