Answer Key
- The Neoclassical model predicts that in the long run, economic policy cannot affect a country’s growth rate. Policies can raise the level of the steady-state growth path by inducing more savings, but the long-run growth rate itself is determined solely by the exogenous rate of technological progress.
- The fundamental difference lies in diminishing returns. The Neoclassical model assumes diminishing marginal productivity of capital, which eventually chokes off growth from capital accumulation alone, whereas the AK model assumes constant returns to a broad measure of capital, meaning there are no diminishing returns to counteract.
- Creative destruction is the driving force of the Schumpeterian model, where quality-improving innovations render old products and technologies obsolete, creating a crucial role for exit and turnover. In contrast, the Product-Variety model assumes innovations create new, but not necessarily improved, products, meaning exit can only reduce GDP by decreasing the variety that determines aggregate productivity.
- Conditional convergence is the prediction that a country will grow faster the farther it is below its own steady-state level of GDP. Empirically, it is tested by examining whether poor countries tend to grow faster than rich ones after controlling for the fundamental determinants of their steady states, such as saving rates, population growth, and depreciation rates.
- A primary limitation is the difference between accounting and causation. While growth accounting can decompose growth into components like capital deepening and TFP growth, it cannot determine the underlying cause; for example, in the neoclassical model, technological progress is the ultimate cause of both capital deepening and TFP growth in the long run.
- Club convergence refers to the phenomenon where some countries converge to the growth rates of the most advanced economies, forming a “convergence club,” while other countries fall further behind and diverge. This contrasts with simple conditional convergence, which suggests all countries with similar fundamentals should converge to the same steady state, and it explains why the very poorest countries often grow more slowly than moderately poor ones.
- The market-size effect is the principle that innovations will be directed toward sectors or technologies with larger potential markets, as this offers the prospect of greater profits for innovators. This can explain why technical change may be biased towards certain labor skills (e.g., skilled labor) or certain consumer groups (e.g., wealthier customers for pharmaceuticals).
- A new GPT can cause an initial slowdown because its implementation requires costly restructuring, adjustment, and the development of an entirely new set of complementary intermediate goods. During this adjustment period, resources are diverted from current production into R&D and reorganization, causing a temporary dip in aggregate output and productivity growth before the full benefits of the new GPT are realized.
- “Appropriate institutions” refers to the idea that the institutions or policies that are most growth-enhancing depend on a country’s stage of development, measured by its proximity to the frontier. Far from the frontier, institutions that facilitate imitation and technology adoption may be optimal, whereas closer to the frontier, institutions that encourage leading-edge innovation become more important for sustaining growth.
- The inverted-U relationship suggests that, starting from a low level, increases in competition spur innovation as firms are forced to innovate to “escape competition.” However, beyond a certain point, further increases in competition reduce innovation because the prospective monopoly rents that reward successful innovators are eroded, which is known as the “Schumpeterian effect.”