The Solow Residual

The Solow Residual is the somewhat mystical factor which explains why some economies, with rougly equal endowments of capital and labour, are able to produce more than others. It is named after the Nobel Prize winning economist Robert M Solow.

It can be defined as the constant ‘A’, in the often proverbial Cobb-Douglas:

Output = AK½L½

With K being the capital stock and L the quantity of labour employed.

But what could be the defining factors of this intangible residual?

Immediately springing to mind are the usual education of labour, and technology levels of capital, but I think there is an intangible lying deeper then that. As all of the economic output, spending and allocation of resources and capital depends on the acts of human beings, I believe it is necessary to think on a more human level, moreover human potential.

For people, from a multitude of socioeconomic backgrounds to reach a higher plane of achievement, some conditions act as a catalyst:

  1. A moderate level of income inequality
  2. Ethics and values instilled
  3. Secure family structure

When income inequality is too high, many individuals may become demoralised, for example feeling their labour is being unrewarded, whether it be for the (often wealthy) shareholders or studying a potential employer only to find family connections have filled the internships. A state of learned helplessness sets in, certainly lowering productivity among the masses, and casuing other ugly manifestations, as seen in the English riots this year. The moderate level of inequality is a driving factor in the prosperity of Sweden, Norway and Denmark, each with a Gini Coefficient in the 20’s¹.

The Kuznets Curve theorises a limiting factor of high inequality

The nations philosophy approach to work plays a major role in the skills, and longevity of the labour force: Work with high versus low intensity; just to pay the bills or do what you enjoy. What children are taught by their parents and at schools imbeds itself for the remainder of their life, and that attitude defines the output and creativity.

Work Ethic

For instance, Western philosophies have viewed ‘hard work’ as positive, even if mainly futile, and frowned upon laziness, even if necessary for recuperation. This Puritan work ethic possibly accounts for the high output but arguable standards of living and stresses in these economies. This brilliant piece may change your entire thinking on ‘work’~ http://www.anxietyculture.com/puritan.htm

Reminding the reader about the human potential approach, underlying this piece, it is statistically proven that family breakups have a damaging effect on youth academic and career prospects² although this is obvious a priori: The route is often family breakups leading to insecurities, drink, then drugs. Although in some cases it may drive one to greater achievement, unfortunately the former is more common.

Human beings shape the economy, with capital being merely a manifestation of human action. Human potential is thus what defines the Solow Residual, how much of it is realised and if not, what is holding it back.

Sources

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