theories of economic growth

Growth has been a major concern on economic theorists for centuries.

Adam Smith Inquiry into the Nature and Causes of the Wealth of Nations (1776):

Advocated division of labour, specialisation (absolute advantage) & accumulation of capital
Advocated Laissez Faire - minimum government interference
Emphasised importance of a stable legal framework, within the market could function

David Ricardo:

Formalised notion of diminishing returns, but did not take innovation into account
Showed some of the welfare gains from specialisation and international trade based on comparative advantage

Robert Solow: Neo-classical growth model

Growth depends on capital accumulation - increasing the stock of capital goods to expand productive capacity
Net investment and the need for sufficient saving to finance investment
Higher savings - postponing consumption to finance increased allocation of resources towards investment

Capital widening: capital stock rising at rate which keeps pace with labour force growth.

Capital deepening: capital stock grows faster than labour force. Considered more important.

Quality of capital goods - improvements due to R&D & innovation

Solow - a combination of capital deepening & technological improvement explains major trends in economic growth

1. Prediction - Adding more capital goods to a fixed amount of labour will lead to diminishing returns to capital.

2. Increased capital accumulation drives the rate of return on capital down

3. Eventually, the rate of return may be so low that no further net capital accumulation takes place.

4. In which case the rate of technological progress determined the rate of growth of output

Technological progress is assumed to be exogenous i.e. lies outside the growth model

Schumpter

Schumpeterian innovation - an explanation of technological progress

Schumpeter
Long waves of innovation - "gales of creative destruction"
Increased profits arise because of constant birth of new products and new markets.
Technology raises productivity by increasing quantity and quality of all those resources to which it is applied.

NEW ECONOMIC GROWTH THEORY

Associated with economists such as Paul Romer and Paul Ormerod

Seeking to make technological progress endogenous.

A firm will not innovate unless it thinks it can steal a march on its competition & earn higher profits.
Inconsistent with Neo-Classical assumption of perfect competition - no "abnormal profits".
Attention shifted to conditions under which a firm will innovate most productively:

Endogenous growth theory says that government policy to increase capital or foster right kinds of investment in physical capital can permanently raise economic growth.

If capital broadened to include human capital, law of diminishing returns may not apply - increasing returns to investment from education & efficiency - innovation not necessary.
Extent of capacity usage - government encouragement of open markets

ECONOMIC RESOURCES AND LONG RUN GROWTH

LABOUR FORCE

Increase in population can stimulate growth by expanding domestic market.
Rise in participation rates among population of working age
Quality of the labour force - human capital - conducive to high productivity & real output

ENTREPRENEURSHIP

Entrepreneurial ability - organises and combines other resources to make a profit.
The quantity of entrepreneurs - forces which encourage entrepreneurial talent include:
A well-developed capital market, infrastructure & favourable social & political climate
Quality of entrepreneurs improved by increasing education & government assistance to business.

CAPITAL STOCK

Importance of gross and net investment
Quality of investment as important at quantity
Positive externality effects from higher investment (increasing returns to scale?)

GOVERNMENT POLICIES AND ECONOMIC GROWTH

Open markets - internal and external competition in markets for goods and services
Promotion of liberal capital market providing a flow of liquidity to finance investment
Protection of private property rights
Scale of government spending - possible crowding out of the private sector if government spending is too
Efficiency of the tax and benefit system - may create disincentives which constrains the active labour supply
Incentives for entrepreneurial activity
Investment in human capital - active labour market policies
Macro-economic stability and credibility of macro economic policy

Young, 1994, Asian tiger's success resulted from:

Rapid accumulation of capital (through high investment)
Labour (through population growth and increased labour-force participation)
Government policies of encouraging education, opening economy to foreign technologies, promoting trade, keeping taxes low & encouraging savings (30% of GDP in 'tiger' economies)
Small state - government spending around 20% of GDP compared to over 50% in Europe

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