A New Theory of Economic Growth: Why Countries’ Per Capita Income Converge or Diverge

Abstract

The main contribution of this research is that based on a model much simpler than Solow growth model, it shows how countries can achieve a persistent economic growth and show a convergence or divergence pattern in per capita income, which can get affected through flow of savings, productive labor and / or capital across countries. It shows that output growth is independent of population growth rate (i.e., opposite to what Solow growth model suggests; according to which national income, saving, investment, and consumption, all grow at the rate of population growth), and rather depends on fractions of savings’ feedback into labor and capital to get more output. The existing literature has the underlying assumption that savings equal capital investment, whereas this article is based on the assumption that a fraction of savings gets invested into labor, which becomes a contributing factor in the long-term economic growth, a result which contradicts Solow growth model’s conclusion that a change in saving rate has no effect on the rate of growth in the long run. The model predicts convergence of per capita output for countries depending on their parameter values, such as savings fraction invested for more output, labor and capital productivity, population growth rate, etc., and it also predicts divergence for different sets of parameter values for two countries.