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Determinants Of Growth Essay
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Pip Reeve Development Economics Week 1 Do growth models illuminate the determinants of growth and of the levels of GDP per capita in developing countries?
Easterly & Levine claim that 'while the poor are not getting poorer, the rich are getting richer a lot faster than the poor.' There have been many growth models developed, both exogenous and endogenous, in order to attempt to explain this. There are no models that fit with all of the empirical evidence and so alternative theories have been developed in order to explain the determinants of this growth, or lack of. I will begin with a brief discussion of some of the stylised facts of economic growth. This will be followed by a discussion of some of the exogenous and endogenous growth models, and whether or not these models accurately fit this evidence. Finally, I will suggest a number of alternative theories which have been used to illuminate the determinants of growth and the levels of GDP per capita in developing countries. Easterly and Levine suggest some key facts in the discussion of economic growth. Total Factor Productivity, rather than factor accumulation accounts for most of the income and growth differences across nations. Total Factor Productivity is a part of growth accounting and can be defined as follows:
∆Y(t) = MPK∆K(t) + MPL∆P(t) Divide this through by Y(t) and define Ωk(t) = (MPK.K(t))/Y(t) TFP growth is then:
∆Y(t)/Y(t) = Ωk(t)(∆K(t)/K(t) + Ωp(t)(∆P(t)/P(t)) + TFPG (t) This factor accumulation is persistent while growth is not, and the growth path of countries exhibit significant variation. This suggests that something other than factor accumulation is a fundamental determinant of growth. Furthermore, Easterly & Levine suggest that income diverges over the long run and economic activity is highly concentrated, with all of the factors of production flowing to the richest areas. Finally, national policies are closely associated with long run economic growth rates. Many attempts to research convergence, or divergence, are biased towards convergence as rich countries tend to be over represented due to the relative ease of obtaining data for these countries. However, Pritchett (1997) claims that 'the lack of historical data on incomes in the currently poor countries need not blind us to reality.' In terms of exogenous growth theory, the famous Solow model is a prominent example. This model was not originally developed in order to explain cross country convergence. The Solow model has a number of assumptions, these include; constant returns to scale, perfect competition and decreasing returns to capital. In fact, constant returns to scale can only be sustained by perfect competition. Hence, in order to have imperfect competition there must be increasing returns to scale. There is a clear distinction between factor accumulation and the rate of technological progress in this model, and structural change and institutions do not play a fundamental role. The model suggests that, without technological progress, output and employment grow at the same rate in the steady state therefore output per worker stays constant, meaning that there is a zero growth rate of output per capita. Investment in capita cannot drive long run growth in GDP per worker and so technological change is needed in order to avoid diminishing returns to capital. An increase in the savings rate will shift the economy to a new steady state, meaning there is a level effect but not a growth effect. Importantly, the Solow model suggests that if there is no technological progress, economic growth will only be a transitional process. Although the Solow model is useful in explaining some aspects of the empirical facts, it does not plausibly explain observed divergence. The Solow model assumes a constant returns to scale production function: Y=F(K,L)=f(k)L where k=K/L This means that: S=sY=I=ΔK+δK.
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