Appendix: Capital Accumulation in a Neoclassical Growth Model
39. This appendix describes a simple, benchmark closed-economy neoclassical growth model and its implications for capital accumulation. The economy is characterized by a representative firm and a representative household. Although the closed-economy assumption is not directly defensible for the countries analyzed in this paper, Barro and others (1992) have shown that such a model has essentially the same steady-state properties, if capital is a composite of physical capital and human capital and if only physical capital can be used as collateral for international borrowing.
Acemoglu, Daron, 2000, “Labor- and Capital-augmenting Technical Change,” Working Paper No. 7544, National Bureau of Economic Research.
Barro, Robert J., N. Gregory Mankiw, and Xavier Sala-i-Martin, 1992, “Capital Mobility in Neoclassical Models of Growth,” Working Paper No. 4206, National Bureau of Economic Research.
Blanchard, Olivier, 1998, “Revisiting European Unemployment: Unemployment, Capital Accumulation, and Factor Prices,” Working Paper No. 6566, National Bureau of Economic Research.
Broadbent, Ben, Dirk Schumacher, and Sabine Sachels, 2004, “No Gain without Pain—Germany’s Adjustment to a Higher Cost of Capital,” Global Economics Paper No. 3, Goldman Sachs.
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Kaas, Leo and Leopold von Thadden, 2001, “Unemployment, Factor Substitution, and Capital Formation,” Discussion Paper 01/01, Economic Research Centre of the Deutsche Bundesbank.
La Porta, Rafael, Florecio Lopez-de-Silanes, and Andrei Schleifer, 2002, “Government Ownership of Banks,” Journal of Finance, Vol. LVII (1), pp. 265–301.
Mendoza, Enrique, Gian Maria Milesi-Ferretti, and Patrick Asea, 1997, “On the Effectiveness of Tax Policy in Altering Long-run Growth: Harberger’s Supernuetrality Conjecture,” Journal of Public Economics, Vol. 66, pp. 99–126.
Romer, Paul M., 1998, “Capital Accumulation in the Theory of Long-Run Growth,” in Modern Business Cycle Theory, (edited by Robert J. Barro), Cambridge, MA: Harvard Unversity, pp. 51–127.
Prepared by Allan Brunner.
See the Appendix for a brief discussion of the neoclassical growth model. See Romer (1989) for an extended discussion of capital accumulation and long-run growth.
For example, a permanent change in the tax rate on capital income could have important effects on the capital-to-labor ratio or the net investment rate—as labor is substituted for capital—but such a policy change would likely have little impact on the long-run growth rates for capital, labor, or income.
The literature is somewhat ambiguous as to whether public investment is a substitute or a complement for private investment.
Henceforth, the sum of TFP growth and labor force growth will be referred to as “the fundamentals.” Also, note that changes in employment rates and hours worked will be reflected in changes in TFP, since the labor force is being used as the measure of labor supply.
Ideally, one would like to use longer-term real interest rates. However, long time series on such measures were not available for most countries in the sample.
This model could have been set up as an error-correction model, but the presence of a lagged dependent variable would complicate the decomposition analysis in the next section.
Several other proxies for the capital-to-labor ratio were used with similar results.
The Cobb-Douglass production function assumes that the elasticity of substitution between capital and labor is one. This assumption has important implications for rate of capital accumulation when the economy is not in steady-state, as discussed in the main section of the paper.
There is no labor-leisure choice in the model, so there is no distortionary role for the taxation of labor.