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Augmentation or Elimination?

  • Pietro Peretto
  • John J. Seater

Endogenous growth requires that non-reproducible factors of production be either augmented or eliminated. Attention heretofore has focused almost exclusively on augmentation. In contrast, we study factor elimination. In our theory, maximizing agents decide when to reduce the importance of non-reproducible factors. We use a Cobb-Douglas production function with labor and capital as factors of production. There is no augmenting progress of any kind, whether Hicks, Harrod, or Solow neutral, thus excluding the standard engine of growth. What is new is the possibility of changing the factor shares endogenously by spending resources on R&D. Firms invest in physical capital, and they undertake R&D that alters the factor shares of the capital and labor used for production. The model allows derivation not only of the balanced growth solution but also of the full transition dynamics. There are two possible ultimate outcomes, depending on parameters and initial conditions. The economy may evolve into one that uses both labor and capital at shares that settle upon fixed final values, or it may evolve into one that uses only capital. The first outcome is the standard Solow model, and the second is the AK model. The latter produces perpetual endogenous growth, and it is itself an endogenous outcome of a rational maximizing process. In contrast to virtually all existing endogenous growth literature, neither monopoly power nor an externality is a necessary condition for perpetual endogenous growth. The transition paths are interesting, allowing non-monotonic behavior of both the capital/labor ratio and the factor shares. An aspect of the transition path that is unique for a Cobb-Douglas economy is that the origin is not an equilibrium. An economy that starts at the state space origin (capital equal to zero, capital's share equal to zero: pure labor production) moves away from the origin, simultaneously accumulating capital and increasing capital's share to make the capital useful. The theory thus offers a purely endogenous explanation for the transition from a primitive to a developed economy, in contrast to other existing theories. Finally, several aspects of the transition paths accord with the evidence, suggesting that the theory is reasonable.

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Paper provided by DEGIT, Dynamics, Economic Growth, and International Trade in its series DEGIT Conference Papers with number c011_060.

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Length: 28 pages
Date of creation: Jun 2006
Date of revision:
Handle: RePEc:deg:conpap:c011_060
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  1. Douglas Gollin, 2001. "Getting Income Shares Right," Department of Economics Working Papers 2001-11, Department of Economics, Williams College.
  2. Robert M. Solow, 1994. "Perspectives on Growth Theory," Journal of Economic Perspectives, American Economic Association, vol. 8(1), pages 45-54, Winter.
  3. Robert E. Hall & Charles I. Jones, 1999. "Why Do Some Countries Produce So Much More Output Per Worker Than Others?," The Quarterly Journal of Economics, MIT Press, vol. 114(1), pages 83-116, February.
  4. John Bound & George Johnson, 1995. "What are the causes of rising wage inequality in the United States?," Economic Policy Review, Federal Reserve Bank of New York, issue Jan, pages 9-17.
  5. Alan Krueger, 1999. "Measuring Labor's Share," Working Papers 792, Princeton University, Department of Economics, Industrial Relations Section..
  6. Olivier Blanchard, 1998. "Revisiting European Unemployment: Unemployment, Capital Accumulation, and Factor Prices," NBER Working Papers 6566, National Bureau of Economic Research, Inc.
  7. Charles I. Jones, 2003. "Growth, capital shares, and a new perspective on production functions," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  8. Ethier, Wilfred J, 1982. "National and International Returns to Scale in the Modern Theory of International Trade," American Economic Review, American Economic Association, vol. 72(3), pages 389-405, June.
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