Solow model
Higher income countries are not the fastest growing
Most countries are poor, and most people live in poor countries
Most economic growth is resource intensive
Why are some countries Rich and others Poor?
A model with endogenous capital accumulation. Studying this model will help us to investigate:
⇒ capital accumulation as an engine for economic growth
⇒ potential other factors that can affect long run growth
⇒ if countries with lower income per capita will catch up with richer countries
- For simplicity, we keep
assuming that L are fixed
over time: no population
growth
- Given our research
question, A is also fixed over
time: no technological
change
,1) What is a steady state of economic growth? Explain steady-state growth of income and
capital accumulation using the Solow growth model. What do you mean by "Catch up by a
country" and "convergence by a country" about economic growth?
growth in income per capita is an outcome of accumulation of capital per capita. This is the only source of
economic growth in the model. Without productivity constant, it is just accumulating physical capital. At this
point, there is equality between investment and depreciation. The economy will converge to a long
equilibrium which will be referred to as a steady state. It is simply a situation where income and capital
accumulation are not growing further.
All economies will eventually converge in terms of income per-capita. Underdeveloped
countries tend to grow more rapidly than wealthier economies. The less wealthy economies will
catch-up with the richer countries. Mainly because there is a higher marginal rate of return on
invested capital in faster-growing countries. This is also referred to as the theory of
convergence.
2) Why do poorer countries grow faster? Explain your answer using the Solow model.
In the long-term, there is no growth. This is only true if countries have the same population
growth rate, savings rate and capital depreciation rate, therefore, they will have similar
steady-states. Hence, they will converge. In the Solow model, it predicts conditional
, convergence. Thus, along this convergence path, poorer countries tend to grow faster. Poorer
countries, generally characterised by a lower level of capital stock per worker, have greater
potential for faster economic growth due to the concept of diminishing returns to capital.
According to the Solow growth model, the rate of economic growth depends on the savings rate
and the efficiency of capital utilisation. In poorer countries, the savings rate tends to be higher
as people have a greater incentive to save. This can be attributed to several factors, such as
limited social safety nets, lower access to credit, and the absence of well-developed financial
markets. Higher savings rates lead to increased investment, which in turn drives capital
accumulation. Furthermore, in the Solow growth model, technological progress plays a crucial
role in long-term economic growth. Technological progress can take various forms, including
improvements in production techniques, increased knowledge, and innovation. Poorer
countries have more room for technological catch-up, as they can adopt and adapt existing technologies
already developed by wealthier countries. This process of technology transfer
allows poorer countries to experience faster productivity growth and catch up with advanced
economies. Additionally, poorer countries often have a higher population growth rate compared
to wealthier countries. This implies a larger labour force and a higher potential for economic
output. However, for sustained economic growth, it is essential to have productive employment
opportunities and sufficient investment in human capital (education, health, skills
development) to harness the potential demographic dividend. Overall, the Solow growth model
suggests that poorer countries can experience faster economic growth due to their lower initial
levels of capital stock, higher savings rates, potential for technological catch-up, and larger
labour force. However, it is important to note that these are general tendencies and there are
several other factors, such as institutions, governance, infrastructure, and natural resources,
which can influence economic growth in specific countries.
(vi) Productivity/ideas were treated as exogenous to the model. But…much of growth is about growth in ideas. And
most Idea generations takes place as R&D in firms…(OECD ~60-80%) -- Ideas are non-rivalrous and cannot be
produced in competitive markets since marginal cost is zero (some monopoly power required to profit from ideas)…
(PAUL ROMER modified solow model)
-- Ideas create spillovers! Universities, Patents, Human K in Research, trade, market size and role of Rules, Equality
before the law,…
- huge amount of persistence in prosperity. Relatively rich countries in the 1960s remain relatively rich and vice
versa.
Solow model: Vast differences in prosperity due to differences in technology, physical capital, and
human capital (proximate causes). Fundamental causes explain why poor countries fail at these.
Higher income countries are not the fastest growing
Most countries are poor, and most people live in poor countries
Most economic growth is resource intensive
Why are some countries Rich and others Poor?
A model with endogenous capital accumulation. Studying this model will help us to investigate:
⇒ capital accumulation as an engine for economic growth
⇒ potential other factors that can affect long run growth
⇒ if countries with lower income per capita will catch up with richer countries
- For simplicity, we keep
assuming that L are fixed
over time: no population
growth
- Given our research
question, A is also fixed over
time: no technological
change
,1) What is a steady state of economic growth? Explain steady-state growth of income and
capital accumulation using the Solow growth model. What do you mean by "Catch up by a
country" and "convergence by a country" about economic growth?
growth in income per capita is an outcome of accumulation of capital per capita. This is the only source of
economic growth in the model. Without productivity constant, it is just accumulating physical capital. At this
point, there is equality between investment and depreciation. The economy will converge to a long
equilibrium which will be referred to as a steady state. It is simply a situation where income and capital
accumulation are not growing further.
All economies will eventually converge in terms of income per-capita. Underdeveloped
countries tend to grow more rapidly than wealthier economies. The less wealthy economies will
catch-up with the richer countries. Mainly because there is a higher marginal rate of return on
invested capital in faster-growing countries. This is also referred to as the theory of
convergence.
2) Why do poorer countries grow faster? Explain your answer using the Solow model.
In the long-term, there is no growth. This is only true if countries have the same population
growth rate, savings rate and capital depreciation rate, therefore, they will have similar
steady-states. Hence, they will converge. In the Solow model, it predicts conditional
, convergence. Thus, along this convergence path, poorer countries tend to grow faster. Poorer
countries, generally characterised by a lower level of capital stock per worker, have greater
potential for faster economic growth due to the concept of diminishing returns to capital.
According to the Solow growth model, the rate of economic growth depends on the savings rate
and the efficiency of capital utilisation. In poorer countries, the savings rate tends to be higher
as people have a greater incentive to save. This can be attributed to several factors, such as
limited social safety nets, lower access to credit, and the absence of well-developed financial
markets. Higher savings rates lead to increased investment, which in turn drives capital
accumulation. Furthermore, in the Solow growth model, technological progress plays a crucial
role in long-term economic growth. Technological progress can take various forms, including
improvements in production techniques, increased knowledge, and innovation. Poorer
countries have more room for technological catch-up, as they can adopt and adapt existing technologies
already developed by wealthier countries. This process of technology transfer
allows poorer countries to experience faster productivity growth and catch up with advanced
economies. Additionally, poorer countries often have a higher population growth rate compared
to wealthier countries. This implies a larger labour force and a higher potential for economic
output. However, for sustained economic growth, it is essential to have productive employment
opportunities and sufficient investment in human capital (education, health, skills
development) to harness the potential demographic dividend. Overall, the Solow growth model
suggests that poorer countries can experience faster economic growth due to their lower initial
levels of capital stock, higher savings rates, potential for technological catch-up, and larger
labour force. However, it is important to note that these are general tendencies and there are
several other factors, such as institutions, governance, infrastructure, and natural resources,
which can influence economic growth in specific countries.
(vi) Productivity/ideas were treated as exogenous to the model. But…much of growth is about growth in ideas. And
most Idea generations takes place as R&D in firms…(OECD ~60-80%) -- Ideas are non-rivalrous and cannot be
produced in competitive markets since marginal cost is zero (some monopoly power required to profit from ideas)…
(PAUL ROMER modified solow model)
-- Ideas create spillovers! Universities, Patents, Human K in Research, trade, market size and role of Rules, Equality
before the law,…
- huge amount of persistence in prosperity. Relatively rich countries in the 1960s remain relatively rich and vice
versa.
Solow model: Vast differences in prosperity due to differences in technology, physical capital, and
human capital (proximate causes). Fundamental causes explain why poor countries fail at these.
