Test of the Harrod Domar Growth Model

The Harrod-Domar Model was developed in the first half of the Twentieth century. Since that time, it has been improved upon or discredited by many economists. Despite the fact that it was developed to explain business cycles in First World countries, it has been most used in development economics and today is the most widely used growth model. According to the model the growth in Gross Domestic Product (GDP) will be proportionately tied to the savings rate (s) and the marginal product of capital (c). For economic growth, a country must save a certain proportion of its national income. Because some of these savings will be used to offset depreciation (δ), the rest of the savings, in order for the economy to grow, must be used to make net additions to the capital stock. The model assumes that there is a surplus of labor so that the only way to increase output (Y) is to increase the capital stock. Because of this surplus there are constant returns to scale on capital. Mathematically the formula looks like:

%ΔY=sc-δ

Literature surrounding the model emphasizes that the savings rate is the driver of economic growth and that governments should adopt policies that increase the savings rates. In order to test if this was correct I collected GDP growth and gross savings as a percent of income for 21 low income countries from the World Bank Database. To see if there was a correlation between high savings and high growth I took the average of the savings rates and growth rates. Only 2 countries had both a higher than average savings and growth rate, and 10 had both a lower than average savings and growth rate. That means savings rate is only indicative of growth rate for 54% of the countries in the sample. Worse, a higher than average savings rate was only indicative of a higher than average growth rate for 9% of the sample. Because this was across countries I decided to regress the savings rate against the growth rate for the years 2000 to 2009 in each of the...