Professional Documents
Culture Documents
Growth Theories
Growth Theories
GROWTH THEORIES
Also the trouble of identifying relevant growth theories for each stage
of development (Rostow’s Stages), as well as for each country (avoiding
‘Ontological Universalism’ Components of all economies and the
interactions between them are the same for all economies).
GROWTH THEORIES
SINGLE-SECTOR
THEORIES
Harrod-Domar
Model states that the rate of growth consistent with equilibrium in both input and
output markets (the Warranted Rate of Growth) is the level of savings divided by
the incremental capital output ratio (ICOR).
gw If the actual growth rate exceeds the warranted, then the economy will veer into
v
inflationary pressures.
If below, the economy will accrue excess capacity and rising unemployment. BOTH
scenarios compound themselves over time.
Thus, the Government must play a role in keeping the economy on the
equilibrium, growth follows capital accumulation (higher savings).
BUT: the knife-edge equilibrium and unstable/difficult to calculate ICOR meant that
it is unlikely the Government would be able to put the economy on equilibrium,
and the assumption of fixed-proportions is not a realistic one.
The Solow Growth model builds on H-D by assuming substitutability of Labour and
Capital.
SINGLE-SECTOR
THEORIES
The Solow Growth Model:
As shown in the diagram (see slide 6), the economy will converge to a ‘steady
state’ level of income and capital, where there is a 0 level of income per capita
growth.
Capital accumulation is, as in all neoclassical growth models, the key to growth.
SINGLE-SECTOR
THEORIES
The Solow Growth model has had the following criticisms levied at
it:
Limited applicability to developing nations: the model assumes
competitive markets, but many developing nations have dualistic
markets (formal and informal sectors). There thus might be
surplus labour to draw upon at low incomes. Further, the model
assumes a balanced growth path (discussed later), which is
troublesome due to input constraints in developing nations.
Convergence is not a ubiquitous phenomenon: Maddison (1995)
calculates that 30/43 follower countries converged on the US
1950-1989. However, there was long-run divergence driven by the
poorer countries – despite their greater ‘catch-up’ potential.
Even if one adjusts for differences in fundamentals (Maddison
notes that convergence occurred amongst the ‘advanced
capitalist nations’ and Japan, whilst Cypher + Dietz find that the
NICs are converging on an equilibrium ahead of the advanced
capitalist nations due to higher saving/investment rates), there
are large differences in absolute income levels despite modest
differences in savings rates.
SINGLE-SECTOR
THEORIES
Y
y k n d
L
y f k
y*
sy
k* K
k
L
SINGLE-SECTOR
THEORIES
Exogenous Growth Theory:
The higher the level of human capital accumulation, the greater these
effects, due to complementaries between the factors of production(see
Kremer’s O-ring theory).
Lucas (1988) noted that an economy with low levels of human capital will have a growth
level permanently below an economy with higher levels.
Therefore, the model actually suggest that there will be long-run divergence, as opposed to
convergence.
These two aspects of endogenous growth theory (divergence and multiple equilibria) can be
seen in the diagrams on the next slide:
The first one is the simple AK model, where technological change is a function of capital
accumulation (where human and physical capital embodies new techniques and ways of
doing things). The production function is a ray from the origin, with savings being a constant
fraction. Thus, economies will continuously move to higher levels of income per capita at
higher growth rates as the two rays diverge. Thus, a country with higher levels of capital will
always be ahead of a country with lower levels of capital.
The second is presented by Easterly (1998). With increasing returns to scale (an upward-
sloping marginal product of capital) and a constant discount rate, there is some threshold
level of capital accumulation below which vicious cycles occur, above which, virtuous cycles
occur, with ever increasing growth.
SINGLE-SECTOR
THEORIES
Y
y
L y ak
MPK
sa Discount Rate
K
K k
k L
L
Endogenous Growth 1: Long-run Endogenous Growth 2: Multiple
Divergence due to spillovers. equilibria due to IRS.
SINGLE-SECTOR
THEORIES
Because of the presence of externalities, there is inevitably market failure.
Thus, there is a role for Government in addressing this market failure by stimulating
R+D, providing popular education and amending copyright laws in order to realise the
marginal social benefit of human capital accumulation.
Additionally, Government must play a role in preventing the economy from being stuck
in a low-level equilibrium trap, by implementing policies that promote a higher return to
capital (free trade, financial deregulation, less inhibitive taxation structures).
In this sense, there are slightly different roles for Government depending on proximity
to the threshold; below or close to it there is a cause for ‘big push’ (described later) to
be undertaken – however, regardless of development status, the Gov. Should always
promote human + physical capital accumulation.
However, accumulation by itself is a necessary but not sufficient condition for growth.
In order for the spillover effects to be realised, there must be proper social conditions
for the assimilation of that new capital.
New technology must be received by people who know how to use it, and are able to
adapt it to maximise its efficiency for their localised need. There needs to be a type of
‘adaptive entrepreneurship’.
SINGLE/DOUBLE-SECTOR
THEORIES
SINGLE/DOUBLE-SECTOR
THEORIES
Let Ait be the productivity attached to most recent tech in industry ‘i’ at time
‘t’, the first equation implies growth can be driven by creative destruction:
A higher firm turnover means faster increases in the value of ‘Ait’.
Pulling in the frontier; let Mu‘n’ be the rate of leading-edge innovation, let
Mu‘m’ be the rate of implementation (copying) innovation; gamma is a
parameter of how much the leading edge innovations are surpassing old tech,
and at is a parameter signifying the distance to the frontier.
The smaller ‘a’, the farther from the frontier and the faster the rate of
growth so long as the rate of implementation innovations is high enough.
This requires Government support through the creation of institutions and
policies that facilitate such innovation (primary education, and reverse
engineering for example).
The closer to the frontier, however, the more important is the need to
switch from copying innovations to leading-edge innovations, which
requires more tertiary education (the US is a good example of this, as
university education confers greater spillovers).
1
Yit Ait K it
CREATIVE DESTRUCTION
g t n 1 m a 11
it
Advantages of Backwardness
DOUBLE-SECTOR
THEORIES
DOUBLE-SECTOR
THEORIES
Output/Revenue/ Modern
Cost Prod. F’n.
W3
W2
Q2 B
W1
C2
Traditional
A Prod. F’n.
Q1
C1
Assume that there are ‘n’ tasks in a production process and that you can define
individuals by their skill level, ‘q’ (where ‘q’ is the probability of completing a task, and
lies between 0 and 1).
Example:
The theory suggests that there will be POSITIVE ASSORTITATIVE MATCHING:
2 Skill Levels : q H , q L
People of similar skill levels will work together.
4 Workers, 2 of each.
Everyone wants to work with the higher productivity individual as it raises the group
output. A firm with higher skilled persons can also afford to employ higher skills,
thus it is likely that similar skills will band together.
Output is always higher if
Implies that : they band together;
Workers performing the same task earn more in a high-skill firm. qH2 qL2 2qH q L
qH qL 0
Multiple equilibria with low and high quality persons. 2
Cumulative Causation: When those around you have higher average skills, you have
an incentive to invest in human capital, when faced with bottlenecks in low-
productivity firms, it reduces the incentive to invest in skills.
A
Wm
M
Wa A
q
0a Z La Lm 0m
Urban
unemployment
CONCLUSION
ARGENTINA
ARGENTINA
ARGENTINA