Solow residual

The Solow residual is a number describing empirical productivity growth in an economy from year to year and decade to decade. Robert Solow defined rising productivity as rising output with constant capital and labor input. It is a "residual" because it is the part of growth that cannot be explained through capital accumulation or increased labor. Note that increased physical throughput – i.e. environmental resources – are specifically excluded from the calculation, thus some portion of the residual can be ascribed to increased physical throughput. The Solow Residual is procyclical and is sometimes called the rate of growth of total factor productivity.

In the 1950s, many economists undertook comparative studies of economic growth following World War II reconstruction. Some said that the path to long-term growth was achieved through investment in industry and infrastructure and in moving further and further into capital intensive automated production. Although there was always a concern about diminishing returns to this approach because of equipment depreciation, it was a widespread view of the correct industrial policy to adopt. Many economists pointed to the Soviet command economy as a model of high-growth through tireless re-investment of output in further industrial construction.

However, some economists took a different view: they said that greater capital concentrations would yield diminishing returns once the marginal return to capital had equalized with that of labour – and that the apparently rapid growth of economies with high savings rates would be a short-term phenomenon. This analysis suggested that improved labour productivity or total factor technology was the long-run determinant of national growth, and that only under-capitalized countries could grow per-capita income substantially by investing in infrastructure – some of these undercapitalized countries were still recovering from the war and were expected to rapidly develop in this way on a path of convergence with developed nations.

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