Question

Which features distinguishes new growth theory compared to Solow's growth theory? Define those features in terms of the AK & Lucas model.

Answer 1

The New growth theory is an economic theory that states that human desires and unlimited wants forms the major reason behind the increasing productivity and economic growth and argues that the real GDP would continue to grow with time owing to the increasing profit motive of the people. The Solow model of economic growth is set within the neoclassical economics. It states that the long run economic growth is a result of technological progress which includes capital accumulation, labour growth and increase in productivity. The following are the major differences that distinguishes the new growth theory from the solow model of growth.

· In the Solow model, savings would lead to growth only on a temporary scale and the diminishing returns to capital eventually would force the economy to approach a steady state growth which depends only on the technological progress. But the New growth theory suggests that the increase in the GDP growth is always dependent on the increased needs and profit motives.

· According to the new growth theory, the economic growth is determined by external and uncontrollable factors.

· Knowledge is treated as an asset for growth in the New growth theory whereas it is not mentioned in the Solow model.

· In solow model, the diminishing returns implies that at some point, the amount of new capital produced is just enough to make up for the amount of existing capital lost due to depreciation, whereas knowledge is treated as an asset in the new growth model which does not contribute to the diminishing returns.

· According to the Solow model, the rate of growth diminishes over time due to the diminishing returns whereas it is expected to grow according to new growth model.

                                                  The following are the major relation of these features, especially the diminishing returns based on AK and Lucas model of growth

· The AK model holds a key feature that it doesn’t consider the diminishing returns to capital as in the new model and it uses a linear model where the output is a linear function of capital

· The Lucas model is an extension of the AK model wherein it considers that the physical and human capital are produced by different technologies and it explains the long run economic growth as a consequence of human capital accumulation.

· While the Solow model human capital is constant, the Lucas model measures the total capital as the ratio of physical to human capital and not as a sum

                                        Thus, with the consideration of the four models of economic growth, it can be seen that the New model of growth focus on eliminating the concept of diminishing returns and states that many factors such as knowledge contributes to the technological progress and a steady economic growth is always possible which is backed by the AK and Lucas model of economic growth. The Solow model on the other hand states that there is an effect of diminishing returns and hence the growth would decline in the long run due to the dominance of the diminishing returns and would reach a steady state where the growth would be only determined on the basis of the technological progress.