Economic Growth and Economic Fluctuations - Essay Example

The question of economic growth and progress represents one of the most fundamental concerns of the government and governmental agencies. Governmental officials are constantly in search of methods of maximizing and sustaining growth. To that end, there have been many macroeconomic theories designed to determine the delicate balance between crucial elemental factors such as GDP, national savings rates, educational levels, openness and other factors. These theories include the exogenous growth model as well as endogenous growth model. This paper will represent an examination of the viability of several governmental initiatives aimed determining the if certain policies will facilitate economic growth whereby a developing nation is able to catch up with already developed nations and to maintain a steady-state after catch up. The economic theories and models examined would be the Solow Model, the human capital theory and screening model. The effects of governmental policies on the openness of the economy will also be examined here. The data given will serve as guiding force in the determination of the ability of our study country to achieve rapid short-term economic growth and long-term sustenance of a steady rate of growth. When charged with the responsibility of determining the best policy to foster long-term economic growth, it is vital to analyze many economic factors and trends. These factors include the impact of productivity, savings and depreciation on the economy as well as the economy's ability to sustain long-term growth under the given circumstances. In so doing, the Solow Model can serve as a general guidance in determining whether an economy can sustain long-term growth given the present combination of factors. In order to examine this it is vital to offer an operational definition of Solow's model. Solow's model is a model the increase in the capacity of a country's economy to produce goods and services over time. This increase theoretically implies that the well-being of the citizens will improve over time. According to Solow the increase can be determined utilizing a formula whereby the GDP is determined by combinations of inputs. Solow simplifies this very intricate function by presuming certain factors are held constant. One of the most fundamental simplifications is the assumption that a single good is produced by the economy in question. In so doing, the GDP is greatly simplified and its implications are clearly depicted. The other assumptions of the Solow model include the assumption that all data is collected on a time continuum, a single good is produced with a constant technology, there is no governmental or international trade, all factors of production are utilized to their full capacity, the growth within the labor force is constant. Utilizing the relationship existent between the savings and the investment and extending the Solow model further, we can assume that the depreciation rate, the amount of capital depreciation and the change in capital over time are held constant. The implications of this are such that in the long-run, we are able to yield a production function whereby Y = AF(K, L). Essentially, it establishes a relationship between capital stock and the economic output. Taking this one step further and assuming that labor input is held constant and there is a positive correlation between changes in capital and output we can see that in time additions to capital stock will yield additions in output. This relationship can be expressed in terms of labor and economic output. In so doing, we can determine the economic output for each individual in the society. The pertinent equation is y=Y/L and can be graphically depicted as follows: The Impact of Savings Rate on Long-term Economic Growth After having examined the production function, we need to examine a prudent question-Is it possible for our country of study to catch up with richer countries and at what rate will it occur In examining that question, we need to realize that according to the Solow model, in order to be able to catch up with richer countries, a developing nation has to be exhibit high economic growing rates in domestic savings. Our test country had a national savings rate of 35% in 2001. This savings rate is significantly higher when compared to richer countries. In examining this it is prudent to state that the total saving equation is as follows: Total National Savings = Private Savings + Public Savings + Net Foreign Savings The above equation indicates that the total national savings represents a combination of public and private savings as well as net foreign savings. Applying this to the Solow model, it is evident that the key to jump-starting an economy is savings. An examination of the majority of developing countries that have caught up with already developed countries indicates that these countries share a common factor--a strong propensity towards accelerated savings with little or no deficit. As the Solow model indicates, when there is an accelerated rate of investment, the change in capital stock results in an addition to the annual growth rate. This is evident in the capital to labor ration as well as the productivity of the average worker. The Solow model makes very serious predictions. One of the most salient predictions is the prediction that developing countries fostering a policy of high savings will grow at a faster pace than already developed countries. This faster pace will be instrumental in narrowing the gap between a developing country and the already developed nations. This has implications for both the output per worker and standard of living experienced by the workers in the developing country. This rapid growth rate, however, is short-lived in that and will slow down to exhibit a steady-state growth rate. The rationale behind this is that for a certain growth rate, a large net investment increases the capital stock as time goes on. As the economy accumulates capital stock, the depreciation of the capital stock also increases. The increase in depreciation essentially means that in order to offset it, a larger percentage of savings needs to be present. This percentage of saving proves too great for the economy to handle. As a direct result, economic growth slows down to a steady-date. Utilizing the convergence hypothesis of the Solow model, one can predict that rapidly growing countries will experience faster economic growth rates for a short period of time. Over the course of time, the capital stock and the output per worker will rise and eventually plateau. By that time, there would have been a convergence in both the per worker capital available and economic output by each worker. The implication of this is that the countries who were previously experiencing rapid economic growth would reach a standard of living comparable to already developed countries. This implication does not include any consideration with regard to the economic distribution of income within the developing country as well as the fairness employed to distribute economic. The implication, however, does demonstrate that it is highly likely that developing nations can catch up with already developed nations and this potential rests heavily on heightened national savings as well as the policies of the government. In order for the nations to catch up, the government must promote certain policies. These policies include an investment in education, a policy of open and competitive markets, strong emphasis on foreign trade, a decrease in governmental involvement and the allowance of the people to freely own property. As demonstrated, the changes in savings rate loom large in creating a picture of a successful economy-one with the potential of sustaining growth in the long-run. When the savings rate increases and depreciation is held constant, capital stock can be added to facilitate an increase in capital output. The net result of this would be a change in growth equal to the original output plus the rate of investment. This growth however, cannot be sustained over the long-term but will serve to jumpstart the economy and leave it to other measures to sustain a steady-state economy. In any event, the short-term effect of increased savings would be an increase in capital output which is seen to level off in the following graphical depictions of economic output at various savings rates. Savings Rate of 30% Savings Rate of 35% Savings Rate of 40% The Impact of Education in Economic Growth The Solow model proved effective in establishing a baseline on which we can build our examination of economic growth, however, this baseline is not effective in explaining many of the components of growth. In the case of education and its impact on a country's bottom line-GDP, it fails to explain the role of education. This is due to the fact that the traditional Solow model embodies a point of view that economic growth is realized through technological progress but it fails to delineate the sources of technological progress. In attempting to explain the role of education in economic growth, we can resort to the utility of the human capital theory and the models which serve as justification for a drive towards educational expenditure as a means of increasing human capital and thus impacting the GDP. In addition to the human capital theory, the screening theory embodies the desire to invest in education while simultaneously reducing the governmental investment in education with little impact on the GDP. First and foremost, the Human Capital Theory is one that has been used in recent times to as the preliminary economic devise for sustained long-term growth. It is very powerful in creating a framework on which many governmental policies are based. It has been touted as a key determinant of economic performance. It operates under the basic precept that individuals will act in such a manner that their economic self-interest will be placed first and foremost. This interest is best served in a free competitive market. In such a market technological progress, per capita productivity, education and competitiveness serve as guiding forces with education being stressed as a significant component of economic growth. An extension of this theory can be seen in the human capital model. The human capital theory serves as an extension of the basic rudimentary notion that schools serve as a means of imparting students with the necessary skills that will be utilized in later life as a means of individual economic enrichment. It essentially serves as an investment which will in the long-term offer monetary and non-monetary returns. This theory is applicable in the short-term to increase the productivity function of an economic system and in the long-term to produce a valuable resource-one which will facilitate a steady-state economy. The practical applications of the human capital theory has been more or less limited to education and training as a means of increasing the wages experienced by employees within a nation. It has been proven time and again that in order earn more, it is essential for employees to acquire more skill through training and education. The logic in this lies in the fact that in order to maintain a viable economy, there is a dire need to have a relatively low supply of skilled workers. This will serve to minimize the cost of training and education while increasing the output of many employees. The resultant of this dynamic is that skilled workers (more educated and trained) will experience a level of content facilitated by their increased wages while unskilled workers will tend to be dissatisfied with their employment and wages. This dissatisfaction will fuel a desire to increase his/her wages and will facilitate a self-funded education on the part of the unskilled worker. This relieves the burden of the government to fund education. Eventually, the return on investment of education and training will become apparent and will beg the question as to how much an unskilled employee is willing to spend on the acquisition of skills as a means of procuring higher wages. In order to explore this notion, it is prudent to examine this in the vein of standard investment analysis. In so doing, we need to make one fundamental assumption-an individual can invest in education and training without risking their investment. That is they can invest in education and training with a fair degree of certainty that he/she will be able to procure higher wages when education and training is completed. Essentially, we need to be able to calculate the present value of their investment as well as the future value and determine whether investing in education and training will yield an increase in output as represented by the increased earnings he/she will experience. This examination is basically begging the question as to how much a person should spend to acquire skills necessary to procure higher paying employment. In order to examine this question in the framework of macroeconomics, we must assess the present and future values of an investment in education. In so doing, theoretically we can arrive at a figure which represents the return on investment for education. Utilizing the average years of education as 4.01 years for our study country and a 2.1% rate of college education in 2000 coupled with the income share of the top 20% being 0.44 and the bottom 20% being 0.07, we can see that this country is in dire need of education as well as training. Additionally, there is a disparity between the income share of the top and bottom 20% of the nation. An examination of the implications of this in terms of investment in an education of a computer consultant will serve to illustrate the point. Let's say for example, investing in a career as a computer consultant may yield returns over the course of twenty-five years. Assuming that the comparative increase in income would be $50,000 per year for each of the twenty-five years, we can calculate the present value of this increased earning as follows: Present Value = 50,000/(1=r) + 50,000/(1=r)2 + 50,000/(1=r)3 ..50,000(1=r)25 Or Present Value = Returns/(1=r)25 The resulting present value calculated above would be the maximum amount capital an individual can expect to spend on a computer consultant education to basically break even. Essentially, this figure can be utilized by a government in order to determine the upper limit of investment in education for a given career path. In order to lend prudence to this examination, it is imperative that we examine the returns on an investment in education. These returns are both monetary and non-monetary. The monetary return is essentially a measure of the amount of capital gained as a result of the investment in education alone. In order to validate this, there has to be no future investment made. This implication serves as the fundamental basis of the examination of investment in education. Essentially we must examine the income potential of an individual who has completed the rudimentary education necessary to procure employment as an unskilled worker but is contemplating receiving further education or training in order to achieve monetary gains. In so doing, we must examine both the cost of attaining the education and the penalty for not attaining that education. In order for education to be a viable alternative, the cost of attaining that education coupled with the monetary gain has to far outweigh the decrease in potential earning as a result of not having attained additional education. After having examined both the investment in training and education as well as the return on that investment utilizing our study country as a frame of reference, we can only arrive at one conclusion-an investment in education and training is vital to long-term economic capital output. The main deciding factor of this recommendation has to be the fact that the educational level for this country is so far below that of already developed nations that once the economy is jump-started by accelerated savings, education is one of the very few alternatives available for the attainment of a steady-state that is necessary for economic success. The strong case of the benefit of education can also be built utilizing the screening model of education. The screening model entails a method of somehow identifying the students with the greatest potential to excel and invest in higher education for those students while only providing the basic education for those students who do not fit the selection criteria. In so doing, it is theorized that the government will be able to maximize its investment in education. This is a system that is utilized in developing countries such as Haiti and proves to be successful to some degree. This system, however, has garnered great criticism in that it has a great potential for discrimination. The brightest and the best are selected while the average children are basically doomed to a life of mediocrity with very little hope of improving their financial situation over the course of their lives. The only hope they hold for advancement lies in their departure from their country of origin to other countries with liberal policies on education. Examining this in the theoretical framework of our test country, this can prove to be a viable alternative for sustained growth over time. It has the potential to be very selective in its spending on education. This ability serves as a means of monetary savings on education while maximizing the economic impact of educational investment. This is vital in an economy where the amount of available capital is limited and has to be utilized with a great degree of certainty in its ability to generate a large return on investment. The impact of Governmental Policies on the GDP Repeated examination of the role played by the trend to establish markets on a global level has served to indicate that the resulting economic benefit is great. This benefit has been shown to have a strong influence in shaping a nation's domestic macroeconomic policies and has served to facilitate a trend toward trade liberalization. The implications of this are such that discriminatory and restrictive domestic policies can serve as a basis for exclusion of nations in the national markets. With this in mind, it is prudent for nations who wish to partake in the lucrative national market to custom tailor their polices to foster inclusion. One of the most prolific of those policy ramifications is the notion of openness in the national market to global competition. Essentially, in order for a developing country to catch up and keep pace with already developed nations, it is prudent that the necessary regulatory conditions be established to facilitate openness in the market. Governmental regulation of economic activity is essential to promote a variety of initiatives aimed at affecting the quality of life experienced by its citizens. This regulation includes the fostering of policies to enhance the health and well being of its citizens as well as the safety of the environment in which they live. It also entails the derivation of a standard size and weight of its gross domestic products as well as the development of networks wherein trade would be possible. Inherent in the establishment of trade networks would be methods that ensure consumers are protected as well as the establishment of guidelines on which the network would operate. Operating with these objectives in mind, Governmental agencies are free to pursue regulation through several means. These include the following: 1. The establishment of clear standard for products and services, production processes, employers, and service providers. 2. The regulation of economic activity within certain sectors of the economy and within certain industries 3. The use of fiscal incentives, subsidies and taxes in order to facilitate an increase in the monetary gains of both individuals and the business sector 4. The establishment of laws governing the conduction of business. 5. The establishment of property laws. In examining the role of governmental policies on a nation's economic growth, it is prudent that we examine the ramifications of technological advances, the development of new goods and services, economically efficient regulation and globalization of the product market. First and foremost, in recent history, technological advances have been exponential in their rate of occurrence. This rapid increase has been most abundant in the field of computer technology. As a direct result the potential for competition between already developed nations and developing nation remains one to be exploited by developing nations. Essentially, this venue represents an area which developing nations can utilize in order to position themselves for great economic benefit. When examining this within the context of our study nation, it becomes prudent to mention that our study nation possesses 2.1 computers per thousand residents. This figure is very low when compared to already developed nations. As it stands, our study nation is unable to take advantage of the technological advances in computer technology which has to potential of ensuring economically efficient competition in many of the sectors of the economy. Secondly, the role of the government and its policies with regard to the development of new goods and services looms large in the economic outcome of the nation. It is essential for the government to impact regulations which ensure the quality of the goods and services produced are comparable with those of already developed nations. In so doing, it ensures that the goods and services will be utilized for export and serve as a valuable addition to the GDP. Thirdly, a close examination of the incentives created by various governmental regulations their effectiveness in achieving an increase in the quality of life experienced by individuals is instrumental in illustrating the impact of governmental policies on the nations bottom-line. In order to be proven effective, these regulations all exhibit one commonality-they are not restrictive in their scope and their ramifications incorporate a deliberate level of market openness. Essentially, these studies have proven that a strong focus on only the critical aspect of an activity that needs to be regulated is sufficient to achieve the objective of a marked increase in the quality of life experienced by a nation's citizens. Finally, an examination of the potential of regulatory is definitely guided by the concept of international cooperation. In making policies, it is prudent for a government to consider its role in the global economy. In so doing, it aims to maximize its benefits in participation without facilitating the appearance of a nation whose participation is solely for its own benefit without a consideration of the potential detriment to the economy of other nations. Essentially the regulatory reforms need to be secured by the acknowledgment that the reforms will not negatively impact the cost of living, the number of choices available to its citizens and the short and long-term GDP. After having examined the pertinent factors of our study country it has been determined that the country is capable of achieving rapid economic growth and in the short-term catch up with the economic growth of already developed nations. This is evident in examining the national savings rate and the average rate of investment. These rates are high when compared to developed nation and prove adequate to sustain rapid growth and investment of capital to offset the depreciation of capital resources every nation must experience. Further investigation indicates that the study country exhibits a level of education that is far below that of already developed nations. This fact lends itself to the notion that an investment in education would be beneficial for the government. Such an investment would raise the quality of life for many individuals. The only question remaining in terms of education would involve the best method for instituting educational changes into the economy. The screening model would effectively and efficiently serve to minimize the capital investment in education while ensuring a great return on investment. This return would translate to long-tern sustained economic growth. A liberalization of the economic market will prove to be beneficial to the long-term economic growth but when devising liberal policies. The government must be cognizant of the fact that there has to be definite stands for goods and services. These standards would ensure the quality of the goods and services produced which lends itself to an increase in the economic output as well as its consumption by foreign nations. In addition to this policies of liberalization have to be undertaken with the primary goal of elevating the standard of living of the individuals within the nation. Secondary to this goal, is the potential of establishing a symbiotic relationship with other nations. Such a relationship can be made possible through the admission of the study nation into the World Trade Organization. Finally an examination of the likelihood of a nation with a large income disparity to sustain rapid economic growth proves that it is indeed possible. The income disparity is compensated for by the fact that the individuals earning low income are responsible for most of the GDP. This responsibility essentially means that there is very little governmental investment in those individuals. The lack of governmental investment translates to a greater availability of capital for the purpose of investment to compensate for depreciation. 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