Exogenous Growth Model of Economic Development

Exogenous Growth Model (Neo-Classical Model)

The Exogenous growth model was an extension to the Harrod-Domar model which included the new term, "productivity growth". The most important contributor to this model, Robert Solow; in 1956 developed a relatively simple growth model which fit available data on US economic growth with some success. Solow received the 1987 Nobel Prize in Economics for his work on this model.

Solow extended the Harrod-Domar model by:

* Adding labour as a production factor;
* Requiring diminishing returns to labour and capital separately, and constant returns to scale for both factors combined;
* Introducing a time-varying technology variable distinct from capital and labor.
The capital-output and capital-labor ratios are not fixed as they are in the Harrod-Domar model. These refinements allowed increasing capital intensity to be distinguished from technological progress.

In neo-classical growth model, the long-run rate of growth is Exogenously determined, i.e. it is determined outside of the model. A common prediction of these model is that an economy is always converged towards a steady state rate of growth, which depends only on the rate of technological progress and the rate ofl growth of labor force.
A country with a higher saving rate will experience faster growth, e.g. Singapore had a 40% saving rate in the period 1960 to 1996 and annual GDP growth of 5-6%, compared with Kenya in the same time period which had a 15% saving rate and annual GDP growth of just 1%. This relationship was anticipated in the earlier models, and is retained in the Solow model; however, in the very long-run capital accumulation appears to be less significant than technological innovation in the Solow model.

The key assumption of the this model is that capital is subjected to diminishing returns. Given a fixed stock of labor, the impact on output of the last unit of capital accumulated will always be less than the one before. Assuming for simplicity no technological progress or labor force growth, diminishing returns implies that at some point the amount of new capital produced is only just enough to make up for the amount of existing capital lost due to depreciation. At this point, because of the assumptions of no technological progress or labor force growth, the economy ceases to grow.

Assuming non-zero rates of labour growth complicates matters somewhat, but the basic logic still applies- in the short-run the rate of growth slows as diminishing returns take effect and the economy converges to a constant "steady-state" rate of growth.

Including non-zero technological progress is very similar to the assumption of non-zero workforce growth, in terms of "effective labour": a new steady state is reached with constant output per worker-hour required for a unit of output. However, in this case, per-capita output is growing at the rate of technological progress in the "steady-state".

Limitations of the model include its failure to take account of entrepreneurship (which may be catalyst behind economic growth) and strength of institutions (which facilitate economic growth). In addition, it does not explain how or why technological progress occurs. This failing has led to the development of endogenous growth theory, which endogenizes technological progress and/or knowledge accumulation.

From the far left, Marxist critics of growth theory itself have questioned the model's underlying assertion that economic growth is necessarily a good thing. While the model is welfare maximizing, the use of a representative agent hides equity issues.
combat population growth and depreciation. Therefore output per worker falls from y2 to y0.