SOLOW GROWTH MODEL

Objective
Explains positive long-term growth in per-capita
variables only through some type of exogenous
growth in productivity
ASSUMPTIONS OF THE MODEL
1. Continuous time.
2. Single good produced with a constant
technology.
3. No government or international trade.
4. All factors of production are fully employed.

5. Labor force grows at constant rate n such that

6. Initial values for capital, K 0 and labor, L 0 given.

Y = Af (K,L) (production function)

Y = GDP,A= technology,
K = capital, L = labour

NEOCLASSICAL PRODUCTION FUNCTIONS

Solow-Swan assume:

diminishing returns to capital or labour (the law of diminishing returns), and

constant returns to scale (e.g. doubling K and L, doubles Y).

For example, the Cobb-Douglas production function

Y AK L1
1

Y AK L
y
L
L

where 0 1

AK
K
A Ak
L
L

Hence, now have y = output (GDP) per worker as function of capital to labour ratio (k)

Solow noted that any increase in Q could come from one of three sources:
Increase in L . However, due to diminishing returns to scale, this would imply a reduction in Q / L or
output per worker.
Increase in K . An increase in the stock of capital would increase both output and Q / L
Increase in A or in multifactor productivity could also increase Q / L or output per worker.

SIMULATING SIMPLE SOLOW MODEL

Indias Savings Rate (2012) 30% of GDP and US

17% of GDP
Assuming rate of depreciation to be 4% for both
India and USA *
Productivity per worker: India 0.35, USA 1

* Source: http://www-personal.umich.edu/~kathrynd/india.2005.pdf

GROWTH ANALYSIS

INDIA

USA

ECONOMIC GROWTH

Gross Domestic Product

GDP Growth Rate

The Gross Domestic Product (GDP) in India was worth 1841.70 billion US dollars in 2012. The GDP value of
India represents 2.97 percent of the world economy
From 1970 until 2012, India GDP averaged 485.7 USD Billion reaching an all time high of 1872.9 USD Billion in
December of 2011 and a record low of 63.5 USD Billion in December of 1970.
India's economic growth accelerated slightly last year to more than 5%, but the nation continues to struggle
with a weak economy and high inflation.
A mix of problems including chronic fiscal and current account deficits, shoddy infrastructure and rising
borrowing costs have hurt business confidence in India and choked investments over the past few years.

COMPARATIVE ANALYSIS
Research and Development (as % of GDP)

Savings (as % of GDP)

Gross domestic savings have increased continuously

from an average of 9.6 per cent of GDP during the
1950s to almost 28 per cent of GDP in 2012. It
peaked at 34% in 2007.
Savings as a % of GDP has shown a steady decline in
USA since the 1980s Great Moderation made
people less fearful of economic uncertainty
Indian economic growth has been financed
predominantly by domestic savings whereas the
foreign savings have remained modest in Indian
growth period

India lags far behind in the field of scientific research

and development globally which is led by USA.
While USA has consistently spent around 2.5% of its
GDP on Research and Development, the figure for
India has been below 1%.
This is the reason for USAs technological progress
and thus translates into better factor productivity.
Hence, India lags behind USA on this metric of
economic growth according to Solow Model.

Low R&D expenditure can lead to: (a) Lack of innovation and discovery of new techniques which can power the
economy (b) The productivity of labour (people) remains low as their skills may not be fully utilized due to lack of
access to research tools and techniques.

COMPARATIVE ANALYSIS

Public Spending on Education (as % of GDP)

Health expenditure (as % of GDP)

Indias health expenditure at 4% is considerably

below the global average of 10%, and shows a
declining trend.
On the other hand, USAs expenditure on health has
shown an increasing trend and is well above the
global average at almost 18%.

There has been a steady fall in public spending on

education in India which accounted for 3.35% of
GDP in 2012.
Public expenditure on Education across the world
witnessed a steady rise and increased to 5%. Going
with the trend, USAs spending on education steadily
increased to reach 5.42% in 2010.

USA ranks considerably higher at 4 on HDI as compared to Indias 135. USA scores high on human development
index as the average achievement in three basic dimensions of human developmenta long and healthy life,
knowledge and a decent standard of living is high in case of USA.

COMPARATIVE ANALYSIS- AGRICULTURE

Agricultural Value Added per worker- USA

CAGR- 6%

The Agriculture Growth rate in India has

been high at a CAGR of 6% for USA having
sustained for the past 20 years
Some of the reasons for this are disruptive
innovation in farm technology, better
pricing and direct access to wider and
more competitive market

COMPARATIVE ANALYSIS- AGRICULTURE

Agricultural Value Added per worker- INDIA

CAGR- 2%

The Agriculture Growth rate in India has been low at

a CAGR of 2%
Technological challenges, land fragmentation, lack
of nonfarm services, institutional factors and
demographic pressure are the reasons attributed
to the same
Majority of the population is employed in the
agriculture sector although this trend has shown a
steady decline over the past few years.
But the value added per worker is lower than the
USA and stands at less than 700 as compared to
USAs 50,000

One of the major reasons for the same can be that

output per worker increases at a diminishing rate as
k increases due to the law of diminishing returns.
In the absence of continuing improvements in
technology, growth per worker must ultimately
cease. This prediction follows from the assumption
of diminishing returns to capital.