Another View on Growth Matters: Investment, Capital, and Solow Residual

The debate on Solow residual (SR), its extent and significance and the critic against the neoclassical growth equation (NGE) by endogenous and new growth theory (ENGT) have not managed to obliterate the contribution of NGE and of SR to the development of growth accounting and TFP measurement, to the convergence and competitiveness debates, the realization of productivity slowdown in industrialised economies and to real business cycle theory. After the proliferate critic of ENGT against NGE, other critics were left unattended, for example that by Domar on the non-incorporation of intermediate goods in growth equations. Moreover, significant amendments in the calculation of capital by OECD had unveiled its underestimation and, subsequently, TFP overestimation. The contribution of each specific type of investment to capital and subsequently to growth has also been underestimated in growth equations. This was made clearer through DeLong and Summers studies and the distinction between equipment and infrastructure investment but it was also claimed much earlier by the concept of accelerator and the various distinctions of investment types used in economics. The proclaimed “death” of NGE has harmed economic growth studies by contributing in the displacement of decreasing returns and perfect competition from their disciplinary throne. While most economists gregariously espoused such a disciplinary path, this article seeks to refresh economic thinking in growth models, by creating a new growth model that comprises labour -apart from capital- and integrates an additional, aggregate growth component that encapsulates ENGT variables and intermediate inputs. Few but significant implications for growth theory and policy are discussed.