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Beyond The Solow Model Notes

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Beyond the Solow Model
27 October 2010

Topics Reading Key Points
• Why doesn't capital move from rich to poor countries • Williamson (Chapter 6-7, p.225-245) • Reasons for moving beyond Solow model (3)
• Growth accounting • Weil (Chapter 7)
• Why doesn't capital flow from rich to poor
• Development accounting
countries?
• The "AK" model
• Interpretations of TFP
• Institutions
Beyond the Solow Model
• Growth accounting
• Three main reasons why growth economists have moved beyond Solow model:
○ Lucas - "Why doesn't capital move form rich to poor countries?" • Alwyn Young - "Asian Tiger Economies"
• Growth accounting shows the important contribution of technological progress to growth within • Development accounting
a country • Why is there technological progress?
○ Development accounting shows difference in the levels of "technology" are needed to account
• Why is endogenous growth not possible in
for large cross-country income differences
Solow model

Why Doesn't Capital Flow From Rich to Poor Countries? • The "AK" model
• Lucas argues that large differences in income per worker must imply large differences in capital per
worker Definitions
• This implies that returns to capital in the poor countries must be much higher than in the rich • Growth Accounting = Measures how much of
• So why doesn't capital flow from rich to poor? the growth in aggregate output is accounted
for by factor accumulation (e.g. capital, labour
Why Doesn't It? and human capital) and by increases in total
Method for deriving return on capital as a function of y factor productivity (not directly measurable)
• Allows us to compare return on capital between countries • Institutions = The set of rules which govern
decision making
○ Starting with the production function:
• Rent-Seeking (Diversion) = Activities which try
○ Output per worker: to take from the economy and do not add to
the aggregate economy
○ ○ Express k as a function of y:
○ The marginal product of capital:
 i.e. return on capital Formulae
○ Substitute the relationship between k and y into MPK to deliver MPK as a function of y: •

• From C.D function:
○ Return on capital as a function of y: =
• In steady state:
○ For an example Lucas compared income per capita ratio between India and the US (about 15 in
• Return on capital as a function of y: =
1988)
○ He set (average of U.S. and Indian capital shares) so that
○ If z is the same and y is 15 times higher in the US, then the MPK in India must be times • Solow Residual:
higher
○ So if return to capital is 58 times higher in India why doesn't capital flow from the US to India
• Possible answers:
 There is missing capital in the model (i.e. human capital)
• TFP is different across countries

Interpretations of TFP
• One interpretation of TFP is the level of technology
 But poor countries don't need to carry out R&D, they can adopt the technology of the rich
countries, so why don't they adopt?
○ A more general interpretation of TFP:
• TFP is the level of effective technology
□ i.e. technology operates with different efficiencies in different countries even when
they have access to the same technology
 This may be because of institutions
○ There is a gap between the MPK and private incentives to save/invest due to tax rates, corruption,
risk of expropriation
 Graph demonstrating the link between protection from expropriation and GDP per Capita

Institutions
• One reason that capital doesn't flow
• We focus on the set of institutions that encourage productive activities such as investment in physical
and human capital or technology adoption, over "diversion or rent-seeking"
• Institutions = The set of rules which govern decision making
• Rent-Seeking (Diversion) = Activities which try to take from the economy and do not add to the
aggregate economy
• Baumol (1990 JPE) argued that policies affect the rules of the game
○ i.e. some countries focus more on intellectual achievements in the middle ages
• There are vast differences in GDP per capita despite close proximity and relationships between nations
○ i.e. North and South Korea, Hong Kong and China before 1998

Growth Accounting
• Another reason that capital doesn't flow
• Growth Accounting = Measures how much of the growth in aggregate output is accounted for by
factor accumulation (e.g. capital, labour and human capital) and by increases in total factor productivity
(not directly measurable)

Capital Accumulation vs. Technological Progress

Course Notes Page 15

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