Lecture Notes 4

TFP and Long-Term Economic Growth

Intermediate Macroeconomics, EC2211

Martin Flodén
Fall 2025
Department of Economics, Stockholm University
Contents and literature

• Towards endogenous growth

• The Romer model
• Institutions and growth
• Growth at the frontier

Literature:
• Jones (2024), chapter 6
• The Royal Swedish Academy of Sciences (2018), ”Integrating nature and
knowledge into economics”, in particular pages 1-4
• Royal Swedish Academy of Sciences (2024) ”They provided an explanation for
why some countries are rich and others poor”
• Gordon (2014), ”The demise of U.S. economic growth”, sections 1-3.3
• Jones (2023), ”The outlook for long-term economic growth”
• Draghi (2024) ”The future of European competitiveness”, pages 5-19

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Towards endogenous growth
Towards endogenous growth

• The Solow model offers valuable insights into cross-country differences in

income per capita but fails to explain sustained growth

• Next: endogenous growth

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The AK ”model”

What happens when we relax the assumption of diminishing marginal product

of capital?

Yt = AKt (1)

Capital accumulation:

Kt+1 = (1 − δ)Kt + It = (1 − δ)Kt + sAKt (2)

Equations (1) and (2) imply that:

Yt+1 Kt+1
= = 1 − δ + sA (3)
Yt Kt

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The AK ”model”

Since
Yt+1 − Yt Yt+1
γ≡ = − 1,
Yt Yt
the growth rate of GDP is:
γ = sA − δ (4)
An assumption of constant marginal product of capital thus generates
endogenous growth!
Recall that a higher savings rate s did not generate higher long-run growth in
the Solow model
We see here that higher savings (more investments) would generate higher
long-run growth if the marginal product of capital were not diminishing

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The Romer model
The Romer model

• Romer (1990), ”Endogenous technological

change”

• Nobel prize 2018: ”for integrating

technological innovations into long-run
macroeconomic analysis”

Paul Romer 1955-

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The Romer model

• Distinguish between objects (rivalrous) and ideas (non-rivalrous)

• Workers can either produce consumption goods or new ideas

• A single idea can be used by many people simultaneously

• Non-rivalry generates increasing returns

• Omit physical capital for simplicity

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From Royal Academy of Sciences (2018)

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Notation

Yt : output of the consumption good

At : the existing stock of knowledge
Lt : the population
n: population growth rate
Lyt : number of workers employed in goods production
Lat : number of researchers (producing ideas)
γ: parameter in the production function
λ: fraction of labor force employed in research
ζ: productivity parameter
A0 : the initial stock of knowledge

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The Romer model

Production of the consumption good:

Yt = Aγt Lyt (5)

Production of new ideas:

∆At+1 = ζLat (6)
Resource constraint for labor:

Lyt + Lat = Lt (7)

and Lt+1 = (1 + n)Lt

Assume that labor is allocated according to:

Lat = λL (8)

Lyt = (1 − λ)L (9)

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Solving the model

Dividing (5) by L and using (9) gives output per capita:

Yt
yt ≡ = Aγt (1 − λ) (10)
Lt
Dividing (6) by At gives the growth rate of TFP:

∆At+1 Lat
gAt ≡ =ζ
At At
or (assuming that the growth rate is positive)

ζ
At = Lat (11)
gAt

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The balanced growth path

• Is there a long-run equilibrium (”balanced growth path”) where all variables

grow at constant rates?
• If so, gAt must be constant (since we assume that L, Ly and La grow at
constant rates)
Equation (11) then shows that the stock of knowledge is proportional to the
number of researchers, Lat

• Since Lat in turn is a constant fraction of the population, this means that A
and L must grow at the same rate on the balanced growth path
That is, gA = n in the long run

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Interpreting the Romer model

• Equation (10) shows that output per capita will grow as long as the stock
of knowledge, At increases
• The model moreover shows that the stock of knowledge increases at the
same rate as the population
• And from the production function we see that the growth rate of output per
capita is γn
• Note the key difference to the Solow model where an investment generates
more capital, but where capital is rivalry – it is ”less useful” when shared by
many workers
• In the Romer model, investment generates more knowledge which is not
rivalry; all workers become more productive irrespective of how many they
are

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A permanent rise in research productivity (higher ζ)

Figure 6.3 in Jones (2024). Recall that his z is our ζ.

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A permanent rise in the research share (higher λ)

Figure 6.4 in Jones (2024). Recall that his l is our λ.

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Summing up:
Malthus → Solow → Romer
Malthus → Solow → Romer

• What is important in production?

Land (Malthus) → Physical capital (Solow) → Ideas (Romer)

• Population growth rates

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Total fertility rates have trended down

Total fertility rates (the number of children that would be born to a woman if she were to live to the end of her childbearing years and bear children
in accordance with age-specific fertility rates of the specified year). Source: World Bank

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Malthus → Solow → Romer

• What is important in production?

Land (Malthus) → Physical capital (Solow) → Ideas (Romer)

• Population growth rates

◦ Malthus: Population growth is endogenous. (Do falling birth rates indicate that
productivity has fallen?)
◦ Solow: A lower population growth rate means that we do not have to build as
much capital for our children
◦ Romer: A lower population growth rate means that there will be fewer new
ideas

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Institutions and growth
The role of institutions

”The factors we have listed (innovation, economies of scale, education,

capital accumulation, etc.) are not causes of growth; they are growth.”

-North, D.C. and Thomas, R.P. (1973),

The Rise of the Western World: A New Economic History, Cambridge
University Press, Cambridge, UK.

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Proximate versus fundamental causes of growth

• If growth is about factor accumulation and innovation, why do not poor

countries invest and innovate?

• Why do countries provide different incentives to firms and households?

• Proximate causes of growth: factor accumulation and investment in R&D

• Fundamental causes of growth: luck? geography? culture? institutions?

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Institutions and growth (Acemoglu, Johnson and Robinson)

• Institutions
◦ Humanly devised set of rules
◦ Place constraints on individual behaviour

• Economic institutions
◦ Property rights
◦ The presence and functioning of markets
◦ Contractual opportunities available to firms and households
◦ Entry barriers

• Political institutions
◦ Polity and electoral laws
◦ Checks and balances on political leaders

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Democracy and income

• Is democracy conducive to high income?

• All the old democracies of the world are rich

• Growth performance of autocracies highly heterogeneous

◦ Dictatorships excel or fall behind
◦ Many of the East Asian growth miracles started out autocratic

• Complex relationship between polity and income!

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Growth at the frontier
Economic growth: summing up

Sources of temporary and/or long-run growth:

• Physical capital
• Labor, hours worked
• Human capital
• Productivity, technology
◦ Catching up with the frontier
◦ Efficient use of resources and people
◦ New ideas, research

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Growth accounting: Can we quantify the contribution of differ-
ent sources?

Consider our Cobb-Douglas production function:

Yt = At Ktα L1−α
t

Apply the rules for growth rates:

gYt = gAt + αgKt + (1 − α)gLt

In per capita terms, production is yt = At ktα , so

gyt = gAt + αgkt

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Growth accounting for the USA

Table 6.2 in Jones

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Growth accounting with human capital

Suppose that the production function is:

Yt = At Ktα (ht Lt )1−α

where h is human capital per worker

In per capita terms:

yt = At ktα ht1−α

Then:
gyt = gAt + αgKt + (1 − α)ght

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Growth accounting with human capital

Can we measure human capital or do we have to put it in the unexplained TFP

term?
Human capital is often measured by the average number of years of schooling
in the adult population. This is then converted to a human capital index based
on empirical data on how schooling affects wages.
The Penn World Tables report such an index:

Years of schooling ”Human capital”

USA 13.6 3.75
Sweden 12.3 3.44
Mexico 9.2 2.78
Malawi 5.7 0.71

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The outlook for long-term economic growth

Growth in the U.S. has been surprisingly stable at 2% per year for the past 150
years

Gordon (2014) and Jones (2023) note that much of this growth is a result of
• Rising educational attainment
• Rising investment in research

I would add globalization (with offshoring, restructuring etc) to the list

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The outlook for long-term economic growth

Figure 5 in Jones (2023)

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The outlook for long-term economic growth

Potential tailwinds:
• Better utilization of resources (use of talents)
• More frontier contribution from China and India
• AI

Headwinds:
• Educational attainment cannot/will not continue to increase
• Research intensity cannot/will not continue to increase
• Population growth will slow or turn negative
• Geopolitics, end of globalization

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What we did (growth part of the course)

• Growth facts

• Growth accounting

• From Malthus to Solow to Romer

• Institutions

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