Neoclassical growth theory: Convergence of economic growth rate and income level to that of richer countries

Country A was able to achieve economic growth rates and income levels comparable with many of its neighboring countries during the neoclassical growth period. Country A's scientists, together with the engineering department of a university, provided access to the finest technology in the world. In addition, country A opened up its equity markets to outside investors and allowed its currency to float. Dr. S believes that, given time, these capital market improvements should allow the country A's economy to achieve an economic growth rate and per capita income level comparable to any country in the world.

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[Question]

Country A has access to the same world class technology and capital markets as its more advanced neighbors. Dr. S expects country A's economic growth rate and income level to converge to that of richer countries over time. Indicate whether convergence with richer countries is likely or unlikely. Convergence is:

A. likely, due to country A's similar access to capital and technology.

B. unlikely, due to differences in savings rates and target rates of return.

C. likely due to differences in savings rates and target rates of return, but not due to similar access to capital and technology.

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Answer: B

The neoclassical growth theory model does indeed imply that given access to the same technology and capital markets, then growth rates and income levels per person should begin to converge on a global basis.

While some convergence has occurred over time, many countries are just as far away from the rich countries as they have ever been. This lack of convergence in the real world is probably due to the fact that the neoclassical growth model leaves out many of the variables that must grow at the same rate in different countries for convergence to occur.

Obstacles to convergence include differences in:

• population growth rates
• rates of technological change
• (and most importantly) savings rates and target rates of return

In essence, if the countries do not have similar economic and demographic characteristics, then it would be difficult for them to grow at the same rate.