A DYNAMIC-MODEL OF INVESTMENT AND ENDOGENOUS GROWTH

Models of endogenous growth assume that private investment in either physical or human capital yields positive externalities to production possibilities as a whole. But what is the structure of such externalities? We present a model of ''learning by watching'' which implies a nonlinear relationship between productivity growth and the investment rate. This results in multiple steady-state growth rates in a deterministic setting, and in a rich dynamic structure that generates both growth and cycles in a stochastic model (calibrated by reference to observable shocks to tax rates in the U.K.). Economies with identical structures can experience very different growth rates for long periods. The model exhibits path-dependence and history matters.