PUBLIC POLICY AND ECONOMIC GROWTH; OEVELOPING NEOCLASSICAL IMPLICATIONS
Robert G. King Sergio Rebelo
Working Paper No. 3338
NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Masaarhusetts Avenue Cambridge, MA 02138 April 1990
This paper is part of NBER's research program in Growth. Any opinions expressed are those of the authors and not those of the National Bureau of Economic Research.
NBER Working Paper #3335 April 1990 PUBLIC POLICY AND ECONOMIC GROWTH: DEVELOPING NEOCLASSICAL IMPLICATIONS ABSTRACT Why do the countries of the world display considerable disparity in long term growth rates? This paper examines the hypothesis that the answer lies in differences in national public policies which affect the incentives that individuals have to accumulate capital in both its physical and human forms. Our analysis shows that these incentive effects can induce large difference in long run growth rates. Since many of the key tax rates are difficult to measure, our procedure is an indirect one We work within a calibrated, two sector endogenous growth model, which has its origins in the microeconomic literature on human capital formation. We show that national taxation can In particular, for small open substantially affect long run growth rates. economies with substantial capital mobility, national taxation can readily lead to "development traps" (in which countries stagnate or regress) or to "growth miracles" (in which countries shift from little growth to rapid expansion) This influence of taxation on the rate of economic growth has important welfare in basic endogenous growth models, the welfare cost of a 10 % implications: increase in the rate of income tax can be 40 times larger than in the basic neoclassical model.
Robert i"ing Department of Economics University of Rochester Rochester, NY 14627 and Rochester Center for Economic Research
Kellogg Graduate School of Management Northwestern University 2001 Sheridan Rd Evanston, IL 60201 and Rochester Center for Economic Research
Introduction Economists have long suspected that there is a link between national
term rates of economic growth.
For example, Schultz 
suggests that many public policies contain disincentives for growth because they reduce the rewards to accumulation of a comprehensive concept of capital encompassing human as well as physical capital. a In this paper, ye show that
basic Schultzian model has the property that modest variations in tax rates are associated with large variations in long run growth rates. Our model follows leads provided by Uzawa , Lucas [1988b], and Rebelo . In our analysis, changes in public policy can potentially explain periods of secular stagnation or high economic growth. Public policy is particularly powerful in affecting small open economies with freely mobile capital. For these economies, taxes can easily shut down the growth process, leading to "development traps
in which countries stagnate or even regress for lengthy that we
construct belongs to an important class of
endogenous growth models based on work by Uzawa  and retains the following
on the basic neoclassical model of Solow
Swan , constant coincide this
Cass [19651, and Xoopmans
existence of a
rate; and (ii) competitive and optimal allocations
in the absence of public interventions, class of o-dels is that ther. is a "core" of
The crucial attribute of capital goods which can be
produced without the direct or indirect contribution of non—reproducible factors. In developing our model we begin with the analysis of individual decisions at given prices and then consider the implications of production structure.
This path leads us to develop aspects of individual accumulation
technology not present in...