?Y/Y = s/c
c = 5, ?Y/Y = 8%
8% = s / 5
s = 40%
required saving propensity to achieve the desired growth rate.
this case savings propensity must be 40% which is very high rate to achieve.
There are several options that government has to decide to achieve the high
levels of savings output ratio, which are increasing the tax incomes, foreign
aid or general consumption sacrifices. The solution might be the combination of
these options by all together in respect of the conditions in the country.
Government could increase the taxes and make some sacrifices of its own general
consumptions or bring foreign aid to the country to achieve the required domestic
savings propensity and achieve the targeted growth rate which is not easy to
accomplish with this level and in this solution if the government choose to
fill the gap with foreign aid it might be problem for later to pay back the
debt. (Todaro and Smith, 2015)
Harrod-Domar model defines the growth rate with two different variables which
are savings ratio and capital output ratio. Savings ratio is the key to get
high levels of growth rate for the model. Higher savings basically means higher
growth. The other key issue is the capital output ratio which means how much
capital to get or produce one unit of output. In other words, this ratio shows the
productivity level of the capital in the country and a major measurement that
is using in the model.
the perspective of developing countries or less developed countries Harrod
Domar (HD) model did not deliver the expected results because of several reasons.
These are; the availability of the data and structure of the model.
is the availability of the data in the developing countries or less developed
countries is not always easy to get as the developed countries and sometimes
there might be no data to make estimations or building the model in right
conditions. Also, the model is not analysing the regional or structural
problems with the specific countries. (Ghatak, 2003)
The other and the main problem is the
design of the model itself. Harrod-Domar Model has been designed for the
developed countries at times of great depression and because of that Harrod-Domar
(HD) model did not deliver the expected results for the developing or less
developed countries. The model has a cycle which is suggest that high levels of
savings ratios leads to investments, more investments increase the capital
stock which increase the output and it increases the income and growth rate,
but in the developing countries or less developed countries, this cycle is not
working, because of the low levels of savings ratios. Low levels of savings
ratios lead the country to low levels of investments and also, poor banking
system does not help in this point to give more credit besides than the
savings, which ends up with low levels of capital stock and output which causes
low levels of income and low growth rates.
Resource Curse as known as paradox of plenty is a development problem for the
countries which has great amount of abundance of natural resources. Normally
abundance must give great surplus and advantage to the development processes
for the countries but, natural resources come with their problems either
spending or management struggles for the economies of the developing countries
(Sachs and Warner, 2001). In the
literature of economic development one of the Natural Resource Curse called as
Dutch Disease. After discovering large amount of high market price commodities
economy has a great effect of new export rates, it leads the economy big and
temporary surplus in the balance of payments (BoP) and attract lots of new
foreign investors to the country. This temporary huge surplus in the economy
can affect the production process by the appreciation the exchange rate. Because
of the powerful currency country lost competitiveness in the global markets and
in the long run it will lead to a de-industrialization. Another problem beside
the losing competitiveness in the market, is the struggles in the policies and
management of the temporary income which provided by the natural resources.
Governments and its policies will lead the countries with natural resources to
a curse or a bless because of the dependency in policy makers and their
attitudes is remarkable in this case. Lots of examples that shows us natural
resources could affect the development processes in political way in which has
a rise in the rent seeking economy. In this point political conflicts and
corruption rise and country lost its stability. But also, there are different
democratic examples like Norway and Australia which has strong institutional
structure in the country force the governments about the transparency of processes.
order convert curse to a bless the biggest role is the governments and their
policy makers. First, they must maintain the currency in a competitive level in
the market for not losing manufacturing sectors. It is very important to make a
development about labour intensive manufacture based on their own comparative
advantages. Because this will improve the diversity of economic development and
does not let lose track in technological levels to be competitive and effective
in the market. The other point is establishing a competitive domestic market
for investors either foreign or local which is very important to have a dynamic
business cycles in the country to attract more capital and being less dependent
on natural resources.
Table 1 shows
that macroeconomic changes the between the years 1977 and 1983 with using
several macroeconomic variables includes gross domestic product (GDP) growth,
Current account (CA) (% of GDP), Capital Account (KA) (of % GDP), Central
Bank`s FX reserves (in millions of dollars) and Real Exchange Rate. In the year
of 1973 Chilean economy has a rate of 8.7 of gross domestic product (GDP)
growth. The following years this rate changes like 7.5, 8.7, 8.1, 4.7 -10.3,
and -3.8 which means between the years of 1981 and 1982 there is a big decline
in rate of GDP.
The other important indicators about the table
are current account (CA) and capital account (KA) and the exchange rate. In
1977 Chilean economy has the rate of current account (CA) according to percentage
of GDP -4.1 and the following years, -7.1, -5.7, -7.1, -14.5, -9.5 and -5.6
besides the CA in 1977 the capital account (KA) according to percentage of GDP
has the rate of 4.6 and the following years 12.0, 12.0, 12.2, 13.8, 4.2, and
5.7. After 1973 the Central bank reserves had a huge jump until the year 1981.
In the years between 1980 and 1982 Chilean Central Bank had lost more than 1.2
billion Us dollars to defend the own currency to maintain the exchange rate. Table
also shows big loss in the GDP in the same period.
economy gives capital account (KA) surplus till 1980 but then it reverses to a
current account (CA) deficit. The unreliable and unsustainable expansion of
public sector led by booming foreign trade in between the years 1977 to 1980
caused balance of payment crisis after 1981 with losing competitiveness of
goods in the global markets.
The Balance of Payment crisis could occur unintentionally
as a reason of domestic policies or reforms such as liberalization. It starts
with finding easy and cheap money or loans in the international capital markets
in foreign currency to finance the domestic consumption or investment. Loans
come as foreign currency and it converts to domestic currency to finance the
projects. It rises the external debt. This situation causes an appreciation in
the real exchange rate and it is a standard problem for developing countries
with underdeveloped production structures. It leads economy to an expansion and
increase in the prices which triggers trade imbalances. It makes economy
questionable about the foreign reserves due to payment commitments of foreign
debt and generate a country factor risk in the view of foreign investors. After
the increase of the country factor risk in the financial markets, the foreign
money will go another low risk country, and this cause a problem for the
liquidity in foreign reserves and central bank needs to preserve the exchange
rate to maintain in sustainable and investable levels. This attempt of the
central banks usually ends up with failure and it leads the central bank to
devaluates the currency and the foreign debt become unpayable.