A Contribution to the Empirics of Economic Growth

1. A Contribution to the Empirics of EconomicGrowth PSME M1 EconomicGrowth Tutorial

2. Contents • Introduction • Review of Classic Solow Model • Shortfalls of Solow • Human Capital Accumulation • Convergence Theory and Model Prediction • Theoretical Solow Model • Estimation results of Classic Solow Model and Analysis • Augmented Solow Model and itsPredictions • Estimation resultsof Augmented Solow Model and Analysis • EndogenousGrowth and Convergence

3. Introduction • Paper by Mankiw, Romer and Weil • Published in The Quarterly Journal of Economics, Vol 107, No. 2, 1992, pg 407-437 • Paper examines whether the Solow growth model is consistent with international variation in the standard of living

4. Paperaims to fill up someshortfallings of the Solow model • Solow model isaugmentedwithhuman capital as well as physical capital accumulation • An augmented Solow model is a betterrepresentation of cross-country data • Prediction of the model isthat by holding the population growth and capital accumulation constant, countries converge in terms of standards of living at a given Solow convergence rate

5. Review of Classic Solow Model • Standard neoclassical production functionwithdecreasingreturns to capital (and labor) • Treatsavings and population rate as exo (s and n are given) • s and n determine the steady-state level of income per capita [(f(k*)] ={(n+δ)/s} k*) • If s ishigher, then f(k*) islarger -> the higher the saving rate, the richer the country • If n ishigher, then f(k*) issmaller –> the higher the pop rate, the poorer the country

6. Shortfalls of Solow • Using cross-country data, paperfindsthat s and n affect income in the directions predicted by Solow • Problemisthat the magnitudes are not coherant • Mightbeomitted variables soneed to includehuman capital accumulation

7. Human Capital Accumulation • For anygiven rate of human capital accumulation, higher s or lower n leads to higher f(k*) and thus a higherlevel of H* • Human capital accumulation maybecorrelatedwith s and n, leading to omitted variable bias • According to paper, the augmented Solow model provides an almostcompleteexplanantion (80% of country income variation isexplained) of whysome countries are rich and others are poor

8. Convergence Theory and Model Prediction • The article argues thatthereis no absolute convergence (countries need not converge in per capita income) • Rather, thereisconditional convergence (countries generally converge to theirrespectivelydifferentsteady state incomes) • Finally, the model predictsthatpoor countries tend to have higher rates of return to physical and human capital

9. Theoretical Solow Model • Given exo s, n and g (rate of techprogress) and a Cobb-Douglas production function • Solow predictsα=1/3

10. Estimation Results of Classic Solow Model

11. ResultAnalysis • 3 aspects of model issupported • (1) Coefficients of s and n have predictedsigns and are highlysig • (2) Restriction on coefficients of s and (n+g+δ) is not rej • (3) Differences in s and n account for a large fraction of cross-country variation (R^2=0.59) • Problemwithα (≠ 1/3 as predicted)

12. Augmented Solow Model

13. Predictions of Augmented Solow • Human capital accumulation increases the impact of physical capital on income • High population growthlowersincome per capital because the amounts of bothphysical and human capital must bespread more thinly over the population • Use percentage of working-age pop thatis in secondaryschool as a proxy for human capital accumulation

14. Estimation Results on Augmented Solow Model

15. ResultAnalysis • Human capital issignificantis all threesamples • Size of coefficient on physical capital accumulation isreduced • Fit of regressionisimproved • The paperconcludesthataddinghuman capital to the Solow model improvesits performance

16. EndogenousGrowth and Convergence • Endogenousgrowthmodels are characterized by non-decreasingreturns to inputs • Impliesthat countries thatsave more growfasterindefinitely and countries need not converge in income per capital even if they have the samepreferences and technology • The Solow model predictsthat countries reachdifferentsteady states (conditional convergence at the rate the model predicts)

17. Conclusion • The paper argues that the Solow model is consistent with the international evidencewhenaugmentedwithhuman and physical capital • The augmented Solow model saysthatdifferences in saving, education and population growthshouldexplain cross-country differences in income per capita • Direct furtherresearch on exo variables thatvaryacross countries egdiff in taxpolicies, educationpolicies, etc