Topic 2%202%20_Growth_%20-%202005-2006%20version

Topic 2%202%20_Growth_%20-%202005-2006%20version - Topic 2:...

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Topic 2: Economic Growth In topic 1 we noted how power of compound interest ensures that apparently small differences in rates of economic growth can have huge effects over time. See diagram from World Bank re differing experiences of Thailand and sub-Saharan countries such as Nigeria, Malawi. Note economic growth is a comparatively modern phenomenon, really only dating from Industrial Revolution in Britain. Also even relatively small rates of growth can lead to huge changes in living standards. Begs question of what theories of economic growth have to say about growth process – is there a magic formula? We will review these theories. Harrod-Domar : Fundamental condition of macroeconomic balance is S=I. More I leads to more K goods, leads to more output hence growth. H-D model came up with approximate equation s gn θ δ ≈+ + * , where s is savings rate, θ is capital-output ratio i.e. amount of capital required to produce a single unit of output, g * is per capita growth rate, δ is rate of depreciation and n is rate of population growth. If we assume n and δ are exogenous, then this implies higher growth occurs via higher saving and/or lower capital- output ratio. In market economies these factors may be outside control of government but in highly planned economies e.g. Soviet Union and India, the H-D model was highly influential. Also there could be different emphasis put on different aspects of S and I e.g. in Soviet Union the Feldman growth approach stressed role of heavy industry – see table 3.3. How exogenous/endogenous are s and n? Discussed in more detail below. In very low income countries s likely to be very low – thus it may be positively related to level of income both within a given country over time and between countries at point in time. May also be related to degree of inequality – high degree of inequality may spur higher savings among middle classes – thus relaxation of assumption of exogeneity of saving may imply relationship between s and income with higher s among middle income countries relative to very rich and very poor countries. Examination of World Bank data supports this – low to middle income countries have highest savings rates – very poor countries (who have greatest need for investment) have low savings. Note also that while relative saving (i.e. as a proportion of income) may be low for high income countries, absolute amounts saved are still very large. What about exogeneity of n? Reason to believe that it follows inverted U pattern. So far we have looked at effect of relaxing assumptions of exogeneity of s, n. What about exogeneity of θ ? Turn to Solow model.
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The Solow Model Start off with a production function YF K L = (,) We assume constant returns to scale – also known as homogeneity of degree one of production function.
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Topic 2%202%20_Growth_%20-%202005-2006%20version - Topic 2:...

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