KC =
1-α
K ( (1 - α ) P ) -
P' =
r* +δ-α
48
β 1P 1~-
β---δK,
λP
K(0) = K0,
1-α
( (1 - α ) P ) -
P(0) free.
The steady-state value of P is independent of λ, but the steady-state value of K increases after
downward and permanent jump in λ induced by a windfall of foreign exchange. Note that as
the share of traded goods in capital goods vanishes, γ→0, the capital stock adjusts
immediately to a natural resource windfall. As a result of the downward jump in λ, there is an
immediate and permanent upward jump in K and there is no need for the real exchange rate to
appreciate whatsoever. However, much capital (think of nurses and teachers as well as
infrastructure) must be home-grown and cannot be imported. Consequently, γ is closer to one
and absorption constraints will manifest themselves. This may be seen from the saddle-path
diagram given in fig. 7. The optimal response to a windfall is for the real exchange to
appreciate on impact signalling labour to shift from the traded to the non-traded sector and
shifting demand from non-traded to traded goods. Over time, investment induces a gradual
expansion in home-grown capital which permits a gradual reversal of the initial appreciation
of the real exchange rate. The resulting temporary boost to the return on capital in the non-
traded sector r(P) is in line with the anticipated capital losses on those capital goods (as over
time the relative price of investment goods c(P) will fall and return to its original level). The
windfall results in an immediate and permanent increase in the consumption of traded goods,
but consumption of non-traded goods increases on impact and subsequently continues to
increase towards its new steady-state level. Home-grown capital also jumps up on impact and
then continues to rise to its new steady-state level. Due to the gradual increase in consumption
as supply constraints are gradually relaxed, the total stock of assets increases by more than the
windfall. Hence, there is initial saving (parking funds abroad) relative to the permanent
income hypothesis. Van der Ploeg and Venables (2010b) provide a much more general
analysis allowing for capital accumulation in the traded sector as well and highlighting the
impossibility of shifting capital between the two sectors once it has been installed.
References
Acemoglu, D. (1995). Reward structures and the allocation of talent, European Economic
Review, 39, 17-33.
Acemoglu, D., S. Johnson and J.A. Robinson (2001). The colonial origins of comparative
development: an empirical investigation, American Economic Review, 91, 1369-1401.
Acemoglu, D., S. Johnson and J.A. Robinson (2003). An African success: Botswana, in D.
Rodrik (ed.), Analytic Development Narratives, Princeton University Press, Princeton.
Acemoglu, D., S. Johnson, J. Robinson and Y. Thaicharoen (2003). Institutional causes,
macroeconomic symptoms: volatility, crisis and growth, Journal of Monetary
Economics, 50, 49-123.
Acemoglu, D., J.A. Robinson and T. Verdier (2004). Kleptocracy and divide-and-rule: a
theory of personal rule, Journal of the European Economic Association, 2, 162-192.
Acemoglu, D. and J.A. Robinson (2006). Economic backwardness in political perspective,
American Political Science Review, 100-131.
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