The literature on cross-country divergence or convergence of levels and rates of growth uses a closed economy neoclassical growth framework which neglects the role of capital mobility and the effects of differences in tax regimes. In Discussion Paper No. 760, Research Fellow Assaf Razin and Chi-Wa Yuen develop a model to take account of these factors. Consumption growth is a function of population size, after-tax returns on capital and agents' preferences. A simple representative household allocates time to child-rearing, education and work. Immobile labour is taxed only at home, but mobile physical capital may be subject to double taxation. Tax policies are uncoordinated internationally, population growth is determined endogenously by altruistic motives but constrained by time costs of child-rearing. This trade-off between investment in human capital and fertility can account for the remarkable drop in fertility among the world's fastest-growing countries in the last three decades.

Razin and Yuen find that with asymmetric taxation of income from home and abroad (the `source' principle), arbitrage equalizes after-tax rates of return and capital mobility tends to equalize growth. With different tax rates on investment (the `residence' principle), however, per capita income growth rates may diverge, but capital mobility ensures that long-term growth rates of total income remain equal. They note in conclusion that related policy differences (such as protectionist measures or population control) and capital market imperfections may also account for differences in growth rates.

Convergence in Growth Rates: The Role of Capital Mobility and International Taxation
Assaf Razin and Chi-Wa Yuen

Discussion Paper No. 760, January 1993 (IM)