Transitional Dynamics with Endogenous Control Variables

The method of cross-sectional conditional convergence regression is crucially based on the concept of exogenous control variables. However, there are strong theoretical arguments and solid empirical support for the view that at least a subset of the control variables varies systematically in the course of economic development. In addition to econometric issues, the explicit consideration of endogenous control variables affects the theoretical interpretation of the conditional convergence results. Accordingly, the variation of some of the control variables with the level and the growth rate of per capita income contains important information about the transition to the balanced-growth equilibrium rather than information about the balanced-growth equilibrium itself.