Wednesday, September 15, 2010

critique of Solow Model

One serious drawback of the Solow Model the single good it has in the model has only homogeneous quality. This is an unreasonable assumption, with consequences in conclusion. Because of this set up, technology innovation has to be interpreted as efficiency improvement--that is with the same input of labr and capital, the economy is able to produce much more. However, this assumption is unrealistic. In most areas of the world, what can be witnessed is that techonology improves the quality of the products, leading to so-called "climbing the quality ladder". However, if we model the technological innovation as improvements in quality and thus introducing a continuum of quality of the goods, we can accomplish much more. We then have to introduce multiple goods, since quality only matters when there is substitution. But to do this, we also have to abandon the competitive market assumption, without which the whole model could be ridiculously complicated. What I hope to show is that, when there is a small difference in A(t), the less developed counties could still specialize that technology-intensive industry, but reaping less benefit. Another possible consequence is that with higher growth rate (that is higher dA/dt), less developed countries might find it harder to catch up.
This is only a sketch of the model, there are so many things left out and not thought out. Also, currently I do not have the ability to formalize this hypothesis.
Also, I have the crunch that if monetary stuff are introduced, then we might have a model to explain the exchange rate level's influence on growth rate and catching up.

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