The Underestimated Virtues of the Two-sector AK Model

Abstract This paper analyzes some unnoticed predictions of the two-sector AK model in line with the recent literature on embodied technical change. Firstly, by confining constant returns to capital to the investment sector, the AK model generates endogenously the secular downward trend of the relative price of equipment investment and the rising real investment rate observed in US NIPA data. Secondly, Jones' (1995) claim that the AK model fails to reconcile the empirical facts of trending real investment rates and stationary output growth vanishes in the two-sector version. Thirdly, consistent with the evidence from cross-country studies, the model predicts a negative relation between GDP per capita and the relative price of equipment. Hence, in spite of its overly simplistic structure, the two-sector AK model provides important intuition on the implications of a trending relative price of equipment investment in endogenous growth environments.