Economic Growth in an Interdependent World Economy1

The Solow-Swan growth model predicts that growth should be uncorrelated with the ratio of national investment to GDP. If capital markets are open, the model predicts instantaneous convergence of GDP per capita across countries. Convergence is achieved by capital flows from rich to poor countries and a consequence of these flows is that the ratio of national savings to GDP in each country should differ substantially from the ratio of investment to GDP since there is no reason to expect that countries with high savings rates should be those with large investment opportunities. In the presence of capital market imperfections, such as the inability to borrow to finance human capital accumulation, convergence is predicted to occur more slowly. But savings and investment ratios should still differ substantially across countries. In the data, investment ratios are strongly correlated with growth across countries and investment ratios are closely correlated with savings ratios within countries. Both of these facts are difficult to explain with versions of the Solow-Swan model. We study a two-sector two-country AK model and argue that this model can account for these facts and that in this sense it provides a better description of the data than the Solow-Swan model. JEL Classification: F43, O16, O41