Models of economic growth

Август 1, 2022

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Models of economic growth

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2. Topics: Roots and Branches Adam Smith and classic evolution The Solow-Swan economic growth
3. references: Barro, R., „Notes on Growth Accounting”, Working Paper, No. 6654, National Bureau of Economic Research,
4. The economic growth is a notion which grids both the governments and the normal people at
5. According to mainstream and to most of the economics textbooks, this has been defined as an
6. One good example in this direction is represented by the emergence of the Internet and the
7. All above-mentioned growths must be comprised in models, because the systematic structuring of reality into models
8. Traces the history of economic growth theory Begins with Adam Smith who started it all Shows
9. The economic growth models were interesting for the economists ever since the classical period (Adam Smith,
10. Roots and Branches The proximate causes of economic growth are the effort to economize, the accumulation
11. The first revolution: Adam Smith Theory of wealth creation, public policy, and economic growth Saving and
12. The first revolution: Adam Smith Saving and investment stimulate growth direct effects through accumulation of capital
13. The first revolution: Adam Smith Smith’s reference to ‘private misconduct’ and the ‘publick extravagance of government’
14. The first revolution: Adam Smith Benefits from division of labour If specialization increases efficiency and wealth
15. The first revolution: Adam Smith Benefits from division of labour The effort to economize ... all
16. The first revolution: Adam Smith Smith on education, efficiency, and growth Distinction between the quantity and
17. The first revolution: Adam Smith - Summing up Economic growth = increase in the quantity and
18. Adam Smith’s followers Distribution of wealth and foreign trade David Ricardo Thomas Malthus Question of population
19. Adam Smith’s followers John Stuart Mill rejected Malthus’s prediction that population would outgrow productive capacity more
20. Adam Smith’s followers Karl Marx Economic mechanisms driving production and distribution are closely related The limits
21. Adam Smith’s followers Alfred Marshall organization as a fourth factor of production made explicit the connection
22. Adam Smith’s followers Joseph Schumpeter technology through invention, innovation, and entrepreneurship rent-seekers motivated by monopoly profits
23. Adam Smith’s followers John Maynard Keynes Accumulation of capital ‘Science and technical inventions’ ‘I draw the
24. Enter mathematics: Harrod and Domar Paul Samuelson’s Foundations of Economic Analysis (1948) laid the basis for
25. Enter mathematics: Harrod and Domar Net investment equals the increase in the capital stock … net
26. Enter mathematics: Harrod and Domar Efficiency is crucial for growth High level of efficiency stimulates growth
27. Enter mathematics: Harrod and Domar Harrod and Domar expressed the dynamic relationship between saving, efficiency, and
28. The Harrod-Domar model Economic growth depends on three factors: A. the saving rate B. the capital/output
29. The Harrod-Domar model Shortcomings: Neither theory nor empirical evidence seemed to provide much support for the
30. The second revolution: The neoclassical model Even so, saving and efficiency play an important role for
31. The second revolution: The neoclassical model … but also with a constant rate of growth of
32. The second revolution: The neoclassical model Growth is exogenous because its two main determinants, population growth
33. The third revolution: Endogenous growth The neoclassical growth model seemed unable to answer some burning questions
34. The third revolution: Endogenous growth Do poor countries grow more rapidly than rich countries? What is
35. The third revolution: Endogenous growth Key idea Technology is probably not exogenous More probably Technology depends
36. The third revolution: Endogenous growth Economic growth free to respond to changes in saving and efficiency,
37. The third revolution: Endogenous growth and development The effort to economize Accumulation of knowledge Accumulation of
38. The third revolution: Endogenous growth - Summary Growth theory and the origins of economics Classical economists:
39. . 2. The Solow-Swan economic growth model One of the most known models of economic growth
40. Questions for review 1. Suppose foreign trade stimulates economic growth as argued by Adam Smith, other
41. Questions for review 3. Explain how more and better education affects (a) the level of per
42. Further, we will briefly present few of the main characteristics of this model, as well as
44. The production function represented by the correlation between the output per inhabitant and the coefficient capital-work
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Topics:
Roots and Branches
Adam Smith and classic evolution
The Solow-Swan economic growth

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references:
Barro, R., „Notes on Growth Accounting”, Working Paper, No. 6654, National

Bureau of Economic Research, Cambridge, 1998
Dornbusch, R., Fischer, S., Startz, R. (2007). Macreconomie, Editura Economică, București
Mokir, J. (2005). Long term economic growth and the history of technology, Handbook of Economic Growth Volume 1B, edited by Phillipe Aghion and Steven N.Durlauf,
Elsevier Romer, P. (2007). Economic Growth, from The Concise Ecyclopedia of Economics by David R. Henderson, Liberty Fund Socol, C. (2009).
Macroeconomie – Volumul I, Editura Economică, București

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The economic growth is a notion which grids
both the governments and

the normal people
at the moment of speech. Why? Because we
are still kept inside the waves of a big storm
which is far from being stopped; in fact we are
facing the threatening of a second wave,
perhaps more dangerous than the first one.
What does this economic growth mean?

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According to mainstream and to most of the economics textbooks, this

has been defined as an increase of the capacity of one economy to produce goods and services, using a comparison between two defined periods. The economic growth might be measured in nominal terms, which include inflation or, in real terms, adjusted with inflation. Often, the economic growth is associated with the innovation part and with the technological changes.

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One good example in this direction is represented by the emergence

of the Internet and the changes underlying the production process which have been brought by this new technology. We shouldn’t understand through the economic growth just the increase capacity of production of one economy, but also an improvement of the life quality of those people which are part of that economy(1). The economic growth can be measured through the percentage changes of various indicators GDP, GNP and GDP per capita.

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All above-mentioned growths must be comprised in models, because the systematic

structuring of reality into models represents a passion – sometime too burning passion – of the modern scientific phenomenon. In this paper we will focus on the validity and viability of these models during crisis times and we will try to define which their grade of applicability is, taking into consideration the mentioned conditions. Also, taking into consideration the fact that the research is in an incipient stage, the main model used here will be the neoclassical model of growth (Solow-Swan).

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Traces the history of economic growth theory
Begins with Adam Smith who

started it all
Shows how Smith’s theory evolved, and culminated in the Harrod-Domar model
Explains why Solow rebelled against classical growth theory …
… and why and how endogenous-growth theory came about

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The economic growth models were interesting for the economists ever since

the classical period (Adam Smith, David Ricardo). Keynesian models, as well as their direct descendants, the Neo-Keynesian models, claim that in order to have a stable economy it is necessary to use macroeconomic politics and the direct intervention of State for reaching the equilibrium and stimulating the economic growth. On the other side there are the models of the Neo-Classics, who are saying that the economy is self-stable and the equilibrium comes naturally.

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Roots and Branches
The proximate causes of economic growth are the effort

to economize, the accumulation of knowledge, and the accumulation of capital.
ARTHUR LEWIS
To change the rate of growth of real output per head you have to change the rate of technical progress.
ROBERT SOLOW

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The first revolution: Adam Smith
Theory of wealth creation, public policy, and

economic growth

Saving and investment are by-products and precursors of domestic and foreign trade

size of the market

division of labour

efficiency

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The first revolution: Adam Smith
Saving and investment stimulate growth
direct effects through accumulation of

capital
indirect effects through labour productivity
further indirect effects through interaction with exchange and trade, through foreign investment
domestic market can take the place of foreign markets

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The first revolution: Adam Smith
Smith’s reference to ‘private misconduct’ and the

‘publick extravagance of government’
Distinction between quantity and quality
Mutual advantages of trade and growth, links to geography

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The first revolution: Adam Smith
Benefits from division of labour
If specialization increases efficiency
and

wealth and, thereby, economic
growth, then ...

... just about anything that increases efficiency by the same amount, other things being equal, should be expected to have the same effect on growth.

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The first revolution: Adam Smith
Benefits from division of labour
The effort to economize
...

all other equivalent means of
increasing the efficiency or quality
of labour, capital, and land should be
expected to affect economic growth in the same way.

So, if foreign trade enlarges the market and thus facilitates further division of labour à la Smith, thereby increasing wealth and growth, then ...

Arthur Lewis

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The first revolution: Adam Smith
Smith on education, efficiency, and growth
Distinction between the

quantity and quality of labour → education, by increasing labour productivity, increases also efficiency and growth
Smith feared the economic, political, and social consequences of inferior education among the masses
He favoured public support for education

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The first revolution: Adam Smith - Summing up
Economic growth = increase in

the quantity and quality of the three main factors of production: labour, capital, and land
Growth accounting is based on this classification
Two shortcomings:
quantity of land
increase in the labour force does not really count as a source of economic growth

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Adam Smith’s followers
Distribution of wealth and foreign trade
David Ricardo
Thomas Malthus
Question of

population

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Adam Smith’s followers
John Stuart Mill
rejected Malthus’s prediction that population would outgrow

productive capacity
more and better education would restrain population growth
distribution a different matter than production but can be changed through policy

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Adam Smith’s followers
Karl Marx
Economic mechanisms driving production and distribution are closely

related
The limits to growth observed by Malthus are inescapable → ‘technological unemployment’

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Adam Smith’s followers
Alfred Marshall
organization as a fourth factor of production
made explicit

the connection between education and growth
distribution of income and wealth matters for efficiency and growth

‘Knowledge is our most powerful engine of production ... Organization aids knowledge’

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Adam Smith’s followers
Joseph Schumpeter
technology through invention, innovation, and entrepreneurship
rent-seekers motivated by

monopoly profits
perfectly competitive markets … may not be very conducive to economic growth
No rent to capture under perfect competition
Static efficiency does not go along with dynamic efficiency, but ...

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Adam Smith’s followers
John Maynard Keynes
Accumulation of capital
‘Science and technical inventions’
‘I draw

the conclusion that, assuming no important wars and no important increase in population, the economic problem may be solved, or be at least within sight of solution, within a hundred years.’

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Enter mathematics: Harrod and Domar
Paul Samuelson’s
Foundations of Economic Analysis (1948)
laid the

basis for mathematical economics, including the modelling of ...
... dynamic interactions among macroeconomic variables

New lines of thought ⇒

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Enter mathematics: Harrod and Domar
Net investment equals the increase in the

capital stock

… net of depreciation due to physical or economic wear and tear

High level of investment entails an increasing level of the capital stock

High levels of saving and investment are good for growth even if they are stationary, that is, not increasing

By continuously augmenting the capital stock ...

… even stationary levels of saving and investment relative to output drive output higher and higher, thus generating economic growth

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Enter mathematics: Harrod and Domar
Efficiency is crucial for growth
High level of

efficiency stimulates growth by ...

… amplifying the effects of a given level of saving and investment on the rate of growth of output

All that is required is a steady accumulation of capital through saving and investment

A given level of efficiency, including the state of technology will, then translate the capital accumulation into economic growth

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Enter mathematics: Harrod and Domar
Harrod and Domar expressed the dynamic relationship

between saving, efficiency, and growth in a simple equation which ...

The Harrod-Domar model →

... neatly formalized, simplified, and summarized the essence of almost 200 years’ theorizing about economic growth

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The Harrod-Domar model
Economic growth depends on three factors:
A. the saving rate
B.

the capital/output ratio
C. the depreciation rate

So, it is essentially all here, from Adam Smith onwards, in a single, simple equation: Growth depends on saving and efficiency, including depreciation

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The Harrod-Domar model
Shortcomings:
Neither theory nor empirical evidence seemed to provide much

support for the capital/output ratio as an exogenous behavioural parameter in the model
a more elaborate formulation of the link between capital and output was called for
The model did not leave much room for the other crucial factor of production, labour
population or labour-force growth is absent from the formula, which explains output growth solely by saving and efficiency

Proved fatal to the Harrod-Domar model, as Solow was to show in 1956, or so it seemed

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The second revolution: The neoclassical model
Even so, saving and efficiency play

an important role for growth over long periods, that is, the medium term

Economic growth was considered immune to economic policy, good or bad

According to Solow, saving behaviour was no longer relevant for long-run growth, nor was efficiency in a broad sense, except insofar as it mattered for technology

Since population growth is basically a demographic phenomenon and, hence, exogenous from an economic point of view, it must follow that economic growth is also exogenous

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The second revolution: The neoclassical model
… but also with a constant rate

of growth of output per capita, a constant rate of interest, and a constant distribution of national income between labour and capital, all of which seemed to apply to the real world

Once attained, the long-run equilibrium is consistent with not only a constant capital/output ratio

… is better viewed as an endogenous variable, which moves over time and ultimately reaches long-run equilibrium

Solow showed how the capital/output ratio, rather than being exogenously fixed as in the Harrod-Domar model,

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The second revolution: The neoclassical model
Growth is exogenous because its two main

determinants, population growth and technological progress, are exogenous

He treated the capital/output ratio as an endogenous variable that adjusts over time to the exogenously given growth rate of output

Solow reversed the roles of the rate of growth and the capital/output ratio

… possible to view growth as an endogenous variable: growth adjusts to the exogenously given capital/output ratio

The capital/output ratio is exogenous

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The third revolution: Endogenous growth
The neoclassical growth model seemed unable to answer

some burning questions about economic growth
Is technological change exogenous from an economic point of view?
Do economists really have nothing to say about economic growth in the long run?
If output per capita grows at a rate that depends solely on - in fact, is equal to - the rate of technological progress, then why is it that the growth performance of different countries differs so radically over long periods?
What does the neoclassical model tell us about relative growth performance anyway?

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The third revolution: Endogenous growth
Do poor countries grow more rapidly than rich

countries?
What is the empirical evidence?

Called for new thinking about economic growth

⇒

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The third revolution: Endogenous growth
Key idea
Technology is probably not exogenous
More probably
Technology

depends on economic factors: the amount of capital available to workers - the capital/labour ratio

The capital/output ratio turns out to be a constant after all

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The third revolution: Endogenous growth
Economic growth free to respond to changes in

saving and efficiency, and depreciation, even in the long run
The Harrod-Domar model has thus been restored
Endogenous technology makes economic growth also endogenous

Throws all windows wide open

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The third revolution: Endogenous growth and development
The effort to economize
Accumulation of knowledge
Accumulation

of capital

Economic growth responds to economic policy

Economic growth obeys the same laws as economic development

Arthur Lewis

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The third revolution: Endogenous growth - Summary
Growth theory and the origins of

economics

Classical economists: viewed economic growth as endogenous

The classical view was neatly summarized in a simple equation by Harrod and Domar

Solow: economic growth depends on technology, and is exogenous in the long run

Economic theorists went back to their drawing boards, and re-endogenized growth

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. 2. The Solow-Swan economic growth model
One of the most known

models of economic growth is the neoclassical model or the Solow-Swan model of growth, as it is known in the specialised macroeconomic literature. This model is an extension of the growth model Harrod-Domar (1946); and the extension is represented by including in the model a new term: increase of productivity. In this new model, the new capital is more valuable than the old capital, because it appears as a result of the improvement of technology during the time.

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Questions for review
1. Suppose foreign trade stimulates economic growth as argued

by Adam Smith, other things being equal. Does it follow that large countries with limited trade with the rest of the world should be expected to grow less rapidly than small countries with extensive foreign trade?
Why not?
2. ‘A high saving rate ensures rapid economic growth.’ Is this statement true or false? Discuss.

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Questions for review
3. Explain how more and better education affects (a)

the level of per capita GNP in the long run and (b) its long-run rate of growth according to
I. the Harrod-Domar model;
II. the Solow model;
III. the endogenous-growth model.
4. Why does increased depreciation of capital reduce economic growth, other things being equal? Does it matter whether the depreciation is physical or economic? - i.e. whether it results from physical wear and tear or from low-quality investment decisions in the past.

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Further, we will briefly present few of the main characteristics of

this model, as well as the function on which this is built, but also changes of the models due to the variable compounds. This model actually shows how the rate of economic growth, the population growth and the technological progress influence the economic growth during a certain period of time. The premises used in this model are:
The economy is perfectly competitive;
There are two production factors which are perfectly substitutable (work L and capital K – in the initial analysis does not appear the technical progress);
The perfect mobility of the production factors;  Complete employment in using the resources (Socol, 2009). In this model, the production function is one of the type Cobb-Douglas, in the following format:

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The production function represented by the correlation between the output per

inhabitant and the coefficient capital-work may be graphically represented as follows

Models of economic growth

Содержание

Topics:Roots and BranchesAdam Smith and classic evolutionThe Solow-Swan economic growth

references:Barro, R., „Notes on Growth Accounting”, Working Paper, No. 6654, National

The economic growth is a notion which gridsboth the governments and

According to mainstream and to most of the economics textbooks, this

One good example in this direction is represented by the emergence

All above-mentioned growths must be comprised in models, because the systematic

Traces the history of economic growth theoryBegins with Adam Smith who

The economic growth models were interesting for the economists ever since

Roots and BranchesThe proximate causes of economic growth are the effort

The first revolution: Adam SmithTheory of wealth creation, public policy, and

The first revolution: Adam SmithSaving and investment stimulate growthdirect effects through accumulation of

The first revolution: Adam SmithSmith’s reference to ‘private misconduct’ and the

The first revolution: Adam SmithBenefits from division of labourIf specialization increases efficiencyand

The first revolution: Adam SmithBenefits from division of labourThe effort to economize...

The first revolution: Adam SmithSmith on education, efficiency, and growthDistinction between the

The first revolution: Adam Smith - Summing upEconomic growth = increase in

Adam Smith’s followersDistribution of wealth and foreign tradeDavid RicardoThomas MalthusQuestion of

Adam Smith’s followersJohn Stuart Millrejected Malthus’s prediction that population would outgrow

Adam Smith’s followersKarl Marx Economic mechanisms driving production and distribution are closely

Adam Smith’s followersAlfred Marshallorganization as a fourth factor of productionmade explicit

Adam Smith’s followersJoseph Schumpeter technology through invention, innovation, and entrepreneurship rent-seekers motivated by

Adam Smith’s followersJohn Maynard KeynesAccumulation of capital‘Science and technical inventions’‘I draw

Enter mathematics: Harrod and DomarPaul Samuelson’s Foundations of Economic Analysis (1948)laid the

Enter mathematics: Harrod and DomarNet investment equals the increase in the

Enter mathematics: Harrod and DomarEfficiency is crucial for growthHigh level of

Enter mathematics: Harrod and DomarHarrod and Domar expressed the dynamic relationship

The Harrod-Domar modelEconomic growth depends on three factors:A. the saving rateB.

The Harrod-Domar model Shortcomings:Neither theory nor empirical evidence seemed to provide much

The second revolution: The neoclassical modelEven so, saving and efficiency play

The second revolution: The neoclassical model… but also with a constant rate

The second revolution: The neoclassical modelGrowth is exogenous because its two main

The third revolution: Endogenous growthThe neoclassical growth model seemed unable to answer

The third revolution: Endogenous growthDo poor countries grow more rapidly than rich

The third revolution: Endogenous growthKey idea Technology is probably not exogenousMore probablyTechnology

The third revolution: Endogenous growthEconomic growth free to respond to changes in

The third revolution: Endogenous growth and developmentThe effort to economizeAccumulation of knowledgeAccumulation

The third revolution: Endogenous growth - SummaryGrowth theory and the origins of

. 2. The Solow-Swan economic growth modelOne of the most known

Questions for review1. Suppose foreign trade stimulates economic growth as argued

Questions for review3. Explain how more and better education affects (a)