Page 125 - Global Political Economy_Understanding The International Economic Order

CHA PTER F IVE
can explain only a small portion ofwhat it purports to explain. For
example, the theory cannot explain the persistently large gap in
20
wealth between rich and poor countries. Despite these serious limi-
tations, and lacking any satisfactory alternative, the neoclassical the-
ory is considered by most economists to be generally correct because
it does what it is meant to do. 21
Another criticism is that the original theory neglected human capi-
tal and knowledge skills. Work by Edward Denison and others dem-
onstrated the crucial role ofeducation in economic growth and hence
22
the importance ofinvestment in human capital. Other studies have
indicated that, due to positive investment externalities, investment in
physical and human capital may contribute more to economic growth
than the original neoclassical theory suggested; although investment
improves the productivity ofthe investing firm, technological and
other spillovers can also benefit other national firms and even the
entire economy. For example, such positive externalities may explain
why, since World War II, the return on capital investment in the in-
dustrialized countries has been much greater than neoclassical theory
had predicted. Research in industrial organization, which emphasizes
the importance ofincreasing returns to scale and the crucial role of
research and development (R & D), has raised doubts about the basic
assumptions ofneoclassical growth theory. These ideas and others
have been incorporated by Romer and Lucas into the new (endoge-
nous) theory ofeconomic growth.

The New Endogenous Growth Theory. Technological innovation and
advances in knowledge are at the core of the differences between the
neoclassical model and the new endogenous growth theory. 23
Whereas the neoclassical model builds on only two factors of produc-
tion, (labor and capital), treats technology or knowledge as an exoge-
nous factor, and assumes that progress in technology is produced by
random scientific and technological breakthroughs, the new theory

20
Maurice Obstfeld and Kenneth Rogoff, Foundations of International Macroeco-
nomics (Cambridge: MIT Press, 1996), 473.
21
Mankiw, Romer, and Weil, “A Contribution to the Empirics ofEconomic
Growth.”
22
Cited in Sachs and Larrain, Macroeconomics in the Global Economy, 558.
23
Many, ifnot most, ofthe central ideas in the new growth theory had been set forth
earlier by other economists, including Joseph Schumpeter, Kenneth Arrow, Christopher
Freeman, Richard Nelson, and Sidney Winter. A valuable history and critique ofthe
theory is in Richard Nelson, “How New Is New Growth Theory?” Challenge 40, no.
5 (September/October 1997): 29–58. Nelson himselfattributes much ofthe new think-
ing about economic growth to Moses Abramovitz.
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