Growth and distribution

Abstract

Interest in the determinants of the rate growth of different economies is as old as our subject itself Book III of Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations was subtitled ‘Of the different Progress of Opulence in different Nations’. But the systematic formal modelling of growth took as its inspiration the proposition of Harrod (1939) and Domar (1946) that a steady-state rate of growth was feasible only in fortuitous circumstances. It was based on three main assumptions. First, the amounts of capital and labour needed to produce a unit of output are given by technological requirements. In particular, the capital-output ratio, denoted by u, is a technological constant. Second, the fraction of net income in the economy that is saved, denoted by s, is fixed. Finally, potential output from given inputs of capital and labour grows at an exogenous rate determined by technical progress. Labour supply, the only non-produced input, also grows at an exogenous rate. Hence the only feasible long-run steady-state rate of growth is the rate of technical progress plus the rate of population growth, the ‘natural’ rate of growth denoted by n. Stochastic shocks to potential output are ignored in this model. Much of equilibrium growth theory has been devoted to understanding the conditions necessary for individual saving and investment decisions to be compatible with the levels implied by the natural growth rate. An equilibrium growth path is one along which planned net saving equals planned net investment. Denote the current level of output by Y and the expected change in output by AK Planned saving is equal to the product of the saving ratio and the level of net output, sk: Planned investment is equal to the product of the capital-output ratio and the expected change in output, IJAY The expected growth rate of output is AY/Y and in equilibrium this is equal to s/v from the condition that planned saving equals planned investment. When