A time-varying markov-switching model for economic growth

Abstract

This paper investigates economic growth’s pattern of variation across and within countries usinga Time-Varying Transition Matrix Markov-Switching Approach. The model developed follows theapproach of Pritchett (2003) and explains the dynamics of growth based on a collection of differentstates, each of which has a sub-model and a growth pattern, by which countries oscillate over time. Thetransition matrix among the different states varies over time, depending on the conditioning variablesof each country, with a linear dynamic for each state. We develop a generalization of the Diebold’sEM Algorithm and estimate an example model in a panel with a transition matrix conditioned onthe quality of the institutions and the level of investment. We found three states of growth: stablegrowth, miraculous growth, and stagnation. The results show that the quality of the institutions is animportant determinant of long-term growth, whereas the level of investment has varying roles in thatit contributes positively in countries with high-quality institutions but is of little relevance in countrieswith medium- or poor-quality institutions.