note6_n5 - Econ303 Solow Growth Model Part Two Empirical...

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Econ303 Solow Growth Model: Part Two 1 Empirical success of the Solow growth model The Solow growth model predicts the following: 1. A country with high investment (or saving) rate enjoys high GDP per capita in the long run. 2. Two countries with the same initial capital stock, the country with higher investment (or saving) rate grows faster. 3. Two countries with the same saving rate, the country with lower initial capital stock grows faster. These predictions agree with data. The first two scattered plots on the next page show the positive correlation between the investment rate and GDP per capita and the positive correlation between the investment rate and the growth rate of GDP per capita. The third plot shows a weak negative correlation between the growth rate of GDP per capita and the initial level of capital per capita. A more sophisticated quantitative analysis (regression analysis) also supports the Solow growth model. Let’s regress the average growth rate of GDP per capita on a constant, initial level of capital per capita, and average investment rate for the period of 1960-1990. Growth rate = constant + b 1 · log( Initial capital ) + b 2 · Investment rate Below are the values of the regression coefficients and how to interpret them: 1. Constant = 2.9827 The average growth rate within this group of countries is 2.98% per year. 2. b 1 =-0.4571 The negative sign means that the higher the initial level of capital is, the lower is the growth rate. (Agrees with the Solow model) In addition to this qualitative result, it also give a quantitative result. One percent increase of the initial per capita capital level leads to 0.46% decrease of growth rate of GDP per capita. 3. b 2 =0.1665 The positive sign means that higher investment rates result in higher growth rates. (Also agrees with the Solow model) One more percent of GDP invested generates 0.17% increase of growth rate.
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Econ303 Solow Growth Model: Part Two 2 0 0.5 1 1.5 2 x 10 4 0 5 10 15 20 25 30 35 GDP per capita Investment rate -0.1 -0.05 0 0.05 0.1 0 5 10 15 20 25 30 35 GDP growth rate Investment rate -0.02 0 0.02 0.04 0.06 0.08 4 5 6 7 8 9 10 11 Initital capital GDP growth rate 0 0.5 1 1.5 2 x 10 4 0 1 2 3 4 GDP per capita Population growth rate Furthermore, the effect of initial capital suggests that poorer countries should grow faster than richer ones. Eventually the poor will catch up and all countries go to the same steady state. This is called the convergence result of the Solow model. If we look at economies that are close to each other and are linked with free factor mobility, such as 50 states in the US, prefectures in Japan and even a group of western European countries, this is an accurate picture of what happened.
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