Adam Smith's Model of Economic Growth:

Definition and Explanation:

Adam Smith's model of economic growth is more or less available in the different parts of Smith's well
reputed book "Wealth of Nations" written in 1776. This model primarily deals with capitalistic economies
and their process of economic growth. In other words, this theory of economic growth portrays that
process which enabled the developed and the rich nations of the world to attain economic growth.

In this model of economic growth we shall discuss the followings:

(i) Production Function, (ii) Natural Resources, (iii) Institutions, (iv) Labor Force and (v) Capital
Accumulation.

(i) Production Function:

The classical economics is based upon 'Labor Theory of Value' which states that labor is the only factor of
production and the costs of production entirely depend upon labor costs.

But Adam Smith includes land and capital, in addition to labor (because growth is a long run
phenomenon) in the production function. Thus Smith's production function shows that the production of
the economy depends upon labor, land and capital. It is as:

Y = f (L, K, N)

Where Y = national product, K = capital, L = labor and N = natural resources.

The Smith's production function is not subject to diminishing returns, rather it is subject to increasing
returns. Smith says that as that:

Production increases the economies of scale are attained, both internal as well as external The market
will be extended and real costs of production will decrease. He says that due to economies of scale not
only division of labor is permitted, but the improvement in machinery also takes place. He further says
that the difference in productivity of labor in different nations is attributed to difference in degree of
division of labor. Smith says that the division of labor is limited by the extent of market. And the size of
market is affected by the amount of capital and institutional framework. He further says that the size of the
market and productivity of labor are influenced by regulation of domestic and international trade. This is
the reason that Smith was in favor of domestic and international division of labor and specialization. As
we presented earlier the Adam Smith's production function, it is as:
Y= f (K, L, N) ............. (1)

We also told that the productivity of labor (MPL) and land (MPN) are affected by stock of capital (K) and
institutional framework (U). Therefore, following restrictions are placed on the above production function:
(ii) & (iii) Natural Resources and Institution:
According to Smith dU/dt is exogenously determined. Therefore, he considers such factor of production
as given or fixed. It is as:

U = U (t) ........................ (7)

Regarding land Smith says that land is also fixed. In other words, there occurs no change in the supply of
land with the passage of time, as:

dN/dt = 0 ..................... (8)

Now the growth rate of the economy will be expressed as:

From the equation (9), we find that there are only two independent variables in Smith's model:

They are = dL/dt and dK/dt

Therefore, to understand this model we will discuss the determinants of labor force (dL/dt) and capital
accumulation (dK/dt).

(iv) Labor Force in Smith's Model:

Here we consider the demand for labor as well as supply of labor. Regarding supply of labor. Smith says,
it is related to the population. While in long run the population is affected by the wages given over to the
labor. If the labor are given more actual wages (W) than the subsistence wages (W), then the marriages
will take place leading to increase the population. On the other hand, if the actual wages are less than the
subsistence wages the marriages will be postponed leading to decrease the population. If both the actual
wages and subsistence wages are equal the population will remain constant. Therefore, the supply of
labor will be expressed as:

dLs/dt = q (W - W) ................ (10)

Here q > 0

Whereas the demand for labor is determined by wage fund. In other words, according to Smith there is a
specific amount of 'Wage fund' in the economy Such wage fund determines the demand for labor. It is
shown by the following equation:

dLD/dt = a . dK/dt + b . dY/dt ............... (11)

According to equation (11) the demand for labor (dLD) depends upon changes in capital (dK/dt), changes
in income (dY/dt) and the parameters 'a' and 'b'.

Smith says that in long run because of perfect competition in the labor market demand for labor will be
equal to supply of labor. It is as:

dLs/dt = dLD/dt .............. (12)

Rewriting the equation (11), the labor market theory in Smith's model is as:

dL/dt = a . dK/dt + b . dY/dt .............. (13)

According to equation (13) the growth of labor force is determined by the growth of income (dY/dt) and
growth of capital (dK/dt). Now we substitute the equation (13) into growth equation of the economy. In
other words, we shall like to see the effects of labor market and its determinants on the rate of change in
national product.

The equation (15) throws light on the importance of capital accumulation in growth process. Now we
discuss it.

(v) Capital Accumulation in Smith's Model:

According to Smith the capital accumulation depends upon investment whereas the investment is
determined by savings. As Smith says:

"Capitals are increased by parsimony and diminished by misconduct".

Now we see what are the determinants of savings in Smith's model. According to Smith it is the
consideration of private profit which determines the saving. In other words, the desire to save and invest
is determined by profit. He further says that as long as the rate of profit is more than the amount of
compensation for the risk from the investment capital accumulation will continue taking place. It is
expressed as:

dK/dt = v (r - r . Y) ............... (15a)

where (r - r) denotes the way whereby capital accumulation takes place. 'r' shows the rate of profit
while rshows the minimum risk compensation from investment.

In the course of economic development as capital stock grows in the economy the rate of profit comes
down. Smith says that the rate of profit is also determined by the institutional framework. In other words
the degree of commerce, control over monopoly or competition and the restrictions over international
trade also influence the rate of profit.

He further says that the minimum rate of profit (r) is also affected by institutional framework. That is the
security of the property and legality of lending operations also influence the minimum rate of profit. Thus
the theory of profit in Smith's model is as:

r - r = m {K, U (t)} ................ (16)

Smith says that rate of interest also affects capital accumulation. As the rate of interest falls the people
will find that they can no longer live on property income, they will force to turn to business. As a result, the
capital accumulation will increase. He says if social changes occur in the society even with no change in
rate of interest, the capital accumulation will increase. It has been described in Smith's model that as
capital
accumulation increases the rate of profit falls till it becomes r . Here there will be no risk from investment.
The capital accumulation will stop. The population will become constant and the economy will enter into
"Stationary State".

(vi) Dynamic Path of Economy:

Combining the equations (15a) and (16) we are in a position to describe the dynamic process as
presented by Smith.

dY/dt = f [r {K, U (t)}] ............... (17)

This equation shows that in a Growing Economy national product (dY/dt) increases, as the capital
accumulation (dK/dt) increases. Therefore, the dY/dt is a positive term. But along with increase in stock of
capital the rate of profit comes down. Whereas the capital accumulation increases along with fall in rate of
interest. Thus in Smithian model the capital accumulation will increase in a growing economy, which in a
turn will lead to increase the level of output of the economy. In this way, the process of economic
development will become cumulative. It will proceed at an accelerated rate until the capital stock
becomes so large that the rate of profit falls to r. After this the stationary state of the economy starts. This
is shown by the Fig.

Figure/Diagram:

It is clarified that the stationary state does not mean the case of under development. Rather it means that
here there is no growth, the per capita output becomes stagnant, profits are minimum, wages are
subsistence, population remains constant and there is no change in the output of the economy. From the
above discussion we conclude that in Smith's model economic growth depends upon followings:

Y = f [Ko, Lo, No, a ........ aN; U (T)]

Where Ko = basic capital, Lo = basic labor, No = basic land, a .......... aN are parameters of the model,
while U (T) represents institutional changes which occur with the passage of time.

The last equation shows that the development (growth) of the Smithian Economy depends upon
initial amounts of K, L and N; structural parameters a............ aN; and the
institutional framework (U) of the economy.

Criticism:
The beauty of Smith's model lies in this fact that it identifies that how economic development takes place
and what are growth inhibiting factors. The model stresses upon the role of saving and parsimony in the
capital accumulation. The technology, division of labor, specialization and extended markets are
important pillars of economic growth, according to Smith's model. Despite those merits, followings are
the demerits of Smith's theory of economic growth.

(i) Smith in his model includes just two segments of the economy, i.e., the capitalists (landlords) and
laboring class. But it is not true, in addition to these two classes, there is also a middle class which plays
an important role, in the economic growth. The savings are not just made by the rich class, the middle
class also saves.

(ii) The Smith's model is based upon Laisseze-Fair. But the non-intervention system is possible just in
dreams. Each govt. has to intervene to tackle both internal and external matters.

(iii) In Smith's 'model, we do not find the role of entrepreneurs. While according to Schumpeter, it is the
entrepreneur which combines other factors of production and it starts the process of production.

(iv) The Smith's hypothesis regarding stationary state is also misleading, because economic growth is not
a smooth process. It is furnished with jumps and shocks. As in this regards John Hicks says that Smith's
model is a static model.

Smith's Model and UDCs:

(i) Smith's model is least applicable in case of UDCs. Here the size of market is limited. As the size of
market is determined by the volume of output, while the level of output is determined by level of national
income. As far as UDCs are concerned they have low level of national income. Consequently, they lack
the power to save and invest. The low saving and investment generate low incomes. Hence, in the next
round the size of market again, remains limited.

(ii) In Smith's model greater stress has been laid upon social, political and institutional changes. But as far
UDCs are concerned they are backward socially as well politically.

(iii) Smith's model is based upon laisseze-fair. But UDCs are furnished with monopolies and other market
imperfections. Therefore, they have to depend upon state intervention.

Inspite of these Smith's model conveys a good message for the UDCs that they should raise savings for
capital accumulation. If the poor countries wish to attain economic growth they will have to extend the
markets; they should follow the principle of division of labor and specialization. Smith's slogan of Free
Market economies has been re-popularized both in UDCs and DCs under the disguise of privatization.
Ricardo's Model of Economic Growth:
Definition and Explanation:

The Ricardo's model of economic growth encompasses the production function, natural and human
resources, capital accumulation and pattern of development. Now we present them.

(i) Production Function:

Ricardo's production function is as:

Y = f (L, N, K) ......................... (1)

However, this production function is subject to diminishing marginal productivity. It means that as more of
K, more of L and more of N are employed the marginal productivity of K, L and N falls. Such all is
represented as:
According to equation (9) Ricardo's model depends upon change in capital accumulation with respect to
time (dK/dt), change in labor with respect to time (dL/dt), change in land with respect to time (dN/dt) and
change in technology with respect to time (dS/dt).
(ii) Natural and Human Resources:
According to Ricardo land includes the original and indestructible powers of soil. Therefore, he considers
land to be fixed m supply, as it is a gift of nature. It is shown as:

dN/dt = 0 .................. (10)

Regarding population growth (dL/dt), Ricardo says that there is a market wage rate (W) and natural wage
rate (W). The natural wage rate is similar to the subsistence wage rate of Smith. According to Ricardo, if
the market wages are above the natural wages the population will increase. While if the market wages
are below the natural wages the population will decrease. It is stated as:

dLs/dt = q [W - W (t)] .......................(11)

Ricardo says that the natural wage rate (W) is determined by productivity of land and socio-cultural
environment. This is represented as:

The movement in the market rate of wages are regulated by the relationship of demand and supply.
Therefore, it is written as:

W = n (Ld/Ls) ................... (13)

Where Ld = demand for labor, and Ls = supply labor.

If Ld > Ls the market wages will rise. If Ld = Ls the market wages will remain constant and they will fall if
Ls > Ld.

Ricardo further says that the Ld is directly influenced by the change in stock of capital in the economy. It
is shown as:

d . Ld/dt = q . dK/dt ..................... (14)

Where q is a constant and its value is greater than zero. According to Ricardo in long run the W becomes
equal to Wand here Ls = Ld. It is as:

d . Ld/dt = d . Ls/dt = dL/dt .................. (15)

Substituting equation (11) and (14) in equation (15):

The equation (16) shows that in long run the growth of labor force depends upon capital and the
relationship between two variables is proportional. Thus the above discussion shows that the change in
labor force or population depends upon comparison between natural wages and market wages, and rate
of change of capital formation.

(iii) Capital Accumulation:

Ricardo includes both fixed and circulating capital in capital. Fixed capital is that part of wealth of country
which is employed in production, and it is consisted of food, clothing, tools, machinery and raw material.
While circulating capital consists of 'Wage Fund'. This capital grows in constant proportion to fixed
capital provided no technical changes are taking place in the economy. According to Ricardo, there are
two ways whereby capital is accumulated:

(a) Due to increase in revenues and (b) Due to decrease in consumption.

As result of both these cases the savings will be generated. And whatsoever is saved is invested. He
further says that rate of capital accumulation is regulated by two factors. (a) The ability to save, (b) The
will to save.

The ability or power to save depends upon the surplus over the total product necessary to maintain
labor's subsistence level. Larger this surplus is greater will be the means to save. The will to save
depends upon the rate of profit. As he says, "while the profits of stocks are higher, men will have motive
to accumulate, if the rate of profit falls men can move towards increased consumption".

The capital accumulation in Ricardo's model is presented as:

dK/dt = f (r - r, y - WL) ................... (17)

Where y - WL represents the net income of the society or the incomes left over meeting the subsistence
level of living. While r - r means the difference between the actual and minimum rate of profit.

Ricardo says that as community's net income grows, and the difference between actual profit (r) and
minimum compensation for risk (r) increases the capital accumulation will grow. Thus it is the net income
and the rate of profit which play an important role in the dynamic process of capital accumulation. He
further says that the rate of profit would rise and fall depending upon subsistence wages, it is as:

r = d (W) ................... (18)

Ricardo says that it is a natural tendency amongst the profits to fall. It is because of the reason that as
development takes place the labor will be requiring more food. As a result the level of net income will fall.
Moreover, because of application of diminishing returns in production the rate of profit will fall in long run.
Thus, according to Ricardo in the
beginning capital accumulation increases at an increasing rate, and when the ratio of profit in total output
decreases the capital accumulation becomes sluggish. Because of increase in population and cultivation
of less fertile lands the level of profit eventually falls to r . Here capital accumulation stops, population
becomes stagnant and the economy enters into "Stationary State". It is shown with Fig.
(iv) Patterns of Development:
With the help of equation No. (9), (10) and (16) the economic development can be represented as:

The equation (19) shows that capital accumulation plays an important role in economic development.
With the help of equation (17) and (19) we can find the dynamic path of national income as:

Y = f [Ko, No, Lo, a.............aN; U(t); S(t)] ....................... (20)

This equation shows that the growth of the economy depends upon initial amounts of K, L and N like Ko,
No and Lo; structural parameters like a......aN and U(t) and S(t) which are institutional framework and
technology. Regarding U(t) and S(t), Ricardo says that they are exogenously determined.

Criticism:

The neatness and beauty of this model lies in this fact that it stresses upon raising of savings and profits,
the most important elements of economic growth. But still this model has following shortcomings:

(i) Ricardo's model is based upon diminishing returns. But due to modern scientific knowledge its
application can be suspended.

(ii) The concept of stationary state advanced by Ricardo is baseless. How that economy can be a
stationary one whose output is expanding, whose profits are rising and capital accumulation is taking
place.

(iii) Ricardian concept of subsistence wages and the concept of increase in population due to rise in
wages are misleading. As far as western countries are concerned the wages have never been
subsistence and because of rise in wages the population in these countries decreased, rather increasing.

(iv) Like Smith, Ricardo also assumes the system of 'Laisseze-Fair'. But it is not applicable in real life and
the state does have to interfere with.

(v) Ricardo assumes that there are no institutional changes. But the institutional changes highly influence
the process of growth.

(vi) Ricardian model basically explains the theory of rent determination. Therefore, this model is like a
theory of national income distribution.

(vii) Ricardian model did not incorporate the role of rate of interest in economic growth. Moreover,
according to Hicks it is a static model and fails to analyze the dynamic situation, the important feature of
growth theory.

Ricardo's Model and UDCs:

Ricardo's model is based upon 'diminishing returns' and Malthusian theory of population. If we analyze
UDCs we find that here population increases more than food. The use of superior technology on lands is
limited. Consequently, there applies diminishing returns. In case of UDCs the supply does not match the
demand. Hence rent goes on to increase. Whereas because of abundance of labor the wages remain low
leading to low savings and low investment. Such is in accordance with what it has been said by Ricardo
in his model.
Classical Model of Economic Growth:
Adam Smith and Ricardo both were the classical economists. They had much more similarities in their
models of growth. But now a days, there is a customary to present a full fledge classical model which is
composed of the ideas given by Smith, Ricardo, J.S. Mill and Malthus etc., regarding economic
growth.

Features:
The classical model has following features:

(i) According to classical economists if the amount of labor is assumed to be a specific one which is used
to produce certain level of output, the labor will be given the 'subsistence wages'.

(ii) The amount of surplus which is earned by the capitalists will be utilized in capital accumulation. The
increase in capital accumulation will increase the demand for labor. The wages will increase if the
population of the country remains fixed. As wages exceed the subsistence wages the population will
increase, following Malthus theory of population.

(iii) Because of increase in population the manpower will increase leading to decrease the wages. In this
way, they will come back to subsistence wages and producers will be able to reap 'Surplus'.

(iv) The 'Surplus' earned by the capitalists will be reploughed by them leading to increase . the demand
for labor and the same process will take place which we have mentioned above.

(v) This dynamic process will come to an end when 'diminishing return' applies in production. Here the
total output produced by the economy gets equalized the wages given over to the labor. In this way, the
producers will not be earning any surplus. With this situation, there will be no capital accumulation, no
increase in production and no increase in population. It is shown with Fig.

Diagram/Figure:
Here on y-axis the total production and on x-axis the labor has been shown. The OW curve shows the
subsistence wages. If level of population is ON, the level of output is OP. Here the per capita wage is NR.
Thus, the surplus (profit) is RG. Because of this surplus the process of capital formation starts. As a
result, the demand for labor increases leading to increase the wages, as they move to GH. If the
population of the country remains constant at ON and the wages exceed the subsistence wages (NG >
NR), the population and then the
working force will increase, as it goes to OM. Because of increase in population the 'Surplus' will be
recreated and it will be reploughed. In this way, the above mentioned process will be continued till the
economy reaches point E, as shown by the arrow movement in the fig. The point E represents a
stationary situation where the wages and output become equalized and no surplus would rise. In this way,
the expansionary process of capital accumulation and output will come to an end. This would represent
'Doom's Day'. However, they think that if the technical progress takes place in the country the production
function will shift upward, as shown by TP2 curve in the Fig. They further say that economic stagnation
and stationary state can be postponed, but it cannot be avoided of.

Limitations:
(i) This model ignored the role which technical progress could play. It is the technical progress which can
minimize the role of diminishing returns.

(ii) According to 'Iron Law of Wages' the wages can not exceed as well as go below the subsistence level.
But, because of changes in industrial structure and economic development the iron law of wages cannot
be accorded as the law of wage determination. Moreover, according to classical economists it is the
supply of labor which plays an important role in the determination of wages. But it is wrong, the wages are
determined both by demand for labor and supply of labor. Furthermore, the classical model did not
consider the role played by trade unions in the wage determination.

(iii) The development experience of advanced countries has also rejected 'Malthuaian' theory of
population. The classical economists following Malthus were of the view that whenever wages exceed the
subsistence level the tendency to have more children develops. But it is not necessary, it may happen
that rather making marriages people go for the purchase of luxuries when their wages increase.
(iv) The classical model fails to incorporate all those complicated factors which influence the economic
development of poor countries. In UDCs, there is a big shortage of capital. In addition to capital
accumulation, the economic development is also influenced by the culture, civilization, traditions and
institutional setup of the people. Such all has not been examined in classical model.
Marxian Model of Economic Growth:
The traces of Karl Marxian model of economic growth are available in his famous book "Das-Capital".
He rejects the salient features of classical model of economic growth. Afterwards, he presents his own
theory which has a social and historical framework where the economic forces play an important role.
Marx model rejected the law of diminishing returns. Marx says that the outcome of stationary state in
classical model is not a natural process, rather it is due to human arrangements. He also rejects
Malthusian theory of population.

Marx analyses the economic development from social and historical point of view and each stage of
economic development is based upon the Heagle's philosophy where a thesis and then its anti-thesis
have been presented, and then their contradictions have been mentioned. Marx says that in capitalism
'Social relationships of production' are more important than 'Distribution of goods'. Marx says that the
productivity of labor is not a gift of nature rather it is the result of history which embraces thousands of
centuries.

The concepts of relations of production is vague. In this concept he includes the 'Organic Whole' which is
characterized by the labor organization and skill, the standing of the labor in the society, the technological
and scientific knowledge and its use in certain environment. In Marx model those relations of production
determine the socio-cultural setup of a society. Marx was of the view that the capitalism would not end up
in a quiet classical 'stationary state', rather it would break up with a 'Bang' when the expropriators are
expropriated.

In this Marxian model of economic growth, we shall just discuss the economic aspects, ignoring social
and institutional aspects.

Marx model is based upon following dynamic laws:

(i) Law of Capitalistic Accumulation: According to this law the prime desire of the capitalist class is to
accumulate more and more capital.

(ii) Law of Falling Tendency of Rate of Profit: According to Marx the profits have a tendency to come
down and it plays an important role in the break down of the capitalistic economy.

(iii) Law of Concentration of Capital: Marx says that in a capitalistic economy the capital is
concentrated and centralized in a few hands. In other words, with the growth of capitalism the cut-throat
competition will develop amongst the capitalists. As a results, the big firms will throw away the small firms,
monopolies will grow and power will be concentrated into few hands.

(iv) Law of Increasing Pauperization: According to this law as the capitalism grows the miseries and
agonies of laboring class increase. It is because of the reason that the labor are given subsistence
wages, and the number of unemployed which Marx calls 'Industrial Reserve Army of Labor' increase
when the technical changes occur and capital is substituted for labor.

According to Marx, because of simultaneous inter-play of these laws such circumstances will rise
whereby the class conflict between capitalists and workers or between 'have' and have-nots' will sharpen
Eventually, the capitalism will face a violent death in the final confrontation when the expropriators will be
expropriated. Hence, Marx gave the clarion call: Workers of the world, unite, as they have nothing to lose
excepting their 'Chains'.
Now we describe the law of falling tendency of rate of profit. This law plays an important role in the whole
process of change.

According to Marx, the value of commodity (w) is given by the sum of "constant capital" (c) or the plant
and machinery used up in production plus the "variable capital" (q) which is paid to labor in the form of
wages plus the 'surplus value' (s) which is earned by labor but it is pocketed by the producers.
The concept of 's' is further explained as:

If the working day is consisted of 8 hours and only 4 hours are required to produce a commodity then for
the remaining 4 hours the worker is producing a surplus which is expropriated by capitalists. It is
expressed as:

w=c+q+s

If 'x' is used to represent rate of surplus value or the rate of exploitation and it is shown as:

x = s/q

Reference previous example:

x = s/q = 4/4 = 100 %

The rate of profit (p) in Marxian model is given as:

p = s/(q+c)

Dividing the numerator and denominator by q then:

p= s/q
q/q + c/q

p= s/q
1 + c/q

As x = s/q (rate of exploitation) and if c/q = j which he calls 'organic composition of capital', then putting
them in the above equation:

p= x
1+j

This equation shows that if 'x' remains constant, then there exists an inverse relationship between "p" and
"j". As the capitalistic system grows the amount of organic composition of capital (j) increases. Moreover,
whenever the wages exceed the subsistence wages the producers substitute capital for labor in order to
maintain their profits. This situation promotes unemployment. On the other hand, due to cyclical
fluctuations and fall in the rate of profit the capitalistic system faces crisis. The falling tendency of the rate
of profit would lead to cut-throat competition amongst the capitalists. This would promote monopoly
capitalism. But the conflict between 'Immiserized Proletarians' and the capitalists would toll the death knell
of capitalism.

According to Marx the law of a tendency for the rate of profit to fall may not always be observed within an
economic system. In other words, the tendency of fall in the rate of profit can be checked. It is shown as:

p= x
1+j

Differentiating 'p' with respect to 't':

According to Marx if rate of exploitation of labor increases more than amount of capital, the rate of profit
will increase. If amount of capital is more than the rate of exploitation whether it will lead to decrease the
rate of profit or not, it depends upon the difference between dx/dt and p . dj/dt.

If p . dj/dt which is negative term exceeds the dx/dt, the rate of profit will decrease. But a fixed rate of
exploitation and increase in capital intensity may not go together because a rise in organic composition of
capital would raise productivity which would either raise the rate of exploitation or raise the real wages.
But Marx says that instead of rise in real wages, there would be an increase in the rate of exploitation.

Criticism:
(i) On empirical basis Prof. Kaldor has concluded that in case of long run the proportion of wages to
national income has remained constant in rich countries. Again, so many socialist countries which
followed Marxian philosophy failed to remove poverty. The labor residing in socialist and communist
countries were always found dreaming for the life standard enjoyed by their western counter-parts. Such
all led to a reaction against socialism in Russia which culminated in disintegration of Russian Federation.
The prosperity enjoyed by laboring class in US, Japan and European countries contradict Marxian law of
increasing pauperization. However, Marxian philosophy of concentration of capital in few hands is
available in case of both rich and poor countries.

(ii) According to Prof. Fellner in case of rich countries the ratio of capital to output has increased. This has
not only promoted capital accumulation but the real wages of the labor have also gone up. Such all is
against Marxian model.

(iii) Mrs. Robinson also rejects the Marxian law of declining of rate of profit. She says that the technical
progress can be capital saving which would increase the productivity of labor. As a result, the rate of profit
will increase, rather decreasing.

(iv) Marx failed to entertain that capitalism would be protected by democracy. It is the democracy which
promoted social security, anti-monopoly laws and mixed economies. Such all contradicted Marxian
philosophy of 'Self-Demise' of capitalism.

(v) According to Sehumpeter Marx model is based upon: (a) labor theory of value, (b) a modified version
of subsistence wage theory. Both these are the instruments of constant situation. Thus, following
Sehumpeter Marx model has been presented under constant circumstances. It fails to treat the matters
dynamically.
(vi) According to Marx there exists a correlation between the growth of the average firm and increase in
the degree of concentration. But this logic does not look appropriate. But, as far as unemployment is
concerned it has increased both in UDCs and in DCs.

Inspite of these flaws Marx model of economic growth is of greater significance, it analyzed the role of
technical growth, inventions and innovations and capital accumulation. He attributed the growth of
capitalism to rate of profit. He considers the trade cycles something inevitable. He says that more and
less wages as compared with production may influence the process of economic growth.
J.E. Meade's Model of Economic Growth or Neo-Classical
Model of Economic Growth:
Introduction:
The model of economic growth which has been constructed by J.E. Meade describes those
conditions which will be helpful for a sustainable economic growth in the presence of constant technical
progress and a constant increase in population of a country. According to Meade along with economic
growth:

(i) The production of capital equipments increases because savings are made out of current incomes.

(ii) The ratio of working force increases.

(iii) Because of technical progress it is possible to produce goods and services in the presence of fixed
resources.

Assumptions:
(i) There is a closed economy having no financial and trade links with other countries.

(ii) 'Laisseze Fair' economy where govt. neither imposes taxes, nor makes expenditures.

(iii) There exists perfect competition in goods and factor markets.

(iv) Constant returns to scale exist.

(v) The machines constitute the capital goods and all machines are alike.

(vi) The ratio of labor to machines can easily be changed in short run and long run.

(vii) The production of consumer goods and capital goods is substitutable.

(viii) A certain proportion of machines becomes prey to depreciation. Therefore, there rises the need for
replacement of machines.

Production Function:
The production function in Meade's model is as:

Y = f (K, L, N, t)

Where:

Y = Net production of the economy.

K = Stock of machines.

L = Amount of labor.

N = Land or productive resources.

t = State of technology which goes on to change along with change in time.

According to Meade the production of the economy can increase if:

(i) The stock of capital goods (K) increases in the economy. The increase in capital stock will increase the
savings of the people leading to increase the real capital accumulation in the economy. The increase in
stock of capital is represented by ΔK. If we represent the value of marginal product of machine by "V", the
increase in the output of the economy will be represented as: VΔK.

(ii) The working force of the economy (L) increases which is represented by ΔL. If we accord W as the
value of marginal product of labor then the increase in production of the economy will be represented
as: WΔL.

(iii) Even no change occurs in capital, labor and natural resources the production of the economy can
change due to technical progress which is shown by ΔY/.

Thus the increase in the production of the economy can be represented as:

ΔY = VΔK + WΔL + ΔY/

Dividing this equation by basic factors of production of the economy shown in production function. In
other words, by dividing ΔY/s equation by Y/s equation:

ΔY//Y = VK/Y . ΔK/K + WL/Y . ΔL/L + ΔY//Y

Here ΔY/Y shows annual rate of growth of income of the economy. While ΔK/K shows the annual rate of
growth of stock of capital. ΔL/L represents the annual rate of growth of labor and ΔY//Y means the annual
rate of growth of income due to technical progress.

We use the symbols like y, k, l and r to represent such propornate rates of growth. The term VK/Y shows
the proportion of capital in total output while WL/Y shows the relative share of labor in total production of
the economy. Out of VK/Y a certain percentage of national income is accrued to the owners of the capital
in the form of net profits which is shown by 'U'. While a certain proportion of national income which is
accrued to labor in the form of wages is shown by 'Q'. Therefore, in the light of these symbols
the national income equation is written as:

y = Uk + Ql + r

According to this equation the total output of the economy (y) is summation of three outputs:

(i) Uk [the product of rate of capital growth (k) and proportion of profits (U)].

(ii) Ql [the product of rate of labor growth (l) and proportion of wages (Q)].

(iii) The growth of technical progress (r).

Subtracting (l) from the both sides of above equation:

y = Uk + Ql + r

y - l = Uk - l + Ql + r

y - l = Uk - l (1 - Q) + r

Where y - l shows the difference in between growth rate of production and growth rate of labor force.
Thus it shows the growth of per capita income. The above equation shows that y - l can be increased with
Uk and r. Whereas y - l decreases with l (1 - Q).
Now we introduce savings in this equation. The Uk is presented in some other way. As we assumed that
all of savings are invested. Therefore, the increase in the amount of capital (ΔK) will be equal to the
savings made out of national income (SY). It is as:

ΔK = SY where SY = annual savings

Dividing both sides by K.

ΔK/K = SY/K

As Uk = VK/Y . ΔK/K putting SY/K in place of ΔK/K, then:

Uk = VK/Y . SY/K or UK = Vs

Putting the value VS in place of Uk in the above equation:

y - l = Vs - l (1 - Q) + r

Changes in Growth Rate:

After analyzing the determinants of growth rate of income we discuss those conditions whereby growth
rate of the economy will increase or decrease. As Meade assumed the constancy of growth rate of
population (l) and growth rate of technology (r), then the changes in y - l would be depending upon the
behavior of s, V and Q.

As no change occurs in population and technology and savings increase the amount of capital. But in this
way, the MPK will come down. Thus because of increase in savings there will be a slower increase in the
production. In such state of affairs the 'Vs' will decrease. If technical progress takes place such negative
effect on V will be offset. It means that if with the passage of time the changes in 'r' occur it will have an
effect on V. It is so because that the productivity of all factors will increase because of 'r' leading to
increase savings. Moreover, the savings in an economy also depend upon distribution of income. If the
share of profits in national income distribution increases the savings will increase.

Technical Progress and Economic Growth:

The technical progress can be measured with those effects which occur on the MPs of different factors.
The nature of technical progress can be labor saving as well as labor intensive. If technical progress
leads to labor saving the MPL which is shown by Q = WL/Y will increase. If because of technological
change the use of labor increases the MPL = Q = WL/Y will decrease. The technical progress which leads
to increase the use of machinery the MPK = U = VK/Y will increase. While because of technological
change which is labor intensive
the U will decrease.

The above discussion shows that the rate of economic growth of an economy (y) is determined by the
rate of capital accumulation (VS) and technical progress (r), population remaining the same. It is as:

y = VS + r

If r remains constant the economic development will entirely depend upon Vs. It is shown by the
figure/diagram.
Here the curve OG1 represents that level of output which can be produced with the help of a specific
amount of capital in a year. If we employ OL of machinery the level of output is LR. If amount of
machinery is increased to OM, the production will rise to ME. As the slope of the curve OG1 has gone
down at E as compared with the point R. This shows that here the MPK has gone down. If we take the
next year the new curve OG2 comes into being because of technical growth. As in the second year the
technical progress has taken place, then with the same capital (OL), the LD output is being produced,
which is more than earlier. Again, with OM capital in the presence of technical growth, the MF output is
being produced. All this means that technical change may have the effect of boosting national output.

Conditions of Steady Growth:

If the level of technical progress remains same and population increases at some particular rate, then the
steady economic growth requires the fulfillment of following conditions:

(i) The nature of technical progress should be neutral for all the factors of production.

(ii) The elasticities of substitution between factors of production are equal to one.

(iii) The ratio of wages, profits and rent remains the same.

According to first and second condition the. proportion of profits in NI (U), the proportion of wages in NI,
(Q) and proportion of rent in NI (Z), all remain same when the economy is passing through the process of
economic growth. In this connection, Meade introduces new symbols. They are as:

The Sv shows the savings out of profits; the Sw the savings out of wages and Sg represents the savings
out of rent. Thus the savings of the economy are as:

S = SvU + SwQ + SsZ

We rewrite the basic equation:

y = Uk + Ql + r
As U, Q, l and r remain constant, then the production depends upon capital (K). If amount of capital
remains fixed the production will remain constant. As growth of capital is equal to SY/K where SY
represents that annual increase in capital which became possible due to savings. As we assumed above
that 's' remains constant. Hence SY/K would remain constant if Y/K remains constant. This would happen
if K and Y grow at the same rate.

Thus according to Meade the equilibrium growth rate of the economy depends upon growth rate of capital
accumulation. Meade says that there exists a critical rate of growth of capital accumulation where growth
rate of income and growth rate of capital would be equal. Now we introduce such critical growth of capital
accumulation (a) in the model.

a = Ua + Ql + r or a - Ua = Ql + r

a (1 - U) = Ql + r or a = Ql + r/(1 - U)

At such critical growth rate of capital accumulation (a), the y = k, where growth rate of income will remain
constant. Therefore, if the growth rate of capital accumulation is Ql + r/(1-U), the rate of increase in
production will also be [Ql + r/(1 - U)] and here the conditions of steady growth will be met. If SY/K > Ql +
r/(1-U) which means that growth rate of capital accumulation will be more than its counter part critical rate.
In such situation, the MPK and profits will decrease leading to reduce the savings. In this way, the SY/K
will fall till it reaches the
critical level Ql + r/(1-U). If at any time SY/K < Ql + r/(1-U), this shows that income will grow more than
increase in capital leading to increase the savings till it reaches the critical level Ql + r/(1-U).

All this shows that Ql + r/(1-U) is a condition to maintain the steady economic growth which Meade
calls "Critical Rate of Growth".

Evaluation of the Model:

The Meade's model tells that economic development is based upon growth of population, capital
accumulation and technical progress. It means that the model presents the determinants of steady growth
in a better way. But this model is close to classical model when it also assumes perfect competition and
constant returns to scale. But this model fails to entertain the social and sociological effects in the growth
process. Therefore, it is hardly applicable in case of UDCs where the social and sociological obstacles
hinder economic growth.

Criticism:
The neo-classical model of economic growth is a reaction against Harrod-Domar (H-D) model of
economic growth which states that the ratio of capital to labor remains fixed. Hence there are reduced
chances of equality between warranted growth rate and natural growth rate. Whereas the neo-classical
economists dismiss the assumption of constancy of capital-labor ratio. They are of the view that both
labor and capital are substitutable. The neo-classical model also portrays the process of economic
growth, but it is better than H-D model, because it reaches a stable equuilibrium level whereas it was not
the case with H-D model. Still this model suffers from following drawbacks, according to Prof. A.K. Sen.

(i) The neo-classical model tries to create equality between GW and Gn, but fails to create an equality
between G and GW.

(ii) In neo-classical model we do not find the existence of investment function. If it is introduced, the
results will be different.

(iii) In this model the prices of factors have been assumed flexible, but such assumption may serve an
obstacle in the way of economic development.
(iv) The assumptions of the model like perfect competition and constant returns to scale may not be true
in practical life.

(v) The neo-classical model assumes technical progress as an exogenous factor. Therefore it ignores
investment in research, and capital accumulation for technical progress.

Meade Model and UDCs:

So many economists are of the view that neo-classical model does not apply in case of UDCs. In this
respect, they give following arguments.

(i) In UDCs the well defined production function is non-existing.

(ii) The marginal productivity theory loses its efficacy in UDCs where the concept of family labor prevails,
rather wage labor.

(iii) In UDCs the structure of the market and financial mechanism operates in such a way that it is difficult
to equalize the rate of interest and rate of profit. Such equality may be possible, perhaps of organized
money markets in the cities.

(iv) In UDCs it is difficult to determine the nature of capital. Moreover, here all the units of capital are not
alike.

(v) The neo-classical- model is based upon the concept of marginal productivity. But in case of UDCs it is
difficult to assess marginal productivity. Here the rains as well as droughts may change the marginal
productivity. Accordingly, how wages will be determined on the basis of marginal productivity.
Schumpeter Model of Economic Growth:
The Schumpeter model of economic growth moves round the inventions and innovations. This model
is explained with the followings:

(1) Process of Production, (2) Dynamic Analysis of the Economy, (3) Trends of Growth, (4) The Demise of
Capitalism.

(1) Process of Production in Schumpeter Model:

The process of production shows the combination of productive forces which result in the production of
goods. These productive forces are composed of material and immaterial factors. The physical or material
factors consist of land, labor and capital, while non-physical or immaterial factors are composed of
technical facts and social organization.

Thus Schumpeter production function is as:

Y = f (L, K, N, S, U)

Where; Y = output of the economy, K = produced means of production, L = labor, N = natural resources,
S = technology and U = social set-up or social organization.

Taking total differential of production function and then dividing it by dt.

According to this equation the production of the economy depends upon the rate of change of productive
forces (dK/dt, dN/dt, dL/dt), the rate of change of technology (dS/dt) and the rate of change of social set-
up (dU/dt).

(2) Dynamic Evaluation of Economy in Schumpeter Model:

In respect of dynamic analysis of economy we present two types of effects.

(i) The effects of change in factors of production like K, L and N, which he calls "Growth Components".

(ii) The effects of change in technological and social changes, as the effects of changes in S and U, which
he calls "Evolution Components".

In respect of growth components he keeps the land as fixed. As dN/dt = 0.

Then we have the remaining two variables like change in population (dL/dt) and change in means of
production (dK/dt).

dL/dt: Regarding population he says that it is an exogenous variable. In other words, the exogenous
factors determine population in the economy. He further says that the population growth is a slow
process, and it is not furnished with heavy fluctuations. Thus the population function will be as: L = f (t).
dK/dt: Regarding capital goods or produced means of production Schumpeter says that their change
depends upon savings. Whereas savings depend upon rate of profit. But it is not possible to get profits
without development and without profits the development is not possible. He says that according to
circular flow of NI, the value of a product will be equal to its costs. In this way, no profits will be accrued.
But Schumpeter says that when new technique? are introduced they will generate profits. It means that in
capitalistic system the profits depend upon technology. In other words, the stock of capital changes due
to change in applied technical knowledge. It is as:

dK/dt = k (dS/dt)

This shows that in Schumpeter model the capital accumulation is attached with technical changes. The
increase in technical changes lead to increase in capital accumulation.

dU/dt: Regarding institutional and social changes Schumpeter says that it is a complicated situation and
it is attached with social, psychological, technical and political atmosphere of a country. Thus, it is as:

dU/dt = u (K, L, N, S, U)

Thus we find that in Schumpeter model the change in production of the economy depends upon
technological change and socio-cultural set-up of the economy.

Role of Technology in Development:

Now we discuss the effect of technology on economic development. Schumpeter says that economic
development is the result of discontinuous technical changes. He says that the process of economic
development can be initiated with five different events, like:

(i) Introduction of some new good, (ii) Introduction of some new technique of production, (iii) Discovery of
some new market, (iv) Discovery of some new source of supply, (v) The change in the structure and
organization of some industry.

Because of such all changes the absorption of factors of production changes.

Role of Entrepreneurs in Development:

Schumpeter says that 'Entrepreneur' is such a factor of production who introduces new combinations of
factors of production. He is neither a technician, nor he is a finance manager. He just makes inventions
and innovations. He makes inventions just for the sake of inventions. However, he is also influenced by
the desire of profit and socio-cultural set-up of the society. In order to perform his economic functions the
entrepreneur is need of two things:

(i) He must be having technical knowledge so that he could produce new goods.

(ii) He could easily get the funds. In this respect, credit plays an important role. Because of credit, an
entrepreneur gets a command over factors of production. Not doubt, in short run the credit leads to create
inflation in the economy, but still it encourages the inventions and innovations.

The above discussion reveals that in Schumpeter model, economic growth depends upon technical and
technological conditions of the economy. Whereas the technological changes depend upon the activities
of entrepreneurs; and the activities of entrepreneurs depend upon entry of new. entrepreneurs and
creation of credit.

(3) Trends of Growth in Schumpeter Model:

According to Schumpeter the capitalistic economies possess the properties of cyclical fluctuations, i.e.,
they are furnished with booms and depressions. The entrepreneur or entrepreneurs who invent some
new technique of production or some new product when it is introduced in the market the producers earn
heavy profits. After some interval the other firms also produce that very product. In this way, the supply of
that product increases in the market. As a result, the economy will experience increased level of income
and employment. But, because of abundance of goods in the market the prices of goods fall leading to
create depression in the economy. In such situation some new entrepreneurs will come forward who will
invent new techniques of production or some new product. This will create revival and then boom in the
economy and finally the economy will enter into the phase of boom. All such means that according to
Schumpeter the inventions and innovations are responsible for trade cycles in the capitalistic economies.

(4) Prediction on Decline of Capitalism:

Like Karl Marx Schumpeter also thinks that eventually the capitalism will come to an end and it will be
replaced by Socialism.

In this respect, he gives following arguments:

(i) Along with the evolution of capitalism the entrepreneurs and their techniques of production will get
obsolete. The salaried managers will take-over the charge of industrial units in place of entrepreneurs.

(ii) Technical changes on the one side, create economies. But, on the other hand, the expansion in the
industrial net-work along with the growth of capitalism, the trade unions and other bargaining activities will
flourish.

(iii) Along with the growth of capitalism the 'Liberalism' will increase. This will weaken the institution of
'Monarchy'. The capitalistic class will get weaker, and it will depend upon civil and military bureaucracy. In
this way, an unrest will develop in the society.

(iv) The capitalism will promote emaciation and women rights. It will disrupt the family life.

(v) The capitalism provides the right to speak and write. The people will express their dissatisfaction
against capitalism in tea-houses, parks, hotels and in journals and newspapers.

In this way, the capitalism will finally convert into socialism. Thus according to Schumpeter the capitalism
will have a 'Self-Demise".

Criticism:
(i) In Schumpeter Model 'the inventor and innovator' has been accorded as an 'Ideal Man'. But now a
days the inventions and innovations are the routine activities of industrial concerns. Schumpeter further
says that economic fluctuations occur because of inventions and innovations. But it is not true. They
come into being because of business expectations, psychological behavior and monetary and fiscal
measures.

Again, Schumpeter assigns top importance to inventions and innovations in respect of economic
development. But in Pakistan like countries where there is shortage of funds and resources the inventions
cannot be made.

(ii) Schumpeter depends upon credit creation for the sake of inventions. But it is objected by saying that in
short run the Bank Credit may be helpful for industrial development. But in case of long run the bank
loans will be inadequate for such development. In such situation, the industrial development will be
depending upon sale of shares etc.
(iii) According to Meir and Baldwin it is wrong to say that society, will eventually move towards socialism.
As if we analyze Europe and America like capitalist countries they have a higher degree of industrial
development. They have a right to speak and write. But till now no possibility has emerged whereby the
rich capitalist country could turn towards socialism. While the reverse has occurred and the socialists
countries are converting themselves into 'Market Economies', after the disintegration of Soviet Union.

Schumpeter's Model and UDCs:

(i) Schumpeter's model is concerned with that particular social and economic structure which prevailed in
Europe and US in 18th and 19th century. But such model is least applicable in case of Pakistan like
developing countries. Our socio-economic structure is different from them. We do not have the necessary
requirements of growth.

(ii) The Schumpeterian model is based upon 'Entrepreneurs'. But in UDCs, there is a shortage of these
people. Here the rate of profit is low. The technological level is poor. Consequently, the spirit to invent
and innovate remains lacking. Moreover, lack of funds, poor means of transportation and research
facilities discourage the potential entrepreneurs.

(iii) In UDCs so many projects are controlled by govts. because they have low profits, the risks are more;
and they are run by bureaucrats and managers which hardly engage themselves in inventions and
innovations.

(iv) Economic development is associated with so many economic and non-economic factors. Whereas
Schumpeter attaches economic development with just inventions and innovations.

(v) In case of UDCs the entrepreneurs follow and copy those techniques and products which have gone
obsolete in DCs, rather making inventions.

(vi) According to Schumpeter the internal circumstances of an economy will generate economic
development. But UDCs are surrounded by centuries old sufferings, problems, agonies, traditions,
customs and techniques of production etc. In such like situation, the Schumpeter's model will lose its
efficacy there.

(vii) In UDCs the population growth is a big issue. The rising population often distorts the growth efforts.
In such state of affairs what the Schumpeter's inventions will do?

(viii) Schumpeter depends upon 'Credit' for economic development. But in case of UDCs where
production can not be enhanced the inflation will rise which will thwart the process of growth.
Secular Stagnation - Hansen's Thesis:
A.H. Hansen is also known as American Keynes. He has analyzed trade cycles, as well as he has
suggested the measures regarding sustained economic growth. The basic notion behind 'Secular
Stagnation' is this that the capitalistic economy is basically characterized with instability. Therefore, to
create a coordination between the economic activities state should interfere.

Features of the Thesis:

The followings are the salient features of this Thesis:

(i) The fall in the birth rate will affect the process of economic growth. In this way, the economic motivation
will come to an end and the economy will experience stagnation.

(ii) The economic motivation and development will also be influenced by fall in autonomous investment
due to fall in population. Again the discovery of new resources will also become difficult.

(iii) The population of a country, the number of its people, and the people itself play an important role in
the economic life and in economic fluctuations.

The other economists like Mathews, Gordon, Handerson and Kurihara have also supported Hansen.
They are of the view that the fluctuations in supply of labor play an important role in the determination of
time schedule of trade cycles. After 1930's Great Depression a thinking developed in US and UK that they
cannot only face short run unemployment, but they can also experience the depression and crisis relating
to long run period. This may occur due to fall in MEC in long run. The economic growth in long run is
attributed to rise in per capita income. While the stagnation shows that in long run the per capita income
has become constant or it has fallen down, or it increases less than earlier.

According to Hansen, such all happens that the capitalistic economies fail to maintain that high level of
income and employment which could be possible due to the potential resources of the economy and
technical progress. The secular stagnation theory is concerned with the Maturity stage of capitalistic
economies, where the savings increase at the level of full employment but the net investment falls. As a
result, the economic activities shrink. The short run crisis and depressions become acute and tense. The
boom and prosperities are weaker and short-lived whereas the depressions are stronger and long-lived.
Hansen further says that the sick type of revivals die even in their infancy while the depressions become
powerful and powerful. Consequently, the problem of unemployment gets acute day by day.

Thus, according to this theory a developed and mature economy may experience 'Deflationary
Gap'. And in case of long run the determined level of income may be at below full employment level of
national income. In such situation there will be unemployment and the level of the output of the economy
will be far less than that output which could be possible because of the resources of the economy. In such
situation the level of income may be less than earlier, or the increase in output of the economy may be
very slower. It is explained with fig.

Diagram/Figure:
Here YP represents that crude level of GNP which an economy can produce, whereas YA curve
represents actual GNP of the economy. The secular stagnation of the economy starts at time "T", and
after the time "T" the difference in between the potential GNP and real GNP increases. When the actual
GNP of the economy reaches the point S the secular stagnation starts, as after S the income of the
economy increases slowly. It may assume the shape of YC where income is increasing at a constant rate;
or income may fall down as shown by YD curve.

Secular Underdevelopment Equilibrium:

At the secular under employment level, equilibrium may occur due to two reasons:

(i) At full employment level the investment is not capable enough to offset the savings.

(ii) The propensity to consume remains more or less constant.

Because of these reasons such a level of equilibrium will come into being where unemployment will grow
in the economy. This situation will last for a longer time. And when unemployment or under employment
lasts for a longer period of time it is given the name of secular stagnation equilibrium. It is explained with
fig.
.
We suppose that the point Eo represents full employment equilibrium level of NI. Here the AD curve (C +
I) is capable enough to offset the savings which are being made at Yo level of NI (assumed to be full
employment level). In other words, here the investment of full employment is equal to savings of full
employment. Because of many a reasons, the investment decreases - as shown by the curve C/ + I/. This
intersects C + S curve at E1
leading to the income level of OY1. This level of income is lower than Yo. Because of fall in income the
people will get unemployed. Therefore, in order to maintain the income of full employment either the
savings will have to be decreased or investment will have to be increased. If savings decrease the
consumption will increase and AD will not fall and the economy will go on operating at full employment. In
this way, the secular stagnation could be avoided.

According to Hansen, because of fall in MEC the level of investment comes down. The decrease in
investment ultimately generates unemployment and stagnation. Not only Hansen, but the orthodox
economists like Smith, Ricardo, Marx, J.S. Mill and modern economists like Schumpeter, Harrod and
Domar agree upon it that in capitalistic economies the rate of profits have a tendency to fall down. As a
result, the capitalistic system will face stagnation and crisis. The same like is identified by Smith and
Ricardo's models of economic growth which state that after economic maturity an economy enters into
'Stationary State'. While Marx and Schumpeter's model conclude with the "Demise of Capitalism". Again,
according to H - D model it is difficult to maintain equilibrium at full employment.

Keynesian View about Secular Stagnation:

Keynes himself did not present any theory regarding secular stagnation. However, he was agreed with
this that because of fall in population investment will decrease. To meet this situation, either the rate of
interest will have to be decreased or consumption expenditures will have to be increased. Moreover,
Keynes says as an economy gets affluent the gap between actual and potential output will increase. In
such situation the defects of capitalistic system will come to lime-light- In affluent societies the MFC
becomes weakened as well as the attraction in investment opportunities comes down because of
concentration of capital in a few hands.

Therefore, according to Keynes and MRs Robinson, followings are the reasons of secular stagnation:

(i) The exogenous factors like technology, increase in population, and discovery of new regions and
markets.

(ii) The endogenous factors like concentration of industries and growth of monopolistic competition.

(iii) The social changes in the society as govt's control over the businesses and pressure of trade unions.

In addition to these basic reasons the economists present the following theoretical reasons regarding
secular stagnation.

(i) The paradox of thrift.

(ii) The income inequalities which promoted savings.

(iii) The increased corporate savings, the increase in the ratio of dividends and the growth of insurance
business which increased savings.

(iv) The population declined in Europe and US which reduced investment.

(v) Because of fall in population and non-discovery of new regions etc. the expenditures will not have to
be made on means of transportation, bridges, canals and power houses etc. As a result, the investment
will decrease.

(vi) Along with growth of capital the MEC will decrease. This will discourage new investment.

(vii) Because of growth of capitalism the demand for capital saving technology also increased which
decreased investment. As with the growth of atomic technology the demand for hydle and thermal plants
has decreased.

(viii) The inventions and innovations reduced employment or encouraged unemployment. Again, with the
passage of time the space race expenditures and defense expenditures are decreasing. With this all
investment is decreasing.

(ix) The external trade sector problems are rising; the exports are not increasing; the climate for foreign
investment is not improving; and the flow of foreign aids and loans is decreasing. Consequently, the
investment and expenditures remain low.

Because of all the above mentioned reasons either the savings increase or investment decreases. As a
result, the capitalistic economy will face secular stagnation.

Criticism:
(i) The economists like Fellner, King and J.H. Williams have discarded the Hansen thesis. They say that it
is based upon exaggeration. They say that in UDCs the population is decreasing and the discovery of
new territories has also come down. As a result, the investment has come down in UDCs. But as far as
Pakistan, India, Africa and Latin American countries are concerned such like situation is not available
there. In such countries the economy as well as society is moving towards a change. The non-monetized
economy is converting itself in a monetized one. The plough is replaced by a tractor; and the handicrafts
are being replaced by manufactured goods. Accordingly, in such economies how the secular stagnation
will come into being. Here, neither over savings nor under investment is taking place.
(ii) In case of DCs the Keynes psychological law of consumption has been refuted which states that MFC
< 1. As according to Dusenberry, Modigliani and Friedman's theories of consumption the value of MFC is
equal to one, and the APC is not decreasing in case of affluent societies. Consequently, the rising of
consumption expenditures in DCs will lead to increase the investment, rather decreasing it.

(iii) Haberler, Peterson, Dusenberry and Learner are of the view that the secular stagnation theory is
based upon 'fall in population'. But it is incorrect to say that investment would take place just on the basis
of increase in population. The changes in the tastes of the population can also become responsible for
increase in investment. In mature economies the style and designs of automobiles, aircrafts and other
consumer durables are changing day by day. All this is increasing investment. In such situation, the
secular stagnation theory will be nothing more than an exaggerated story.

(iv) If we observe the circumstances of DCs we find that in these countries govts are spending reasonable
amounts on transfer payments, old age benefits, subsidies, and social security measures. Again, the easy
monetary policies are also being followed in these economies. All such is increasing aggregate demand.
Rather creating secular stagnation they are creating inflation.
Kaldor - Mirrlees Model of Economic Growth:
Kaldor presented his first model of economic growth in 1957 and second model in 1962. But here we will
present that model which he presented in 1962 along with collaboration of Mirrlees.

Features of the Model:

The salient features of Kaldor - Mirrlees Model of Economic Growth are as:

(i) By making the saving rate flexible a constant growth rate of the economy can be attained.

(ii) Contrary to neo-classical economists, the capital - output ratio remains fixed and constant.

(iii) This model rejects the production function approach. Rather, it introduced the function of technical
progress.

(iv) In neo-classical model the investment function has not been introduced. But this model also presents
the investment function which depends upon that investment which is linked with one laborer.

(v) In this model the assumptions of full employment and perfect competition have been dropped.

This model starts with this hypothesis that national income (Y) is the sum of wages (w) and profits (p). It is
as:

Y=W+P

The total savings (S) consist of savings made out of wages (Sw) and the savings made out of profits (Sp).
It is as:

S = Sw + Sp

Where Sw = SwW and Sp = spP, then putting them in the above equation:

S = swW + SpP

Where sw = marginal propensity to save of wage earners, and sp = marginal propensity to save of profit
earners. The sw and sp are assumed constant. It means that their average and marginal values will
remain the same. Thus, as:

Y = W + P or Y - P = W and S = swW + spP

Then putting the value of W:

S = sw (Y - P) + spP

S = swY - swP + spP

S = spP - swP + swY

S = (sp - sw) P + swY

As at Equilibrium S = I, then putting the value of S:

I=S
 I = (sp - sw)P + swY

Dividing both sides by Y:

I = (sp - sw) (P) + swY

Y Y Y

I - swY = (sp - sw) (P)

Y Y Y

I - sw = (sp - sw) (P)

Y Y
Solving for P/Y:

The last equation shows the ratio between profits (P) and the level of income (Y). The stability of the
model requires that:

0 ≤ sw ≤ sp ≤ 1

The flexibility of savings in Kaldor-Mirrlees model can be obtained with the help of different
propensities with respect to wages and profit. If we are having the values of sp and sw (which can be
obtained with the help of income distribution in a country) we can tell that what are the determinants of
1/Y and P/Y. If we assume that sw = 0, then the last equation will assume following shape:

P= 1 . I - 0
Y sp - 0 Y sp - 0

P= 1 . I
Y sp Y

If capital-output ratio (K/Y) is considered constant, (as it was assumed in H - D model), then the above
equation is multiplied by (Y/K).

P (Y/K) = 1 . I (Y/K)
Y sp Y

P/K = (1/sp) . (I/K)

If P/K is shown by V which represents profit on capital, and I/K is shown by J which represents capital
accumulation the above equation will be as:

V= 1/sp . (J) or (sp) (V) = J

If sp = 1, then V = J

If the natural growth rate is shown by 'n' and it is assumed as given, then the above equation will be as:
 V=J=n

The equation shows that the growth rate is associated with the rate of profits, and it is determined by
propensity to profit.

Criticism:
(i) According to Prof. Pasinetti there exists a logical defect in Kaldor's arguments as he permits the
laboring class to make the savings, but these savings are neither ploughed in capital accumulation, nor
they generate income. He further says that if any country lacking the investing class and there are no
profits, then how the growth rate will be determined.

(ii) Kaldor assumes that the saving rate remains fixed. But assuming so he ignores the effects of 'Life-
Cycle' on savings and work.

(iii) Kaldor model fails to describe that behavioral mechanism which could tell that distribution of income
will be such like that the steady growth is automatically attained.
Golden Rule of Economic Growth:
Mrs. Joans Robinson Model of Economic Growth:
Mrs. Robinson includes the issue of population growth in her model. She shows the effects of Population
on the rate of Capital Accumulation and rate of Growth of Output.

Her model is based upon two conditions:

(i) Capital accumulation depends upon distribution of income.

(ii) The utilization of labor depends upon supply of labor and capital.

Assumptions of the Model:

(i) National income is distributed between two classes of the economy, i.e., labor and producers.

(ii) The laborers entirely spend their wages on consumption and do not make savings.

(iii) The producers who earn profits make the savings and reinvest such savings and do not make any
consumption. If they do not earn profits, they will not be able to invest. And if they do not invest, they will
not be able to earn profits.

(iv) There are no technological changes and ratio of K to L remains constant.

(v) There is no change in price level.

(vi) There is closed economy and no intervention by the state.

(vii) There is no shortage of supply of labor in the economy.

As told above that model assumes the existence of two classes in the economy. The labor class
consumes all of its income while the entrepreneurs reinvest their profits. Accordingly, the real savings
remain equal to real investment. But how much money producers invest, depends upon the real wages
demanded by. the labor. Moreover, the productive efficiency and BOP, etc., are obstacles in the way of
promoting investment. As the economy grows, such obstacles become high and high. Thus, in the
presence of such obstacles, economic growth depends upon the role of entrepreneurs. If they make
inventions and innovations then the obstacles in the way of economic growth will be surmounted. In this
way, the economy will enter in a stage which is known as Golden Age by Mrs. Robinson. Here, capital
accumulation is at a higher rate. Here, capital accumulation is maintained through the constant rate of
profit - which is known as Golden Rule of economic growth by Mrs. Robinson.

The growth rate during golden age will be similar to Harrod's Natural Growth rate. We now explain the
model symbolically.
The equation (3) shows that the rate of profit (π) depends upon the efficiency of labor = p = Y/N, real
wages (w/P) and the ratio of K to N. i.e., θ = K/N.

As producers wish to maximize their profits. Accordingly, we will take first derivative of profit function and
keep it equal to zero. As P.F. is:

Y = f (N, K) ............. (4)

Equation (11) shows the growth rate of capital which the entrepreneurs can attain by depending upon
capitalistic principle. This equation also shows that growth rate of capital may grow if net return of capital
(p - w/P) increases more than capital labor ratio (9). As Ricardo said, "Capital accumulation will be
strengthened if the level of real wages is low". This means that Mrs. Robinson wishes to take us towards
Ricardian growth theory through Keynesian window.

In Robinson's golden age, at equilibrium, labor will be fully employed and full use of capital will become
possible. But such will happen only if θ = K/N remains constant. At Yf, the rate of change of labor and rate
of change of capital will be equalized. It is as:

K/N = θ

K = Nθ

K/θ = N

N = K/θ

In case of change, we have:

ΔN = ΔK/θ
From this relation we can find the rate of change of labor force having compatibility with the rate of
change of capital.

Dividing both sides by N, we get:

The eq.(12) shows that the labor will be fully employed if labor and capital grow at the same rate or if
capital grows at the same rate to that of growth of labor, Yf of labor will become possible. Because in this
situation the ratio of K to N, i.e., θ will remain constant. When labor and capital grow in the same ratio -
the equilibrium position of the economy is known as Golden Age. It is shown in fig.

Diagram/Figure:

Here, OW* is minimum wage rate. ON is growth of labor force. While OY* is expansion path. At C, we
draw a tangent. Here, K/N = OK, while growth rate of labor is ON*. The wages given to labor are OW*,
then the rate of surplus (profits) will be equal to HC. Such profits will be able to absorb the growth of labor
which is ON*. This is the golden age, because profits absorb the labor growth.

Golden Age:
Showing the effect of capital accumulation on growth of the economy, we show the effects of growth of
labor force on economic growth. She says if in an economy, population and labor grow but capital does
not grow. As a result, the MPL will decrease. If real wages remain constant then profits of producers will
decline - badly affect the capital accumulation.

This will result in unemployment, as it is happening in LDC's. Thus Yf ia possible only if increase in labor
force and increase in capital are equal. This is the golden age. It is as:

ΔN/N = ΔK/K

In golden age, the proportion of profits and wages remain the same. All the variables in the economy
grow at the same rate. Under the proper rate of capital accumulation - there is a neutral technical
progress and there is a constant ratio between capital and output.
Neo-Classical Theory of Economic Growth:
We know that Hicks, J.E. Meade, Mrs. Joan Robinson, Salow and Prof. Swan are Neo-Classical
economists. They have presented their growth models individually as Meade model (1961), Solow model
(1956, 1960), Swan model (1956), and Mrs. Joan Robinson model (1956, 1999). Now we present all
these models in a single model which wee simply call Neo-Classical Model of Economic
Growth, where we discuss the salient features of neo-classical theory and this model is called a
reaction to H-D model.

(i) According to H-D model economy is always prey to instability. But according to Neo-Classical, if capital
- output ratio is made flexible, the instability will come to an end.

(ii) The basic Neo-Classical model assumes that in long run the constant - returns to scale applies and no
technical progress takes place in the economy. The stock of capital can be adapted in capital intensive
technology, more or less. It means that labor and capital are substitute table. Accordingly, by changing
the capital labor ratio the equality can be brought in changes in labor, capital and output. This model also
assumes that the factor prices are equal to their marginal productivities. Accordingly in this model, there
exist flexibility of wages, prices and rate of interest.

(iii) Whenever warranted growth rate exceeds natural growth rate the economy will cross the ceiling of
full-employment. In such situation the labor saving technology will be used. As a result the capital-output
ratio will increase. This will depress down the warranted growth rate till it becomes equal to natural growth
rate. On the other band, if warranted growth rate is lower than natural growth rate the excess amount of
labor will emerge. As a result, real rate of interest will fall as compared with real wage rate. This will
induce the firms to adopt labor intensive technology. In this way, the capital-output ratio will fall. This will
lead to increase warranted growth rate (s/v) till it becomes equal to natural growth rate.

(iv) According to neo-classical model because of changes in v and s/v the Harrodian instability and
Raisor's Edge will not persist, and economy can attain a steady-state equilibrium. Its means to say that in
neo-classical model the equilibrium growth rate coincides with dynamic disequilibrium where output, stock
of capital, supply of labor
and change investment, all will grow at the same exponential rate. In such situation there will be no
change in K, L and Y, This situation is accorded as Golden Age following Mrs. Joan Robinson. Thus in
Golden Age, the following situation will occur:

Q = Qo eqt, K = Ko eht, L = Lo emt, I = Io emt

Where Q = output, K = Capital, L = Labor, and I = Investment. The signs of bars on all the variables
represent the constant values in the golden age, while the m, n, h and q represent constant growth rates.

(v) According to neo-classical model at the level of full employment, the investment will be equal to the
level of savings at the level of full employment and net investment (I) will be equal to level of stock of
capital (dk/dt). As I = dk/dt = sQ, hence Io emt = h Ko eht = sQo eq. For all the values of t, last
equation will hold true if growth rates of m, h and q are equal to each other. It is reminded that according
to neo-classical theory, the growth rate of Golden Age is not influenced by growth of savings, and it is
contrary to H-D model. It is due to the reason that whenever the proportion of savings increase there will
by growth of capital and output. But such increase will be temporary because due to operation of law of
decreasing returns the initial growth rate will be existing. As if growth of capital increases more than labor,
the marginal productivity of capital will decrease leading to decrease the growth rate of output. Thus
according to neo-classical growth model, because of changes in capital-labor ratio and flexibility of
wages, prices and interest rate the economy will attain a stable equilibrium. Here, growth of savings (sQ),
growth of capital (sQ/k), growth of output (q) and growth of population (n) will be equal to each other, as:
 q = sQ = (sQ/k) = n

It is shown with fig.

Diagram/Figure:

Here the schedule sQ/k shows the growth of capital which is function of output - capital ratio (Q/K), and
slope of this curve shows the saving ratio (s). The growth of output curve q1 passes in between growth of
labor schedule (n) and growth of capital schedule (sQ/k). The output is divided on the basis of elasticities
of capital and labor (a and B). In this figure, after E, the growth of capital is more than growth of output.
This leads to decrease Q/K, hence equilibrium is established at E. While before E, growth of output is
more than growth of capital. This will lead to increase Q/K. Thus Q/K2 is an equilibrium Q/K which is
stable one where growth of capital (sQ/K) growth of output (q) and growth of population are equal.