Solow model - how well it holds in the real world?

Prepared by:-

Amol Rattan (75013)

Introduction

Prior to Solow Model, Harrod Domar model had shown how the savings rate could play a crucial role in determining the Long run rate of Growth. Solow model however proved a result that was contrary to what Harrod Domar model had predicted.

It showed that savings has only level effect on income and the growth rate of income depends upon the rate of efficiency or technical progress in the country.

Solow Model relies on certain assumptions
1. There are constant returns to Scale(CRS)
2. The production function is standard neoclassical production function with diminishing returns to factor 3. The markets are perfectly competitive
4. Households save at a constant savings rate ‘s’

Equilibrium in Solow Model is defined as the steady state level of capital where the economy grows at a constant rate. By assuming that the two factors of production are capital and labour per efficiency unit, it can be shown that savings only affects the level of per capita income. It is only the rate of growth of efficiency which determines the rate of growth of per capita output.

For production function: Y= KαL1-α

Steady state values are:

y•=[s/π+δ+n]α/1-α

k• =[s/π+δ+n]1/1-α

Objective
i) To find how true the result of convergence of Solow model holds for a sample of countries of the world ii) Test Solow model for India for the period 1990-2008

Methodology
i) To find how true the result of convergence of Solow model holds for a sample of countries of the world

• To prove: Convergence result

Solow model predicts that all nations with same parameter of savings rate, population growth rate and depreciation rate will all grow at the same rate in long run. This implies
A) The rich...

...Augmented SolowGrowthModel
The augmented Solowmodel was proposed by Mankiw, Rower and Weil (MRW) in their treatise “A Contribution to the empirics of Economic Growth”. To better explain the variation in living standards across regions, they propose a model that adds human capital accounting for the fact that labor across different economies can possess different levels of education.
To test this model, a proxy variable in the form of human capital accumulation is added as an explanatory variable in the cross-country regression. MRW find that human capital accumulation is directly correlated with savings and population growth and the inclusion of human capital lowers the impact of savings and population. MRW claim that by testing the data, they find that this model accounts for 80% of the cross country income variance [cross–section regression of the 1985 level of output per worker
for 98 countries producing an R² of 0.78 ]
The model also predicts that poor countries are likely to have higher returns to human capital. The incorporation of human capital has the ability to tweak the theoretical modeling and the empirical analysis of economic growth. The theoretical impact will be based on the restructuring of growth process ideology. MRW quote Lucas (1988) stating that although there...

...
The SolowGrowthModel
Economics 202
14 April 2014
Statement on plagiarism: I understand that plagiarism is a serious offence and confirm that unless otherwise acknowledged the content of this essay is my own.
Economic growth rates across countries are hardly ever the same and the Solow-growthmodel is the starting point at determining whygrowth rates differ across countries (Burda and Wyplosz, 2013: 61). This essay aims at examining the aspects of the Solow-Growthmodel of economic growth while highlighting the strengths and weaknesses and identifying whether or not capital accumulation has been the main cause for economic growth in South Africa. This will be achieved through examining economic growth with capital-stock growth, population growth and technological progress.
The Solow-growthmodel measures growth rates of different economies and according to Solow, it is the starting point to determining why these growth rates differ across economies (Burda and Wyplosz, 2013). The Solow-growthmodel is an exogenous growthmodel which means variables are...

...Recall that in the Harrod-Domar, Kaldor-Robinson, Solow-Swan and the Cass-Koopmans growthmodels, we have maintained, either explicitly or implicitly, that technical change is "exogenous". In the Schumpeter version, this was not true: we had "swarms" of inventors arising under particular conditions. The Smithian and Ricardian models also had technical change arising from profit-squeezes or, in the particular case of Smith, arising because of previous technical conditions.
Allyn A. Young (1928) had argued for the resurrection of the Smithian concept in terms of increasing returns to scale: division of labor induces growth which enables further division of labor and thus even faster growth. The idea that technological change is induced by previous economic conditions one may term "endogenous growth theory".
The need for a theory of technical change was there: according to some rather famous calculations from Solow (1957), 87.5% of growth in output in the United States between the years 1909 and 1949 could be ascribed to technological improvements alone. Hence, what is called the "Solow Residual" - the g(A) term in the growth equation given earlier, is enormous. One of the first reactions was to argue that by reducing much of that influence to pure capital improvements, capital-intensity seem to play a larger role than...

...how a steady economic growth rate will be accomplished with the proper amounts of the three driving forces: labor, capital and technology. The theory states that by varying the amounts of labor and capital in the production function, an equilibrium state can be accomplished. When a new technology becomes available, the labor and capital need to be adjusted to maintain growth equilibrium.
This theory emphasizes that technology change has a major influence on economic growth, and that technological advances happen by chance. The theory argues that econonomic growth will not continue unless there continues to be advances in technology.
Neo classical theory maintains that economic growth is caused by:
• increase in the labour quantity (population growth)
• improvements in the quality of labour through training and education
• increase in capital (through higher savings and investment)
• improvements in technology.
The neo-classical model was an extension to the 1946 Harrod–Domar model that included a new term: productivity growth. Important contributions to the model came from the work done by Robert Solow, in 1956, Solow and T.W. Swan developed a relatively simple growthmodel which fit available data on US economic growth with some success....

...limitations of the Solowmodel? Discuss with reference to theory and evidence.
The SolowModel, also known as the neoclassical growthmodel or exogenous growthmodel is a neoclassical attempt created in the mid twentieth century, to explain long run economic growth by examining productivity, technological progress, capital accumulation and populationgrowth. This model was contributed to by the works of Robert Solow, in his essay ‘A Contribution to the Theory of Economic Growth’ and by Trevor Swan in his work, ‘Economic Growth and Capital Accumulation’, both published in 1956. The model is perceived to be an extension of the 1946 Harrod-Domar model, which Solow (1956) describes as a ‘model of long-run growth which accepts all the Harrod-Domar assumptions except that of fixed proportions.’ Instead Solow (1956) supposes that a ‘single composite commodity is produced by labour and capital under the standard neoclassical conditions.’ This notion will be elaborated on further in the course of this essay. Economists today use the Solowmodel source of growth accounting to estimate the individual effects on economic growth of capital, labour and...

...“Countries grow at different rates because they accumulate capital at different rates.” Is
this true? Explain your answer.
Eyeballing any cross sectional data on growth across countries shows that countries grow at different rates. Many theories try to explain this phenomenon with emphasis with capital accumulation being one of them. I will start by developing the standard neoclassical growthmodel as developed by Solow(1956)[1]. I will then proceed to discuss the extensions that have been made to this basic model in an attempt to better understand actual growth figures, for e.g. the standard neoclassical model cannot explain the magnitude of international differences in growth rates. Mankiw[2] points out that “the model can explain incomes that vary by a multiple of slightly more than two. Yet income per person varies by a multiple of more than ten.”
Economic growth is conventionally measured with the percentage of increase in Gross Domestic Product(GDP). Statistics from the OECd shows the big divergence of GDP annual growth rates from 1998 to 2002 between countries. The top GDP growth rate countries were Ireland and China at 8.1% while the bottom GDP growth rate is that of Japan at only 0.2%. In the standard neoclassical model, GDP denoted by Y is a function of...

...1
Explain how the Solowgrowthmodel would analyse the effects of a fall in the household saving ratio.
In this essay, I will focus on two important aspects. The first is to give a brief historical
outline of the Solowgrowthmodel. The second thread runs express how the outline on the Solowgrowthmodel might explain the effect of a fall in the household savings ratio.My essay will be guided by the diagram provided on which I have to make specific references and to think through as well as explain the various steps of the Solowgrowthmodel and
what this would mean for economic growth.
Without dismissing earlier attempts, the foundations upon which modern economic growth theory rests on the foundations put by US economist Robert Solow (1924-) in the 1950s and 1960s.The Solowgrowthmodel is very neoclassic in that it focuses primarily on the supply side. The Solowmodel seems to implicitly assume that, as long as the supply of goods increases, economic growth can be attained. In this way it is apparently different from Keynesian models of which focus is on the demand side of the economy such as inflation and unemployment. One of the major central...

...Economic Growth is the increase per capita gross domestic product (GDP). There is a distinction between nominal and real economic growth, where the first is the growth rate including inflation, while the second is the nominal rate adjusted for inflation. Moreover economic theorists distinguish short-term economic stabilization and long-term economic growth. The topic of economic growth is mainly related to the long run. Short-run variation of economic growth is termed the business cycle. The long-run path of economic growth is one of the central questions of economics.
In 1377, the Arabian economic thinker Ibn Khaldun provided one of the earliest descriptions of economic growth in his Muqaddimah (known as Prolegomena in the Western world) (cited in Weiss, 1995):
When civilization [population] increases, the available labor again increases. In turn, luxury again increases in correspondence with the increasing profit, and the customs and needs of luxury increase. Crafts are created to obtain luxury products. The value realized from them increases, and, as a result, profits are again multiplied in the town. Production there is thriving even more than before. And so it goes with the second and third increase. All the additional labor serves luxury and wealth, in contrast to the original labor that served the necessity of life.
Economic growth is...