Growing Through Cycles Author(s): Kiminori Matsuyama Source: Econometrica, Vol. 67, No. 2 (Mar., 1999), pp.

335-347 Published by: The Econometric Society Stable URL: http://www.jstor.org/stable/2999587 . Accessed: 24/02/2011 18:08
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Economnetrica, Vol. 67, No. 2 (March, 1999), 335-347

GROWING THROUGH CYCLES

BY KIMINORI MATSUYAMA The neoclassical growth model focuses on factor accumulation as an engine of growth, while the neo-Schumpetarian growth model stresses innovation. This paper argues that these two views of growth may capture different phases of a single growth experience. In the model presented below, the balanced growth path is unstable and the economy achieves sustainable growth through cycles under an empirically plausible condition, perpetually moving back and forth between two phases. One phase is characterized by higher output growth, higher investment, no innovation, and a competitive market structure. The other phase is characterized by lower output growth, lower investment, high innovation, and a more monopolistic market structure. Both investment and innovation are essential in sustaining growth indefinitely, and yet they move in an asynchronized way; only one of them appears to play a dominant role in each phase. The economy grows faster along the cycles than along the (unstable) balanced growth path.
K1EYWORDS:

Endogenous cycles, endogenous growth, innovation, investment.

1. INTRODUCTION

GROWTHliterature focuses on factor accumulation as an THE NEOCLASSICAL

engine of growth. One important message of this literature is that the process of growth based solely on factor accumulation must stop eventually, as it runs into diminishing returns. The recent literature on neo-Schumpetarian growth stresses the innovation of new products, motivated by monopoly profits, as a way of avoiding diminishing returns, and of sustaining growth indefinitely. Many recent studies on growth accounting have attempted to assess empirically the relative importance of these two alternative views of growth. What is implicit in these studies is the assumption that the relative contribution of the two sources of growth is stable over time. This paper argues that these two views of growth, one based on factor accumulation and the other based on innovation, are complementary in that they may capture different phases of a single growth experience. The model is based on the lab equipment model of Rivera-Batiz and Romer (1991). It is shown, under an empirically plausible condition, that the balanced growth path is unstable and the economy achieves sustainable growth through cycles, perpetually moving back and forth between two phases. In one phase, when output and investment grow faster, there is no innovation and the market structure is competitive, as in the neoclassical model. In the other phase, when the growth rates of output and investment are lower, innovation takes place, and the market structure is more monopolistic, as in the neo-Schumpetarian model. In
1The author is grateful for the comments received during seminars at Northwestern, ULBECARE, Linz, DELTA-ENS, and Carlos-III, where a very preliminary version of this paper was presented. He also thanks Clark Robinson for clarifying some subtlety of nonlinear dynamical systems, a co-editor and a referee for valuable suggestions. 335

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KIMINORI MATSUYAMA

the long run, both investment and innovation grow at the same rate, but they move over the cycles in an asynchronized way; the economy alternates between periods of high investment and periods of high innovation. Although both investment and innovation are essential in sustaining growth indefinitely, only one of them appears to play a dominant role in each phase. It turns out that such an asynchronization is growth-enhancing. Along the cycles, the economy grows faster than it could along the (unstable) balanced growth path. The present model differs critically from the Rivera-Batiz and Romer lab equipment model in that the innovators of new products enjoy temporary monopoly power. This assumption plays a dual role in generating cycles. First, the degree of monopoly prevailing in the economy can change over time. Second, a potential innovator wants to enjoy its temporary monopoly power when the degree of monopoly prevailing in the economy is higher. This is because the potential innovator needs to enter when the market for its product is large enough to recover the cost of innovation. The size of the market depends in part on how the products with which it competes are priced. This leads to a synchronization of innovative activities. If the innovator chooses to introduce its product when others do, some of its competing products are monopolistically priced. On the other hand, if the innovator enters after others have innovated, the market for its product would be too small to recover the cost of innovation, because competing products become more competitively priced, as their innovators lose monopoly power. As a result, the economy experiences periods of high innovation with a monopolistic market structure, followed by periods of no innovation with a competitive market structure. Once innovation stops, output and investment growth go up, partially because resources are now redirected from innovative activities to manufacturing activities and partially because the competitive market structure allocates resources more efficiently among the existing products. And, as a result of high investment growth, the economy will eventually build up enough of a resource base to enter another period of innovative activity. Note that the temporary nature of monopoly leads to a synchronization of innovative activities, which in turn leads to an asynchronization of innovation and investment in this model. These results should provide a caution when interpreting a country's growth experience. For example, recent growth accounting studies, such as Young (1995), have shown that the Asian growth miracle can almost entirely be attributed to factor accumulation. From such a finding, one should not conclude, as Krugman (1994) did, that the growth miracle in this region must stop sooner or later. The model suggests that the economy may eventually enter a period of innovation, once it builds up a sufficiently large resource base. The model's prediction is also consistent with observations that an economy may experience slower output growth during the period of high innovative activity, from which one should not conclude that innovation contributes less to the growth. Indeed, the present paper offers an alternative explanation to the productivity slowdown puzzles, reported in Hornstein and Krusell (1996) and Greenwood and Yorukoglu

GROWING THROUGH CYCLES

337

(1997), which attribute productivity slowdown to the learning cost associated with new technologies.2 Although mainly motivated by the question of growth, this paper can also be viewed as a contribution to the literature on endogenous business cycles. See Boldrin and Woodford (1990) and Guesnerie and Woodford (1992) for suiveys. Among these studies, Deneckere and Judd (1992), Gale (1996), and Shleifer (1986) all construct models of innovation cycles, based on the temporary nature of the monopoly enjoyed by innovators. These models do not have factor accumulation, and hence are unable to capture the asynchronized nature of innovation and investment cycles. Like the Deneckere-Judd model and many models in the neo-Schumpetarian growth literature, the present model assumes free entry to innovative activities. This means that an incentive to delay implementing innovations, a crucial element in the models of Gale and of Shleifer, plays no role in generating cycles in the present study.3 Jovanovic and Rob (1990) is closest in spirit to this paper. They develop a search-based model of technology evolution, in which the industiy could grow through two different forms of innovation, intensive search and extensive search, and identify the condition under which the industry alternates between the two. Interestingly, the industry grows faster during the period of intensive search.

2.

THE MODEL

Time is discrete and extends from one to infinity. The structure of production is based on Rivera-Batiz and Romer's (1991) "the lab equipment model." There is a single final good, taken as a numeraire; it is competitively produced and can either be consumed or invested. Let Kt_ I be the final good left unconsumed in period t - 1 and carried over and made available for use in production in period t. Labor is supplied inelastically in amount L in each period.
2Another possible explanation to productivity slowdowns is that the arrival of a new technology makes the existing goods obsolete: see Helpman and Trajtenberg (1994). Among learning-based models (see Jovanovic (1997) for a survey), Young (1993) is closest in spirit to this paper. In Young's model of innovation and bounded learning-by-doing, the innovator maintains its monopoly power permanently, but an innovated good attains its full potential only after its production technique is improved through learning-by-doing. In the present model, an innovated good attains its full potential only after its innovator loses its monopoly power. Young's analysis is limited to the steady state and it is not clear if his model has endogenous cycles of alternating innovation and learning-by-doing. 3Recently, Evans, Honkapohja, and Romer (1996) developed a model of growth cycles, which differs from the present study in two crucial respects. First, the cycles in their model are based on sunspots, expectational indeterminacy, and the multiplicity of equilibrium. In contrast, the results in this paper do not rely on multiple equilibria; the cycles appear here, as the unique steady state loses its stability. Second, in their model, the investment and the rate of innovation always move together, as the economy alternates between the states of high and low growth. On the other hand, in the present model, investment grows faster during periods of no innovation than during periods of innovation.

338

KIMINORI MATSUYAMA

Labor (L) goes directly into final goods production. Capital (K, 1) must be first converted into a variety of differentiated intermediate products; these intermediates are aggregated into the composite by a symmetric CES. Labor and the composite of intermediates are combined with a Cobb-Douglas technology. More specifically, the final goods production function is (1) Yt=A
(L)({f
[X[t(z)]
/

dz},

where xt(z) is the input of variety z in period t, o- E (1, xo)is the direct partial elasticity of substitution between each pair of intermediates, and [0, Nt] is the range of intermediates available in period t. Some features of this specification deserve comments. First, final goods production satisfies constant returns to scale for a given availability of intermediates, Nt. Second, the price elasticity of the final goods sector's demand for each intermediate is equal to v. Third, the labor share of the economy is equal to I/la. One significant departure from the lab requirement model of Rivera-Batiz and Romer lies in the market structure of the intermediate sector. Prior to period t, the economy developed all the intermediates in the range, [0, NtA 1], with N0,> 0. These "old" intermediates are manufactured by converting a units of capital into one unit of an intermediate, and sold competitively in period t. In addition, the intermediates of variety z E [Nt- 1,NtI may be introduced and sold exclusively by their innovators in period t. Innovating "new" intermediates require F units of capital per variety. The process of manufacturing new intermediates, just as old ones, requires a units of capital per output. Let ;-t denote the price of capital.4 The marginal cost of manufacturing intermediates in period t is then equal to art. The old products are supplied competitively and hence at the marginal cost; pt(z) p[ = art for z E [0, Nt J]. All the new products, if they exist, are sold at pt(z) - p "?= acrt;/(o- - 1), where z E [Nt- , NtJ, because of the constant price elasticity o-. Since all the intermediates enter symmetrically in the final goods production xt(z) x c for z E [0, Nt' j], and xt(z) -x ' for z E [ANt 1' Nt, and they satisfy (2)
Xt

[PtJ[

1--

o-J

The one-period monopoly enjoyed by the innovator provides an incentive for innovation, and there is no barrier to entiy for innovative activities. The period t + monopoly profit, net of the fixed cost, is 'rt =p lx'77 rt(ax'71 F); it is negative iff x... < (o- - 1)F/a. The free entry condition thus ensures - Nt .) = n. ax'9'< (r- -1)F1 Nt > Nt, (ax'9'- (o- -)F)(Nt (3)
-

4Note that r does not need to be one, even though capital is nothing but the final good left unconsumecl. This is because it must be carried over from the previous period before it is made available for use. This is a mere artifact of the discrete time assumption. (In Rivera-Batiz and Romer (1991), time is continuous and hence, without any delay, r, = 1.) As will be seen below, the analysis is indepenidenitof r1.

GROWING THROUGH CYCLES

339

That is, when potential innovators do not expect the sale of a new product to reach the break-even point (x.7. < (o- - 1)F/a), there is no incentive for innovating new products (Nt = Nt). When innovation occurs and some new products are introduced (Nt > Nt- I), the innovator earns no excess profit and operates at the break-even point (x<' = (o- - 1)F/a). The resource constraint on capital in period t is expressed as
=Nt- lc

+ (Nt - Ntl)(ax'

+ F).

Using equations (2) and (3), the above constraint becomes

(4)
and (5) where

ax,=a[I-?V

x' =minf

,Oo-F

Nt=Nt1? +max(O,

-F

ONt-I

ao

I-

which plays a critical role in the following analysis, depends positively on its value changes from 1 to e = 2.71828..., as o- varies from 1 to co. From Equation (1), total output is equal to
Yt =A (L)/J[Nt-I(x)l (1/T + ( -N _,)(x`'

of

and

Using equations (3), (4), and (5), this can be rewritten as (6) (6) where Y y I ]1 !~A[OoFNt- 1]110f[Kt-I (1/0f) if Kt_ < ?Nt_l if K ? Oor FN if Kt IOo-FNt-1, AKt_1

A-

A [aL]7 a Oo-F

Equations (5) and (6) summarize what takes place on the production side of the economy in period t. If Kt- I/Nt I < Oo-F, the resource base of the economy, K, is too small relative to the number of the existing products, N, and there is no innovation. All the goods are competitively supplied, and the reduced form aggregate production function has the standard neoclassical properties, including diminishing returns in capital. The economy is hence in the Solow regimze.Note that a higher innovation cost, F, expands the Solow regime. A higher elasticity of substitution, o-, has the same effect, as it reduces profit (the

340

KIMINORI MATSUYAMA

return from innovating). If K, 1/A'N> > OorF,the resource base is sufficiently large relative to the number of the existing products, and some new products are introduced. As in the model of Rivera-Batiz and Romer (1991), the reduced form aggregate production function is linear in capital in this range. In this case, we shall say that the economy is in the Romer regime. In order to close the model, it is necessary to specify the mechanism for determining capital accumulation. In this paper, it is simply assumed that (7) Kt = lyt.

That is, the economy carries over a constant fraction of its output to the next period.5 Then, equations (5), (6), and (7) jointly determine the unique equilibrium path for any initial condition, Ko and No. This dynamical system is linearly homogenous in K and N. Let us define Kt t 0oFNt

so .hat the critical value of k, kc, which separates the Solow and Romer regimes is equal to one. Then, the system can be expressed as the one-dimensional map, (1: R+->R+, G(kt_ IVl (1/ff) Gk_ ____________-__ t- -1 +(kt if kt 1 < 1, if kt-1 I21,

(8)
(8)~~~

~~

where G -uA. The equilibrium path for an initial condition, ko, is then given by PPt(ko)}, where t(k) is defined iteratively by P1(k) P(k) and Wt(k) Cofft- 1(k)). The Steady State: The dynamical system, (8), has a unique steady state. If G < 1, the steady state is in the Solow regime, given by kt = k* G' < kc = 1. Without innovation, all the goods are competitively supplied and the economy does not grow: the steady state is a neoclassical stationarypath. If G > 1, the 1 + (G - 1)/ 0> kc = 1. steady state is in the Romer regime, given by kt = k* In this steady state, new products are introduced steadily, and K and N grow at the same rate. It is a balanced growthpath. From (6) and (7), Kt = ,uEt= ,uAKt = GKt_, so that G is equal to the gross rate of growth. Note that G = ,uA is the key parameter determining the growth potential of the economy. If it is greater than one, the economy grows. If it is less than one, the economy stays stationary.
5At first glance, this assumption may appear extreme. As shown in Matsuyama (1996, Section 3), however, this specification can be justified as the result of an optimal saving decision in the case of two-period-lived overlapping generations consumers. Furthermore, Matsuyama (1996, Section 4) extended the analysis for the case of the infinitely-lived representative consumer, and demonstrated that much of the results shown below do not depend on this assumption.

GROWING THROUGH CYCLES

341

3.

THE DYNAMICS

Figures 1-3 illustrate the dynamics of k, = k(k, 1)* The map is increasing and concave in the Solow regime, where capital accumulation, without innovation, is subject to diminishing returns. The map is decreasing in the Romer regime. When innovation occurs, a further increase in capital increases innovation more than investment, as innovation is a more capital intensive activity than the final goods production. Figure 1 depicts the case of G < 1, where the steady state, k*, is a neoclassical stationary path. For any initial condition, after at most one period, innovation stops and the economy is trapped in the Solow regime. Once trapped, the economy grows solely on capital accumulation, and growth eventually peters out. The convergence to the stationary state, k*, is monotone. Figures 2 and 3 both depict the case of G > 1, or equivalently, P(k,) > kc, where the steady state, k**, is a balanced growth path. The two figures differ in the local stability of the steady state, determined by the slope of the map at the steady state, P'(k**)= (1 - O)/G < 0. Figure 2 shows the case of 1 < G < 0 - 1,

kt

,~~~~

kc

kt-1

The SolowRegime
FIGURE 1.-G

The RomerRegime
< 1.

342

KIMINORI MATSUYAMA

kt

p3 (kc 4- ---- -- -- --- -- --

,_

?|
t . w The

(kc)
_

k
-------

?(kc)

k t1
. ._ }

e~~kc\

The Solow Regime

,k

The Romer Regime <G < 0- 1.

FIGURE 2.-1

where k** is locally unstable: (P'(k**) < -1. The interval, [p2(k,), (P(k,)], represents the trapping region, i.e., the region that the economy enters eventually, and once entered will never leave. Some algebra can show that the condition, 1 < G < 0- 1, is equivalent to (p2(k,) < k, < (P(k,); that is, the trapping region covers both the Solow and Romer regimes. If the economy starts with a small ko, the economy may stay in the Solow regime for many periods, but eventually accumulates enough capital to enter the Romer regime, and innovation begins. This way, the economy begins sustainable growth through cycles, bouncing back and forth between the two regimes. In Figure 3, G > 0- 1 and hence - 1 < (P'(k**) < 0 and kC< (p2(kc). In this case, the steady state is globally stable. As in the previous case, the economy may initially stay in the Solow regime for many periods, but eventually enters the Romer regime. Then, the economy stays forever in the Romer regime and oscillates around and converges toward the steady state, or a balanced growth path.

GROWING THROUGH CYCLES

343

kt

O
_s _

~~ ~ ~~~~kc
s t L

k
v

k t-1
__
_k1

The Solow Regime

FIGURE

The Romer Regime 3.-G

> 0-1.

The graphical analysis thus suggests that there are three distinct asymptotic behaviors, depending on parameter values. The following proposition states it more formally.6 A. Then: PROPOSITION 1: Let G (i) If G < 1, then, for any ko E R, k, < kc for all t, and lim, kt = k. That is, the economy immediately settles down to the Solow regime and converges to a neoclassical stationarypath. (ii) If 1 < G < 0 - 1, there are period-2 cycles;7kt fluctuates forever between the Solow and Romer regimesfor almost all initial conditions, that is, for ko E R+\D, where D is at most countable subset of R +.
J

6The propositionignores the two nongenericcases: G = 1, and G = 0 - 1. The formercase is similarto case (i). In the lattercase, there are a continuum period-2cycles,satisfyingkH > kL > 1, of andfor anyinitialcondition,the economyconvergesto one of the period-2cycles.The existenceof a continuum period-2cycles,however,is not structurally of stable. 7For any integern ? 2, period-n cyclesof the map are definedas {(t(k)), such that Vt(k) 0 k for all 1 < t < n and " (k)= k.

344

KIMINORI MATSUYAMA

(iii) If G > 0- 1, for any ko C R+, there exists a t' such that {kt; t ? t'} c [kc, iP(kc)] and lim, . kt = k**. That is, the economy eventually settles down to the Romer regime, and then oscillates around and eventually converges to a balanced growthpath.
PROOF: (i) The graphical analysis would suffice. (ii) First, in order to show the existence of period-2 cycles, it suffices to show that H(k) =P2(k) - k = 0 has a solution other than k = k**. Since > [Vp2(kc), iP(kc)] is the trapping region, H(@p2(kc))= (p4(kc) - P2(kc) 0 and H(kC) = (p2(kc) - kc <0, hence H(k) = 0 has a solution in Vp2(k), kc]. This proves the existence of period-2 cycles. Next, suppose that t(ko) converges. Let the limit point be denoted by k'. Then, from the continuity of P, k'= limt CotC1(ko) = (limtm At(kd)) = (kc), therefore kc =k**. Let D{koCR+ IlimtAPt(ko) =k**}. Since k** is locally unstable, (Pt(ko) cannot approach it asymptotically. Hence, D = {ko C R+ I t'(ko) = k** for a finite t'}, which is at most countable, since the uni-modality of (P implies that, for any k, there are at most two x's that solve k = d>(x). Hence, for almost all initial conditions, kt fluctuates indefinitely. The graphical analysis would suffice to show that the economy cannot be trapped in the Solow regime. To prove that the economy cannot be trapped in the Romer regime unless kt 0 k**, note that, as long as the economy stays in the Romer regime, the dynamics can be described by 1/kt+s - 1/k** = {(1 - o)/G}s[1/kt - 1/k** ]. Hence, I(1 0)/GI > 1 implies that, after a finite number of periods, kt+s < kc. (iii) First, for any ko C R+, there exists a t', such that kt, c [kc, P(kc)]. Then, kc < P2(kc) implies that kt+1 C [P2(kc), P(kc)] c [kc, P(kd)]. Hence, for all t> t', k c [k ,P(kd)]. Hence, from I(1 - O)/GI < 1, 1/kt - l/k** = Q.E.D. {(1 - O)/G}t-t'[1/kt, - l/k**] > 0, as t -> oo.

For any 0, a sufficiently large G leads to an oscillatory convergence to a balanced growth path, and a sufficiently small value of G leads to a monotone convergence to a neoclassical stationary path. When 0> 2, or equivalently o-> 2, there is an intermediate range of G, for which the economy fluctuates for almost all initial conditions. Although convergence to a balanced growth path is possible (with zero probability), this is an unstable situation and cannot be observed with occasional perturbations to the system. To understand the mechanics of generating cycles, let us consider the following thought experiment. Initially, the parameter satisfies G > 0 - 1, and the economy is in a balanced growth path. Then, all of a sudden, there is a decline in G. As G becomes smaller than 0 - 1, the balanced growth path loses its stability. This bifurcation generates stable cycles of period-2. The simulation suggests that the period-2 cycles remain stable for a wide range of parameter values. As G becomes even smaller, however, period-2 cycles eventually lose their stability and this bifurcation leads to stable cycles of period-4. A further decline in G causes another bifurcation to generate stable period-8 cycles, and then stable period-16 cycles. However, it seems that G must reach 1 and that

GROWING THROUGH CYCLES

345

the cycles should be replaced by a stable stationary state, before such a series of flip bifurcations would lead to a chaos.8 The instability of the balanced growth path and the emergence of cyclical behavior are due to the complementarity in the timing of entry/innovation decisions. Timing matters in this model, because innovators can enjoy only a temporary monopoly power. Innovations take place only when the market for a new product is sufficiently large that the innovator can reach the break-even level of output. The market size partially depends on how the products with which it competes are priced. If the innovator enters when other firms also enter, some of the products are monopolistically priced. If it enters in the following period, then these products become competitively priced, as their innovators lose monopoly power. This consideration gives an incentive for firms to enter when other firms also enter. This effect is stronger when different products are highly substitutable, i.e., when 0 is high. At the same time, a growing resource base gives an offsetting force of spreading innovative and entry activities, the effect of which is stronger when G is high. When the former effect dominates the -latter, there is a bunching of entry activity, and the economy moves back and forth between the Romer regime (the period of innovation) and the Solow regime (the period of no innovation). To understand further the nature of cyclical behaviors, let us focus on the period-2 cycles, in which the economy alternates between the Solow regime, kL < 1, and the Romer regime, kH > 1, where kL and kH are determined jointly by (8a) and
GkH +0(kH_1) kH
=

?P(kL) = G(kL)

-(11ff

(8b)

kL=P(kH)=

Proposition 2 summarizes the properties of period-2 cycles.

8See Grandmont (1986) for an accessible review of mathematics of chaos. It is straightforward to show that this system is not chaotic in the sense of Li-York, by demonstrating the nonexistence of 1 - O(G - 1) j1 period-3 cycles. For this, it suffices to show that (p3(k,) > kc, or h(G) =- G2 2+ --/(o1) > 0. Since h is convex and h(l) = 0, h(G) > 0 for all G > 1 follows from h'(1) 0 > 3 - e > 0, where e = 2.71828.... Note, however, this does not rule out the possibility of chaotic trajectories; that is to say, for some initial conditions, the economy indefinitely fluctuates, and yet may never converge to any cycles. To rule out such a possibility, one needs to show that all the cycles have the period length of a power of 2, a property that is difficult to demonstrate analytically. Another difficulty is that the Schwartzian derivative of the map, P, is not negative, which means, among other things, that the iteration of the critical point, Pt(k,), may fail to detect stable cycles, even if they exist.

346

KIMINORI MATSUYAMA

PROPOSITION 2: Let gx be the (gross) growth rate of variable X. Along the period-2 cycles, in the Solow r-egime; (a) gN = 1 < G < G(kL)-I1/u =gK =gy (b) gN = 1 + o(kH - 1) > G =gK = gy in the Romer- regime; (C) gN =gK =gy = {1 + 0(kH - 1)}I/2 = G(kL)-l /27 > G over the cycles.
= kL, k = kH. Then, from (5), Nt/N_1 = 1 and PROOF: Let kt2 = kH, kt A 1 Nt+ /Nt = 1 + 0(kH- 1). Hence, Yt/<Yt = Kt/Kt 1 = (kH/kL)(Nt_1)= kH/kL, and Yt+ l/Yt=Kt+ I/Kt=(kL /kH)(N+ 1/Nt)=(kL/kH){1 +0(kH 1)} Q.E.D. Inserting Equations (8a)-(8b) into these expressions yields the results.

Proposition 2(a) and 2(b) show that output and investment grow faster in the Solow regime (the period of no innovation) than in the Romer regime (the period of innovation). Even though the innovation of new goods is a crucial way of avoiding diminishing returns and of sustaining growth indefinitely, the economy actually experiences lower growth in output and in investment during the period of innovation. Only after innovation stops, and the market structure becomes competitive, does the economy enjoy the benefits of the innovation. In this model, a synchronization of innovative activities leads to an asynchronization of innovation and investment. Proposition 2(c) states that the cycles are growth-enhancing; they allow the economy to grow even faster than along the balanced growth path.
4. EMPIRICAL PLAUSIBILITY OF CYCLES

Is the condition for cycles, 1 < G < 0 - 1, empirically plausible? Let G = (1 + g)Y, where g is the annual growth rate along the balanced growth path, and T is the number of years in which an innovator enjoys monopoly power. The condition is then rewritten as 0 <g < (0 - 1)1/7 - 1. Table I shows the upper bound, for some values of 0 and T. For 0, recall that u- plays two distinctive roles in this model. First, 1 - (i/o-) is the share of capital, broadly defined, including both physical and human, which suggests that o- would be around six, or 0= 2.49. Second, u- is the price elasticity, and the monopoly margin enjoyed
TABLE I
(01)1/70 2.40 2.45 2.50 2.55 2.60 2.65 2.70 1

3 6 9 12 15 18

11.87% 5.77% 3.81% 2.84% 2.27% 1.89%

13.19% 6.39% 4.21% 3.14% 2.51% 2.09%

14.47% 6.99% 4.61% 3.44% 2.74% 2.28%

15.73% 7.58% 4.99% 3.72% 2.96% 2.46%

16.96% 8.15% 5.36% 3.99% 3.18% 2.65%

18.17% 8.70% 5.72% 4.26% 3.39% 2.82%

19.35% 9.25% 6.07% 4.52% 3.60% 2.99%

GROWING THROUGH CYCLES

347

by the innovator is 1/(o- - 1). Conservatively, this suggests that 5 < u- < 20, or that 2.44 < 0 < 2.65. For T, agnosticism leads us to use a wide range (from 3 to 18) for T in Table I. Since g is lower than the annualized long run average growth rate (Proposition 2(c)), Table I suggests the empirical plausibility of the condition for cycles. Dept. of Econoinics, NorthwesternUniversity,2003 Sheridan Road, ELanston, IL 60208, U.S.A.
Maniiiisciipt receivedDecember; 1996; flutulrevision receivedApril, 1998.

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