CHAPTER

44
State Growth Steady State Growth
MEANING
The concept of steady state growth is the counterpart of long-run equilibrium in static theory. It is consistent with the concept of equilibrium growth. In steady state growth all variables, such as output, population, capital stock, saving, investment, and technical progress, either grow at constant exponential rate, or are constant. Taking different variables, some of the neo-classical economists have given their interpretations to the concept of steady state growth. To begin with Harrod, an economy is in a state of steady growth when Gw=Gn. Joan Robinson described the conditions of steady state growth as Golden Age of accumulation thus indicating a mythical state of affairs not likely to obtain in any actual economy. But it is a situation of stationary equilibrium. According to Meade, in a state of steady growth, the growth rate of total income and the growth rate of income per head are constant with population growing at a constant proportionate rate, with no change in the rate of technical progress. Solow in his model demonstrates steady growth paths as determined by an expanding labour force and technical progress.

PROPERTIES OF STEADY STATE GROWTH*

The neo-classical theory of economic growth is concerned with analysing the properties of steady state growth based on the following basic assumptions of the Harrod-Domar model: 1. There is only one composite commodity which can be consumed or used as an input in production or can be accumulated as a capital stock. 2. Labour force grows at a constant proportional rate n. 3. Full employment prevails at all times. 4. Capital-output ratio (v) is also given. 5. Saving-income ratio (s) is constant. 6. There are fixed coefficients of productions. In other words, there is no possibility of the substitution of capital and labour. 7. There is no technical change (m). The neo-classical growth models discuss the properties of steady state growth by incorporating and relaxing these assumptions. In order to discuss the properties of steady state growth, we first study the Harrod-Domar model briefly. The Harrod-Domar model is not a steady state growth model where Gw ( = s/v ) = Gn (=n + m). It is one of knife-edge balance between cumulative inflation and cumulative deflation. It is only when the warranted growth rate s/v equals the natural rate of growth n+m, that there will be steady state growth. But, s,v.n and m being independent constants, there is no valid reason for the economy to grow at full employment steady state. So we discuss the roles assigned to them one by one in neo-classical growth theory. 1. FLEXIBILITY OF n Economists like Joan Robinson and Kahn have shown that the presence of unemployment is compatible with steady growth. So the assumption of the growth rate of labour force at full employment is dropped. Instead, it is replaced by the condition that the growth rate of employment should not be greater than n. For steady growth it is not necessary that s/v=n. Rather, equilibrium growth is compatible with s/v<n. This is what Kahn calls a bastard golden age as against Joan Robinsons golden age where s/v=n. In a bastard golden age, the rate of capital accumulation (s/v) is less than the growth rate of population (n), so that unemployment increases. In this age, capital stock is not growing faster because of inflationary pressures. Rising prices mean a lower real wage rate. When the real wage rate is at the tolerably minimum level, it sets a limit to the rate of capital accumulation. 2. FLEXIBLE CAPITAL-OUTPUT RAIO (v) Now we turn to the second assumption of the Harrod-Domar model, that of a constant capitaloutput ratio (v). Solow and Swan have built models of steady state growth with a variable capital-output ratio. Theoretically, the Harrod-Domar assumption of an unchanging capital-output ratio implies that the amount of capital and labour required to produce a unit of output are fixed. The neoclassical economists postulate a continuous production function linking output to the inputs
* The following sections also relate to the Basic Neo-Classical Growth Model.

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of capital and labour. The other assumptions of constant returns to scale, no technical progress and constant saving ratio are retained. Solow-Swan show that because of the substitutability of capital and labour and by increasing the capital-labour ratio, the capital-output ratio can be increased and hence the warranted rate s/v can be made equal to the natural rate, n+m. If the warranted growth rate exceeds the natural growth rate, the economy tries to break through the full employment barrier, thereby making labour more expensive in relation to capital, and making inducements to shift to labour-saving techniques. This raises the capital-output ratio and the value of s/v is reduced until it coincides with n+m. If, on the other hand, the warranted growht rate is less than the natural growth rate, there will be surplus labour which lowers the real wage rate in relation to the real interest rate. Consequently, more labour-intensive techniques are chosen which reduce the capital-output ratio (v) thereby raising s/v. This process continues till s/v equals n+m. Thus, it is the capital-output ratio which maintains the steady state growth singlehanded while s, n and m remain constant. This situation is explained in Fig. 1 where capital-labour ratio (or capital per man) k, is taken on the horizontal axis and output per man, y, is taken on the verticle axis. The 450 line OR represents capital-output ratio where the warranted growth rate equals the natural R y Y growth rate. Every point on OR also shows a T constant capital-labour ratio. OP is the T" production function which measures the P A A2 marginal productivity of capital. It also Y T' expresses the relation between output per man (y) and capital per man (k). The tangent WT to the production function OP indicates the rate of profit at point A corresponding to the W At marginal productivity of capital. It is at this point A that the warranted growth rate equals the natural growth rate, i.e., s/v=n+m. Here the 0 45 k share of profit is WY in national, income is OY, O K2 K K1 and OW is the wage per man. Assume a Fig. 1 situation K2 where the stock of capital is above the equilibrium stock. It indicates that the capital-labour ratio is above the full employment equilibrium level ratio at A2. Thus, there is some idle capital which cannot be utilised and the rate of profit declines (which can be shown by joining tangent T" at A2 to the Y-axis where it shall be above OW) till it reaches point A of steady state growth. The opposite is the case at K1 where the growth rate of capital accumulation is higher than that of labour force. The rate of profit increases at A1 (which can be shown by joining the tanget T' to the Y-axis where it shall be below OW) till the steady state growth point A is reached. In the Harrod-Domar model there is a single point of equilibrium A on the production function OP because the capitaloutput ration (v) is fixed. But in the new-classical model there is a continuous production function along which the capital-output ratio is a variable and if the economy is thrown off the steady state level A, it will itself return to it by variations in the capital-labour ratio. Thus the equilibrium value of K is stable.

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315

3. FLEXIBILITY OF SAVING RATIO (s) The Harrod-Domar model is also based on the assumption of a constant saving-income ratio (s). Kaldor and Pasinetti have developed the hypothesis which treats the saving-income ratio as a variable in the growth process. It is based on the classical saving function which implies that savings equal the ratio of profits to national income. The hypothesis is that the economy consists of only two classes, the wage-earners and the profit-earners. Their savings are a function of their incomes. But the propensity to save of profit-earners(sp) is higher than that of wages-earners (sw). As a result, the overall saving ratio of the community depends on the distribution of income. A special case of this hypothesis is where the propensity to save out of wages is zero (sw=0) and the propensity to save out of profits is positive and constant. Thus the overall propensity to save (s) is equal to the propensity to save of profit-earners (sp) multiplied by the ratio of profits () to the national income (Y), i.e., S = sp./Y. This is th classical saving function. There is also the extreme classical saving function where all wages are consumed (sw=0) and all profits are saved (sp=1). Hence the saving-income ratio s = /Y. With a constant capital-output ratio (v) and a variable saving-income ratio (s), steady state growth can be maintained through the distribution of income. So long as the saving-income ratio (s) required to satisfy the condition s/v=n+m is not less than the propensity to save of wage-earner (sw=o) and not greater than the propensity to save of profit-earners (sp=1), steady state growth will be maintained. 4. FLEXIBLE SAVING RATIO (s) AND FLEXIBLE CAPITAL-OUTPUT RATIO (v) Steady state growth can also be shown by taking both the saving-income ratio and the capitaloutput ratio as variables. With the classical saving function given by sp./Y, the warranted growth rate s/v can be written as :

Gw =

s sp Y sp . = = v Y K K

LQs = sp. / Y
v = K /Y

where /K is the rate of profit on captial which can be denoted by r. Thus the warranted rate becomes spr. For steady state growth, spr = n+m, whereby the warranted rate becomes equal to the natural rate of growth. In the special case where sp=1 equilibrium between the two is reduced to r = n+m. Steady state growth with a variable saving ratio and a variable capital-output ratio is shown in Fig. 2. OP is the production function whose slope measures the marginal productivity of capital (r) at any capitaloutput ratio on a point on OP. Equilibrium takes palce where the tangent WT touches the OP curve at point A. The tangent WT originates from W and not from O because savings taking place out of non-wage income WY. Point A indicates the rate of profit corresponding

y T P Y A

O Fig. 2

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to the marginal productivity of capital. In other words, at point A labour and capital receive the rewards equal to their marginal productivities. OW is the wage rate (the marginal productivity of labour) and WY is the profit (the marginal productivity of capital). Thus the steady state equilibrium exists at A. 5. TECHNICAL PROGRESS So far we have explained steady state growth without technical progress. Now we introduce technical progress in the model. For this, we take labour augmenting technical progress which increases the effective labour force L* in the form of a rate of increase in labour productivity. Assume that the labour force L is growing at a constant rate of n in year t, so that Lt = LOent ...(1) with labour augmenting technical progress, the effective labour force L* is growing at the constant rate of in year t, so that L*t = L*Oe (n + ) t ...(2)

where L* represents the total effective labour force in the base period t=o embodying all technical O progress up to that point in time; n is the natural growth rate of effective labour in the base period; is a constant precentage growth rate of effective labour embodied in the base period. Now the production function for output per worker is

q=

Q Q Q = t = f t = f ( k ) * Le L Le

...(3)

where k = K/L*, and the growth rate of k (the capital-effective labour ratio) is equal to the difference between growth rate of capital stock

FK

and the growth rate of effective labour

FL

. . . , i.e. k = K L

...(4)

Since L* = LOe (n + ) t the growth rate of effective labour L* is exogenously given as (n + ), so that equation (4) can be written as

k=
=

Q (n + ) K q (n + ) k
K/L

Lq = Q / L = Q
k K
= f (k) (n+) [Q q = f (k) in equation (3) ...(5)

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317
q

By setting

= O, we have f (k) = (n+)k ...(6)

(n+)k

which is the equilibrium condition for steady state growth with technical progress. This is illustrated in Figure 3 where the capital per effective worker k is taken horizontally and output per effective worker q is taken on the vertical axis. The slope of the ray (n + ) k from the origin to point E on the production function f (k) determines the stable equilibrium values k' and q' for k and q repectively at E and the capital used per unit of effective labour grows at the rate with technical progress.

q'

f(k)

k' Fig. 3