The Neo Classical Model of Economic Growth
The neo classical model of the economic growth in the long run have been introduced by Robert Solow and by Trevor Swan in the year 1956. It is known to evaluate the convergence of the economy. The neo classical growth is known to be an economic theory which states how a steady growth rate of economy will result from a combination of labour, technology and capital which are known to be the driving forces in the economy. The theory of the neo classical growth model also states that short term equilibrium usually takes place from varying amounts of labour as well as capital in the production function (Agénor and Montiel 2015). It also states that technological change will also have a large impact on the economy and the economic growth also cannot take place without the advances in the technology. The neo classical model is known to be the part of Harrod Domar model which includes the growth of the productivity.
The basic neoclassical growth model of Solow is known to be characterized by constant returns to scale production function where the production function is denoted by Y = F (K, L). Since investment is equal to savings therefore, K= sY and the production function is given by Y = F(K,L). Equating both, S=sF (K,L) where L is total employment and F is functional relationship. The Solow model of the economic growth states that during the long run it have been found out that economies tend to converge to steady state equilibrium.
The permanent growth can only be achieved with the help of technological progress. The growth of population and shifts in savings will only lead to level effects during long run. The Solow model also implies that the countries which are poor will be growing faster and then slowly catch up with the rich countries. The convergence in the Solow model can be explained by the lag in the diffusion on knowledge along with efficient allocation of foreign capital. The reason is that the rate of return on capital is high in case of poor countries.
One of the assumptions in case of neoclassical growth model is that in case of a closed economy capital is subjected to diminishing returns. The production factors are capital and labour which are paid according to marginal productivity. There is a presence of flexible system of price wage interest. The output that is produced is regarded as the net output which means proper allowance for the depreciation of the capital that is made. It is also assumed that the technical progress does not affect the capital productivity and labour efficiency. There is full employment of labour and also the capital stock which is available is fully utilised. There is also a presence limited substitutability between the existence of labour and capital.
Factors Driving the Economy
The aim of the paper is to show how Solow’s economic neoclassical model has been applied for the development in Taiwan. The paper also states how foreign aid can help in economic development.
The fast pace of the economic growth in most of the nations in East Asia can be stated as one of the biggest examples of the Solow’s economic development. The experience of the Asian economies are the miracles of the economic progress. The high level of growth which took place for many years have allowed the countries to catch up with the western countries. Singapore is the global centre of finance and trade which enjoy high standard of living. (Madsen and Mamun 2016). The experiences of the “Asian Tigers” and the Newly Industrializing economies of East Asia have succeeded in developing their backward economies and poor economies at a much faster rate compared to the rest of th developed world. This suggests that the economies of Asia follow economic theories of global convergence where the growth rates are better than other regions.
The economic growth explains a remarkable difference in income as well as in living standards across the countries. The term “Tigers” have been used to the group of South Asian countries as a result of extraordinary growth from 1965 to 1995. Human capital is also used as one of the factors which is used for measuring the productivity of the country. With the endowment of natural resources, skilled as well as more educated labour force will help in producing more output along with the low skilled labour (Pratoomchat 2013). The intervention of government had huge effects in some of the liberal countries that include Taiwan and South Korea and contribute to the rise in the enrolment rates of the secondary education around the year 1986. During the 1990s, the tertiary rates have known to experience a further boost which lead to the growth of 44 percent in South Korea and 25 percent in Hong Kong.
The Solow Swan model mainly relies on the assumptions that countries produce homogenous output. The output is measured as GDP of the country. The capital inputs are also subject to diminishing returns and all the factors of production are fully employed.
The technological factor is also an important determinant of the growth of Taiwan. The developing countries also had to acquire new technologies for achieving the growth. Technology can help in economic development in many ways such by creating direct jobs, innovating business and contributing to the growth of gross domestic product, emerging of new services and industries and by transforming workforce. The transfer of technology states the technology leaders interacts with the rest of the world. Taiwan is known to be one of the high performing Asian economy as a result of technological progress (Korotayev and De Munck 2015). The early development of Taiwan had been had been aimed at increasing the agricultural output along with development of infrastructure. The foreign aid of the United States has known to play a very important role in financing the imports and formation of capital. The import substitution policy had been taking place since 1960. From that point of time, the exports of manufacturing industries have started taking place. Taiwan after that have adopted the strategy of building a complex industrial structure which includes machine tools, steel along with electronic equipment’s. Taiwan have also made efforts in promoting high technology sectors and industries. It has also known to broaden the export base to include machinery along with equipment’s. The electronic sector is Taiwan have also led to success of the country. Technology is known to lead the growth of the economy since it will be increasing the pace of economy of a developing country. It can be said that it will be helping to solve the social as well as economic problems of the developing countries which provides advancements for better to the developed economies. Technology also help in the agricultural production and also increases their overall income. Capital expenditure and technological progress are the two most important aspects of the economic development. Capital can therefore be increased with the help of technological progress. Technological advances will be allowing a given unit of capital for enabling a given unit of labour for increasing production (Korotayev and De Munck 2015). A given unit of labour usually have more capital to work with and will be producing more levels of output.
Solow Model of Economic Growth
The neoclassical growth of the Solow model theory has also explained that growth paths of some of the most emerging economies in the world. The endogenous, exogenous along with the institutional approach to the economic growth have explained how sustained growth have originated in Asia. The rapid growth of economic progress of East Asia is an example of how developing countries have achieved globalization (Dumrongrittikul and Anderson 2016). Taiwan have also showed that the countries which are poor in nature known to achieve huge growth in shor period of time. The neoclassical model has predicted that high rate of savings, increase in the labour hours, investment in new capital and labour force participation have helped most of Asian countries in achieving the growth. Therefore, in order to conclude it can be said that the progress in technology will provide the engine for growth in long run.
The above chart shows the relationship between output per capita which is against the stock of technology. The figure shows the growth rate of the gross domestic product between 1960 and 1997 against per capita output. The convergence that is present between the world’s economies states that the countries which had been poor in 1900s, should be achieving high growth rates in the coming decades than those developed countries that were initially rich. However, the graph above shows a presence of slight negative relationship present between relative output and the average growth. Hong Kong and Taiwan which have started in 1960 as backward and developing economies. Within few years, Taiwan have experienced a huge increase in their capital stock as well as in labour hours along with improvement in education. These factors are known to contribute to high level of economic growth. Which allowed Taiwan to converge towards the income levels in the advanced countries.
Many researches have been done on the success of Taiwan which have known to followed the Solow neoclassical model. The productivity growth of Taiwan took place especially due to large amount of capital accumulation along with rise in the output. The productivity growth can therefore be termed as an important aspect of the growth for most of the countries in East Asia.
The foreign aid is known to boost the economic growth. The economic development is the process by which the nation can improve the political, economic as well as social wellbeing of its people. The foreign aid leads to economic growth and leads to the development of the less developed countries. The voluntarily transfer of resources from one country to another is known as foreign aid. This kind of transfer comprises of flow of capital from the developing countries. Countries are known to provide foreign aid for enhancing he own security
Role of Technological Progress in Economic Growth
Transitory effects of the foreign aid
The basic neoclassical model states that foreign aid which is in the form of grants of the capital goods known to have transitory effect on per capita consumption.
The above figure is assumed to be closed for everything except for the foreign aid transactions. It is also assumed that the donor country wants that the aid should be in the form of capital goods. The foreign aid which is a flow is received by the recipient country whose capital labour ratio is known to rise from K1 TO K4. The situation will be present as long as the foreign aid is received (Crouch 1973). After the withdrawal, the ratio goes back to K1 and Y1. The capital requirement of the recipient country also exceeds the per capita savings. therefore, for this reason, the aid is proving to be transitory in nature.
The traditional neoclassical theory implies that foreign aid which is received in the form of grants of capital goods will be having transitory effect on per capita consumption (Crouch 1973). For this reason it can be said that developed countries will be rendering to underdeveloped countries which will be having a permanent effect on the welfare of the recipient country.
Foreign aid will help in increasing the income level and investment rate of the particular country by supplementing the available resources. Foreign aid is therefore known to be advantageous for the receiving country. Some of the benefits of foreign aid are they are known to save lives, rebuild livelihoods, encourage development, aids agriculture and help in building sanitation (Edlund 2017). It have also been found out that huge number of countries which are yet not developed does not have huge success with convergence which can only be achieved with the help of foreign aid. However, the huge amount of foreign aid should not be affecting the steady state capital state of the economy or the output level, but the foreign aid will be speeding up the dynamic adjustments to the steady state for an economy. The foreign aid will be having the positive effects in economies where the economy already have good monetary, fiscal as well as trade policies.
Foreign aid helps in economic growth for many countries. It have been an essential tool for the socio economic development in case of developing contries since 1960s. For example, in case of Africa, Ethiopia have received a foreign id of more than $40 billion.. The foreign aid help helped in boosting the economy and bring growth by preparing space for foreign direct investment. However, in case of Ethiopia, it have been found out that the foreign aid is negatively associated with the democracy. When the foreign aid rises, the level of the democracy have declined. After receiving the foreign aid, the Ethiopian democracy have fallen from 4 to 6. Therefore, it could be concluded that foreign aid in Ethiopia have reduced democracy.
Application of Solow’s Model for Taiwan’s Development
However, in case of Taiwan it can be said that development of Taiwan mainly resulted due to accumulation of capital from abroad. The foreign aid have helped Taiwan in rapid economic progress (Lin et al. 2016). Exports were up about 30 percent over the same period. Because of the foreign aid, the manufacturing also rose by 20 percent. Therefore, it can be said that foreign aid have positively affected the growth of Taiwan.
Majority of the countries around the world have known to engage in the process of foreign aid as donors or recipients. Many countries are known to use foreign aid for pursuing the foreign policy objectives. When aid is withdrawn, it is known to create economic hardship or destabilization in the economy . One of the primary reason for the aid allocation is pursuing foreign policy goals. The commercial and strategic interests of the developed countries are known to be the driving force behind the aid programs (Agénor and Montiel 2015). One of the main objectives of foreign aid is influencing the foreign governments and reshaping the international affairs. A study has been made on the effect of foreign aid on the economic growth and has been found out that there is a presence of positive relationship between the foreign aid and economic growth. However, the less developed country will be suffering from many constraints for growth which includes investment limits as a result of low savings, presence of fiscal constraints in investments and limited ability for importing investment goods. The constraints can however be relaxed by the foreign aid when it is financed by public investments and import capital goods and intermediate inputs.
Conclusion
There are two types of growth which are the catch-up growth and the cutting edge growth which includes developing new ideas and focus on developing new technology for the resources. Countries with high rate of investment have higher GDP per capita and countries are known to grow faster than before. The neoclassical growth theory is an economic theory which states the fact that steady economic growth rate from a combination of labour, technology and capital. The high level of growth which took place for long time have allowed the countries for catching up with the western countries.
In order to conclude, it can be said that the accumulation of capital in Taiwan and the other East Asian countries have mainly taken place as a result of productivity growth. Both direct and indirect impacts of the growth of productivity account for more than half the growth of Taiwan. Therefore, it can be said that Solow residual have a huge impact on the accumulation of capital.
The paper therefore, describes the modern economic growth and it also states that neoclassical model of growth will also be relating to the growth of Taiwan during the period of 1960. The low total factor productivity also states about the growth. It has been found out that countries such as Hong Kong as well as Taiwan grew very fast compared to other countries.
Reference list and bibliography
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