David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

26.6 Growth in the OECD
II : e!p ;: ctatro: s :co. :na !or people earning only
y save sy and consume (1 - s)y. But if y is low enough, (1 - s)y is too low to stop starvation.
So they consume all their income and save none. Below a critical income level y0, saving is zero. What
does the Solow diagram look like now? See diagram below. Suppose k0 is the capital per person that just
generates the critical income Yo· Higher capital generates saving as in previous diagrams, and nk is still the
gross investment needed to maintain a given capital-labour ratio in the face of growing population. There are
now three steady states!
If capital begins above k 1 the economy converges to the steady state at E. Between k1 and k2, saving and investment
exceed the amount needed for capital widening: capital-deepening also occurs and the economy grows. Above
k2, saving and investment are insufficient to maintain the capital-labour ratio, and the economy shrinks. Either
way it ends at E. This is the case analysed in Figures 26.2 and 26.3. Suppose, next, the economy begins at exactly
k1• Saving and investment just maintain the capital-labour ratio. So this is a steady state, but an unstable one.
A little above k1 the economy begins converging
on E. And below k1 there is insufficient saving
and investment to provide for the growing
nk
population. Capital per person shrinks and keeps
shrinking until the economy reaches k = 0.
In this model, countries beginning with capital
below k1 are stuck in a poverty trap. They
cannot break out. All output is consumed to
prevent starvation. There is never a surplus to
begin accumulation and growth. This model
can also explain why convergence seems to
occur within the OECD (countries already
above k1), but why simultaneously many countries
are stuck in poverty. Modern growth in
the last two centuries began when some key
events first generated the surplus to allow
saving and accumulation to begin.
Questions
(a) Why is there no poverty trap when saving is proportional to income?
y
(b) When a poverty trap exists, is the payoff to overseas aid from rich countries greater if it is concentrated
on helping poor countries break out of the poverty trap?
(c) The poverty trap shown above is based on there being a minimum level of per capita consumption.
Could we get a poverty trap based on different population growth rates above and below some critical
threshold of living standards? Is this plausible?
To check your answers to these questions, go to page 688.
0
k
Neither the internet boom nor supply-side reforms restored the productivity growth rates that the rich
countries enjoyed prior to 1973. Emerging market economies, such as China, India, Brazil and Russia, are
now where the action is. We turn to their story in Part Five. For rich mature economies, Table 26.2 confirms
that underlying productivity growth showed a modest improvement after 1990, until it was dramatically
interrupted by recession after the financial crash.
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