Income Disparity Among Countries and Endogenous Growth Chapter 7 Income Disparity Among Countries and Endogenous Growth

Convergence of Growth Experiences Prediction of the Solow model: Given the same n,s, and z, y converges among countries It is not entirely consistent with the data Question: Why? Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Maybe z is different across countries. Maybe different countries can have different growth rate, i.e., the growth rate can be endogenously determined. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Convergence: Theory and Evidence Unconditional convergence in Solow model. Data show convergence only in rich countries. Suppose that the countries do not have access to the same technology. There exists significant barriers to the adoption of new technology. Labor Unions Trade restrictions Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Differences in z imply differences in y Policy Implications The barriers to the adoption of new technology differ across countries imply differences in z across countries Differences in z imply differences in y Policy Implications Promote greater competition Promote free trade Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.1 Rich and Poor Countries and the Steady State Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.2 Convergence in Income per Worker Across Countries in the Solow Growth Model Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.3 Convergence in Aggregate Output Across Countries in the Solow Growth Model Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.4 Differences in Total Factor Productivity Can Explain Disparity in Income per Worker Across Countries Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

An Alternative: Endogenous Growth with Human Capital Accumulation Solow model is an exogenous growth model. It does not explain the growth itself! We need an endogenous growth model. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Why we cannot generate the unbounded growth in Solow model? The key is diminishing marginal return to capital stock (from concavity of production function) To have an unbounded growth, we need to break this trap. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Human Capital: stock of skills and education embodied in people. The acquisition of human capital is nonrivalrous. It has positive externality. It does not have the diminishing return. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

The Representative Consumer The economy only has one representative consumer (per capita=aggregate) who does not value leisure Assume he cannot save C=wuHs u is the fraction of time devoted to working, Hs is the current stock of human capital Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

The accumulation of human capital Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

The Representative Firm Production function Firm’s problem Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.5 Determination of the Equilibrium Real Wage in the Endogenous Growth Model Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Competitive Equilibrium The equilibrium wage is w=z. Labor market clears We have Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

The growth rate of human capital is It’s easy to show same holds true for C and Y. This model economy does not grow because of any exogenous forces. n=0, b and z are fixed. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.6 Human Capital Accumulation in the Endogenous Growth Model Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Economic Policy and Growth Change u through taxes or subsidies to education. The welfare effect depends on the trade-off b\w current consumption and future consumption. Government could also increase b by education policy Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.7 Effect of a Decrease in u on the Consumption Path in the Endogenous Growth Model Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Convergence in Endogenous Growth Model Convergence does not occur even if countries are identical in all respects except that there are differences in the initial level of human capital. Higher (1-u) means higher growth rate, hence implies higher y over time. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.8 No Convergence in the Endogenous Growth Model Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.9 Growth and Education Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Figure 7.10 Income per Worker and Education Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Class Discussion How should China do to improve long-run economic growth rate? How would China grow after the deplatation of “population dividend”? Copyright © 2005 Pearson Addison-Wesley. All rights reserved.