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Solow Model- Growth Potential for China and US

“Using the Solow model, compare the growth potential for the US with that for China. What factors are most likely to affect GDP per head in the short and long run in both countries?” http://economistsview.typepad.com/economistsview/2006/08/differences_in_.html

United States: Growth potential: (Estimates) Saving rate: 5.8% Population: .9% Capita (percent of GDP): 8.29

The Solow growth model uses saving, population growth and technological advances to help predict or determine the level of growth in the standard of living for a country. As we can see the United States does not have a very high saving rate. When a country does not have a high savings rate, we assume that the economy will have a small capital stock and a low level of output in the steady sate. With the low saving rate we can assume that much of the US population spends money as oppose to saving it for the future. A low saving rate also indicates that there will not be fast economic growth. The population growth of the United States is higher than that of China. We can use this to assume that growth in the number of workers causes capital per worker to fall. The Solow model also predicts that countries with higher population growth will have lower GDP per person. The Capital growth affects both output and depreciation. We are not sure of the countries Golden Rule Steady State. If the capital, however, is below the Golden Rule, the increase in capital will raise output more than depreciation so consumption will rise. It is visa-versa when the capital is above the Golden Rule. If I were to assume one way or another, I would think that the saving rate would be increasing, which would lead one to assume consumption is decreasing. This would mean that capital is above the Golden Rule. However the Solow model shows that there are many factors that affect economic growth, so although we make one assumption concerning consumption we do not know the full extent of the changes in economic growth, without knowing all the other factors.

The affects on the economic growth that happen immediately are short run affects. In the short run I would assume that GDP per head in the United States will be lower. We can assume this by looking at the population growth. We have a higher population growth that some other countries so we can assume that in comparison we will have a lower growth of GDP per person. In the long run however the United States will reach the Golden Rule Steady State, and this would mean that the population growth will not have much of an affect on the GDP per head as it may during the short run. In the long run the other factors affecting the GDP per head and the economic growth of the country will begin to equal out so that equilibrium is met.

China: Growth potential: (Estimates) Saving rate: 30% Population: .5% Capital (percent of GDP): 15

Using the Solow growth model again, we can make some predictions about the overall economic growth of China. To start off we can see that China has a very high saving rate. This high saving rate we can assume that China will have a large capital stock and low level of output in the steady state. This high saving rate shows that many people of China’s population save much of their money. One assumption we may be able to make about the high saving rate in China is that people are accustomed to the type of economic life they are already living. So with the great economic growth in China, and the growth of personal income, people are able to save more, not being accustomed to the new, higher standard of living. This (steady) high savings rate in China can also help us predict that the economic growth will continue in the long run. The population growth is not as high in China as it is in the United States. One thing that you may think about when looking at the population growth in China, is the difference in cultures between China and the Unites States. China used to have a one child policy where a family could only have only child. While in the United States the average number of children in a family is usually around 2.5. Using the Solow model, we can assume that the lower population growth will lead to a higher GDP per person, than if the population growth was higher. When looking at the capital growth of China, we can see that this too is above that of the United States. A higher capital growth will cause immediate increases in output and consumption. However as we can see, the saving rate is quite high, and it has been steadily high, so we can assume that there have not been that many large shocks or changes to capital.

Using the numbers above we can assume that in the short run, the change in capital will affect the economic growth right away. When there is an increase or decrease in capital there is an immediate affect. We can also assume that if there was an increase, consumption would rise which would also let one assume that the saving rate would decrease. However in the short run, using the numbers that we have above, I would assume that the GDP per head will be higher in the short run. In the long run however we will meet a Golden Rule Steady State in which the GDP per head will remain fairly constant, this would be because equilibrium is met and the other factors of the Solow model are staying fairly constant, or at least equally affecting the production function as a whole.

Economics


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