Neoclassical growth theory is an economic theory that outlines how a steady economic growth rate results from a combination of three driving forces—labor, capital, and technology. In 1956, Robert Solow and Trevor Swan developed and introduced the model of long-run economic growth. Initially focusing on exogenous population increases, Solow later incorporated technological change into the model in 1957.
- Robert Solow and Trevor Swan first introduced the neoclassical growth theory in 1956.
- The theory states that economic growth results from three factors—labor, capital, and technology.
- While an economy has limited resources in terms of capital and labor, the contribution from technology to growth is boundless.
How the Neoclassical Growth Theory Works
The theory asserts that short-term equilibrium stems from varying amounts of labor and capital in the production function. It also posits that technological change significantly influences an economy, making continuous economic growth impossible without technological advances.
Neoclassical growth theory outlines three essential factors for a growing economy: labor, capital, and technology. However, the theory distinguishes between temporary equilibrium, which depends on the three factors, and long-term equilibrium, which does not.
Special Considerations
The accumulation of capital within an economy and its utilization is vital for economic growth. Furthermore, the relationship between an economy’s capital and labor determines its output. Technology is thought to enhance labor productivity and increase labor’s output capabilities.
Thus, the neoclassical growth theory production function measures an economy’s growth and equilibrium:
Y = AF (K, L)
- Y: Economy’s gross domestic product (GDP)
- K: Share of capital
- L: Amount of unskilled labor
- A: Level of technology
However, due to the relationship between labor and technology, the production function is often rewritten as Y = F (K, AL).
Increasing any one input shows its effect on GDP and, consequently, the economy’s equilibrium. However, without equal growth in labor, capital, and technology, returns from labor and capital diminish, resulting in exponentially decreasing returns while technology remains inexhaustibly contributing to growth.
Example: Maximizing Economic Growth Through Technology
A 2016 study by Dragoslava Sredojević, Slobodan Cvetanović, and Gorica Bošković titled “Technological Changes in Economic Growth Theory: Neoclassical, Endogenous, and Evolutionary-Institutional Approach” examined technology’s role in neoclassical growth theory.
The authors found consensus among various economic perspectives, underscoring technological change as a key generator of economic growth. They highlighted historical pressures from neoclassicists encouraging governments to invest in scientific research and development for innovation.
Endogenous theory advocates, for instance, emphasize technological spillover and research and development as catalysts for innovation and economic growth. Evolutionary and institutional economists consider the economic and social environment in their models for technological innovation and economic growth.
Related Terms: economic growth rate, long-term economic growth, labor productivity, gross domestic product, endogenous growth theory.
References
- National Bureau of Economic Research (NBER). “Trevor Swan and the Neoclassical Growth Model”, Pages ii, 2-3, 10-11, 13.
- National Bureau of Economic Research. “Trevor Swan and the Neoclassical Growth Model”, Page ii.
- National Bureau of Economic Research. “Trevor Swan and the Neoclassical Growth Model”.
- Simon Fraser University. “Chapter 1 Neoclassical Growth Theory”, Pages 2-4.
- ResearchGate. “Technological Changes in Economic Growth Theory: Neoclassical, Endogenous, and Evolutionary-Institutional Approach”.
