Solow Residual

Robert Solow won the Nobel prize in economics for his Solow residual. He's...a big deal.

In general, we like economies to grow, making GDP bigger. But where is that growth coming from? Many economists will tell you it’s coming from the factors of production, meaning the accumulation of capital and labor. All those factories and their equipment and tools and workers...it comes from all that stuff. Multiplied by the deployment of technology.

Solow thought bigger. He asked, "What about the part of an economy’s output growth that has nothing to do with the factors of production?" That’s what the Solow residual measures. Solow’s model held capital and labor constant, and looked at an increase in output from there. How do you make more with the same stuff? Is it possible? Yep...because you’re being more efficient with your capital and labor.

Maybe you introduced the assembly line to your factory. That made things much more efficient. Maybe your labor got more experience and better trained. Maybe your staff is just awesome...or maybe you’re driving them like slave labor. Whatever the cause: higher output with the same inputs means more efficiency and productivity.

The reason the Solow residual is such a big deal is because he found that increases in efficiency were much more responsible for increases in output than increases in capital. The Solow Residual determined that only one-eighth of the increase in labor productivity was from an increase in capital in the U.S. Yep...America was mostly built on the vision and Brunswicks of risk-takers who started companies and then paid workers to execute their vision.

Thanks, Henry F. Thanks, Bill G. Thanks, Jeff B. We appreciate the jobs. (And global domination.)