Endogenous
Endogenous
Endogenous
MODELS
Structure
9.0 Objectives
9.1 Introduction
9.2 The Neoclassical Growth Model with Human Capital
9.3 Endogenous Technology, Increasing Returns and Monopolistic Competition
9.4 Some Issues in Endogenous Growth Theory
9.5 Let Us Sum Up
9.6 Keywords
9.7 Soriie Useful Books
9.8 Answers /Hints to Check Your Progress Exercises
9.0 OBJECTIVES
After going tlirougli the unit, you sliould be able to:
disti~iguishbetween exogenous growth models and e~ldogenousgrowtli models;
o describe the impact of human capital on economic growtli;
discuss the nature of ideas as a spur to liunza~icapital formation arid as an engine
of growth;
'analyse how teclinology can be nod el led as nn endogenoi~svariable; and
discuss what impact increasing returns and ~no~iopolistic
competition have on the
growtli process.
9.1 INTRODUCTION
Endogenous growth encompasses a wide body of theoretical and empirical work on
growtli theory tliat emerged in the 1980s. 'Tlie work differs from the standard neo-
classical model in empliasisi~igthat economic growth is caused by forces e~idogenous
to the eco~ionzicsystem ratlier than being influenced by factors outside the system.
These tnodels do not rely on exogenous technical change to explain the rise in per
capita income, nor do these rnodels set great store by the growtli accounting methods
i and the measurement of the growth accounting 'residual'. Endogenous growth theory
began with the works of Paul Romer in 1986 ar~dRobert Lucas in 1988.
f
Models of endogenous growtli had their origins in two sources: one was to give a
coherent explanation of the convergence controversy, and the other, to go beyond a
simple world of perfect competition and co~istantreturns to scale i n growtli theory.
You are studying in your microecono~nicscourse about inlperfections in the market,
but the assumption in macroeconomics and growth tlieory seems to be that there is
perfect co~npetitioneverywhere in the economy. Althoi~glieconomists had given up
this simplifying assunzption in mauy areas of economic theory, it took a long time in
growth tlieory to construct models tliat bring in imperfect competition. Another
standard assumption that was challenged was,that (eventual) di~ninisliingreturns to
ilidividual factors of production would set in, and that the aggregate production
function would exhibit co~istantreturns to scale.
Economic Growth The neo-classical Solow model exhibited diminishing returns to capital and labour
Models- Ill
separately and constant returns to scale. Thus the idea was, like in traditional
economic theory, diminishing returns to factors would eventually set in. The new
endogenous growth theories extend the Solow model in this respect: they explore the
idea that it is possible to stave off diminishing returns, and there can be increasing
returns, because of specialisation and investment in knowledge capital. The basic
neoclassical model suggests that countries with a higher return to capital (relatively
lower stock of capital) would catch up with richer countries. Failure to show
empirical convergence led to plans to drop neoclassical assumptions of (1) exogenous
technological change (2) equal technological opportunities across different countries
Endogenous growth theory does not require abandoning the neoclassical framework,
only extending it. Also, we should not look at growth theory only to investigate the
issue of convergence. A different perspective on models of growth is needed. The
basic idea in endogenous growth theory is that growtl~is caused by factors like
technology, and technology is not something given exogenously but is determined
within the system.
Let us denote by lower-case letters variables divided by the stock of unskilled labour
1,. We can rewrite tlie production .filnction in terms of output pcr worker:
I-lere h = e@". The model assumes that q is constant and given exogenously. Since 1
too is a constant, this model ilnplies tliat along n balanced growth path, y and k will
grow at the constant rate g, the rate of technical progress. Let LIS dividc tlie per-
worker production function by dividing by Ah. We obtain
k --
- " .substituting this into the prod~~ctioo in tenns of the equation
fb~~ction
-
Y
1z+g+6
involving y , we can find the steady-state value of tlie output technology ratio y :
a-
1-a
Here t is introduced to stress that: some variables are growing over time.
This gives us some explanation into why some countries are rich and some are poor.
Those countries that have a high investment rates in physical capital (That is, those
that save more), have high levels of technology, and spend a high propol-tion of time
accumulating skills are comparatively richer.
'Knowledge capital' or 'ideas' is slightly different from human capital, and facilitates
i n the accumulation of the latter. In the new growth theories endogenise
technological progress and human capital formation. New knowledge is produced by
investment in the research sector. Once knowledge is treated as a public good, there
are spillover effects that accrue to other firms. This is what we will discuss in the
next section. ,
Cheek Yorlr Progress 1
1) In what way arc the models Lhat incorporate human capital different From the
I
standard neoclassical model?
2) Using the human-capital augmented model, can you provide an explanation why
in spite of diminishing returns to physical capital, similar savings and similar
levels of technology, there may not be convergence in the growth rates of
countries?
K = sY - 6 K , where the dot on top indicates time derivative, s is the rate of saving
and 6 denotes depreciation. Here whatever the initial quantity of capital, it will
continue to grow since investment in this model is greater than depreciation since sY
and 6K are both linear upward sloping lines, since saving is a constant function of Y,
and Y is linear in K.We can show it as follows:
K=sY-SK
Dividing both sides by K, we have
K
Using this in the equation - = sA - 6 we obtain
K
Thus we see that growth rate of the output is an increasing function of the rate of
investment.
The general progression in that area has been to attribute a smaller fraction of
observed growth to the residual and a higher fraction to the accumulation of inputs.
The way that literature started out was a statement that technology is extremely
important because it explains the bulk of growth. Endogenous growth theory admits
that technology does not explain, by itself, the majority of growth. Initially, these
theorists overstated its importance. But some people say there is no need to
understand technology, because it is such a small part of the contribution to growth.
They argue that we can just ignore it. It does not follow logically. We know from the
Solow model, and this observation has been borne out empirically, that even if
investment in capital contributes directly to growth, it is technology that causes the
investment in the capital and indirectly causes all the growth. Without technological
change, growth would stop. If we look at AF {K, L) we find that there are increasing
returns {to factor) in all the relevant inputs A, K and L We need to think of
technology as a key input and one that is fundamentally different From traditional
inputs. Technology makes increasing returns possible.
Let us look a little closely now at the notion of technology and how it is produced.
.The neoclassical growth model considers technology as exogenous and leaves it
unmodeled, although technology is a key ingredient of that theory. Thc neoclassical
model also does not explain differences in technology across economies. What is
technology? In development economics the term technology denotes the way inputs
to the production process are transfomed into output. If we take a normal production
function Y = f ( K , L ) , the functionf(.) represents technology because it explains
how the inputs K and L are transformed into output. In the Cobb-Douglas production
function .
PROGRESS EXERCISES
Check Your Progress 1
1 ) See section 9.2
2) See section 9.2
Check Your Progress 2
1 ) See section 9.3
2) See section 9.3
Claeck Your Progress 3
1 ) See section 9.4
2) See section 9.4