Question

What is the most important implication of the Solow growth model? Does it imply that an increase in the rate of private saving is useless as a means to increase the standard of living in the long run?

Answer 1

If we only focus on the Solow model which is alternatively known as exogenous growth model, it can be presented as below:-

y = A*f(K, L),

Where,

y = output, A = productivity, f(.) = production function, K = physical capital, L = labor (could also be separated into raw labor and human capital).

If the term “A” is constant then the output level will be determined by f(.). There are three main implications derived from this result:-

(1) the steady-state output is constant, i.e., the growth rate is zero;

(2) short-run growth is only transitional growth; and

(3) countries with similar characteristics, mainly f(.), will converge to the same steady-state (it's also possible to have a weaker-condition of conditional convergence).

In case of a Solow model, for a long-term economic development, there must be a growth in “A” over time. There can be a number of factors involved in the growth of “A” over time but the most vital ones are being increased in factor input efficiency and technological advances.

In case of Solow model, a vital element of economic growth can be seen as saving and investment. The capital stock increases due to increase in saving and investment and therefore there will be an increase in the full-employment national income and product. There will be an increase in national income and product and the rate of growth of national income and product increases.

In his analysis, Solow determined the effect of higher saving and investment on the long terms economic growth. In the short run, there will be an increased growth rate of national income and product due to higher saving and investment but in case of long run, there will be no effect on the rate of growth of higher saving and investment in the long run

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