Investment and Saving along the Development Path

In this paper we document that the investment and saving rates follow a large and long-lived hump-shaped profile along the development path. This pattern is present both in the large panel of countries of the Penn World Tables (PWT) between 1950 and 2010 and also in the historical data recently assembled by Jorda, Schularick, and Taylor (2017). The hump of investment with development is a challenge for the standard neo-classical model of growth. We propose two simple mechanisms that can jointly explain the observed paths of investment. First, we allow for richer transitional dynamics by assuming that households value their consumption in reference to a slow-moving endogeneous standard of living of the society where they live in, and show that a calibrated model with this feature alone can reproduce the large and long-lasting hump-shaped profiles of investment with development. Second, we look at the data of each country as coming from the transitional dynamics of economies whose technology does not grow at a constant rate. In particular, we extend the model to have separate consumption and investment goods sectors and feed it with the observed paths of investment-specific technical change, total factor productivity, and investment depreciation for each country. We exploit the Euler equation of consumption with a large panel of countries to estimate the preference parameters of the model as it is standard in the micro consumption literature. The estimated model allows us to understand which forces drive the investment rates observed in the data for every country and period.