Endogenous growth theory

1.1 AK model

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.

Main article: AK model

The AK 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

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

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]

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

If f (k)
= A is sunstituted in the equation of trank
sitional Dynamics of Solow-Swan model (exogenous
growth model), and f(k) is the output function per worker,
how an economys per capita incomes converges toward
its own steady-state value, to the per capita incomes of
The AK model, which is the simplest endogenous model, other nations, can be seen.
gives a constant-saving-rate of endogenous growth and The transitional dynamics equation, in which the growth
assumes a constant, exogenous, saving rate. It models rate on k is given by
technological progress with a single parameter (usually
A). It uses the assumption that the production function
does not exhibit diminishing returns to scale to lead to en- K = k/k
= s.f (k)/k (n + ) ,
dogenous growth. Various rationales for this assumption
have been given, such as positive spillovers from capital on substituting A , this is gotten:
investment to the economy as a whole or improvements
in technology leading to further improvements (learning
by doing). However, the endogenous growth theory is K = sA (n + ) ,
further supported with models in which agents optimally
determined the consumption and saving, optimizing the The case of zero technological progress, x = 0 , is reresources allocation to research and development leading turned to because per capita growth can now occur in the
to technological progress. Romer (1987, 1990) and sig- long-run even without exogenous technological change.
nicant contributions by Aghion and Howitt (1992) and The gure 1.1 explains the perpetual growth, with exogeGrossman and Helpman (1991), incorporated imperfect nous technical progress. The vertical distance between
markets and R&D to the growth model.[6]
the two line, sA and n+ gives the K
1

As, sA > n+, so that K > 0 . Since the two line are
parallel, K is constant; in particular, it is independent
of K . In other words, K always grows at steady states

rate, K
= sA (n + ) , .
Since

y = AK , K equals K

at every point of time. In addition, since

c = (1 s)y
the growth rate of

.
c equals K

CRITICISMS

rms will be more productive than small ones, because

at the rm 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 nal output and an R&D sector. The R&D sector develops ideas
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
that these prots are dissipated on R&D spending.

3 Implications

Hence, the entire per capita variable in the model grows

An endogenous growth theory implication is that policies
at same rate, given by
that embrace openness, competition, change and innovation will promote growth.[7] Conversely, policies that
have the eect of restricting or slowing change by pro = sA (n + ) ,
tecting or favouring particular existing industries or rms
However, y = AK technology displays a positive long- are likely, over time, to slow growth to the disadvantage
run per capita growth without any exogenous technolog- of the community. Peter Howitt has written:
ical development. The per capita growth depends on behavioural factors of the model as the saving rate and population. It is unlike neoclassical model, which is higher
saving, s, promotes higher long-run per capita growth
.[6]

Endogenous versus exogenous

growth theory

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

growth is exogenously determined by either the savings
rate (the HarrodDomar model) or the rate of technical progress (Solow model). However, the savings
rate and rate of technological progress remain unexplained. 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
maximize prots. Crucial importance is usually given to
the production of new technologies and human capital.
The engine for growth can be as simple as a constant return to scale production function (the AK model) or more
complicated set ups with spillover eects (spillovers are
positive externalities, benets that are attributed to costs
from other rms), increasing numbers of goods, increasing qualities, etc.
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

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 o 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. (Conclusion,
Growth and development: a Schumpeterian
perspective, 2006 ).

4 Criticisms
One of the main failings of endogenous growth theories
is the collective failure to explain conditional convergence
reported in empirical literature.[8]
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 exogenous growth theory in explaining the income divergence between the
developing and developed worlds (despite usually being
more complex).[9]

3
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 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 (PDF). 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
(PDF). econ2.jhu.edu. Retrieved 11 October 2011. the
steady-state 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 (PDF). 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.

7 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.

8 External links
Economic Growth by Paul Romer.
New Growth Theory, Technology and Learning: A
Practitioners Guide, U.S. Economic Development
Administration.

9 TEXT AND IMAGE SOURCES, CONTRIBUTORS, AND LICENSES

Text and image sources, contributors, and licenses

9.1

Text

Endogenous growth theory Source: https://en.wikipedia.org/wiki/Endogenous_growth_theory?oldid=697590847 Contributors: JeLuF,

Edward, Michael Hardy, Mydogategodshat, Thincat, Discospinster, Bender235, Sicherlich, Tobacman, Maurreen, MPerel, TheParanoidOne, John Quiggin, Maestral, Uncle G, Bluemoose, Audiovideo, Terryn3, Rjwilmsi, Stubedoo, Wragge, Volunteer Marek, Farmanesh, Closedmouth, SmackBot, Lawrencekhoo, Chris the speller, Brimba, Byelf2007, Joseph Solis in Australia, Stevennnnnnnnnn, JHP,
Mellery, Lachambre, Surturz, CronopioFlotante, Med1972, CommonsDelinker, MickO'Bants, Ontarioboy, KylieTastic, DMCer, Lights,
Dindon~enwiki, MaCRoEco, Munci, SieBot, Flyer22 Reborn, Dans, Anchor Link Bot, Danielmee, Drmies, DragonBot, Addbot, CanadianLinuxUser, CarsracBot, Hsansom, Lightbot, RigasLijie, Bebestbe, AnomieBOT, ChristopheS, Genghis Cunn, RibotBOT, Wyrd*, ,
Oracleofottawa, EmausBot, Dewritech, ZroBot, Funraiser, Helpful Pixie Bot, NUMB3RN7NE, Metricopolus, Dryhsba, Devanshi tripathi,
Shikhabhanu, BattyBot, Mi23nen, OccultZone, TaqPol and Anonymous: 67

9.2

Images

File:Edit-clear.svg Source: https://upload.wikimedia.org/wikipedia/en/f/f2/Edit-clear.svg License: Public domain Contributors: The

Tango! Desktop Project. Original artist:
The people from the Tango! project. And according to the meta-data in the le, specically: Andreas Nilsson, and Jakub Steiner (although
minimally).

9.3

Content license

Creative Commons Attribution-Share Alike 3.0