A Question About Solow Growth ModelWatch
Conditional convergence hypothesis: The Solow growth model sug- gests that countries with identical saving rates and population growth rates should converge to the same per capita income level. To test the hypothesis, you collect data on the average annual growth rate of GDP per worker (g6090) for 1960-1990, and regress it on the (i) Starting GDP per worker in 1960 (RelProd60), (ii) average popu- lation growth rate of the country (n), (iii) average investment share of GDP from 1960 to1990 (sK - remember investment equals savings), and (iv) educational attainment in years for 1985 (Educ). The results for close to 100 countries is as follows (numbers in parentheses are for heteroskedasticity-robust standard errors):
g6d090 = 0:004 - 0:172n + 0:133sK + 0:002Educ - 0:044 * RelProd60;
(0.007) (0.209) (0.015) (0.001) (0.008)
R2 = 0:537; SER = 0:011
(a) Interpret the results. Do the coefficients have the expected signs? Why does a negative coefficient on the initial level of per capita income indicate conditional convergence (beta-convergence)? Is the coefficient on this variable signi cantly different from zero at the 5% level? At the 1% level?
(b) Test for the signi cance of the other slope coefficients. Should you use a one- sided alternative hypothesis or a two-sided test? Will the decision for one or the other infuence the decision about the signi cance of the parameters? Should you always eliminate variables which carry insigni cant coefficients? (Hint: Economic theory gives us the signs of the variables)
You want to test whether conditional convergence is observed in the data. Conditional convergence occurs when countries with similar characteristics (savings rate, pop. growth etc) converge to have similar output levels. This means that a country with a similar characteristic which had a negative shock (e.g. Germany in WWII) would experience high growth to catch-up with other OECD member countries.
The regression is Growth Rate of GDP/worker = GDP in 1960 + Population Growth + Investment/GDP + Education
Population growth has a negative affect (as Solow predicts)
Investment has a positive effect
Education has a positive effect
Production in 1960 has a negative effect
Does economic theory match this?
(b) This is just econometrics