EC3040 Economics of LDCs

Module B

Professor Patrick Honohan

http://www.tcd.ie/Economics/staff/phonohan

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 EC3040 Economics of Less-developed Countries
Module B January-May 2009
Professor Patrick Honohan
Room C6.009, Institute for International Integration Studies,
6th Floor, Arts Building, Trinity College, Dublin
Office hour: Monday 3-4pm or email me at phonohan@tcd.ie

Outline
This module begins (in January 2009) with a look at some of the economic
models that have been used to analyze cross-country differences in overall
economic growth. We then focus on international and financial dimensions to
development, including the problem of LDC debt. The final topic covers aid,
government and institutions.

Sources
Text:
Todaro, Michael P. and Stephen C. Smith. 2008. Economic Development
10th Edition (Addison-Wesley) (Earlier editions will do)

The aim is to cover Chapters 3-4 and 11-17 of the core text (Todaro and
Smith) in this module.
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There will not be sufficient time to discuss all the material in the lectures so
students should ensure they read these chapters.

Additional background reading will be listed in a note on tutorial topics and

some other items will be mentioned in the lecture notes to be posted below.

Topics
1.   Theories of growth: old and new
Slides will be available here
2.   International trade: Engine of growth or obstacle to development
Slides will be available here
3.   Finance: “neither a borrower nor a lender be”?
Slides will be available here
4.   Aid, government and institutions
Slides will be available here

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EC3040 Economics of LDCs
Module B Topic 1

Theories of Economic Growth

(Drawn mainly from Todaro-Smith Ch 3 & 4)

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…we start with an animation from www.gapminder.org

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2006

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Deaton, JEP 2008
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Deaton, JEP 2008
Average
growth
rates
1960-2000

Source for these

blue figures:
Weil (2007)

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What causes economic growth?
The role of capital

• Rostow’s “Stages of growth”

– Emphasized mobilization of savings
• The Harrod-Domar growth model
– Saving→ increasing stock of capital → growth
of output
• Solow’s model
– Recognizes diminishing returns
– Reaches dramatically different conclusions!
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The Harrod-Domar Model

S  sY (3.1)

I  K (3.2)

Y  K /k Y  K / k (3.3)

SI (3.4)

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The Harrod-Domar Model (2)

S  sY  kY  K  I (3.5)

sY  kY (3.6)

Y s (3.7)

Y k

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The Harrod-Domar Model (2)

S  sY  kY  K  I (3.5)

sY  kY (3.6)

Y s (3.7)

Y k

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Interlude – how good is all this data?

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 The Solow Model

S  sY (3.1) 

I  K  K (3.2) Depreciation*

Y  F (K ) (3.3) With diminishing returns

SI (3.4) 

*Adding this alone to Harrod-Domar 17

just changes s to s-δk in 3.7
The Solow Model (2)

Y Y
K  0  
K K

Diminishing returns implies

increasing “incremental
capital output ratio”

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The Solow Model (3)

Y  K
K  0  
Y K

Eventually capital (and

output) grow to the point
where saving is only
sufficient to pay for
depreciation

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Long-term equilibrium in simplest Solow model

sY

δK

K
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Long-term equilibrium in simplest Solow model

sY

δK

K
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Long-term equilibrium in simplest Solow model

sY

δK

Stationary point K
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Long-term equilibrium in simplest Solow model

sY

δK

Stationary points K
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Long-term equilibrium in simplest Solow model

sY high saving

low saving

δK

Stationary points K
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Harrod-Domar and Solow model
predictions
• Harrod-Domar says growth is proportional to savings
rate …and inversely to capital-output ratio

• Although Solow agrees that (at the same level of income

per head) a country with higher savings will grow
faster…

• Solow also says growth eventually stops despite

savings (unless population or technology changes)

• But eventual income per worker will depend on savings

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 Role of population growth in
Solow model

• Reduces the effect of diminishing returns

to capital
• So boosts long-term growth of output
• But still no long-term growth in per capita
output
• (See figures in Appendix to Chapter 3)

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 Role of population growth in
Solow model (2)
• Focus shifts from output Y and capital K to
output/labour ratio Y/L written y and
capital/labour ratio K/L, written k.
Warning: this is not the same k as in the Harrod-Domar model!

• If population is growing at the rate n, then

k  sy  (n   )k
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 Quantifying the Solow model
Let’s be specific about the function f(y) in y=f(k)

Log-linear function has the kind of shape we want:


y  Ak
Which is the same as
 1
Y  AK L
Also called: “Cobb-Douglas” production function

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Weil (2007). Uses Solow model Cobb-Douglas production function with capital share of 1/3
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Weil (2007). Uses Solow model Cobb-Douglas production function with capital share of 1/3
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Quantifying the Solow model (2)
Solow made the most of this gap:

Her argued that the missing element must be

improvements in technology.

These got called the “Solow residual” – and

represented most of growth for advanced
economies

But where does the technology come from?

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