Saturday, June 14, 2008

Professor Robert M. Solow's Growth Theory and After

...We know now that endogenous growth theory led to an avalanche of papers that has recently slowed a little, but only a little. It is easy to see why the idea was so popular. The models offered the possibility of having a theory of the steady-state growth rate itself, instead of treating it as an exogenously given, if sometimes changing, fact of life. But there was an even more important attraction, I think. The nature of the theory was such that one could easily find feasible, even fairly traditional, policies that would influence the long-term growth rate. Adding a couple of tenths of a percentage point to the growth rate is an achievement that eventually dwarfs in welfare significance any of the standard goals of economic policy. Who would not be excited?

It is important to understand how it was that endogenous growth theory could offer this prospect. The earliest models simply assumed constant returns to capital, or to the set of factors of production that can be accumulated, like capital. (They were called "AK models" for this reason.) Thus, for example, if output is just proportional to capital and saving-and-investment is proportional to output, then investment is proportional to capital and the saving?investment rate enters the factor of proportionality. So a higher saving-investment rate means a higher ratio of investment to capital, i.e. a higher growth rate of capital, and therefore a higher growth rate of output. But we think we know policies that will increase the level of saving-investment from given output. This easy passage from influencing a level to influencing a growth rate is what makes the theory so powerful. The trouble is that constant returns to capital is a highly special, pinpoint assumption. This is one of those cases where "approximately" will not do. But exactly constant returns to capital is not very plausible empirically, and has no convincing theoretical foundation either.

Deeper and more interesting models soon emerged in the endogenous growth tradition. Some of them focus on the creation and accumulation of human capital, others on the process of technological invention and innovation (and the temporary monopolies that go with it). There is also a flourishing group of "Schumpeterian" models that emphasize the rivalry (or occasional complementarity) between an innovation and its predecessors. It seems to me that work along these lines might eventually tell us something interesting and useful about the role of knowledge in the economy and society. We have always realized that there is an important endogenous element in the development of new technology; all those businesses investing millions in research are not suffering from a mass delusion... Read more Professor Robert M. Solow's Growth Theory and After
Read more - Exogenous growth model(Solow growth model)
Solow growth model-by Fiona Maclachlan,
The Solow model - interactive Java applet

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