A financial analyst is comparing two countries, Country X and Country Y, based on their long-term economic growth prospects. Both countries have similar levels of physical capital per worker. However, Country X has significantly higher investment in education and research & development (R&D) compared to Country Y. According to the Solow growth model (without endogenous technology), which of the following is the most likely long-term outcome regarding their steady-state growth rates?
- ACountry Y will achieve a higher steady-state growth rate of output per worker due to diminishing returns to capital.
- BCountry X will achieve a higher steady-state growth rate of output per worker than Country Y.
- CThe Solow model cannot predict the steady-state growth rates based on these factors.
- DBoth countries will eventually converge to the same steady-state growth rate of output per worker.
Show answer & explanationAnswer & explanation
Correct answer: D. Both countries will eventually converge to the same steady-state growth rate of output per worker.
In the basic Solow growth model, the long-run steady-state growth rate of output per worker is determined solely by the exogenous rate of technological progress. Differences in investment rates in education (human capital) and R&D (which influences technology) affect the *level* of output per worker in the steady state, but not its *growth rate*. Both countries, assuming they share the same rate of technological progress, will eventually converge to the same steady-state growth rate of output per worker, equal to the (exogenous) rate of technological progress.
Why the other options are wrong
- A. Incorrect. Diminishing returns to capital explain why growth from capital accumulation slows, but the long-run growth rate is still tied to exogenous technology, not to Country Y having higher growth.
- B. Incorrect. While Country X will have a higher *level* of output per worker in the steady state due to better technology/human capital, its *growth rate* will converge to the same exogenous technological progress rate as Country Y.
- C. Incorrect. The Solow model does make predictions about steady-state growth rates based on these factors (implicitly through the exogenous technology rate).
Solow Growth Model (Basic)
A neoclassical economic model of long-run economic growth that explains how growth in the capital stock, labor force, and technological progress interact.
- Predicts that countries converge to a steady state where capital per worker and output per worker are constant.
- Long-run growth rate of output per worker is determined by exogenous technological progress.
- Differences in savings rates or population growth affect the *level* of steady-state output, not its *growth rate*.
Memory trick: Steady State: Tech is the only constant growth engine.