Economic Growth Models

1. EconomicGrowthModels Exogenous Models vs. Endogenous Models

2. SovietExperience: GrowthEngineering • Direct gov’t control over production and allocation, • Strong powers of taxation and confiscation, • Confiscation, => Manipulate the parameters to influence the growth rates!

3. TargetsandAchievements of theFirstFiveYearly Plan (1928-29 to 1932-33)

4. BeyondHarrod-Domar: OtherConsiderations • If – then statements about the variables, • Parameters that are used to predict growth rates may themselves be affected by the growth process (endogenously determined).

5. TheEndogeneity of Savings -1- • The rate of savings may itself be influenced by the overall level of p c income in the society, • Economies where the majority of the citizens are close to subsistence levels of consumption are unlikely to have a high rates of savings, • Then, the growth efforts must rely on other sources of capital accumulation, i.e. External credit, aid… • As the economy grows, there is increased room for savings.

6. TheEndogeneity of Savings -2- • Overalldistribution of incomewithinthecountry, andacrossthecountries, • Theexistence of someinequalitymayspursavingsamongthemiddleincomeclass, because of thedesireforprestige, • Thereshould be tendencyforthesavings rate torise as wemovefromverypoortomiddleincomelevels, bothwithin a countryandacrosscountries, • Fortherich, althoughtherich can affordtosave, thefactthattheyareahead of manyotherindividualsblunttheirneedtoaccumulatewealthforthispurpose => consumptionmaybecomerelativelyatractive!

7. TheEndogeneity of Savings -3- • An adjustment is necessitated in theHarrod-DomarTheory: As incomechange, thesavings rate thatentersintotheHarrod – Domarformulawillchange! • Thiscreates a tendencyover time forthegrowth rate of a countrytoalter => Bothlowandhighincomecontrieshavelowergrowthratesthanmiddleincomecountries. • Neutrality of Harrod – Domar model is lostwiththisamendment: A pattern linkin p c incometogrowthrates is created.

8. TheEndogeneity of PopulationGrowth -1- • Evidence suggests that population growth rates systematically change with the overall level of development of a society,

9. TheEndogeneity of PopulationGrowth -2- • DemographicTransition Model: • InPoorCountries: Incidence of famine, undernutrition, anddisease, as well as difficultconditions of sanitationandhygiene, allcontributetohighdeathrates => Highdeathratesandhighbirthrateskeepthepopulation at a lowlevel. • Middle –IncomeCountries: With an increase in livingstandards, deathrates start tofall. Birthratesadjustrelativelyslowlytothistransformation in deathrates => Populationincreasesrapidly. • HighIncomeCountries: Withfurtherdevelopment, birthratesbegintheirdownwardadjustmentandthepopulationgrowth rate fallsto a lowlevelagain.

10. TheEndogeneity of PopulationGrowth -3- Population growth rate Growth rate of Total Income Growth rate of p c income

11. TheEndogeneity of PopulationGrowth -4-

12. Solow Model: endogenouscapitaloutputratio

14. Solow Model:

15. Solow Model: continued

16. TheSteadyState • With a high initial capital stock; • Return on capital is low, • Output – capital ratio is low, • Population growth > Capital growth. • With a low initial capital stock; • Return on capital is high, • Output – capital ratio is high, • Population growth < Capital growth. • Economy reaches to k* steady state level

17. Solow vs. Harrod-DomarModels

18. HowParametersaffectSteadyState • (1+n)k(t+1) = (1-δ)k(t)+sy(t) • k(t+1)=k(t)=k* steady state level • (1+n)k*=(1-δ)k*+sy* • Divide both sides by k* • (1+n)=(1-δ)+sy*/k* • (n+δ)/s=y*/k* • k*/y*=s/(n+δ) s↑; steady state level↑

19. LevelEffects & GrowthEffects • Population Growth => Double Effects: • Lowers the steady state level of p c income • But total income must grow faster. • Labour; • Factor of production => increases income • Consumer => decreases p c income • Growth Effect: changes the rate of growth of a variable, typically income or p c income. • Level Effect: leaves the rate of growth unchanged, while shifting the entire paths of the logarithm of income over time.

20. Solow Model • “s” has level effect only in Solow Model, • Shifts the k*/y* ratio up • Long run growth rate is unaffected • How is it that long run growth rate unaffected? • In short and medium run, the increase in the savings rate pushes the economy to a higher trajectory, but the effect is ultimately killed off by diminishing returns.

21. TechnicalProgress If there is continuing technical progress; that is the production function shifts upward over time as new knowledge is gained and applied, long run growth is then achieved.

22. TwoSources of Growth • Technical Progress: Through better and more advanced methods of production, • Capital Accumulation: via the continued built up of plant, machinery, and other inputs that bring increased productive power. • In the absence of Technical Progress, Capital Accumulation is not enough for sustained growth.

23. AUGMENTED SOLOW MODEL

24. THE BIG RESULT: ALL ROADS LEAD TO THE STEADY STATE LEVEL!!!

25. Predictions of theSolow Model • Unconditional Convergence: Assume (s, , δ, n) are the same across countries, • All countries will have the same y’* and k’*, • In the long-run, all countries will grow at rate , • In the short – run poor countries will grow faster. • Conditional Convergence: Assume (s, δ, n) are different  is the same, • Countries converge to different y’* k’*, • In the long run, all countries will grow at rate , • In the short run, the growth rate depends on how close a country is to its steady state.