Neoclassical Models of Endogenous Growth: The Effects of Fiscal Policy, Innovation and Fluctuations∗

Despite its role as the centerpiece of modern growth theory, the Solow model is decidedly silent on some of its basic questions: Why is average growth in per capita income so much higher now than it was 200 years ago? Why is per capita income so much higher in the member countries of the OECD than in the less developed countries (LDC) of the world? The standard implementation of the Solow model really has no answers for these questions except, perhaps for differences, across time and across countries in the production possibility set. This is typically summarized by differences in Total Factor Productivity (TFP). The fundamental reasons for why TFP might be different in different countries, or in different time periods is left open for speculation. If these differences are supposed to be due to differences in innovations, it is not made clear why access to these innovations should be different, nor is it noted that these innovations themselves are economic decisions— they have costs and beneÞts, and are made by optimizing, private agents. This basic weakness in the Solow model (and its followers) was the driving force behind the development of the class of endogenous growth models. This literature has been wide and varied, with the models developed ranging from perfectly competitive, convex models to ones featuring a range of types of market failures (e.g., increasing returns, external effects, imperfectly competitive behavior by Þrms, etc.). But, a common feature that has been emphasized throughout is knowledge, or human capital, and its production and dissemination. In come cases, this has been