21
CHAPTER OUTLINE
I. The authors provide the building blocks common to modern theories of
growth: the production function (technology), saving and investment behavior,
the relationship between existing stock of capital and new investment, and
labor force growth.
II. The chapter presents two models of growth that have informed much of the
empirical work and policy analysis on developing economies. They are the
Harrod- Domar growth model, which is short- term in orientation and Keynes-
ian in spirit, and the Solow growth model, which is long– term in orientation
and neoclassical in spirit. The basic Harrod- Domar growth model suggests
that the steady– state rate of growth is determined by the saving rate, the xed
incremental capital- output ratio (ICOR), and the rate of depreciation of xed
capital. Full employment is assured if this growth rate is equal to the rate of
growth of the labor force. The chapter provides an evaluation of the model in
terms of the realism of its (highly restrictive) assumptions and its widespread
use by development institutions in formulating policy advice.
III. The basic Solow model suggests that the steady- state rate of growth is deter-
mined by the saving rate, the exible ICOR, and the rate of depreciation of
xed capital. Furthermore, factor substitution ensures that steady– state output,
net capital, and the labor force grow at the same rate. This implies that all per
capita variables (per capita income, per capita capital stock, etc.) remain
unchanged in the long run following any changes in such pa ram e ters as the
saving rate or the population growth rate. The basic model is extended to
accommodate exogenously given, labor- augmenting technological change,
which ensures that total output will grow at the rate of labor force growth plus
technological progress.
Theories of Economic Growth
CHAPTER 4
22 | Chapter 4
IV. This chapter concludes with a discussion of the convergence theory, for–
merly in Chapter 3 in the sixth edition. Advancing on earlier ideas of absolute
convergence— popular over a generation ago— it presents the evidence that
suggests the existence of conditional convergence. According to this argument,
countries that share certain characteristics are able to achieve rapid growth
and begin to catch up with the richer countries.
V. The chapter continues with a brief discussion of recent research that attempts
to explain technological progress within the model (endogenize it) rather than
taking it as determined outside the model. Endogenous growth models seek
tounderstand how the interplay between technological knowledge (produced
by such efforts as investment in human capital, R&D, and the diffusion of
ideas to latecomers) and a country’s institutions affect the prospects for sus-
tained economic growth.
Boxed Examples
Box 4–1: Economic Growth in Thailand
Box 4– 2: Population Growth and Economic Growth
Box 4– 3: Explaining Differences in Growth Rates
There are three boxed examples. The rst explains the factors that account for
Thailand’s growth boom and the accompanying structural transformation. The
second deepens the relationship between population growth and economic growth.
The third analyzes the determinants of differences in growth rates among Africa,
Asia, and Latin America.
In the New Edition
The seventh edition has streamlined and consolidated the information presented
in the sixth edition. This edition integrates into its pre sen ta tion of growth theory
the discussions of production functions and growth convergence previously found
in Chapter 3. The previous discussion of dual– sector growth models has been
eliminated from the discussion of growth theory and relocated to Chapter 16,
where its primary purpose is to illustrate sectoral interactions as a foundation for
discussing the role of agriculture in development. Chapter 4 also provides newly
updated data and illustrative gures.
Class Notes
This is one of the foundational chapters on the theories of economic development.
To motivate students in dealing with more abstract material, it would be useful to
do the following:
1. brie y discuss economic models, including the role of assumptions, behavioral
3. review the well- known problems of data quality and adjustment and explain
how to read regression lines and logarithmic scales.
The Harrod- Domar and Solow models provide much of the subsequent discus-
sions on the supply side of the economy, including structural change, human
resources, capital resources, aid, trade, technological change, and development
policy. The economic intuition of students can be sharpened by varying the assump–
tions and showing how a model’s conclusions are modi ed. This can be done
graphically by changing the con guration of curves and pa ram e ters or by looking
at different classes of countries. The models are tools for more informed and dis-
ciplined policy analysis, even though policy decisions ultimately are a matter of
informed judgment. The convergence discussion— now in this chapter— should
also be reviewed in class. This can provide for lively and provocative opinions
about convergence arguments, depending upon students’ prior knowledge of
po liti cal and economic trends in today’s world.
A useful review is to make a table with the following rows: assumptions, contri-
butions, policy implications, and limitations. In the columns, place Harrod- Domar,
Solow, and new growth models. Ask the students to ll out this table, either in
class or as an assignment.
QUESTION BANK
Concept Map
24 | Chapter 4
Multiple- Choice Questions
1. The father of modern growth theory is:
a. David Ricardo.
b. Thomas Malthus.
c. Robert Solow.
d. Jeffrey Sachs.
2. Growth depends on which two pro cesses?
a. accumulation of assets and making those assets more productive
b. harnessing natural resources and marketing them to developed nations at
a “fair trade” rate
c. exploitation of the agricultural sector in order to advance
industrialization
d. engaging in free trade while subsidizing domestic agricultural and
industrial production
3. Every model of economic growth embodies:
a. risk theory.
b. aggregate production functions.
c. an isoquant map.
d. the basic theories of growth espoused by Adam Smith.
4. The capital- output ratio provides an indication of the:
a. limits of growth.
b. capital intensity of the production pro cess.
c. a country’s production function.
d. the health and educational level of the population.
5. Because of population growth, Ghana’s GNP must grow by 1.5 percent per
year just to avoid a decline in average standards of living. With an ICOR of
6.0, achieving this minimum- growth target requires a saving rate of:
a. 18 percent.
b. 3 percent.
c. 50 percent.
d. 9 percent.
6. Suppose the saving rate for a low- income country is given. If production
becomes less capital intensive, the ICOR will ________ and the growth rate
will _________.
a. increase; increase
b. decrease; increase
c. decrease; decrease
d. increase; decrease
7. Consider the Harrod- Domar relationship for an economy:
g = (s/v) − d
Assume that the depreciation rate is 0. If the saving rate is 24 percent, the
ICOR is 3, and the depreciation rate is 5 percent, the economy can be expected
to grow:
a. 8 percent.
b. 19 percent.
c. 3 percent.
d. 2 percent.
8. Consider the Harrod- Domar relationship for an economy:
g = (s/v) − d
Assume that the depreciation rate is 0. A country can only save 15 percent
but wants to grow 15 percent. Assuming the ICOR is 3, the gap of ________
should be provided by foreign aid.
a. 10 percent
b. 0 percent
c. 5 percent
d. We cannot say without more information.
9. If the investment rate in Indonesia is 29 percent of GDP, which of the follow–
ing combinations is consistent with the Harrod- Domar growth model?
a. ICOR = 15.4; GDP growth rate = 7.6 percent per annum
b. ICOR = 2.86; GDP growth rate = 5.1 percent per annum
c. ICOR = 50.6; GDP growth rate = 2.2 percent per annum
d. ICOR = 1 percent; GDP growth rate = 22 percent per annum
10. According to the Harrod- Domar model, what effect does an increase in the
saving rate have on long- term growth?
a. leads to an increase
b. leads to a decrease
c. the advent of hyperin ation
d. dif cult to determine because of the unknown level of corruption in
government
11. One of the problems of the Harrod- Domar framework is that its xed–
proportion production function does not allow for any:
a. population growth.
b. substitution between labor and capital.
c. endogenous technical change.
d. depreciation.
12. From 1999– 2007, Thailand’s economy experienced an annual growth rate of:
a. 2.1 percent.
b. 3.9 percent.
c. 4.7 percent.
d. 7.5 percent.
13. Unlike isoquants for a xed– coef cient production function, the isoquants
for a neoclassical production function:
a. take labor as well as capital into account.
b. are L-shaped.
c. are capital- intensive rather than labor– intensive.
d. are curved.
14. According to the Solow model, the relationship between saving and growth
is not linear because of:
a. coordination failures between the banking sector and industry.
b. business cycles that naturally occur in all economies.
c. diminishing returns to capital in the production function.
d. uctuations in macroeconomic policy.
15. When an economy increases the amount of capital per worker, it is called:
a. capital widening.
b. capital deepening.
c. labor widening.
d. labor deepening.
16. In the Solow model, an increase in the population growth rate leads to:
a. capital deepening.
b. dynamic economic growth and development.
c. the ful llment of the Malthusian hypothesis.
d. lower average income per worker.
17. The most unsettling conclusion of the Solow model is the conclusion that
once the economy reaches its long– run potential level of income, economic
growth simply:
a. declines, leading to what is referred to as a “failed state.”
b. matches population growth, with no chance for sustained increases in
average income.
c. causes a rapid in ation, leading to an erosion of gains made during the
growth period.
d. subsides, as socialism becomes an acceptable form of po liti cal economy
for the people.
18. While there is no evidence of absolute convergence, there is strong evidence
today of conditional convergence in which:
a. countries sharing certain characteristics are able to achieve rapid growth
and begin to catch up with the richer countries.
b. by entering into the World Trade Or ga ni za tion, a nation implicitly and
explicitly agrees to integrate into the global economy.
c. countries all agree to play by “the rules of the game.”
d. countries considered at the most advanced stage of capitalism begin to
decline, while developing nations accelerate past them.
19. Which of the following statements is true about new growth theories and the
Solow and Harrod- Domar models?
a. Both underline the importance of factor accumulation and productivity
in the growth pro cess.
b. Both treat technology as endogenous.
c. Both take externalities into account.
d. Both assume increasing returns to scale.
IDs and Paired- Concept Questions
These terms can be used individually as short- answer identi cation questions, or
they can be used in pairs. In the latter case, ask students to explain (1) the meaning
and signi cance of each of the two terms and (2) the relationship between them.
2. Savings, investment
Theories of Economic Growth | 29
4. Harrod- Domar equation, L-shaped isoquants
6. Labor force growth, depreciation
8. Level effect, growth effect
10. Human capital, effective units of labor
12. Unconditional convergence, conditional convergence