2. Udviklingsøkonomi - grundfag Lecture 4 Convergence? 1

3. Summing up: one-sector growth models Harrod-Domar (capital fundamentalism) Savings and population growth drive growth of national income There is constant returns to capital, and the capital-output ratio is constant Policy implications: 1.Domestic savings, s should be increased 2.Foreign capital can substitute if domestic savinsg are too low 3.Capital should be applied (invested) more efficiently (unfortunately this was often forgotten…) Solow (neoclassical growth theory) Technological progress and population growth drive long run income growth Decreasing returns to capital mean that accumulation of capital is insufficient Policy implications: Savinsg affect the level of income but not its rate of growth How to share in technological progress? 2

4. 3 Why convergence? Catching up (intuition): 1.Technology is a global public good – is spread among countries 2.Change from agriculture to industry has a higher pace in poor countries 3.Falling marginal returns to capital, (Solow model) Convergence in the Solow model: All countries converge to a steady state growth path characterized by the parameters s, n og A If all the parameters of the Solow model are the same across countries we have converge to the same steady state – unconditional converge If the parameters of the Solow model are not the same, but the speed of technical progress is the same, we have convergence to same rate of growth – conditional converge

5. 4 Testing unconditional converge Interpretation: If b < 0 poor countries grow faster, indicating unconditional converge If b > 0 rich countries grow faster – divergence Two types of data: 1. Few countries, long time series 2. Many countries, short time series (fra 1960 eller 1970) regress g = a + b log y t0 + e

6. 5 Results 1.Baumol (1986): 16 rich countries, 1870-1979 Finds unconditional converge His countries differed in 1870, but are all rich and alike today But there is ’selection bias’; these countries are not selected randomly (”winners write economic histrory”) 2.De Long (1988) adds 8 countries that (seen with the eyes of 1870) should have caught up (eg Argentina, Ireland, Spain) unconditional converge does not hold 3.In scatterplots of average growth versus initial income we do not see convergence Conclusion: unconditional converge does not hold!

7. 6 Conditional converge Parameters (of the Solow model) may differ Each country converges towards its own steady state remember: g^* = A (technical progress) Assume A similar in all countries (knowledge is a public good) Leads to convergence towards same rate of growth But tests should condition on where the steady- statecurve is Countries above their S-S curve grow slowly Countries below their S-S curve grow faster

8. 7 Econometrically testing conditional converge Consider the Solow model: In steady-state It can be shown that Mankiw, Romer and Weil (1992) regress 1985 per capita GDP on s and on (n+0.05) using cross-sections of countries. Find s and n to have large explanatory power: s positive effect (+1.47) n negative effect (-1.97) But the simple Solow model does not quite hold, because these coefficients are 1) too large 2) not alike 3) cross country income differences larger than predicted

9. 8 Summing up so far Unconditional convergence rejected Conditional convergence (controlling for savinsg and population growth) Perhaps Not completely unreasonable Neoclassical growth models focus on 1.Savings, investment 2.Population growth 3.Technological progress -Empirically important -But not explained by the model (ie the rate of growth is determined exogenously outside the model) The rest of this course will try to 1.Assess the determinants of savings, investment, population growth and technical progress 2.Other factors that are also important (environment, poverty, inequality, market efficiency etc) Why doesn’t capital flow from rich to poor countries???

10. 9 Human capital Augmenting the Solow model with human capital can improve its ability to explain cross country income differences  Human capital = education, health, nutrition, knowledge, experience  Why is this a form of ”capital”?  How is it treated in the national accounts?

11. 10 A simple growth model with human capital Where h is human capital, and the economy saves in both physical (s) and human capital (q) Constant returns to physical and human capital combined. Ignore depreciation, land and unskilled labour. In steady state y, h and k all grow at the same speed In steady state h/k = q/s, and The rate of growth is

12. 11 Implications of the human capital model 1.No unconditional convergence (despite diminishing returns to capital alone) 2.s and q affect both the level and the growth rate of income; the rate of growth is determined endogenously. Why doesn’t capital flow from rich to poor countries??? Developing countries lack both human and physical capital. Return to capital is therefore not (enormously) higher than in rich countries. For this and other reasons capital does not flow (soo much) to the developing countries

13. 12 NOTICE Constant returns (all inputs can be accumulated) Decreasing returns (one or more fixed inputs cannot be accumulated) Accuumulation drives growth Technical progress required to explain continuing growth The simple human capital model had constant returns to scale in all inputs. If there are fixed inputs such as land or unskilled labour, there will be decreasing returns to the accumulated inputs and its results will no longer hold

14. 13 Next lecture Will look at the role of technical progress What was most important for South- East Asia’s ”Miracle” growth: technical progress, or Just rapid growth of human capital??? Read Ray chapter 4 to find out!