Download Growth Theories

Lecture 2 of Eco 3317
Harrod-Domar Model of
Economic Growth
‘Crude but Flexible’
Harrod-Domar Model
as a Neo-Classical Model
• This model is older and cruder than Solow Model
• This model links Growth with K:
- Quantity of Capital through Savings = Investment
- Effectiveness and Efficiency of Capital
- Different Institutions can make a difference
in effectiveness and efficiency of capital
• It explain some Asian Economic Development to
some extent.
1. Derivation of Harrod-Domar equation
Income Growth Rate = Saving Rate x Efficiency of Capital
dY/Y = dY/dK x
dK/Y
As S = I = dK , and thus
= dY/dK x S/Y
= Marginal Product(ivity) of Capital x Savings Ratio
Alternatively we can say
Growth Rate =
S/Y
dK/dY
=
Average Propensity to Save
Incremetal Capital Output Requirement
Quantity of K x Efficiency of K
=
2. Key Concepts
• Savings Rate
• ICOR = 1/Marginal Productivity of K
-> Inverse of Efficiency of K
“The higher MPK, the lower ICOR,
the more efficiently is capital being used.”
“The more effectively capital is raised and the
more efficiently it is used, the higher the rate
of economic growth will be”
3. Implications of the H-D model
i)The key to economic growth is to expand the level of
investment: capital accumulation or ‘Mobilization
of capital’
ii)Equally important is the productivity or efficiency
of use of capital: the higher the marginal product of
capital,(MPk) the better, or the lower the required
incremental capital-output ratio(ICOR), the higher
the economic growth rate will be.
iii) In general, eventually, the more amount of
capital, the Marginal Productivity of capital
decreases – “Convergence”
Recall: In the latter part of the S curve, the MP of capital is a decreasing function of
capital –“Decreasing Marginal Returns” or “Law of Diminishing Marginal Return”
This happens as the size of capital grows in the natural course of economic growth.
• It is a formidable task to keep the weighted
average Marginal Product of Capital constant
or even Increasing for the entire economy.
• Technical Innovations may keep it high
4. This leaves a room for Institutions:
What makes differences in effectiveness of
raising capital and efficiency of using capital
across countries?
It may be their ‘Different Institutions’
or ‘Different Economic Organizations’.
• Different ‘Institutions’ or ‘Organizations’ leads to
Different Effectiveness of raising Capital and
Different efficiency of using Capital
• What are institutions?
covers visible Direct Government Policy or Indirect Policy Environment
Business Operating System;
invisible Value System(ethics,religion)
5. Applied to East Asian Economic
Growth
There must be unique ‘institutions’ that help
effectively mobilize capital and enhance efficiency of
capital
Theory: The studies of economic growth is to find out
what institutions they are.
Practice: The strategy of economic growth is first to
foster such ‘institutions’
* Case Studies
1) Japan
Kozo Yamamura’s or Kazuo Sato’s paper reports
that during the take-off stage of economic growth
of Japan, 1) there was a big increase in capital due
to high savings rates, and 2) the average capitaloutput ratio fell significantly.
In turn, these two factors were due to favorable
Government policies, business organizations, and
institutions.
Specifically, what are they?; how did they work?
For detailed explanation
• Read Kozo Yamamura’s paper and
• Kazuo Sato’s paper
• Government’s
Economic Development Planning(Progressive
Stages)
Industrial Policies
• Institutions
No social welfare system
Bonus System
Minimum Investment on Housing
(max. investment on production facilities)
Lifetime Employment System
Conglomerate System
2) Korea
Exact replica of the Japanese economic growth
model
3) Some failures
Some countries have succeeded in mobilization of
capital, but failed in the efficient use of capital.
Stalinist Economy
North Korea
Great Leap Movement in China
4) Chinese economic growth
A bit of mystery?
• Effectiveness of Raising Capital
“Is China a capital-poor country?”
eg) Guo Taiming at Foxconn invested on his
home town in Jincheng, Shanxi Province.
• Efficiency of Capital Use
“Where does efficiency come from or not?”
6. Shortcomings of the Harrod-Domar Model
• In a underdeveloped country, it is intrinsically difficult to
stimulate domestic savings
- One may say that one solution would be foreign
savings(=foreign investment): However, borrowing from
overseas causes dependency and debt repayment problems
later.
• Over time, naturally, efficiency of capital use falls.
- The law of diminishing returns suggests that as capital
increases, the marginal productivity of the capital will
diminish, and ICOR will rise: The model predicts that in the
long-run, economic growth rate will fall- convergence.
Empirically it is always the case. And we attribute this to
Technical Innovation.