Chapter 2 Notes

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Chapter 2: Aid for investment
-What is the financing gap?
Gap between required investment and domestic saving
-Explain the Harold-Domar approach and its failings?
GDP growth will be proportional to the share of investment spending in GDP. Its failings are that this model applied more to the short-run business cycle in rich countries. Also, he was writing in the aftermath of the Great Depression, thus taking high unemployment as given. -True or False. There is no relationship between aid and investment _T_ -What incentives does the financing gap approach provide to recipients? Hint: p.44 The financing gap is larger, and aid is larger, the lower the savings of recipient. It creates incentives against recipient’s saving his own resources for development. Aid will not lead to increased investment; but to higher consumption. Aid can promote investment if it requires matching increases in the country’s savings rate, public and private. -How can aid rightfully promote investment? Under what conditions? Hint: p.38 Aid should have been made conditional on matching increases in a country’s savings rate. That would have given the governments in poor countries incentives to increase their own savings and to promote private savings, through a combination of tax breaks for income devoted to savings and taxes on consumption. Chapter 3: Solow’s surprise

-What is capital fundamentalism? Hint: p. 47-48
Capital fundamentalism is the belief that increasing buildings and machinery is the fundamental determinant of growth. -Explain the role of diminishing returns and labor productivity in the context of the Solow model. Hint: p.48-49. Increasing machines per worker will soon lead to diminishing marginal returns, a consequence of the low share of physical capital in output. The only way we can have a higher standard of living is if we increase production per worker, or labor productivity. -How does technology/technical change make sustained growth possible? Hint: p. 51-52 Technical change will avoid diminishing returns by saving on labor, making workers more efficient. The effective number of workers keeps up with the increasing number of machines, so diminishing returns never sets in. In long-run, all growth of production per worker has to be labor-saving technical change.

-Explain the Luddite Fallacy. Hint: p. 53
An economy-wide technical breakthrough enabling production of the same amount of goods with fewer workers will result in an economy with fewer workers. Dismisses alternative: produce more goods with fewer workers, thus increasing income per worker. Luddites confuse the shift of employment from old to new technologies with an overall decline in employment; but overall, workers as a whole are better off with more powerful output-producing technology available to them. -Why did the Solow model not work when applied to the tropics? Hint: p. 69 Capital accumulation does not explain a lot of the cross- country differences in growth. There was an economic presumption that the poor would catch up to the rich. Poor countries had gotten to be poorer than rich ones by growing more slowly over some previous period. “Why doesn’t capital flow from rich to poor countries, if capital offer higher returns in poor countries, where machines are scarce?” Answer: Better technology in rich countries offsets diminishing returns. And technology varies across countries for economic reasons.

Chapter 4: Educated for what?
-Has the educational expansion of the last four decades resulted in growth? Why or why not? No, it has not. Because 1)Schooling pays off only when government actions create incentives for growth rather than redistribution. 2) Administrative targets for universal primary education do not in themselves create the growth incentives for investing in the future. 3) The magnitude of the relationship between initial schooling and subsequent growth is more consistent with the story of growth causing schooling rather than schooling...
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