What is the Solow growth model?
The Solow growth model, also called the neoclassical growth model, was developed by Robert Solow and Trevor Swan in 1956. Robert Solow later received the Nobel Prize in Economics in 1987 for his work on this theory.
The Solow growth model is an extension of the Harrod-Domar Model. It states that there are three factors: technology, capital accumulation and labour force that drive economic growth.
What are the factors affecting economic growth?
Capital and labour force
The Solow growth model believes that a rise in capital accumulation and labour force will increase the economic growth rate, but only temporarily because of diminishing returns.
For example, imagine if an economy only has one worker. If you add one more worker, output will increase dramatically. But if the economy has thousands of workers, adding one more worker will not cause output to increase as much. Eventually, the economy will grow at a steady rate, with GDP growing at the same rate as the increase in labour force and productivity.
Once the steady-state is reached and the resources in a country are used up, the economic growth rate can only be increased through innovation and improvements in technology.
What are the implications of this model?
- The Solow model predicts that the gap between rich and poor countries will narrow, a concept called the catch-up growth. This is because poor countries have less capital to start with, so each additional unit of capital will have a higher return than in a rich country. This helps to explain why China’s GDP grew at 9% on average over the last three decades, while the UK only grew at around 2%
- The theory also explains why Germany and Japan, despite losing in the Second World War, managed to grow faster than the US and UK during 1950-1960 period. This is because many capital stocks in those countries were destroyed during the war, so any new addition of capital would have a high return and significantly increase economic development.
Capital stock – The total physical capital available in an economy at any given time.
Diminishing returns – A situation where increasing one factor in a production process will bring forth successively smaller amounts of output.
Economic growth – This is when a country’s production of goods and services increases over time.
Gross domestic product (GDP) – This is the total value of all goods and services produced in an economy during a set period of time.
Harrod-Domar Model – This is a growth model used in development economics that states an economy’s growth rate is dependent on the level of saving and the capital output ratio.
Productivity – This is a measure of output per unit of input.