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Friday

Solow-Swan model on the brink


A property of the Solow-Swan growth model which is a bit disturbing is the fact that, at steady-state, all ratios -- the capital-labor ratio, output per person and consumption per person -- remain constant.

This is a bit of a disappointment for it implies that standards of living do not improve in steady-state growth. This is not only despiriting, it is also empirically dubious: it contradicts at least two of the "stylized facts" of industrialized economies laid out in Kaldor (1961) -- namely, that the capital-labor and output-labor ratios have been rising over time and that the real wage has been rising.

Of course, just because industrialized countries, and others besides, have experienced ever-increasing per capita consumption and output over the past three centuries does not, by itself, "contradict" the Solow-Swan model. After all, out of steady-state, we can easily have changing ratios. So, one possible explanation for the "stylized facts" that is consistent with the Solow-Swan model is simply that industrialized nations are still in the process of adjusting and just have not reached their steady-state equilibrium yet. And why not? It is not unreasonable to assume that adjustment to steady state might take a very long time (cf. Sato, 1963; Atkinson, 1969).

But economists are a rather impatient sort. They like to believe that economies tend to be at or around their steady-states most of the time (a noble exception is Meade (1961)).

As a consequence, in order to reconcile the Solow-Swan model with the stylized facts, it is tempting to argue that there has been some sort of "technical progress" in the matter.

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