Endogenous growth theory

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Endogenous growth theory holds that

The AK model production function is a special case of a Cobb–Douglas production function:

${\displaystyle Y=AK^{a}L^{1-a}\,}$

This equation shows a Cobb–Douglas function where Y represents the total production in an economy. A represents total factor productivity, K is capital, L is labor, and the parameter ${\displaystyle a}$ measures the output elasticity of capital. For the special case in which ${\displaystyle a=1}$, the production function becomes linear in capital thereby giving

To avoid the contradictions, Russian economist Vladimir Pokrovskii proposed to write the production function in the united form

${\displaystyle Y={\begin{cases}\xi K,&\xi >0\\Y_{0}{\frac {L}{L_{0}}}\left({\frac {L_{0}}{L}}{\frac {P}{P_{0}}}\right)^{\alpha },&0<\alpha <1\end{cases}}}$

where ${\displaystyle P}$ is a capital service; ${\displaystyle Y_{0}}$, ${\displaystyle L_{0}}$ and ${\displaystyle P_{0}}$ correspond to output, labour and substitutive work in the base year. This form of the theory explains growth as a consequence of the dynamics of the production factors, without any arbitrary parameters, which makes it possible to reproduce historical rates of economic growth with considerable precision.^[5][8][9]

Versus exogenous growth theory

In neo-classical growth models, the long-run rate of growth is

Often endogenous growth theory assumes constant marginal product of capital at the aggregate level, or at least that the limit of the marginal product of capital does not tend towards zero. This does not imply that larger firms will be more productive than small ones, because at the firm level the marginal product of capital is still diminishing. Therefore, it is possible to construct endogenous growth models with perfect competition. However, in many endogenous growth models the assumption of perfect competition is relaxed, and some degree of monopoly power is thought to exist. Generally monopoly power in these models comes from the holding of patents. These are models with two sectors, producers of final output and an R&D sector: the R&D sector develops ideas which grant them monopoly power. R&D firms are assumed to be able to make monopoly profits selling ideas to production firms, but the free entry condition means that these profits are dissipated on R&D spending.^{[citation needed]}

Implications

An endogenous growth theory implication is that policies that embrace openness, competition, change and innovation will promote growth.^{[citation needed]} Conversely, policies that have the effect of restricting or slowing change by protecting or favouring particular existing industries or firms are likely, over time, to slow growth to the disadvantage of the community. Peter Howitt has written:

Sustained economic growth is everywhere and always a process of continual transformation. The sort of economic progress that has been enjoyed by the richest nations since the Industrial Revolution would not have been possible if people had not undergone wrenching changes. Economies that cease to transform themselves are destined to fall off the path of economic growth. The countries that most deserve the title of "developing" are not the poorest countries of the world, but the richest. [They] need to engage in the never-ending process of economic development if they are to enjoy continued prosperity.^[10]

Criticisms

One of the main failings of endogenous growth theories is the collective failure to explain conditional convergence reported in empirical literature.^[11]

Another frequent critique concerns the cornerstone assumption of diminishing returns to capital. Stephen Parente contends that new growth theory has proved to be no more successful than

Paul Krugman criticized endogenous growth theory as nearly impossible to check by empirical evidence; "too much of it involved making assumptions about how unmeasurable things affected other unmeasurable things."^[13]

See also

• Economic growth
• Human capital
• Feldman–Mahalanobis model
• Solow–Swan model, "the" exogenous growth model
• Ramsey–Cass–Koopmans model, a microfounded growth model with infinite horizon

Notes