Banco Central de Chile Documentos de Trabajo Central Bank of Chile Working Papers N ° 172 Julio 2002 15 YEARS OF NEW GROWTH ECONOMICS : WHAT HAVE WE LEARNT ?

Paul Romer’s paper Increasing Returns and Long Run Growth, now 15 years old, led to resurgence in the research on economic growth. Since then, growth literature has expanded dramatically and has shifted the research focus of many generations of macroeconomists. The new line of work has emphasized the role of human capital, social and political variables, as well as the importance of institutions as driving forces of long-run economic growth. This paper presents an insight into the theoretical and empirical literature of the past fifteen years, highlighting the most significant contributions for our understanding of economics. ___________________ Keynote Address to the Fifth Annual Conference of the Central Bank of Chile The Challenges of Economic Growth, Santiago, Chile, November 29 and 30, 2001. I thank Laila Haider for her comments. E-mail: xs23@columbia.edu. 1 Paul Romer’s paper "Increasing Returns and Long Run Growth" is now 15 years old. This pathbreaking contribution led to a resurgence in research on Economic Growth. The new literature has made a number of important contributions. One of the main ones, perhaps the main one, is that it has shifted the research focus of macroeconomists. From the time Lucas, Barro, Prescott and Sargent led the rational expectations revolution until Romer, Barro and Lucas started the new literature on economic growth, macroeconomists devoted virtually zero effort to the study of long-run issues and they were all doing research on business cycle theory. And, in this sense, the new growth theory represented a step in the right direction. The new growth literature has had a similar impact on macroeconomics classes and textbooks. Up until 1986, most macroeconomics classes and most macroeconomic textbooks either relegated economic growth to play a marginal role or they neglected it altogether. Things are very different now. Modern undergraduate textbooks devote more than a third of their space to economic growth and most macroeconomic classes (graduate and undergraduate) devote a substantial amount of time to this important subject. The impact of these two changes on the training of new young economists is very important, and this should be viewed as another contribution of the new economic growth literature. But the contributions I wish to highlight in this conference are the substantial ones: I want to discuss the most significant ways in which the new economic growth literature has expanded our understanding of economics. (1) The Empirical Touch (A) The Construction of New Data Sets 1 Some of these facts did not really come from careful empirical analysis, but were quoted and used as if they were widely proved empirical facts. 2 One of the key differences between the current and old literature is that, this time around, growth economists have dealt with empirical issues much more seriously. This has led to the creation of a number of extremely useful data sets. Of course, the Summers and Heston data set tops the list. Summers and Heston (1988, 1991) constructed national accounts data for a large cross-section of countries for a substantial period of time (for some countries, the data starts in 1950, for most countries it starts in 1960). The usefulness of this data set is that, in principle, the data is adjusted for differences in purchasing power across countries, which allows for strict comparability of levels of GDP at a point in time. Even though some researchers have complained about the quality of this data set, overall, this has been one of the main contributions of this literature because it has allowed researchers to confront their theories with actual data. This was not true the last time growth economics was a popular area of research in the 1960s (the reason being, perhaps, that they did not have access to the data that we have today). But the Summers-Heston data set is not the only data set which has been created recently. Barro and Lee (1993), for example, have also constructed a large number of variables, mainly related to education and human capital. This was especially important because the first generation of endogenous growth theories emphasized the role of human capital as the main (or at least one of the main) engines of growth. Other data sets constructed recently include social and political variables which are especially useful for one of the most recent lines of research which emphasizes institutions (see for example, Knack and Keefer (1995) or Deininger and Squire (1996) and others. ) (B) Better Relation Between Theory and Empirics A second important innovation of the new growth literature is that it has tied empirical studies closer to the predictions of economic theory. The neoclassical literature of the 1960s linked theory and evidence by simply “mentioning” a bunch of stylized facts (such the Kaldor “facts” ) 2 Paul Romer’s seminal paper (Romer (1986)), is an example of an AK model. See also Rebelo (1987), Jones and Manuelli (1990) and Barro (1990). 3 The derivation of this equation assumes constant savings rates a la Solow-Swan. 3 (1) and showed that the theory being proposed was consistent with one, two or perhaps several of these “facts”. Today’s research, on the other hand, tends to derive more precise econometric specifications and these relationships are taken to the data. The best example can be found in the convergence literature. Barro and Sala-i-Martin (1992) use the Ramsey-Cass-Koopmans (Ramsey (1928), Cass (1975) and Koopmans (1965)) growth model to derive an econometric equation that relates the growth of GDP per capita to the initial level of GDP. Mankiw, Romer and Weil (1992) derive a similar equation from the Solow-Swan model ((Solow (1956) and Swan (1956)). These researchers derived a relationship of the form: where is the growth rate of per capita GDP for country i between time t and time t+T, is per capita GDP for country i at time t and is the steady-state value of per capita GDP for country i. The term is an error term. The coefficient is positive if the production function is neoclassical, and is zero if the production function is linear in capital (which was usually the case in the first generation one-sector models of endogenous growth, also known as “AK” models). In particular, if the production function is Cobb-Douglas with a capital share given by " then, the parameter $ (also known as the speed of convergence) is given by , where * is the depreciation rate and n is the exogenous rate of population