Solow Growth Model: Modern Principles: Macroeconomics
Cowen and Tabarrok’s Modern Principles: Macroeconomics presents a wonderful opportunity to bring modern growth coverage and theory into the principles class. Because of the inclusion of the Solow model it does present a challenge with that opportunity. We truly believe that Solow is presented in an appropriate level for principles and the benefits of including it outweigh the challenges.
We realize not all instructors will teach the entire Model as it is presented. In fact we realize some instructors will want to minimize the coverage of it entirely while still teaching the wonderful growth lessons presented in Modern Principles: Macroeconomics.
This document is designed to illustrate the flexibility of this coverage.
1) Why teach the Solow growth model?
We want students who read the Modern Principles to be able to answer three paradigmatic questions.
· Why is South Korea richer than North Korea?
· Why is China growing faster than the United States?
· What determines the growth rate of the country (or countries) on the cutting edge?
The first question is covered in Chapter 6 and involves incentives and institutions (property rights, corruption, the rule of law, and so forth; in essence everything the student has learned about the invisible hand plus political economy).
Answering the first question, however, naturally raises a second question. Why is China growing so much faster than the United States? After all, on every score China has worse institutions and incentives than the United States. Indeed, if the student is not puzzled by this question he or she may draw precisely the wrong conclusion--reasoning that if China is growing quickly it must be because it has good institutions. This type of error is very common. When Germany and Japan were growing more quickly than the United States many observers pointed to the German labor system or Japanese "cooperative capitalism" as the key institutions that the US needed and did not have. These institutions may or not be growth enhancing but the key point is that one shouldn't compare growth rates without first correcting for catch-up, the fact that capital in poorer economies tends to be more productive because capital per worker is low.
We cover diminishing returns to capital and its importance in the first section of Chapter 7. Diminishing returns alone takes us quite far in answering the China question. If we add capital depreciation to the mix we can arrive at a second important conclusion. Capital alone cannot explain growth in the long run. At this stage, we have covered the key elements of the Solow model and we leave it to the instructor to pursue one of two paths. Finish the Solow model by discussing changes in saving rates and so forth. An instructor who follows this path usefully ties growth to the chapters on financial intermediation. We have made the material simple enough so that it can be taught to principles students but, there are diminishing returns in all things, so an instructor may want to allocate more time to other topics. Alternatively, an instructor can follow through on the conclusion that capital alone cannot explain growth in the long run to ask, What does explain growth in the long run? Alternatively stated, What determines the rate of growth of the cutting edge countries?
The cutting edge countries are the countries that cannot grow much by adding capital (since returns are low and depreciation of the already existing capital stock is high) and so must grow by increasing the productivity of a given supply of capital. We cover the economics of ideas in the second half of Chapter 7.
Together Chapters 6 and 7 give the student a very good grounding in economic growth, both for the citizen and for the student continuing on in economics. We think that the importance of economic growth for human welfare and the value of the unique insights offered by economists on this topic more than justify the careful attention given to this material in Modern Principles.
2) If I teach the Solow growth model, do I have to teach it in-depth?
No. As is said in the preface:
The second option is to cover only a portion of the Solow model in Chapter 7.
We sometimes do this in our larger classes so this will be a good choice for many.
The chapter has been written so the most intuitive and important aspects of the
model are covered in the beginning, more difficult and detailed material in the
middle may be skipped, and then important material on growth and ideas is covered
toward the end of the chapter. The material in the middle may be skipped
without loss of continuity. Instructors with smaller and more advanced classes can
easily cover the full chapter. The instructor’s guide written by John Dawson offers
many excellent tips for covering this material
Specifically, you can skip pages 124 – 130, as we sometimes do in our larger classes.
3) Do I have to teach the Solow model at all?
No. Again, from our preface:
One important point: it is not at all necessary to teach the Solow model to cover
our chapters on business fluctuations. We offer a “Solow growth curve” in these
chapters, but without delving into the details of the Solow model, the curve is readily
explained as a potential growth curve analogous to a potential GDP curve.
Specifically, on page 243, we state:
We learned in Chapters 6 and 7 that economic growth depends on increases in
the stocks of labor and capital and on increases in productivity (driven by new
and better ideas and better institutions). Thus, the economy has a potential
growth rate given by these fundamental or real factors of production. If markets
are working well and prices are flexible, then an economy will grow at its
potential rate. In other words, when prices are flexible, actual growth will be
equal to potential growth. But, we will see later that all prices are not perfectly
flexible; in the short run some prices, especially wages, can be “sticky” and because
of this an economy need not always be growing at its potential.
We call it the Solow growth curve because Robert Solow, one of the giants
of economics, created an important model of an economy’s potential growth
rate. In Chapter 7, we described Solow’s model in more detail, but if you
skipped that section don’t worry; just think of the Solow growth rate as the
rate of economic growth given flexible prices and the existing real factors of
capital, labor, and ideas.
Thus, you can teach the intuitive growth concepts presented in Modern Principles: Macroeconomics and introduce the Solow model without actually going into depth as we do in Chapter 7.