The neoclassical growth model and global poverty

When using an economic model to represent a real-world problem and study the implications of different solutions, the model’s usefulness depends most heavily on its ability to simulate the real world without oversimplification. One of the questions this can lead to is whether the neoclassical growth model is a useful tool for economists and policymakers to understand global poverty and design poverty reduction strategies. This will be the topic of discussion in this paper and we will note that while there are reasons to use the neoclassical growth model to analyze the plight of the world’s poor, it fails to take into account many important factors relevant to the study of this problem are crucial from every imaginable point of view.

High on the agenda, we need to examine the ideas and concepts that underpin this model. The neoclassical growth model emphasizes the role of technological advances and labor productivity in maintaining a sustainable long-term growth rate. Population growth, capital devaluation and, above all, technological progress have a direct impact on the dynamics of the growth process.

A key idea that encompasses the framework of this model underscores the assumption that economic growth is independent of the saving rate (or, equivalently, investment) in the long run. However, the economy is experiencing a transient state of growth or decline in the capital stock that could last for decades due to investment volatility resulting from savings being larger or smaller than the required investment. Therefore, at steady state, the growth rate of production is equal to the growth rate of population and the rate of technological advance. This shows that output per worker will grow at the rate of technological progress if growth is balanced in the long term.

The neoclassical growth model is achieved by assuming a diminishing marginal product of capital, where the economy gradually moves to a point where savings provide only sufficient investment to cover depreciation. To put saving and investing on an equal footing, let’s assume the economy is closed. This is an important and unrealistic assumption, but it allows the problems of trade surpluses and deficits to be overlooked. Taxes and government spending are also ignored in order to focus on the behavior of private savings. Finally, we assume that personal savings are proportional to income.

The first idea we want to explore is whether or not the idea of ​​economic growth is relevant to the development of poverty reduction strategies in developing countries. In fact, the neoclassical growth model effectively highlights an important correlation between economic growth and poverty reduction. This model is based on the theory that economic growth depends on the accumulation of capital – both human and physical – and technological progress. Human capital refers to increasing labor productivity due to people’s education, skills and experience, and health. Physical capital represents the tools used in production. Finally, technological advance has a twofold meaning: it is the ability to produce larger quantities of output with the same amounts of capital and labor. Likewise, technological advances are the key factor behind the development of new, better and more varied products for the public to consume.

Studies have shown that “literacy and other indicators of education remain appallingly low in much of the developing world,” and policies that help poor people acquire human capital would result in them earning higher wages (Besley and Burgess, 2003). . The neoclassical growth model could be used to argue that a pro-investment and pro-entrepreneur climate would help reduce poverty. This idea follows from the premise that strong regulation of company ownership is not in the public interest, since it leads to low capital intensity, low human capital per worker, and low productivity (Bigsten and Levin, 2000).

The implication that the economy is closed, used to develop the neoclassical growth model, severely limits our ability to accurately represent real scenarios related to the plight of the poor. One of the handicaps this creates is our inability to account for foreign capital inflows along with domestic investment. Developed countries may find it advantageous to boost the economy of a developing country, for example by investing in research and development (R&D) in that country. The promotion of new technologies can help poor people living in agricultural and rural areas to achieve a higher per capita outcome and better maximize their land and resources. The incentive for the developed country could be to establish new trading partners and open up new markets for their own economy.

Evidence that opening up international markets is conducive to economic growth is illustrated by the fact that ‘growth problems were most pronounced in countries that pursued inward-looking policies’ (Bigsten and Levin, 2000). This may be one of the reasons why many African countries have had low per capita production, low growth rates and declining living standards over time. Other possible reasons for economic stagnation in African countries are also examined to reflect problems of poverty.

Other assumptions in the development of the neoclassical growth model come at the expense of simulating the realistic nature of the model by reflecting the real world. Any major components of countries’ social infrastructures or political arenas lie primarily outside the workings of this model. This therefore limits the ability of economists and policymakers to examine the full spectrum of poverty reduction ideas. For example, an important component of social infrastructure that lies outside the workings of this model is the idea of ​​“removing social barriers for women, ethnic minorities and socially disadvantaged groups to broaden growth” (World Bank, 2001). . Other considerations that are beyond the reach of the neoclassical growth model include areas such as “politics, institutions, history and geography” (World Bank, 2001). For example, government policies play an important role in the level of steady state, particularly in terms of their influence on property rights, public consumption, and both domestic and international markets. Bad policies may be the reason why many developed countries have experienced slow growth or even a low-level steady state (Bigsten and Levin, 2000).

Another issue to consider with the neoclassical growth model is the idea that investment and various other factors will affect the growth rate of output per capita for as long as it takes the economy to transition from one stable growth path to another has hired . In fact, investments and other factors could affect growth in the long-term as they could be considered equivalent to technological improvement under certain circumstances. For example, education and foreign trade will increase the level of output that can be produced from given inputs through increased efficiency. As a result, per capita income (or standard of living) will increase because this will equate to an improvement in technology. As we have already noted, the low literacy characteristic of unskilled workers has hampered growth in much of the developing world.

In summary, the neoclassical growth model has some utility in helping economists and policymakers design effective poverty reduction strategies. It is extremely thorough and complete in its way of analyzing the plight of the poor in the context of economic growth. Technology is identified in this model as a key factor in sustaining long-term economic growth. The idea of ​​investing in physical and human capital, implicit in the neoclassical growth model, has powerful implications that could indirectly lead economists and policymakers to propose social policies that would promote health, education, and other safety nets to help the poor. The basic argument against this model is the fact that many factors that can actually affect economic growth and world poverty are simply not quantifiable, such as legal structures, the political environment and social infrastructure. These are very relevant real-world forces with lasting impacts on economies, but we are unable to analyze these impacts through the lens of this model. Nonetheless, the neoclassical growth model steers us in the right direction when considering the long-term impact of different policies on the well-being of an economy by considering the situation in terms of economic growth and technological advances.

Bibliography:

Bigsten, Arne and Levin, Jörgen. 2000. “Growth, Income Distribution, and Poverty: A Review.” Working Papers in Economics 32, University of Gothenburg, Faculty of Economics.

Besley, Timothy, and Robin Burgess. 2003. “Having Global Poverty in Half.” Journal of Economic Prospects. Sommer, 17:3, pp. 3-22.

Blanchard, Olivier. 2003. Macroeconomics-3. Ed. New Jersey: Prentice Hall, Ch. 11-13.

World Bank, 2001. “Chapter 3. Growth, Inequality and Poverty,” in World Development Report 2000/2001: Attacking Poverty (New York: Oxford University Press, pp. 45-59).