Solow's 1956 Contribution in the Context of the Harrod-Domar Model

Abstract

Shortly after World War II growth theory came to occupy a central position in modern economics. Two of the most important early contributions were made by Harrod and Domar. Both aimed to extend Keynes's analysis in the General Theory into the long run by considering under what conditions a growing economy could realize full capacity utilization and full employment. Solow's neoclassical model came into existence as a reaction to the approaches by Harrod and Domar and some problems associated with it, as in particular the enormous instability. Solow saw the main reason for this “knife-edge” problem in the absence of any adjustment mechanism and based his alternative model on substitution between capital and labor in production and flexibility of factor prices. This article focuses on Solow's motivation and the main content of his approach in reaction to Harrod and Domar's impulse. Furthermore, focus is on the reactions by Harrod and Domar et al. as well as on the distinction between two different instability problems, namely, the divergence between the warranted and the natural rates of growth that marked Solow's starting point, and the divergence between the warranted and the actual rates of growth creating a business-cycle problem.