Endogenous growth theory

Endogenous growth theory holds that economic growth

is primarily the result of endogenous and not external
forces.[1] Endogenous growth theory holds that investment in human capital, innovation, and knowledge are
signicant contributors to economic growth. The theory also focuses on positive externalities and spillover effects of a knowledge-based economy which will lead to
economic development. The endogenous growth theory
primarily holds that the long run growth rate of an economy depends on policy measures. For example, subsidies
for research and development or education increase the
growth rate in some endogenous growth models by increasing the incentive for innovation.

2 The AK Model

Main article: AK model

The model works on the property of absence of diminishing returns to capital. The simplest form of production
function with non-diminishing return is:

Y = AK
where

Models in Endogenous Growth

K
In the mid-1980s, a group of growth theorists became increasingly dissatised with common accounts of
exogenous factors determining long-run growth. They favored a model that replaced the exogenous growth variable (unexplained technical progress) with a model in
which the key determinants of growth were explicit in the
model. The work of Kenneth Arrow (1962), Hirofumi
Uzawa (1965), and Miguel Sidrauski (1967) formed the
basis for this research.[2] Paul Romer (1986), Robert
Lucas (1988),[3] and Sergio Rebelo (1991)[4][5] omitted
technological change instead, growth in these models is
due to indenite investment in human capital which had
spillover eect on economy and reduces the diminishing
return to capital accumulation.[6]

Now, assume output per capita be determined by the constant A > 0

y = Ak
k = capital per worker
y = output/income per worker

If we substitute f (k)
= A in equation of transitional
k
Dynamics of Solow-Swan model (Exogenous growth
model), where f(k) is the output function per worker, it
is seen how an economys per capita incomes converges
toward its own steady-state value and to the per capita
The AK model, which is the simplest endogenous model, incomes of other nations.
gives a constant-saving-rate of endogenous growth. It assumes a constant, exogenous, saving rate. It models tech- Transitional Dynamics equation, where Growth rate on k
nological progress with a single parameter (usually A). It is given by,
uses the assumption that the production function does not
exhibit diminishing returns to scale to lead to endogenous
= s.f (k)/k (n + ) ,
growth. Various rationales for this assumption have been K = k/k
given, such as positive spillovers from capital investment
to the economy as a whole or improvements in technol- on substituting A , we get,
ogy leading to further improvements (i.e. learning-bydoing). However, the endogenous growth theory is further supported with models in which agents optimally de- K = sA (n + ) ,
termined the consumption and saving, optimizing the resources allocation to research and development leading We return here to the case of zero technological progress,
to technological progress. Romer (1987, 1990) and sig- x = 0 , because we want to show that per capita growth
nicant contributions by Aghion and Howitt (1992) and can now occur in the long-run even without exogenous
Grossman and Helpman (1991), incorporated imperfect technological change. The gure 1.1 explains the permarkets and R&D to the growth model.[6]
petual growth, with exogenous technical progress. The
1

CRITICISMS

vertical distance between the two line, sA and n+ gives least that the limit of the marginal product of capital does
the K
not tend towards zero. This does not imply that larger
As, sA > n+, so that K > 0 . Since the two line are rms will be more productive than small ones, because
parallel, K is constant; in particular, it is independent at the rm level the marginal product of capital is still
of K . In other words, K always grows at steady states diminishing. Therefore, it is possible to construct endogenous growth models with perfect competition. How
rate, K
= sA (n + ) , .
ever, in many endogenous growth models the assumption
Since
of perfect competition is relaxed, and some degree of
monopoly power is thought to exist. Generally monopoly

y = AK , K equals K
power in these models comes from the holding of patents.
These are models with two sectors, producers of nal output and an R&D sector. The R&D sector develops ideas
at every point of time. In addition, since
that they are granted a monopoly power. R&D rms are
assumed to be able to make monopoly prots selling ideas
to production rms, but the free entry condition means
c = (1 s)y
that these prots are dissipated on R&D spending.
the growth rate of

c equals K
.

4 Implications

Hence, the entire per capita variable in the model grows An Endogenous growth theory implication is that policies
at same rate, given by
which embrace openness, competition, change and innovation will promote growth.[7] Conversely, policies which
have the eect of restricting or slowing change by protect = sA (n + ) ,
ing or favouring particular existing industries or rms are
likely over time to slow growth to the disadvantage of the
However, we can observe that y = AK technology discommunity. Peter Howitt has written:
plays a positive long-run per capita growth without any
exogenous technological development. The per capita
Sustained economic growth is everywhere
growth depends on behavioural factors of the model as
and
always a process of continual transformathe saving rate and population. It is unlike neoclassical
tion.
The sort of economic progress that has
model, which is higher saving, s, promotes higher long [6]
been
enjoyed
by the richest nations since the
run per capita growth .
Industrial Revolution would not have been possible if people had not undergone wrenching
changes. Economies that cease to transform
3 Endogenous versus exogenous
themselves are destined to fall o the path of
growth theory
economic growth. The countries that most
deserve the title of developing are not the
poorest countries of the world, but the richIn neo-classical growth models, the long-run rate of
est. [They] need to engage in the never-ending
growth is exogenously determined by either the savings
process of economic development if they are
rate (the HarrodDomar model) or the rate of techto enjoy continued prosperity. (Conclusion,
nical progress (Solow model). However, the savings
Growth and development: a Schumpeterian
rate and rate of technological progress remain unexperspective, 2006 ).
plained. Endogenous growth theory tries to overcome this
shortcoming by building macroeconomic models out of
microeconomic foundations. Households are assumed to
maximize utility subject to budget constraints while rms 5 Criticisms
maximize prots. Crucial importance is usually given to
the production of new technologies and human capital. One of the main failings of endogenous growth theories is
The engine for growth can be as simple as a constant re- the collective failure to explain conditional convergence
turn to scale production function (the AK model) or more reported in the empirical literature.[8] Another frequent
complicated set ups with spillover eects (spillovers are critique concerns the cornerstone assumption of diminpositive externalities, benets that are attributed to costs ishing returns to capital. Stephen Parente contends that
from other rms), increasing numbers of goods, increas- new growth theory has proven no more successful than
ing qualities, etc.
exogenous growth theory in explaining the income diverOften endogenous growth theory assumes constant gence between the developing and developed worlds (demarginal product of capital at the aggregate level, or at spite usually being more complex).[9] Paul Krugman crit-

3
icized endogenous growth theory as nearly impossible to
empirically verify; too much of it involved making assumptions about how unmeasurable things aected other
unmeasurable things.[10]

See also
Economic growth
Human capital
FeldmanMahalanobis model
SolowSwan model, the exogenous growth model
RamseyCassKoopmans model, a microfounded
growth model with innite horizon

Notes

[1] Romer, P. M. (1994). The Origins of Endogenous

Growth. The Journal of Economic Perspectives 8 (1): 3
22. doi:10.1257/jep.8.1.3. JSTOR 2138148.
[2] Monetary Growth Theory. newschool.edu. 2011. Retrieved 11 October 2011.
[3] Lucas, R. E. (1988). On the mechanics of Economic Development. Journal of Monetary Economics 22.
[4] Rebelo, Sergio (1991). Long-Run Policy Analysis and
Long-Run Growth. Journal of Political Economy 99 (3):
500. doi:10.1086/261764.
[5] Carroll, C. (2011). The Rebelo AK Growth Model.
econ2.jhu.edu. Retrieved 11 October 2011. the steadystate growth rate in a Rebelo economy is directly proportional to the saving rate.
[6] Barro, R. J.; Sala-i-Martin, Xavier (2004). Economic
Growth (2nd ed.). New York: McGraw-Hill. ISBN 0262-02553-1.
[7] Fadare, Samuel O. Recent Banking Sector Reforms and
Economic Growth in Nigeria. Middle Eastern Finance
and Economics (8 (2010)).
[8] See Sachs, Jerey D.; Warner, Andrew M. (1997). Fundamental Sources of Long-Run Growth. American Economic Review 87 (2): 184188. JSTOR 2950910.
[9] Parente, Stephen (2001). The Failure of Endogenous
Growth. Knowledge, Technology & Policy 13 (4): 49
58. doi:10.1007/BF02693989.
[10] Krugman, Paul (August 18, 2013). The New Growth
Fizzle. New York Times.

8 Further reading
Acemoglu, Daron (2009). Endogenous Technological Change. Introduction to Modern Economic
Growth. Princeton University Press. pp. 411533.
ISBN 978-0-691-13292-1.
Barro, Robert J.; Sala-i-Martin, Xavier (2004).
One-Sector Models of Endogenous Growth. Economic Growth (Second ed.). New York: McGrawHill. pp. 205237. ISBN 0-262-02553-1.
Farmer, Roger E. A. (1999). Endogenous Growth
Theory. Macroeconomics (Second ed.). Cincinnati: South-Western. pp. 357380. ISBN 0-32412058-3.
Romer, David (2011). Endogenous Growth. Advanced Macroeconomics (Fourth ed.). New York:
McGraw-Hill. pp. 101149. ISBN 978-0-07351137-5.

9 External links
Economic Growth by Paul Romer.
New Growth Theory, Technology and Learning: A
Practitioners Guide, U.S. Economic Development
Administration.
Technological Implications of New Growth Theory
for the South, United Nations Development Programme.

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