Endogenous growth theory

II. The empirics of GDP growth

Questions

• What are the variables (institutional, cultural, demographic…) which determine GDP per capita and/or LT growth

• Do we expect poor countries close the gap with rich countries?

• What are the policies/institutions which allow such convergence to take place

An industry developed in the 1990s

• Take a cross-section of countries• Regress their growth performance over a given

period on a set of explanatory variables:– Investment– Education– Financial development– Corruption– Age– Political variables: coups, etc…

• Then write a World Bank report saying that variable X is “good for growth”

The findings:

• A recent paper by Sala-i-Martin et al. runs a horse-race between a large number of specifications involving more than 67 variables

• They rank variables by robustness using Bayesian techniques

A distribution of estimators across models:

The most robust variables:

The shortcomings

• Whether we are really talking about growth depends on the specification

• The economic interpretation of these regressions is not clear

• Many variables are not robust

The initial income problem:

• If initial income is not included in the regression, we estimate a permanent sustainable growth rate

• If it is and has a negative coefficient, we estimate the long-run output level

• It can only grow if– One of the explanatory variables grow (but

most can’t)– A growth trend affects all countries

The interpretation problem

• Some variables affect growth because they proxy for the growth in the inputs of the production function: education, investment, etc…

• Others matter because they affect human behaviour and therefore how the economy accumulates these inputs

• Finally, whether initial income should enter depends on how the input contributions are specified

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Convergence in neo-classical models

• Neo-Classical models: each country converges to its own steady state

• All own steady states grow at the same rate

• But the level depend on policies, savings rates, etc

Similar countries converge to same GDP per capita

Convergence in endogenous growth models

• A laggard never closes the gap

• Therefore, no convergence in income levels

• This because MPK is no higher for the laggard

• Furthermore, differences in policies affect the long-run growth rate

Looking at convergence allows us to

• Test the relevance of endogenous growth models

• Assess the magnitude of the returns to accumulable factors

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Two approaches

• Barro and Sala-i-Martin: take a data set of similar economic units and look at convergence between them in pc GDP

• Mankiw-Romer-Weil: take a cross-country regression of growth rates on initial income controlling for own long-run steady state

Barro and Sala-i-Martin

• They use a data-base of U.S. states over a long-run period

• They estimate the equivalent of our local speed of convergence regression:

The BSM Universal Law of Convergence:

The speed of convergence is 2 % per year

What do we expect?

• The Solow model predicts (δ+g)(1-α)

• A reasonable calibration is δ=0.06, g=0.02, α=0.3

• This gives v=5.6 % per year

How universal is the law?

Findings:

• The more similar the countries, the more it holds unconditionally

• The less similar the countries, the more likely we find divergence

• But the law is restored if controls are added, controlling for own steady state

How to eradicate poverty?

• 1. Adopt the policies and institutions of advanced countries

• 2. Wait!

• How long? Suppose I am 10 times poorer than the US. How long does it take to be 2 times poorer?

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What do we get?

• With v=0.02, ρ0 = 0.1, ρ1 = 0.5, t = 60 years!

• With v=0.056, we instead get t = 21 years

• We want to understand why the speed of convergence is so low

• Can policy increase the speed of convergence?

Gloom?

• In principle, the speed of convergence only depends on the deep technological parameters

• That it is low tells us that the technology is not what we thought it was

• But it does not tell us we can increase v

Mankiw-Romer and Weil

• National accounts suggest that the elasticity of capital is 0.3

• Speed of convergence is more like

1-v/(g+δ) = 1-0.02/0.08 = 0.75

• To reconcile these two facts, they introduce another form of capital: Human capital

The Augmented Solow model

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Explaining cross-country differenced in pcGDP:

• The preceding equations define “own” steady state

• They use it to see if it explains cross-country income differences:

Measuring sH

What have we learned?

• We have seen that with α = 0.3, it is difficult to explain X-country income differences

• But now what matters is α + β, which acts as α

• So with α + β large enough we can explain cross-country differences.

• A natural question is: can we also expect slow convergence?

Recomputing the speed of convergence

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Empirical strategy

• Investment rates and schooling are kept to proxy for own steady state

• Initial output is added

• Coefficient in initial output related to SOV as in BSM

• No other control variable is added in strict interpretation of Solow model

Old Solow does not work…

…but new does.

Does it add up?

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Summary

• The Solow model predicts too low income disparities and too quick convergence

• The AK model predicts zero convergence and widening disparities

• The Augmented Solow model does well to predict both the disparities and the speed of convergence