GROWTH THEORIES

Classical growth theory

Adam Smith economic growth as the selfgenerating process Production function Q = f (L,K,N) Increasing returns due to division of labour Division of labour extent of market capital accumulation Capital accumulation strategic to growth process I = S, ability to save and invest limited by income Stationary state

Contd

Ricardos dynamic process of development with short term disruptions

Production Role

function Q = f (L,K,N, S)

of capital accumulation

Stationary

state

Contd

Malthus Explanation of development & underdevelopment Human resources and capital accumulation IS Growth retarding factors
Backward

slopping supply curve of effort Inability of economy to transform structurally Slow technological progress

Harrod-Domar Model

Keynes General Theory

Orientation towards short run full employment and equilibrium level of income Static theory, where disturbances to I =S corrected in the short run Questions related to long run growth unanswered

Extending Keynesian short run theory into a long run growth problem examine the effect of change in capital accumulation on incomes in the long run Harrod-Domar model bridging the gap between Keynes short-run static theory and dynamics of long run growth Starting point of modern growth theories Determining conditions for smooth uninterrupted growth in national output

Contd

Dual effect of capital accumulation

Net investment generating income & creating demand for output Raising productive capacity by expanding capital stock

Potential level of GDP as a function of net investment spending under given productivity of capital Ex-ante savings = ex-post investment Three different growth rates (Harrod)

Warranted growth rate (gw) growth rate required for full utilization of growing stock of capital Actual growth rate (g) Natural growth rate (gn) determined by current growth of working population and current potential for technical progress

Contd

Knifeedge equilibrium path with g = gw = gn Any instability will result in severe inflation or chronic unemployment Y /Y = g = s /v , s = marginal propensity to save out of GDP and v = capital output ratio Policy implications Knife edge growth path may often lead to instability for which active interventionist government policy is required Rate of savings is the chief determinant of the rate of growth, hence growth depends on the ability to save