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Subject ECONOMICS

Paper No and Title 12: Economics of Growth and Development I

Module No and Title 5: Swan and Meade Growth Model

Module Tag ECO_P12_M5

ECONOMICS Paper 12: Economics of Growth and Development I

Module 5: Swan and Meade Growth Model
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TABLE OF CONTENTS
1. Learning Outcomes
2. Introduction
3. Neo-Classical Development Model
4. Harrod - Domar model
5. Swan Model
6. Result & Drawback of Swan-Solow Model
7. Summary

ECONOMICS Paper 12: Economics of Growth and Development I

Module 5: Swan and Meade Growth Model
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1. Learning Outcomes

After studying this module, you shall be able to

 Know the concept of Swan- Solow model

 Learn the various aspect of growth
 Identify the important features of growth
 Evaluate the growth model
 Analyse the growth path

2. Introduction

Before disapproving a specific model or even estimating its’ success it is significant to

understand the various-- historical methods of economic development. Various paths to
economic development have been taken ever since the Industrial Revolution. The first
contributors in the Industrial revolution witnessed very productive agricultural sectors
which created surpluses. These surpluses permitted for specialization in other industries.
These countries were the first to develop organized markets & took an export-led
industrialization path. Late participants in the Industrial Revolution suffered from a less
productive agricultural sector, had less advanced markets and institutions, and had to rely
on inward growth because of lack of trade. Many land scarce countries throughout history
have suffered from low productivity growth and experienced massive poverty. Others
have gained from balanced productivity growth in agriculture & industry, allowing them
to build developed markets and rely on a diverse export led economy. Economists have
understood from history. The most prosperous countries gained from more developed
markets, high factor endowments, human resources, & political systems accessible to
capitalism.

At the end of World War II the ideologies of the United States & the Soviet Union were
at odds. The 2 super powers could not reach an agreement on how to rebuild the
economies destroyed by the war. The development approaches produced in the US
sought to contain communism while spreading capitalism throughout the world. The
conflict that ensued came to be known as the Cold War and development strategy was
only one of many areas in which this clash played out. Years after the Cold war
prevailing development models still compete against the communist theory. One such
model is the Neo-Classical development model. Embedded in early economic thought,
Neo-Classical development purposes to spur economic growth through government
support. A sequence of market failures in the 1960’s led to the indication that the
government should provide infrastructure to support the market. Based on the theory of
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Neo-Classical economics, this model purposes to construct organized markets to rise

productivity and development. It hinges on the idea that investment will raise the growth
rate of per capita output.

3. Neo-Classical Development Model

The Neo-Classical development model is focused on Neo-Classical economic theory.

Neo-Classical economics emphases on prices, outputs, & income distributions in markets
accessed through supply & demand. The prime goal of Neo-Classical Economics is to
offer efficient allocation of scarce resources. It assumes an individual’s rationality allows
them to maximize their utility or profit. An emphasis is placed on equilibrium. The
interactions of consumers & firms in a free market should exercise an equilibrium
quantity and supply. The architects of the Neo-Classical Development model knew that
highly developed markets & institutions were required for the theory to work. It calls for
the government to gather capital by eliminating trade barriers and encouraging foreign
direct investment. Once capital is gathered it should flow from areas of low productivity
to areas of higher productivity. As per capita productivity grows economic growth will
follow. This is only a brief synopsis of the model, but it illustrates the basic assumptions
made. The Neo-Classical Development model points us in the right direction. It
recognizes the importance of advanced markets and institutions to economic growth.
History has demonstrated their importance. It also recognizes the importance of free trade
to economic growth. The major contributors to the neo-classical theory of growth have
been R.M.Solow,T.W.Swan, j.R.Hicks, and J.E.Meade.

Addressing an American Economic Association celebrating the fiftieth anniversary of his

1956 “Contribution to the Theory of Economic Growth,” Robert Solow (2007, p. 3)
reminded his audience that, “If you have been interested in growth theory for a while,
you probably know that theory in1956 (Swan, 1956). In that article, for the first time the
essentials of the basic neoclassical model of economic growth has given. Swan’s
contribution initially won international academic recognition. He was a Visiting
Professor at MIT in 1958. Despite the generous efforts of Robert Solow (e.g. Solow
1997), Swan’s work on growth theory has been overshadowed, at least outside Australia,
by Solow (1956, 1957). Textbooks and classroom presentations discuss the steady-state
equilibrium path of the neoclassical growth Model in terms of the capital/labor ratio, as in
Solow (1956), rather than the output/capital ratio, as in Swan (1956).

In 1945, around the time of the Australian White Paper on Employment Policy, Swan
wrote a memorandum on “The Principle of Effective Demand – A ‘Real Life’ Model”
(published Posthumously in 1989). This paper laid out the first macroeconomic model of
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the Australian economy. While still Chief Economist in the Prime Minister’s Department,
Swan (1950a) made his first venture into trying to reach some understanding of “the
theory underlying any policy of economic development” with a sixteen-page
memorandum entitled “Size and Composition of Investment, and the Industrial
Distribution of Labour in a Closed Progressive Economy.”

Although no formal mathematical model was written down, the discussion involved
Several formal assumptions including:
 Savings a constant proportion of income and unaffected by the rate of interest
 complete mobility of labour
 constant physical returns from land
 full employment
 no inventions

Setting savings equal to investment, Swan reasoned using a simple numerical example
that if capital and population is increasing at the same rate, then “the population increase
will wholly exhaust net investment” and capital and output per head will remain constant.
In this case, the “increment of consumpion demanded is an increment in the existing
‘average’ consumption in proportion to the rate of population increase”, but most of the
analysis is concerned with a more complicated, but policy relevant case, in which
marginal consumption as real income rises is biased towards specific uses, such as
housing. According to him Consumption goods were divided into three categories:
Houses produced with capital alone, Manufactures produced with current labor and
capital (in the form of machinery) and Services produced with current labor alone. The
capital used to produce housing and manufactures embodies past labor services
(classified as Building and Engineering services respectively). Capital and labor are
substitutable in the production of manufactures.7 However, given the difficulties of
verbal analysis, it is not surprising that the general equilibrium effect of an increase in
capital on relative factor prices and hence on the proportions of labor and capital in
manufacturing is ignored. He argued that if the population is constant, but at the margin,
desires only increased housing, all increments in capital are diverted to housing and
“capital per head will remain constant in manufactures”. However, if the Population
desires only more manufactures, then all next investment is in machines and “capital per
headwill rise steadily in manufactures, which will have constant current labor”. If it is
services that peopledesire marginally, then all net investment is in machinery for
manufactures, but the increase in capital perhead and output per head in manufactures
“means that manpower must be released from manufactures” toproduction of services.

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4. Harrod-Domar model

As stated by Harrod-Domar model “steady states and stability” in which the most
powerful and characteristic and powerful conclusion is that even for long run the
economic system which assumed fixed-coefficient production technologies that gave
their models “knife-edge” equilibrium with the implausible implication that any deviation
at all from equilibrium would cause the model to diverge further and further away from
Equilibrium. There are so many economists has given solutions to the dis-equilibrium
among them one of the pioneer was Swan.

5. Swan Model

The original contribution of swan was not the elimination of the Harrod-Domar knife-
edge by making the output/capital and capital/labor ratios endogenous rather Swan
created a simple, convenient, and powerful apparatus for finding the steady-state growth
path of a one-commodity world .Swan (1956) demonstrates the importance of technical
progress for long-run growth. In considering technical progress, Swan (1956) introduces
a third factor, land, which is fixed in supply and hence induces diminishing returns. Swan
considers the rate of technical Progress that is necessary to prevent population pressure
from moving the economy to a Malthusian outcome. A higher savings rate (and a faster
accumulation of capital) raises the growth rates at every point, but only temporarily
interrupts the inevitable progress towards the stationary state determined by technical
progress. “Swan notices that the model makes technical progress a powerful way of
improving the standard of living and capital accumulation a disconcertingly weak reed.
He looks for an answer to ‘this anti-accumulation, pro-technology line of argument’ and
mentions two possibilities. One is very classical: if higher output per head will induce
faster growth of the labor force, then something like Arthur Lewis’s unlimited supply of
labor is present, and additional capital accumulation becomes much more powerful. His
second idea is that ‘the rate of technical progress may not be independent of the rate of
accumulation of capital, or accumulation may give rise to external economies, so that the
true social yield of capital is greater than any ‘plausible’ figure based on common private
experience. This point would have appealed to Adam Smith, but it will not be pursued
here. Trevor Swan independently developed the standard neoclassical growth model.
Swan was published ten months later than Robert Solow but included a more complete
analysis of technical progress. Swan is able to directly illustrate the effects of variations
in the rate of technical progress. Swan was also involved in developing the constant
elasticity of substitution production function, of which Cobb-Douglas (elasticity of
substitution equal to one) and Leontief fixed coefficients technology (zero elasticity of
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substitution). In deciding on the contribution of economic analysis (whether theory or

econometric estimation), Swan placed a huge weight on the importance of the work for
economic policy in addition to requirements for originality and rigor.18 Swan (1964),
“Growth models: Of golden ages and production functions”, prepared for the Roundtable
Conference (1960) in Japan19, explains some of the inadequacies of growth models for
practical development. It is also likely that Swan’s interest in further contributions to the
growth literature was reduced by the frustrations of dealing with bureaucracy while
working on India’s five year plan in 1958. Swan had first to develop a composite growth
model in which he had introduced some deeper determinants of growth which varies
from country to country. Those factors are basically non-economic factors which can be
classified into four broad categories are: geographical, institutional, political and cultural.
Geographical differences are perhaps the most obvious. He has emphasized, countries
that are landlocked, that suffer from a hazardous disease environment and that have
difficult obstacles in the way of internal transportation, will almost certainly produce at a
lower level than countries without these problems, even if they use the same technology
and the same array of capital. In addition, the lower productivity of these countries will
serve to reduce the rate of return to accumulating capital and to generating new
technologies. Institutions matter because of the way they affect private contracts and also
because of the way they affect the extent to which the returns to different kinds of
investments can be appropriated by the government.

In long run productivity growth requires technical progress, it depends on political,

institutional and regulatory factors that affect the way the conflict between the winners
and losers of technical progress will be resolved, and hence affect the incentives to create
and adopt new technologies. Economic policies matter not only because of the way they
affect the return to investing in capital and technology but also because of the
inefficiencies that can be created by taxes and subsidies. But how these policies affect
economic growth can vary from one country to another. Culture is a difficult factor to
measure. In principle, however, it is capable of explaining a great deal of cross-country
variation in growth, because a society in which people are socialized to trust each other,
to work hard, to value technical expertise and to respect law and order is certainly going
to be thriftier and more productive.

Among the neo classical economist “solow” was so impressed by the growth model
developed by “swan” that he has given all credit to swan for the neoclassical model of
growth. The model developed by swan and solow has such similarities that the model of
growth named as swan-solow model. But “Solow model” has over shadowed on swan
model of development. Though there is some different approach of the theory but due to
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similarities the approach is known as “swan –solow” model of growth. The growth model
is saying that the economy is self-stable and the equilibrium comes naturally.

6. Result & Drawback of Swan-Solow Model

This model actually shows how the rate of economic growth, the population growth and
the technological progress influence the economic growth during a definite period of
time. The properties used in this model are: economy is perfectly competitive; two
production factors which are perfectly substitutable (work L and capital K – in the initial
analysis does not appear the technical progress); the perfect mobility of the production
factors; Complete employment in using the resources. The model takes into concern a
closed economy, with a single sector in which the homogeneous production has as target
either they consume or the investments, in order to create new capital units and the
savings are equal to the investments. The capital will have a constant and positive
depreciation rate. According to the neo-classical theory, the saving rate will not affect the
long-term rate of economic growth, but will long-term influence the level of the
output/capita. According to this theory the saving rate represents one of the main
indicators of an economy, but it reflects the level of the financial education of one nation
(if the saving rate is high, of course the amount of incomes for consume is more reduced.

The major shortcoming of the theory of swan model is overlook of behavioral

economics. The psychological fundamentals of the human behaviour determined the
population – who was facing a risk and so was mentally forced – to take precautions
measures, in order to evade being unprepared in the following period.

Another big problem of the models aiming to explain the economic growth & to offer
recovering scenarios is represented by the implementation of these models. There are big
gaps of the transfer of knowledge between those who develop models (academic world,
researchers) and those who are supposed to ensure the smooth running of the economy
(both governments and the business community).

The key criticisms of the Swan model development model should be in the scope of its’
assumptions. There are a wide range of difficulties faced by developing countries & this
model addresses very few of them. It leads to creating an economy receptive to
capitalism, but fails to benefit the population as a whole. There is historical evidence
displaying developed markets & advanced institutions are crucial to economic
development. How about the accumulation of human capital or the effects of corruption?
The Neo-Classical Development model fails to address these issues. Barriers to economic
development are not always measurable. The greatest failure seems to be it’s reliance on
weak sustainability. It is a simple evidence which states overall capital stock should be
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non-decreasing. It permits for natural resources to be entirely exhausted as long as other

forms of capital recompense for this loss. A country could quickly find itself on a track to
unsustainable development.

7 Summary

 In Steady State, GDP per worker will be higher in countries where the rate of
investment is high and where the population growth rate is low - but neither factor
should explain differences in the growth rate of GDP per worker.
 Harrod-Domar equation is the distinct case of the Cobb-Douglas equation that
elasticity of output with respect to labour equals zero and elasticity of output w.r.t
capital equals one.
 The Slow-Swan model states that the growth of income per capita cannot be
continued without progressive technological progress. Its perspective on the
strategy of economic development is entirely different from the Harrod-Domar
model that identified capital accumulation as the engine of development. Clearly
the difference stems from different assumptions of the production function.

ECONOMICS Paper 12: Economics of Growth and Development I

Module 5: Swan and Meade Growth Model