Written by Ryan McGuine //
Economic growth is the ultimate goal of most economic policy interventions, and there are a number of models — mathematical representations of the economy — designed to explain how adjusting certain variables affects output per capita. The Solow Model is one of the simplest models of economic growth, and this post is a non-mathy overview of its implications. Readers interested in a more technical explanation can check out Dietrich Vollrath’s study guide.
The first key takeaway from the Solow Model is that output per worker depends on physical and human capital per worker. Physical capital refers to equipment or tools used by workers to create goods, while human capital refers to a worker’s level of education and training. Workers can produce more with more tools and knowledge at their disposal — a manufacturing employee with an electric drill and 10 interchangeable screw heads is more effective than one with only 1 screw head, and an employee who has worked at a firm for 5 years is more effective than one who has worked there for 3 months.
Secondly, capital faces decreasing marginal returns — each additional unit increases the output less than the previous one. The benefit from having 11 instead of 10 interchangeable screw heads is smaller than the benefit that they gain by having 2 instead of 1. Similarly, attaining a graduate-level degree might benefit the employee more than an undergraduate degree, but the difference between those two benefits is smaller than the difference between graduating high school or not.
The final important takeaway is that the rate of capital accumulation rises with the savings rate, and falls with population growth rate and depreciation rate. The quality of our manufacturing employee’s electric drill improves with the amount of money spent on it, and declines with both the number of people sharing it and the harshness with which it is used.
Most economies maintain fairly stable savings rates, population growth rates, depreciation rates, and educational levels. These stem from the prevailing economic conditions and societal norms, so policymakers find them difficult to alter significantly. However, the extraordinary persistence of economic growth since the Industrial Revolution suggests a missing feature.
That missing factor is technological progress. Technology augments labor and boosts productivity, enabling more production using the same inputs. Crucially, technological progress is not subject to diminishing marginal returns that constrain capital. Continuing the manufacturing example, a robotic drill arm will consistently outperform an employee with an electric drill, regardless of the drill’s quality. This makes productivity-enhancing technological advancement the key to sustained, long-run economic growth.
Economists classify factor (physical and human capital) accumulation and technological progress as “proximate causes of growth” — that is, measurable factors that fit into economic models. However, what is missing is why countries experience different rates of factor accumulation and technological progress. These deeper reasons for cross-country differences are called “fundamental causes of growth,” specifically: geography, culture, and institutions. For more on the fundamental causes of growth, Interested readers can see Chapter 4 of Professor Daron Acemoglu’s textbook on growth economics.
The Solow Model is far from the only analytical model of economic growth. However, it has few moving parts, makes intuitive sense, and matches empirical observations, making it valuable for initial policy analysis.