CHAPTER

38
Meades Meades Neo-Classical Model of Growth Economic Growth
THE MEADE MODEL
Prof. J.E. Meade has constructed a neo-classical model of economic growth which is designed to show the way in which the simplest form of economic system would behave during a process of equilibrium growth.1 Assumptions. Meade constructs his model around the following assumptions: (i) There is a laissez-faire closed economy where there is perfect competition. (ii) There are constant returns to scale. (iii) Two commoditiesconsumption goods and capital goodsare produced in the economy. (iv) Machines are the only form of capital in the economy. (v) All machines are assumed to be alike. (vi) It is assumed that there is a constant money price of consumption goods. (vii) There is full use of land and labour. (viii) The ratio of labour to machinery can be changed both in the short and the long run. Meade calls this the assumption of perfect malleability of machinery.
1. J.E. Meade, A Neo-Classical Theory of Economic Growth, 1961.

(ix) It is further assumed that there is perfect substitutability in production between capital goods and consumption goods. (x) There is the assumption of depreciation by evaporation, that is, each year some percentage of machines wears out which requires replacement. The Model. In the economy visualised above, the net output produced depends upon four factors: (i) the net stock of capital available in the form of machines; (ii) the amount of available labour force; (iii) the availability of land and natural resources; and (iv) the state of technical knowledge which continues to improve through time. This relationship is expressed in the form of the production function as, Y = F(K,L,N,t) where, Y is net output or net national income, K the existing stock of capital (machines), L the labour force, N land and natural resources and t is time, signifying technical progress. Assuming the amount of land or natural resources to be fixed, net output can increase in any one year with the growth in K, L, and t. This relationship is shown as Y = VK + WL + Y where, in each case represents an increase, V is the marginal product of capital, W the marginal product of labour and Y is used in place of t. Thus the increase over the year in the rate of annual net output (Y) is equal to the increase in the stock of machinery (K) multiplied by its marginal products (V) plus the increase in the amount of labour (L), multiplied by its marginal product (W) plus the increase in the rate of annual output due simply to technical progress (Y). The annual proportionate growth rate of output is

Y VK K WL L Y ' = . + . + Y Y K Y L Y
where, Y/Y is the proportionate growth rate of output, K/K the proportionate growth rate of the stock of capital, L/L the proportionate growth rate of labour force and Y/Y the proportionate growth rate of technical progress during a year. Let these proportionate growth rates be expressed as y, k, l and r respectively, the proportionate marginal product of capital VK/Y as U and the proportional marginal product of labour WL/Y as Q*. Now the basic relationship is y = Uk + Ql + r This shows that the growth rate of output (y) is the weighted sum of three other growth rates, first, the sum of the growth rate in the stock of capital (k) weighted by the proportional marginal product of capital (U) plus the growth rate of population (I) weighted by the marginal product of labour (Q) plus the growth rate of technology (r). But the real index of the growth of the economy is the growth rate of real income per head rather than the growth rate of income (y). If, for example, total income (y) rises by 10 per cent per annum and population (l) by 8 per cent, income per head (y-l) will rise by about 2 per cent per annum. The growth rate of real income per head is yl = Uk + Ql + rl
* VK/Y represents the proportion of the net national income being paid as profit to the owners of machines, while WL/Y is the proportion of income going to the labour force as wages.

274

The Economics of Development and Planning

= Ukl + QI + r = Uk (lQ)/ + r The equation reveals that the growth rate of real income per head is raised in two ways: first, by an increase in the rate of real capital (k) weighted by its proportional marginal product (U); and second, by an increase in the rate of technical progress (r). On the other hand, it is depressed by the growth rate of population (l) weighted by one minus the proportional marginal product of labour (1 Q). This part of the equation, i.e., [ ((1Q)/] shows the tendency for diminishing returns as the quantity of labour is increased on a given amount of land and capital. One of the important factors contributing to the growth rate of output is the annual rate of capital accumulation in the economy. This fact is implied in the element Uk. U = VK/Y, and k = K/K, but K, the addition to the stock of capital is equal to the savings out of the net national income. Therefore K = SY, and k = K/K = SY/K where, SY represents the amount annually added to the stock of capital through savings.* Hence, Uk = VK/Y X SY/K=VS,** and the basic growth relationship can be expressed as y-l = VS (1Q) l + r Having examined the main factors determining the growth rate of real income per head, Prof. Meade discusses the conditions which may lead to changes in the rate of economic growth over time. Assuming l and r to be given and constant, changes in growth rate would be determined by the behaviour of V, S, and Q over time. If there is no change in population (l) and technical progress (r), an increase in the rate of savings (S) would raise capital per head and bring a decline in the marginal product of capital (V). This decline in V will, however, be less if it is possible to substitute capital for land and labour. And if technical progress takes place, V will tend to rise instead of declining. But the amount of land and labour being fixed in the economy, more capital per head will be used and at the same time technical progress will tend to raise V. Under these conditions, the rate of growth of income per head over time would rise which in turn would tend to raise S. There will be a D B F2 tendency for S to rise still further due to a change in income distribution towards larger profits caused by the above-mentioned factors. F1 C A We may conclude that with a constant population (l=0), real income per head depends upon the rate of capital accumulation (VS) and technical progress (r). The equation is yl = VS(1Q) l + r Since l = 0 y = VS + r If the rate of technical progress alongwith population growth is assumed to be constant, O K K1 the growth rate in income per head will vary Total Stock of Machinery directly with VS. Fig. 1
*S is the propensity to save and not absolute savings. **Prof. Meade explains this point with certain numerical examples. If V, the marginal product of capital (rate of profit) is 5 per cent per annum and S, savings are 1/10 of the national income, then the contribution of capital accumulation to the growth rate of output would be 5x1/10=1/2 per cent per annum. See, op. cit., pp. 16-17 for other solutions.

Total Annual Output

Meades Neo-Classical Model of Economic Growth

275

The effect of technical progress on total national output (income) is shown in Fig. 1. The total stock of machinery (capital) is represented on the horizontal axis and the total annual out-put on the vertical axis. OF1 is the production function which shows the quantity of output, produced in year 1 with the given quantity of machinery when the technical knowledge is given. If in year 1 the quantity of machinery is OK, the production in that year will be KA. The slope of the curve at point A shows the marginal productivity of machinery which declines as we move towards the right along the curve. This is because like other factors the law of diminishing returns applies on machinery. Thus the marginal product of machinery at point C will be less than at point A. In year 2, the new production function becomes OF2 due to technical progress. As a result, production increases from KA to KB by using the same machinery OK. Similarly, by the use of OKl machinery the production increases from K1C in year 1 to K1D in year 2. Thus technical progress leads to increase of total annual output. The State of Steady Growth. Further Prof. Meade examines the conditions of the state of steady economic growth. It is a state in which the growth rate in total output (income) is constant and so is the growth rate in income per head. It is assumed that population is growing at a constant proportionate rate (l) and the rate of technical progress does not change. The state of steady economic growth requires the existence of the following three conditions to ensure a constant growth rate in total income: (a) All elasticities of substitution between the various factors are equal to unity. (b) Technical progress is neutral towards all factors. (c) The proportions of profits saved, of wages saved, and of rent saved are all constant. Conditions (a) and (b) mean that the proportions of the national income going to profits (U), wages (Q) and rents (Z) remain constant. So do the proportions of national income saved out of these remunerations of factors remain constant as per condition (c). Let these savings out of profits (U), wages (Q) and rents (Z) be represented by Sv, Sw and Sg respectively, so that total savings S=SvU+SwQ+SgZ. Since all the elements in this equation are constant vide conditions, (a), (b) and (c), it follows that the ratio of total savings to total national income (S) will also be constant. The growth rate of income is represented by the basic relationship y = U + Ql + r wherein U, Q, I, and r are assumed to be constant Therefore, for y to be constant (as required by the state of steady economic growth), k should be constant. We know that k=SY/K but S is constant as seen in the preceding para. So k will be constant if Y/K is constant. Y/K will be constant if the rate of growth of Y and K is the same which implies the equality of y and k itself, i.e., y=k. The obvious conclusion follows that the growth rate of income will be constant if the growth rate of capital stock (k) is equal to the growth rate of national income (y). Critical Growth Rate. The equilibrium position ultimately depends upon the rate of accumulation of the capital stock. According to Meade, there is a critical growth rate of the capital stock which makes the growth rate of income equal to the growth rate of capital stock. A more or less growth rate in the capital stock than this critical growth rate will not bring about the equality of y and k. If we put a for the critical growth rate then the basic relationship will be a =Ua + Ql + r or

a=

Qi + r * 1U

*This can be proved with a numerical example given by Meade. Let Q = , l = 2 per cent, r=l per cent, U = then

276

The Economics of Development and Planning

It is this critical rate which will make y=k, and keep the growth rate of national income constant at the steady growth level.** If at any time there is any deviation from this level of steady growth, forces will set in to bring the growth rate of the capital stock at the equilibrium level of

Ql + r SY Ql + r > . Suppose k or . 1U K 1U SY towards the critical level. K

In this situation income will be growing at a lower rate than the capital, stock, as a result savings will decline, so will the growth rate of capital, thereby bringing

Conversely, if

SY Ql + r > then income would increase more rapidly than the capital stock, K 1U SY would rise towards the K

savings would increase, and so would the capital stock, as a result

critical level

Ql + r . 1U

Thus under the two assumptions and the three conditions noted above, the growth rate of national income and the growth rate of the capital stock would both tend towards a constant rate of

450 (k) growth is explained with the help of Fig. 2. The H y ( = Uk + Ql + r) growth rate of the stock of capital is measured B along the horizontal axis and the growth rate of A national income along the vertical axis. The U C curve represents the proportional marginal product of capital, the curve Ay the total growth U G rate of national income and the 45 k the growth D rate of the capital stock. k O E F Suppose to begin with the growth rate of the capital stock is OE, then growth rate of national Fig. 2 income will be BE. But BE=BD + DE, where BD= OA = Ql + r. B point y is greater than k, i.e., BE>CE. As a consequent, k will start rising till point F on the X-axis is reached which brings about the equality of y and k (the 45 line) at H. This
= 2 = 2 x 4/3 = 2 2/3 1 ** Now with 22/3 as the growth rate of the capital stock, the equality of y and k can also be shown in the basic equation: y = Uk + Ql + r = (1/4 x 2 2/3) + (1/2 x 2) + 1 = 22/3. This is the value which y and k will have in the state of steady economic growth. See Meade, op. cit., pp. 33-34.
a= ( 2 ) + 1

Ql + r . This model of steady economic 1U

Ql + r

Meades Neo-Classical Model of Economic Growth

277

represents the state of steady economic growth where the critical growth rate brings y = k. The critical growth rate can also be derived from this diagram. y = Uk + Ql + r HF = GF.HF + GH [Q Ql + r = GH ] HF GF.HF = GH HF (1 GF) = GH

or

OF =
k=

GH 1 GF
Ql + r (1 U )

[Q HF = OF ]

or

A CRITICAL APPRAISAL Prof. Meades neo-classical model has been severely criticised due to its unrealistic assumptions. This model is steeped in the classical tradition of a perfectly competitive economy where all production units are assumed independent of each other. But these are unrealistic assumptions for neither is there perfect competition nor are the production units independent of each other. The assumption of the neo-classical theory that there are only constant returns to scale is also defective. The fact is that there are increasing returns to scale rather than constant returns in the growth process. Mrs. Robinson calls Meades model pseudo-causal because it merely states that monetary policy keeps the prices of consumption goods constant, while money wage rates ensure full employment. Another serious defect of the neo-classical model stems from the assumptions that all machines are alike and there is perfect malleability of machines. The latter implies that the ratio of labour to machinery can be changed both in the short and long run. But this is unrealistic because the ratio of labour to machinery cannot be changed in the short run. Thus Meade sidetracks the problem of foresight by assuming perfect malleability of machines and depreciation by evaporation. This makes his model impracticable. According to Prof. Butterick, there is no place for uncertainty in Meades model. The interrelations of all variables have been regarded as certain. This detracts from the practicability of the model and it simply remains a theoretical analysis. Like the Harrod-Domar and Joan Robinson models, Meades model is based on the assumption of a closed laissez-faire economy. But this is an unrealistic assumption which neglects the importance of foreign trade in economic development. Another serious defect of this model is that it completely neglects the role of institutional factors in the development process. Meade forgets that social, cultural, political and institutional factors play an important part in economic growth. In the absence of these factors his model simply becomes the Robinson Crusoe model. Despite these defects, the Meade model has the chief merit of demonstrating the influences of population growth, capital accumulation and technical progress on the growth rate of national income and per capita real income over time. Further, the state of steady growth is indeed Mrs. Robinsons Golden Age explained in a more realistic manner by studying the behaviour of those variables which she assumes as constants.

HF =

GH (1 GF )