By Kelvin Tai - Economics and Management Student @ Harris Manchester College, Oxford
Robert Solow was one of the early members of the MIT Economics department. He won the 1987 Nobel Prize in Economic Sciences and this article will attempt to explain the growth model named after him. In the 1950s, many economists believed that the key to growth lay in accumulating capital. This makes intuitive sense: if you have a farm that produces a profit from its harvest, investing a portion of this profit into new production facilities would give greater capacity to generate even greater profits in future harvests.
The Solow model explores this intuition by factoring in depreciation as well as a diminishing return on investments. By assuming a constant rate of depreciation (d) - which when multiplied with the amount of capital (K) gives total depreciation - and diminishing returns on capital, there comes a point when investment can only just make up for the amount of capital depreciated. Another key assumption is that all output saved (not consumed) goes towards investment.
Because of this, the point where dK and I intersect is known as the ‘steady-state”, where investment will no longer create economic growth. The economy will always tend towards this state, regardless of the initial level of K. If the K is at a level to the right of the steady state K*, dK would actually be more than I and the amount of investment is insufficient to make up for the depreciation so capital stock actually decreases. The further the country is from the steady-state, the faster the rate of approach towards it, be it through the growth or reduction of capital stock. This is an explanation as to why countries that are developing tend to grow faster than already developed countries. China’s rapid rise since 1979 as well as the spurt in growth rates demonstrated by Germany and Japan in the reconstruction phase post-WW2 are but some examples.
The steady-state of every country differs, however. It does after all represent the fullest potential of a country’s development and will vary based on the policies and natural endowment of the country, among other factors. The positive news is that technology can push this steady state higher by rotating the investment curve upwards. Hence, countries can aspire to a higher steady-state and standard of living in the long-term by encouraging innovation (through a higher savings rate or better institutional protection), as well as through decreasing depreciation by implementing laws against the destruction of infrastructure.
Solow’s model found that growth did not come largely from population growth or capital accumulation. Rather, the engine for growth comes from total factor productivity, an elusive category that could be attributed to technology.
There are other models that bring Solow’s model forward, with more recent assumptions woven in. For instance, the Romer model builds in the growth of technology as a non-rivalrous driver of continuous growth. There is no doubt, however, that Robert Solow will remain regarded as one of the key pioneers of the field of macroeconomics, having developed such a fundamental basis for this field of study.
Further reading:
Robert M. Solow, The last 50 years in growth theory and the next 10, Oxford Review of Economic Policy, Volume 23, Issue 1, Spring 2007, Pages 3–14, https://doi.org/10.1093/oxrep/grm004
Valdés, B. (2003). An Application of Convergence Theory to Japan's Post-WWII Economic "Miracle". The Journal of Economic Education,34(1), 61-81. Retrieved March 23, 2021, from http://www.jstor.org/stable/30042525
Chen, W. (2017). Is the Green Solow Model Valid for CO2 Emissions in the European Union? Environmental and Resource Economics, 67(1), 23-45.