Understanding Conditional Convergence in Macroeconomics

1. Lecture 6: Conditional Convergence and Growth L11200 Introduction to Macroeconomics 2009/10 Reading: Barro Ch.4 : p83-94 4 February 2010

2. Introduction • Last time: • Solow model with no variation in s, n, δ, A between nations implies all countries (eventually) move to same GDP per capita and low GDP per capita nations grow faster: ‘absolute convergence’ • Data appears to reject this • Today • Allow these factors to vary and introduce idea of ‘conditional convergence’

3. Conditional Convergence • How do the model’s predictions for growth change when we allow the factors to vary • E.g. economies have different saving rates • The economy with the lower saving rate will have lower steady state k*, y* compared to an economy with a higher saving rate • Atany level of K(0), the economy with a higher saving rate will be growing faster

4. Other factors • The same is true for n, δand A • Higher n implies lower k*, y* • Higherδ implies lower k*, y* • Higher A implies higher k*, y* • And at any K(0), the economy with higher technology or lower depreciation / population growth will grow faster.

5. Implications for growth rates • This gives to implications • For a given K(0), the economy with the higher k* will have a faster growth rate • For a given k*, a decrease in K(0) raises the growth rate • We can write this as:

6. Implications for Convergence • This may explain the lack of absolute convergence • Economies don’t converge to the same GDP per capita levels, so growth rate doesn’t depend on level of GDP per capita • Maybe the economies with lower growth rates also have lower k*, y* steady states, so they are on a growth path to a different steady state.

7. Conditional Convergence • This is the idea of conditional convergence: each economy is converging to it’s own steady state k*, y* determined by it own s, n, δ, A • This can be tested if we have data on each of these factors • Data is available on each: so can plot relationship between per capita GDP and per capita GDP growth conditional on these covariates

8. Conditioning Variables • Graph actually hold more than just s, n, δ and A constant. It also controls for other factors which affect k*, y* not in our model: • Measures of extent of rule of law and democracy • Extent of openness to trade • Investment in health and education • Measure of inflation

9. Example I • Europe after World War II: • Previously strong characteristics, but capital and labour had been destroyed by war • So steady state k*, y* are high, current k low due to effects of war • Post WWII fast growth in European economies – consistent with conditional convergence

10. Example II • Sub-Saharan African nations are very poor • Absolute convergence predicts they should grow rapidly • But they don’t: because they have poor levels of saving and technological growth • Also (maybe more importantly) they have poor rule of law, governments, education programmes and health systems. All factors which influence k* and y*.

11. Summary of Progress • We began with some questions: • Why are some economies more developed than other? • Why do GDP growth rates vary across nations? • What is the relationship between the level of GDP and the growth rate of GDP

12. Explaining the patterns • Absolute convergence: all economies have the same steady state. Smaller economies should grow faster, all should converge to same per capita GDP. • Limited evidence for this • Conditional Convergence: economies converge to own steady-state, conditional on structural factors • Much stronger empirical evidence

13. Long-Run Growth • Question still remains: why do we observe long-run persistent growth rates for U.K. and U.S.? • Conditional convergence predict economy moves towards steady state • So expect growth rate would slow over time • But growth rate is steady over time: continual, or long-run growth.

14. Summary • Conditional convergence more plausible model than absolute convergence • Better supported by the data • Explains lack of growth in poorly developed nations through structural factors • How to explain long-run growth? • Need a model in which economy can maintain high growth rate continually.