QED, Macroeconomics II

Lesson 3: Growth Theory

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Why did GDP per capita grow at 2%

1. The Ramsey-Cass-Koopmans model

2. Endogenous growth

3. R&D-based growth models and scale effects

4. The prospects of future growth

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The Ramsey-Cass-Koopmans Model
■ We investigate a model that resembles the Solow model
but is based on microfoundations.

■ It takes growth rates of labor and knowledge as given,

but derives the K evolution from the interaction of
households and firms in competitive markets.

■ Exogenous parameters will only be fundamentals –

preferences, endowments, and production technology.

■ Extension of the Arrow-Debreu general equilibrium

setup to an infinite environment. Preserves both welfare
theorems and the equilibrium is determinate.

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The Ramsey-Cass-Koopmans Model

■ BLACKBOARD: The Ramsey-Cass-Koopmans

model (RCK) – Ramsey (1927), Cass (1965) and
Koopmans (1965)

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Phase Diagram in the RCK Model

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Phase Diagram in the RCK Model

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Endogenous Growth

■ Sustained growth from capital accumulation is not

possible because the marginal productivity of
capital becomes too low.

■ BLACKBOARD:
─ AK models – Rebelo (1991)
─ Capital-externality models – Romer (1986) and
Barro (1990)
─ R&D-based models – Romer (1990) and Jones
(1996)

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R&D-Based Growth Models
■ In Romer,
─ Policy affects long-term growth (g = δLA).
Less taxes net of subsidies on R&D activity or stronger
property rights increase LA.
─ Scale effects –size of economy also matters.
─ Monopoly pricing: critical to invest in R&D, but
reduces input demand below social optimum. This
time subsidizing purchase of xs only has level effects.
■ In Jones, no scale effects, and policy only affects long-
run income but not growth.

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The Prospects of Future Growth
Robert Gordon (2014): "The Demise of U.S. Economic
Growth: Restatement, Rebuttal, and Reflections“

■ Question: can GDP per capita in the US keep growing

at 2% in the future as it did during the last 150 years?

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The Prospects of Future Growth
Robert Gordon (2014): "The Demise of U.S. Economic
Growth: Restatement, Rebuttal, and Reflections“

■ His answer is NO.

■ What are the "headwinds" that will push median income
growth well below a 1%-year labor productivity growth
1) Demography. The increase in the hours of labor per
capita enjoy in the last 100 is no longer possible. The
participation rate is already falling.
2) Education. The increase in human capital accounted
for 0.38 percent per year during the interval 1913-1979
mainly from increases in secondary schooling. This
along the very high cost of college education in the US
hurt the growth prospects.

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The Prospects of Future Growth
Robert Gordon (2014): "The Demise of U.S. Economic
Growth: Restatement, Rebuttal, and Reflections“

3) Inequality. The share of the top 1% of the income

distribution has increased steadily since the late 1970s.
The average growth rate of real income for the bottom
99 percent of the income distribution was 0.53 percent
slower than for the average of all income recipients.
4) Repaying Debt. The future reckoning for the
indebtedness of government at all levels of government
will arrive at some unknown year over the next several
decades. This may mean: higher taxes, lower
government spending, lower pensions in an aging
society,... .

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The Prospects of Future Growth
Robert Gordon (2014): "The Demise of U.S. Economic
Growth: Restatement, Rebuttal, and Reflections“

■ Can technological progress offset those headwinds and

permit this 2% growth in the future? Unlikely!
■ Industrial revolutions: electricity, internal combustion
engine, telephone, running water, sewer pipes,... , all these
great inventions pretty much happened all at once.
■ Last 40 years have been also great inventions: personal
computers, bar-code scanning, internet, e-commerce, cell-
phones, supply-chain innovation,...
■ However, poor labor-productivity performance
compare to the past. Can we do better in the future?

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