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According to the exogenous growth theory economic growth is determined by external factors
rather than internal ones. Exogenous growth theory says that if given a fixed amount of labor and
technology which is static, the economic growth will therefore stop at a economic growth will
stop at a point after some time, as the production level will reach a state of internal equilibrium.
This growth model is based on the belief that external factors affect the growth of the economy,
whether it be shifts in the labor supply or government spending or technological growth. Tax
cuts, shifts in the labor supply will only impact the growth of the economy in the short run.
Whereas a change in the technology will lead to a longer impact on the economic growth of the
economy and in the longer run economy will reach a higher state of equilibrium.
The exogenous growth model was given by Solow through extension of the Harod Todar model.
According to the Solow model, labor and capital had diminishing returns while they had
combined constant returns to scale together. According to the Solow model, with capital and
labor fixed, the economy converges to a steady state of equilibrium after a period of time. In the
short run, policy measure like subsidies and taxation changes will lead to change in the steady
economy. The staedy state level of output is at a point where the production function and the
capital accumation rate converge. The neo-classical model predicts that countries with low per-
capita incomes grow faster than those with high y, so that over time per-capita incomes converge
(Ickes, 1996).The rate of capital accumulation is determined by the savings rate of the economy
and the depreciation rate of capital
Therefore when the savings rate increases and is more than the sum of population growth
rate and the depreciation rate , then the production curve shifts upwards, this means that savings
rate is greater than population growth and depreciation of capital rate, so there is capital
accumulation and a higher steady state with more capital is reached. But in the longer run there is
no effect on the rate of growth of the economy. Similarly change in population growth and
depreciation rate has only effect on the steady state and does not have an effect on the growth
rate of the economy in the longer run. In the exogenous growth model, the impact on the growth
is exogenously determined by the changes in the technological growth of the country. However
this technological growth is unexplained in this model.
One of the conclusions of the exogenous growth model is that an economy will always
converge to its steady state level of growth which is affected only by the exogenously
determined by rate of technological progress. The neoclassical theory says that differences in
productivity of workers largely depend on the country’s initial position relative to the balanced
growth path. Thus, if richer countries are closer to the balanced growth path, and poorer
countries are further away, initially, then the poor should converge towards the level of the rich
and possibly overtake them. Convergence was mainly observed in the case of the growth of the
countries referred to as the East Asian Tigers, namely, Taiwan, Hong Kong, South Korea and
Singapore. These countries grew at a high rate in the 1960s to converge with the more developed
nations. However, there are several limitations to this model. Many countries in Africa have been
trapped in the poverty trap and because of several factors their growth has not converged with
that of more developed nations. According to this theory, technological knowledge is usually
freely traded and therefore poor countries can learn from more developed nations and grew at a
rapid pace and finally reach a steady state level of growth. However, this has not been the case in
practice. The economies have been growing at different rates. Therefore certain economists have
come up with new theories, which explain how government policies and research and
development affect the growth of a nation.
Contrary to the exogenous growth model, in the endogenous growth model, growth is
affected by internal factors. This theory holds that if a country invests in human capital, research
and development and knowledge generation and innovation, this will impact the growth rate in
the longer run, In the exogenous theory, the government policies just had an effect of change in
the steady state level of output for a shorter period, but had no affect on the growth rate of the
economy in the longer run. However, in the endogenous growth theory, government subsidies
and investment in research and development leads to growth because it leads to innovation in
technology. The simplest endogenous growth model is Y = AK, where A is the level of
technological innovation and K is the human capital. Technology and human capital affect each
other in the endogenous model. Therefore in this model a change in the savings rate would lead
In the exogenous growth model if the government introduces a policy of fiscal spending, i.e.,
if the government increases the subsidies, this will have an impact only in the shorter run.
Therefore government policies will have no effect on the long run growth level of the economy.
The exogenous model has therefore been criticized by economists because it renders the political
institutions and the knowledge accumulation useless in the long run growth of the economy. It
also cannot explain why poorer economies for decades have not grown at a higher rate and not
converged with the growth rate of more developed nations.
In the endogenous model, however, if the government policy provides expenditure
for research and development, technological innovation which helps develop more efficient labor
force or better improved capital inputs. This will have an effect on the longer run growth rate of
the economy. Major implications of the endogenous growth models is that economic policies like
trade openness, free competition and the promotion of innovation might have a positive impact
on economic growth. According to this model, the country will reap benefits of the government
policy of investment in research and development, innovation and education of its population
which will develop an effective labor force.
References
Howitt, P. (n.d.). Endogenous growth. Retrieved December 6, 2014, from
http://www.econ.brown.edu/fac/Peter_Howitt/publication/endogenous.pdf
Ickes, B. (1996). Endogenous Growth Models. Retrieved December 6, 2014, from
http://grizzly.la.psu.edu/~bickes/endogrow.pdf
LEC 2: Exogenous (Neoclassical) growth model. (n.d.). Retrieved December 6, 2014, from
http://faculty.ksu.edu.sa/imtithal/Documents/502 ECO/LEC2.pdf
Rossi, L. (2011). Exogenous Growth Models. Retrieved December 6, 2014, from
http://economia.unipv.it/pagp/pagine_personali/lorenza.rossi/
LECTURES_EXO_GROWTH.pdf
