Question

What is your experience in dealing with developed or developing countries and how that maps into what the balanced growth rate, the equation g Y = g A + αg K + (1 − α)g L, and developing countries growth rate. Provide some real world examples

Answer 1

Sol:

Definition of balanced growth:

Balanced growth refers to a specific type of economic growth that is sustainable in the long term. It is sustainable in terms of low inflation, the environment and balance between different sectors of the economy such as exports and retail spending. Balanced growth is the opposite of volatile boom and bust economic cycles.

The balanced growth equation : g Y = g A + αg K + (1 − α)g L.

The scale of technological change (g A) and the increase of the labor force (g L) are exogenous in the Solow model. That is, they are fixed outside of the  model. The growth prices of output (g Y ) and capital (g K ) are endogenous. That is, they are arranged by the economic model.

In a constant state, there is balanced growth. That is, output and capital grow in develoing countries at the same rate: consider g.

Lets.g Y = g K = g in the growth accounting equation:

Set g Y = g K = g in the equation: g = g A + αg + (1 − α)g L.

Set g Y = g K = g in the equation: g = g A + αg + (1 − α)g L.

Now ,solve for g to get: g = g A 1 − α + g L. If g A = g L = 0 (neither technology nor the labor force is developing), then g = 0. This is the case we analyzed previously

Throughout macroeconomics, a dynamic model's balanced growth rate is a line, such that all variables are increasing at a constant rate. Balanced growth is a simple assumption in the traditional exogenous growth model, whereas other variables such as capital stock, real GDP, and production per worker are on the rise. Developing economies may adopt an unbalanced growth strategy to rectify past investment decisions.

Example:

1. Sustainable debt levels. If growth is financed by unsustainable debt, then it is always at risk from debt-deleveraging – a period where firms and consumers seek to pay back the debt. For example, between 2002-2006, the US economy saw an increase in subprime mortgages – with households buying a house and relying on low-interest rates. When interest rates rose, households defaulted, banks lost money and it led to a credit crunch.

The fall in the savings ratio to 4% in 2008, was an indication growth was becoming unbalanced – relying more on debt.

Economic growth in the UK

It was felt the UK had balanced growth between 1993 and 2007 – a long period of economic expansion and low inflation.

However, the credit crunch of 2007, showed the growth wasn’t as balanced as previously thought. Despite low inflation, there was a boom in bank lending and the growth of credit. There was also a boom in house prices which got reversed from 2007.

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