Endogenous Growth Theory
An economic concept challenging the exogenous growth theory.
What is the Endogenous Growth Theory?
It is an economic concept challenging the exogenous growth theory(economic growth arising due to influences outside the economy) and firmly believing that economic growth is due to factors that are considered internal rather than external.
Internal processes such as technological advancement and innovative production will result in human capital enhancement, thus causing economic growth.
In contrast with Neoclassical Theories, endogenous growth theory believes that internal forces are drivers of economic growth rather than external forces. It facilitates building macroeconomic models to forecast economic growth from microeconomic foundations.
Under this theory, industries such as knowledge-based and technology play a crucial part as they help in the growth of human capital, which is the key driver of economic growth according to the theory.
To understand this theory, one needs to study how it contrasts with old-school growth theories.
The neoclassical theories believed in specialization and advancement of technology for causing trade gains and helping growth rates to increase in the economy.
The ones who believe in the advancement of human capital with the help of technology and population growth ultimately pushed economic growth upwards.
History of Endogenous Growth Theory
By 1980, a group of economists started feeling dissatisfied with theories on how exogenous forces affecting long-term growth are studied and relied upon. Over time they developed different theories and models challenging exogenous/neoclassical growth theories.
So, the Endogenous growth theory is based on internal processes such as the advancement of technology causing the enhancement of human capital in the economy. It is backed by several endogenous models like the AK model etc.
This theory supports the question that if infrastructure investments in countries are based on diminishing returns, then the inequality among countries may be given a push.
Economist Paul Romer, the father of the theory, thinks that in a knowledge-based economy, the spillover effects from investment in technology and people keep generating returns.
He also states that growth from external forces is the byproduct of independent technological advancement. He believed that the government should foster R&D investments, thus supporting the fuel engines for economic growth.
Assumptions in the Endogenous Growth Theory
Some of the assumptions are:
-
Government policies foster economic growth rates if they can create more competitive markets in the domestic economy.
-
The government must enact policies supporting businesses, ultimately providing jobs to labor.
-
Investments in R&D or patents by the private sector fosters technological progress. They should be incentivized by the government to bring innovative production processes.
-
Human capital is considered a vital component of growth. Learning or training programs will be provided to improve the quality of labor.
-
Many individuals and firms have market power and earn profits from their discoveries. This assumption arises from increasing returns to scale in production that leads to imperfect competition.
Examples of Endogenous Growth Models
Endogenous growth theory is backed by certain models described below:
1. Romer model
Derived as the variation of the Arrow Model, it is also known as learning by investment.
Romer believed that technology produced by investments of one firm in R&D spillovers to the whole economy fastly. It then ultimately becomes a determinant of the long-term growth of an economy.
All the firms may be able to ramp up production processes through technology innovation, causing long-term economic growth. Thus it is considered an endogenous factor in growth theory.
Assumptions of Romer model:
a) Technological change/innovation is considered endogenous.
b) Economic growth comes from investments in R&D for technology by both government and the private sector.
2. Lucas model
Somewhat similar to the Romer model, Lucas believed that investments in the education sector convert the unemployed into skilled human capital for the economy. It is a crucial determinant in the long-term growth process.
In this model, technology is provided as a side effect of investments by the government and private sector into R&D for innovation.
Conclusion
The theory states that economic growth is primarily the result of internal forces and not external forces.
In contrast with neoclassical growth theories, it states that the productivity of human capital can be linked with technological innovation and advanced production processes.
Although theory contradicts the neoclassical theory of growth, nothing is saved from criticism in this world so is the Endogenous growth theory. Various stakeholders have criticized the theory in the following statements:
- Impossible to validate with empirical evidence: It means statements of endogenous theory can’t be tested or backed by observations from experiments. Usually, economic scientists use this evidence to approve or disapprove of any hypothesis.
- Over-weightage to human capital: People argue that this theory gives over-weightage to human capital instead of organizations or big institutions and also disregards their role in building the economy and fostering growth rates.
or Want to Sign up with your social account?