DP1693 | Beyond Balanced Growth

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One of the most striking regularities of the growth process is the massive reallocation of labour from agriculture into industry and services. Balanced growth models are commonly used in macroeconomics because they are consistent with the well-known Kaldor facts about economic growth. Unfortunately, these models are inconsistent with the structural change dynamics that are a central feature of economic development. This paper discusses models with generalized balanced growth paths. These paths retain some of the key features of balanced growth, but are consistent with the observed labour reallocations dynamics. The conventional explanation for the observed patterns of structural change is that the rate of technical progress has been higher in agriculture than in services. We show that this pattern of technical progress is neither necessary nor sufficient to account for the observed dynamics of structural change. The key to producing these reallocation dynamics are differences in the income elasticity of the demand for the goods produced by the different sectors.