Modelling Policy Change in Endogenous Growth Theory

Innovation-based endogenous growth (IBEG) models are often used for evaluating R&D related policies. In such evaluations different policies correspond to different long-run balanced growth paths. If the model contains predetermined state variables, whose values cannot change discontinuously, the model economy cannot immediately move to a new long-run equilibrium after policy change. However, the transition paths from one long-run equilibrium to another have until now been left unanalyzed in the context of many important IBEG models. The theory of dynamic systems provides tools for such analyses. We review theory of dynamical systems and the development of IBEG models. We apply the theory of dynamical systems to Romer’s model of growth by specialization, and we recapitulate the reasons that make the transition paths of the first quality ladder models trivial and unique. We point out that the transition paths of many newer quality ladder models pose much more challenging problems.