## 5/6/11

### Ireland and Solow's exogenous growth model

Three months ago we revisited the evolution of real GDP per capita in Ireland. This was an example of a country which demonstrated an extremely high annual increment of GDP per capita growth between 1990 and 2005. This observation undermined our concept of constant increment in GDP per capita in developed countries which expresses the idea of inertia in economic growth (see our post on theory of economic growth).  In this post, we present an updated version of the previous post on Ireland with new estimates of GDP per capita as published by the Conference Board in 2011. The newly published set includes readings for 2010 and also revises the previous estimates, sometimes severely. It allows seeing the case of Ireland in some new light and strongly supports our concept. As we supposed 5 years ago, Ireland GDP was highly overestimated and has fallen quickly to fit the concept of constant annual increment or inertial growth

Originally, the concept of constant annual increment in real GDP per capita, G, as observed in all developed countries, was introduced 5 years ago in a working paper [1] and then published in the Journal of Applied Economic Sciences [2]. We found that in the long run the trajectory of GDP growth is a linear function of time:

G(t-t0)= G0+B(t-t0)
where G0 is the initial level of GDP per capita at time t0 in a given country, B is the country dependent increment measured in dollars. Therefore, the rate of growth of real GDP per capita, dlnG/dt, has a decelerating trend:

dlnG/dt = B/G

This assumption gives excellent statistical results and explains the evolution of real GDP per capita in the biggest developed countries. There were two exceptions – Ireland and Norway. (The latter economy is likely driven by oil demand.) Before 1990, Japan also demonstrated a larger positive deviation from the constant trend but then quickly returned to it during the 1990s and 2000s. We foresaw the same effect for Ireland.

So, five years ago, I wrote

An opposite example of an excellent recovery gives Ireland with corresponding results displayed in Figure 11. A slow start was quickly compensated and the last twenty years of an extremely fast growth resulted in the leading position in the world economy with the mean increment \$678. There are some doubts, however, that future will be so successful. Such a long and quick growth always ends up in a depression. This was observed in Japan and is related to the long-term decrease in the number of the specific age population [Kitov, 2005a]. Ireland has managed to increase birth rate for a very long period and has an age structure similar to that observed in Japan 20 years ago. The population distribution is currently peaked near 20 years with the defining age of 18 years. The years to come will demonstrate only decrease in the defining age population.
Fig. 11. Same as in Figure 4 for Ireland. The mean value is \$678. The growth of the real GDP per capita is outstanding during the last twenty years. There is a downward tendency during the last four years, however.

In Figure 11 borrowed from the paper, one can observed an extremely high deviation of constant increment. Nevertheless, we put the progress of the Irish economy under doubt. The reason was its similarity to the Japanese case and the underlying model of real GDP growth, which includes population of a country specific age. In January 2011, we presented a new version of the curves in the above Figure (see Figure 1 below) with data up through 2009 which were available in January 2011. The slope of the trend was +0.0272 instead of +0.0608 in 2004, i.e. fell by a factor of 2. This slope is much close to the zero value.

Figure 1. Same as in Fig. 11  above with data between 1950 and 2009. The increment of real GDP per capita vs. real GDP per capita in Ireland. All data are borrowed from the Conference Board data base (http://www.conference-board.org/economics/database.cfm).

The revised GDP per capita data and one new reading present a quite different picture in Figure 2. The positive excursion between \$30000 and \$50000 in the curve does not look so dangerous for our concept and the slope now is only +0.0155, i.e. by a factor of 3 lower than in 2004. Hence, the Irish GDP per capita is not an exclusion form the general rule that real GDP per capita does grow with a constant increment in the long run, as other developed countries.

This observation makes Solow's model of economic growth empirically inconsistent, and thus, void.

Figure 2. Same as in Figure 1 for the 2011 version of the Conference Board Total Economic Database

The near future of the Irish GDP per capita is under question as well: it will likely decrease or increase just marginally in 2011 and in the next several years. We will keep reporting on the case.   Ireland provides a higher volatility in the GDP growth, which is driven by unusual population pyramids with a strong peak at one age. (Same shape is observed in Japan, but the peak age is 25 years larger.)

References

[1] Kitov, I., (2006). Real GDP per capita in developed countries, MPRA Paper 2738, University Library of Munich, Germany, http://ideas.repec.org/p/pra/mprapa/2738.html
[2] Kitov, I., (2009). The Evolution of Real GDP Per Capita in Developed Countries, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, vol. IV(1(8)_ Summ), pp. 221-234.