Harrod-Domar Model Analysis of German Economic Growth
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Following the Harrod-Domar Growth Model to Analyze Germany’s Economic Performance
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Harrod-Domar Model Analysis of German Economic Growth
- 1. IIFT Akshay K Gupta Kumar Gaurav Pranjal Parihar Shivani Bagani Udit Srivastava 1
- 2. Overview Harrod Domar Model – Salient features Harrod Domar Model – Mathematical Formulation Germany, Phase 1 : 1971-1982 Germany, Phase 2 : 1982-1995 Germany, Phase 3 : 1996-2014 Criticism of the model 2
- 3. Harrod-Domar Model – Salient Features A growth model not a growth strategy Explains how growth has occurred in the past vs growth expected in future Rate of economic growth – Savings ratio/Capital-Output ratio Economic growth of a country depends upon – Level of national saving Productivity of capital investment (Capital-Output ratio) If the K/O ratio is low, lot of output from little capital If the K/O ratio is high, lot of capital needed for production Examples – Savings rate = 10%, Capital Output ratio = 5, Growth = 2% Savings rate = 24%, Capital Output ratio = 4, Growth = 6% Thus growth can be increased in one of the two ways – Increased level of savings Reduce the capital-output ratio
- 4. Harrod-Domar Model – Mathematical Formulation Mathematical formulation Y : Output = Income K = Capital stock S = Total Saving s = Savings rate I = Investment Delta = Rate of depreciation of capital stock Assumptions - 4
- 5. Phase 1 : 1971-1982 GDP Growth : 1973 – Inflation @ 8% – Oil Crisis Impact on unemployment – dramatic increase (0.3 million in 1973 to 1.1 million in 1975) 2nd Oil Crisis : 1979 | Price per barrel from $50 in 1974 to $107.25 in 1979 Savings Rate: Steady savings from 1971 to 1979, particularly due to rising oil prices and inflation Little effect of lower interest rate for short-term economic boost Economic recession in late 1970s, stagflation leading to lowering savings rate, with decrease in GDP Capital Output Ratio: Inadequate saving and increased cost of using capital main parameters for rising Capital Output ratio Unemployment rise(about 7.5%) leading to increase in capital-output ratio Parameters : Decrease in GDP, low investment and savings rate 5 0% 5% 10% 15% 20% 25% 30% 35% - 200000.0 400000.0 600000.0 800000.0 1000000.0 1200000.0 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Savings Savings Rate -20% -10% 0% 10% 20% 30% 40% 50% - 500000.0 1000000.0 1500000.0 2000000.0 2500000.0 3000000.0 3500000.0 4000000.0 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 GDP GDP Growth Harrod Domar Growth 0% 5% 10% 15% 20% 25% 30% 35% 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Capital Output Country data taken from World Bank website
- 6. Phase 2 : 1982-1995 GDP Growth: Supply Side Growth generation : Economic recovery after recession (1981-82) German reunification of 1990 – The process was swift, assisted in economic growth East Germans from Hungary and different parts of Europe entered West Berlin and provided cheap labour, leading to productivity enhancement Savings Rate: Anti-inflation monetary policy emphasizing the value of the Deutsche Marc and restraining money supply growth, which led to much lower interest rates once inflation was tamed Capital Output Ratio: Substantial subsidies for business investment in plant and equipment. The subsidies came in the form of accelerated depreciation and investment tax credits Decrease in unemployment from 0.8 mn to 0.5 mn 6 0% 5% 10% 15% 20% 25% 30% 35% - 200000.0 400000.0 600000.0 800000.0 1000000.0 1200000.0 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Savings Savings Rate -20% -10% 0% 10% 20% 30% 40% 50% - 500000.0 1000000.0 1500000.0 2000000.0 2500000.0 3000000.0 3500000.0 4000000.0 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 GDP GDP Growth Harrod Domar Growth 0% 5% 10% 15% 20% 25% 30% 35% 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Capital Output Country data taken from World Bank website
- 7. Phase 3 : 1996-2014 GDP Growth: Euro – Germany formally adopted the Euro in 1999 after fixing the Deutsche Marc rate at 1998 level The Dotcom Crisis(2000) : Originated in the US, high degree of integration in global markets, leads to economic stagnation in Eurozone, subsequently in Germany. The benefit of adopting euro goes away, though there is subsequent spike in Growth from 2001-2008 The Subprime Crisis(2008) : The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 2005–2006. The effect spills over to Europe leading to a decline in the rate of economic growth Eurozone debt crisis (2012-14) – The latest reason for “fluctuating” economic performance Savings Rate: Due to the debt crisis of 2012 the savings of the people saw a dip, Germans financed majority of PIIGS debt along with IMF Technology/Capital Output Ratio: The recessions of 2000, 2008 and 2012 saw a sharp fall in gross fixed capital formation. This is because if output falls, firms expect to make lower profits, therefore they start to think of cutting back output rather than increase it There is increasing emphasis in Europe to resort to protectionism and decouple the economies from shocks in the world 7 0% 5% 10% 15% 20% 25% 30% 35% - 200000.0 400000.0 600000.0 800000.0 1000000.0 1200000.0 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Savings Savings Rate -20% -10% 0% 10% 20% 30% 40% 50% - 500000.0 1000000.0 1500000.0 2000000.0 2500000.0 3000000.0 3500000.0 4000000.0 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 GDP GDP Growth Harrod Domar Growth 0% 5% 10% 15% 20% 25% 30% 35% 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Capital Output Country data taken from World Bank website
- 8. Criticism of the model Level of assumption No reason for growth to be sufficient to maintain full employment Relative price of labour and capital is fixed and they are used in equal proportions Economic boom and burst explained only from output perspective Sees economic growth and development to be same According to the model, Poor countries should borrow from abroad to to finance investment, but it leads to repayment problems later on There is no investment function (On what factors does investment depend?) Full employment is assumed, not discussed Doesn’t discuss inflationary situation, only recession and production is discussed Doesn’t show how to make G = s x σ if the system is not in steady growth 8