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ECONOMICS ESSAYS
AGRICULTURE A COLOSSAL NEGLECT
Now one may find that the same has happened with our
agriculture. The suicides in 2007 and 2008 in Andhra
Pradesh are just the beginning. Bihar and other eastern
states have been facing floods on regular basis. Things may
go further worse. For example, Bihar has no industry, it has
lost its minerals and floods are killing agriculture. Under
these conditions only God is helping them.
When Then I was a small boy, I was told that one should
not neglect those things, which are certain in nature and
not run after uncertain things. If it is done, the uncertain
becomes further uncertain and even the certain becomes
uncertain.
Agriculture (including allied activities) accounted for 17.8
per cent of the Gross Domestic Product (GDP-at constant
prices) in 2007-08 as compared to 21.7 per cent in 2003-
04. Notwithstanding the fact that the share of this sector in
GDP has been declining over the years, its role remains
critical as it accounts for about 52 per cent of the employ-
ment in the country. Apart from being the provider of food
and fodder, its importance also stems from the raw materi-
als that it provides to industry. The prosperity of the rural
economy is also closely linked to agriculture and allied
activities. Agricultural sector contributed 12.2 per cent of
national exports in 2007-08. The rural sector (including ag-
riculture) is being increasingly seen as a potential source
of domestic demand; a recognition, that is shaping the mar-
keting strategies of entrepreneurs wishing to widen the de-
mand for goods and services. Indian agriculture suffers from
a mismatch between food crops and cash crops, low yields
per hectare except for wheat, volatility in production and
wide disparities of productivity over regions and crops. The
domestic production of pulses and oilseeds are still below
the domestic requirements and India imports pulses and
edible oils to satisfy domestic demands. Further, a distinct
bias in agricultural price support policies in favour of rice
and wheat has distorted cropping pattern and input usage.
Food management is inefficient with unsustainable level of
food subsidies imposing heaving burden on Government fi-
nance. The rural economy and the private sector severely
lack the basic infrastructure to build sufficient buffer stocks,
and the country remains vulnerable to weather stocks. The
rural credit is one of the most concerned areas. The Credit
Deposit Ratio (CDR) in rural areas for both public and pri-
vate sector banks was substantially low compared to ur-
ban and metropolitan areas. The Gross Capital Formation
(GCF) in agriculture as a proportion to the total GDP has
shown a decline from 2.9 per cent in 2001-02 to 2.5 per
cent in 2007-08.
The agriculture sector faces challenges on various fronts.
On the supply side, the yield of most crops has not im-
proved significantly and in some cases fluctuated down-
wards. The scope for increase in the net sown area is lim-
ited and farm size has been shrinking. In the case of cer-
tain crops like sugarcane, extreme variability in the acre-
age and production over the years has been a matter of
concern. On the other hand, in the case of pulses, pro-
duction has just not kept pace with the requirement leading
to a rise in prices given that its availability in the interna-
tional markets is limited. The ill-treatment of the agriculture
appears to be the best way to preserve poverty on which
the sectarian politics survives. The politics of poverty alle-
viation thrives only when there is persistence of poverty.
Indian policy making has suffered from a typical anti-agri-
culture bias since 1956, the day Indian policy makers
adopted Mahalanobis model, under which agriculture was
given a step son treatment. Although, agriculture was al-
ways out of the purview of direct taxation, yet, it has been
proved that it is heavily taxed. Protection accorded to in-
dustry and over-valued exchange rate constitute an indirect
and implicit tax over agriculture.
Keeping domestic prices below world prices gave negative
protection to agriculture and it was another form of taxa-
tion. In this way, agriculture and poor agriculturists had to
bear the brunt of generating resources for industry, when
the sector itself was ailing. Indian agriculture and hence
rural India has always been betrayed in the past, but, kept
alive by occasional injections of technologies, subsidies
and sops. Formation of Commission for Agricultural Costs
and Prices (CACP), introduction of seed-fertilizer-water tech-
nology, formation of different cooperative societies, market-
ing agencies, etc. have created a positive atmosphere for
agricultural growth but, all these were short-lived and were
unable to compensate it fully. Over the past few years, lib-
eralization has meant the withdrawal of several subsidies
from the farming sector, resulting in a sharp increase in the
cost of fertilizers and seeds coupled with power hikes. Lib-
eralization and globalisation are the process in the process
of elimination of unfair treatment at the national and inter-
national level. The protection must go. But, a State cannot
forget its basic duty to protect a common man. The protec-
tion cannot be withdrawn without the creation of proper in-
frastructure and investment. The subsidies must be I with-
drawn in proportion to the investment. There cannot be one
drug for all the diseases. Liberalisation may be pancea of
one, may not be for all. The rural credit system can be
streamlined by the following measures:
(a) Self-Help Groups must be encouraged for banking in
the rural areas;
(b) The rural banks must relinquish narrow banking and
must resort to universal banking;
(c) Even Narasimham Committee suggested consolidation
of rural branches of commercial banks into banking enti-
ties;
(d) There should be separate prudential norms for the rural
banking;
(e) It should be possible to devise a model in which the
resources of commercial banks are available for rural lend-
ing, which would be carried out through specialised banks
operating only in rural areas. The main-line commercial
banks can buyout rural loan portfolios of these rural banks;
(f) The government must provide incentives in the form of
exemptions to the commercial banks to operate in rural
areas;
(g) The banking system should equip itself to identify the
eligible clients based on prescribed norms in the govern-
ment-sponsored programmes such as IRDP rather than to
depend on the government agencies;
(h) The operating systems of banks and other rural financ-
ing institutions (RFIs) like RRBs and District Credit Coop-
erative Banks (DCCBs) in terms of appraisal, supervision
and follow up must be properly reviewed and strengthened.
I strongly feel that there is urgent need to reconsider the
following measures:
(a) India’s agricultural policy should continue to be “grain-

2
oriented”, supplemented by pulses and oilseeds;
(b) Seed Act must be introduced which lays down strin-
gent punishment to those who sell spurious seeds/fertiliz-
ers;
(c) A more comprehensive and farmer-friendly crop insur-
ance policy should be formulated;
(d) Food for work programme should be modified. It should
be restricted to construction of permanent structures, to
stop diversion of grains in the name of short-term fictitious
projects;
(e) The Budget 2004-05 has also admitted that the agricul-
ture sector requires massive investments. Such investments
can be through credit-enabled private investment and en-
hanced public investment. For this fiscal instruments to
boost investment in agriculture would be needed;
(f)The rural credit system must be revamped. The function-
ing of Regional Rural Banks (RRBs) and Cooperative Banks
must be streamlined. A comprehensive rural credit delivery
system should be evolved. The Kishan Credit Cards (KCC)
suffers from adhocism. It should further be simplified;
(g) Nothing has been done on long-term basis to solve the
age-old flood problems in Bihar and other eastern states.
The main cause of flood in North Bihar is the heavy rainfall
in Nepal. The rainwater enters Bihar through Gandak, Koshi,
Adhawara Group of rivers. We must take immediate mea-
sures to control the rainwaters;
(h) The irrigation facility is only confined to food-grain areas
but it is almost absent in the dry land areas. This averts
crop diversification. The existing Accelerated Irrigation Ben-
efit Programme (AIBP) should be restructured and there
should be a spatial growth of irrigation system. For this,
both private and foreign investments should be invited;
(i) Even though the horizontal productivity has been in-
creased to a very large extent but the vertical productivity
has been thoroughly neglected;
(j) The cropping pattern is more or less static not only be-
cause of direct neglect of the same by the agricultural policy
formulators but also because of the failure of various re-
sponsible institutions to change the rigid socio-psycho per-
spectives of farmers;
(k) Introduction of rational market mechanism is indispens-
able for the sustained growth of Indian farmers. For this,
the subsidy provisions should be minimized and the same
financial resource could be utilised to increase the invest-
ments;
(l)Green revolution produced regional disparity in the coun-
try. For minimizing this negative fallout, Indian agriculture
needs area specific programmes, which could bring ever-
green revolution in the country. But for this, the policy for-
mulation should depend upon ground realities rather than
they be knit in air conditioned rooms;
(m) The biggest problem of Indian Agriculture is that it is
still nature ridden. Till it is brought out of the clutches of
monsoonal vagaries, it would continue to show skewed re-
sults;
(n) Capital formation in agricultural sector should be made
government’s responsibility;
(o) A transparent linkage between field and market should
be established so that farmers get remunerative returns and
role of intermediaries can be minimized;
(p) Agro-processing industries should be installed all over
the country. This would help cater domestic as well as for-
eign demand. India contributes just 1 per cent of the agro-
processed products of the world. This is abysmally low;
(q) Government should garner some resources by taxing
income of a few big landlords. This would ensure equity
and give some money to the exchequer;
(r) A shift from minimum support price system and devel-
oping alternative product markets are essential for crop di-
versification and broad based agricultural development;
(s)The Central government must provide financial assistance
to the state Governments for procurement and distribution
of food grains at subsidized rates, particularly to the fami-
lies below the poverty line. Only an enhanced agricultural
growth would provide stimulus to other off-farm activities in
rural areas due to its forward and backward linkages. This
would generate more employment and income in rural ar-
eas, which in turn would cause reduction of poverty in these
areas;
(t) APMC Act must be amended and mandi taxes should
be abolished. It will allow competitive markets to develop.
Suggestion by Economic Survey 2008-09
There is clearly a need for a renewed focus on improving
productivity. At the same time to step up the growth of al-
lied activities and non-farm activities that can help improve
value addition. The current focus on developing rural infra-
structure particularly rural roads needs to be maintained as
it would go a long way in providing connectivity that is es-
sential for movement of agricultural produce. The irrigation
sector requires a renewed thrust both in terms of invest-
ment as also modem management. There is considerable
scope for development of micro-irrigation systems and wa-
tershedsandintheuseof aparticipatoryapproachforachiev-
ing the same.
There is a need to narrow the gap between producer prices
and consumer prices through proper marketing support. The
development of marketing infrastructure and storage and
warehousing and cold chains and spot markets that are
driven by modern technology will go a long way in address-
ing this need.
As per the Report of the Committee on Financial Inclusion
Qanuary 2008), more than 73 per cent of farmer house-
holds have no access to formal sources of credit. Innova-
tive institutional mechanisms that provide credit and finan-
cial products (including insurance products) specifically
designed to meet the needs of the farm sector keeping
their risk - bearing ability in view is the need of the hour.
The rural economy needs to be viewed as comprising of a
continuum of interrelated economic activities. Farming
needs to be dovetailed with viable off-farm and non-farm
activities. Farmers need to be facilitated to take up value
addition such as processing of agricultural produce, horti-
culture, pisciculture, poultry, development of non-farm rural
enterprises. On the distribution side, there is need to en-
sure that benefits accrue to the targeted population. A mis-
sion approach for promotion of smart cards and its cross
reference with ration cards and voter ID cards would help
better targeting, lesser leakages and easier administration.
An area that requires focused attention is the issue of
sustainability of agriculture with due emphasis on environ-
mental concerns. Soil erosion, water logging, reduction in
groundwater table and the decline in the surface irrigation
are the problems faced by agriculture. The consequences
of climate change on Indian agriculture also need to be
factored in the strategy for the development of this sector.
On the whole, while the challenges faced by the agriculture

3
ECONOMIC GROWTH
HARROD-DOMAR MODEL,
INSTABILITY OF EQUILIBRIUM.
NEOCLASSICAL GROWTH
SOLOW’S MODEL,
STEADY STATE GROWTH.
MODELS OF GROWTH OF
JOAN ROBINSON AND
KALDOR;
TECHNICAL PROGRESS
HICKS,
HARROD AND
LEARNING BY DOING,
SOME GROWTH MODELS
THE HARROD-DOMAR MODELS
The Harrod-Domar models of economic growth are based
on the experiences of advanced economies. They are
primarily addressed to an advanced capitalist economy and
attempt to analyse the requirements of steady growth in
such economy.
Requirements of Steady Growth
Both Harrod and Domar are interested in discovering the
rate of income growth necessary for a smooth and
uninterrupted working of the economy. Though their models
differ in details, yet they arrive at similar conclusions.
Harrod and Domar assign a key role to investment in the
process of economic growth. But they lay emphasis on the
dual character of investment. Firstly, it creates income, and
secondly, it augments the productive capacity of the
economy by increasing its capital stock. The former may
be regarded as the ‘demand effect’ and the latter the ‘supply
effect’ of investment. Hence so long as net investment is
taking place, real income and output will continue to expand.
However, for maintaining .a full employment equilibrium level
of income from year to year, it is necessary that both real
income and output should expand at the same rate at which
the productive capacity of the capital stock is expanding.
Otherwise, any divergence between the two will lead to
excess or idle capacity, thus forcing entrepreneurs to curtail
their investment expenditures. Ultimately, it will adversely
affect the economy by lowering incomes and employment
.in the subsequent periods and moving the economy off the
equilibrium path of steady growth. Thus, if full employment
is to be maintained in the long run, net investment should
expand continuously. This further requires continuous growth
in real income at a rate sufficient enough to ensure full
capacity use of a growing stock of capital. Thus required
rate of income growth may be called the warranted rate of
growth or “the full capacity growth rate.”
Assumptions
The models constructed by Harrod and Domar are based
on the following assumptions.
(1) There is an initial full employment equilibrium level of
income.
(2) There is the absence of government interference.
(3) These models operate in a closed economy which has
no foreign trade.
(4) There are no lags in adjustments between investment
and creation of productive capacity.
(5) The average propensity to save is equal to the marginal
propensity to save.
(6) The marginal propensity to save remains constant.
(7) The capital coefficient, i.e., the ratio of capital stock to
income is assumed to be fixed.
(8) There is no depreciation of capital goods which are
assumed to possess infinite life.
(9) Saving and investment relate to the income of the same
year.
(10) The general price level is constant, i.e., the money
income and he real income are the same.
(11) There are no changes in interest rates.
(12) There is a fixed proportion of capital and labour in the
productive process.
(13) Fixed and circulating capitals are lumped together under
capital.
Lastly, there is only one type of product.
All these assumptions are not necessary for the final solution
of the problem; nevertheless they serve the purpose of
simplifying the analysis.
THE DOMAR MODEL
Domar builds his model around the following question: since
investment generates income on the one hand and increases
productive capacity on the other, at what rate investment
should increase in order to make the increase in income
equal to the increase in productive capacity, so that full
employment is maintained?
He answers this question by forging a link between
aggregate supply and aggregate demand through
investment.
Increase in Productive Capacity. Domar explains the
supply side like this. Let the annual rate of investment be /
, and the annual productive capacity per dollar of newly
created capital be equal on the average to s (which
represents the ratio of increase in real income or output to
an increase in capital or is the reciprocal of the accelerator
or the marginal capital-output ratio). Thus the productive
capacity of /dollar invested will be I.s dollars per year.
But some new investment will be at the expense of the old.
It will, therefore, compete with the latter for labour markets
and other factors of production. As a result, the output of
old plants will be curtailed and the increase in the annual
output(productivecapacity)oftheeconomywillbesomewhat
less than I.s. This can be indicated as la; where a (sigma)
represents the net potential social average productivity of
investment ( I/YÄ= ). Accordingly la is less than I.s. la
is the total net potential increase in output of the economy
and is known as the sigma effect. In Domar’s words this “is
the increase in output which the economy can produce,” it
is the “supply side of our system.”
Required Increase in Aggregate Demand. The demand
side is explained by the Keynesian multiplier. Let the annual
increase in income be denoted by ÄY and the increase in
investment by A/and the propensity to save by a (alpha)
(= Ä S/ Ä Y). Then the increase in income will be equal to
the multiplier (I/α) times* the increase in investment.
á
1
IÄYÄ =
Equilibrium. To maintain full employment equilibrium level
of income, aggregate demand should be equal to aggregate
supply. Thus we arrive at the fundamental equation of the
model
∆I I
1
α
σ=
Solving this equation by dividing both sides by /and

4
multiplying by we get :
∆I
I
= ασ
This equation shows that to maintain full employment the
growth rate of net autonomous investment ( I/IÄ ) must be
equal to ασ (the MPS times the productivity of capital).
This is the rate at which investment must grow to assure
the use of potential capacity in order to maintain a steady
growth rate of the economy at full employment.
Domar gives a numerical example to explain his point: Let
σ =25 per cent per year, α=12 percent and Y=150 billion
dollars per year. If full employment is to be maintained, an
amount equal to 150x12/100=18 billion dollars should be
invested This will raise productive capacity by the amount
invested ‘y times, i.e., by 150x12/100x25/100=4.5 billion
dollars, and the natioiial income will have to rise by the
same amount. But the relative rise in income will equal the
absolute increase divided by the income itself, i.e.,
150
12
100
25
100
150
12
100
25
100
3x
x
x percent= = =ασ
Thus in order to maintain full employment, income must
grow at a rate of 3 per cent per annum. This is the equilibrium
rate of growth. Any divergence from this ‘golden path’ will
lead to cyclical fluctuations. When I/IÄ is greater than
aa, the economy would experience boom and when I/IÄ
is less than acr, it would suffer from depression.
The Harrod Model
Professor R.F. Harrod tries to show in his model how steady
(i.e., equilibrium) growth may occur in the economy. Once
the steady growth rate is interrupted and the economy falls
into disequilibrium, cumulative forces tend to perpetuate
this divergence thereby leading to either secular deflation
of secular inflation.
The Harrod Model is based upon three distinct rates of
growth. Firstly, there is the actual growth rate represented
by G which is determined by the saving ratio and the capital-
output ratio. It shows short-run cyclical variations in the
rate of growth. Secondly, there is the warranted growth rate
represented by Gw which is the full capacity growth rate of
income of an economy. Lastly, there is the natural growth
rate represented by Gn which is regarded as ‘the welfare
optimum’ by Harrod. It may also be called the potential or
the full employment rate of growth.
The Actual Growth Rate. In the Harrodian model the first
fundamental equation is:
GC = s ...(1)
where G is the rate of growth of output in a given period of
time and can be expressed as Y/YÄ ; C is the net addition
to capital and is defined as the ratio of investment to the
increase in income, i.e., YÄ/I and s is the average
propensity to save, i.e., S/Y. Substituting these ratios in
the above equation we see
SIor
Y
S
Y
I
or
Y
S
YÄ
I
Y
YÄ
===×
The equation is simply a re-statement of the truism that
expost (actual, realized) savings equal expost investment.
The above relationship is disclosed by the behaviour of
income. Whereas S depends on Y, I depends on the
increment in income ( )YÄ , the latter '. nothing but the
acceleration principle.
The Warranted Rate of Growth. The warranted rate of
growth is, according to Harrod, the rate “at which producers
will be content with what they are doing.” It is the
“entrepreneurial equilibrium; it is the line of advance which,
if achieved, will satisfy profit takers that they have done the
right thing.” Thus this growth rate is primarily related to the
behaviour of businessmen. At the warranted rate of growth,
demand is high enough for businessmen to sell what they
have produced and they will continue to produce at the same
percentage rate of growth. Thus, it is the path on which the
supply and demand for goods and services will remain in
equilibrium, given the propensity to save. The equation for
the warranted rate is
GwCr=s ...(2)
where Gw is the “warranted rate of growth” or the full capacity
rate of growth of income which will fully utilize a growing
stock of capital that will satisfy the entrepreneurs with the
amount of investment actually made. It is the value of
Y/YÄ Cr, the ‘capital requirements’, denotes the amount
of capital needed to maintain the warranted rate of growth,
i.e., required capital-output ratio.It is the value of YÄ/I or
C. s is the same as in the first equation, i.e., S/Y.
The equation, therefore, states that if the economy is to
advance at the steady rate of Gw that will fully utilize its
capacity, income must grow at the rate of s/Cr per year
i.e., Gw=s/Cr.
If income .grows at the warranted rate, the capital stock of
the economy will be fully utilised and entrepreneurs will be
willing to continue to invest the amount of saving generated
at full potential income. Gw is therefore a self-sustaining
rate of growth and if the economy continues to grow at this
rate it will follow the equilibrium path.
Genesis of Long-run Disequilibria. Full employment
growth, the-actual growth rate of G must equal Gw, the
warranted rate of growth that would give steady advance to
the economy and C (the actual capital goods) must equal
Cr (the required capital goods for steady growth). If G and
Gw are riot equal, the economy will be in disequilibrium.
For instance, if G exceeds Gw, then C will be less than Cr.
When G>Gw, shortages result. “There will be insufficient
goods in the pipeline and/or insufficient equipment.” Such
a situation leads to, secular inflation because actual income
grows at a faster rate than that allowed by the growth in the
productive capacity of the economy. It will further lead to a
deficiency of capital goods, the actual amount of capital
goods being less than the required capital gods (C<Cr).
Under the circumstances, desired (ex-ante) investment
wouldbegreaterthansavingandaggregateproductionwould
fall short of aggregate demand. There would thus be chronic
inflation. This is illustrated where the growth rates of income
are taken on the vertical axis and time on the horizontal
axis. Starting from the initial full employment level of income
Y0
, the actual growth rate G follows the warranted growth
path Gw upto point E through period t2
. But from t2
onwards,
G deviates from Gw and is higher than the latter. In
subsequent periods, the deviation between the two becomes
larger and larger.

5
It, on. the other hand, G is less than Gw, then C is greater
than Cr. Such a situation leads to secular depression
because actual income grows more slowly than what is
required by the productive capacity of the economy leading
to an excess of capital goods (C>Cr). This means that
desired investment is less than saving and that the
aggregate demand falls short of aggregate supply. The result
is fall in output, employment arid income. There would thus
be chronic depression. This is illustrated when from period
t2
onwards G falls below Gw and the two continue to deviate
further away.
Harrod states that once G departs from Gw, it will depart
further and further away from equilibrium. He writes: “Around
that line of advance which if adhered to would alone give
satisfaction, centrifugal forces are at work, causing the
system to depart further and further from the required line of
advance.” Thus the equilibrium between G and Gw is a knife-
edge equilibrium. For once it is disturbed, it is not self-
correcting. It follows that one of the major tasks of public
policy is io bring G and Gw together in order to maintain
long-run stability. For this purpose, Harrod introduces his
third concept of the natural rate of growth.
The Natural Rate of Growth. It “is the rate of advance
which the increase of population and technological
improvements allow.” The natural rate of growth depends
on the macro variables like population, technology, natural
resources and capital equipment. In other words, it is the
rate of increase in output at full employment as determined
by a growing population and the rate of technological
progress. The equation for the natural rate of growth is
Gn. Cr = or # s
Here Gn is the natural or full employment rate of growth.
Divergence of G, Gw and Gn. Now for full employment
equilibrium growth Gn=Gw=G. But this is a knife-edge
balance. For once there is any divergence between natural,
warranted and actual rates of growth conditions of secular
stagnation or inflation would be generated in the economy.
IfG>Gw,investmentincreasesfasterthansavingandincome
rises faster than Gw. If G<Gw, saving increases faster than
investment and rise of income is less than Gw. Thus Harrod
points out that if Gw> Gn secular stagnation will develop. In
such a situation Gw is also greater than G because the
upper limit to the actual rate is set by the natural rate.
When Gw exceeds Gn, C>Cr and there is an excess of
capital goods due to a shortage of labour. The shortage of
labour keeps the rate of increase in output to a level less
than Gw. Machines become idle and there is excess
capacity. This further dampens investment, output,
employment and income. Thus the economy will be in the
grip of chronic depression. Under such conditions saving is
a vice.
If Gw<Gn, Gw is also less than G as shown in the tendency
is for secular inflation to develop in the economy. When Gw
is less than Gn,C<Cr. There is a shortage of capital goods
and labour is plentiful. Profits are high since desired
investment is greater than realised investment and the
businessmen have a tendency to increase their capital
stock. This will lead to secular inflation. In such a situation
saving is a virtue for it permits the warranted rate to increase.
This instability in Harrod’s model is due to the rigidity of its
basic assumptions. They are a fixed production function, a
fixed saving ratio, and a fixed growth rate of labour force,
Economists have attempted to relieve this rigidity by
permitting capital and labour substitution in the production
function, by making the saving ratio a function of the profit
rate and the growth rate of labour force as a variable in the
growth process.
The policy implications of the model are that saving is a
virtue in any inflationary gap economy and vice in a
deflationary gap economy. Thus in an advanced economy,
s has to be moved up or down as the situation demands..
A Comparative Study of the two Models
Points of Similarity
THE DOMAR MODEL
áó
I
IÄ
I
YÄ
ó ==
YÄ
SÄ
I
YÄ
I
IÄ
YÄ
SÄ
á ×==
I
SÄ
I
IÄ
=
or SÄIÄ =
THE HARROD MODEL
SIor
Y
S
s
Y
S
Y
I
YÄ
I
C
Y
S
YÄ
I
Y
YÄ
or
Y
YÄ
GsGC
=
===
==×
==
=
Given the capital-output ratio, as long as the average
propensity to save is equal to the marginal propensity to
save, the equality of saving and investment fulfils the
conditions of equilibrium rate of growth.
Looked at from another angle the two models are similar.
Harrod’s s is Domar’s ∝ . Harrod’s warranted rate of growth

6
(Gw) is Domar’s full employment rate of growth ( ó∝ ).
Harrod’s Gw=s/Cr=Domar’s áó.
To prove it
)2(.......óIYÄor
I
YÄ
ó
)1(......YáSor
Y
S
á
==
==
Since S=I and substituting S for I in equation (2) we have
[ ]






==∴
=
=∴=
Y
YÄ
GwSinceáóGw
)3(......áó
Y
YÄ
or
YáSóYáYÄ
We have proved mathematically that Harrod’s Gw is the
same as Domar’s ó∝ . But, in reality, Domar’s rate of
growth r=αs is Harrod’s Gw, and Domar’s ór ∝= Harrod’s
natural growth rate. In Domar’s model s is the annual
productive capacity of newly created capital which is greater
than ó which is the net potential social average productivity
of investment. It is,the lack of labour and other factors of
production which reduces Domar’s growth rate from
órtosr =∝=∝ . Since labour is involved in’ ó therefore
Domar’s potential growth rate resembles Horrod’s natural
rate. We may also say that the excess of s over ó in
Domar’s model expresses the excess of Gw over Gn in
Harrod’s model.
Points of Difference. There are, however, important
differences in the two models.
:(1) Domar assigns a key role to investment in the process
of growth and emphasises on its dual character. But Harrod
regards the level of income as the most important factor in
the growth process. Whereas Domar forges a link between
demand andsupplyofinvestment,Harrod,ontheotherhand,
equates demand and supply of saving.
(2) The Domar model is based on one growth rate ór ∝=
But Harrod uses three distinct rates of growth: the actual
rate (G), the warranted rate (Gw) and the natural rate (Gn).
(3) Domar uses the reciprocal of marginal capital-output
ratio, while Harrod uses the marginal capital-output ratio. In
this sense Domar’s ó = 1 / Cr of Harrod.
(4) Domar gives expression to the multiplier but Harrod uses
the accelerator about which Domar appears to say nothing.
(5) The formal identity of Harrod’s Gw equation and Domar’s
equation’s maintained by Domar’s assumption that
Y/YÄI/IÄ = . But Harrod does not make such
assumptions. In Harrod’s equilibrium equation Gw, there is
neither any explicit or implicit reference to ∆I or I. It is,
however, in his basic equation G=s/C that there is an implicit
reference to I, since C is defined as YÄ/I . But there is no
explicit or implicit reference to IÄ ..
(6) For Harrod the business cycle is an integral part of the
path of growth and for Domar it is not so, but is,
accommodated in his model by allowing ó (average
productivity investment) to fluctuate.
(7) While Domar demonstrates the technological relationship
between capital accumulation and subsequent full capacity
growth in output, Harrod shows in addition a behavioural
relationship between rise in demand and hence in current
output on the one hand, and capital accumulation on the
other. In other Words, the former does not suggest any
behaviour pattern for entrepreneurs and the proper change
in investment comes exogenously, whereas the latter
assumes a behaviour pattern for entrepreneurs that induces
the proper change in investment.
Limitations of these Models
Some of the conclusions depend on the crucial assumptions
made by Harrod and Domar which make these models
unrealistic:
(1) The propensity to save ( )sor∝ and the capital-output
ratio ( )ó are assumed to be constant. In actuality, they
are likely to change in the long run and thus modify the
requirements for steady growth. A steady rate of growth
can, however, be maintained without this assumption. As
Domar himself writes, “This assumption is not necessary
for the argument and that the whole problem can be easily
reworked with variable ∝ and ó .”
(2) The assumption that labour and capital are used in fixed
proportions is untenable. Generally, labour can be
substituted for capital and the economy can move more
smoothly towards a path of steady growth. In fact, unlike
Harrod’s model, this path is not so unstable that the
economy should experience chronic inflation or
unemployment if G does not coincide with Gw.
(3) The two models also fail to consider changes in the
general price level. Price changes always occur over time
and may stabilize otherwise unstable situations. According
to Meier and Baldwin, “If allowance is made for price changes
and variable proportions in production, then the system may
have much stronger stability than the Harrod model
suggests.”
(4) The assumption that there are no changes in interest
rates is irrelevant to the analysis.” Interest rates change
and affect investment. A reduction in interest rates during
periods of overproduction can make capital-intensive
processes more profitable by increasing the demand for
capital and thereby reduce excess supplies of goods.
(5) TheHarrod-Domarmodelsignoretheeffectofgovernment
programmes on economic growth. If, for instance, the
government undertakes a programme of development, the
Harrod-Domar analysis does not provide us with causal
(functional) relationship.
(6) It also neglects the entrepreneurial behaviour which
actually determines the warranted growth rate in the
economy. This makes the concept of the warranted growth
rate unrealistic.
(7) The Harrod-Domar models have been criticised for their
failure to draw a distinction between capital goods and
consumer goods.
(8) According to Professor Rose, the primary source of
instability in Harrod’s system lies in the effect of excess
demand if supply on production decisions and not in the
effect of growing capital shortage cr redundancy on
investment decisions.
Despite these limitations, “Harrod-Domar growth models

7
are purely laissez-faire ones based on the assumption of
fiscal neutrality and designed to indicate conditions of
progressive equilibrium for an advanced economy.” They
are important because they represent a stimulating attempt
to dynamize and secularise Keynes’ static short-term saving
and investment theory.
APPLICATION OF HARROD-DOMAR MODELS TO
UNDERDEVELOPEDCOUNTRIES
Growth theory in advanced economies has been associated
with three principal concepts: the saving function,
autonomous vs. induced investment, and the productivity
of capital. The Harrod-Domar models are based on these
concepts and were primarily developed in order-to illuminate
secular stagnation that was threatening the advanced
economies in the post-war period. The application of these
models has now been extended to the development-
problems of underdeveloped economies. As Hirschman
writes: “The Domar model, in particular, has proved to be
remarkably versatile, it permits us to show not only the rate
at which the economy must grow if it is to make full use of
the capacity created by new investment but inversely, the
required savings and the capital-output ratios if income is
to attain a certain target growth rate. In such exercises, the
capital-output ratio is usually assumed at some value
between2.5and5;sometimesseveralalternativeprojections
are undertaken; with given growth rates, overall or per capita,
and with given population projections, in the latter case,
total capital requirements for five- or ten-year plans are then
easily derived. Let us see how these models can be used
for planning in underdeveloped countries.
Suppose the capital-output ratio is assumed to be 4:1 and
the full capacity growth rate or the warranted growth rate is
estimated at 3 per cent per annum for the economy. By
applying either the Harrod or the Domar formula, the planners
can find out the saving income ratio required to sustain the
growth rate of 3 per cent per annum.
In Harrod’s model:
Gw.Cr=s and by applying the assumed rates we get,
3/100x4/1=12/100 or 12 per cent which is the saving-income
ratio. Similarly, in Domar’s model :
∝= áY/YÄ
=3/100x4/1=12/100 or 12 per cent (a being the reciprocal
of Harrod’s Cr),
Thus, if the capital-output ratio is assumed as 4:1 in an
economy, the community will have to save 12 per cent of
its annual income, if its annual growth rate of output is to
be 3 per cent. Let us work it out in practice. Given the
saving ratio and the capital-output ratio, the Harrod formula
for calculating the growth rate is
Gw=s/Cr, If s is 12 per cent and the value of Cr 4, then
Gw=12/4=3 per cent.
Sir Roy Harrod in the Second Essay an Dynamic Theory
has tried to make his model more applicable to
underdeveloped countries. He has elaborated the supply
side of his fundamental equation by introducing the role of
interest rate in determining the supply of savings and the
demand for savings. The natural rate of interest in is defined
as the ratio of the natural growth rate of per capita output
Pcand the natural growth rate of income Gn to the elasticity
of diminishing utility of income e. Thus
r n
Pc Gn
e
=
.
Taking the values of Pc and Gn- as given, the natural rate of
interest depends on the value of e which is assumed to be
less than unity, rn and e are inversely related to each other.
When e is small, rn is high and vice versa.
The capital requirements, Cr, depend on the rate of interest,
Cr =f(rn). Rather, Cr is a decreasing function of rn. The higher
the rate of interest, the lower the capital requirements, and
vice versa.
The savings Requirements Sr, like Cr, are.also-of much
importance in underdeveloped countries. But the average
propensity to save s is not necessarily equal to social
requirements of savings, Sr, The actual savings S may be
greater or less than Sr, i.e., S ≠ Sr. If S>Sr then’ Gw>
Gnwhich means that actual savings being larger in the
community, entrepreneurs would desire to invest more? In
the long run howeverGwcannot continue to be greater than
Gn which is the highest growth rate that can be attained. In
such a situation, the actual growth rate would attain full
employment and will be less than Gw, i.e., G<Gw. This will
lead to depression in the economy. On the contrary, if S<Sr,
then Gw<Gn. It implies that actual savings being less than
the required savings in the community, there would be fall
in investment. In the long run, it would lead to a fall in the
warranted growth rate below the actual growth rate, i.e.,
Gw<Gand the level of investment would increase. Ultimately
there will be chronic inflation.
Since low savings, high level of investment and chronic in-
flation are some of the features of underdeveloped coun-
tries, Harrod suggests the financing of large investments
through the expansion of bank credit and automatic invest-
ment of inflationary profits in the capital markets. But there
are no organised capital markets in such economies, there-
fore, expansion of bank credit is the only way to finance
investments and generate economic growth. Low savings
in an underdeveloped country are responsible for its low
rate of growth and the existence of mass unemployment
andunderemployment. Thustheactuallevelof savingshould
be raised to the level of required rate of savings by a com-
pulsory levy or a surplus budget to that S=Sr Besides,
Harrod also emphasizes the need for changes in social
and institutional factors in such economies. For social and
institutional obstacles may be the cause of a low growth
rate rather than the lack of savings -in underdeveloped coun-
tries, Under the circumstances, Sr will also be low and S
may approximate to it.
LIMITATIONS OF THESEMODELS FROM THE STAND-
POINT OF UNDERDEVELOPED COUNTRIES
The Harrod-Domar models are not applicable to underde-
veloped countries for the following reasons:
1. 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 industri-
alization programmes in underdeveloped economies. The
limitations of these growth models, as applied to such
economies, therefore, stem from this fact.
2.Saving Ratio. These growth models are characterized,
by a high saving ratio and a high capital-output ratio. In an
underdeveloped economy, however, decisions to save and
invest are generally undertaken by the same group of per-

8
sons. The vast majority of the people live on the margin of
subsistence and thus very few are in a position to save.
3.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
productionaridremovingthevariousobstaclestoinvestment.
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.
4.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-utilization 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.
5.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.
6.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.
7. 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.
8. 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 .
9.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.
Conclusion. 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 its 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 stabilizing role
but also a development role, if these economies are to
industrialize more effectively and rapidly than the now
industrialized 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 these
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.

9
IMPORTANT POINTS
INDIAN ECONOMICS
ANCIENT & MEDIEVAL INDIAN ECONOMY
• Basic features of an economy- Unlimited wants, limited
resources have alternative uses.
• Basic problems of an economy- What to produce, how to
produce, whom to produce, and growth
of resources.
• Kautilya Artha sastra gives details of political, social, eco-
nomic, and military organisation of the Mauryan empire
• Subsistence agriculture - Production of crops for the sake
of self consumption by the farmer and the family and not for
sale in the market.
• In urban areas, the group of handcrafters having common
interests is called as guilds
• Sher Shaw Suri first introduced rupee coins in India in
1809.
• Kautilya Arthasastra has been considered as the most
authoritative work on ancient Indian economic thought.
• Kautilya Arthasastra deals with state craft.
• Arthasastra and Neeti sastra deals with the production
and exchange.
• Arthasastra felt material wealth is not an end in itself but
as an important means to achieve the objectives of life.
• In ancient India Vartha means the branch of knowledge
dealing with agriculture, commerce, cattle breeding, money
lending and artisanship.
• Arthasastra is broader than Varta, because Arthasastra
deals with jurisprudence, politics, and economics.
• During Sher Sha tenure, lands were surveyed and land
tax were determined scientifically based on productivity.
• Jagir system was abolished by Akbar.
• Akbar introduced land tax based on last ten years aver-
age land price.
• Laissez-fair (freeness) principle was followed during
ancient India.
• In ancient Indian economy agriculture and animal hus-
bandry was occupies important place as occupations.
• Kharaj- Fax on cultivation
• Charat Tax on milch cattle
• Ghari- Tax on houses.
• The first Portuguese explorer ,Vascoda Gama opened
sea route to India in 1498.
• Grand trunk road was constructed by - Sher Shaw Suri
• Main cereals grown during ancient period were Wheat
and Barley.
• Jizia is a tax imposed on Hindus , who failed to preach
Islam .
• Muhammed bin Tuglak introduced token currency.
• Jajirs means the group of villages.
• Begar means land less labour
• Jajimani system- It is the system prevails in rural India
between farmers and the village artisans. Generally reward
for service is paid in the form of kind as per contract
• According to Dharmasastras consumption should be
based on dharma. Artha, Kama, Moksha
• Dharma sastra deal with consumption and distribution.
• Role ol state is limited in economic decision making in
ancient India.
• The three distinct classes in villages in ancient India are -
The agriculturists, village artisans. Menials and village offi-
cials.
• Slier Sha surveyed and graded lands for the imposition of
land taxes based on productivity.
• Akbar fixed land taxes based on the average price of
land.
• The founders of modem Indian economic thought are
Dadabai Nauroji, Ranade, and RC. Dutt and Ghokale.
• Ancient literature recognized 4 factors of production.
• Commercialization of agriculture—Production of crops
for sale rather than for family consumption.
• Cash crops Cotton, Jute, Sugar cane. Ground nuts and
Rubber.
INDIAN ECONOMY DURING BRITISH RULE
• Dadabai Nauroji first estimated national income of India
unofficially.
• During pre British period, Textiles and Handicrafts were
enjoyed world wide reputation.
• First jute mill was started in Calcutta in 1855.
• First iron and steel company was started by Jamshed ji
Tata in 1907 in Jamshedpur.
• The first modern industry stated in India is- Iron and Steel
• Indian Handicrafts are badly affected due to industrial revo-
lution in Britain
• Poverty and Un British rule in India was written by Dadabai
Nauroji. In this book, he analyzed how Britishers are re-
sponsible for drain of wealth and to increase poverty in In-
dia.
• The triangular trade system prevails during British rule
among three nations i.e. India, China and Britain.
• Indigo (useful for coloring textiles) cultivation during Brit-
ish rule prevails under two systems (1) Ryot system (2) Nij
system
• Absentee land lordism - Zamindars sublet their zamindari
right to some body on commission basis to collect land
revenue from peasants.
• Most of the sugar factories are set up by Europeans in
India were shut down, following the fall in prices of sugar.
• East India company is a joint stock company.
• Home charges in the form of salaries, pension, interest
on debt, expenditure, for the maintenance of Army and Navy.
• Essay on Indian political economy was written by M.G.
Ranade.
• The word political economy first used by Ranade. He stated
that economic laws are not universal and economic growth
not an isolated phenomenon it depends up on social, politi-
cal and religious factors.
• Ranade is the first Indian economist criticized classical
economic model.
• GK.Ghokale stated that Swadeshi is the only means to
initiate industrial growth in the country.
• Mahatma Gandhi’s economic thought was influenced by
Ruskin
• Colonial economy - Country is treated as a colony of rul-
ing foreign country to serve their own interests (rulers).
• British used colonial economies as suppliers of raw ma-
terials and market for finished goods.
• Britishers invested their capital in India through Managing
Agency system
• Two major forms of British investment in India are — Pri-
vate foreign direct investment in mines, mills and plantation
(2) sterling loans for infrastructure projects.
• Managing agency system can be defined as partnership
of companies formed by group of persons having huge fi-
nancial resources and business experience.

10
• During colonial period the large a’mount of British capital
was invested in infrastructure
• The chief industry spread over the whole nation is Textiles
and handicrafts.
• The industry first hit during the British rule are Textiles
and handicrafts.
• The opening of Sue/ Canal reduced transport costs and
made the exploitation of Indian markets easier.
• Progressive Ruralization means during British period be-
cause of loses occurred from the production and sale of
industrial goods and closures of industrial units, un em-
ployed craft men returned to agriculture.
During British rule major crops in India are — Rice and
Wheat.
• Main agricultural exports during British rule - Jute and
Cotton raw materials.
• During British period, India is the main exporter of pri-
mary goods.
• During major period of British rule, India’s foreign trade
was in positive balance.
• During British period 75% of the trade confined with Brit-
ain.
• The most important function of managing agency system
is to provide finance to set up Jute mills and Tea planta-
tions.
• Features of Indian economy during British rule - Stagnant
and weakened economy, low levels of living, predominance
of agriculture as’an occupation.
• On the eve of independence the nature of Indian economy
Under developed economy, stagnant economy, semi feu-
dal economy, depreciated economy, disintegrated economy.
• Causes of stagnation of Indian economy during British
rule- Backward and age old techniques of production, cus-
toms, traditions, colonial policy of British, and economic
drain.
• Semi feudal economy- It is an economy in which the
means of production are in the hands of rich people, who
lease their lands to tenents by charging exploitative rent.
East India company was established in AD 1600.
• During British period India’s foreign trade is protective
and discriminatory.
• Britishers mainly interested in production of plantation
crops.
• Subsistence farming prevails during British rule. Main
power used for agricultural operations are human and Bul-
lock power.
• Depreciated economy- During II world war Indian economy
was depreciated due to excessive use of machinery by in-
crease in production, to meet war needs but the broken
machinery was not replaced by new.
• Disintegrated economy- During British rule India was di-
vided into small states and units. It is anti for the adoption
of uniform and integrated economic policy for the whole
nation.
• Nature of Indian economy as an underdeveloped economy
on the eve of independence- Backward agriculture, short-
age of basic industries, industrial backwardness, low capi-
tal formation and low standards of living.
• Features of Indian economy as an underdeveloped
economy- Agriculture dominance, shortage of capital, preva-
lence of unemployment and underemployment, shortage of
infrastructure, backward and low techniques.
• Stagnant economy- GDP growth rate is very low or nega-
tive because of political, social and economic reasons.
• Features of Indian economy as a mixed economy- Exist-
ence of public and private sectors, joint sector, licensing
and controls, economic planning.
• Features of Indian economy as a developing economy-
Saving, capital accumulation, national income. Percapita
income is increasing, development is occurring in infra-
structure and all the three sectors i.e primary, secondary
and tertiary sectors.
• Economic history of India was written by R.C.Dutt.
• Poverty and un British rule in India was written by Dadabai
Nauroji.
• The only journal in the subject of economics during Brit-
ish rule The Indian economist.
• The founders of modern Indian economic thought were
Dadabai Nauroji. Ranade. R.C. Das, and Ghokale
• Drain theory was advocated by Dadabai Nauroji.
• National income of India was written by V.K.R.V.Rao in
1939. to In 1793. permanent settlement act was enacted
in Bengal presidency.
• First Railway line was constructed from Bombay to Flume.
In 1853.
• The trade monopoly of East India Company was abol-
ished in 1853 by the British parliament. to Between 1 829
to 1838, India had positive trade balance with Britain and
China.
• During British rule greater degree of monetization of the
economy was occurred due to inflow of silver.
• First Cotton mill in Bombay was started in 1854. to First
Jute mill was started in 1855 in Calcutta.
• Bombay plan was prepared by industrialists for the period
of 15 years for India.
• The aim of devaluation is to increase exports and de-
crease imports.
• Economic history of India was written by R.C. Dutt. to
The first country was established trade relations with India-
Portugal.
• The main aim of east India company is - To earn profits
through trade
• Permanent settlement implies The amount of land rev-
enue the xamindari is supposed to pay is fixed for 30 or 35
years, but the rate of land tax and the amount of land rev-
enue is to be colleted from the farmers was not specified.
• Mugalzari settlement means -It combines the features of
both the permanent zamindari and Ryotwari systems.
• East India company and traders enjoyed monopoly over
the forced cultivation of the cash crops i.e. Indigo and Poppy.
• Dadabai Nauroji calculated Percapita income per annum
Rs 20, during the three years from 1867 to 1870.
• The burden of tax on Indian people was about 2.5 times
greater than on the people of England.
• During British rule tax revenue is 22% of GDP now it is
not more than 15%.
• The champion of historical method to study Indian economy
is Ranade
• The idea of economic nationalism was advocated by
Ranade.
• The book famines in India were written in 1900 by R.C
Dutt.
• Tax and expenditure system prevails during British rule is
regressive.
• Mahatma Gandhi’s economic thought was influenced by
Ruskin’s book Un to the last.

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