The growth process under time non -separable preferences

Our objective is to investigate how alternative assumptions about preferences affect the process of economic growth. To do this, we analyze a neoclassical growth model under three alternative preference specifications: (i) time separable, (ii) catching up with the Joneses, and (iii) habit formation. Departing from the time separable specification leads to important differences in the dynamic structure, the adjustment path followed by key economic variables, the correlation patterns implied by the time series generated by the model, and the speed of convergence to the new steady state. In the catching up with the Joneses economy the differences arise from a consumption externality, while in the habit formation economy the difference arises from the fact that agents not only smooth consumption but also its rate of change. We then proceed to examine the effects of both consumption and production externalities on capital accumulation and economic performance under time non-separable preferences and a non-scale growth production technology. We show that a consumption externality in isolation has long-run distortionary effects if and only if labor is supplied elastically. With fixed labor supply, it has only transitional effects, though it may generate long-run distortions through its interaction with the production externality. Production externalities always generate long-run distortions, irrespective of labor supply. The optimal taxation to correct for the distortions is characterized.