Super-robust endogenous growth: Theory and empirical insights

AbstractWe propose an endogenous growth model that accommodates increasing, constant, or decreasing aggregate returns to scale with respect to the growth driving factor: quality-improving knowledge accumulated by firms in house. When aggregate production is non-linear in firm knowledge, the profitability of firms reflects that property, and entry (new product creation) responds accordingly. The consequent changes in market share offset the non-constant aggregate returns to scale and deliver constant firm-level returns to innovation in steady state. Because returns to innovation are constant, the steady-state growth rate of income per capita is constant and fully endogenous (i.e., dependent on policy parameters). The non-linearity with respect to the growth driving factor has testable implications for convergence dynamics. Specifically, the speed of convergence is decreasing (increasing) in the distance from the steady state when aggregate returns to firm knowledge are increasing (decreasing), causing asymmetric convergence dynamics. This propagation mechanism ensures that, subject to symmetric shocks, the average growth rate across shocks differs from the steady state rate, implying that these shocks’ frequency and magnitude are a determinant of long-run growth. The model reduces the growth dynamics to a single quadratic differential equation in the growth rate of GDP per capita. The quadratic term captures the non-linearity in convergence and uniquely identifies the aggregate returns to firm knowledge. We estimate this equation on a panel of countries in the post-industrial revolution era finding evidence of increasing aggregate returns to firm knowledge.

Duke Scholars

Author Pietro F. Peretto Economics