Business Economics

Economic Growth Theories

Written by Clayton Reeves for Gaebler Ventures

Take a look at the major economic growth theories and how they measure up to real-life situations.

In a previous article, we discussed economic growth and their drivers.

Economic Growth Theories

Now, we will take a look at growth theories and how they have evolved. There are basically three economic growth theories that currently have believers.

First, the classical growth theory links population growth to the productivity of labor. Neoclassical growth advocates believe that real GDP growth is primarily a function of technology breakthroughs.

Finally, the new growth theory states that while technology is the main driver of productivity increases, there are barriers that prevent the standard of living in countries from equalizing.

Classical Growth Theory

This is the oldest theory of the three. It basically states that the economy has a subsistence level that it will revert to whenever productivity increases. If there is a technological breakthrough that brings the productivity of workers up across the nation, then the population will simply expand until the productivity reverts to the previous level.

The conclusions you can draw from this theory are relatively straight forward. The long run equilibriums or real GDP per capita and growth rate of real GDP per capita are both zero. This means that any deviations from the real levels of these two measures are temporary.

Neoclassical Growth Theory

This is a more modern approach to growth theory. Two forces come into play in this theory. Concerning the population, as incomes rise the opportunity cost of birthing children increases. This is because of the time associated with raising children, maternity leave, and other factors.

Also, as incomes rise, the standard of living and life expectancy follows suit. These two conflicting forces offset one another, and therefore, it is hypothesized that economic growth has no effect on population growth.

Therefore, there must be another factor that can make a difference in the growth of productivity. Technology is the factor that this theory chooses as the driving force behind productivity growth. This makes sense, since technological advances can be credited with huge increases in productivity.

Just think of what happened when light bulbs, steam engines and automobiles were invented. These all provided huge returns and increases in productivity. The computer, however, has not had the expected impact on productivity - yet. Sometimes it takes awhile for a change in technology to change the way people work.

There is one final aspect of the neoclassical growth theory involving standard of living. It postulates that as countries gain access to the same technologies, their standard of living will converge.

New Growth Theory

As you recall from the neoclassical growth theory, the theory predicts that standards of living will converge as countries gain access to the same technologies. However, this does not hold true in practice. Countries maintain their impoverished status despite apparently having access to the same technologies that wealthy countries do. The new growth theory attempts to explain this discrepancy.

The new growth theory explains this by including motivation factors in the economic model. Basically, the theory suggests that the more motivation there is for people to pursue innovative ideas, the more creativity will be fostered. This is directly related to the rate of technological advancement. Although breakthroughs appear to be random, they are actually related to how much capital is allocated to providing incentive to innovate.

When he's not playing racquetball or studying for a class, Clayton Reeves enjoys writing articles about entrepreneurship. He is currently an MBA student at the University of Missouri with a concentration in Economics and Finance.

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