Thoughts on Solow and Foreign Aid

One of the major models used in macroeconomics is the Solow-Swan growth model. Skipping a lot of mathematics, the model essentially tells us that economic growth is a function of capital (k), labor (l), and some mysterious A factor that sums up pretty much everything else (education, technological progress, institutions, etc).

When Solow first developed this model, he figured that he’d see economic growth was driven primarily by capital.  However, in testing this model over the years, the conclusion is repeatedly that the A factor is the driving aspect of the model, not labor or capital.

To the extent this is true (the Solow Model has many limitations, even Robert Solow himself recognized this), it would have serious implications for foreign aid.  Given the A factor accounts for everything not capital and labor, and that it appears this A factor is the main driver of economic growth, it would suggest that most foreign aid done by wealthy nations is wrong-headed.  US (and other 1st World Nations) foreign development aid is very capital-focused: building factories, expanding ports, providing machines, that sort of thing.  Given the findings of the Solow model, it would suggest this is the wrong way to handle foreign aid.  In order to be more effective, foreign aid would need to focus on the A factor.  Of course, the problem here is how broad A is.  Other models have tried to break apart A into various components, such as human capital (education), but even those aspects appear to have limited effects.  It’s an interesting question (as well as the question on, given this evidence, why foreign aid is still very capital-focused.  I hope to address this in some hypothetical sense in a future post).

Of course, none of this is to say that there should be no foreign aid.  Just because capital’s influence on the growth rate is limited doesn’t mean it shouldn’t be supplemented.  But it does suggest that the current regime of foreign aid is inefficient.

5 thoughts on “Thoughts on Solow and Foreign Aid

  1. Foreign aid actually appears to be destructive as it is typically a government to government transfer which tends t sustain regimes that (usually nominally socialist) tend to obstruct entrepreneurial activity.

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  2. Great subject, Jon.

    Deirdre McCloskey has written extensively on some of the important ingredients to be found in the “A factor”. She doesn’t believe capital and labor are the main drivers of economic growth either.

    II agree with Sam on this, and would add that it is tyrannical government itself that keeps people in poverty by failing to allow for protection of property rights and enforcement of contracts. Therefore foreign aid merely helps keep despotic dictators in power to the detriment of the people of a poor country – the opposite of it’s intended purpose. Without this support, people might decide they had had enough, and overthrow these tyrants.

    Emergency aid is little better. Here’s a specific example of the massive misdirection of funds away from their intended purpose.

    I know I sound pretty cynical, but I can’t find a kinder explanation.

    Government aid? No.

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    • Ha! Dr. Coyne’s book just arrived in my mailbox last week. I found a good used copy for $0.83. I’m sure the knowledge it contains will be worth much more to me than that.

      It’s now on my ever growing pile of unread material. The good news is that I will be forced to live a very long time to finish it all.

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