Question

“Convergence in growth rates and income per capita across the different countries is a necessary outcome expected by both the neoclassical Solow growth model and the endogenous growth theory. “Is this statement true? (Discuss the issue by giving references to the fundamental premises of these two theories). Looking at the real-life data, has the convergence hypothesis been validated in the world? Explain.

Answer 1

• Among the determinants of the growth and convergence processes identified by the theoretical literature, human capital is certainly one of the most important.
• In particular, I will provide the necessary link between the theory on growth, convergence and human capital and the empirics of convergence.

The Solow model and the convergence hypothesis: absolute convergence
In the Solow model, capital deepening is at the heart of the growth process. The aim of the model is to explain the link between savings and growth, where savings are exogenous. This link is the process of capital accumulation. The model describes an economy in which the production function of the representative producer is Y = F( K ,AL ) , where Y is the flow of output, K is the stock of capital, L is the labour force and A is knowledge or, in general, “effectiveness of labour”. Note that A and L enter multiplicatively, in which case technology is known as labour augmenting or Harrod-neutral. Both population growth and technological progress are exogenous.

Conditional convergence and the role of human capital

We have seen that countries would converge in the absolute sense if the only difference between them is the initial level of per capita income. One of the most convincing arguments in endogenous growth literature against the Solow model was that the latter cannot account for international differences in income, since there is no evidence of international convergence. However, there are two possibilities for reconciling evidence based on convergence, using the Solow model.

Endogenous growth: early divergence, possible convergence

The divergence hypothesis has been explicitly formulated and tested in various studies on endogenous growth. As stated above, one of the main motivations for further studies in endogenous growth literature has certainly been the model’s inadequacy in explaining the absence of convergence among countries Endogenous growth models are highly heterogeneous. A simple and unifying definition of the endogenous growth models uses their relationship with the Solow model: what distinguishes the endogenous growth literature from the solovian approach is the possibility of positive long-run growth rates without the presence of exogenous technological progress. Nevertheless, different models within this literature give quite diverse interpretations regarding the engine of long-run growth.

• Summarising with a play on words, we might conclude that during the last fifteen years there has been a convergence of ideas between endogenous and exogenous models with respect to the convergence hypothesis where human capital plays an important role.
• Despite the still theoretically important difference between models that assume exogenous versus models that assume endogenous long-run growth rates, both theories predict that a mechanism of convergence is possible, but it will only be so among similar economies.
• In particular, most theoretical literature assumes that similar levels of human capital are fundamental for catch up to take place. Therefore, both theories are currently able to explain a stylised fact of the empirical literature on growth, namely the observed convergence among groups of homogeneous countries and the absence of convergence when large and heterogeneous data sets are introduced. This observation explains why, with current econometric techniques, it is not possible to discriminate endogenous versus exogenous models by simply using a convergence regression.
• In other words, given these theoretical developments, simple convergence tests cannot be considered fully supportive of one theory against the other. However, this conclusion does not imply that empirical investigations on convergence across economies have become an uninteresting issue in growth literature.