The Output Per Worker And The Savings Rate - Essay Example

The Solow Model considers an economy evolutionary and assumes that the supply of goods and services depends upon the production function - Another important fact to be considered of the Solow Model, is that in the absence of productivity growth, the economy reaches a steady-state in the long run in which the output per worker (yt), the consumption per worker and the capital per worker are all constant. The Solow model suggests that the Under Developed economies that have a high internal savings rate, will grow at a faster pace than developed countries.

The high economic growth rate that these economies can enjoy, will help to narrow the gap in the output per worker (yt) and living standards in contrast with the developed economies. But the Solow model further states that the rapid pace of growth of these countries would eventually die down resulting in a steady-state growth rate. The reason for this is that as more and more capital stock would be generated with the rapid growth rate, the total level of depreciation also increases. As a result a large proportion of the savings is required to offset the depreciation and hence leaving less savings for net investments.

How are savings important for the growth of the output per worker and the economy as a whole The answer to this is that savings are very important for economic growth and worker productivity. The total savings include - Total Savings = Private Savings + Public Savings + Net Foreign Savings Savings must be sufficient enough to cover the replacement of depreciated capital and to equip new workers with their share of capital as the working population continues to grow. If savings fall below this sufficient level, then the capital-labor ratio falls and worker productivity will go down as an effect, decreasing the output per worker (yt) and living standards as an externality.

Now consider the US and the European Economies. The US and the European Countries are developed nations. For such developed countries, the steady-state growth model indicates that their total savings are sufficient to replace the depreciated capital, to equip new workers with the same capital to maintain a constant capital-labor ratio (kt), and update the capital stock according to the new technology. As a result they have a higher worker output level (yt). In addition to this, the technological advancements have increased the worker productivity of the Developed countries that led to an increase in the output per worker.

Under Developed Countries like African Countries on the other hand, have low standards of living, smaller economies, less capital, and lower capital-labor ration as compared to the developed countrie