Endogenous Growth, Human Capital and the Dynamic Costs of Recessions

Abstract

The purpose of the paper is two-fold: (i) to construct and analyze a novel endogenous growth model, in which unbounded growth is possible without the need to assume increasing returns to scale, and (ii) to use the model to estimate the long-run (or dynamic) costs of recessions. In our model, endogenous technology and human capital accumulation serve as the "twin engines of growth". Simulations are used to derive growth rates consistent with long-term experience of developed countries, to understand better the differences between balanced growth and unbounded growth, and to provide an estimate of the dynamic costs of capacity utilization shocks that produce business-cycle-like behavior. Conservative calculations show that the costs of the capacity shocks can be large – about 1.5% of the present value of output over a 100-period horizon. The theoretical model also suggests that differences in the technology production and human capital accumulation functions, possibly due to differing institutions, may help explain diverse growth experiences. The paper, for first time, combines two strands of the economic growth theory – endogenous technology and endogenous human capital production – into a single model. It uses the implications of the model to argue, through simulations, that the benefits of counter-cyclical policies are potentially large in the long run.

Keywords: Endogenous growth, human capital, cyclical depreciation, learning by doing, long-run costs of recessions

JEL Classification: O30, O41, E27, C62