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1. CHAPTER SIX GROWTH MODEL Prepared by: Dagim F. Department of economics, mizan-tepi university

2. 6.1. Meaning of Economic Growth The meaning of economic growth is unambiguous. Almost all economists would accept the increase in the output of goods and services of a country per unit time as its definition. Output is measured by the gross national product (GNP) or gross domestic product (GDP). Growth in GNP/GDP can be calculated either at market price or factor cost. In order to measure the effect of growth on the standard of living of the population, the GNP/GDP per capital is taken, which is also known as per capital income. 12/17/2022 [email protected] 2

3. Cont… Per capital income can be measured in terms of home currency and for international comparisons in terms of US dollar. However, the US dollar has different purchasing power in the market of different countries especially for non-traded goods. The problem associated with the use of official exchange rate in converting GNP of a country measured in home currency to US dollar is discussed in the third section of this chapter. 12/17/2022 [email protected] 3

4. Cont… Development , however, is defined as the capacity of the economy to generate and sustain fast growth rate of GDP (per capital income). Others tried to explain development in terms of the process of structural transformation of the economy. In this regard, development is the planned alteration of the structure of production and employment so that agriculture’s share of both declines and that of the manufacturing and service industries increases. 12/17/2022 [email protected] 4

5. Cont… Todaro, an economist, define development as “conceived as a multi-dimensional process involving major changes in social structures, popular attitudes, and national institutions, as well as the acceleration of economic growth, the reduction of inequality (and unemployment), and the eradication of absolute poverty”. Therefore, development is hardly possible without growth, but growth is possible without development. 12/17/2022 [email protected] 5

6. Cont… A country may produce more of some types of its goods and services. However , the benefits of this growth may exclusively be appropriated by a privileged elite and small middle class. In this case the vast majority of the country’s people may be completely unaffected or worsened. For instance, the growth attained in the past in countries such as South Africa, Brazil, and the oil rich countries was largely without development. 12/17/2022 [email protected] 6

7. Cont… However, growth without development is not sustainable. In the oil rich countries, for example, their economies grow when price of oil increases. Nevertheless , this growth is not sustainable, as prices cannot be increased indefinitely. Development , on the other hand, is sustainable because it is a change in the structural and institutional factors, social attitudes and customs accompanied with a secular rise in real income through a change in output and occupational structure and improvement in the relative contribution of inputs 12/17/2022 [email protected] 7

8. 6.2. Economic Growth theories 6.2.1 The Harrod-Domar (H-D) Growth Model The growth model that was particularly popular with economic planners just after World War II came to be known as the Harrod-Domar model, since it was based on independently published articles by Roy Harrod and Evsey Domar. The fact that the two authors independently produced identical models was not surprising . This is because their models were simple extensions of John Maynard Keynes’s well-known macroeconomic model, which dominated economic thinking in the 1940s. 12/17/2022 [email protected] 8

9. Cont… The Harrod-Domar model makes similar assumptions to the Keynesian macroeconomic model. These include: Since there is unlimited amount of unemployed labour, output can be increased without triggering price increases. As there is abundant labour to keep the capital-labour ratio constant, this leads also to the assumption of constant marginal product of capital (capital output ratio). With constant capital-output ratio, therefore, output growth is directly proportional to new investment in new capital. Moreover , this model assumes that productive investment is always equal to saving. 12/17/2022 [email protected] 9

10. Cont… A. Harrod's Growth Model As mentioned above, Harrods original model is a dynamic extension of keynes' static equilibrium analysis. In this regard, there are three questions that Harrod raised and tried to answer. In keyens' General Theory, the condition for income and output to be in equilibrium (in a closed economy) is that plans to invest equals plans to save. Hence, Harrod asked 3 questions: Firstly, if changes in income encourage investment, what must be the rate of growth of income for plans to invest to equal plans to save in order to ensure a moving equilibrium in a growing economy through time? 12/17/2022 [email protected] 10

11. Cont… Secondly , in static Keynesian theory, if equilibrium between saving and investment is disturbed, the economy corrects itself and a new equilibrium is achieved via the multiplier process. Then the second question is if growth equilibrium is disturbed, will it be self-correcting or self-aggravating? Lastly, will this equilibrium rate be equal to the maximum rate of growth that the economy is able to sustain given the rate of growth of productive capacity? If not what will happen? 12/17/2022 [email protected] 11

12. Cont… To explain this condition, Harrod distinguished three different growth rates. These are: Actual growth rate (g ) Warranted growth rate (gw) and Natural growth rate (gn) 12/17/2022 [email protected] 12

13. Cont… The actual growth: The actual growth rate is defined as: g = s/c- -------------------------------------------------Eq.6.l Where : s = the ratio of saving to incomes (S/Y) c = the actual incremental capital output ratio, that is the ratio of extra capital accumulation or investment to the growth of output (∆K/∆Y=I/∆Y ) The expression for the actual growth is definitionally true since it expresses the accounting identity that saving equals investment. 12/17/2022 [email protected] 13

14. Cont… This can be shown as g = s/c = (S/Y)/ ( I/∆Y) = (S/Y) (∆Y/I ) = ∆Y/Y , given S=I, the change over the level (∆Y/Y ) represents the rate of growth of output. We need more than a definitional equation, however, to know whether the actual growth rate will provide the basis for steady advances in the future. This means that it keeps plans to invest and plans to save in line with one another at full employment. This is where the warranted rate & natural rate of growth become important. 12/17/2022 [email protected] 14

15. Cont… Warranted rate of growth: Warranted rate is that rate of growth which, if it occurs, will leave all parties satisfied. At this rate producers have produced neither more nor less than the right amount. To state matters otherwise, warranted rate of growth will put all parties into a frame of mind which will cause them to give such orders as will maintain the same rate of growth. 12/17/2022 [email protected] 15

16. Cont… In other words, it is the rate that induces just enough investment to match planned saving and therefore keeps capital fully employed so that manufacturers are willing to carry on investment in the future at the same rate as in the past. It is determined as: Plans to save at any time are given by the Keynesian saving function as S =sY ----------------------------------------------Eq.6.2 12/17/2022 [email protected] 16

17. Cont… The demand for investment is given by the acceleration principle . This is where cr is the accelerator coefficient measured as the required amount of extra capital or investment to produce a unit flow of output at a given rate of interest, determined by technological condition. Thus Cr = ∆Kr/∆Y = I/∆Y I = Cr∆Y ------------------------------------------------- Eq.6.3 For planned savings to equal planned investment therefore, we have sY = Cr∆Y ------------------------------------------------- Eq.6.4 12/17/2022 [email protected] 17

18. Cont… And the required rate of growth for a moving equilibrium through time is ∆Y/Y= s/cr = gw---------------------------------------------Eq.6.5 This is the warranted rate of growths (gw). For dynamic equilibrium, output must grow at this rate. The condition for equilibrium is that g=gw From Eq.5 and Eq.l, this means gc = gwcr, i.e., (g/gw = cr/c) Suppose there is disequilibrium such that actual growth rate exceeds the warranted rate. 12/17/2022 [email protected] 18

19. Cont… It is easily seen that if g>gw then c<cr, which means that actual investment falls below the level required to meet the increase in output. There will be a shortage of equipment, a depletion of stocks and an incentive to invest more. The actual growth rate will then depart even further from the warranted rate. Conversely , if the actual growth rate is less than the warranted growth rate (g<gw) then c>cr. In this case, there will be a surplus of goods and investment will be discouraged, causing the actual growth rate to fall even further below the equilibrium rate. 12/17/2022 [email protected] 19

20. Cont… Thus, as Harrod points out, in the dynamic field we have a condition opposite to that in static field. A departure from equilibrium instead of being self-righting will be self-aggravating. This is the short-term trade cycle problem in Harrod's growth model . But even if growth proceeds at the rate required for full utilization of the capital stock and a moving equilibrium through time, this still does not guarantee the full employment of labour, which depends on the natural rate of growth. 12/17/2022 [email protected] 20

21. Cont… The natural growth rate The natural growth rate is derived from the identity : Y = L (Y/L ) Where L = Labour and Y/L = Productivity of labor; or taking the rate of growth (Y = 1 + q) The natural rate of growth is therefore made up of two components: the growth of labor force (l), and the growth of labour productivity (q) both exogenously determined. 12/17/2022 [email protected] 21

22. Cont… The natural rate of growth plays two roles in Harrods model. It defines the rate of growth of productive capacity or the long run full employment equilibrium growth rate. It sets the upper limit to the actual growth rate. If g>gw, g can only continue to diverge from gw until it hits gn. When all available labor has been fully absorbed, g cannot be greater than gn in the long-run. The long-run question for an economy then is the relationship between gw and gn. With fixed coefficient of production, the full employment of labor requires g= gn, and the full emp1oyment of labor and capital requires g = gw = gn . . This is a state of affairs, which Jean Robinson called it the golden age 12/17/2022 [email protected] 22

23. Long-Run Disequilibrium If gw >gn, there will be a tendency towards chronic depression . This is because the actual rate of growth will never be sufficient to stimulate investment demand to match the amount of saving at full employment equilibrium. There is too much capital and too much saving . This was the problem during the 1930's. Here the economy is in a state of stagnation . Savings are not fully utilized and the economy suffers from over accumulation of capital. 12/17/2022 [email protected] 23

24. Cont… This will produce excess capacity, rising inventories and unemployment . Here Harrod suggest reduction of savings, which also reduce gw. On the other hand, if gw < gn, there will be a tendency towards demand inflation because there will be a tendency for the actual rate of growth to exceed that necessary to induce investment to match saving. 12/17/2022 [email protected] 24

25. Relevance of the Model to Developing Countries In most developing countries, the natural growth rate exceeds the warranted rate . If the population growth is say 2% and labor productivity is growing at 3%, this gives a rate of growth of the labor force in efficiency units of 5%. If the net savings ratio is, say 9% and the required incremental capital-output ratio is 3, this gives a warranted growth rate of 3%. 12/17/2022 [email protected] 25

26. Cont… This has two main consequences. It means that the effective labor force is growing faster than capital accumulation, which is part of the explanation for growing unemployment in LDCs It implies greater plans to invest than plans to save, and therefore resulting inflationary pressure. If gn= 5% and cr =3, there will be profitable investment for 15% saving whereas actual saving is only 9%. 12/17/2022 [email protected] 26

27. Cont… Given the inequality gn≠gw or (l+q) ≠ (s/cr), Harrod suggested four ways in which gn and gw might be reconciled. If the problem is gn>gw: Reduce the rate of growth of the labour force. Measures to control population size can be justified on the grounds, as a contribution to solving the problem of unemployment. A reduction in the rate of growth of labour productivity would help, but this would of course reduce the growth of living standards of those in work. A rise in the saving ratio could narrow the gap. This is at the heart of monetary & fiscal policies in UDCs. Reducing the capital-output ratio through the use of more labour intensive techniques. 12/17/2022 [email protected] 27

28. B. Domar’s Model The American economist Evsey Domar, working independently of Harrod, also arrived at Harrod's central conclusion, although by a slightly different route. A basic principle emphasized by Domar and incorporated in all modern growth theory is the dual effect of net investment . In other words Domar recognized that investment is a double-edged sword: net investment constitutes a demand for output, and it also increases the capacity of the economy to produce output. 12/17/2022 [email protected] 28

29. Cont… If the expanded capacity is to be fully utilized, aggregate demand in the next period will have to exceed that of this period . Thus , in general, as long as there is net investment in one period after another, aggregate demand must rise period after period if expanding productive capacity resulting from net investment is to be fully utilized. Hence, the question that Domar asked is what rate of growth of investment must prevail in order for supply to grow in line with demand (at full employment)? In the words of Domar , if investment increases both productive capacity and generates income, it provides us with both sides of the equation, the solution of which may give the required rate of growth. 12/17/2022 [email protected] 29

30. Increase in Capacity Output The basic theory involves a simple production function that relates the generation of total output to the stock of capital via the capital-output ratio. Taking the technique of production as given, some specified amount of capital goods is necessary to produce a given amount of output. If we let ‘ K’ represent the capital stock and Y the level of output, we may define the average capital output ratio as K/Y. In contrast, the marginal capital output ratio ∆K/∆Y tells us how much additional capital is necessary to produce a specified addition to that flow of output. To simplify the analysis, we assume that the constant ∆K/∆Y equals K/Y so that K/Y is also constant (because technology is constant). 12/17/2022 [email protected] 30

31. Cont… The reciprocal of the average capital-output ratio, Y/K , represents the average productivity of capital. Given an increase in the capital stock , ∆K , ∆Y/∆K indicates the ratio of the increase in output to the increase in capital stock. In the simple model Y/K=∆Y/∆K . This ratio of output to capital stock is designed by  (sigma), which Domar calls the “ potential social average productivity.” Since ∆K in any period equals that period’s net investment, I, ∆Y/∆K =  may also be expressed as ∆Y/I =  or ∆Y = I . 12/17/2022 [email protected] 31

32. Cont… From this it follows that the cumulative net investment of any period increases capacity output by  I . This is the most important relationship in the model . It must be noted that ∆Y is not necessarily the actual, or realized, increase in output but rather the potential increase possible with full utilization of the expanded productive capacity . Since the actual increase need not necessarily equal the potential, let us now distinguish the actual, or realized, increase from the potential by appending subscripts: ∆Yr and ∆Yp . 12/17/2022 [email protected] 32

33. Increase in Aggregate Demand In a two-sector economy, aggregate demand equals the sum of consumption and investment expenditures. With a stable consumption function, consumption expenditures will rise only as a result of a rise in income and therefore a rise in investment expenditure is necessary to initiate a rise in income. Consequently , we may determine the total rise in expenditures, or income that will result from any given rise in investment by using the simple multiplier expression: ∆Y = (1/s) X (∆I ), where s is marginal propensity to save (MPS) This rise in income, or expenditure, is matched by an equal rise in actual output, since, with a stable price level, output responds in proportion to the rise in demand. With subscript ‘r’ designating realized or actual, we have ∆Yr =∆I/s 12/17/2022 [email protected] 33

34. The Equilibrium Rate of Growth There is some rate of growth at which the increase in actual output in each period, ∆Yr , will just equal that period’s increase in capacity output, ∆Yp . This rate at which ∆Yr=∆Yp is called the Equilibrium Rate of Growth. To determine equilibrium in a growing economy, Domar starts with the assumption that the economy is at full employment equilibrium. From an original period in which there is equilibrium as given by Yr = Yp, it follows that if the rate ∆Yr/Yr remains equal to the rate ∆Yp/Yp period after period, Yr will remain equal to Yp period after period. In such situation, aggregate realized output grows as fast as aggregate potential output, thereby producing a path of equilibrium growth over time. 12/17/2022 [email protected] 34

35. Cont… Since ∆Yr = ∆I/s and ∆Yp = I , the equilibrium rate is also that at which ∆I/s = I . The left side shows the increment to aggregate realized output for the period, since this is equal to the increment of aggregate demand, it may be called the demand side. The right side shows the increment to productive capacity for the period and as such may be called the supply side. On the right side of the equation, we find not the change in net investment for the period but the total net investment for the period. The reason of course is that total net investment for the period times the average productivity of capital determines the change in productive capacity. 12/17/2022 [email protected] 35

36. Cont… Thus Domar's fundamental equation is ∆I/s = I multiplied by s yields ∆I = sI then, dividing by I gives ∆ I /I = s The left side of the equation now gives the required rate of growth of net investment. If actual output is to rise as fast as potential output, the growth rate of net investment must be s, or the propensity to save multiplied by the productivity of capital . Although ∆I is subject to a multiplier that makes ∆Y greater than ∆I , we can see that the growth rate of actual output, ∆Yr/Yr must be the same as the growth rate of investment, ∆I/I . 12/17/2022 [email protected] 36

37. Cont… Since in equilibrium ∆Yr = ∆Yp and since ∆Yp = I , it follows that ∆Yr = I . Furthermore , since I = sY in equilibrium, then by substitution Y = sY and ∆Y/Y = s. Therefore ∆I /I = ∆Y/Y = s The rate at which actual output and investment must grow in order that actual output remains equal to potential output is determined by the propensity to save and the productivity of capital. If  = 1/cr (at full employment), then the Domar result for equilibrium will be ∆I/I = s/cr which is the same as Harrod's result for equilibrium growth 12/17/2022 [email protected] 37

38. Similarities and differences between Harrod and Domar Models Similarities Both models have studied the requirement of steady growth with reference to developed countries Assumptions of both models are similar Investment or capital accumulation has a central place in both models in the problem of economic growth According to both approaches given the capital output ratio so long as APS = MPS the equality of saving and investment satisfies the conditions of equilibrium rate of growth The Harrod model suggests that for an economy to be constantly at equilibrium, it should grow at gw. In Domar’s model full employment rate of growth is s . Harrods gw is similar to Domar's s and Domar's  is the reciprocal of Harrods cr 12/17/2022 [email protected] 38

39. Cont… Differences Harrod uses incremental capital output ratio and the accelerator to build up his model. But Domar relies on incremental output capital ratio (i.e. inverse of incremental capital output ratio) and multiplier to formulate his model Harrod assumes certain behavioral pattern for entrepreneurs and deduce that it induces investment. In Domar's model, no such behavioral pattern has been assumed. He thinks that proper change in investment comes exogenously. For Harrod, business cycle is an integral part of the growth process. Domar, however, accommodates fluctuations by allowing  to fluctuate. The causal relationship between investment and income is reverse in both models. 12/17/2022 [email protected] 39

40. Criticisms of Harrod-Domar (H-D) Model Fixed coefficient production function: The H-D model assumes that labour and capital are used in fixed proportions. However, this is untenable. The capital ¬labour ratio changes with the changes in factor prices, i.e. one factor is substituted for another factor. Constant assumptions: The H-D model is also criticized for its unrealistic assumptions. The effect of technological progress has not been incorporated in both the models. Both models ignore human capital formation The two models also fail to consider changes in the general price level. Price changes always occur overtime and may stabilize otherwise unstable situations. 12/17/2022 [email protected] 40

41. 6.2.2. Model of Capital Accumulation Capital means the stock of physical reproducible factors of production. When capital stock increases with the passage of time, it is called capital accumulation or capital formation. Capital formation is investment in capital goods that leads to increase in capital stock, national output and income. Capital formation is the key to economic development. On the one hand it reflects effective demand and on the other hand, it creates productive efficiency for production. Capital formation possesses special importance to LDCs. The process of capital formation leads to the increase in national output in a number of ways. 12/17/2022 [email protected] 41

42. Cont… Capital formation is essential to meet the requirements of an increasing population in such economies. Investment in capital goods not only raises production but also employment opportunities. It is capital formation that leads to technological progress. Technological in turn leads to specialization and the economies of large scale production. The provision of social and economic over heads, like transport, power education etc in a country is possible through capital formation. It is also capital formation that leads to the exploitation of natural resources, industrialization and expansion of markets which are essential for economic progress. 12/17/2022 [email protected] 42

43. 6.2.3. The Solow Growth Model Solow’s model was a response to the Harrod-Domar model and some of its obvious weaknesses, especially its assumption of a constant capital-output ratio. In the introduction of his 1956 paper, Robert Solow explained the rationale for his neoclassical growth model: “ A remarkable characteristic of the Harrod-Domar model is that it consistently studies long-run problems with the usual short-run tools. Instead one thinks of the long run as the domain of the neoclassical analysis, the land of the margin”. The model is based on the following assumptions: One composite commodity is produced and output is regarded as net output after making allowance for the depreciation of capital 12/17/2022 [email protected] 43

44. Cont… There are constant returns to scale. In other words, the production function is homogeneous of degree one The factors of production - labour and capital - are paid according to their marginal physical productivities Prices and wages are flexible There is perpetual full employment of labour and stock of capital Labour and capital are substitutable for each other and there is unitary elasticity of substitution between the factors. There is neutral technical progress The saving ratio is constant 12/17/2022 [email protected] 44

45. Cont… Given these assumptions, Solow shows in his model that with variable technical coefficient there would be a tendency for capital-labour ratio to adjust itself through time in the direction of equilibrium ratio. If the initial ratio of capital to labour is more, capital and output would grow more slowly than labour force and vice versa. Therefore, combining variable proportions of the factors and using flexible factor prices, Solow showed that the growth path of output was not inherently unstable . If the labour force grows faster than the stock of capital, the price of labour would fall relative to the price of capital. 12/17/2022 [email protected] 45

46. Cont… If capital grew faster than labor, the wage rate would rise. Solow’s model is convergent to equilibrium path (steady state) to start with any capital labour ratio with factor substitutability. Gw=Gn and equilibrium path is stable. To show the model, Solow takes output as a whole, the only commodity, in the economy denoted as Y(t ). If saving is denoted by S and the rate saving is sY(t). K(t ) is the stock of capital. Then net investment is the rate of increase of this stock of capital, i.e., dk/ dt or K. 12/17/2022 [email protected] 46

47. Cont… So the basic identity is : K=sY………………………………………………..……Eq.6.6 The production function which shows constant returns to scale is given by Y=f(K,L) …………………………………………………………Eq.6.7 Inserting Eq.6.7 in Eq.6.6 we get K= sf (K,L) …………………………………………………………Eq.6.8 In Eq.6.8, L represents total employment. Since population growth is exogenously determined, the labor force increases at a constant relative rate n. Thus L(t)=Loe nt ……………..……………………………………………Eq.6.9 12/17/2022 [email protected] 47

48. Cont… He regards this basic equation as determining the time path of capital accumulation, k, that must be followed if all available labour is to be fully employed. It provides the time profile of the community’s capital stock which will fully employ the available labour. Once we determine the time path of capital stock & labour force, we can compute the time path of the real output from the production function. 12/17/2022 [email protected] 48

49. Cont… Solow concludes that when production takes place under the usual neoclassical conditions of variable proportions and constant returns to scale, no simple opposition between natural and warranted rates of growth is possible. There may not be any knife-edge. The system can adjust to any given rate of growth of the labour force, and eventually approach a state of steady proportional expansion i.e. ΔK/K=ΔL/L =ΔY/Y 12/17/2022 [email protected] 49

50. Critical Appraisal of Solow’s model The Solow model is a major improvement over the H-D model. The H-D model is at best a knife edge balance in a long run economic system where the saving ratio, the capital output ratio and the rate of increase of the labour force are the key parameters . If the magnitudes of these parameters were to slip even slightly from the dead center, the consequences would be either growing unemployment or chronic inflation in Harrods model. This balance is poised by the equality of Gw (which depends on saving & investing habits of households and firms) and Gn (which depends, in the absence of technical change, on the increase of labour force). 12/17/2022 [email protected] 50

51. Cont… According to Solow's model, this delicate balance between Gw & Gn follows from the crucial assumption of fixed proportions in production whereby there is no possibility of substituting labour for capital. If this assumption is abandoned, the knife edge balance between Gw and Gn also disappears with it. He therefore, builds a model of long run growth without the assumption of fixed proportions in production demonstrating steady state of growth. 12/17/2022 [email protected] 51

52. 6.2.4. Population growth model A longer labor force means more productive man power, while a large growth of population increases the potential size of domestic markets. However , it is questionable whether rapidly growing man power supplies in “labor surplus” developing countries exert a positive or negative influence on economic progress. Obviously it will depend on the ability of the economic system to absorb and productively employ these added workers ability such as an ability associated with the rate and kind of capital accumulation and the availability of related factors, such as managerial and administrative skills. 12/17/2022 [email protected] 52

53. Cont… Population growth, however, alters the basic Solow model in three ways. First , it brings us closer to explaining sustained economic growth. In the steady state growth population, capital per worker and output per worker is constant. Second , population growth gives as another explanation for why some countries are rich and others are poor. Solow model predicts that countries with higher population growth have lower level of GDP per person. 12/17/2022 [email protected] 53

54. Cont… Finally , growth affects our criterion for determining the Golden Rule (consumption-maximizing) level of capital. Golden Rule is the steady state that maximizes consumption per effective worker. In the Golden Rule steady state the marginal product of capital net of depreciation equals the rate of population growth. 12/17/2022 [email protected] 54

55. 6.2.5. Technological progress and Growth Growth also affected by technological progress. I.e., the growth also resulted from new and improved ways of accomplishing traditional tasks such as growing maize, making clothing or building a house. There are three basic classifications of technological progress: neutral, labor-saving and capital saving. Neutral technological progress: It occurs when higher output levels are achieved with the same quantity and combination of factors inputs. Simple innovations like those arise from the division of labor can result in higher total output levels and greater consumption for all individuals. 12/17/2022 [email protected] 55

56. Cont… Labor-saving : The use of electronic computers, automated textile looms, high speed electric drills, tractors and mechanical ploughs and many other kinds of modern machinery and equipment can be classified as labor saving. Capital-saving : This is a much rare phenomenon. In the developed world almost all the scientific and technological research is conducted in save laborer and not capital. In the labor abundant (capital-scarce) countries of the developing world, however, capital-saving technological progress is the main focus. 12/17/2022 [email protected] 56

57. Cont… In general, a higher rate of saving leads to a higher rate of growth only until the steady state is reached. Once the economy is in steady state, the rate of growth output per worker depends only on the rate of technological progress. According to Solow model, only technological progress can explain persistently rising living standard. The introduction of technological progress also modifies the criterion for the Golden Rule. 12/17/2022 [email protected] 57