Chapter 8
Cypher & Dietz
Neoclassical Growth Models:
the Solow Growth Model
Y(t) =A(t)K(t)1-a L(t)a
where 0<a<1;
in a perfectly competitive setting where each factor input is entitled to a return
equal to its own marginal product,
a = income share of labor
1-a = income share of capital.
This production function is such that
 K and L are subject to diminishing returns in the short term.
 production is subject to constant returns to scale in the long term.
y = Y/L = (s/n)a/1-a
where s=savings rate;
n=exogenous population growth rate
Neoclassical Growth Models:
the Solow Growth Model
Implications of
the Neoclassical Growth Model
for Developing Countries
The Model predicts CONVERGENCE:
 Developing economies will sooner or later catch
up with developed economies.
 This result follows directly from the assumption
of diminishing returns to capital.
Convergence is based on two strong assumptions:
1. All countries have access to the same technology
2. All countries share similar savings (and
investment) rates
from the Neoclassical Growth Model to
Developmentalist Theories of Development
Solow’s theoretical structure lent credence to
Developmentalist Theories → Growth depends on
 expansion of industrial capital stock; and
 the rate of savings.
 “the big push”; “balanced vs. unbalanced growth”, etc.
 Both optimistic in development potential and eventual
convergence (decreasing income gap)
The Income Convergence Controversy (Table
8.1)
The Income Convergence Controversy (Table
8.2)
The Income Convergence Controversy:
An Institutionalist Economic Perspective
Path Dependence
Vicious circles
Virtuous circles
However, Path Dependence is not ultimately binding
Endogenous Growth Models as an Answer to the Income
Convergence Controversy
 Empirical research found that over 50% of the
growth rate of a country can not be accounted for
by changes in the use of capital and labor, leaving
the unexplained Solow residual as the major
determinant of growth rates.
 ENDOGENOUS GROWTH Models emerge in the
1980s as an effort to account for the unexplained
residual through a host of other factors such as
education, R&D, technology and so on.
Endogenous Growth Models
Y = F(R,K,H)
Y= total output; R= research & development;
K= physical K; H= human K
Let Kt = combined stock of human, physical and research capital;
Assuming
 constant returns to scale as well as
 constant marginal returns to K stock,
the EG Models suggest the so-called AK production function
Y = aKt
To capture the endogeneity of the growth process, the aggregate
production function can be rewritten as
Y = A(Kt)Kt
A(Kt) = induced/endogenous tech. Change imparted to the economy by the
stock of physical, human and research K particular to that country
Endogenous Growth Models
 Endogenous Growth Models are different from the Neoclassical
Growth Models in that
 No assumption of physical K to be the dominant determining factor in
spurring economic growth, other factors such as human K is integrated;
 drop the assumption of diminishing returns to reproducible factors of
production;
 Technology is not assumed to be exogenous but rather endogenous.
As such in EG Models sustained growth is possible even without a change
in the savings rate or an exogenous boost to technology
Therefore EG Models are able to explain the sustained or even increasing
income gap between developed and developing economies.
An Endogenous Growth Production Function Figure 8.1
Some Empirical Findings on EG Models Table 8.3
Some Empirical Findings on EG Models Table 8.4