The Augmented Solow Model

Abstract

This chapter considers human capital accumulation as the engine of economic growth as it is introduced in Lucas (1988) and Lucas (1993). Following Mankiw, Romer, and Weil (1992) we assume that households fix the saving ratio and the educational spending ratio. So we have an augmented Solow model. Buiter and Kletzer (1991, 1993), Zhang (1997) and Josten (2001) consider human capital in overlapping generations models of the open economy. In Buiter and Kletzer and in Zhang deficit financing policies that boost financial saving reduce the relative rate of human capital accumulation and labour productivity growth. Josten considers human capital in a small open economy. An increase in public debt that is used to redistribute every individual’s tax burden from the youth to the middle age increases the steady state growth rate. Hence, in overlapping generations models of the open economy, public debt need not be harmful for growth. However, Josten (2000a) considers a continuous time overlapping generations model of a closed economy where human capital is the driving force of growth and shows that in this case public debt reduces growth. Now it is the question which of the results carries over to the augmented Solow model of the closed economy. In the following we will first consider the fixed deficit ratio and then we assume that the government fixes the tax rate.