What is the 'Endogenous Growth Theory'

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.

BREAKING DOWN 'Endogenous Growth Theory'

This view contrasts with neoclassical economics, which contends that technological progress and other external factors are the main sources of economic growth.

Endogenous growth economists believe that improvements in productivity can be tied directly to faster innovation and more investments in human capital. As such, they advocate for government and private sector institutions to nurture innovation initiatives while offering incentives for individuals and businesses to be more creative. 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.

Central tenents to 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.

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