MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT 4/27/2019 MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT 2nd edition Endogenous Growth and Convergence PowerPoint by Beth Ingram University of Iowa Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Key Concepts Endogenous growth Conditional convergence Poverty traps Steady state determinants

Sources of growth Exogenous growth (Solow model) Endogenous growth Capital produces growth until economy reaches steady state Continuous growth arises from technological progress Technological progress is exogenous to model Endogenous growth Provide explanation internal to the model

Constant MPK Output Capital Stock Output = AK K: Capital Y: Output A: Parameter s: Investment Rate Output Investment = sY Depreciation Capital Stock

Constant MPK Output Capital Stock Output = AKLb Investment = sY Depreciation K0 K1 Capital Stock

Does constant MPK make sense? Interaction between physical and human capital Suppose increase in K induces increase in human capital? Consider IT investment and education This represents a spillover effect

In equation form Output = A x (Human capital)b x Ka x Lc Output = A x (DxK)b x Ka x Lc Output = A x (D)b x Ka+b x Lc

Social versus Private Return Output = A x (DxK)b x Ka x Lc Private Return measured by this term

Social versus Private Return Output = A x (DxK)b x Ka x Lc Extra return due to spillover effect

Case: a + b < 1 Marginal product of capital Cost of Capital, r/p Social MPK Private MPK KP KS Capital Stock

Effect of subsidy Private MPK Social MPK Marginal product of capital Cost of Capital Cost of Capital with subsidy KP KS Capital Stock

Poverty Traps Increasing MPK MPK Marginal product of capital Cost of Capital, r/p K0 Capital Stock MPK is less than cost of capital, so capital decreases to zero

Poverty Traps Increasing MPK MPK Marginal product of capital Cost of Capital, r/p K0 Capital Stock MPK is higher than cost of capital, so capital increases continuously

Why increasing MPK? Agglomeration Interdependencies in inputs Spillovers Increasing MPK leads to income divergence between sectors (states, countries, etc.)

Just the facts, Ma’am What does the data say about convergence? What does convergence mean empirically? Levels of income should coincide in the long run Low income countries grow faster than high income countries Higher MPK for low income countries

Growth and per capita GDP Annual Growth rate, 1980 - 2000 Real GDP per capita 1980, USD Source: Penn World Table

Top 10 in Real GDP per capita, 1980 Ireland Annual Growth rate, 1980 - 2000 USA Switzerland Argentina Real GDP per capita 1980, USD

Conditional Convergence Little evidence of convergence across all countries Some evidence of convergence for select, similar countries Countries may have different steady states

Two Steady States Output Depreciation Real GDP Investment (30% of GDP) SS 1 SS 2 Capital Stock

What determines the steady state? Level of investment and savings Accumulation of human capital (education) Government policies Economic environment (e.g., corruption, property rights, crime)

Empirical Evidence Data supports conditional convergence Investment, education, health have positive effects on growth Effects of other variables are harder to discern in available data

Determinants of steady state for selected countries, 2001 Table 6.2

4/27/2019 Why is Africa so poor? Africa Focus is a site with lots of info on Africa, including country studies.

Possible explanations Ethnic/linguistic diversity Climate and disease Colonial influence The impact of aid

Summary Constant MPK Increasing MPK (spillovers and interactions) Poverty traps Factors affecting steady state The example of Africa Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained therein.