Informal Economy

YOU MUST USE EViews software 

This homework will take you to the actual test, with real data, of some of the Theories of Economic Development. Please use Eviews. Excel will NOT do.

1. Historically, Neo-Classical economists embraced Malthus’s inverse relationship between population growth and real growth but acknowledged the key role of investment and thus savings in the process of growth. That is, adjustments in growth take place due to the behavior of investment in physical capital and the law of diminishing returns on the factors of production holds. In Neo-Classical models, growth is a worldwide process and country characteristics determine the relative level of income. Solow (1956) proposed a growth model where population is taken into consideration, but economic growth takes place through investment. Based on the standard Solow Model and following Mankiw et al (1992), the following reduced form is estimated to test this theory:

ln (Q/L)t = w ln (A) + (α/(1-α)) ln (s)t – (α/(1-α)) ln (n+g+ δ) + εt (1)

where Q is the TRGDP and it includes the informal economy, L is the labor force, A is the level of technology in the US and w is the weight. s is the average share of private and public real investment on GDP, i.e. ln(I/GDP), n is the average rate of growth of working age population (15 to 64), g is the long run rate of growth of output per capita, and δ is the rate of depreciation which you can assume it to be 10%. Please remember that an AR(1) process typically is found, be aware of the possible need to include a dummy variable for shifts in the series, and that most macro variables are random walks.

To test for the validity of the Malthusian assumption embedded in the Neo-Classical model, the following linear restriction can be tested: [ln(I/GDP) – ln(n+g+δ)]. If Malthusian theory holds, the sign of the coefficient should be negative.

Please estimate and evaluate the performance of this model for the U.S. (or any other developed country of your choice) and for a developing country you chose to follow for the remainder of the semester. As you do so, remember to test and control for the typical violations of OLS found in time series macro-variables. Also, remember you need at least 60 data points.

Given the signs and significance of both the fertility rate (n+g+δ) and the Malthusian restriction captured by [ln(I/GDP) – ln(n+g+ δ)] what do you conclude regarding the Malthusian assumptions embedded in the Solow’s model? Can the fact that a country is mainly an agriculture production country explain some of these outcomes?

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