Question

What is the main idea behind Harrod-Domar growth model? What does it say about the relative low growth performance of countries China despite their high savings rate?

Answer 1

Harrod Domar model explained:

This model is based on the importance of savings and investments determinants of growth.

Growth depends on level of national saving and capital output ratio.

Capital-output ratio is the productivity of capital investment, if it is low it means that a country ,for any given capital can produce a large amount of output.

Equation =

for eg, if savings rate is 40% and capital output ratio is 4, then the country will grow at 10% per year.

So, a country's growth rate can be increased by either decreasing the capital output ratio( i.e. improving productivity of capital or by increasing savings rate )

Limitations

Countries that lack a stable financial system will experience problems in increasing overall savings rate.

Inadequate capital to invest in Research and Development to invest in improving productivity of capital output ratio will lead to problems for that country.

As far as china is concerned, the harrod domar model states that as china's growth rate is roughly 40% of income, still the growth was not dramatic because there will mobilization of savings and insufficient investing to achieve low capital output ratio, hence the growth rates are not that high.