What Is Endogenous Growth?

Endogenous growth theory has redefined the concept of economic growth. It assumes that the long-run rate of growth is primarily determined by endogenous variables that are internal to the system, such as human capital, innovation and investment capital; rather than exogenous factors where technological and scientific process are independent of economic forces. Accordingly, population growth and innovation have more impact on growth than physical capital.

Understanding Endogenous Growth

Endogenous growth theory emerged in the 1980s, as a conceptual framework that could challenge neo-classical growth theory. It aimed to explain how differences in wealth between developed and underdeveloped countries could persist, if investment in physical capital like infrastructure is subject to diminishing returns. Such differences should disappear over time, if productivity growth is determined exogenously by factors outside its control, as neo-classical models assume.

Endogenous models assume that the key determinants of economic growth are population growth and the accumulation of human capital and knowledge. In a knowledge-based economy, supported by robust intellectual property rights, there are no diminishing returns to capital accumulation thanks to positive spillover effects from investment in technology and people. Productivity growth is determined by differences in spending on R&D and education in endogenous models. And this feeds back into faster technological progress. In other words, superior economic growth can be cultivated.

The reasons some countries grow faster than others remain mysterious. But the concept of endogenous technological change is relevant to population growth and technological adoption in places like Africa, and can help us understand the economic impacts of aging populations in Europe, Japan and China. Economies have to ceaselessly transform themselves and develop, if they are to enjoy continued prosperity and become more productive.

Key Takeaways

  • The endogenous growth theory is an economic theory which argues that economic growth is generated from within a system as a direct result of internal processes.
  • More specifically, the theory notes that the enhancement of a nation's human capital will lead to economic growth by means of the development of new forms of technology and efficient and effective means of production.
  • Under this theory, knowledge-based industries play a particularly important role — especially telecommunications, software and other high tech industries — as they are becoming ever more influential in developed and emerging economies.

Endogenous Growth Theory

The central tenets of endogenous growth theory include:

  • Government policies ability to raise a country’s growth rate if they lead to more intense competition in markets and help to stimulate product and process innovation.
  • There are increasing returns to scale from capital investment especially in infrastructure and investment in education and health and telecommunications.
  • Private sector investment in research & development is a key source of technological progress
  • The protection of property rights and patents is essential to providing incentives for businesses and entrepreneurs to engage in research and development
  • Investment in human capital is a vital component of growth
  • Government policy should encourage entrepreneurship as a means of creating new businesses and ultimately as an important source of new jobs, investment and further innovation

Critics argue endogenous growth models are nearly impossible to validate by empirical evidence.