Question

Define the main ideas of the Lucas, and AK new growth model respectively. Is growth endogenous or exogenous in these models?

Answer 1

Lucas Model

• Lucas assumes that investment on education leads to the production of human capital which is the crucial determinant in the growth process.

• He makes a differentiation between the internal effects of human capital where the individual working undergoing training turns out to be increasingly gainful and which spillover and increase the productivity of capital and of other workers in the economy. It is investment in human capital opposed to  physical capital that have spillover effects that increase the level of technology.

• Lucas favours subsidies by the state or schooling in developing countries because investment in education has a spillover effect on the productivity of other people. He also advocates incentives to such firms which invest more on research and development of new technologies

• In the Lucas model, each firm faces constant returns to scale, while there are increasing returns for the whole economy. Further, learning by doing or on the job training and spillover effect involve human capital. Each firm benefits from the average level of human capital in the economy, rather than from the aggregate of human capital. Thus it is not the accumulated knowledge or experience of other firms but the average level of skills and knowledge in the economy that are crucial for economic growth. In the model technology is endogenously provided as a side effect of investment decisions by firms.

AK Model

• Learning by doing formed the basis of the first model of endogenous growth theory, which is know as the AK model. The AK model assumes that when people accumulate capital, learning by doing generates technological progress that tends to raise the marginal product of capital, thus offsetting the tendency for the marginal product to diminish when technology is unchanged.
• The AK model predicts that a country ís long-run growth rate will depend on economic factors such as thrift and the efficiency of resource allocation.
• The AK model stresses the relationship between policies and economic growth. This contrasts with the Solow model, whereby changes in the key parameters only produce level effects. The empirical evidence has not been, however, very favourable to the simpler version of the AK model. In general, country characteristics, such as the saving rate and aggregate efficiency are found to influence the levels of per capita income, rather than growth rates.
• The AK model reveals in a simple manner that getting rid of diminishing returns, factor accumulating alone can generate continuous growth of per capita income. In the context of the AK model, changes in the saving rate produce “growth effects” rather than “level effects”.
• Extending the AK model to the case with endogenous savings, the direct effect of aggregate efficiency on growth is reinforced by an indirect effect via a higher return on savings. The implication is that, wherever financial markets are more developed, the impact of policy changes on growth is more dramatic.
• The model with endogenous savings appeals to the distinction between proximate causes of growth, like the savings rate and aggregate efficiency, and fundamental causes of growth, that determine why some countries have higher investment rates and better efficiency than others.