2. • New Growth Theory emphasizes that
economic growth results from the increasing
returns associated with new knowledge.
• The ability to grow the economy by increasing
knowledge rather than labor or capital
creates opportunities for nearly boundless
growth.
• All forms of knowledge, from big science to
better ways to sew a shirt exhibit these
properties and contribute to growth.
3. • WHAT IS NEW GROWTH THEORY?
• New Growth Theory is a view of the economy
that incorporates two important points.
• First, it views technological progress as a
product of economic activity.
• Previous theories treated technology as a
given, or a product of non-market forces.
• New Growth Theory is often called
“endogenous” growth theory, because it
internalizes technology into a model of how
markets function.
4. • Second, New Growth Theory holds that unlike
physical objects, knowledge and technology
are characterized by increasing returns, and
these increasing returns drive the process of
growth.
• The essential point of New Growth Theory is
that knowledge drives growth.
• Romer is credited with stimulating New
Growth Theory, but as Romer himself notes,
(Romer 1994b) there is really nothing new
about the theory itself.
5. • The central notion behind New Growth
Theory is increasing returns associated with
new knowledge or technology.
6. History
• In the 1950s, Robert Solow crafted theory that
addressed this problem, building a model that
kept diminishing returns to capital and labor,
but which added a third factor—technical
knowledge—that continued to prod economic
productivity and growth.
• Solow’s model pictured technology as a
continuous, ever-expanding set of knowledge
that simply became evident over time—not
something that was specifically created by
economic forces.
7. • In Solow model, technology was assumed to
be determined by forces outside the
economy, Solow’s model is often referred to
as an “exogenous” model of growth.
• The model Solow devised—ultimately
recognized in the 1987 Nobel Prize for
economics became a mainstay of the
economic analysis of growth.
• Neoclassical theory has brought us a number
of important ideas that we apply to the world
of economic policy.
8. • Taken as a whole, neoclassical assumptions lead
us to conclude that markets are generally very
competitive, and don’t tend toward monopolies,
that left un-impeded, market processes usually
result in optimum levels of production and
allocation.
• They also imply that we have relatively limited
opportunities for government to promote
economic ends, other than encouraging market
competition, providing adequate schooling and
encouraging savings and investment.
9. • The New Growth Theory challenges the
neoclassical model in many important ways.
The exogenous growth models developed by
Solow and other neoclassical scholars largely
didn’t try to explain what caused technology
to improve over time.
• Implying that technology “just happened” led
to an emphasis on capital accumulation and
labor force improvement as sources of growth.
10. • Economists have for a long time agreed that
technological progress forms a basis for
economic progress.
• In the theories of classical economists like
David Ricardo, Karl Marx and Adam Smith,
technological change plays crucial roles.
• Schumpeter (1934) had presented convincing
arguments that technological change is the
driving force in capitalist development.
• Technological change, as expressed in the
residual, was revealed as the main contributor
to economic growth.
11. • Solow (1994) traces out three stages or waves
in the history of growth theory for the last 50
years.
1. Harrod Domar models of economic growth.
2. development of the traditional neo-classical
growth model in the 1960s.
3. emergence of the endogenous growth
theories in the early 1980s.
• For the purpose, the second and the third
12. • Perhaps the first coherent growth theory which
was stimulated explicitly by the increasing spread
of incomes per person across countries was
Arthur Lewis’ two sector model.
• It portrayed growth as a transfer of labor from a
traditional sector, mainly but not exclusively
agricultural, to a modern sector grouping
relatively new processes such as plants and
factories.
• Lewis claimed there was excess labor in the
traditional sector because it operated in a pre
capitalist mode of family enterprises and farms
which used more labor than necessar
13. • Neoclassical Model--Solow (1956, 1957)
• The Three Central Assumptions
– Constant Returns To Scale
– Perfect Competition
– Exogenous Technological Change
• Role Of Investment Summarized By Two Equations:
Production Function and Capital Accumulation
• Production Function: Relationship Between Output,
Technology and Capital and Labour Inputs
• Capital Stock Equation Relates Investment to Capital
Accumulation
14. Neoclassical Model
• Growth Determined By Accumulation Of
Capital And Labour Along With Technical
Change.
• Technical Change Is Calculated Residually
– Is Assumed To Grow Regardless Of The Pace Of
Accumulation In The Factors Of Production
• Accumulation Of Capital Will Directly
Contribute To Economic Growth Based On Its
Share Of Income
15. • Solow’s growth model triggered the second wave
of interest in growth theory.
• Solow abandoned the assumption of fixed
coefficients in production and introduced
possibilities of substitution in the macro
production function.
• This demonstrated that full capacity utilization of
both labor and capital was not a knife-edge
phenomenon that would occur only by chance, as
predicted by earlier models.
• Thus, Solow’s model and its subsequent
extensions changed the approach in growth
theory from analyses of conditions for full
employment to determinants of growth when full
capacity utilisation was assumed.
16. • The dominant paradigm for three decades was
Robert Solow’s neoclassical theory, a general one
that could apply to any economy, rich or poor.
• The basic assumption was that all economies
had access to the same global technology in the
form of a single production function which
transformed labor and capital into GDP or total
income.
• This does not mean they all had the same “mix”;
some, with more capital per worker, would tend
to use more capital-intensive techniques.
17. Early attempts at endogenising
growth
• Attempts had been made at endogenising
technological change at an early stage.
• Nelson (1987) discriminates between appreciative and
formal theorizing.
• Appreciation theorizing denotes ‘the way economists
write and talk about phenomena where the emphasis
is on understanding these, rather than advancing a
specifically theoretical point.
• Formal theorising is more self-consciously analytical,
more concerned with how a logical structure works.
18. • Schmookler (1966) is particularly important
Within the appreciative tradition.
• Schmookler presents analysis of the role of
technological change for economic growth in
which the production of knowledge, the
diffusion of knowledge and the feedback
from growth to knowledge creation are
discussed.
• As such, Schmookler preceded endogenous
growth theory with his emphasis on the two-
way causation of technology to growth and
back to technology.
19. • Haavelmo introduced educational level in growth models.
In one version, of his model, Haavelmo assumed a society’s
educational level accumulate proportionally with time, to
capture ‘the length of experience of the society
considered’.
• In another version, the educational level was assumed to
depend on investments in physical capital. Haavelmo
demonstrated that his model could give rise to balanced
growth paths, stationary levels, exploding developments
and a rich set of other trajectories in economic
development.
• Haavelmo’s analysis was frequently cited in the literature in
the 1960s, but more seldom later on. One possible reason
may be that there was no explicit micro-foundation in
Haavelmo’s models.
• Thus, his analysis was apart from the hard core in the neo-
classical research programme arising with the emergence
of Solow’s growth model.
20. • Both Kaldor and Mirrles (1962) and Arrow
(1962) developed the ideas proposed by
Haavelmo in which know-how, and therefore
productivity, depended on society’s economic
activities.
• In Kaldor and Mirrles’s growth model
productivity growth is assumed to depend
positively, but decreasingly on the level of
investments.
21. Neo-classical endogenous growth
models
• The third wave of interest in economic growth
was the introduction of the endogenous
growth models in the 1980s.
• These models explicitly analyse production of
knowledge, knowledge’s effect on economic
growth and growth’s repercussion back to
production of knowledge.
22. • The first publications in this tradition were Romer (1986) and
Lucas (1988).
• These first models were simple as regards endogenising
productivity growth.
• They assumed firm’s production being dependent both on
knowledge acquired by the firms themselves but also by
the aggregate knowledge in the economy.
• The effect of this assumption was twofold.
1. Firstly, their assumption introduced external effects into
the economy. Firms investing for the sake of their own
productivity do not take into account the effect of these
investments on the aggregate knowledge. Importantly,
these models imply too little investments in human capital
in decentralised markets.
2. Secondly, the models were capable of analysing long-run
growth. Solow’s growth model predicted stagnating growth
in the absence of productivity increase.
23. new growth theory
• Although many economists worked on theoretical models of growth after
Solow, it wasn’t until Paul Romer published his model in 1986 that there
was a resurgence of interest in growth.
• In contrast to the Solow model, where technological progress is
exogenous, new growth theory attempts to explain the sources of
technological progress. Three important candidates for the source of
such progress are:
• Ideas (Profit-Seeking Research)
• International Openness
• Human Capital Formation
24. ideas and growth
• Research (both formal and informal) leads to the
development of new goods and better goods.
• ‘As for the Arts of Delight and Ornament, they are best
promoted by the greatest number of emulators. And it
is more likely that one ingenious curious man may
rather be found among 4 million than among 400
persons….’ William Petty, 1682.
• Does this mean that the larger the world population,
the faster the rate of growth (a growth effect of scale)?
• Or that the larger the world population, the greater the
world income (a levels effect of scale)?
