Question

I have two parts. Please explain all parts in detail.

(1). Poor countries have lower capital stock levels compared to wealth countries. Therefore in order for a developement policy to be effective it must target the saving rate.

(2). The prediction of solow growth model are inconsistent with the empirical evidence regarding income convergence.

Answer 1

1)

• Domestic saving is more critical for adopting new technologies in developing rather than developed economies.
• Familiarity with the technology frontier reduces its cost of adoption.
• Advanced countries readily adopt the frontier technology, but for countries far from the technology frontier, it is too expensive to adopt such technology without outside help. Entrepreneurs in these countries need to rely on foreign investors.
• However, domestic entrepreneurs may not deliver on their input contribution unless they have invested sufficient capital in the project. This co-investment is in turn financed out of domestic saving, highlighting the role of domestic saving in economic growth.

2) Real convergence in income per capita distribution had been one of the most intensively studied issues in growth literature. Even though transition countries have been examined heavily in the growth literature, the vast majority of studies analyzed the mechanics of output decline in the post-socialist transition.

Although the transition from planned economy to decentralized market mechanism sparked a considerable discussion on the theoretical approach to the evolution of institutional reforms, little had been discussed of the nature of growth in transition countries. Starting from a low income per capita level after years of cumulative output decline naturally implies higher marginal productivity of capital and higher growth rate in the steady state.

Central European countries share common political, historical and institutional similarities arising from decades of Habsburg rule. Moreover, the region experienced similar economic and political fate after the end of WW2 by adoption the socialist economic model. Nevertheless, despite common institutional, political and economic background, the per capita income distribution in the region has emerged unevenly. Whereas Slovenia, Estonia, Poland, Czech Republic and Slovakia forged ahead to the EU15 income level, Hungary and Croatia failed to keep the catch-up face and experienced considerably slower growth. The onset of economic and financial crisis changed the politico-economic map of Central Europe considerably since Hungary slipped from high-income to upper-middle income status at the World Bank and Croatia’s per capita income fell back to the pre-transition level. Given a wide degree of heterogeneity across transition countries, especially in terms of income per capita variation, the paper builds on the panel of 7 high-income transition countries to test the conditional convergence hypothesis, using human capital accumulation and fertility rates as determinants of conditional convergence.