Externalities and Growth Accounting

This paper tackles two puzzles: the high empirical elasticity of aggregte output with respect to the measured capital input and the seemingly high variability of growth rates over countries in the medium run. We find that one need not invoke increasing returns or externalities to capital to explain these two puzzles. Rather, they are consistent with a constant-returns-to-scale aggregate production function, so long as the exogenous Solow residual process has enough persistence in it. In our model, causality runs exclusively from knowledge to capital, and therefore the apparent absence of an external effect to the capital input says nothing about the importance of spillovers in the creation of knowledge. Copyright 1991 by American Economic Association.