Miguel Moneo

310 ECN

Advanced Economic Issues

The neoclassical growth model of Solow is a macroeconomic model that emerged in 1956 and tries to
explain economic growth and the variables involved in it. The three variables are Labour, capital and
technology and we will obtain economic growth by using them. Equilibrium may be achieved by
varying the amounts of each of these three variables. The model used is quantitative and there we
have: Fixed apital (K), labour (L) and finally technology (A). This model assumes that technology
remains constant even when it could be higher using the same labour and capital. We assume that
increasing K is the way to increase GDP, so we will have more equipment next year that will be used
to produce more goods. In this model, the steady accumulation of capital is the cause of economic
growth. In the long term, there will be a substantial increase in production since the equipment and
facilities will provoke increasingly large productions over time.
One of the qualitative predictions of this model is to achieve a steady state. It is achieved by capital
accumulation and thus maintaining the same labour as the savings rate. In this steady state, growth is
zero and depreciation fixed capital depreciation is compensated by investments.
In exogenous models, decreasing returns to scale in physical capital do not generate sustained yield.
In the particular case of growth being generated in the long term, it is generated by an exogenous
factor (technology). It means technical change is the source of constant growth and the speed is
constant and exogenous Finally, consumer preferences are not taken into account to obtain the
growth rate.
When we speak of endogenous growth theory, growth is obtained due to endogenous factors and not
by external forces (neoclassical model) Growth can be powered by three very important factors such
as human capital, innovation and knowledge. We will consider the positive externalities and spill over
effects that are the basis for economic development. One the one hand, Subsidies to research or
education are policies that have positive long-term effects on the growth rate, since they get to increase
it. On the other hand, while in the neoclassical model the rate of technical progress is determined from
factors which are outside the economic sphere( little empirical evidence), in the endogenous growth
model, we have that technical progress is the result of investments made by operators to make a profit.
This theory helps us to explain why the economy of industrialized countries has greater quantities per
capita than a century ago. It is also a useful theory for developing countries because it offers an
alternative without dependence on exogenous factors.
The main differences between the endogenous growth theory and the theory of neoclassical growth
are:
In neoclassical models, the long-term growth is independent of the economic policy pursued and its
effects on output per capita are only temporary, they believed that the state cannot play any particular
role in the process of economic growth, while for endogenous growth theory, state intervention can
stimulate growth to encourage the players to invest more in technical progress.
In the neoclassical model, according to the hypothesis of diminishing marginal productivity of capital,
growth is paralyzed in the absence of technological progress and population growth. By contrast, in
the endogenous growth theory it is considered that capital productivity does not decrease when the
capital stock increases and thus increasing returns to scale remain rather constant yield basis.
The neoclassical model considered that there was a trend towards convergence between countries,
while endogenous growth theory emphasizes the heterogeneity of growth rates between them.
Factors in the neoclassical model only affected the income level, now also affect the level of growth.

The endogenous growth models appear in the 80s as a variation to the neoclassical model, by a group
of growth theorists like Kenneth Arrow (1962) and Paul Romer (1986). They disagreed with the
existing model in those years ,arguing that growth is the result of endogenous factors rather than
external were like in the neoclassical model. They decided to skip the technological change to give
more importance to investment in human capital.
On the one hand the simplest model used is the AK model, and has the distinction of eliminating
diminishing returns. It also has a constant level of technology and a savings rate. Moreover, the theory
is supported by models where agents optimally determine consumption and saving.
The model uses AK AK = Y as a function of production, being A the level of technology, capital K and
Y = AK's output per capita. When A> 0 average and marginal product are both constant.

In the equation of Solow-Swan model, if we substitute this expression:

, we see

how the income is reaching steady state.

Given the following equation:

the following equation

if we replace A, it leads to
which implies that technological progress is zero (X

= 0), because we want to show that in the long term growth per capita is possible, even when there are no
exogenous technological change. If we have
growth rate equals to

, equal to

and considering c = (1-s) and its

we can say that every variable per capita will grow at the same rate:

If we confront the two models, endogenous model aims to go beyond the microeconomic foundations,
building a macroeconomic model. Earlier in the neoclassical model, growth rate is determined I a
exogenous way or by other methods such as the Solow model (technical progress) or the Harrod-Domar
model (saving). There are differences in the behavior of firms and households: firstly households maximize
a function subject to a budget constraint. Then, firms maximize a function of benefits. The AK model,
although quite simple, can be the driving force for growth, so we will be able to add spillover effects, and a
greater number of goods among other instruments in order to make the production function more complete.
By using endogenous models we must assume that competition is perfect as endogenous theory assumes
constant marginal productivity of capital aggregate and marginal product is decreasing at an enterprise
level. As a result large companies will be more competitive than small ones. There is also the option for
certain models, that the assumption of perfect competition can relax, resulting in some degree of
monopolistic power.
With the endogenous theory, growth is encouraged by policies that create greater economic openness,
competition, change and innovation. In that sense, the policies that have the effect of restricting or lenition
of shift resulting from protection or favoring existing industries or companies, will cause growth to slow to
the detriment of society. Peter Howitt wrote about in his work "Growth and development: a Schumpeterian
perspective". 2006 wrote:

Sustained economic growth is a process of continuous transformation. The type of economic progress
experienced by richer nations since the Industrial Revolution would not have been possible if people had

not been subject to change. Economies which stop processing, are condemned to deviate from the path of
economic growth. Countries that deserve the name of "developing" are not the poorest in the world, but the
richest. They need to be in the endless process of economic development if they want to continue enjoying
prosperity
One of the major flaws of the endogenous theory is its inability to explain the conditional
convergence( empirically observed). Another frequent criticism engages with the assumption of
diminishing returns. Some authors argued that the "new growth theory" has not proved much more
successful than the exogenous theory to explain the divergence in income between developing countries
and developed countries.

References

-Agnor, P.R (2004). "Growth and Technological Progress: The SolowSwan Model". The

Economics of Adjustment and Growth. Cambridge: Harvard University Press. 439462

-Romer,P.M. (1990) Endogenous Technological change, University of Chicago
https://cumoodle.coventry.ac.uk/mod/resource/view.php?id=501817
-Ickes, B.W. (1996) Endogenous growth models, Penn state University, Department of
Economics
http://grizzly.la.psu.edu/~bickes/endogrow.pdf
-Jones,L.E. (2004), Neoclassical Models of Endogenous Growth: The Effects of Fiscal
Policy, Innovation and Fluctuations, University of Minnesota and Federal Reserve Bank of
Minneapolis, 1-26
http://down.cenet.org.cn/upfile/34/200529204957158.pdf
-Mccallun,B.T,(1996), Neoclassical vs. Endogenous Growth Analysis: An Overview
http://richmondfed.org/publications/research/economic_quarterly/1996/fall/pdf/mccallum.pdf
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https://atmire.com/dspace-labs3/bitstream/handle/123456789/6801/file14428.pdf?
sequence=1
-Boucekkine,R. Germain,M. and Licandro,O. (1996), Replacement echoes in the vintage
capital growth model Universidad Carlos III de Madrid, departamento de Economa 1-9
http://e-archivo.uc3m.es/bitstream/handle/10016/4096/we963820.pdf?sequence=1

Jones,C.I.(1995), Time series of Endogenous Growth Models 495-525

http://www.jstor.org/discover/10.2307/2118448?
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