macro chapter 5 technological progress and growth

In one respect the basic Solow model presented in Chapter 3 did not perform well
empirically: its long-run balanced growth path displayed zero growth in GDP per
capita. This is at odds with the observed long-run growth in living standards in
Western economies.
We want to develop a growth model whose long-term prediction is a balanced growth
path with strictly positive growth in GDP per person. Obviously we can only trust the
answers to our big questions, 'what creates prosperity in the long run?' and 'what creates
transitory and long-run growth?' , if these answers are grounded in a (growth) model that
accords with the most basic empirical facts.
This chapter presents a growth model with the properties we are looking for: the
steady state of the model exhibits balanced growth with positive growth in output per
worker. We obtain this by a slight generalization of the basic Solow model. The resulting
model is close to the one actually suggested by Robert M. Solow in his famous 19 56 article
referred to in Chapter 3.1
The essential new feature of the model is that total factor productivity is no longer
assumed to be a constant. B. Instead it will be given as an exogenous sequence, (B1). which
may be steadily growing over time. In that case the model's steady state will display
balanced growth with steady positive growth in GDP per worker.
Hence, according to the general Solow model (as we will call it) tile root of steady
positive long-run growth in GDP per person is a steady exogenous technological progress. This
explanation of growth may not seem deep. However, it is not trivial that the consequence
of steadily arriving tech nological progress should be a balanced growth path, and it is
reassuring for the application of the model to issues of economic policy that its steady state
mirrors a robust long-run growth fact. Of course, explaini11g the technological progress
th at creates growth in GDP per worker is a matter of great interest and it is the subject of
Part 3 of this text.
Having obtained in this chapter a model that llts the basic stylized growth facts better,
we are going to take the model through some more specific empirical tests. The tests will focus on the steady state prediction of the model as well as its outside steady state prediction
concerning transitory growth or convergence. 2 Our conclusion will be that the
general Solow model does quite well empirically. both with respect to its steady state and
its transitory growth predictions, although there will be some aspects still to be improved
upon. The general Solow model is indeed a very important growth model.

The general solow model

With respect to the qualitative features of the underlying 'micro world'. the general Solow
model is identical to the basic Solow model. It has the same commodities and markets. and
the markets are again assumed to be perfectly competitive. There are also the same kinds
of economic agents, and their behaviour is essentially the same. In particular, a representative
profit-maximizing firm has to decide on the inputs of capital and labour services, K:1
and L;\ in each period t, given the real rental rate of capital. r,. and the real wage rate, w 1•
The only difl'erence is th at the production function . which tells how much output can be
produced by K and L so that over time more and more output can be obtained from the same amounts of inputs.

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