He talks more about Solow model. Explained is how the model changed thinking, by saying the equilibrium was general. It gave the model more flexibility. The system could now adjust and eventually approach a steady state of proportional expansion. Solow's model shows that savings rates don't effect growth rates. Only population and technological growth could effect growth. We get the definition of the Residual "the portion of growth that the model did not explain"
"The 'Solow growth model' is not intended to explain or derive the empirical residual, but rather to demonstrate how it will affect the economy in the long run when imposed on an aggregate model of the macro economy exogenous. This model was really a tool for demonstrating the impact of “technology” growth as against “industrial” growth rather than an attempt to understand where either type of growth was coming from. The Solow residual is primarily an observation to explain, rather than the outcome of a theoretical analysis. It is a question rather than an answer, and the following equations should not obscure that fact."-Wikipedia.com
B for Sue for grammatical problems.
ReplyDeleteThe two big advantages of the construction of Solow's model are that it is general, and it is dynamic.
General, in this sense, means that you are never left asking whether two parts of the model (say variables) might be connected and capable of influencing each other. It may not include every detail you want, but every detail it does include is connected to another one.
Dynamic is important because it is a model that explains movement through: specifically, the change in measured output. For example, you have a (not so good) mental model that furthering your education will cause your future income to grow. Solow's model, on the other hand, is very specific about how output growth is related to its causes.
The usefulness of a model is that it can draw out conclusions that wouldn't be obvious otherwise. With the Solow model, one of those insights was that the saving rate didn't matter very much. This is contrary to most intuition, and to the claims of politicians around the world. But plugging in some illustrative numbers into Solow's model shows that both growth and well-being are fairly inelastic with respect to the saving rate.
In the language we've been using this past month, an impulse to the saving rate, when propagated through the Solow model 1) does have an effect on the growth rate of output but the half-life is short, and 2) does have a permanent effect (an infinite half-life) on the ultimate level of well-being in a country, but not a very large one.
Another big implication of plugging data into Solow's model is that — even though it is a model of growth — it says that most growth is actually unexplained. That is, it's a residual — what's left over after the model has explained what it can. This means that growth in labor and capital (L and K) help, but that most growth is coming through technology, A. And remember that this is the part of the model about which Solow could offer the least specifics.
There's a bigger problem here, that wasn't recognized for 40 years. Put these 3 ideas together at the same time in your mind: 1) technology is the big determinant of growth, 2) technology crosses borders more readily than capital or labor does, yet 3) growth rates differ substantially across regions. The first two tend to suggest that the third one shouldn't be true.