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Growth Accounting And Neoclassical (Solow) Growth Theory

Using the analytical tools of growth accounting and/or the neoclassical (Solow) growth theory, comment on the following real life questions from Asia's economic development.

A. Many developing countries—China and India being notable examples—have pursued in the past policies to curb population growth. What was the rationale? What was the impact of this policy on the level and growth in GDP as well as per capita GDP?

B. In his famous 1994 article in Foreign Affairs, Nobel Laureate Paul Krugman argued that Asia's economic growth was driven more by "perspiration" than "inspiration". A key element of "perspiration" was increasing saving, and hence, investment, by suppressing consumption. Assess the impact of such policy on per capita GDP growth.

C. China's policy to curb population growth (e.g. "one-child policy" from 1978) proved more effective than India's. As a result, China is now at a demographic turning point, where the population is beginning to age and dependency ratio is rising (more older population to support per working population). By contrast, India still has one of the youngest demographic structures. What are the implications of these demographic differences for growth in GDP and per capita GDP in China and India over the next generation (i.e., next 20-30 years)?

D. Many Asian countries have been able to narrow the gap in their living standard with rich countries. What has been more challenging is further closing the gap once they reached the middle income level (e.g. around USD5,000-10,000 per capita GDP). Why is it generally "easier" for a poor country to narrow the gap with rich countries when they are starting out poor? What do countries need to do escape the "middle income trap"?

Solution Preview

A.
China's phenomenal growth is not connected to its one-child policy, which it has now largely abandoned. From the neo-classical point of view, we can draw two conclusions: first, that since capital accumulated rapidly since the policy began in 1979, the excess labor was not needed and would have lowered wages. On the other hand, the laborers who were never born cannot become either workers or consumers.

The theory behind curbing population growth is that the sheer number of mounts to feed will outstrip the economy's ability to provide for them. The amount of jobs, especially as capital is being accumulated rapidly, will also decrease, as labor intensity gives way to capital intensity.

Richard Lehmann, writing in Forbes, argues that the purpose of the one child policy, imported from the US, was to break down the family structure and focus all loyalties on the central state. Traditions of primogeniture run deep in China, and hence, the hereditary property principle in the eldest son was the tradition. Mao and his successors needed to break this down.

One aspect of the one-child policy (which, it should be noted, was largely ignored in the countryside) was the China's population is aging rapidly. This will be a drag on economic growth, especially since rural health in China is non-existent and there is no standard pension system in the country (Lehmann, 2013).

The fact of the matter is that China is mostly empty land. The population is crammed into a few southeastern cities. Hence, the economic rationale for population control made little sense. Had the population been evenly distributed, China would not seem in the least overpopulated, and the regional disparities in economic development could have been avoided.

Taiwan, Singapore and the Netherlands, all successful economies, have a far greater population density than China. One neo-classical approach here is that the excess population may well have colonized the empty lands to the northeast, north and west. At present, the Chinese government is struggling to direct investment to these regions, but the labor supply is limited (Pearse, 2010).

B.
The IMF made the argument in 2009 that China's policy in this respect caused a serious market failure in global trade. Specifically, that the underconsumption of the Asian economies, especially China, has led to a severe imbalance of liquidity, where China has the ability to flood the market with cheap paper, making an already difficult corporate situation I America worse: interest rates were kept artificially low as a result.

In most of the Asian powerhouses, from 1999-2009, the share of household consumption as a percentage of GDP has fallen. The same could be said for India. Most growth in China and India has been from capital, which, from Solow's point of view, is not a bad thing, at least for the short term. Yet, the IMF argues that the savings rate, which feeds investment, has ...

Solution Summary

The expert uses analytical tools of growth accounting and neoclassical growth theory. Asia's economic development is analyzed.

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