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 Solo 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 Solo 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 up. 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 solo residual. Solo 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 II, 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 solo 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. that's the first road you build, and that road is a very high value. So when the capital stock is low and 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 solo 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 solo model. Because of catch-up growth, the solo 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 solo 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 solo 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 solo 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 on 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... I 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.