Economic Growth II: Technology, Empirics, and Policy

Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s? If so, what, exactly? If not, what is it about the “nature of India” that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else.

— Robert E. Lucas, Jr., 1988

This chapter continues our analysis of the forces governing long-run economic growth. With the basic version of the Solow growth model as our starting point, we take on four new tasks.

Our first task is to make the Solow model more general and realistic. In Chapter 3 we saw that capital, labour, and technology are the key determinants of a nation’s production of goods and services. In Chapter 7 we developed the Solow model to show how changes in capital (through saving and investment) and changes in the labour force (through population growth) affect the economy’s output. We are now ready to add the third source of growth—changes in technology—into the mix. The Solow model does not explain technological progress but instead takes it as exogenously given and shows how it interacts with other variables in the process of economic growth.

Our second task is to move from theory to empirics. That is, we consider how well the Solow model fits the facts. Over the past two decades, a large literature has examined the predictions of the Solow model and other models of economic growth. It turns out that the glass is both half full and half empty. The Solow model can shed much light on international growth experiences, but it is far from the last word on the subject.

Our third task is to examine how a nation’s public policies can influence the level and growth of its citizens’ standard of living. In particular, we address five questions: Should our society save more or save less? How can policy influence the rate of saving? Are there some types of investment that policy should especially encourage? What institutions ensure that the economy’s resources are put to their best use? How can policy increase the rate of technological progress? The Solow growth model provides the theoretical framework within which we consider these policy issues.


Our fourth task is to consider what the Solow model leaves out. As we have discussed previously, models help us understand the world by simplifying it. After completing an analysis of a model, therefore, it is important to consider whether we have oversimplified matters. In this last section, we examine a new set of theories, called endogenous growth theories, that hope to explain the technological progress that the Solow model takes as exogenous.