The Solow-Swan Theory

I. Theories Underlying Global Income Convergence

The Solow-Swan theory is a neoclassical model of economic growth with a Cobb-Douglas production function. The theory focuses on the relationship between capital and output, and assumes savings, population growth and technology are erogenous (Solow, 1956).
The central hypothesis of the Solow-Swan model is that over time an economy converges towards a steady state of output. Due to the diminishing marginal productivity of capital, the growth rate of a country will slow as it reaches its steady state of output. This implies that richer economies will grow at a slower rate than poorer economies, and the resulting effect is that the poorer economies will catch up with the richer ones in terms of

Using econometric analysis of 110 countries, Sala-i-Martin (1996) found that over the period from 1960-1990, the economies of poor countries did not grow faster than rich one. The analysis found that over the course of 30 years, the economies showed no signs of sigma convergence, and showed no signs of absolute beta convergence, indicating that global income inequality was increasing.
Park (1997) also examined trends in cross-country income inequality using data from the Penn World Table over the period from 1960-1990 found no evidence of convergence. By estimating shares of global income accruing to percentiles of the world population, Park calculated the Theil index and found no evidence of global income

The first estimates of inequality across the worlds population were not made until the early 1980’s, when data on income distributions of some of the worlds most populous regions such as China, the Soviet Union and large parts of Africa first became available (Milanovic, 2006). Since then, the question of whether global income inequality has increased or decreased has been the subject of much debate. The answer appears to depend on the method used to measure differences in cross-country incomes. Exchange rate comparisons suggest there has been an increase in income inequality however they ignore the relative price of non-tradables (Dowrick & Akmal, 2004) resulting in an exaggerated estimation of the income gap between the rich and the poor. While purchasing power comparisons using the Penn World Table suggests a reduction in inequality, however the fixed price method is subject to substitution bias (Dowrick & Akmal, 2004), which often results in substantially understated level of income inequality. However, the latter measure is widely considered more appropriate for measuring income inequality as it takes into account information about the “typical” level of prices in various countries. When data adjustments are made for both measures, no clear trend is apparent in global income