Harrod-Domar Growth Model - Essay Example

a) Does net saving rate promote economic growth? b) We use Harrod-Domar growth model to partially explain it. H-D model is “a functional economic relationship in which the growth rate of gross domestic product (GDP) depends directly on the national net saving rate(s) and inversely on the national capital-output ration (COR).” (P111, Todaro) There are several assumptions of this model. The first one is that H-D model is an investment drive growth model. Additionally today we often referred to this model as AK model whose aggregate production function is Y=AK. From the lecture notes with marginal product capital (MPK) equals to A, and there is a constant MPK. Secondly, in the closed economy, saving equals to investment, and saving is some proportion of income as well. Thus we find that saving equals to saving rate times income equal to investment (St=sYt=It). The last one is that we can write the capital-accumulation in the form of Kt+1=(1-d)*Kt+It, where K is capital stock and d is the rate of capital depreciation. Based on all assumptions and according to the mathematics, in order to simplify all equations and use Log method, we can get the growth rate of GDP is gY=s*A-d, where d is the depreciation rate of capital. This is the main idea of the H-D model. Based on the result, the growth rate of an economy, therefore, depends on the saving rate. It means that saving rate will promote economic growth. However, it must be satisfying the assumptions, otherwise, the result will be different. Here is an example to prove it. The data source from Gapminder World; as indicated in the graph below proves that there is no relationship between investment and GDP/capita growth in 1970 and 2010. In summary, the H-D model cannot completely explain the fact that the rate of saving can prove economic growth. The model has to satisfy all the assumptions otherwise the results obtained will be different. c) Why developing countries are developing faster than western countries? d) There are two sets data from World Bank. The first one is about Canada which is developed country and the second one is about China, which is developing country. According to the table, one can see that China’s GDP is much great than Canada’s, and all the percentage value lager than Canada. This is, therefore, an indication that China growths faster than Canada. Solow model can play a significant role in explaining this phenomenon. One assumption of the model is the constant return on scale. This means that all input are increased by the same amount the output. The assumption therefore yields the aggregate production as follows; Y=F(K,L). Usually, this can be written as Cobb-Douglas production function Y=A*Kα*L1-α, where Y is gross domestic product, K is the stock of capita, L is the labor, and A represents the productivity of labor. The other two assumptions for this model are that the closed economy saving equals investment and that constant saving rate (which is saving) equals saving rate multiplied by gross domestic product. As a result of the constant return scale, the aggregate production, Y=F(K,L) can be written as γY=F(γK,γL); in which γ can be any positive number. Using mathematical method, we can get income per worker as a function that depends on per worker capital which is y=f(k). Alternatively, it can be written as y=Akα. According to text book, the “Solow equation is Δk=sf(k)-(d+n)k, it shows the growth of k which depends on savings sf(k); after allowing for the amount of capital required to service depreciation, dk, and after capita widening.”(P147, Todaro). We assume that A is constant, then find the steady state, set Δk=0. After then, a long run equilibrium cab be gotten; which is sf(k*)=(d+n)k*. K* means the level of capital per worker. As a matter of fact, the growth rate is the speed of convergence. From all above equations, gk=s*A*kα-1-d-n can be gotten using a mathematical method. This means that the smaller the k, the faster gk will be. Unconditional convergence can also be used which means that all countries have the same s, n, d, A. This subjects countries/provinces to the same steady state k*. The summary of all the results obtained can be used to explain why developing countries are developing faster than western countries. Question2 A “A state of affairs in which the inability of agents to coordinate their behavior (choice) leads to an outcome (equilibrium) that leaves all agents worse off than in an alternative situation that is also an equilibrium.”(P156.Todaro) with the definition of coordination failures, we can use the example like river pollution. In China, there is a famous river called “Tai Hu”. This river passes through many cities such as WuXi and HuZhou. With the development of the surrounding cities, the pollution of the river is getting worse especially by the factories around it. There is no factory willing to control its pollution because this will mean that it has to spend too much capital and human capital. Therefore, the outcome becomes more expensive to the company. On the other hand, every city has the responsibility to control pollution. Some cities disagree with this though; they think that the pollution of the river in their areas is caused by other cities and that they only bear the effects. However, in as much as such cities want to spend less money on the preservation of the river, they may end up spending more if they do not participate actively on preventing pollution. With this trend, perhaps no one will control pollution in the end. Therefore, the government needs to intervene and develop policies that compel every city to control pollution together in order to help them get minimum cost. B In my point of view, it is not plausible that underdevelopment is mostly caused by coordination failures. There are lots of reasons that can cause underdevelopment. For examples, political instability is a major problem because it means ethnic and multi-religious disunity, coupled with historical issues. In such instances, anti-government militia conflicts seriously. Lack of the political stability is a major reason that causes underdevelopment in Africa. “The ethnic diversity of the continent is extraordinary; linguists have identified around 900 separate language groups. Nation-building in Africa’s independent states has thus been particularly difficult.” This proves that building a nation is extremely hard in Africa; thus the sluggish rate of development in these regions. Citizens of these nations make great efforts which are sadly hampered by internal conflicts, civil wars, and the worst forms of anarchy. This can be seen in Congo; which is an African country. Similarly, there is lack of capital, human capital, resources, and inadequate education in Africa that result to underdevelopment. Another important historical reason is that the long-term colonial slavery and exploitation of western countries also has an impact on the development of the African nations. For nearly a century, European powers had control of trade in Africa which gradually developed into their own supplier of raw materials and dumping site for their which led to the single and misshaped economic structure of many African countries. Therefore, the sustainable development of economy of these countries had been limited and affected for long time. Besides, according to the requirements of suzerain, the colonial authorities adopted the policy of “divide and rule” to divide national boundaries and administrative areas artificially, thereby creating ethnic discords and provoking religious conflicts which led to social unrest. This is the historical origin of ethnic, religious and regional contradictory intensification of Africa at present. Due to the issue of party affiliation, tribal wrangles, religious controversies, boundary issues and scrambling for natural resources, there were continuous wars and coups in Africa. The many years of war resulted to the instability and lack of need to engage in normal economic construction activities. In general, there are many reasons that cause underdevelopment in Africa. These are the constant internal wars, irrational economic structures, lack of resources, technology and talent and imperfect market systems. Others also include heavy foreign debts, lack of regulation, low level of education and irrational external international economic system. The extraction of raw materials by western developed countries from African and the damping of the finished products also resulted to underdevelopment. Additionally, the continuous poverty leads to the further chaos and germinates into terrorism that further worsens the economic situation and forms the vicious circle. Thus, the developed countries need to pay close attention to the issue of development of poor areas when they are following up on the issue of world peace and development Read More