Transition Dynamics in the Neoclassical Growth Model: The Case of South Korea

Abstract

Many successful examples of economic development, such as South Korea, exhibit long periods of sustained capital accumulation. This process is characterized by a gradually rising investment rate along with a moderate rate of return to capital, both of which are strongly at odds with the standard neoclassical growth model that predicts an initially high and then declining investment rate with an extremely high return to capital. We show that minor modifications of the neoclassical model go a long way towards accounting for the transition dynamics of the South Korean economy. Our modifications recognize that (i) agriculture (which makes up a large share of the aggregate economy in the early stage of development) does not rely much on capital and (ii) the relative price of capital declined substantially during the transition period.

Keywords: neoclassical growth model, transition dynamics, industrialization, price of capital, South Korea

JEL Classification: E13, E22, O11, O13, O14, O16, O4, O53