Question

U.S. and Chinese GDP Growth in the Long Run. China is a country with a very high savings rate s, about 40%. The U.S. has a much lower savings rate, closer to 15%. (There are many reasons for this difference.) For this question, assume that the population growth rate n, technology growth rate g, depreciation rate δ, and production function f(k) in China are the same as in the U.S.

a) According to the full Solow growth model (with technology growth), what does this higher savings rate imply about the steady state of China’s output per effective worker relative to the U.S.? Draw a diagram to help illustrate your answer.

b) China’s GDP/person has been growing at about 8.2%/year for the past 25 years, while GDP/person in the U.S. has been growing closer to 2%/year. According to the full Solow growth model (with technology growth), how will the growth rate of China’s GDP/person compare to that of the U.S. once these two economies reach their steady states?

c) According to your analysis in part b, can China’s GDP/person continue to grow at its historical average rate of 8.2%/yr. for the indefinite future, while the U.S.’s steady-state growth rate of GDP/person is around 2%/yr.?

Answer 1

* Answer:

a) Higher saving rate in China implies higher investment and higher output per effective worker as campared to US.

China's steady state output per effective worker is determined at point E​​​​​​'​​​ (red curve) whereas US is at point E.

See diag 1 in attachment

b) China's GDP/person is higher at steady state as campared to US at steady state and this is because of higher saving rate in China.

( Please refer the diag 1)

Since both the countries have different saving rates, their output/person will be different at steady States i.e. they both have different steady state outcomes. The solow growth model does not predict absolute convergence.

Note: if their saving rates are also same along with other parameters then their steady state output per person will tend to converge in the long run.

c) Both the economies of US and China are growing at the rate of 2% and 8.2% respectively for over 25 years. It can be assumed that they are at their steady state level of capital per worker. Therefore, at this point the economies can grew indefinitely at their respective growth rates until there is change in any exogenous factor like rate of depreciation, g or n or saving rate.

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