New growth theories

Ms Salma Shaheen

• 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.

• 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.

• 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.

• The central notion behind New Growth Theory is increasing returns associated with new knowledge or technology.

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—technicalknowledge—that continued to prod economicproductivity 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.

• 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.

• 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.

• 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.

• 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.

• 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

• 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 thetraditional sector because it operated in a precapitalist mode of family enterprises and farmswhich used more labor than necessar

• 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

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

• 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.

• 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.

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.

• 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.

• 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.

• 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.

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.

• 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.

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

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)?