What are the limitations of Harrod-Domar models in the underdeveloped countries?

Limitations of Harrod-Domar models in the underdeveloped countries

The Harrod-Domar models are applicable to underdeveloped countries for the following reasons. Following are the major limitation of Harrod-Domar Models.

Different Conditions:

The Harrod-Domar analysis was evolved under different set of conditions. It was meant to prevent an advanced economy from the possible effects of Secular stagnation.

It was never intended to guide industrialisation programmes in underdeveloped economies. The limitations of this growth, models, as applied to such economies, therefore, stem from this fact.

Saving Ratio:

These growth models are characterised by a high saving ratio and a high capital-output ratio. In an underdeveloped economy, however, decisions to save area invest are generally undertaken by the same group of persons. The vast majority of the people live on the margin of subsistence and thus very few are in a position to save.

Capital-Output Ratio:

Similarly, it is difficult to have a correct estimate of the capital-output ratio where normal productivity is often inhibited by shortages and bottlenecks. When they are removed, there is considerable increase in the productivity of already invested capital.

Such an economy, therefore, would have either to increase its saving ratio or capital-output ratio by improving methods of production and removing the various obstacles to investment.

Prof. Hirschman is of the view that the ‘predictive and operational value’ of a model based on the propensity to save and on the capital- output ratio is low and is bound to be far less useful in underdeveloped than in advanced economies.

Structural Unemployment:

According to Professor Kurihara, the Harrod-Domar growth rate of investment fails to solve the problem of structural unemployment to be found in underdeveloped countries.

It can tackle the problem of ‘Keynesian unemployment’ arising out of deficiency of effective demand or due to under-utilisation of capital. But when population grows faster than accumulation of capital in an underdeveloped country, structural unemployment will arise due to lack of capital equipment.

Disguised Unemployment:

These models start with the full employment level of income but such a level is not found in underdeveloped countries. There exists disguised unemployment in such countries which cannot be removed by the methods suggested by Harrod-Domar. Thus the main assumption of the Harrod-Domar models being absent in underdeveloped countries, these models are not applicable to them.

Government Intervention:

The Harrod-Domar models are based on the assumption that there is no government intervention in economic activities. This assumption in not applicable to underdeveloped countries because they cannot develop without government help in such countries the role of the state as a ‘pioneer entrepreneur’ in starting large industries and in regulating and directing private enterprise has been increasingly recognised.

Foreign Trade and Aid:

The Harrod-Domar models are based on the assumption of a closed economy. But underdeveloped countries are open rather than closed economies where foreign trade and aid play very crucial roles in their economic development. Both these factors are the bases of their economic progress.

Price Changes:

These models are based on the unrealistic assumption of a constant price level. But in underdeveloped countries price changes are inevitable with development.

Institutional Changes:

Institutional factors have been assumed to be given in these models. But the reality is that economic development is not possible without institutional changes in such countries. Therefore, these models fail to apply in underdeveloped countries.

Thus is appears from the above discussion that the Harrod-Domar models, based as they are on unrealistic assumptions, have little practical application in underdeveloped countries, Hirschman, therefore, suggests that “economics of development, like the underdeveloped countries themselves, must learn to walk on it’s own feet, that is, it must work out its own abstractions.

But Professor Kurihara is of the view that though “their policy implications are very opposite of what one might expect of an underdeveloped economy,” yet “the growth models have this positive lesson for underdeveloped economies.

That the state should be allowed to play not only a stabilising role but also a development role, these economies are to industrialise more effectively and rapidly than the how industrialised economies did in conditions of laissez-faire.”

He further opines that because of the universal character of saving-income ratio and capital-output ratio (or its reciprocal) as measurable strategic variables, the growth mechanism discussed by Harrod and Domar is applicable to all economic systems, albeit with due modification.

That is why, these growth models are applicable to those underdeveloped countries in which the technique of planning with ‘balanced growth’ is adopted because under this technique, saving-income ratio and capital-output ratio remain constant during the plan period.