Theories of growth
What makes some economies grow faster than others? Economists have developed models that emphasise capital, technology, and ideas.
The Solow model
Robert Solow's model (1956) explains growth using capital accumulation, labour, and technology. Saving funds investment in capital, which raises output. But because of diminishing returns to capital, each extra machine adds less output, so capital accumulation alone cannot sustain growth forever.
The steady state
In the Solow model, an economy approaches a steady state where investment just covers depreciation and new workers, and output per worker stops growing. A higher saving rate raises the steady-state level of income but does not permanently raise its growth rate. Only continuing technological progress produces sustained growth in income per person.
Convergence
The Solow model predicts that poorer countries with less capital should grow faster, catching up with richer ones, because the returns to capital are higher where it is scarce. Conditional convergence is observed among countries with similar institutions and saving rates, such as across US states or Western Europe, but not universally across the world.
Endogenous growth theory
Endogenous growth theory, developed by Paul Romer and others in the 1980s-1990s, explains technological progress from within the economy. Ideas are non-rival: one person's use does not prevent another's, so knowledge can grow without diminishing returns. Investment in research, education, and the rules protecting and spreading ideas drive long-run growth. Romer shared the 2018 Nobel Prize.
Institutions
Daron Acemoglu, Simon Johnson, and James Robinson argue that inclusive institutions, such as secure property rights, rule of law, and broad political participation, encourage investment and innovation, while extractive institutions that serve narrow elites hold growth back. They won the 2024 Nobel Prize for this work. Contrasts like North and South Korea illustrate the point.
Geography and culture
Other explanations emphasise geography (access to the sea, climate, disease environment), culture (trust, attitudes to work and innovation), and history (colonial legacies). Most economists see these interacting with institutions and policies rather than determining outcomes alone.
Catch-up growth
Poorer countries can grow quickly by adopting existing technologies from richer ones, rather than inventing new ones. This 'catch-up' explains much of the rapid growth in East Asia. Frontier economies, already using the best technology, must innovate to grow, which tends to be slower.
Worked example
Two countries have the same technology. Country A saves 10% of income; Country B saves 25%. In the Solow model, B reaches a higher steady-state income per person, because it accumulates more capital. But once both reach their steady states, income per person grows at the same rate in both: the rate of technological progress.
Key takeaways
The Solow model emphasises capital, labour, and technology, with diminishing returns to capital leading to a steady state. Higher saving raises income levels but not long-run growth rates; only technology sustains growth. Conditional convergence is observed among similar economies. Endogenous growth theory explains innovation through non-rival ideas. Institutions, geography, and culture also matter. Catch-up growth lets poorer countries grow fast.
Flashcard
Growth from capital, labour, technology
Check your understanding
In the Solow model, what happens in the long run if a country raises its saving rate?