Endogenous Growth, Market Failures and Economic Policy

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In contrast to the Solow model, the Ramsey model explains crucial factors such as the saving rate endogenously. Technological progress however is still exogenous. The aim of endogenous growth theory is then to explain the emergence of technological progress within a model in order to gain more detailed insights into the determinants of economic growth.

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Another key point of the lecture refers to the policy implications of the theories in the presence of market failures. Also, an overview is given how endogenous growth theory has changed in the past 15 years. The focus here is on the increasing empirical testing and further development of the basic models. Therefore, we will start with the explanation of the neoclassical growth models and exogenous growth.

Economists’ Untold Secrets 183: Endogenous Growth

To demonstrate this principle, the well-known neoclassical Solow-Model will briefly be discussed. Afterwards its assumptions as well as its shortcomings will be examined.

Endogenous growth, market failures and economic policy

The concept of convergence is also worth mentioning in this context. This leads us to the origins of endogenous growth models. The passing of perfect competition will be explained based on the five facts which Romer pointed out in his work of Subsequently, the different approaches of Arrow, Lucas and Romer will be introduced, discussing their models regarding the influences of learning-by-doing, human capital, knowledge spillovers and increasing returns, respectively.

To complete this section, neo-Schumpeterian models will be presented as well. Finally, potential critiques will be discussed and the practical relevance of endogenous growth models will be reviewed. The second part of the thesis is of empirical nature. Starting with the provision of background facts about South Tyrol and Luxembourg, their histories as well as their economies, geographies and populations will be exhibited.

Afterward the data sources, which were utilized for this thesis, will be shortly introduced. After this step, historical growth observations of both regions will be presented and analyzed. Then, the following chapter will try to explain their growth with a major factor suggested by endogenous growth theory — human capital. In the case this will not lead to a conclusive result, alternative explanations outside endogenous growth theories will be sought.

Possibly, foreign income increase for South Tyrol and high dynamic capabilities for Luxembourg may come into question. Growth within an economy can be defined either as change of output or as change of output per capita. Most often the latter definition is used in growth models.

As in neoclassical growth theory, the focus in endogenous growth is on the behavior of the economy as a whole. However, it distinguishes itself from neoclassical growth by emphasizing that economic growth is an endogenous outcome of an economic system, not the result of forces that irrupt from outside Romer In this section, an overview of the origins of endogenous growth theory will be given and how it differs from more traditional views. In order to do so, a selection of models from several authors will be looked at, each of them focusing on a different aspect.

To set a frame of reference for endogenous growth models to be discussed later, an outline of neoclassical growth theory will be drawn. The most basic proposition of growth theory is that in order to sustain a positive growth rate of output per capita in the long run, continual advances in technological knowledge in the form of new goods, new markets or new processes have to be made. This proposition can be demonstrated using the neoclassical growth model developed by Solow , which shows that if there were no technological progress, the effects of diminishing returns would eventually cause economic growth to cease Aghion et al.

Neoclassical growth theory, in particular, is a formulated collectivity of models that had its peak in the s and s. In a narrower sense, the neoclassical paradigm contains the assumption that all economic decisions are made under boundless rationality Christiaans The basic building block of a neoclassical growth model is an aggregate production function exhibiting constant returns in labor and reproducible capital. Aghion et al The Solow-Model assumes the production of only one commodity, whose rate of production is designated Y t. The production of this good is described by a production function in which capital K t and labor L t are deployed to variable proportions.

The commodity, so called output Y , can either be consumed or it can be used for productive purposes, i. This means that the not-consumed income s increases the stock of capital. The existing stock of capital wears out, which continuously causes a constant percentage of capital to become defective. The population of this theoretical world consumes a constant percentage of its income. Furthermore the number of inhabitants increases with a constant growth rate.


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In addition the model assumes full employment and perfect competition Solow ; Christiaans One crucial property of the aggregate production function is that there are diminishing returns to the accumulation of capital. If you continue to equip people with more and more of the same capital goods, without inventing new uses for the capital, then a point will eventually be reached where the extra capital goods become redundant, except those used as spare parts in the event of multiple equipment failure, and where therefore the marginal product of capital is negligible Aghion et al.

These are situations in which all variables, that are expressed as per capita factors like per capita income, per capita consume, etc. The neoclassical model described here determines an equilibrium with an exogenous steady state growth rate, i. Why is that?

Endogenous Growth, Market Failures and Economic Policy - Martin Zagler - Google книги

Intuitively one can answer the question in the following way: imagine that per capita capital stock grows with a positive rate. Hence, per capita income increases over time as well. Because of the diminishing returns on capital, per capita income grows less than per capita capital. The equilibrium capital stock per capital is reached at the point, where the savings, diverted from the income, are just enough to hold the per capita capital stock constant, despite increasing population and capital erosion.

The described state is an equilibrium because the modeled economy tends towards it, regardless of what its initial position might have been Jones The neoclassical model describes therefore an equilibrium in which the population growth rate determines the growth trend of the economy. The result is exogenous growth because national income, stock of capital and consumption increase with the growth-rate of population, which is not explained in the model.

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One of the most important implications of the steady state result is that there is no long run growth in the Solow-Model. In the long run, the economy settles down to a constant level of production and a constant amount of capital. Output per person is constant as well, as is consumption per person. As we can see, this basic version of the Solow-Model can lead to economic growth for a while, but eventually growth stops as the capital stock and production converge to constant levels in the steady state Jones However, to account for historical growth trends, neoclassical growth theory needs another element, as in most countries, positive growth trends for the above mentioned per capita factors have been recorded for quite some time.

Neoclassical theory pays tribute to this development through a second exogenous factor: technological progress A t. Technological progress increases constantly the productivity of capital and labor, so the central statement of the Solow-Model is that, in the long run, only technological progress is of importance for permanent growth. Subsequently, growth politics can only be successful, if they nurture technological advance Solow ; Mankiw et al. In the following, several shortcomings of neoclassical growth theory will be discussed.

These, among others, led to the emergence of endogenous growth models. Taking a look at the assumptions of neoclassical growth theory, one can easily discover the boundedness of these models:. An often expressed critique about macroeconomic assumptions is that they simplify the proofs of desired conclusions.

However, in order to model such a complex, organic matter like the aggregate economy, it is of course necessary to build a framework with certain limitations, in which the models can work. Prominent economists such as Keynes and Joskow have observed that much of economics is conceptual rather than quantitative and difficult to model and formalize quantitatively.

Nevertheless, neoclassical models cannot force someone to address the complicated issues that arise in the economic analysis like non-perfect competition, diffusion of technology, knowledge and information Romer In , N.

Can Endogenous Growth Theories Explain Growth in South Tyrol and Luxembourg?

Romer, mentioned above and below and David N. They showed that Solow correctly predicts the directions of saving and population growth, but not the orders of magnitude. Furthermore they pointed out that, if the model was augmented by the factor of human capital H, it would fit reality better, because human capital is in fact correlated with saving and population growth Mankiw et al.

Thus the neoclassical growth model of Solow … assumed technological progress to be exogenous not because this was a realistic assumption, but because it was the only manageable one. Romer , p. Another stimulus for the birth of endogenous growth theory was the convergence controversy. This question attracted a lot of attention in the beginning of the s.

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In the analysis of the Maddison data set [4] , William Baumol found that poorer countries like Japan and Italy substantially closed the per capita income gap with richer countries like the United States and Canada to But two objections became soon apparent: within the data set, convergence has taken place only in the years since World War II. In fact, between and , income per capita tended to diverge. Because the Maddison data set included only those economies that had successfully industrialized by the end of the sample period, it induces a sample selection bias that apparently accounts for most of the evidence in favor of convergence Abramovitz ; Romer As a result the attention then shifted to a broader sample of countries in the Heston-Summers data set [5].

In , Romer tested for convergence and he clearly failed to prove it.

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