Harrod-Domar+Growth+Model

= =



= Harod-Domar Growth Model =

Rationale
The model suggests that the economic rate of growth depends on the level of savings, and the productivity of investment (i.e. in order to grow, economies must save and invest a certain portion of their GDP).



- Shows that growth of an economy directly (positively) related to saving rate (σ) – the more the economy is able to save out of a given GDP, the greater will there be growth of that GDP. - Growth of an economy is indirectly (negatively) related to the capital-output ratio (λ) – the higher the λ, the lower the rate of GDP flow = ∆Y/Y = σ/ λ= (**∆Y/Y** =growth, **σ**= national saving ratio usually expressed as a percentage, **λ** = national capital-output ration expressed as an integer)

o Greater savings mean higher growth rate because higher saving permits more investment in physical capital; saving rate σ = S/Y (proportion of income saved)





o Capital-output ratio λ shows how much capital is needed to produce a dollar’s worth of output.

§ Usually at 3 in developing countries – to produce 1 dollar worth output, 3 dollars worth of capital are needed. If λ decreases, it means we need less capital to produce the same output, thus is growth. § More physical capital generates economic growth: LDCs have an abundant supply of labor but lacks of physical capital thus holding back its economic growth and development.

o Net investment leads to more capital = generates higher output and income, higher income thus leads to higher levels of saving.

Limitations of the Model
- Economic growth and development is not the same. Economic growth is necessary but not sufficient for economic development. - It is difficult to stimulate the level of domestic savings in LDC where income is low - Domestic savings are insufficient so a financing gap arises - Labor is not a consideration of economic growth - Foreign aid may cause debt repayments problems later



- Foreign aid is not necessary channeled to the investment with the highest social rate of return. - Law of diminishing returns: as investment increases, productivity diminishes - Model only promises LDC growth in the short run through aid and investment – ignores other structural, institutional, and attitudinal preconditions for economic growth -, but has proven ineffective.

Application to Economic Development


-Example of the use of formula: Assume that a LDC’s national capital-output ratio is 3, and that aggregate saving ration is 6% of GDP, then the growth rate of the LDC is 2% per year: ∆Y/Y = 6%/ 3, ∆Y/Y = 2% o If the national saving increase from 6% to 15%, then GDP can increase from 2% to 5%: ∆Y/Y = 15%/ 3, ∆Y/Y = 5% - The main obstacle for development in most LDCs is the low level of new capital formation or investment, this gap (difference between required investment and saving) is referred to the ‘savings gap’ which is later referred to the ‘Financing gap’ which can be filled by foreign aid or private foreign direct investment. - This model did not work in the 1960s up to the 1990s but is still used to quantify aid to the LDCs. - Model was developed in the 1930s to analyze business cycles but is later used to explain economic growth. - Model is also applied to calculate short-run investment requirements for a target growth rate by calculating the ‘Financing Gap’ between the required investment and available resources. This gap is filled with foreign aid. o Downturn of this is that countries that saved less would receive more aid.

Real-life Example:


- The equation is the base of many models used to analyze economic growths in organization such as the World Bank and the International Monetary Fund (IMF) - EXAMPLE 1: Ecuador – over 50% of the population is below the poverty line – lesser than $2 per day, poorest country in Latin American with a debt of over $14 billion. o Harrod- Domar model was put forth in 1948 – assistant from the US government programs. o Aggressive borrowing began in 1976 after business elites replace the reformist in the military government of Ecuador (became more responsive to demand) however this led to the debt crisis in the 1980s, which to this day the country has not recuperated -EXAMPLE 2: Fiver year Plans in India (1951-6) - based on the Harrod Domar Model o Community Develop programs were launched in 1952. o There were 2 objectives: one to correct the disequilibrium in the economy (due to inflow of refugees, severe food shortage, inflation), and two to initiate a round balanced development that can ensure a rising national income and steady improvement in living standards. o Government emphasized Agriculture, Price Stability, Power and Transport o WAS A SUCCESS (but this is because good harvests in the last 2 years allowing more saving and stable prices).



Links for interested personnels: - [|Question&Answers for curious children] - [|Complete study on Ecuador] - [|DOC: long but simple explanation of the model] - [|Other Five Year Plans in India] -[|Compilation of Videos-Photos of the Harrod Domar Theory]

Citations:
 * =====Wikipedia contributors. "Harrod–Domar model." Wikipedia, The Free Encyclopedia. Wikipedia, The Free Encyclopedia, 22 Dec. 2010. Web. 3 Feb. 2011. =====
 * =====Westerberg, Lotta. "Foreign Aid and Economic Growth in Ecuador: A Test of the Harrod-Domar/Financing Gap Growth Model." Scribd (2010): 1-5. Web. 28 Jan 2011. . =====
 * =====Houston, Rodent. "HARROD-DOMAR MODEL."Economics4Development. © Economics for Devlopment, n.d. Web. 28Jan 2011. . =====
 * ====="Harrod Domar Growth Model Notes." (2006): 1-6. Web. 28 Jan 2011. . =====
 * ====="Five Year Plans in India ." Economy Planning in India .. N.p., n.d. Web. 2 Feb 2011.  =====
 * =====R F Harrod, Towards a Dynamic Economics (London, 1948); E Domar, Essays in the Theory of Economic Growth (New York, 1957) =====

=** Marina. S. ** =