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Part 3. 1. We still have diminishing returns to physical capital (k). But: we have constant returns to h and k combined. ◦ In basic Solow, this resulted.

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Presentation on theme: "Part 3. 1. We still have diminishing returns to physical capital (k). But: we have constant returns to h and k combined. ◦ In basic Solow, this resulted."— Presentation transcript:

1 Part 3

2 1. We still have diminishing returns to physical capital (k). But: we have constant returns to h and k combined. ◦ In basic Solow, this resulted in convergence to the same steady state level of k ss & y ss. ◦ Not here: Even if all countries have similar savings rates (q &s), in the long run steady state, these countries will converge to the same long run growth rate  any initial differences in k 0 & y 0 will persist through the long run. ◦ Why? In the basic Solow, k was not a source of growth due to diminishing returns  But after adding human capital h to our k, diminishing returns to both are much less severe! We have constant returns to h and k combined.

3 2. (q) & (s) have growth effects (not just level effects) as in basic Solow.  When savings rates affect growth rates, models are called endogenous growth models  Growth rates are determined within the model, not exogenously through something like technological change (π)

4 3. Human capital model may help explain why rates of return to physical capital are low in poor countries. ◦ Intuition from Easterly:  Mankiw noted that human capital (people with skills) could not move across countries, but physical capital could.  Thus if poor countries have low (h), investors do not want to invest there because you need high (h) to get a good return on capital equipment (k).  Thus: countries invested in high skilled countries - - thus capital flows to rich countries.

5 4. Convergence…do we see it? ◦ Recall first: unconditional convergence ◦ Below is Baumal’s study and De Long’s critique ◦ Point: we know that unconditional convergence does not hold in the basic Solow model

6 4. Convergence…do we see it? ◦ But…what if we account for ["condition" on] the stock of human capital (h)?? ◦ When estimated with data we find: ◦ If we estimate with data and find:  β1<0: means rich countries grow slowly and poor countries grow fast  conditional convergence: after controlling for (h 1960 ), poor countries can grow faster  β2>0: means countries with high (h) will grow more quickly  conditional divergence: after controlling for (y 1960 ), countries with more human capital grow faster  Putting it all together: Rich countries have more human capital ⇒ model predicts neutrality in growth rates income per capita.

7 4. Convergence…do we see it? ◦ Intuition from Easterly:  Mankiw finds that once controlling for capital accumulation (k) and education (h), poor countries did tend to grow faster.  But: it is not necessarily true that all countries were moving toward the same destination (as with Solow)  rather countries with different savings rates of capital & human capital accumulation could head to different destinations.  Further, being poor relative to your own steady state destination, did mean that you would grow faster toward that destination ◦ Points:  controlling for (or conditioning on) h, poor countries grow faster but countries with more h also grow faster.  Countries with different savings rates of h accumulation grow differently and grow in different directions.  Countries don't converge to same spot, but converge in growth rates.


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