Long-Run Policy Analysis and Long-Run Growth Sergio Rebelo The Journal of Political Economy, Vol. 99, No. 3. (Jun., 1991), pp. 500-521. Stable URL: http: //links. jstor. org/sici?sici=0022-3808%28199106%29993A3%3C500%3ALPAALG%3E2.0.CO%3B2-M The Journal of Political Economy is currently published by The University of Chicago Press Your use of the ISTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http: //www.jstor.org/about/terms. html. jstor's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles,and you may use content in the ISTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http: //www.jstor.org/journals/ucpress. html. Each copy of any part of a ISTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. ISTOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding ISTOR, please contact support@jstor.org. http://www.jstor.org/ Mon Sep1800:38:072006
Long-Run Policy Analysis and Long-Run Growth Sergio rebelo Portuguese Catholic University, and Rochester Center far Economic Research The wide cross-country disparity in rates of economic growth is the most puzzling feature of the development process. This paper de scribes a class of models in which this heterogeneity in growth expe riences can be the result of cross-country differences in government policy. These differences can also create incentives for labor migra tion from slow-growing to fast-growing countries. In the models considered, growth is endogenous despite the absence of increasing returns because there is a"cote "of capital goods that can be pro- duced without the direct or indirect contribution of factors that cannot be accumulated, such as land I. Introduction One of the most surprising features of the process of economic growth is the wide cross-country dispersion in average rates of growth. In the postwar period, countries such as Japan, Brazil, and Gabon saw their level of per capita income expand at a fast pace while living.This paper studies a cls niGcant change in their standard of country differences in economic policy can generate this type of het his paper is based on the frst chapter of my Ph. D thesis defended at the University of Rochester. I am indebted to my advisors, Robert King and Paul re continuous guidance and advice. I also benefited from the comments and suggestions of Robert Barro, Marianne Baxter, Monica Hargraves, and numerous seminar pa pants. Any errors are my own. Financial port from the Amelia de Melo Foundation 91 by The University of Chicago. All rights reserved. @e22.980891A9903-000880150
LONG-RUN POLICY ANALYSIS erogeneity in growth experiences. In these models certain policy vari ables, such as che rate of income tax, affect the economy's rate of expansion through a simple mechanism: an increase in the income tax rate decreases the rate of return to the investment activities of he private sector and leads to a permanent decline in the rate of capital accumulation and in the rate of growth The class of economies that I propose in this paper shares with Romer's(1986)model the ty that growth is endogenous in the sense that it occurs in the absence of exogenous increases in produc- tivity such as those attributed to technical progress in the neoclassical growth model. But, in contrast with Romer's emphasis on increasing returns to scale and accelerating growth, the models discussed hete display constant returns to scale technologies and have steady-state growth paths, thus being compatible with the stylized facts of eco- nomic growth described in Kaldor(1961) The simplest model within the class that I consider is a one-sector economy with standard preferences and a production function that is linear in the capital stock. This simple model is usually dismissed as inappropriate to think about growth issues because labor plays apparently no role in the economy and nonreproducible factors such as land are not used in production. The analysis undertaken here more general models that surpass boch of these problems reveals that the simple linear model is a natural benchmark in terms of thinking about the growth process and a good representative of the class of endogenous growth economies that have a convex technology Throughout the paper I shall focus on the effects of taxation on e rate of growth. This focus was chosen because tax policies differ ignificantly across countries but also because the effects of taxation are suggestive of the impact of other government policies, such as those regarding the protection of property rights. The approach will be positive rather than normative: I shall cake as given that there are differences in public policy across countries and, at least for no sidestep the question of whether those different policies can viewed as optimal There is a large literature on tax policy issues in the neoclassical growth model that also concludes that high income tax rates trar late into lower rates of growth. But in the neoclassical model, this effect is too weak to explain the observed cross-country differences in growth rates. Economic policy can affect the rate of growth only luring the transition path toward the steady state since the steady- state growth rate is given by the rate of exogenous technical progress Key references in this literature include Krzyzaniak(1967), Sato(1967),Feldstein (1974), Stiglitz(1978),R. Becker( 1985), and Judd(1985)
JOURNAL OF POLITICAL ECONOMY These transitional effects of economic policy cannot have a large im pact on the rate of growth, given that the rough constancy of the eal interest rate during the last century suggests that transitional dynamics play a modest role in the growth process(King and Rebelo 1989) This paper is organized as follows. Section II studies a two-sector extension of a linear growth model that incorporates nonreproduc ible factors in the production process. This model is used to study he effects of taxation and the influence of the rate of savings on the rate Section III expands this model to distinguish the role of physical apical and human capital along the lines suggested by Lucas (1988 This extended model shows that the feasibility of sustained growth does not require capital to be produced with a linear technology, as might be suggested by Section II and by the models discussed by Uzawa(1965) and Lucas (1988). All that is required to assure the feasibility of perpetual growth is the existence of a"core"of capital goods that is produced with constant returns technologies and with out the direct or indirect use of nonreproducible factors Treating separately the accumulation of physical and human capi tal introduces transitional dynamics that are absent in Section IL. Br the implications obtained for the effects of taxes and of the savings rate along the steady-state path are basically those of Section II, in he case of both exogenous and endogenous leisure choice The remainder of Section III is devoted to generalizing the model of Section II along two different directions. First, capital goods pro- duced with nonreproducible factors are introduced in the economy Second, the consequences of introducing multiple consumptio oods are examined. the main policy implications derived in Section Ii prove to be robust to these generalizations Section iv relates the models discussed here to the neoclassical model and to some of the recent growth literature. Section V provides some conclusions and outlines directions for future research II. A Basic Endogenous Growth Model The point of departure in this paper will be an economy in which there are two types of factors of production: reproducible, which can be accumulated over time(e.g, physical and human capital), and nonreproducible, which are available in the same quantity in ever (e. g, land). The quantity of all rep factors will be summarized by che capital good Ze, which can be viewed as a compos ite of various types of physical and human capital. Similarly, the fixed amount available of nonreproducible factors will be summarized by he composite good T
LONG-RUN POLICY ANALY The economy has two sectors of production. The capital sector uses a fraction(1- e)of the available capital stock to produce investment roods(L,)with a technology that is linear in the capital stock: I Az (1-d). Capital depreciates at rate 8 and investment is irrevers ible (1, 20): Z,=L-8Z2 The consumption sector combines the remaining capital stock with nonreproducible factors to produce con sumption goods(C). Since for steady-state growth to be feasible it must be possible for both consumption and capital to grow at constant (but possibly different) rates, the production function of the con- sumption industry is assumed to be Cobb-Douglas: C:=B(,,)T This technology permits capital to grow at any rate between A-8 production is consumed), and consumption to grow at a rate propor- tional to that of capital: ge =aga The economy has a constant population composed of a large num- ber of identical agents who seek to maximize utility, defined as These preferences imply that the optimal growth rate of consumption (get) is solely a function of the real interest rate (e): gu=(r-p)/o Since in all the economies considered here the real interest rate is constant in the steady state, this ensures that when it is feasible for consumption to grow at a constant rate it is also optimal to do so The competitive equilibrium under perfect foresight for all the cconomies studied in this paper can be computed as a solution to planning problem by exploring the fact that, in the absence of distor tions, the competitive equilibrium is a Pareto optimum. Instead of taking this approach, we shall study directly the competitive equilib rium focusing on the conditions that are relevant to determine the growth rate, since this will be more informative about the economic mechanisms at work in the model To describe the competitive equilibrium, it is necessary to have a market structure in mind. In chis case, it is easiest to think of the economy as having spot markets for all goods and factors and one period credit markets. Firms make their production decisions seeking to maximize profits, while households rent the two factors of produc- tion(Z and T) to firms and choose their consumption so as to max imize lifetime utility(1) To maximize profits, firms have to be indifferent about employing heir marginal unit of capital to produce either consumption goods or capital goods; that is, P,A=aB(p2Z)-, where P is the relative price of capital in terms of consumption. Since in the steady state the The dot notation is used for the time derivative, so Z,=dzldt