Theories Of Economic Growth

The Theories of Economic Growth refer to the theories propagated by renowned economists that define possible ways to boost development in an economy based on the resources available and the dynamic observed between multiple economic variables. The primary purpose of these theories is to enable countries to withstand economic crises and facilitate overall progress.

The theory of economic growth and development dates back to the 18th century. After Adam Smith’s book "Wealth of Nations" was published, several main theories of economic growth became prominent. Further, many classical and neoclassical economists contributed to these theories. However, each of these economic theories had some limitations. These limitations revolved around facets like labor, wages, employment, population growth, inflation, capital, etc.

• Theories of economic growth are theories proposed by renowned economists that help build and boost a nation's economic status.
• The major economists who contributed to these theories are Adam Smith, John Keynes, Robert Solow, Trevor Swan, and Harrod-Damor.
• Economic growth theories include classical, neoclassical (Solow-Swan Model), and endogenous (modern theory) concepts. Among the many theories of economic growth, these are the most popular.
• Certain limitations are seen in every theory that the succeeding model seems to resolve.

Theories of economic growth in economics are a collection of theories that indicate how a country uses its resources and manages its economic variables for empowerment. These theories have evolved through the years. Renowned economists like Adam Smith, David Ricardo, John Keynes, and many others have contributed to them. While they propagated different theories, every theory aimed to accelerate a nation's economic development.

The theories of economic growth and development had a major influence after the 18th-century wars. The American Revolution and the French Revolution paved the way for the development of such theories. Similarly, industrial capitalism in Britain stressed that economists develop theories on economic growth. There were many factors that led to its development. Some of them include unemployment, poverty, and inequality. But poverty was the prime reason.

Most wars resulted in poverty and unemployment. Therefore, to eradicate these economic evils, economists felt the need to develop theories that addressed these issues. However, economist Adam Smith pioneered economic growth theories. In the book "Wealth of Nations," Smith explained how the concept of Division of Labor can contribute to a nation's growth.

Several classical, neoclassical, and modern economists have supported the theories of economic growth. Each economist focused on specific issues to form theories based on relevant assumptions. Of these, theories covering profitability are crucial. Profits can eliminate monetary issues usually encountered in the economic growth process. However, the approach differs based on the theory of economic development under consideration. Modern and classical theories of economic growth aim to increase the total income of the country. To understand this better, it must be noted that economic growth also covers social and cultural changes occurring in a country.

Let us look at the types of theories of economic growth to explore the concept further.

#1 - Classical Theories Of Economic Growth

The classical theory was presented by Adam Smith in 1776. Also, David Ricardo, Robert Malthus, and others contributed in later years. According to them, deliberate efforts to increase Gross Domestic Product (GDP) can lead to overutilization or exploitation of resources, leading to slow economic growth. It means economic growth can be achieved only when markets operate freely based on changing circumstances.

Smith stated a country's growth is possible when certain factors receive attention. These included labor productivity, increased returns of sale, and the role of trade and market forces. For example, if a nation focuses on the market, it will help determine the aggregate demand and supply. Smith also defined how labor specialization can lead to massive growth.

However, there were certain limitations to this model. This theory did not consider important factors such as technology, economies of scale, and improper wage determination in an economy.

#2 - Neoclassical Theory (Solow-Swan or Exogenous Model)

As the name suggests, this theory was primarily popularized by neoclassical economists. However, the most popular model was presented by Solow-Swan (Robert Solow and Trevor Swan) Growth Model. The theory suggests that increased production inputs like labor or capital can cause diminishing returns eventually, i.e., growth can be seen only up to a certain level.

It notes the relation between factors like capital, labor, and output and explains how steady growth can be realized through their interactions. To increase the growth rate, boosting the GDP and investing in technological progress is vital. Although this theory solved a few limitations of the classical model, it failed to prove effective in the long run.

Others who contributed to this theory include French economists Leon Walras and Sir Henry Roy Forbes Harrod and Evsey Domar, who gave the Walrasian Model and Harrod-Domar Model.

#3 - Endogenous Theory

Also known as new or modern theories of economic growth, endogenous growth theory laid emphasis on human resources (or labor). These models use endogenous instead of exogenous variables. It was developed by Paul Romer and Robert Lucas. Endogenous theories highlight human contributions and state how knowledge leads to growth. It states external factors, such as government policies, can also affect economic growth. These theories also throw light on how technological innovation in the private sector affects growth. However, there might be no way to invest in technology in a free market model.

#4 - Others

There are a few other theories that support economic growth. Mercantilism Theory states how the accumulation of gold deposits through increased exports and fewer import orders can cause a rise in an economy's status. In the Keynesian Economics Theory, proposed by English economist John Maynard Keynes (or John Keynes) suggested how demand can cause the nation's per capita income to grow. He propagated the Effective Demand Theory, which stated that the quantum of spending and the level of investment in an economy determine the effective demand. When effective demand is high, employment and profitability levels are high.

Let us study a few examples of modern theories of economic growth.

Example #1

A war disrupted the operations and peace of Countries A and B, leading to huge unemployment rates and poverty. The graph or slope of growth has gone negative on the Y-axis. So, they employed neoclassical and endogenous theories for course correction. As a result, the government implemented policies to combat the ongoing recession.

Various incentives were provided to businesses for tax relief. Plus, it promoted research and development for industrial growth. In contrast, the authorities made products available to customers at cheaper rates. As a result, the demand for essential items rose. By the end of eighteen months, the country was back on track.

Example #2

The Carnegie Endowment for International Peace recently published an independent analysis of the effects of economic growth on various countries against the backdrop of climate change. It explores the connection between economic growth goals and climate change and what such changes mean for developing nations.

Let us look at the merits and demerits of the theories of economic growth in the modern world.

This has been a guide to What are Theories Of Economic Growth. We explain their types, examples, along with merits & demerits. You may also find some useful articles here -

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