Models of Economic Growth: Harrod-Domar, Solow, Robinson, Kaldor | UGC NET – Notes

Theories of economic growth attempt to explain the long-run behaviour of output, capital, and employment in an economy, and to identify the conditions required for steady, sustained expansion of national income over time. The major growth models include the Harrod-Domar model, the Solow neo-classical growth model, Joan Robinson’s model of capital accumulation, and Nicholas Kaldor’s model of growth and technical progress. These models differ chiefly in their assumptions regarding the production function, particularly whether the capital-output ratio is fixed or variable, and in their treatment of factor substitutability, technical progress, and income distribution.

Harrod-Domar Growth Model

Background

• This model of growth was developed by two different economists, each working independently of the other, but almost con-currently. These two economists were R.F. Harrod and E.D. Domar. Harrod, of course, published his theory earlier than Domar. Harrod’s book Towards a Dynamic Economics was published in 1948, while Domar’s book Essays in the Theory of Economic Growth was published in New York in 1957. Harrod Model and Domar Model may differ in details, but the ideas contained in both of the models are so similar that the two models have got integrated and more generally are presented as a single united model, known as the Harrod-Domar Model (HDM).

• HDM integrated the classical and Keynesian analysis of economic growth. In the HDM, capital accumulation plays a crucial role in the process of economic growth. Both the classical economists and the Keynesians had recognised the critical role of capital accumulation in the process of economic growth.

• The classical economists considered only the capacity of the capital accumulation, and, believing that supply created its own demand, did not pay attention to the demand side. Keynesians, on the other hand, erred in the opposite direction. Concerned primarily with the short-period, they considered only the adequacy of demand and neglected the problem of increase in capacity through investment in the long run. HDM considered both the sides of the investment process.

Essence of the Model:

• Starting from a full employment equilibrium level of income, the HDM postulated that continuous maintenance of this equilibrium required that the volume of spending generated by investment must be sufficient to absorb the increased output resulting from investment. Given the marginal propensity to save, the more the capital is accumulated and the larger the initial national income. The larger must be the absolute volume of net investment, maintenance of full employment, therefore, required an ever-expanding amount of net investment. This, in turn, required a continuous growth in real national income. Capital accumulation and growth of income must go side by side.

• An increase in capital expands the productive capacity of the economy. If it is not accompanied by an increase in income, any of the following things may happen:

  • The new capital may remain untitled.

  • The new capital may replace old capital depriving the latter of its labour and/or markets.

  • The new capital may be substituted for labour (and possibly other factors).

• Thus, increase in capital unaccompanied by an increase in income would result into unemployment of capital and/or labour. Excessive capital accumulation may result into overproduction and consequently into a fall in investment leading to depression.

Assumption of the Model:

The HDM is based on the following assumptions:

1. An initial full-employment level of income exists.
2. There is no government interference in the functioning of the economy.
3. The exogenous factors do not influence the growth variables, i.e., it is a closed economy model.
4. There are no lags in adjustment, i.e., the economic variables like savings, investment, income, expenditure adjust themselves in the same period. Any change in saving brings about the corresponding change in investment in the same period.
5. The average propensity to save \((S/Y)\) and marginal propensity to save \((\Delta S/\Delta Y)\) are equal to each other, i.e., the absolute change in saving is equal to the relative change in saving.
6. Propensity to save and capital coefficient (capital-output ratio) are constant. The law of constant returns operated because of the fixity of capital-output ratio.
7. Income, investment and savings are all defined in the net sense. It implies that these variables exclude depreciation.
8. Saving and investment are equal in ex-ante and ex-post sense, i.e., accounting and functional equality between saving and investment. The equality can be expressed as:

$$S_0 = I_0$$

Accounting equality

$$S_e = I_e$$

Functional equality

• \(S_0\) and \(I_0\) are observed saving and investment. \(S_e\) and \(I_e\) are expected saving and investment.

• All these assumptions are not necessary for the final solution of the problem; nevertheless, they serve the purpose of simplifying the analysis.