In the traditional neo-classical growth model, developed by Robert Solow and Trevor Swan in the 1950s, the output of an economy grows in response to larger inputs of capital and labor (all physical inputs). To the neo-classical growth models, non-economic variables, such as human health, skills, knowledge, etc., have no function in the growth process of an economy. This line of thought was described as the Exogenous growth theory and it does not explain why countries with little capital and labor grow more than countries with abundance of these resources.
A new theory described as the endogenous growth theory emerged in the 1980s, particularly due to the works of Paul Romer and his associates in response to the postulations of the exogenous theorists. They argued that economic growth and development in most fast developing economies, particularly, those of the East Asian developing countries, where the economies have continued to grow for well over three decades, demonstrated quite the contrary. The argument is that, it is not only technology, which is the main driving force accountable for maintaining such high growth performance in the economies, but that there were other factors which are outside the realm of the neoclassical growth model.
Romer (1986) in his work titled “Increasing Returns and Long Run Growth”, broadened the concept of capital to include human capital. He argues that the law of diminishing returns to scale phenomenon may not be true as is the case for the East Asian economies. The theory holds that if a firm or an economy which invests in capital (physical) also employs educated and skilled workers who are also healthy, then not only will the labor be productive, but it will also be able to use capital and technology more effectively. This will lead to a “neutral’ shift in the production function and, therefore, there can be increasing rather than decreasing returns to investments. This means that technology and human capital are both endogenous to the system. Other scholars of this school of thought are Lucas (1988), Aharonovitz (2007), Marchand, M., Michel, P., Paddison, O., and Pestieau, P. (2003) and Eicher, T. and Penalosa, C.G. (1999). The basic assumption of the endogenous growth theory is that policy measures can have an impact on the long-run growth rate of an economy. It argues that investment (subsides) on education or research and development increase the growth rate by increasing the incentive to innovate. For instance, Lucas (1988) identified two sources of economic growth to include human capital accumulation due to education investments and technological progress due to learning-by-doing externalities. In other words, education and learning-by-doing improve the knowledge and skills of labor in the production sector. The endogenous theorists also assume that research and development (R&D) is the key to the growth and development of an economy or a firm. Research and development generate new ideas or new technologies that are not common in the society. Whenever there is technological change in a given productive process, those with education or greater skills are faster in adopting the new technology (Eicher&Penalosa, 1999). In addition, the theorists assert that training of the human resources of the society is central to growth and development. Aharonovitz (2007) noted that as managers (or employees) are trained, they will become heads of production units and train more managers who will, in turn, head other production units or set up new firms and further train more managers. This process will be a continuous one that will lead to growth and development. This will produce development in the long run because as new firms spring up, they create employment, which will reduce poverty and improve standard of living in the society.
A new theory described as the endogenous growth theory emerged in the 1980s, particularly due to the works of Paul Romer and his associates in response to the postulations of the exogenous theorists. They argued that economic growth and development in most fast developing economies, particularly, those of the East Asian developing countries, where the economies have continued to grow for well over three decades, demonstrated quite the contrary. The argument is that, it is not only technology, which is the main driving force accountable for maintaining such high growth performance in the economies, but that there were other factors which are outside the realm of the neoclassical growth model.
Romer (1986) in his work titled “Increasing Returns and Long Run Growth”, broadened the concept of capital to include human capital. He argues that the law of diminishing returns to scale phenomenon may not be true as is the case for the East Asian economies. The theory holds that if a firm or an economy which invests in capital (physical) also employs educated and skilled workers who are also healthy, then not only will the labor be productive, but it will also be able to use capital and technology more effectively. This will lead to a “neutral’ shift in the production function and, therefore, there can be increasing rather than decreasing returns to investments. This means that technology and human capital are both endogenous to the system. Other scholars of this school of thought are Lucas (1988), Aharonovitz (2007), Marchand, M., Michel, P., Paddison, O., and Pestieau, P. (2003) and Eicher, T. and Penalosa, C.G. (1999). The basic assumption of the endogenous growth theory is that policy measures can have an impact on the long-run growth rate of an economy. It argues that investment (subsides) on education or research and development increase the growth rate by increasing the incentive to innovate. For instance, Lucas (1988) identified two sources of economic growth to include human capital accumulation due to education investments and technological progress due to learning-by-doing externalities. In other words, education and learning-by-doing improve the knowledge and skills of labor in the production sector. The endogenous theorists also assume that research and development (R&D) is the key to the growth and development of an economy or a firm. Research and development generate new ideas or new technologies that are not common in the society. Whenever there is technological change in a given productive process, those with education or greater skills are faster in adopting the new technology (Eicher&Penalosa, 1999). In addition, the theorists assert that training of the human resources of the society is central to growth and development. Aharonovitz (2007) noted that as managers (or employees) are trained, they will become heads of production units and train more managers who will, in turn, head other production units or set up new firms and further train more managers. This process will be a continuous one that will lead to growth and development. This will produce development in the long run because as new firms spring up, they create employment, which will reduce poverty and improve standard of living in the society.
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