The Different Theories of Economic Growth

There are many theories of economic growth. They include the Solow-Swan model, the Endogenous growth theory, and Adam Smith’s theory. These theories differ widely in their assumptions and their methods for predicting economic growth. Let’s explore the basic ideas of these theories. We will also look at the effects of the constant return to scale production function, positive externalities, and Adam Smith’s theory. Eventually, we’ll have an understanding of which one best suits the world of business.

Endogenous growth theory

The endogenous growth theory argues that economic growth is driven primarily by endogenous forces. In other words, economic growth is primarily the result of investments in human capital, innovation, and knowledge. Economic growth is also a function of government policies, such as tax cuts and deregulation. However, many of the factors that cause economic growth may not necessarily be accounted for by the government, and other factors may be more influential.

The theory relies on the concept that productivity growth is driven by human activity, such as the creation of new ideas. This means that many firms and individuals have market power and can earn profits from new discoveries. Since technological advances are costly, imperfect competition can occur, which is one of the main requirements of the endogenous growth theory. Endogenous growth theories primarily apply to countries in the Western world, which have strong institutions and incentives for innovation.

The theory of endogenous growth challenges the neoclassical theory of economic development, which contends that technological development is the main source of economic growth. Endogenous growth economists believe that increased productivity is directly related to faster innovation and greater investment in human capital. They recommend fostering innovation initiatives and providing incentives for creativity. This can make the economic environment more conducive to growth and development. Therefore, this theory is important for policymakers.

Solow-Swan model

The Solow-Swan growth model is an exogenous model that tries to explain long-term economic growth by examining the relationship between population and labor growth and increases in productivity. This growth is fueled by technological progress. In other words, technological progress is an important factor in driving the world economy. Solow-Swan growth theory is a popular model for explaining the growth of developed nations. However, this theory has its limitations and is not applicable to developing nations.

Moreover, it assumes a constant labor-capital ratio in developing countries. As a result, income inequality between poor and rich countries has not converged since the 1950s. Moreover, it assumes that the ratio of rich to poor countries is not decreasing. Thus, the Solow-Swan model can explain why international investments have failed to flow into developing countries. But, it fails to explain why output and marginal products of capital in developing nations have declined in recent decades.

Another limitation of the Solow-Swan growth model is that it assumes diminishing returns in closed economies. However, the theory does have its supporters. The Solow residual accounts for the effect of capital accumulation. It also takes into account the permanent improvement of factors of production (such as capital, labor, and population growth) and the efficiency of management practices. Solow-Swan growth theory is a popular choice for researchers examining the effects of growth.

Adam Smith’s theory

In his 18th century book, “The Wealth of Nations”, Adam Smith explained how a nation’s economic growth is a function of a nation’s capital, or productive labour. Growth occurs as a result of increases in the number of people, the division of labour, and productivity. Growth also occurs when a nation’s population increases. In his theory, growth and inequality are related. The wealth of nations depends on the proportion of these three factors.

Adam Smith’s theory of growth based on the increasing returns from manufacturing, the division of labour, and the accumulation of real capital. He left the door open for the potential for bank credit, though it’s fairly conservative compared to many economists’ views. However, Henry Dunning Macleod has argued otherwise, and his criticisms are sound. A’responsible man’ can increase his wealth and reduce his taxes.

Industrial Capitalism helped many countries rise from extreme poverty and war to the point where a nation could no longer afford its citizens. The first two books of Adam Smith’s Theory of Growth emphasized the role of profits as means for investments. However, the final years of Industrial Capitalism were bleak for many Western societies. During this period, the wealth of nations was controlled by a small group of individuals and social mobility was virtually nonexistent.