Question

4. If, in the context of a standard production function, Y = F(K,N), where K represents physical capital and N represents raw labor, we were to interpret the Solow residual (ΔA/A) as “technological progress,” we would be in error. What, besides technological progress, would this residual catch? How could you expand the model to eliminate this problem?

Answer 1

The Solow residual is a number describing empirical productivity growth in an economy from year to year.

Rapidly expanding countries (catching up after a crisis or trade liberalization) tend to have a rapid turn-over in technologies as they accumulate capital. It has been suggested that this will tend to make it harder to gain experience with the available technologies and that a zero Solow residual in these cases actually indicates rising labour productivity.