E CONOMIC G ROWTH M ODELS Exogenous Models vs. Endogenous Models

S OVIET E XPERIENCE : G ROWTH E NGINEERING Direct gov’t control over production and allocation, Strong powers of taxation and confiscation, Confiscation, => Manipulate the parameters to influence the growth rates!

T ARGETS AND A CHIEVEMENTS OF THE F IRST F IVE Y EARLY P LAN ( TO ) 1927 – 28 (actual) (plan) 1932 (actual) National Income Gross Industrial Production (a) Producers’ Goods (b) Consumers’ Goods Gross Agricultural Production

B EYOND H ARROD -D OMAR : O THER C ONSIDERATIONS If – then statements about the variables, Parameters that are used to predict growth rates may themselves be affected by the growth process (endogenously determined).

T HE E NDOGENEITY OF S AVINGS -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.

T HE E NDOGENEITY OF S AVINGS -2- Overall distribution of income within the country, and across the countries, The existence of some inequality may spur savings among the middle income class, because of the desire for prestige, There should be tendency for the savings rate to rise as we move from very poor to middle income levels, both within a country and across countries, For the rich, although the rich can afford to save, the fact that they are ahead of many other individuals blunt their need to accumulate wealth for this purpose => consumption may become relatively atractive!

T HE E NDOGENEITY OF S AVINGS -3- An adjustment is necessitated in the Harrod- Domar Theory: As income change, the savings rate that enters into the Harrod – Domar formula will change! This creates a tendency over time for the growth rate of a country to alter => Both low and high income contries have lower growth rates than middle income countries. Neutrality of Harrod – Domar model is lost with this amendment: A pattern linkin p c income to growth rates is created.

T HE E NDOGENEITY OF P OPULATION G ROWTH -1- Evidence suggests that population growth rates systematically change with the overall level of development of a society,

T HE E NDOGENEITY OF P OPULATION G ROWTH -2- Demographic Transition Model: In Poor Countries: Incidence of famine, undernutrition, and disease, as well as difficult conditions of sanitation and hygiene, all contribute to high death rates => High death rates and high birth rates keep the population at a low level. Middle –Income Countries: With an increase in living standards, death rates start to fall. Birth rates adjust relatively slowly to this transformation in death rates => Population increases rapidly. High Income Countries: With further development, birth rates begin their downward adjustment and the population growth rate falls to a low level again.

T HE E NDOGENEITY OF P OPULATION G ROWTH -3- Population growth rate Growth rate of Total Income Growth rate of p c income

T HE E NDOGENEITY OF P OPULATION G ROWTH -4-

S OLOW M ODEL : ENDOGENOUS CAPITAL OUTPUT RATIO

S OLOW M ODEL :

S OLOW M ODEL : CONTINUED

T HE S TEADY S TATE 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

S OLOW VS. H ARROD -D OMAR M ODELS

H OW P ARAMETERS AFFECT S TEADY S TATE (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↑

L EVEL E FFECTS & G ROWTH E FFECTS 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.

S OLOW M ODEL “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.

T ECHNICAL P ROGRESS 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.

T WO S OURCES OF G ROWTH 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.

AUGMENTED SOLOW MODEL

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

P REDICTIONS OF THE S OLOW M ODEL 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.