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1 Introduction ............................................................................... 1
1.1 Historical background .............................................................................1
2 Theoretical Framework ............................................................. 2
2.1 Previous research...................................................................................3
3 Method ....................................................................................... 4
4 Analysis ..................................................................................... 5
4.1 Descriptive Statistics ..............................................................................5
4.2 Discussion of results...............................................................................5
5 Conclusion ................................................................................ 8
Appendix ...................................................................................... 10
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1 Introduction
Norway and Sweden, two developed countries in the north, is the focal point of this paper.
Even though our analysis starts in the 1970’s up to recent years, both countries have ob-
served large changes in growth over the last 100 years. This paper will therefore try to
check where the growth comes from by the use of the endogenous growth model.
The endogenous growth model introduces research and development (R&D) as a new
variable. Innovation and new technology is a large part of this variable that should lead
to growth in a country. The endogenous growth model assumes that the higher a country’s
expenditure on R&D is, the higher will the growth be. With other words, a country with
a high growth rate is assumed to have a substantial stock of R&D.
The purpose of this paper is then to test if the endogenous growth model is good for
explaining the growth of Norway and Sweden when using real world data. We also
wanted to see whether the model fits one country’s data better over the other.
We run three different regressions. One for Norway, one for Sweden and one where we
merge the data of the countries into one data set, where a country dummy is used in order
to investigate the results. The outputs from the regression differ between the countries
and it can be observed that the model fits Sweden better than Norway. We observe some
variables to be insignificant in our model which one would in fact assume to effect
growth. We discuss possible explanations of this in the analysis section where we also
talk about the overall results of the regressions. Both data sets have statistical issues that
one need to deal with. How we solve the problems and the effects of it can be read in the
analysis section.
Although the growth of Sweden is explained better by the model than Norway, it does
not mean that Sweden’s growth is well-explained by this growth model.
The overall result of this paper is that the endogenous growth model does not explain
growth as well as one would assume. Even though the model has a strong theoretical
background, other factors than the one included in the model are useful for explaining
growth.
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part of 1970’s as well as in the beginning of the 1990’s. It was not until 1994-95 that
Sweden somehow recovered from the latter recession. Sweden joined the EU in 1994 and
during 1995-2004, Sweden’s GDP increased by 2.6%, which was higher than other Eu-
ropean countries for the same period (Regeringen, 2014).
2 Theoretical Framework
The endogenous growth model introduces a new variable which explains growth and that
is research and development. This is the sector of the economy where new ideas are es-
tablished. The production function in this model now becomes a combination of labour,
capital and technology which all contribute in improving the technology. Ceteris paribus,
larger resources in R&D lead to more discoveries and therefore to a larger growth. It is
important to notice that the endogenous growth model assumes a Cobb-Douglas function
meaning constant returns to scale to capital and labour. This implies that if the inputs are
doubled so will the output. Moreover, savings and the fraction of capital stock and labour
forced used in R&D are exogenous and do not change over time.
The endogenous model comes in different forms, but the basic one includes four varia-
bles, labour, capital, technology and output:
𝐴̇ (𝑡) = 𝐵[𝑎𝐾 ∗ 𝐾(𝑡)]𝛽 ∗ [𝑎𝐿 ∗ 𝐿(𝑡)]𝛶 ∗ 𝐴(𝑡)𝜃 β≥0, B>0, Υ≥0 (Equation 1)
Where, B is a shift parameter, K is capital, L is labour, A is the stock of knowledge, al
and ak are respectively the fraction of labour force and share of the capital stock used in
R&D. θ reflects the effect of the existing shock of knowledge on the success of R&D.
Its value can be positive if the past discoveries make available ideas for new discover-
ies. In the meantime, it can also be negative if the effect is the opposite.
As it can be seen, the only variable which is outside the Cobb-Douglas function, is
knowledge. That is logical since doubling the inputs for R&D does not always lead to
doubling the number of discoveries.
Depending on the values of the exponentials in the model explained above, the growth
of the economy can take different directions. In this paper, we use the proxies of: al=1/3,
ak =2/3 (Due to C.R.S al+ak=1) and θ=1.
A θ=1 means that the knowledge already existing, is just enough to help in creating new
knowledge proportional to the stock. If this is the case, the economy always shows
steady growth. If capital is not present, this kind of model is also known as Y=AK
which is a linear growth.
However, in the case of taking capital into account, θ+ β becomes automatically over
than 1 due to the restriction of β in the basic model. In this case, the economy experi-
ences increasing growth rates and does not quite converge. This type is known as a fully
endogenous model.
Knowledge, on the other hand, comes in different forms and therefore, it is logical to as-
sume that the accumulation process is not going to be the same in all the forms. All
types of knowledge have one thing in common, they are non-rivalry meaning that the
same knowledge can be used simultaneously in a couple of activities. Despite non-ri-
valry, knowledge is at the same time excludable, implicating that it is possible to pre-
vent others for using it with the help of property rights like patents or trademarks. These
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means give a specific company monopoly powers and therefore a much higher profit
compared to a perfect competitive market. After some time, when the power of the
property rights ends, the knowledge becomes available to everyone.
In reality we are aware that the growth of knowledge has been a crucial factor in the
higher standard of living that we are experiencing nowadays. However, the fact that
there still exists both rich and poor countries is not explained by this growth model. De-
spite the non-rivalry of the knowledge, developing countries still do not have access to
the same technology. And it seems like this is the main reason to why there are huge
economical differences between different countries (Romer, 2011).
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3 Method
The endogenous growth model that we analyse is the same as the one of Tallman and
Wang (1994) in their paper about the case study of Taiwan:
After transforming it into a log form by taking the natural logarithms of each variable, we
receive the following:
𝐿𝑛𝑌𝑡 = 𝐿𝑛𝐴𝑡 + 𝛼 ∗ 𝐾𝑡 + 𝛽 ∗ 𝐻𝑡 + 𝛽 ∗ 𝐿𝑡 (Equation 3)
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The data for FDI, enrollment to tertiary school and GDP per capita came from the
World Bank. However, the data for R&D was collected from NIFU even if it was not
used in the end and the labor force was retrieved from OECD.
4 Analysis
4.1 Descriptive Statistics
Before we analyze the outputs from the regressions, we start by having a look at the de-
scriptive statistics, for both Norway and Sweden, which can be seen in Table 1 and Table
2 in the Appendix.
The values in the descriptive statistics are not logged while the values for the regressions
are in their logged form. Among the observations in the data sets, one can observe varia-
bles taking on various values, for example GDP/capita for Norway has a minimum of
3708 US$ and a maximum of 99143US$. The same variable for Sweden takes on a min-
imum value of 4869 US$ and a maximum value of 56755 US$.
It can be seen that minimum value of GDP/capita is lower in Norway than in Sweden but
the growth in Norway is larger than Sweden. This can most probably be explained by oil
resources that Norway has. Differences can also be seen in other variables as well.
We also conducted a correlation analysis in order to see the variable relationship with
each other. The correlation should range between -1 and 1 with 1 being a perfectly posi-
tively correlated and -1 being perfectly negatively correlated. The results in general
showed relatively high correlation between the regressors.
Graph 1 and 2 in the Appendix show the pattern that the variables have during the time
period tested. It is noticeable that all of them have an upward trend and this is something
which one would expect due to the growth of the economies in general.
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In Table 1 below, one can see the regression result for Norway. We tested for heterosce-
dasticity with the Breusch- Pagan-Godfrey test which gave us a low F-statistic. Therefore,
we cannot reject the null hypothesis of homoscedasticity which is good for the model.
We also tested for misspecification in the model with the help of Ramsey Reset test which
showed no sign of misspecification. The problem of this model however is the presence
of autocorrelation and multicollinearity. We tested for autocorrelation with the help of
Breusch-Godfrey Serial Correlation LM test, and some of the problems of autocorrelation
are inefficiency, wrong standard estimates and an inflated R2. When we fix for it, the
variables become insignificant. Therefore we can conclude that the endogenous growth
model does not explain the growth in Norway.
Table 1
There are more factors that one has to take into consideration when analyzing growth. As
mentioned before, the discovering of oil in Norway has played a huge role in their level
of growth. This does not have any significant relationship with education and level of
knowledge. The only variable that is significant before fixing for autocorrelation is the
labor force. Since the endogenous growth model assume that the only growth could come
from innovation and human capital, a large labor force influence it positively. Moreover,
the level by which knowledge increases is proportional to the skilled labor force.
A reason for FDI being insignificant could be that Norway already before the time period
of this paper had a significant growth in GDP. At the same time, Norway is a developed
and rich country and therefore not quite dependent on foreign investors.
However, one would suggest that education would be a significant factor in explaining
development. The insignificance could be solved by using a larger data set. This was
unfortunately impossible for this paper due to the lack of data.
In the methodology part, we say that due to FDI and R&D being strongly correlated, we
analyze the two variables as one. One would however assume that R&D would have a
significant impact on growth. The endogenous growth model uses R&D as one of the
sources of growth since it leads to a growth in knowledge.
Having access to new technology and ideas should increase growth according to theory.
New ideas and technologies should speed up the factor productivity and due to the labor
force being significant, growth should increase.
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An exogenous model may explain the growth in Norway better than what the endogenous
model does. However, this is something that can be explained in another paper. Norway
is an export driven economy due to its natural resources and that is a highly significant
factor that is not included in the endogenous model.
Table 2
By looking at Table 2 above, one can see the output received from the country of Sweden.
Again we tested for heteroscedasticity, autocorrelation, misspecification and multicollin-
earity. In the case of Sweden, the only problem present was autocorrelation. After fixing
for it by taking the first differentials of all variables, we get insignificance for all regres-
sors. However, we decided to not take that into consideration since the estimates derived
using OLS are unbiased. For Sweden, all the variables in the model are significant at 1%
level. Even though a large R2 is a good sign, having it at this level (0.92) is a result from
autocorrelation, hence, an untrustworthy outcome.
However, one can see that all the variables in the model are significant even at the 1%
level. This means that all the variables in the model are highly explanatory for
GDP/capita. All the regressors show a positive relation to the regressand. It seems that
one unit increase in the labor force would lead to an increase of approximately 9.9 units
increase in GDP/capita.
On the other hand, FDI and education have lower coefficient values. Perhaps this can be
explained by the fact that both education and FDI do not give the results immediately. As
mentioned before, we use the enrollment to tertiary education as a variable and it does
take a couple of years until these students go out in the real life and give their inputs.
The model holds better in Sweden for various reasons. First of all, Sweden does not have
natural resources in the same level as Norway. Therefore, the growth here comes mostly
from the skilled labor force and the increase in education. FDI is also important since
more investment leads to more innovation and therefore more growth. Since Sweden is a
developed country FDI might not play a very large share of growth in GDP. One would
think that total domestic investment would lead to a larger growth, however, this was not
proved in the model. Therefore, we analyze FDI instead.
The same problem as for Norway occurred in this case as well regarding the high corre-
lation between R&D and FDI. Again, we had to exclude one of them from the regression.
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Therefore, we do expect to receive the same results as those regarding foreign investment.
This is due to the very high correlation the variables had. However, by looking at the
coefficient of FDI, one can see that it is not large. One would probably assume the oppo-
site since Sweden is a capital intensive rather than labor intensive country.
To sum up, it seems that the endogenous growth model fits Sweden better than Norway
for explaining the economic development.
The endogenous growth model implies that knowledge leads to a larger rate of growth.
Therefore, we decided to test for correlation between R&D and education. Since R&D
and FDI were so highly correlated, we use FDI and Education instead. The results for
both countries showed values which were close to one. This proves that a higher share of
education would lead to more resources in research for the case of Sweden and Norway.
This means that even if the model itself did not hold perfectly, a part of it still does no
matter the regression output. Many theoretical models make a lot of assumptions and that
does not always hold for real world data. There are other factors which can influence the
growth of GDP that the endogenous model does not take into consideration. Therefore,
just because the output results were not positive, it does not mean that the model is wrong.
It can just mean that it is incomplete or that it holds for some countries or some time
periods better than the others.
Table 3 in the appendix presents the results received from running the OLS regression
with Sweden and Norway simultaneously. In this case, the problems of multicollinearity
and autocorrelation were present. We used the same method as in the two other models
and it can be seen that this model does definitely not follow the theory. Therefore we
decide to separate the countries rather than take them together even if in this case there
are more observations and therefore more degrees of freedom.
If we decide to not take the statistical issues into account, we get insignificant results for
labor and FDI. The only significant variable is the enrollment into tertiary education.
5 Conclusion
In this paper we test whether the endogenous model holds for the real world data of Nor-
way and Sweden. We ran OLS regressions with GDP/capita as the regressand, labor force,
tertiary education, FDI and R&D as the independent variables. By combining the results
and the theory we came up with the following:
One would assume the endogenous growth model to explain the data better than it actually
does, mostly due to the variables being relevant in the growth of one country. From the
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cases of Norway and Sweden, we conclude that the theory fits Sweden’s data better than
it does for its neighbor in the west. The years considered are 1971-2011 and during that
time period, both countries experienced swings in the economy.
An explanation for the model’s poor result of Norway could be due to the fact it is an
export driven economy that can rely on its natural resources. The growth of the Norwe-
gian economy came mostly from the oil rather than human capital and R&D.
For Sweden on the other hand, the focus was as well on exports, however, not at all on
the same level as the oil driven Norway. This is why the endogenous growth model shows
better results in this case.
The results seemed not very optimistic from the model with the two countries merged.
Even though one would assume the variables of the regressions to have an effect growth,
it seems like there are other factors excluded from the model need to be included.
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Appendix
Table 1
Table 2
Graph 1- Sweden
ENROLLMENT FDI
90 25
80 20
70
15
60
10
50
5
40
30 0
20 -5
1975 1980 1985 1990 1995 2000 2005 2010 1975 1980 1985 1990 1995 2000 2005 2010
GDP_PER_CAPITA LABOR_FORCE
60,000 5,200
50,000 5,000
4,800
40,000
4,600
30,000
4,400
20,000
4,200
10,000 4,000
0 3,800
1975 1980 1985 1990 1995 2000 2005 2010 1975 1980 1985 1990 1995 2000 2005 2010
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Graph 2- Norway
ENROLLMENT FDI
80 3.0E+10
70 2.5E+10
60 2.0E+10
50 1.5E+10
40 1.0E+10
30 5.0E+09
20 0.0E+00
10 -5.0E+09
75 80 85 90 95 00 05 10 75 80 85 90 95 00 05 10
GDP_CAPITA LABOR
120,000 2,800
100,000 2,600
2,400
80,000
2,200
60,000
2,000
40,000
1,800
20,000 1,600
0 1,400
75 80 85 90 95 00 05 10 75 80 85 90 95 00 05 10
Table 3
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