What is the evidence in favor of the theory that differences in income among countries are the result of differences in investment rates? What is the evidence against this theory?
The amount of income in a country determines the amount of money is invested. Countries with high income tend to make more investments compared to countries that have low income (Pargianas, 2015). Thus, the rate of investment for such countries differs significantly due to the availability and distribution of income (Howitt, 2000). However, there are arguments that the difference in investment rates among countries does not necessarily depend on income differences. This can be attributed to the fact that the investment rate for any given project is determined by the benefits that a country is likely to get, and the availability of funds.
What is the effect of an increase in the investment rate on the level of steady-state output per worker in the Solow model? What is the effect of an increase in the investment rate on the growth rate of output per worker in the model?
According to postulates of the Solow growth model, diminishing returns lead to a steady-state of a country’s economy. Growth in capital stock leads to a small rise in investment and production. As pointed out by Howitt (2000), an increase in the investment rate leads to a higher steady-state output per worker because the steady-state capital increases over time. Also, Okada (2006) based his argument on the Solow model to assert that if the investment rate increases the output per worker increases since at a higher investment rate, there is a quick increase in capital stock, which increases the growth rate of output.
How does the issue of whether saving rates are endogenous or exogenous affect our interpretation of how well the Solow model explains income differences among countries?
According to the Solow growth model, the difference in income among countries, in the long run, can be attributed to the disparity in countries’ population growth, productivity, as well as their savings (Okada, 2006). As such, a country that has high saving rates tends to accumulate a high amount of income over time. However, the factor of saving rates being exogenous or endogenous largely affects the effective interpretation of the Solow model concerning differences in income among countries (Cardoba & Ripoll, 2008).
If the saving rates are considered to be endogenous, the implication is that the amount of income among countries differs in comparison to a case of exogenous saving rates. For instance, in the case of exogenous saving rates, the implication according to the model is that savings subjectively influence external conditions around income for any country.
Why can a country not grow forever solely by accumulating more capital?
Accumulation of capital does not necessarily imply that the concerned country would grow forever. This can be explained because as a country experiences greater output an increase in its accumulated capital and savings is noticed (Rouzet, 2010). Often, a high amount of capital stock has the potential of reducing investment, which also translates to reduced output. Countries invest to make adjustments to their stock of capital. Thus, by accumulating a lot of capital, there is no replacement of the depreciated capital for the concerned country. However, at a steady-state, a country does not experience growth in the output per worker.
As postulated by the Solow model, an accumulation of more capital in a country leads to a rise in depreciation, while the output, on the other hand, is used to cater only for the depreciation (Cardoba & Ripoll, 2008). The model explains that as capital for a given country increases, the number of depreciation increases by the same amount as the increase in investment and production. In the end, the net investment becomes zero shifting the economy to a steady-state. At this state, the country experiences no growth in consumption per person, output per person, capital, as well as general output (Plummer, 2010).
For this reason, the concerned country does not experience growth in capital stock in the long run, which implies that the accumulation of capital in a country only leads to a short-run growth in the economy.
References
Cardoba, J., & Ripoll, M. (2008). Endogenous TFP and cross-country income differences. Journal of Monetary Economics, 55(6), 1158-1170.
Howitt, P. (2000). Endogenous growth and cross-country income differences. American Economic Review, 90(4), 829-846.
Okada, T. (2006). What does the Solow Model tell us about economic growth? Contributions in Macroeconomics, 6(1), 1-30.
Pargianas, C. (2015). Endogenous economic institutions and persistent income differences among high income countries. Open Economics, 27(1), 139-159.
Plummer, P. (2010). Capital accumulation, economic restructuring, and non-equilibrium regional growth dynamics. Geographical Analysis, 31(3), 267-287.
Rouzet, D. (2010). The neoclassical growth model. Web.