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LOS 12.i: Compare classical growth theory, neoclassical READING 11: CURRENCY EXCHANGE RATES: UNDERSTANDING EQUILIBRIUM VALUE
growth theory, and endogenous growth theory – 3 Models!
MODULE 12.3: GROWTH AND CONVERGENCE THEORIES
the growth rate in technology
(θ) divided by labor’s share
of GDP (1 – α).
Sustainable growth rate of output (G*)
is equal to the sustainable growth rate of output per capita, plus the growth of labor (ΔL).
EXAMPLE: Estimating steady state growth rate: An analyst is forecasting steady state growth rates for Country X and Country Y and has
collected the following estimates:
Answer: Sustainable growth rates:
Country X = (2.0% / 0.60) + 1.2% = 4.53%
Country Y = (1.0% / 0.52) + 2.6% = 4.52%
Sustainable growth rates for the two countries are comparable.
• Country X’s sustainable growth rate is primarily driven by higher growth rate in
TFP.
Calculate and comment on sustainable growth rates for the • Country Y’s sustainable growth rate is mostly driven by a higher population
two countries.
growth rate.
Under Neoclassical theory: In the long-run, capital deepening affects the level of output but not the growth rate; it may temporarily
increase the growth rate, but this will revert back to the sustainable level if there is no technological progress.
Endogenous Growth Theory: Contends that technological growth emerges as a result of investment in both physical and human capital.
Unlike the neoclassical model, there is no steady state growth rate, so that increased investment can permanently increase the rate of growth.
It is based on assumption that certain investments (e.g. R & D) increase TFP benefits the society as a whole.
Total factor productivity is the key difference between the two theories:
• Neoclassical theory assumes that capital investment will expand as technology improves (i.e., growth comes from increases in TFP not
related to the investment in capital within the model).
• Endogenous growth theory, assumes that capital investment (R&D expenditures) may actually improve total factor productivity.
