The Solow Model and Ideas

We've covered a lot of the Super Simple Solow Model. We've looked at the dynamics of capital accumulation, how changes in savings rates influence growth, and we've looked look at some of the predictions of the Solow Model. One thing we've learned is that the model seems to inevitably predict that we end up in a steady state with no growth. Now, however, we're going to turn to the last of our variables: Ideas.

Can ideas keep us growing? Better ideas mean that we get more bang for our buck, more output from the same inputs of capital and labor. Alternatively, we can think about this as increasing our productivity. Henry Ford, for example, took ideas from lots of other industries, like meatpacking, bicycle making, and brewing, and he combined them in a way that had never before been used in the manufacturing of automobiles. This novel combination of ideas sparked a dramatic increase in productivity that transformed the world. The same types of processes - they're continuing today, and in all industries, increasing output per worker across the economies.

So, let's go back to our previous graph of capital and output. We can now add ideas as a multiplier. Better ideas multiply the output from the same capital stock. So, if A increases from 1 to 2, that's a doubling of our productivity. And that shifts the output curve up. When output doubles, so does investment. Now, once again, investment is greater than depreciation. So, we begin accumulating capital once again. And that further boosts our output. So better ideas spur more output, which creates more investment, which leads to capital accumulation. So better ideas lead to growth in two ways: The increased productivity of a given capital stock, and the increased investment, which increases capital accumulation.

Now imagine that ideas are constantly improving. You'd have continual shifts upward of the output curve. And that means continual shifts upward of the investment curve. We'd always stay to the left of the steady state, and there, we'd continually grow. So, growth at the cutting edge - it's determined by how fast new ideas are formed, and how much those new ideas increase our productivity. So that's our Super Simple Solow Model. It combines a model of catching up growth due to capital accumulation, with a model of cutting edge growth due to idea accumulation.

If you want to dive further into the Solow Model, check out our textbook, "Modern Principles." We also have more material in our Development Economics course. In that course, we'll add population growth to the model. and dive deeper into the data to see how well the model predicts. We'll find some things it predicts really well, and other things not so much. Finally, since ideas drive growth on the cutting edge, we'd like to know what factors help to spur the creation of new ideas. This topic is a personal favorite of mine, and it's up next.