Robert Solow

the Solow Growth Model is an exogenous model of economic growth that

analyzes changes in the level of output in an economy over time as a result
of changes in the population growth rate, the savings rate, and the rate of
technological progress

The Solow Growth Model, developed by Nobel Prize-winning economist

Robert Solow, was the first neoclassical growth model and was built upon
the Keynesian Harrod-Domar model. The Solow model is the basis for the
modern theory of economic growth.

Simplified Representation of the Solow Growth Model

Below is a simplified representation of the Solow Model.

Assumptions:

1. The population grows at a constant rate g. Therefore, current

population (represented by N) and future population (represented by
N’) are linked through the population growth equation N’ = N(1+g).
If the current population is 100 and the growth rate of population is
2%, the future population is 102.
2. All consumers in the economy save a constant proportion, ‘s’, of their
incomes and consume the rest. Therefore, consumption (represented
by C) and output (represented by Y) are linked through the
consumption equation C= (1+s)Y. If a consumer earns 100 units of
output as income and the savings rate is 40%, then the consumer
consumes 60 units and saves 40 units.
3. All firms in the economy produce output using the same production
technology that takes in capital and labor as inputs. Therefore, the
level of output (represented by Y), the level of capital (represented by
K), and the level of labor (represented by L) are all linked through the
production function equation Y = aF(K,L).
The Solow Growth Model assumes that the production function exhibits
constant-returns-to-scale (CRS). Under such an assumption, if we double
the level of capital stock and double the level of labor, we exactly double
the level of output. As a result, much of the mathematical analysis of the
Solow model focuses on output per worker and capital per worker instead
of aggregate output and aggregate capital stock.

4. Present capital stock (represented by K), future capital stock

(represented by K’), the rate of capital depreciation (represented by
d), and level of capital investment (represented by I) are linked
through the capital accumulation equation K’= K(1-d) + I.

Solving the Solow Growth Model

1. In our analysis, we assume that the production function takes the

following form: Y = aKbL1-b where 0 < b < 1. The production function
is known as the Cobb-Douglas Production function, which is the most
widely used neoclassical production function. Together with the
assumption that firms are competitive, i.e., they are price-taking firms,
the coefficient b is the capital share (the share of income that capital
receives).

2. Therefore, output per worker is given through the following

equation: y = akb where y = Y/L (output per worker and k = K/L
(capital stock per worker)
3. Under the assumption of competitive equilibrium, we get the
following:

• The income-expenditure identity holds as an equilibrium condition: Y

=C+I
• Consumer’s budget constraint: Y = C + S
• Therefore, in equilibrium: I = S = sY.
• The capital accumulation equation becomes: K’ = (1–d)K + sY

4. The capital accumulation equation in per worker times is given

through the following equation: (1 + g)k’ = (1 – d)k + sy = (1 – d)k +
saf(k) = (1 – d)k + sakb
5. The solution concept used is that of a steady state. The steady state is
a state where the level of capital per worker does not change.
Consider the graph below:

6. The steady state is found by solving the following equation: k’ = k =>

(1 + g)k = (1 – d)k + sakb
7. Therefore, the steady state value of capital per worker and the steady
state value of output per worker are the following:
Implications of the Solow Growth Model

There is no growth in the long term. If countries have the same g

(population growth rate), s (savings rate), and d (capital depreciation rate),
then they have the same steady state, so they will converge, i.e., the Solow
Growth Model predicts conditional convergence. Along this convergence
path, a poorer country grows faster.

Countries with different saving rates have different steady states, and they
will not converge, i.e. the Solow Growth Model does not predict absolute
convergence. When saving rates are different, growth is not always higher
in a country with lower initial capital stock.
Introduction:
Prof. Robert M. Solow made his model an alternative to Harrod-
Domar model of growth.

It ensures steady growth in the long run period without any pitfalls.
Prof. Solow assumed that Harrod-Domar’s model was based on
some unrealistic assumptions like fixed factor proportions, constant
capital output ratio etc.

Solow has dropped these assumptions while formulating its model

of long-run growth. Prof. Solow shows that by the introduction of
the factors influencing economic growth, Harrod-Domar’s Model
can be rationalised and instability can be reduced to some extent.

He has shown that if technical coefficients of production are

assumed to be variable, the capital labour ratio may adjust itself to
equilibrium ratio in course of time.

In Harrod-Domar’s model of steady growth, the economic system

attains a knife-edge balance of equilibrium in growth in the long-
run period.

This balance is established as a result of pulls and counter pulls

exerted by natural growth rate (Gn) (which depends on the increase
in labour force in the absence of technical changes) and warranted
growth rate (Gw) (which depends on the saving and investment
habits of household and firms).

However, the key parameter of Solow’s model is the substitutability

between capital and labour. Prof. Solow demonstrates in his model
that, “this fundamental opposition of warranted and
natural rates turns out in the end to flow from the crucial
assumption that production takes place under conditions
of fixed proportions.”
The knife edge balance established under Harrodian steady growth
path can be destroyed by a slight change in key parameters.

Prof. Solow retains the assumptions of constant rate of

reproduction and constant saving ratio etc. and shows that
substitutability between capital and labour can bring equality
between warranted growth rate (Gw) and natural growth rate (Gn)
and economy moves on the equilibrium path of growth.

In other words, according to Prof. Solow, the delicate balance

between Gw and Gn depends upon the crucial assumption of fixed
proportions in production. The knife edge equilibrium between Gw
and Gn will disappear if this assumption is removed. Solow has
provided solution to twin problems of disequilibrium between Gw
and Gn and the instability of capitalist system.

In short, Prof. Solow has tried to build a model of economic growth

by removing the basic assumptions of fixed proportions of the
Harrod-Domar model. By removing this assumption, according to
Prof. Solow, Harrodian path of steady growth can be freed from
instability. In this way, this model admits the possibility of factor
substitution.

Assumptions:
Solow’s model of long run growth is based on the
following assumptions:
1. The production takes place according to the linear homogeneous
production function of first degree of the form

Y = F (K, L)

Y = Output

K = Capital Stock

L = Supply of labour force

The above function is neo-classic in nature. There is constant

returns to scale based on capital and labour substitutability and
diminishing marginal productivities. The constant returns to scale
means if all inputs are changed proportionately, the output will also
change proportionately. The production function can be given as aY
= F (aK, al)
2. The relationship between the behaviour of savings and
investment in relation to changes in output. It implies that saving is
the constant fraction of the level of output. In this way, Solow
adopts the Harrodian assumption that investment is in direct and
rigid proportion to income.

In symbolic terms, it can be expressed as follows:

I = dk/ dt = sY

Where

S—Propensity to save.

ADVERTISEMENTS:

K—Capital Stock, so that investment I is equal

3. The growth rate of labour force is exogenously determined. It

grows at an exponential rate given by

L = L0 ent
Where L—’Total available supply of labour.

ADVERTISEMENTS:

n—Constant relative rate at which labour force grows.

4. There is full employment in the economy.

5. The two factors of production are capital and labour and they are
paid according to their physical productivities.

6. Labour and capital are substitutable for each other.

7. Investment is not of depreciation and replacement charges.

8. Technical progress does not influence the productivity and

efficiency of labour.
9. There is flexible system of price-wage interest.

10. Available capital stock is fully utilized.

Following these above assumptions, Prof. Solow tries to show that

with variable technical co-efficient, capital labour ratio will tend to
adjust itself through time towards the direction of equilibrium ratio.
If the initial ratio of capital labour ratio is more, capital and output
will grow more slowly than labour force and vice-versa.

To achieve sustained growth, it is necessary that the investment

should increase at such a rate that capital and labour grow
proportionately i.e. capital labour ratio is maintained.

Solow’s model of long-run growth can be explained in two

ways:
A. Non-Mathematical Explanation.

ADVERTISEMENTS:

B. Mathematical Explanation.

A. Non-Mathematical Explanation:
According to Prof. Solow, for attaining long run growth, let us
assume that capital and labour both increase but capital increases at
a faster rate than labour so that the capital labour ratio is high. As
the capital labour ratio increases, the output per worker declines
and as a result national income falls.

The savings of the community decline and in turn investment and

capital also decrease. The process of decline continues till the
growth of capital becomes equal to the growth rate of labour.
Consequently, capital labour ratio and capital output ratio remain
constant and this ratio is popularly known as “Equilibrium
Ratio”.
Prof. Solow has assumed technical coefficients of production to be
variable, so that the capital labour ratio may adjust itself to
equilibrium ratio. If the capital labour ratio is larger than
equilibrium ratio, than that of the growth of capital and output
capital would be lesser than labour force. At some time, the two
ratios would be equal to each other.

In other words, this is the steady growth, according to Prof. Solow

as there is the steady growth there is a tendency to the equilibrium
path. It must be noted here that the capital-labour ratio may be
either higher or lower.

Like other economies, Prof. Solow also considers that the most
important feature of an underdeveloped economy is dual economy.
This economy consists of two sectors-capital sector or industrial
sector and labour sector or agricultural sector. In industrial sector,
the rate of accumulation of capital is more than rate of absorption of
labour.

With the help of variable technical coefficients many employment

opportunities can be created. In agricultural sector, real wages and
productivity per worker is low. To achieve sustained growth, the
capital labour ratio must be high and underdeveloped economies
must follow Prof. Solow to attain the steady growth.

This model also exhibits the possibility of multiple equilibrium

positions. The position of unstable equilibrium will arise when the
rate of growth is not equal to the capital labour ratio. There are
other two stable equilibrium points with high capital labour ratio
and the other with low capital labour ratio.

If the growth process starts with high capital labour ratio, then the
development variables will move in forward direction with faster
speed and the entire system will grow with high rate of growth. On
the other hand, if the growth process starts with low capital labour
ratio then the development variables will move in forward direction
with lesser speed.

To conclude the discussion, it is said that high capital labour ratio or

capital intension is very beneficial for the development and growth
of capitalist sector and on the contrary, low capital-labour ratio or
labour-intensive technique is beneficial for the growth of labour
sector.

B. Mathematical Explanation:
This model assumes the production of a single composite
commodity in the economy. Its rate of production is Y (t) which
represents the real income of the community. A part of the output is
consumed and the rest is saved and invested somewhere.

The proportion of output saved is denoted by s. Therefore, the rate

of saving would be sY (t). The capital stock of the community is
denoted by K it). The rate of increase in capital stock is given by
dk/dt and it gives net investment.

ADVERTISEMENTS:

Since investment is equal to saving so we have following

identity:
K = sY … (1)

Since output is produced by capital and labour, so the production

function is given by

Y = F (K, L) … (2)

Putting the value of Y from (2) in (1) we get

S = s F (K, L) … (3)

Where

L is total employment

F is functional relationship

Equation (3) represents the supply side of the system. Now we are
to include demand side too. As a result of exogenous population
growth, the labour force is assumed to grow at a constant rate
relative to n. Thus,

L (t) = L0ent … (4)

Where

L—Available supply of labour

Putting the value of L in equation (3) we get

K = sF (K, L0ent) …(5)

The right hand of the equation (4) shows the rate of growth of
labour force from period o to t or it can be regarded as supply curve
for labour.

“It says that the exponentially growing labour force is offered for
employment completely in elastically. The labour supply curve is a
vertical line, which shifts to the right in time as the labour force
grows. Then the real wage rate adjusts so that all available labour is
employed and the marginal productivity equation determines the
wage rate which will actually rule.”

If the time path of capital stock and of labour force is known, the
corresponding time path of real output can be computed from the
production function. Thus, the time path of real wage rate is
calculated by marginal productivity equation.

The process of growth has been explained by Prof. Solow as, “At any
moment of time the available labour supply is given by (4) and
available stock of capital is also a datum. Since the real return to
factors will adjust to bring about full employment of labour and
capital we can use the production function (2) to find the current
rate of output. Then the propensity to save tells us how much net
output will be saved and invested. Hence, we know the net
accumulation of capital during the current period. Added to the
already accumulated stock this gives us the capital available for the
next period and the whole process can be repeated.”

Possible Growth Patterns:

To find out whether there is always a capital accumulation path
consistent with any rate of growth of labour force, we should know
the accurate shape of production function otherwise we cannot find
the exact solution.
For this, Solow has introduced a new variable:

The function F(r, 1) gives output per worker or it is the total product
curve as varying amounts ‘r’ of capital are employed with one unit of
labour. The equation (6) states that, “the rate of change of the
capital labour ratio as the difference of two terms, one
representing the increment of capital and one the
increment of labour.”
The diagrammatic representation of the above growth
pattern is as under:
In diagram 1, the line passing through origin is nr. The total
productivity curve is the function of SF (r, 1) and this curve is
convex to upward. The implication is that to make the output
positive it must be necessary that input must also be positive i.e.
diminishing marginal productivity of capital. At the point, of
intersection i.e. nr = sf (r, 1) and r’ = o when r’ = o then capital
labour ratio corresponds to point r* is established.
Now capital and labour will grow proportionately. Since Prof. Solow
considers constant returns to scale, real output will grow at the
same rate of n and output per head of labour, force will remain
constant.

In mathematical terms, it can be explained as:

Path of Divergence:
Here we are to discuss the behaviour of capital labour
ratio, if there is divergence between r and r”. There are
two cases:
(i) When r > r*

(ii) When r < r*

If r > r* then we are towards the right of intersection point. Now nr
> sF (r, 1) and from equation (6) it is easily shown that r will
decrease to r*. On the other hand if we move towards left of the
intersection point where nr < sF (r, 1), r>o and r will increase
towards r*. Thus, equilibrium will be established at point E and
sustained growth will be achieved. Thus, the equilibrium value of r*
is stable.

According to Prof. Solow, “Whatever the initial value of the capital

labour ratio, the system will develop towards a state of balanced
growth at a natural rate. If the initial capital stock is below the
equilibrium ratio, capital and output will grow at a faster rate than
the labour force until the equilibrium ratio is approached. If the
initial ratio is above the equilibrium value, capital and output will
grow more slowly than the labour force. The growth of output is
always intermediate between those of labour and capital.”

The stability depends upon the shape of the productivity

curve sF(r, 1) and it is explained with the help of a diagram
given below:

In the figure 2. the productivity curve sf (r, 1) intersects the ray nr at

three different points E1 , E2 , E3. The corresponding capital labour
ratio is r1, r2 and r3. The points are r3 stable but r2 is not stable.
Taking point r1 first if we move slightly towards right nr > sf(r, 1)
and r is negative implying that r decreases.
Thus, it has a tendency to slip back to r 1 .If we move slightly towards
its left nr < sf (r, 1) and r is positive which shows that r increases
and there is a tendency to move upto point r 1. Therefore, a slight
movement away from r1 creates conditions that forces a movement
towards showing that r1 is a point of stable equilibrium.
Likewise, we can show that r3 is also a point of stable equilibrium. If
we move slightly towards right of r2, sf (r, 1) nr and r is positive and
there is a tendency to move away from r 2.
On the other hand, if we move slightly towards left of r2 nr > sf (r, 1)
so that r is negative and it has a tendency to slip downwards
towards r1. Therefore depending upon initial capital labour ratio,
the system will develop to balanced growth at capital labour ratio
r1 and r3. If the initial ratio is between o and r 2, the equilibrium is at
r1 and if the ratio is higher than r2 then equilibrium is at r3.
To conclude Solow puts, “When production takes place under
neoclassical conditions of variable proportions and constant returns
to scale, no simple opposition between natural and warranted rates
of growth is possible. There may not be any knife edge. The system
can adjust to any given rate of growth of labour force and eventually
approach a state of steady proportional expansion” i.e.

∆K/K = ∆L/L = ∆Y/Y

Unlike Harrodian model, Solow’s model also does not apply to

development’ problem of under-developed countries. Most of the
under-developed countries are either in pre take-off or ‘take-off
condition and this model does not analyse any policy formulation to
meet the problems of under-developed countries.

But certain elements from the Solow model are still valid and can be
used to chalk out the problem of under- development. The
remarkable feature of Solow model is that it provides deep insight
into the nature and type of expansion experienced by the two
sectors of under-developed countries.

The interpretation of under- development is explained

with the help of a diagram 3 given as next:
The line nr represents the balanced requirement line. When the
warranted growth rate and natural growth rate are equal then
steady growth is achieved.

Along this path, there is full employment and unchanging capital

labour ratio. The curve represented by s1ƒ1 (r, 1) gives productive
system in terms of both output and savings. On the other hand
s2ƒ2 (r, 1) gives unproductive system and the per capita income and
savings would decline. Both the systems have low marginal
productivity.
The first system can be identified by industrial sector of under-
developed countries which tends to grow with ever increasing
intakes of capital in relation to labour. The second system conforms
to the agrarian sector of under-developed countries. There is more
labour supply due to rapid population growth. Investment is also
positive.

The bottleneck of skilled labour holds back the expansion of

industrial sector of under-developed countries.

The marginal productivity of labour is bound to fall and as it falls

below the minimum real wage rates, disguised unemployment
would rear its head. If the real wage rate is fixed at certain level,
then employment is such that it can maintain marginal product of
labour at this level.

Once the initial growth of population has occurred and land has
become scarce, the real wage rate tends to be fixed at certain level,
though the marginal productivity declines. The result of this is
disguised unemployment.

In nut-shell, we can conclude the discussion of validity of Solow’s

model is that there are certain elements which could be gainfully
utilized for analysing the problem of under-development. The
phenomenon of technological dualism which is commonly prevalent
in these economies can be better explained in terms of Solow’s
model.

Though, Solow’s model is basically embedded in a different setting,

yet its concept of technical co-efficient provides elegant and simple
theoretical apparatus to solve the problems of under-development.

Applicability to Underdeveloped Countries:

Unlike Harrodian model, Solow’s model also does not apply to
development’ problem of under-developed countries. Most of the
under-developed countries are either in pre take-off or ‘take-off
condition and this model does not analyse any policy formulation to
meet the problems of under-developed countries.

But certain elements from the Solow model are still valid and can be
used to chalk out the problem of under- development. The
remarkable feature of Solow model is that it provides deep insight
into the nature and type of expansion experienced by the two
sectors of under-developed countries.

The interpretation of under- development is explained

with the help of a diagram 3 given as next:
The line nr represents the balanced requirement line. When the
warranted growth rate and natural growth rate are equal then
steady growth is achieved. Along this path, there is full employment
and unchanging capital labour ratio.

The curve represented by s1ƒ1 (r, 1) gives productive system in terms

of both output and savings. On the other hand s 2ƒ2 (r, 1) gives
unproductive system and the per capita income and savings would
decline. Both the systems have low marginal productivity.
The first system can be identified by industrial sector of under-
developed countries which tends to grow with ever increasing
intakes of capital in relation to labour. The second system conforms
to the agrarian sector of under-developed countries.

There is more labour supply due to rapid population growth.

Investment is also positive. The bottleneck of skilled labour holds
back the expansion of industrial sector of under-developed
countries.

The marginal productivity of labour is bound to fall and as it falls

below the minimum real wage rates, disguised unemployment
would rear its head. If the real wage rate is fixed at certain level,
then employment is such that it can maintain marginal product of
labour at this level.

Once the initial growth of population has occurred and land has
become scarce, the real wage rate tends to be fixed at certain level,
though the marginal productivity declines. The result of this is
disguised unemployment.

In nut-shell, we can conclude the discussion of validity of Solow’s

model is that there are certain elements which could be gainfully
utilized for analysing the problem of under-development. The
phenomenon of technological dualism which is commonly prevalent
in these economies can be better explained in terms of Solow’s
model.
Though, Solow’s model is basically embedded in a different setting,
yet its concept of technical co-efficient provides elegant and simple
theoretical apparatus to solve the problems of under-development.

Merits of the Model:

Solow’s growth model is a unique and splendid contribution to
economic growth theory. It establishes the stability of the steady-
state growth through a very simple and elementary adjustment
mechanism.

Certainly, the analysis is definitely an improvement over Harrod-

Domar model, as he succeeded in demonstrating the stability of the
balanced equilibrium growth by implying neo-classical ideas. In
fact, Solow’ growth model marks a brake through in the history of
economic growth.

The merits of Prof. Solow’s model are under-mentioned:

(i) Being a pioneer of neo-classical model, Solow retains the main
features of Harrod-Domar model like homogeneous capital, a
proportional saving function and a given growth rate in the labour
forces.

(ii) By introducing the possibility of substitution between labour

and capital, he gives the growth process and adjustability and gives
more realistic touch.

(iii) He considers a continuous production function in analysing the

process of growth.

(iv) Prof. Solow demonstrates the steady-state growth paths.

(v) He successfully shunted aside all the difficulties and rigidities of

modern Keynesian income analysis.

(vi) The long-run rate of growth is determined by an expanding

labour force and technical process.

Short Comings of the Model:

1. No Study of the Problem of Balance between G and Gw:
Solow takes up only the problem of balance between warranted
growth (Gw) and natural growth (Gn) but it does not take into
account the problem of balance between warranted growth and the
actual growth (G and Gw).

2. Absence of Investment Function:

There is a absence of investment function in Solow’s model and
once it is introduced, problem of instability will immediately
reappear in the model as in the case of Harrodian model of growth.

3. Flexibility of Factor Price may bring Certain Problems:

Prof. Solow assumed the flexibility of factor prices but it may bring
certain difficulties in the path of steady growth.

For example, the rate of interest may be prevented from falling

below a certain minimum level and this may in turn, prevent the
capital output ratio from rising to a level necessary for sustained
growth.

4. Unrealistic Assumptions:
Solow’s model is based on the unrealistic assumption that capital is
homogeneous and malleable. But capital goods are highly
heterogeneous and may create the problem of aggregation. In short,
it is not easy to arrive at the path of steady growth when there are
varieties of capital goods in the market.

5. No Study of Technical Progress:

This model has left the study of technological progress. He has
merely treated it as an exogenous factor in the growth process. He
neglects the problem of inducing technical progress through the
process of learning, investment and capital accumulation.

6. Ignores the Composition of Capital Stock:

Another defect of Prof. Solow’s model is that it totally ignores the
problem of composition of capital stock and assumes capital as a
homogeneous factor which is unrealistic in the dynamic world of
today. Prof. Kaldor has forged a link between the two by making
learning a function of investment.