Topic 3 : Transition to Modern Economic Growth
Department of Economics
University of Warwick
November, 2013
1. What are the main features of endogenous growth theory?
First, let’s talk about the Solow growth model, an
exogenous growth model
Y = F (L, K ) : aggregate production (output)
L : aggregate population (labor force), K : aggregate capital
Define y =
Y
L
: output per head, k =
K
L
: capital per head
s : saving rate (fixed or exogenously given)
Then sY : amount of saving which is equal to investment
1. What are the main features of endogenous growth theory?
some technical stuff,
Define n =
L̇
L
: population growth rate where L̇ =
∂L
∂t
We can think of L̇ as change in population
Also K̇ = sY → change in capital is equal to investment
1. What are the main features of endogenous growth theory?
some more technical stuff,
we know k =
K
L
k̇
k
= ( KL˙ )/( KL ) =
∴
K̇
K
=
Then,
k̇
k
+
L̇
L
sy
k
=
k̇
k
and
K̇
K
=
∂
K
∂t (ln L )
+ n (as
Therefore k̇ = sy − nk
K̇
K
sY
K
=
=
=
sy
k
∂
∂t (ln K
sy
k
and
L̇
L
− ln L) =
= n)
K̇
K
−
L̇
L
1. What are the main features of endogenous growth theory?
Equation, k̇ = sy − nk determines the dynamic of economic
growth in Solow model.
k̇ is change in capital per head
If sy > nk, then k̇ > 0 → k increases
If sy < nk, then k̇ < 0 → k decreases
Intuitively, in order to increase k, you have to save (invest)
enough (sy ) to offset the decrease in k due to population
growth (nk).
1. What are the main features of endogenous growth theory?
Equation, k̇ = sy − nk determines the dynamic of economic
growth in Solow model.
k̇ is change in capital per head
If sy > nk, then k̇ > 0 → k increases
If sy < nk, then k̇ < 0 → k decreases
Intuitively, in order to increase k, you have to save (invest)
enough (sy ) to offset the decrease in k due to population
growth (nk).
1. What are the main features of endogenous growth theory?
Then how does k̇ determines y (income per head)?
We can define y = f (k) from y =
Y
L
= f ( KL , LL ) = f (k, 1)
1. What are the main features of endogenous growth theory?
y, nk
nk
y = f(k)
y***
y*
sy = i
y**
k**
k*
k***
k
1. What are the main features of endogenous growth theory?
If initially, k = k ∗∗∗ then nk > sy (k̇ < 0) → k (also y ) ↓
If initially, k = k ∗∗ then nk < sy (k̇ > 0) → k (also y ) ↑
At k ∗ , sy = nk then k̇ = 0 → k (also y ) does not change
k ∗ is called steady state
1. What are the main features of endogenous growth theory?
Basically, economic growth in Solow model is the process of
converging to the steady state.
So one important mechanism to have economic growth in this
model is by accumulating more capital (by saving).
But this mechanism has some limitations in achieving
sustained economic growth (why?)
The model also implies one needs to have increase in TFP to
have sustained economic growth.
But in this model, TFP is exogenously given and fixed across
countries.
1. What are the main features of endogenous growth theory?
On the other hand, the endogenous growth models say TFP is
endogenously determined
Assume a production functionY = A F (K , L)
where A =TFP and F (K , L) = output generated by inputs.
Exogenous (Solow) model assumes A is a given number and
exogenous to the model. But endogenous model assumes A is
determined within the model
1. What are the main features of endogenous growth theory?
For example A = λK . A is an increasing function of capital.
A rationale behind this assumption is that investments
produce not only capital but also knowledge.
This guarantees sustained economic growth as more capital is
accumulated.
2. What was the role of institutions in modern economic growth?
Let’s focus on the institutional change after the Glorious
Revolution and its implications (North and Weingast, 1989)
The Stuart monarchy was always in deficit but the parliament
mostly did not approve the tax raise.
Methods to raise revenue include
- “forced loans”
- sales of monopolies
- selling hereditary titles
- simple expropriation
Also the Crown had some prerogative powers over the
common law
2. What was the role of institutions in modern economic growth?
loans.pdf
2. What was the role of institutions in modern economic growth?
Following the Glorious Revolution
- the era of parliamentary supremacy
- curtailed the Crown’s prerogative power
All these changes resulted in ‘financial revolution’ which
- secured property rights
- stabilized public and private debt markets
- resulted in growth and development of financial
intermediaries (Bank of England)
As a result, capital markets flourished
This change in institution, they argue, was the cornerstone of
the Industrial Revolution
2. What was the role of institutions in modern economic growth?
3. How did other North-Western European countries compare with Britain?
Kuznets’ characteristics
1)
2)
3)
4)
5)
6)
High rates of per capita output and population
Productivity or intensive growth
Structural transformation
Changes in the structure of society
Opening up of international communications
Wide gap between developed and under-developed nations
While Britain satisfies all 6 characteristics of MEG,
Netherlands misses out some.
1st criterion : It had high growth in per capita income but it
wasn’t sustained.
2nd criterion : It also had growth in productivity but it was
mainly based on Smithian growth based on specialization, not
technical progress in industry.
3. How did other North-Western European countries compare with Britain?
3rd criterion : It experienced shift from agriculture to industry
and service sectors, but never moved to large scale factories.
4th, 5th and 6th conditions are well met in Dutch economy.
In some aspects Dutch growth was clearly modern, but not all.
5. What was the role of technology and incentives in the industrial
revolution?
In Britain, wage was high but energy was cheap.
Famous inventions of Industrial Revolution are responses to
this condition.
More of labour-saving and resource-using technologies were
developed.
Examples include steam engine, spinning and weaving
machines and iron making process.
7. What are the main features of unified growth theory?
Malthusian Regime
The economy is Malthusian steady-state equilibrium.
Technological progress is slow.
The return to human capital is low rightarrow parents have
no incentive to substitute child quality for quantity
Temporary increase in income increases population
proportionally.
Output per capita fluctuates around a stationary level and
then around an increasing but minor trend.
The inherent Malthusian interaction between population and
technology gradually increases both population size and the
rate of technological progress.
7. What are the main features of unified growth theory?
The Post-Malthusian Regime
The pace of technological progress increases due to the
Malthusian interaction between population.
Income per capita and population grow at an increasingly
faster rate.
The demand for human capital gradually increases towards
the end of the period.
7. What are the main features of unified growth theory?
The Post-Malthusian Regime
Technological progress and the rise in the demand for human
capital has two effects
- Income Effect : More resources for raising children
- Substitution Effect : Reallocation towards child quality
The income effect dominates and both population quantity
and quality increases
Output per capita increases along with increase in the rate of
population growth
7. What are the main features of unified growth theory?
Demographic Transition and Sustained Growth
Technological progress intensifies further due to the gradual
increase in the level of human capital
Demand for human capital further increases
The substitution effects dominates and fertility rates decline
permanently, permitting the gain in productivity to be
permanently transformed into gains in output per capita
The economy converges to a steady state where output per
capita grow at positive rate and population growth is
moderate
8. What are the virtues and weaknesses of unified growth theory?
Deterministic view
Unlikely that all economies have to pass through stages in
same order
ex) France
Huge income variances across countries can not be explained
No role for institutions