Group 4 Theories of Economic Growth

Instructor: Msc.Nguyn Trng c 1. Nguyn Th Mai Anh 2. u Vn Hi 3. Hong Th M Lin 4. Trn Hng Nhung 5. Trn Th H Thng 6. Nguyn Th Thy Vn

Introduction
Theories of economic growth are most basic expression of economic growth based on economic factors and their relationship. Some important models of economic growth: 1. Harrod-Domar Growth Model 2. Solow Model 3. Rostow's Model 4. The Lewis Dual Sector Model of Development 5. Two-sector models

The Harrod-Domar Growth Model

Theory of Model
Used in development economics to explain an economy's growth rate in terms of the level of saving and productivity of capital.

The starting point of this model

J.Keynes opinion on equilibrium below potential level and the role of spending (aggregate demand) Investment causes income effect (Harrod same point with J.Keynes) Investment by saving (S = I) Investment to increase capacity of economy (I = K) Fixed technology

Contents of Model
The role of resources factors in the growth The factor effect directly to the growth Y = f(K,L) Factors play a decisive role + S is the source of investment (I) + I create K for the following period + K create directly Y of this period Saving and investment create capital stock which play a decisive role in economic growth.

Content of Model
Role of the capital in economic growth The relationship between K and Y +Incremental Capital Output Ratio (ICOR) =Kt /Yt = It-1/ Yt ICOR measures the productivity of additional capital which depends on: + Level of scarce resource + Efficiency of management and using capital

Harrod-Domar growth model and the rationale

The fixed-coefficient production function

Q= min F(L,K): the production Isoquant is L shaped It shows constant returns to scale (CRS) i.e. doubling inputs will double output The most efficient production point is at the elbow

Harrod-Domar Prod. Function

Y= (1/v)x K or Y=K/v (1) Where v= constant or v=K/Y (2) + v= capital output ratio or measure of the productivity of capital or investment (1) can be convert to relate changes in output to changes in the capital stock: Y=K/ v (3) The growth rate of output g=Y/Y (the increment in output divided by the total amount of output) g =Y/Y=K/Y*v (4) because K=sY-d*K Finally the Basic Harrod Model: g= (s/v)-d (5)

10

The Harrod-Domar model of E.G Summary

The steady-state rate of growth is determined by: the saving rate the fixed incremental capital-output ratio (ICOR), and the rate of depreciation of fixed capital

11

Advantages
Is its simplicity. The data requirements are small, the equation is easy to use and estimate. Can be accurate from one year to next year. Can do reasonable job of estimating expected growth rates in most countries over very short periods of time (a few years). Focuses on the key role of saving. -> It makes clear that saving is crucial for income to grow over time.

12

Disadvantages
It is difficult to stimulate the desired level of domestic savings Meeting a savings gap by borrowing form overseas causes debt repayment problems later. Diminishing marginal returns to capital equipment exist so each successive unit of investment is less productive and the capital to output ratio rises. The amount of investment is just one factor affecting development e.g. supply side approach (free up markets); human resource development (education and training) Economic growth is a necessary but not sufficient condition for development Many developing countries lack a sound financial system

13

Solow Model ( Neoclassical Growth Model)

14

Theory of Solow Model

Is the neoclassical growth model Is a class of economic models of long-run economic growth. Explain by looking at productivity, capital accumulation, population growth and technological progress.
15

Characteristics
An improvement over HarrodDomar Model It drops fixed coefficient or no substitution Allows for substitution between factors Y= f(K,L) Labor and Capital are substitutable The production function is ushaped showing substitution as in figure 4.2
16

Solow growth model diagram

The model starts with a neoclassical production function Y/L = F(K/L) or y = f(k). Where: n = population growth rate d = depreciation k = capital per worker y = output/income per worker L = labor force s = saving rate
17

The Basic Solow Growth Model

Point A is where new savings Sy = amount of new capital needed for growth in the labor force and depreciation (n+d). Point A is steady state level of capital per worker where stable equilibrium occurs At steady state total output continues to grow at the rate of population (n) or labor force, but GDP per capital (y) is constant.

18

The Effect of Changes in Saving Rate and Population Growth

An increase in the Savings rate in the Solow Model from s to s results in an shift in capital deepening curve -> So capital per worker increases from k0 to k3 or A to B The population growth rate has now increased from n to n, this introduces a new capital widening line (n + d)

19

The effect of Population Growth in the Solow Model

20

The Effect of Technical Change on Solow Model

21

Strengths of Solow Model

An improvement over HarrodDomar Fixed coefficient model Allows for substitution between inputs and outputs Provides good insights about the relationship between role of technology and innovation on growth

22

Extension to the HarrodDomar Model

Adding labor as a factor of production Requiring diminishing returns to labor and capital separately and constant returns to scale for both factors combined Introducing a time-varying technology variable distinct from capital and labor.

23

Weaknesses of Solow Model

Lack of direct insight on the fundamental factor influencing the steady state. One sector approach, factors that drive steady state, and assumes saving rate, population growth , and technical change as given Not explain how these parameters change over time. Not shed light on the role of the allocation of capital and labor among various sector.

24

New Approaches to Growth

The Solow model assumes fixed or exogenous saving rate, growth rate of savings and labor force. Recent works provides models where these variables are determined within or endogenously in the model. These new models allow for increasing returns to scale and positive and negative externalities They are called endogenous models but their estimation suffers from lack of good data.

25

Rostow's Model- the Stages of Economic Growth

26

Theories
In 1960, Rostow, the American Economic Historian suggested: countries passed through 5 stages of economic growth. Stage1: Traditional society Stage2: Transitional stage ( the preconditions for takeoff) Stage3: Take off Stage4: Drive to maturity Stage5: High mass consumption
27

Rostows Model
Stage 5 Stage 4 Stage 3 Stage 2

Take off Transitional stage

Drive to maturity

High mass consumption

Stage 1

Traditional society

28

Stage 1: Traditional society

Characterized by subsistence agriculture or hunting & gathering; Output not traded or recorded. Limited technology Existence of barter High levels of agriculture and labour intensive agriculture

29

Stage 2: Transitional stage

- Increase in capital use in agriculture -Some growth in savings and investment - Emergence of a transport infrastructure to support trade -External trade also occurs: primary products.

30

Stage 3: Take off

-Industrialisation increases -Some regional growth -The level of investment reaches over 10% of GNP.

31

Stage 3: Take off

-Number employed in agriculture declines -The "secondary" (goodsproducing) sector expands - Further growth in savings and investment

32

Stage 4: Drive to maturity

-The economy is diversifying into new areas -Wide range of goods and services ; less reliance on imports. - Manufacturing shifts from investment-driven (capital goods) towards consumer durables & domestic consumption.

33

Stage 4: Drive to maturity

-Increase in levels of technology utilised -Transportation infrastructure develops rapidly - Large-scale investment in social infrastructure (schools, universities, hospitals, etc.)

34

Stage 5: High mass consumption

- High output levels - Mass consumption of consumer durables - High proportion of employment in service sector

35

Advantages of Rostows Model

Is historical in the sense that the end result. Is known at the outset Is derived from the historical geography of a developed, bureaucratic society. Its sense is to determine development level of each country in each period. It suggests that each country needs to promote and complete the needs for the development in each period

36

Disadvantages of Rostows Model

Just based on American and European history -> integral to the economic development process of all industrialized societies. Not apply to the Asian and the African countries The stages are not identifiable properly as the conditions of the take-off and pre take-off stage are every similar and also overlap. Growth is a continuous process, not interrupted, so it is not divided into clear and exact stages. Growth and development of some countries dont need to separate above 5 stages The beginning of each country is different while this theory doesnt base on it Just studies the growth
37

Application for Vietnam

Vietnam is in the take-off stage in the Rostows model The 1986 Sixth Party Congress approved broad economic reforms introduced market reforms, opened up the country for foreign investment, and dramatically improved Vietnam's business climate (GDP) increases 8% from 1990 to 1997 and 6.5% from 1998-2003 GDP grew more than 8% annually from 2004 to 2007 GDP is 6.8% in 2010, and reached 5.8% over the first 9 months of 201

38

Application for Vietnam

In the first 9 months of 2011, disbursed FDI capital totaled $9.1 billion, up 1% compared to the same period in 2010 From 1990 to 2011, agricultural production nearly doubled In the first 9 months of 2011, Vietnams exports ($70 billion) were up by 23% compared to the same period in 2010 Per capita income rose from $220 in 1994 to $1,168 in 2010. Increased to 18.2% in the first 9 months of 2011, up from 8.6% in the same period of 2010 Industry and construction contributed 41% of GDP in 2010

39

Lewis Dual Sector Model

Sir Arthur Lewis, an economist from Saint Lucia, is credited for the development of the Dual Sector Model. His contributions to developmental economics earned him a Nobel Prize in economics.

40

Theory of Model
Is a structural- change theory. Explains the mechanism of changing structure of underdeveloped economics Move from subsistence agriculture to more modern and more urbanized. Became the general theory of the development process for surplus labor nation during 1960s and early 1970s.
41

Dual Sector Model

Traditional sector
sector. Marginal productivity of labor is zero. Mainly agriculture Is characterized by very stagnant Labor productivity is very low and surplus labor

Modern sector
Productivity is high Be able to accumulate.. Labor is gradually transferred into this sector from traditional sector

Is overpopulated subsistence Is urban industrial sector.

42

The Lewis Model

43

The advantages of Model

Attracted attention of underdeveloped countries. Brings out some basic relationships in dualistic development. Provide a good general theory on labour transitioning in developing economies.

44

Disadvantages of Lewis Model

Capital accumulation Surplus Labor Competitive labor market in modern sector The modern sector might continue to use more and more of capital instead of labor.

45

Viet Nam economic

Is not a dualistic economy But its move to a market economy. Agriculture remains the main front of us. We need agriculture to export of rice, bring money for raw materials and machinery. -> For agriculture and earn money to create economic growth in Vietnam.

46

Two Sector Model

Recognize the prime importance of labor and capital in the growth process Explore differences in both the levels and growth rates of productivity in different activities and the implications for relative wages Include: - The 2-Sector Labor-Surplus Model (Lewis Classical Model) - The Neoclassical Two-Sector Model

47

The 2-Sector Labor-Surplus Model (The Lewis Classical Model)

48

The 2-Sector Labor-Surplus Model (The Lewis Classical Model)

Fig. 4.10: The Supply and Demand for Industrial labor

49

The 2-Sector Labor-Surplus Model (The Lewis Classical Model)

50

The Lewis Classical Model

51

The Neoclassical Two-Sector Model

52

The Neoclassical Two-Sector Model

53

The Differences implications in neoclassical and classical model

Classical model Population growth is a negative effect. Neoclassical Population growth is not a negative effect.

54

Thank you for attention!

55