Sources of economic slowdown: A simultaneous equations approach

We explore the potential sources of slowdown in growth in a theoretical macroeconomic framework, from which we develop an empirical model consisting of a system of equations for the growth rate of GDP and the consumption share of GDP. Having estimated the basic model, we perform an extreme bounds analysis with a range of control variables as a robustness check on the results. In a sample of middle‐income countries, an increase in the consumption ratio appears to be negatively associated with economic growth; foreign direct investment is found to be significantly associated with both economic growth and the consumption ratio. On considering sub‐samples of Asian and Latin American countries, we find, in the Asian economies, that there is an inverted U‐shaped relationship between the consumption ratio and economic growth while, in the Latin American economies, there is an inverted U‐shaped relationship between the consumption ratio and growth but a U‐shaped relationship between the government spending ratio and economic growth. In both sub‐samples, the investment ratio is positively associated with growth.