Tuesday, September 4, 2012

Neoclassical Growth Model Exemplifies Positive Economics Gone Wrong

For the first week of Macroeconomics we’re learning about the Neoclassical/Exogenous/Solow growth model. As an introduction to the topic, the following Wikipedia page was recommended: http://en.wikipedia.org/wiki/Exogenous_growth_model. The page notes:
A key prediction of neoclassical growth models is that the income levels of poor countries will tend to catch up with or converge towards the income levels of rich countries as long as they have similar characteristics – for instance saving rates.
Considering that this hypothesis remains prevalent today, one can be forgiven for assuming that empirical observation supports this prediction. But, as the following sentences show:
Since the 1950s, the opposite empirical result has been observed on average. If the average growth rate of countries since, say, 1960 is plotted against initial GDP per capita (i.e. GDP per capita in 1960), one observes a positive relationship. In other words, the developed world appears to have grown at a faster rate than the developing world, the opposite of what is expected according to a prediction of convergence.
The Solow model presents an example of positive economics gone wrong. Since countries with “similar characteristics” can never be objectively defined, assuming they can even exist, the hypothesis cannot be refuted by empirical observation. Placing more value upon realistic assumptions will allow economics to enjoy the benefits of “creative destruction” it values so highly in a market system.

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