The Lewis Growth Rule for Developing Economies

Abstract

ABSTRACT:For developing economies, adequate rates of capital formation are required for sustained economic growth, and policy makers have to consider the ratio of savings to invest in capital formation while still being supportive of other economic needs (e.g., servicing of current loans and payment of salaries and administrative overheads). We evaluated the expenditure-savings nexus of four emerging economies (i.e., Ghana, Botswana, Barbados, and Trinidad and Tobago) to investigate, in accordance with the seminal research of Sir Arthur Lewis, how the growth rates of savings and expenditure impact the accumulation of capital and, thus, spur economic development. Based on Lewis' research, we developed the Lewis Growth Rule (LGR) for developing economies – that is, emerging economies can best sustain economic development by maintaining a growth in savings that exceeds that of expenditure and by investing the surplus in the accumulation of capital. As a takeoff strategy for economic development, emerging economies' expenditure should grow by 5%–7%, whereas savings should grow by 7%–12%. We assessed the performance of the LGR by examining the two African and two Caribbean economies using data from the Penn World Tables. Our examination results of long-term trends in these economies demonstrate intermittent periods where the surplus gap as required by the LGR is observed with a downward trend for Barbados and Ghana, while upward for Botswana and Trinidad and Tobago. The impact of Ghana's significant continuous savings gaps on per capita GDP growth is significant over the analysis period. Barbados demonstrated a much lower marginal savings gap, but its positive impact on per capita GDP growth was much higher than that of Ghana. The findings have important implications for policy makers. While a savings gap is important for developing economies, political conflicts depress its impact on the real economy. Hence, the most important is the suggestion that, although critical to capital accumulation, the size of a positive savings gap does not have to be as large as Lewis' rule suggests for economic growth to be sustained. Coordinated government policies, growth supportive institutional arrangements, and investments in technology are also critical in unlocking high productivity that boosts and sustains real economic growth.