According to traditional/old growth theory output growth results from one or more
of three factors:
(i) Increase in the quality and quantity of labor,
(ii) increase in
capital through saving and (iii) investment and improvement in technology.
But as far
as the poor closed economies are concerned they are furnished with very low
rates of savings. Accordingly, their growth rates remain very low. On the other
hand the economies where the saving rates were higher their per capita incomes
rose very sharply. In the presence of open economies the capital out flowed from
the rich economies to the poor economies where capital labor ratios were lower
and thus the returns on investment were higher. Therefore, the measures to
impede the inflow of foreign investment on the part of governments of UDCs
retorted their growth.
Thus, the cornerstone of neo-classical free market theory is attached with
the liberalization of domestic markets which will attract domestic and foreign
investment. In this way, the capital accumulation in the 3rd World Countries
will increase.. In terms of GNP growth, this will be equivalent to raising
domestic saving rates which will enhance capital labor ratios and per capita
incomes in capital poor developing countries.
The traditional neo-classical growth theory stressed upon foreign inflow of
capital to meet the saving gap in UDCs. But practically, such all led to 'debt
crises' in Latin American and African countries etc. during 1980's and 1990's.
In such situation the disparities between the rich and the poor countries
widened, rather decreasing. The World Bank and IMF imposed free market reforms
on highly indebted countries. Such all should have promoted the higher
investment, higher productivity and improved standard of living for the masses
of the 3rd world countries. But after such prescribed liberalization of trade
markets, many UDCs experienced little or no growth and failed to attract new
foreign investment or to halt the flight of domestic capital (the case of
Pakistan which failed to bring any drastic change in its economic life even
following 'Stand by Arrangements' and
'Structural Adjustments programs' imposed by IMF and World Bank). With this
back ground the economists have presented a new approach to the economics of
growth and development which is known as 'Endogenous Growth' or
'New Growth Theory'. Now we discuss its features.
The New Growth Theory or the Endogenous Growth Theory provides
a theoretical framework to analyze the endogenous growth, i.e., the increase in
GNP of a country. Here the growth of GNP depends upon the system of production
function where the variables of the system are endogenous rather than exogenous.
Contrary to traditional neo-classical growth theory the supporters of the New
Growth Theory are of the view that the increase in the GNP of a country is the
natural result of long run equilibrium. The endogenous growth theory analyses
what determines the growth rate in a country and why the growth rates differ
among the countries. In other words, in this theory, it is analyzed that what
are the determinants of the rate of growth of GDP (shown by λ) which Solow
calls Residual Factor in his model.
Old and New Growth Theories:
Despite certain resemblances with neo-classical theory, the new growth theory
is different from the neo-classical theory on the basis of its assumptions and
implications. The differences in these two theories occur due to three factors:
(i) The new growth theory rejects the neo-classical assumption that the marginal
returns decrease along with increase in investment.
(ii) This theory stresses upon
increasing returns to scale.
(iii) The externalities also play their role in the
determination of returns from investment.
As the supporters of this theory are
of the opinion that there arise so many externalities due to public and private
investment in human capital. They increase productivity. Hence, the natural
tendency of falling or diminishing returns can be checked. Thus, when there
applies increasing returns to scale, the incomes of the countries will move away
from equilibrium levels of the income. The role of technology in
the endogenous growth theory, but it does not play necessary role in the
determination of equilibrium level of national income.
H-D model, the new growth theory is also expressed with this simple
Y = AK
Where A is some factor which influences technology, while K
represents the physical and human capital. This equation does not show the
decreasing returns from the capital. Thus there exists the possibility that
because of investment in physical and human capital the External Economies and
Productivity increases could occur which offset the decreasing returns. As a
result, an economy experiences a sustainable growth in long run which is not
accepted by traditional growth theory.
The new growth theory, in order to attain rapid economic growth not only
stresses upon the capital formation in human capital and savings, but it also
describes following implications for growth which are contrary to the
(i) In closed economies there does
not exist any force which could take the economy to equilibrium level.
(ii) National growth rates remain
constant and differ across countries depending upon national saving rates and
(iii) There is no tendency for per
capita income levels in capital poor countries to catch up with those in rich
countries with similar saving rates. As a result of these facts a temporary or a
prolonged recession in one country leads to a permanent increase in the income
gap between itself and the richest countries.
The different models of 'New Growth'
theory also give this view that the international capital flows increase the wealth disparities between the First
World and Third World. This theory thinks that the expected higher rates of
return on investment in UDCs which have low K/L may be offset by the lower
levels of 'Complementary Investments' in human capital (education and training),
infra-structure and research and development. Again, it has also been found out
that the poor countries benefit less from the capital expenditures made on human
capital formation etc. As the individuals receive no personal gain from the
positive externalities created by their own investments, the free market leads
to the accumulation of less than the optimal level of complementary capital.
Where complementary investments produce social as well as private benefits,
govts. may improve the efficiency of resource allocation by providing public
goods or encouraging private investment. Therefore, the new growth theory on the
contrary to counter revolution theory, suggests for an active role for public
policy in promoting economic development. Thus, the new growth theory, despite
similarities with neo-classical theory, is a departure, from dogma of 'free
markets' and 'passive role of governments'.
According to New Growth Theory (NGT), the
results in private and public investment. The complementarily investment can do
so by providing infrastructure and promoting private investment in
knowledge-based industries. As a result, not only the human capital formation
will increase, but increasing returns will also emerge.
Thus, quite against Solow model, the models of NGT accord the technical
progress as an endogenous result of public and private investment in human
capital and the existence of knowledge-based industries. Hence, the NGT models
emphasize upon enhancing investment in human capital directly and indirectly for
the sake of economic growth. Again, these models encourage the foreign direct
investment in the fields of computer software while establishing knowledge or