In April 1946, Evsey Domar published an article on economic growth called "Capital
Expansion, Rate of Growth, and Employment." This article did not discuss long run economic
growth; it discussed the relationship between short-term recessions and investment in the United
States. Domar assumed that production capacity was proportional to the capital stock. He admitted
the assumption was unrealistic.
Eleven years later, complaining of an "ever-guilty conscience," he disavowed the original
model altogether. 1 He said his purpose was to comment upon an esoteric debate on business
cycles, not to derive "an empirically meaningful rate of growth." He said his model made no
sense for long run growth. Domar endorsed the new growth model of Robert Solow, which would
dominate economists' theoretical approach to growth for the next three decades.
To sum up, Domar's model was not intended as a growth model, made no sense as. a
growth model, and was repudiated as a growth model forty years ago by its creator. So it was
ironic that Domar's growth model became, and continues to be today, the most widely applied
growth model in economic history.
In this paper, I tell the story of how Domar's model (usually called the Harrod-Domar
model) survived its supposed demise in the 1950s. Economists applied it (and still do apply it) to
poor countries from Albania to Zimbabwe to determine a "required" investment rate for a target
growth rate. The difference between the required investment and their own savings is the
Financing Gap. Donors fill the Financing Gap with foreign aid to attain target growth. This is not
a story about the long-run relationship between investment and growth -- it's a story about a
model that promised poor countries growth in the short-run through aid and investment.
I tell the story of the Ghost of Financing Gap in part I. In part II, I test empirically how
well the predictions of the Harrod-Domar growth model match the data. Part III concludes with
ideas for future practice.