Endogenous Growth, Convergence and Fiscal Policies in an Interdependent World

Abstract

Older vintages of growth theory such as Solow (1956) Swan (1956) or Cass, (1965) assume diminishing marginal productivity of capital and predict convergence of levels in output and capital, so that they are of little use in answering questions of development. ‘Poor’ countries have a lower capital stock and thus a higher marginal productivity of capital and a higher interest rate than ‘rich’ countries. Consequently, consumers in ‘poor’ countries find it more worthwhile to save and postpone consumption than those in ‘rich’ countries and thus ‘poor’ countries grow faster than ‘rich’ countries until they have caught up. These older vintages of growth theories are of little use in explaining persistent differences in long-run growth rates, since these are simply given by the sum of the exogenous rate of population growth and the exogenous rate of labour-augmenting technical progress.

The authors are grateful to Willem Buiter, Christian Keuschnigg and Ken Kletzer for their detailed, helpful and constructive comments. The participants of seminars at CentER, Free University Amsterdam, ECOZOEK, Copenhagen University, Leuven University, and the Institute for Advanced Studies, Vienna, a CEPR meeting at the Banca d’Espana and a conference organised by the European Science Foundation, Sitges, have also made helpful comments. We also gratefully acknowledge financial support from the SPES programme Macroeconomic Policy and Monetary Integration in Europe (0016-NL (A)) of the European Community and financial support from the CEPR research programme in International Macroeconomics, supported by the Ford Foundation and the Alfred P. Sloan Foundation.