Page 126 - Global Political Economy_Understanding The International Economic Order

NEW ECONO MIC TH EORIE S
incorporates technological progress and advances in knowledge as en-
dogenous factors within the growth model. Technological advance is
considered endogenous because technological innovations are the re-
sult ofconscious investment decisions taken by entrepreneurs and in-
dividual firms. Firms are assumed to invest in research and develop-
ment activities for the same reasons that they invest in other factors
ofproduction; that is, on the basis ofthe expected profitability ofthe
investment. In effect, the new growth theory assumes that knowledge,
technology, and/or “know-how” constitute a separate factor of pro-
duction in addition to capital and labor.
The concept ofknowledge or technology as a separate factor of
production has important implications for understanding economic
growth. Knowledge ofhow to do or make things can raise the pro-
ductivity ofthe other two factors. Whereas knowledge and technol-
ogy just happen in the neoclassical model, the new theory assumes
that they result from conscious decisions and that technological ad-
vance is largely market-driven. Investment in capital and knowledge
can stimulate and reinforce one another in a “virtuous circle” of cu-
mulative causation so that acceleration in the rate ofcapital invest-
ment can raise the long-term growth in per capita income. In addi-
tion, whereas neoclassical growth theory is based on the assumption
ofconstant returns to scale, the new theory is based on the existence
of“economies ofscale.” Thus, whereas neoclassical theory predicts
that the rate oflong-term growth will decline because ofdiminishing
returns, the new theory postulates that the possibility ofincreasing
returns means that the growth rate need not decline.
The new growth theory is important because it permits or even
encourages the use ofgovernment policies to increase the long-term
rate ofeconomic growth. Whereas neoclassical theory assumes that
diminishing returns eventually place an upper limit on the returns to
capital accumulation and hence on the long-term rate ofeconomic
growth, the new growth theory assumes that increasing returns to
scale and positive investment economies can lead to an increased
growth rate, especially in high-tech sectors. Whereas the neoclassical
theory regards the savings rate as having only a modest effect on
the long-term growth rate and technology as exogenous, endogenous
growth theory suggests that government policies, through promotion
ofan increased national savings and investment rate and also in-
creased support for R & D, can lead to a sustained higher rate of
economic growth.
Romer makes several important points regarding the new growth
theory:
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