When using any economic model to portray a real world problem and to study the impact of different resolutions, the effectiveness for the simulation model will be dependent on its ability to simulate the real world with no simplified. One of the issues this may lead to is whether or it is true that the neoclassical growth model can be a useful tool for economists and policymakers in understanding global poverty and developing policies to tackle poverty. This will be the subject of this paper and we will conclude that while there are reasons for using this neoclassical development model in order to analyze the conditions of the world’s most disadvantaged, it doesn’t take into consideration numerous important elements that are essential to understanding the problem from a variety of perspectives.
Foremost on the agenda, we must explore the ideas and concepts that underline this model. This neoclassical growth model emphasizes the significance of technological progress and labor productivity in maintaining a long-term rate of growth. Growth in population, the decline of capital, and most importantly, technological advances directly impact the dynamic that drive growth.
The main idea that is incorporated into the models of this model is an assumption that, over the long term, economic growth is independent of the savings rate (or equivalently investing). But, the economy is in an in-between state of growth or decline in the capital stock which can last over several decades because of fluctuations in savings-generated investment that is greater or less than the amount of investment needed. In steady state, therefore the rate of growth of output is equal to the rate of population growth and the rate of technological advancement. This means that the production per worker will grow in line with technological advancement in a condition of growth that is balanced over the long-term.
This neoclassical growth model is achieved through the assumption of a declining marginal product of capital, where the economy slowly gets to a point at which savings can only provide enough investment to be able to cover depreciation. To make saving and investment equal we presume that the economy is closed. This is an important and unrealistic assumption to make and allows for the issues of trade surpluses and deficits to be overlooked. Taxes and spending by the government is as well ignored to put emphasis on the behaviour of savings by private individuals. We also assume that the private saving rate to correspond to earnings.
The first idea we want to look into is whether or not the concept of economic growth is relevant for developing policies to decrease the level of poverty in countries that are developing. In fact it is true that the neoclassical growth model can demonstrate the significant correlation between economic growth and poverty reduction. This model posits that economic growth is dependent on the accumulation of capital, both technological and physical, as well as human. Human capital is the rise in the productivity of labor due to levels of education, skills and experience and also the health of the people. Physical capital refers to the equipment used in production. Lastly, technological progress has a two-fold meaning It is the capacity to increase the quantity of output being produced with the same quantities of capital and labour. In the same way, technological advancement is the primary ingredient for developing new, better and a greater variety of goods for the general public to consume.
Studies have shown research has shown “literacy and other indicators of education remain woefully low across much of the developing world,” and a policy to help poor people gain human capital would result in their earning higher wages (Besley and Burgess 2003). This neoclassical growth model could be used to argue that a favorable environment more conducive to investing and entrepreneurship can help reduce the level of poverty. This is based on the premise that heavy regulation of businesses isn’t in the public’s best interest due to the fact that it leads to the low intensity of capital, low productivity of human capital, in addition to a low level of productivity (Bigsten and Levin 2000).).
The implication that the economy is closed, as used to develop the neoclassical growth model, hinders our ability to accurately portray real world situations pertaining to the situation that the well-off suffer. One of the limitations it creates is an inability to recognize foreign capital flows in addition to domestic investment. The developed countries might be able to benefit from stimulating an economy in a emerging country with investments in research and development (R&D) within the country for example. Encouragement of the development of new technologies may help poor people who live in rural and agricultural areas attain higher output per person and also to maximize their land and resources. The incentive for the industrialized country may be to develop new trading partners and open up new markets to its own economy.
Evidence shows that the openness of markets internationally is conducive to economic growth, as seen by the evidence the fact that “growth problems have been most pronounced in countries that have pursued an inward-oriented policy” (Bigsten and Levin, 2000). This could be one reason for why numerous African nations have experienced low levels of production per head, low growth rates, and decreases in living standards in the course of time. Other reasons that could be behind the slowing of growth in African countries will be investigated as well to address issues of poverty.
Other assumptions used to develop the neoclassical growth model are at the expense of replicating the reality of the model as it reflects the reality. Every major element of social infrastructures, or the areas of political activity in a country is mostly outside of the scope of this model. This makes it difficult for politicians and economists to examine an array of concepts concerning the reduction of poverty. For instance, a major aspect of social infrastructure that is not covered by this model is the idea of “eliminating social barriers for women, ethnic minorities, and socially disadvantaged groups in making growth broad based” (World Bank 2001). Other issues that go beyond the boundaries of neoclassical growth model include such categories such as “policies, institutions, history and geography” (World Bank, 2001). Policies of the government, for instance can play a crucial role in the level of the steady state especially in regards to its influences on property right and public consumption as well as both domestic and international markets. Poor policies could be the primary reason why many developed countries have experienced slow growth or even a weak steady condition (Bigsten and Levin 2000).