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The Case Japan and Germany are two success stories of economic growth. Although today they are economic superpowers, in 1945 the economies of both countries were in shambles. World War II had destroyed much of their capital stocks. In the decades after the war, however, these two countries experienced some of the most rapid growth rates on record. Between 1948 and 1972, output per person grew at 8.2 percent per year in Japan and 5.7 percent per year in Germany, compared to only 2.2 percent per year in the United States. The “miracle’’ of rapid growth in Japan and Germany, is what the Solow model predicts for countries in which war has greatly reduced the capital stock.

Requirement:

Keeping in view the Solow growth model, consider an economy in steady state position. Suppose that a war destroys some of the capital stock. The level of output will fall immediately with the reduction in capital stock. How the output will grow and economy will reach its steady state position again despite the lower level of capital stock in this economy? Discuss in the context of Solow growth model.

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The Case



Japan and Germany are two success stories of economic growth. Although today they are economic superpowers, in 1945 the economies of both countries were in shambles. World War II had destroyed much of their capital stocks. In the decades after the war, however, these two countries experienced some of the most rapid growth rates on record. Between 1948 and 1972, output per person grew at 8.2 percent per year in Japan and 5.7 percent per year in Germany, compared to only 2.2 percent per year in the United States. The “miracle’’ of rapid growth in Japan and Germany, is what the Solow model predicts for countries in which war has greatly reduced the capital stock.



Requirement



Keeping in view the Solow growth model, consider an economy in steady state position. Suppose that a war destroys some of the capital stock. The level of output will fall immediately with the reduction in capital stock. How the output will grow and economy will reach its steady state position again despite the lower level of capital stock in this economy? Discuss in the context of Solow growth model.



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• Growth comes from adding more capital and labor inputs and also from ideas and new technology.

• The Solow model believes that a sustained rise in capital investment increases the growth rate only temporarily: because the ratio of capital to labor goes up.

• However, the marginal product of additional units of capital may decline (there are diminishing returns) and thus an economy moves back to a long-term growth path, with real GDP growing at the same rate as the growth of the workforce plus a factor to reflect improving productivity.

• There are many differences across countries but there are some common elements to countries that have grown continuously. They have stable governments that pursue prudent economic policies, provide essential infrastructure and services, and take a long-term perspective. They use the opportunities provided by global markets and they have a dynamic and competitive private sector”

• A ‘steady-state growth path’ is reached when output, capital and labor are all growing at the same rate, so output per worker and capital per worker are constant.

• Neo-classical economists believe that to raise the trend rate of growth requires an increase in the labor supply and also a higher level of productivity of labor and capital.

• Differences in the rate of technological change between countries are said to explain much of the variation in growth rates that we see.
• The neo-classical model treats productivity improvements as an ‘exogenous’ variable – they are assumed to be independent of the amount of capital investment.

• The Solow Model features the idea of catch-up growth when a poorer country is catching up with a richer country – often because a higher marginal rate of return on invested capital in faster-growing countries.

• The Solow model predicts some convergence of living standards (measured by per capita incomes) but the extent of catch up in living standards is questioned – not least the existence of the middle-income trap when growing economies find it hard to sustain growth and rising per capita incomes beyond a certain level.

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  • Growth comes from adding more capital and labor inputs and also from ideas and new technology.

 

  • The Solow model believes that a sustained rise in capital investment increases the growth rate only temporarily: because the ratio of capital to labor goes up. 

 

  • However, the marginal product of additional units of capital may decline (there are diminishing returns) and thus an economy moves back to a long-term growth path, with real GDP growing at the same rate as the growth of the workforce plus a factor to reflect improving productivity.

 

  • There are many differences across countries but there are some common elements to countries that have grown continuously.  They have stable governments that pursue prudent economic policies, provide essential infrastructure and services, and take a long-term perspective.  They use the opportunities provided by global markets and they have a dynamic and competitive private sector”

 

  • A ‘steady-state growth path’ is reached when output, capital and labor are all growing at the same rate, so output per worker and capital per worker are constant.

 

  • Neo-classical economists believe that to raise the trend rate of growth requires an increase in the labor supply and also a higher level of productivity of labor and capital.

 

  • Differences in the rate of technological change between countries are said to explain much of the variation in growth rates that we see.
  •  The neo-classical model treats productivity improvements as an ‘exogenous’ variable – they are assumed to be independent of the amount of capital investment.

 

  • The Solow Model features the idea of catch-up growth when a poorer country is catching up with a richer country – often because a higher marginal rate of return on invested capital in faster-growing countries.

 

  • The Solow model predicts some convergence of living standards (measured by per capita incomes) but the extent of catch up in living standards is questioned – not least the existence of the middle-income trap when growing economies find it hard to sustain growth and rising per capita incomes beyond a certain level.

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