1. Beyond the Solow Growth Model

2. Beyond the Solow Growth Model
Three Reasons to Go Beyond the Solow Growth Model (SGM)
The SGM doesn’t fit facts too well
Saving and Investment Don’t Seem to Always Foster Growth
Technology is only a residual in the SGM (technological change is not explained but taken as a fact-of-life).

3. The SGM Doesn’t Fit the Facts
The SGM predicts:
that growth rates would decline as economies approached their steady states
convergence - income per person of poor countries will catch up to that of rich countries
Facts
World growth rates have not declined
Convergence hasn’t happened

4. SGM Predicts Rich Countries Grow More Slowly than Poor Countries

5. Growth in the United States
Period Annual Percent Change
in Real GDP per Person % % % % %

6. Comparisons of Income per Capita

7. Saving and Investment Don’t Always Foster Growth!
The SGM suggests that saving and investing cause economies to grow
The Soviet Union is an exception to the rule
The Soviet Union saved and invested a tremendous amount of capital in its 80-year history
Most of the countries in the former Soviet Union have income levels comparable to developing countries

8. Explanations for Non-convergence (or conditional convergence)
Differences in the Quality of the Labor Force
Education
Health
Sociological Aspects of Labor (Social capital)
Differences in Institutions
Increasing Returns to scale

9. Differing Quality of Labor
The adjustment for quality of labor makes
capital per quality adjusted person smaller in developed countries with more productive labor
the marginal product of capital in developed countries higher
The expanded SGM predicts that a developed country will grow faster.

10. Higher Education

11. Education and Growth

12. Differing 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.

13. Institutions

14. Corruption

15. Rule of Law

16. Foreign Aid and Social Capital

17. Increasing 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

18. Production Function - Increasing Returns
with increasing returns
Output
A: Increasing
returns
Income per person
B: Constant Returns
Inputs
Time

19. Why Increasing Returns Makes Sense
Geographical effects of technology
Areas where technology initially develops may have increasing returns
Hollywood, the Tropics
Learning by doing
The more one does something, the more productive one becomes
Textiles in Bangladesh, toys in China
Agglomeration effects
Concentration of similar firms increases the productivity for all area firms
Silicon Valley, Liverpool

20. New (Endogenous) Growth Theory
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.

21. Capital, 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.

22. Not-So-New Growth Theory
Adam Smith
(18th century)
Specialization
and Markets
Not-So-New
Growth Theory
Developed
From
Joseph Schumpeter
(early 20th century)
Entrepreneurs

23. Adam Smith

24. Specialization and the Market
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.

25. Joseph Schumpeter

26. The 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.

27. 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