Brian Easton reviews the work of Robert Solow, a Nobel prize-winning economist who transformed the way we think about economic growth

This is a re-post of an article originally published on pundit.co.nz. It is here with permission.

When you are in the trenches, you may not always realise what the war is about. Years later you read an account and see more clearly. Thus it was with me in the 1960s when economic analysis went through a revolution.

My insight came later when reading the budgets in the 1960s of Minister of Finance Harry Lake about whom I had been asked to write. The speeches expressed an ambition to increase economic growth, but the analysis was around capital investment only, which sounds very incomplete to today’s economist. Reflecting, I realised Lake was using the explanation I had been taught in my economics courses.

However, I was also working at the NZ Institute of Economic Research, whose first director, Conrad Blyth, had brought back from his overseas studies a different account of economic growth which I had absorbed into my thinking without realising how radical it was. Later Bryan Philpott and I worked together in the area. The key founder of this approach was Bob Solow, who has just died at the age of 99.

Solow’s key finding was that output per worker rose faster than the quantity of capital in the long run. You may know the standard assumption in classical economics as the ‘falling rate of profit’ as in Das Kapital, but Marx was drawing on orthodox economics, beginning with Malthus and Ricardo in the early nineteenth century, and still held by great economists such as Keynes and Schumpeter in the 1930s.

The decreasing marginal return on capital is really a consequence of the laws of thermodynamics. So the laws must imply that there are other things affecting production as well as capital and labour. Solow was humble about what he found. (It was such a gigantic insight he could afford to be.) His seminal 1957 paper explained the paradox by ‘technical change’:

“I am using the phrase ‘technical change' as a shorthand expression for any kind of shift in the production function. Thus slowdowns, speedups, improvements in the education of the labour force, and all sorts of things will appear as ‘technical change'.” (His italics)

Solow's paper is the source of the widely quoted claim that 80 percent of economic growth (output per person) is attributed to technology. But only if the word ‘technology’ has Solow's particular meaning of what we cannot explain. Economist Moses Abramovitz called the unexplained residual the our ‘ignorance'. Today we call it ‘multi-factorial productivity’ (MFP) or Total Factor Productivity (TFP)..

Sloppy thinking has empowered any group – educationalists, managers, scientists, those in the creative sector – to promote its interests by claiming it is making a major contribution to the coefficient of ignorance. Each seizes on their version of the meaning of technology; it makes them seem important and seems to justify spending large quantities of public money on them. (Many of those who argue for increasing our ignorance are well placed to make a contribution.)

Economists have tried to explain MFP/TFP – to reduce the coefficient of ignorance. We have never been able to explain it all. (It has been difficult because we cannot do experiments.) Over the years economists have concluded it is not just a matter of technology in the narrow sense of plans on how to use resources but also covered such things as managerial performance and the speed at which innovations are taken up and adapted to local circumstances. But we have not been able to measure by how much.

More recently, a crucial feature of economic development has hit home. (It is a central notion of my Not in Narrow Seas.) There has been a shift to economic activity in the market from economic activity outside it. Women moving from the kitchen into the factory are included in the calculations, but what about the refrigerators and washing machines which reduced their household grind, making the move easier?

Or consider when in the 1860s New Zealand had the highest productivity in the world as conventionally measured. It was not that we were working smarter or using more advanced technologies then. Rather, we were moving alluvial gold in the river beds outside the market into the market economy – bank vaults. Had the effect been drawn to Solow’s attention, he would have wished he had mentioned the effect moving from outside the market to inside among the ‘any kind[s] of shift’ in his 1957 paper. But in those days, economists were not as sensitive to the resource issue in economic growth (land excepted).

Economists have never said that capital and labour were irrelevant. They are as necessary as classical orthodoxy thought they were, but in a different way. Technology (in the narrow sense of ‘plans’) has to be embedded in capital and labour. So developments in information technology are embedded in personal computers and so on – capital goods. And the developments have to be also imbedded in the skills of the persons using them.

Nor should we ignore the social technologies of how an economy is organised. They range from having a good judicial system, so that contractual arrangements run as smoothly as possible, to how workplace relations are organised.

A curious feature of economic growth is that over a long period the rate of change of New Zealand’s MFP/TFP (the residual contribution to economic growth) does not seem to have changed much. I’ve looked and looked.

Had another go with a new data base a couple of weeks ago and failed, yet again. I was looking for a slow-down in hourly labour productivity growth early this century, as posited by some economists internationally. I thought I had found a slight one but it turned out to be not statistically significant. Bother!

And so to the uncomfortable question of whether we can accelerate the rate of long-run productivity growth. Everyone has been saying that since seven decades ago when we first had reasonable measures of the rate of economic growth. Economists do it as a mantra: ‘adopt my economic policies and the economy will grow faster’. (The commentariat echoes them.) But they provide no systematic evidence that their prescriptions will work. It is more ‘trust me, I know what I am doing’, but since the prescriptions all differ whom do you trust?

The politicians’ slogan is that faster economic growth will mean we can meet the public’s demands for tax cuts and more public spending. It is easier to say this when one is opposition. In government the cruel reality is that no matter what they do, the long-term MFP/FTP growth rate chugs along much as it has for the last century.

It is difficult to identify any New Zealand government that has really changed the growth rate (with the possible exception of the neoliberal policies of the late 1980s and early 1990s which stagnated the economy; we still have not recovered from their damage). Short-term burst, such as the upswing of a business cycle, can be identified by judicious choices of end points which may satisfy those with an ideological bent. A scientist is less able to find a significant long-term change. (A change of 0.1 or 0.2 percentage points in the growth rate is difficult to identify because of noise in the data.)

Most of the paragraphs of this column could not have been written before the systematic measurement of economic output, led by Simon Kuznets, and the resulting analysis, led by Solow. One honours him for his pioneering insights. In the study next door, Paul Samuelson changed how we thought about economics; Bob Solow changed how we thought about the economy.

He wrote with elegance and clarity – he was drawn into the social sciences by reading great novels in his adolescence. They were spliced with wit. Here are some:

    “Economists are divided between those who look at economic aggregates and those who look at the details. I belong to both sides.”

    “Everything reminds Milton [Friedman] of the money supply. Well, everything reminds me of sex, but I keep it out of my papers.”

As an economist, Solow liked formal models and mathematics. But nothing too fancy. Over-refinement reminded him of the man who knew how to “spell banana” but did not “know when to stop”.

    “Part of the job of economics is weeding out errors. That is much harder than making them, but also more fun.”

    “Why does a public discussion of economic policy so often show the abysmal ignorance of the participants?”

*Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.