Many recent models of endogenous growth trace cross-country differences in growth rates to differences in the real rates of return to private sector investment, which they typically attribute to government policy, increasing returns to scale, international trade or poverty traps associated with low levels of development. Most such models predict that simply liberalizing capital flows will induce capital flight to fast-growing countries, where the rate of return is greatest, thus equalizing growth of national consumption and GNP. This contradicts the substantial evidence that poor countries have lower savings rates than rich countries, even with integrated capital markets.

In Discussion Paper No. 667, Research Fellow Sérgio Rebelo notes that this implausible solution to the problem of economic development results from these models' specification of intertemporal preferences such that the optimal savings rates of countries with the same real rate of interest but different income levels are identical. This implies that an underdeveloped country that can invest in the US will adopt the US savings rate and hence expand its GNP (but not its GDP) at the US rate. Rebelo demonstrates that the cross-country variation of the `shadow' real rate of return computed from output growth and the investment share is too wide to be plausible and then reviews the recent literature on an extension of conventional preferences in which utility derives only from consumption above a subsistence threshold.

In this StoneGeary framework, poor countries can have lower savings and growth rates than developed countries even when their real rates of return to capital are the same, so policy reforms to eliminate the distortions causing their low real rates of return are likely to have disappointing short-term effects. Giovannini finds that the elasticity of intertemporal substitution in LDCs is very low and often insignificantly different from zero, as the StoneGeary formulation predicts. Atkeson and Ogaki have shown that this function can also account for the common observation that the rich have higher savings and lower food expenditure shares than the poor. Rebelo concludes that a thorough understanding of the growth process will require further research to find a more satisfactory description of preferences and a better understanding of the behaviour of savings across countries.

Growth in Open Economies
Sérgio Rebelo

Discussion Paper No. 667, August 1992 (IM)