Equipment Investment and Growth in Developing Countries

A large empirical literature investigates the link between "openness" and growth. Cross-country observations suggest that (i) "openness" enhances growth by increasing a country's rate of investment, and (ii) variables related to equipment investment are robustly and strongly correlated with growth rates. This paper proposes a microeconomic mechanism for the link between openness, equipment investment and growth. A dynamic general equilibrium model is developed where countries that face different prices of imported equipment grow at different rates. The proposed theory is based on the notions of technology adoption and learning. Capital productivity depends on the match between the technology embodied in capital and the level of knowledge ("experience") it is combined with in production. Experience is accumulated through "learning-by-using," where using modern capital goods is essential for learning. When making investment decisions, firms choose the type of capital that best matches the level of knowledge available over its lifetime. In developing countries, this implies investment in outdated technologies. Equipment prices affect growth through (i) the rate at which old vintages of equipment are retired (accelerated obsolescence) and (ii) the choice of technologies embodied in new investment. Both in turn change the rate of learning and technology adoption. A calibrated version of the model yields a number of predictions that are testable with microeconomic data