The origin of economic growth can be traced back to Adam Smith's Wealth of Nations. InSmith's view, economic growth of a nation depends on the 'division of labour' and specialization, and is limited by the limits of division of labour. Smithian view was later succeeded by growth theories of Ricardo, Malthus and Mill. The growth theories suggested by the great economists are collectively known as the classical theory of economic growth.
Harrod-Domar model of growth
Harrod-Domar model is essentially an extension of Keynesian short-term analysis of full employment and income theory. The Harrod-Domar model provides a more comprehensive long period theory of output. R.F. Harrod and E.D Domar had, in their separate writings, identified the conditions and requirements of steady economic growth and developed their own models. However, although their models differ in details, their approach and conclusions are substantially the same. Their models are therefore jointly known as Harrod-Domar growth model. The major aspects of their model are discussed below:
The Harrod-Domar model assumes a simple production function with a constant capital output coefficient. In simple words, the model assumes that the national output is proportional to the total stock of capital and the proportion remains constant. The assumption may thus be expressed as:
Y = kK
Capital accumulation and labour employment in Harrod-Domar model
We have so far discussed Harrod-Domar model confining to only one aspect of the model, i.e. accumulation of capital and growth. Let us now discuss another important aspect of model, i.e. availability and employment of labour. Labour has been introduced to the Harrod-Domar model by making the following assumptions:
(i) That labour and capital are perfect complements, instead of substitutes, for each other; and
(ii) That capital/labour ratio is constant
Given these assumptions, economic growth take place only so long as the potential labour force is not fully employed. Thus, the potential labour supply imposes a limit on economic growth at the full employment level. It implies:
(i) That growth will take place beyond the full employment level only if supply of labour increases; and
(ii) That actual growth rate would be equal to warranted growth rate only if growth rate of labour force equals its warranted growth rate.
However, if labour force increases at a lower rate, the only way to maintain growth rate is to bring in the labour saving in the labour saving technology. This is what happens in the developed countries. Under this condition the long term growth rate depends on (i) growth rate of labour force (?L/L) and the rate of progress in labour saving technology (i.e the rate at which capital substitutes labour, m). thus, the maximum growth rate that can be sustained in the long run would be equal to ?L/L plus m. Harrod calls this growth rate as natural growth rate. (Gm).
Criticism: Harrod-Domar growth model is a Razor-edge model
The major defect for the Harrod-Domar model is that parameters in this model, viz, capital/output ratio, marginal propensity to save, growth rate of labour force, progress rate of labour saving technology, are all determined independently out of the model. The model therefore does not make the economy deviate from the path of equilibrium. That is why this model is sometimes called as 'razor-edge model'.