Neoclassical growth theory is a theory that has been successfully used to quantitatively address many aggregate economic questions. These questions include the quantitative contribution of various factors to business cycle fluctuations and the large difference in hours worked across countries and over time. In the process of using the theory, deviations from the theory emerged, and in process of resolving these puzzling deviations, the theory was advanced. One major advance was figuring out a way to incorporate intangible capital produced and owned by businesses. The investment in this form of capital is known to be big and nearly all is expense and therefore most is not part of GDP. This extension resolved the puzzled of why the U.S. boomed in the 1990s even though GDP per hour and corporate profits were low. The model that resolved that puzzle also is consistent with the 2008-2009 recession and the subsequent depression that has persisted for over 5 years.
One major problem was how to account for intangible investment in this theory, which assumes competitive markets, and the aggregates reported in the national income and product accounts. McGrattan and Prescott (2009) developed a way, with technology capital that can be used at any location if permitted by policy. Locational rents, not monopoly rents are what provide the incentive to innovate. With this extension there is a reason for direct foreign investment (See McGrattan and Prescott 2010). The predicted gains from openness are three times bigger than the standard trade models predictions, but still only a third of what the empirics indicate. Other factors are important with the leading candidates being lowering of incentives to set barriers to more efficient production and increasing the rate at which knowledge useful in production diffuses. Determining the quantitative importance of these two factors are two major open problems in aggregate economic theory.
“Technology Capital and the U.S. Current Account,” E. R. McGrattan and E. C. Prescott, American Economic Review, 100 (4), 1493-1522, September 2010.
“Openness, Technology Capital, and Development,” E. R. McGrattan and E. C. Prescott, Journal of Economic Theory 144, 2454–76, November 2009.