The Solow model assumed that there are constant returns to scale and that increases in capital and labour are subject to diminishing marginal product. What if these assumptions are relaxed? Complexity theorists ask how economic actors react to the patterns and outcomes they themselves create, and how these patterns and outcomes would change as a consequence and thus lead to further changed reactions by economic actors. Could this also apply to the way in which capital and technologies are adopted as economies grow?
As countries grow and develop, they grow their capital stock, and as this capital stock grows, it will incorporate new technologies. Firms will adopt some technologies and abandon others; competing technologies might see some winning and others either failing to gain traction and exiting the market or remaining on the periphery. Those technologies that are adopted become better understood and experience in their use means that they are subject to further improvements. Some countries have invested heavily in the development of capital and have succeeded in increasing the productivity of labour quickly. In some cases, it has been argued that the technology developed in Western economies at great expense and time have been ‘stolen’ by developing countries in Asia, infringing intellectual property. These developing countries might well argue that they are merely learning from existing technologies and utilizing them to help take millions out of poverty. Is that an outcome that is more beneficial than the protection of a giant Western firm’s intellectual property and its rights to generate monopoly profit? Professor Justin Yifu Lin, former Chief Economist and Senior Vice President of the World Bank and now honorary dean of the National School of Development at Peking University, noted that China has been able to take advantage of what he calls ‘backwardness’ –
the ability to ‘borrow’ technology, innovation and institutions at relatively low risk and cost from advanced nations. The World Bank Commission noted this as the ability for developing countries to ‘import what the rest of the world knew and export what it wanted’.
It could be that some countries adopt technologies which are actually inferior largely due to the fact that certain technologies have become dominant in the market or introduced into the country because of its peculiar circumstances, when other technologies that subsequently come along could be more efficient. This might explain why some countries do not exhibit strong growth while others in a similar situation do, because the latter are more flexible in the adoption of different technologies.
The idea that increasing returns to scale could exist across a wide range of industries in an economy begs the question, how does the industrial structure of an economy develop?
Industrial structure refers to the number of firms in an industry, their market share and their size.
How many of the industries in the economy exhibit increasing returns to scale as opposed to constant or diminishing returns may affect the speed at which the economy can grow over time. This is particularly relevant to developing countries today but has been experienced by developed economies over many years.
Critical Thinking Questions
1 To what extent do you think that the assumption of constant returns to scale in the Solow model renders the model fundamentally flawed?
2 There are invariably different ways of producing goods and services. Some technologies gain traction while others do not. What factors do you think determine whether particular technologies in an economy gain traction?
To help illustrate your answer, try to find or think of examples of technologies which have gained traction and others that have failed to do so.
3 Explain how the idea of ‘backwardness’ may have allowed China to be able to generate rapid and sustained economic growth over a period.
4 Do you agree that the benefits of taking millions out of poverty is more important than the protection of intellectual property of large Western firms?
5 ‘The understanding of how and why some countries develop and grow while others languish, even though they have access to valuable resources, can be better understood by utilizing the approaches of other schools of economics such as complexity economics, feminist economics and institutional economics.’ Do you agree with this statement? Justify your response.