Testing Economic Growth Models: An Empirical Study of Brazil

Testing Economic Growth Models: An Empirical Study of Brazil

Economic growth and development are the primary goal of the State, and their implications in society cannot be underemphasized. Hence, what drives sustainable economic growth has always been a challenging, yet much studied concept by numerous economists. In class, we have discussed two main models that analyze the dynamics of economic growth: The Harrod-Domar and the Solow Model.

Both models, based on certain assumptions, claim that higher savings rates s (physical investment), cause an increase in GDP per capita growth rate in the medium-run. However, they differ in the long-run approach. Whereas the H-D model argues that growth continues indefinitely at a constant rate, thus a higher s produces a permanent increase in the growth rate, Solow states that an increase in s causes a temporary higher income per capita growth rate, and a permanent increase in the income per capita level. The Solow Model implies that capital exhibits diminishing returns to scale, and therefore income per capita approaches a constant “steady-state” level in the long run. The importance of human capital (q) in explaining income difference across countries has been stressed in the H-Augmented Solow model. In addition to the identical assumptions of Solow, this model refers to q (investment rate in human capital) as another variable behind growth. Human capital embodies the notion that there are investments in people (education, health) that rise an individual’s productivity, resulting in a higher economic growth. The investments in human and physical capital create a certain “feedback effect” on each other, producing a larger and longer lasting growth effect than the one argued in the Solow Model.

Despite the characteristics and powerful conclusion in relation to economic growth of these theories, they all depend on assumptions, which are not quite true in the real world. Here, I shall analyze how well real data “fits” the medium-run theories of these model by examining the economic progress of Brazil.

Figure 1. GDP per capita (constant 2011 US$), 1991 – 2014

Figure 1.1. GDP per capita (current US$), 1966 – 2014

In recent years, Brazil has proven to be the dominant nation in Latin America, and a growing player in in the international scenario; it was relatively unscathed by the 2008 Great Recession and one of the first to experience sustainable economic growth afterwards (see figure 1.1). Brazil’s income per capita has been exposed to an upward trend, and it has overtaken the averages of middle-income countries and the aggregate average of the world income (see figure 1). It’s economy has been enhanced partially by the commodity boom during that the world was exposed until 2011. Brazil has come a long way