Let's talk about economist Robert Solow,
and his contributions to the theory of
economic growth.
You may have seen that Alex
has several excellent videos on
the Solow model,
but those use a fair amount of mathematics,
so if you're not comfortable
with that math,
here's a simpler and shorter version.
It's not as thorough as Alex's treatment,
but you can think of it as a very basic
introduction or overview of Solow.
By the way, this is Robert Solow,
here pictured.
He won a Nobel prize in 1987,
and most of his career, he spent
teaching at MIT.
One important feature of the Solow
model is that it took economic growth,
and it broke it down very carefully
into underlying categories.
So in simplest terms, you can think of
the Solow model as suggesting
that economic growth comes from capital,
it comes from labor,
and it comes from ideas or new technology,
and part of the point of the model
is just to help us figure out
for any particular episode of
economic growth,
how much of that growth came from
adding more capital inputs,
how much of that growth came from
more people working
or people working longer hours,
and how much of that growth
came from innovation?
That sounds pretty simple,
but until the Solow model in the mid-1950s,
it had actually never been done
properly before.
In the context of developing nations,
it's important to note that quite often,
a lot of the growth comes from
adding inputs of capital
and adding inputs of labor
and very often, not so much of it
is from ideas or new technology.
You can think of it this way:
imagine a developing economy,
and a lot of people are moving in
from the countryside,
they're moving to cities,
and as they move to cities
and start working in factories,
they're a lot more productive.
That causes economic growth.
It's a way of thinking about
the sources of the growth,
but it also implies there may
in the future be a potential limit to
that growth because once all the
available people have moved
from the countryside to the city,
well, that additional labor as a
source of growth has somewhat dried out.
Developing economies then often
need to make a transition from just
relying on growth from capital and labor
to relying on growth from more ideas
and new technology,
and of course that's often not a very easy
transition to make.
By the way, that growth from ideas
and new technology,
in the literature,
sometimes, it is called the Solow
residual.
Solow
residual.
Another key feature of the Solow model
it is what is sometimes called
catch-up growth.
Catch-up growth occurs when
there's say, a rich country and a poor country,
and the poor country is growing at
a faster rate than is the rich country.
You can think of the poor country
as in some way catching up to the
rich country,
precisely because the poor country
is lacking so many important things,
the rate of return on investing
capital in the poor country is
especially high.
So if you think of Japan and Germany
after the end of World War 2,
once they start rebuilding,
they have higher growth rates
than does the United States because
they were doing that catch-up.
They were rebuilding their factories, they were repairing roads,
they were putting their cities back together again,
and again, there was a very high
rate of return on capital investment
in those very important ventures.
You can also think of modern China
as having been engaged in
catch-up growth with the West.
Once China got the institutions and
incentives right to be growing at all,
the marginal rate of return on
investing capital in China was very high,
and of course, China grew rapidly.
I've already mentioned the assumption of
diminishing marginal returns
to capital, but it's key
to the Solow model. So let's look at it
just a little more explicitly.
If you think of the situation portrayed
in this picture,
here's a city, and someone needs
to build a road to the city,
maybe that's the first road you build
and that road is of very high value.
So when the capital stock is low,
when there aren't many roads,
the first roads that you build are
extremely valuable roads.
That's that high marginal rate of return
on capital, and in the Solow model,
that tends to spur growth,
it encourages capital accumulation,
the road gets built,
and it has very high value.
Subsequent applications
of capital don't have that same high marginal value as,
you know, building the big, important road to your major city.
So you might build another road
out in the countryside, pictured here.
It would have some value.
People could go for Sunday drives
on the road, but it's a lower
marginal value than building that
first important road to your big city.
So this is diminishing marginal
returns to capital.
As economies get wealthier,
they often experience diminishing
marginal returns to capital, and
that will mean their rate of economic growth is lower,
as portrayed and explained in
the Solow model.
Because of catch-up growth,
the Solow model does generally
predict that there will be a convergence
of living standards around the world
because the poorer countries are
playing catch-up to the richer countries,
and if the poorer countries are growing at a faster rate.
Well, at some point in time, they will indeed catch up.
So if you look at all of the growth in developing economies
over the last 10 to 20 years,
the Solow model is actually seen
as explaining a pretty good piece
of this growth.
But still, there's an important question.
How much convergence really is there?
There's some catch-up,
but we don't by any means
observe complete catch-up,
and there seem to be a lot of very poor countries which are not
succeeding in catching up at all.
In fact, the poorest of them may be lagging behind.
So that's one feature of the world
which really isn't explained by the
Solow model.
There's also something known as the middle income trap,
and we have a separate video on that,
but the middle-income trap comes about when growing economies,
they get a lot of early quick growth
just by throwing a lot of labor and
capital inputs at a problem,
but when the time comes for those same economies to become
innovators when it's not easy for
people to simply work any more hours
because they're already working very hard,
well, a lot of countries tend to get stuck at that level,
and that again is a case where you
have imperfect convergence.
Those are some ways in which the Solow model, even though
it's quite useful,
it doesn't explain every feature of our world.
Finally, in the Solow model, it's
quite an abstract set of numbers
and equations.
There is not an explicit consideration
of institutions and incentives.
in the broader sense of thinking
about what kind of social order
does a place have, and how is it
rewarding innovation, and is there
corruption, and are property rights
enforced, and all of these
important questions, and those in fact may go
a long way toward helping us determine
whether some countries will converge
with the wealthy countries and
maybe other countries will not.
Again, those are some important features of the problem, which to
study them, you need to go
outside of the Solow model.
Robert Solow is a very witty man,
and he's known as such.
He has a lot of famous sayings,
and one of them shows that I think
he really does believe in a good
deal of convergence.
Solow once said, and I quote,
"There is no evidence that God
ever intended the United States of
America to have a higher per
capita income than the rest of the world
for eternity."
The Solow model is a very important place to start
for understanding the nature
and sources of economic growth.
It's an incomplete model, but still
it's a basic model that is really
foundational for the thinking of
economists on growth.
I definitely recommend you give a try
Alex's more complex videos, even
if you don't understand all of what's
in there, they have many very
important points, but you also can
just Google "Robert Solow,"
"Solow growth model,"
and "Economic growth convergence."