Macroeconomics-Lecture Notes-Macroeconomics-Lecture Notes | Study notes Macroeconomics

Lesson 23

ECONOMIC GROWTH (CONTINUED)

2. POLICIES TO INCREASE THE SAVING RATE

x Reduce the government budget deficit (or increase the budget surplus).

x Increase incentives for private saving:

x Reduce capital gains tax, corporate income tax, estate tax as they discourage saving

x Replace federal income tax with a consumption tax

x Expand tax incentives for individual retirement accounts and other retirement savings

accounts

3. ALLOCATING THE ECONOMY’S INVESTMENT

In the Solow model, there’s one type of capital. In the real world, there are many types,

which we can divide into three categories:

x Private capital stock

x Public infrastructure

x Human capital: the knowledge and skills that workers acquire through education

How should we allocate investment among these types?

Two viewpoints:

1. Equalize tax treatment of all types of capital in all industries, and then let the market

allocate investment to the type with the highest marginal product.

2. Industrial policy: Govt. should actively encourage investment in capital of certain types or

in certain industries, because they may have positive externalities (by-products) that private

investors don’t consider.

Possible problems with industrial policy

x Does the govt. have the ability to “pick winners” (choose industries with the highest

return to capital or biggest externalities)?

x Would politics rather than economics influence which industries get preferential

treatment?

4. ENCOURAGING TECHNOLOGICAL PROGRESS

x Patent laws: encourage innovation by granting temporary monopolies to inventors of

new products

x Tax incentives for R&D

x Grants to fund basic research at universities

x Industrial policy: encourage specific industries that are key for rapid tech. progress

(subject to the concerns on the preceding slide)

GROWTH EMPIRICS: CONFRONTING THE SOLOW MODEL WITH THE FACTS

Solow model’s steady state exhibits balanced growth - many variables grow at the same rate.

Solow model predicts Y/L and K/L grow at same rate (g), so that K/Y should be constant. This

is true in the real world. Solow model predicts real wage grows at same rate as Y/L, while real

rental price is constant. Also true in the real world.

CONVERGENCE

Solow model predicts that, other things equal, “poor” countries (with lower Y/L and K/L) should

grow faster than “rich” ones. If true, then the income gap between rich & poor countries would

shrink over time, and living standards “converge.” In real world, many poor countries do NOT

grow faster than rich ones. Does this mean the Solow model fails? No, because “other

things” aren’t equal. In samples of countries with similar savings & population growth rates,

income gaps shrink about 2% / year. In larger samples, if one controls for differences in

saving, population growth, and human capital, incomes converge by about 2%/year.

docsity.com

Partial preview of the text

Download Macroeconomics-Lecture Notes-Macroeconomics-Lecture Notes and more Study notes Macroeconomics in PDF only on Docsity!

Lesson 23 ECONOMIC GROWTH (CONTINUED)

2. POLICIES TO INCREASE THE SAVING RATE Reduce the government budget deficit (or increase the budget surplus). Increase incentives for private saving: Reduce capital gains tax, corporate income tax, estate tax as they discourage saving Replace federal income tax with a consumption tax Expand tax incentives for individual retirement accounts and other retirement savings accounts 3. ALLOCATING THE ECONOMY’S INVESTMENT In the Solow model, there’s one type of capital. In the real world, there are many types, which we can divide into three categories: Private capital stock Public infrastructure Human capital : the knowledge and skills that workers acquire through education How should we allocate investment among these types? **Two viewpoints:

Equalize tax treatment** of all types of capital in all industries, and then let the market allocate investment to the type with the highest marginal product. 2. Industrial policy: Govt. should actively encourage investment in capital of certain types or in certain industries, because they may have positive externalities (by-products) that private investors don’t consider. Possible problems with industrial policy Does the govt. have the ability to “pick winners” (choose industries with the highest return to capital or biggest externalities)? Would politics rather than economics influence which industries get preferential treatment? 4. ENCOURAGING TECHNOLOGICAL PROGRESS Patent laws: encourage innovation by granting temporary monopolies to inventors of new products Tax incentives for R&D Grants to fund basic research at universities Industrial policy: encourage specific industries that are key for rapid tech. progress (subject to the concerns on the preceding slide)

GROWTH EMPIRICS: CONFRONTING THE SOLOW MODEL WITH THE FACTS Solow model’s steady state exhibits balanced growth - many variables grow at the same rate. Solow model predicts Y/L and K/L grow at same rate ( g ), so that K/Y should be constant. This is true in the real world. Solow model predicts real wage grows at same rate as Y/L , while real rental price is constant. Also true in the real world.

CONVERGENCE Solow model predicts that, other things equal, “poor” countries (with lower Y/L and K/L) should grow faster than “rich” ones. If true, then the income gap between rich & poor countries would shrink over time, and living standards “converge.” In real world, many poor countries do NOT grow faster than rich ones. Does this mean the Solow model fails? No, because “other things” aren’t equal. In samples of countries with similar savings & population growth rates, income gaps shrink about 2% / year. In larger samples, if one controls for differences in saving, population growth, and human capital, incomes converge by about 2%/year.

docsity.com

What the Solow model really predicts is conditional convergence - countries converge to their own steady states, which are determined by saving, population growth, and education. And this prediction comes true in the real world.

FACTOR ACCUMULATION VS. PRODUCTION EFFICIENCY Two reasons why income per capita are lower in some countries than others: Differences in capital (physical or human) per worker Differences in the efficiency of production (the height of the production function) Studies: Both factors are important. Countries with higher capital (phys or human) per worker also tend to have higher production efficiency. Explanations: Production efficiency encourages capital accumulation. Capital accumulation has externalities that raise efficiency. A third, unknown variable causes cap accumulation and efficiency to be higher in some countries than others.

ENDOGENOUS GROWTH THEORY In Solow model, sustained growth in living standards is due to tech progress. The rate of tech progress is exogenous. While endogenous growth theory is a set of models in which the growth rate of productivity and living standards is endogenous. A basic model The production function for endogenous growth model can be written as: Y = A K , where A is the amount of output for each unit of capital (A is exogenous & constant). Key difference between this model & Solow model is that MPK is constant here while diminishes in Solow model. Investment: sY Depreciation: K

Equation of motion for total capital: K = s Y K

Divide through by K and use Y = A K , get:

If s A > , then income will grow forever, and investment is the “engine of growth.” Here, the

permanent growth rate depends on s. In Solow model, it does not.

DOES CAPITAL HAVE DIMINISHING RETURNS OR NOT?

Yes, if “capital” is narrowly defined (plant & equipment). Perhaps not, with a broad definition of “capital” (physical & human capital, knowledge). Some economists believe that knowledge exhibits increasing returns. In the endogenous growth model, the assumption of constant returns to capital is more plausible.

A TWO-SECTOR MODEL There are two sectors: Manufacturing firms produce goods Research universities produce knowledge that increases labor efficiency in manufacturing u = fraction of labor in research (u is exogenous) Manufacturing production function: Y = F [K, (1-u) E L] Research production function: E = g (u) E Capital accumulation: K = s Y K In the steady state, manufacturing output per worker and the standard of living grow at rate E/E = g (u).

Y K (^) s A Y K

(^)

Macroeconomics-Lecture Notes-Macroeconomics-Lecture Notes, Study notes of Macroeconomics

Related documents

Partial preview of the text

Download Macroeconomics-Lecture Notes-Macroeconomics-Lecture Notes and more Study notes Macroeconomics in PDF only on Docsity!

docsity.com

Equation of motion for total capital: K = s Y K

If s A > , then income will grow forever, and investment is the “engine of growth.” Here, the

docsity.com