What The Standard Theories Explain

Focusing on their list of 13 stylized facts, Mulder et al. present the core concepts of the standard Solow-Swan growth model followed by a mathematical elaboration of it, with an explanation of how the basic model deals with items 1-6, 9 and 12, as well as two of the determinants listed under 13, namely initial level of GDP and investment (Mulder et al. 2001;

Mulder 2004). They also propose an augmented version that incorporates human capital and thus satisfies some of the other criteria among the 13.

Mulder et al. present a series of five standard criticisms together with the responses offered by adherents of the standard theory. Two of the five major criticisms of the Solow model are concerned with demographic issues, notably the inhomogeneity of the workforce. These problems can be addressed by fairly straightforward modifications (augmentations) of the model. We quote only the most pertinent objection, number 2, namely that the Solow model essentially takes, as given, the behavior of the variables that are identified as the driving forces of growth, viz. population growth and technological change. In other words, it explains growth by simply postulating it. (Mulder 2004)

In response to this major criticism, Mulder et al. note the development of two classes of models in the past two decades, namely evolutionary growth models and neoclassical endogenous growth models (of which there are several sub-classes). They discuss the latter at much greater length than the former, which barely mention the seminal work of Nelson and Winter (Nelson and Winter 1982). As regards the neoclassical endogenous theorizing, three approaches are noted. The first is the so-called AK approach, pioneered by Romer and Rebelo, where capital K is taken to include human capital (hence population as well) (Romer 1986, 1987b; King and Rebelo 1990; Rebelo 1991). The growth of human capital in this approach is not subject to declining returns because of the compensating influence of spillovers, which are productivity-enhancing methods or technologies resulting from progress in another sector.

The second approach emphasizes knowledge creation as a result of maximizing behavior (for example, R&D), again subject to spillovers and dependent on the extent to which benefits of innovation can be appropriated by Schumpeterian innovators (Lucas 1988). More recent work has treated R&D as a separate sector, with capital flowing into it in proportion to the returns on R&D vis-à-vis other investments. Aghion and Howitt have pioneered a 'neo-Schumpeterian approach', emphasizing the research-driven displacement of older sectors by newer ones (namely the process of creative destruction postulated by Schumpeter) (Aghion and Howitt 1992, 1998).

It is worthwhile to note that none of our last four proposed stylized facts (14-17) are explained by any of the neoclassical theories. Indeed, facts 14 and 15 are explicitly inconsistent with the notion - common to so-called 'endogenous theories' - that technology is homogeneous, fungible and continuously improving. (We discussed this issue at some length in Chapter 2.)

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