Editing Economic growth (section)

===Solow–Swan model===
{{Main|Solow–Swan model}}
[[Robert Solow]] and [[Trevor Swan]] developed what eventually became the main model used in growth economics in the 1950s.<ref>{{cite journal|last=Solow|first=Robert M.|year=1956|title=A Contribution to the Theory of Economic Growth|journal=Quarterly Journal of Economics|volume=70|issue=1|pages=65–94|jstor=1884513|doi=10.2307/1884513|url=http://rcin.org.pl/Content/39010|hdl=10338.dmlcz/143862|hdl-access=free}}</ref><ref>{{cite journal|last1=Swan |first1=Trevor W.|year=1956|title=Economic Growth and Capital Accumulation'|journal=Economic Record|volume=32|issue=2|pages=334–61|doi=10.1111/j.1475-4932.1956.tb00434.x}}</ref> This model assumes that there are [[diminishing returns]] to capital and labor. Capital accumulates through investment, but its level or stock continually decreases due to depreciation. Due to the diminishing returns to capital, with increases in capital/worker and absent technological progress, economic output/worker eventually reaches a point where capital per worker and economic output/worker remain constant because annual investment in capital equals annual depreciation. This condition is called the 'steady state'.

In the Solow–Swan model if productivity increases through technological progress, then output/worker increases even when the economy is in the steady state. If productivity increases at a constant rate, output/worker also increases at a related steady-state rate. As a consequence, growth in the model can occur either by increasing the share of GDP invested or through technological progress. But at whatever share of GDP invested, capital/worker eventually converges on the steady state, leaving the growth rate of output/worker determined only by the rate of technological progress. As a consequence, with world technology available to all and progressing at a constant rate, all countries have the same steady state rate of growth. Each country has a different level of GDP/worker determined by the share of GDP it invests, but all countries have the same rate of economic growth. Implicitly in this model rich countries are those that have invested a high share of GDP for a long time. Poor countries can become rich by increasing the share of GDP they invest. One important prediction of the model, mostly borne out by the data, is that of ''conditional convergence''; the idea that poor countries will grow faster and catch up with rich countries as long as they have similar investment (and saving) rates and access to the same technology.

The Solow–Swan model is considered an "exogenous" growth model because it does not explain why countries invest different shares of GDP in capital nor why technology improves over time. Instead, the rate of investment and the rate of technological progress are exogenous. The value of the model is that it predicts the pattern of economic growth once these two rates are specified. Its failure to explain the determinants of these rates is one of its limitations.

Although the rate of investment in the model is exogenous, under certain conditions the model implicitly predicts convergence in the rates of investment across countries. In a global economy with a global financial capital market, financial capital flows to the countries with the highest return on investment. In the Solow-Swan model countries with less capital/worker (poor countries) have a higher return on investment due to the diminishing returns to capital. As a consequence, capital/worker and output/worker in a global financial capital market should converge to the same level in all countries.<ref>{{cite journal|last=Lucas|first=Robert E.|year=1990|title=Why Doesn't Capital Flow from Rich to Poor Countries?|journal=American Economic Review|volume=80|issue=2|pages=92–6|jstor=2006549}}</ref> Since historically financial capital has not flowed to the countries with less capital/worker, the basic Solow–Swan model has a conceptual flaw. Beginning in the 1990s, this flaw has been addressed by adding additional variables to the model that can explain why some countries are less productive than others and, therefore, do not attract flows of global financial capital even though they have less (physical) capital/worker.

In practice, convergence was rarely achieved. In 1957, Solow applied his model to data from the U.S. gross national product to estimate contributions. This showed that the increase in capital and labor stock only accounted for about half of the output, while the population increase adjustments to capital explained eighth. This remaining unaccounted growth output is known as the Solow Residual. Here the A of (t) "technical progress" was the reason for increased output. Nevertheless, the model still had flaws. It gave no room for policy to influence the growth rate. Few attempts were also made by the RAND Corporation the non-profit think tank and frequently visiting economist Kenneth Arrow to work out the kinks in the model. They suggested that new knowledge was indivisible and that it is endogenous with a certain fixed cost. Arrow's further explained that new knowledge obtained by firms comes from practice and built a model that "knowledge" accumulated through experience.<ref>Warsh, David. Knowledge and the Wealth of Nations. W.W. Norton & Company 2006</ref>