The Solow Model in Action, Again

I’ve written many blogposts about the Solow Model in the past, and it remains one of my favorite workhorse models to teach at an introductory level. There are problems with the model, to be sure, and much better, updated versions are available. But if you want a very simple, but very powerful way of looking at the world, you could do a lot worse than the Solow Model.

Read my old posts about the Solow Model, if you like, or watch this video, or consider this description of the Solow Model that ChatGPT4 came up with:

The Solow Model is the lively symphony of an economy, showcasing how savings, population growth, technology, and the tune of institutions together shape its rhythm, while the constant drumbeat of depreciation subtly dictates the tempo of this economic dance.

By the way, if you’re wondering, this is the prompt that I used:

“Give me a one sentence description of the Solow model. The sentence must be short, in simple english, and written in a catchy style, but it must also be correct, thorough and succinct”

I wasn’t happy with it’s first pass answer, so I gave it an additional prompt: “Make it slightly longer if you need to, but the fact that institutions matter must also come through”, and the professor in me couldn’t resist one final prod: “And shouldn’t you be mentioning depreciation?”

And if you’ve seen the video, you’ll probably agree that ChatGPT4 has done a reasonably good job. But what is the point? The point is that being familiar with the Solow Model helps you understand why this chart is such a big problem:

What is the rhythm of the Japanese economy? One should take a metaphor only so far, but it does seem as if the rhythm is a little slow, no? And why is it slow? Well, one of the reasons is that population growth has been slowing down a fair bit in Japan:

In fact, as you probably can tell, it’s not just been slowing down – it’s actually declining!

And it’s not just Japan. Take a look at Italy, South Korea and Singapore:

And ask yourself what the future holds for these countries:

Italy and Japan, in particular, are the poster pensioners for demographic decline and its economic consequences. In both countries the fertility rate (the number of children a typical woman will have over her lifetime) fell below 2.1 in the 1970s. That level is known as the replacement rate, since it keeps a population stable over time. Anything lower will eventually lead to a declining population, something both Italy and Japan have suffered for about a decade. The median Italian is now 47; the median Japanese 49. Earlier this year, Kishida Fumio, Japan’s prime minister, warned that the country is “on the brink of being unable to maintain social functions” because of its baby bust.
But Italy and Japan are no longer the most extreme examples of demographic decline. In 2022 South Korea had a fertility rate of just 0.8. A rate below one means that the next generation will be less than half the size of its parents’. As recently as 2012 the un projected that South Korea’s population would shrink by only a fifth or so by the end of the century, from 52m today to 41m by 2100. More recent forecasts, however, suggest that the population will fall by more than half over the same period, to just 24m

So what?

Well, so the following:

  • Older people in your country will mean rising health expenditures
  • It will also mean lesser people of working age
  • More people drawing out of your pension schemes, and not enough young folks putting money in to them
  • Smaller workforce, which means lesser economic output, but also lesser patents – among other things

Are you tempted to laugh this off and say “Hah! There’s 1.4 billion of us, we don’t need to worry about this”? Consider China:

…the number of Chinese aged between 21 and 30 has already fallen from 232m at its peak in 2012 to 181m in 2021. The decline will accelerate rapidly in the 2040s, leaving China with fewer than 100m people in the same pool in the mid-2050s.

Take a look at the same chart as earlier, but now with only China and India added in:

Ask yourself: how much longer before we find ourselves where China is likely to be ten years from now? Before we start to see a rapid decline in young people of working age? I’d say we have about thirty years to go – around 2050 would be a safe guess. Note that demographics is hard, and forecasting what a country’s demographics are going to look like is even harder – all of which is to say that this is at best an educated guess on my part.

But if you are, say, in your twenties right now, you’re looking at retiring at around that mark, or a little later.

What do you think India is going to look like then? And what are we doing about it?

The Solow Model remains underrated!