Answer the following questions in about 150 words each : (d) Write down the implications of knife-edge problem in Harrod's model of growth.

Implications of the Knife-Edge Problem in Harrod's Model

The "knife-edge problem" in Harrod's growth model refers to the inherent instability of the steady-state growth path. It illustrates that for an economy to achieve balanced growth with full employment, the actual rate of growth (G) must precisely equal the warranted rate of growth (Gw), which in turn must equal the natural rate of growth (Gn). Any slight divergence from this precarious equilibrium can lead to severe macroeconomic consequences.

• Instability of Growth: The fundamental implication is the inherent instability of economic growth. The model suggests that the path of steady growth is like a "knife-edge"—extremely narrow and difficult to maintain. A slight push in either direction leads to a cumulative divergence from equilibrium.
• Divergence from Warranted Growth (G ≠ Gw):
  • If G > Gw (Actual growth exceeds Warranted growth): This implies that actual investment is greater than desired investment, or that aggregate demand is outstristripping productive capacity. Entrepreneurs face accumulating inventories and unsatisfied demand. They react by increasing investment, leading to an even faster actual growth rate, which further deviates from the warranted rate. This can lead to inflationary pressures and boom conditions, but ultimately unsustainable growth and resource shortages.
  • If G < Gw (Actual growth is less than Warranted growth): This signifies that actual investment is less than desired investment, or that productive capacity is growing faster than aggregate demand. Entrepreneurs experience unwanted inventory accumulation and excess capacity. Their response is to reduce investment, which further lowers the actual growth rate, leading to secular stagnation, deflationary conditions, and rising unemployment.
• Divergence from Natural Growth (Gw ≠ Gn): The natural rate of growth (Gn) represents the maximum possible growth rate determined by the growth of the labor force and technological progress.
  • If Gw > Gn: The warranted rate of growth exceeds the natural rate. The economy's capacity to produce grows faster than its ability to achieve full employment with available resources. This leads to persistent excess capacity and secular stagnation, as the economy cannot absorb the growing productive potential due to insufficient labor or technological constraints.
  • If Gw < Gn: The warranted rate is less than the natural rate. The economy cannot generate enough demand to utilize its full potential workforce and technology, leading to secular inflation with growing unemployment, as capital accumulation lags behind labor force growth.
• Policy Challenges: The knife-edge problem poses significant challenges for policymakers. Maintaining the precise balance required for stable growth often requires constant intervention to adjust savings rates, investment, and technological progress, which is difficult in practice.

The Harrod-Domar model, while foundational, has been criticized for the rigidity of its assumptions, such as fixed capital-output ratios and constant savings rates, which make the "knife-edge" problem inevitable. Later models, like the Solow-Swan model, introduced flexibility by allowing for factor substitution and technological progress, offering a more stable growth path.