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The Solow Model and Human Capital in Developing Economies

How can human capital enrichment lead to long-run economic growth?

Human Capital and Economic Growth


How enriched are the minds of the people in a society? How healthy, creative, and efficient are they? How can they bring about disruptive innovation (Robinson & Acemoglu) to lead an economy into virtuous cycles of prosperity? This is all answered by the workforce’s level of human capital. With various definitions at play, human capital can be basically defined as the set of skills used to efficiently create value in an economy. Thus, indicators of human capital are level of education, technical training, experiences, habits, and level of health. In today’s economy, natural resources nor population sizes are the major determinants of growth – human capital is.

The paper by Dr. Armah titled, “Addressing Quality Issues In African Higher Education: A Focus On Ghana’s Emerging, Private, Graduate, Business Higher Education Sector,” focuses on one of Ghana’s key determinants and indicators of Human Capital – Higher education. Through the research key issues pertaining to the flaws in Ghana’s Higher Education system are put to light as limitations of human capital enrichment, thus, prohibitors of economic growth. With proposed solutions pertaining to more STEM focused teachings within business, Armah, puts to light proposals that would adequately enrich Human Capital, thus, accelerate economic growth in Africa.

Technology is the Rosetta stone of the economic growth literature. As such, emphasis on STEM education certainly is the best avenue for enriching human capital. Supported by the central argument in Easterly’s (2011) paper, technology is the largest determinant for vital long-run growth. Said technologies are only brough into existence by enriched workers with high levels of human capital. Sighting cases from the Singapore, Japan, Malaysia, China, and the Scandinavian countries, we come to see a positive relation with their prosperity and investments into their human capital. Specifically viewing Singapore, a nation with essentially no natural resources, and a small population, how is such a country able to attain such high sustainable growth? The answer lies in their human capital investments. With investments in their education, sanitation, and healthcare systems, Singapore is a testimony to the importance of human capital in creating sustainable long-run growth.


Poverty and the Resource Curse


i) According to the World Bank, poverty can be defined in simple absolute terms – those living on less than $1.9 per day. However, according to the UN, the concept of poverty entails much moe than income levels, it also refers to hunger, education availability, healthcare, discrimination and participation on decision making. UN broadly puts poverty into a deeper light by thoroughly seeing poverty as an extremity of poor living standards.

Calculating poverty is quite tricky. But there are two key distinctions in measuring poverty: Absolute Poverty or Relative Poverty.

Absolute poverty refers to a set standard or poverty line which can be used to compare and assess various countries at different times. However, relative poverty calculations are defined on the basis of environmental context. The measure varies from country to country and from time to time.

Hence, absolute can be used for strong comparative analysis however relative calculations of poverty are able to thoroughly contextualize and deliver an accurate understanding of a region’s poverty.

 

 

ii) The major macroeconomic determinants of poverty:

1.      Unemployment

Rate of unemployment is a clear macroeconomic indicator and determinant of poverty. Without sufficient work available, multiple households would be axed from their major source of income.

2.      Inflation

With high inflation rate, particularly that of food inflation, households purchasing power for staple goods would reduce. This essentially leads to household’s inability to make ends meet due to rising prices and falling income purchasing power.

3.      Level of income

Lastly, the most obvious determinant is income. With low incomes, households are pushed closer to the poverty line.

 

iii) According to Esther Duflo’s paper, the poor population tend to live in large households 6 -12 members. The poor population live below $2.16 per day. They earn most of their money via temporary jobs, low skilled (low specialization) work and working in small scale ventures. They tend to be unbanked, have no form of insurance, and the only major asset they own is their land.

iv) Countries in Africa such as Liberia, Congo, Zimbabwe and Ghana are typically poor despite their abundance of resources is due to the marriage of these four main concepts;

1.                Resource Curse

Also known as the paradox of plenty, resource abundant countries typically put themselves in a trap. They focus on industries related to their natural resources as their main source of generating wealth. As such, they fail to diversify the economies adequately. Thus, price shocks or market preference shifts pertaining to their main commodity (say Gold or Cocoa in Ghana or Oil in Gabon), leads to huge economic difficulties in said countries. As such, through their abundance of a few resources and focusing on just those resources, they leave their economies vulnerable, leading to poor economic performance.

2.                The Dutch Disease

The Dutch Disease, very similar to the resource curse, resonates the same story of a lack of economic diversification in resource abundant countries. However, in the case of the Dutch disease, said countries reduce investments in other sectors due to the discovery of a natural resource. The decrease investments in those sectors leads to unemployment and also reduces the economic diversity of the nation. Other unseen negative effects such as fall in total exports and a higher local currency.

3.                Weak Institutions

Despite having high amounts of resources, said countries cannot manage the production effectively. Till date, Nigeria does not know the exact amount of oil it drills each day! Weak institutions are instrumental for growth, as Acemoglu and Robinson repeatedly say. With weak institutions, corruption also prevails as in the case of Gabon in the Elf-Affair. Corrupt officials get in bed with multinational executives, thus, steal money the nation needs to develop as a whole. Hence, revenues from said countries resources are not shared with the society – the largest share goes to political cronies.

4.                Poor Governance

Relating to the earlier point, poor governance leads to a lack of transparency and accountability. This enables corruption to thrive.


Solow Model


From Wolphram Alpha: https://demonstrations.wolfram.com/SimpleSolowModel/




The graph below, created on Wolfram Alpha, shows steady state k*.

 K* is at a steady state when I = D, or better said where investments is equal to depreciation.

 

Simple Solow Growth Model: Steady State



Simple Solow Growth Model: Higher than k*



In the long run, the economy always adjusts itself, thus, would always move towards the steady state. As such K would eventually shift from k1 towards the left (towards the initial K*).

Logically speaking, if the economy is to operate with a capital stock higher than its steady state say at K1, we would come to find that depreciation is much higher than investment. If such is to occur in an economy, we would observe that the rate of capital entering the economic machine (investment) is less than that leaving economy (depreciation of capital goods). Thus, in the long run, or simply put as time goes on, if the rate at which capital is reducing is higher than capital coming inside. Thus, the amount of capital stock would gradually reduce from K1 up until it reaches K*. Thus, K moves towards the steady state k*.

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