The Economics Book

224

OVER TIME, ALL

COUNTRIES WILL

BE RICH

ECONOMIC GROWTH THEORIES

I

n the 1950s US economist

Robert Solow devised a model

of economic growth that

predicted an equalization of living

standards across the globe. His

assumption was that capital

has diminishing returns: extra

investments add less and less to

output. Because poor countries

have little capital, extra capital

would add a lot to output, and

these returns pull in investment.

Countries are assumed to have

access to the same technology;

by using it, poor countries use

the additional capital to increase

output. The effect is larger than

would be the case in a richer

IN CONTEXT

FOCUS

Growth and development

KEY THINKER

Robert Solow (1924 – )

BEFORE

1776 Adam Smith poses

the question of what makes

economies prosper in The

Wealth of Nations.

1930s and 1940s Economists

Roy Harrod of the UK and

Russian-American Evsey

Domar devise a growth

model containing Keynesian

(government interventionist)

assumptions.

AFTER

1980s US economists Paul

Romer and Robert Lucas

introduce Endogenous Growth

Theory, suggesting that

growth is primarily the result

of internal factors.

1988 US economist Brad

DeLong finds little evidence

for the basic convergence

prediction of the Solow model.

Capital in developed

countries is subject to

diminishing returns—

extra investment results

in less and less output.

Poor countries grow faster

than rich ones, and their

living standards catch up.

Poor countries can use

this new capital with new

technologies to provide

very rapid growth.

But poor countries have

had so little capital invested

that investors can still

make high returns on

their investments.

Over time, all countries

will be rich.