An understanding of the qualitative nature of the transitional dynamics of
the neociassical model - the process of convergence from an initial capital
stock to a steady state growth path - is a key part of the shared knowledge of
most economists. It forms the basis, for example, of the widespread interest
in hypotheses about convergence of levels of national economic activity.
Based on several quantitative experiments undertaken in the 1960s with fixed
savings rates versions of the neoclassical model, many economists further
believe that the transition process can be lengthy, potentially rationalizing
differences in growth rates across countries that are sustained for decades.
In this paper, we undertake a systematic quantitative investigation of
transitional dynamics within the most widely employed versions of the
neoclassical model with interteorally optimizing households. Lengthy
transitional episodes arise only if there is very low intertemporal
substitution. But, more important, we find that the simplest neoclassical
model inevitably generates a central implication that is traced to the
production technology. Whenever we try to use it to explain major growth
episodes, the model produces a rate of return that is counterfactually high
in the early stages of development. For example, in seeking to account for
U.S-Japan differences in post war growth as a consequence of differences in
end-of-war capital, we find that the immediate postwar rate of return in
Japan would have had to exceed 500% per annum.
Frequently employed variants of the basic neoclassical model - those that
introduce adjustment costs, separate production and consumption sectors, and
international capital mobility - can potentially sweep this marginal product
implication under the rug. However, such alterations necessarily cause major
discrepancies to arise in other areas. With investment adjustment costs, for
example, the implications resurface in counterfactual variations in Tobin's Q.
We interpret our results as illustrating two important principles. First, systematic quantitative investigation of familiar models can provide
surprising new insights into their practical operation. Second, explanation
of sustained cross country differences in growth rates will require departure
from the familiar neoclassical environment.
*Published:
American Economic Review, vol. 83, no. 4, p. 908-931, Sept. 1993
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