Economic growth and economic development 534

Introduction to Modern Economic Growth
What about wages? Because labor is being used in the consumption good sector,
there will be positive wages. Since labor markets are competitive, the wage rate at
time t is given by

µ

(1 − κ (t)) K (t)
w (t) = (1 − α) pC (t) B
L
Therefore, in the balanced growth path, we obtain
w˙ (t)
p˙C (t)
K˙ (t)
=
+α
w (t)
pC (t)
K (t)
∗
= αgK ,

¶α

.

which implies that wages also grow at the same rate as consumption.
Moreover, with exactly the same arguments as in the previous section, it can be
established that there are no transitional dynamics in this economy. This establishes
the following result:
Proposition 11.4. In the above-described two-sector neoclassical economy, starting from any K (0) > 0, consumption and labor income grow at the constant rate

given by (11.33), while the capital stock grows at the constant rate (11.32).
It is straightforward to conduct policy analysis in this model, and as in the
basic AK model, taxes on investment income will depress growth. Similarly, a lower
discount rate will increase the equilibrium growth rate of the economy
One important implication of this model, different from the neoclassical growth
model, is that there is continuous capital deepening. Capital grows at a faster rate
than consumption and output. Whether this is a realistic feature is debatable. The
Kaldor facts, discussed above, include constant capital-output ratio as one of the
requirements of balanced growth. Here we have steady state and “balanced growth”
without this feature. For much of the 20th century, capital-output ratio has been
constant, but it has been increasing steadily over the past 30 years.

Part of the

reason why it has been increasing recently but not before is because of relative
price adjustments. New capital goods are of higher quality, and this needs to be
incorporated in calculating the capital-output ratio. These calculations have only
been performed in the recent past, which may explain why capital-output ratio has
been constant in the earlier part of the century, but not recently.
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