Models of Economic Growth
Parts I and II of this book focused on the microeconomic issues surrounding innovation, intellectual property, and economic growth. This chapter explains how macroeconomists have modeled the process of economic growth. Economic growth is defined as a situation where GDP per capita increases over time. The objective of this chapter is twofold. First, it aims to provide a short yet rigorous overview of the growth models used by macroeconomists to think about growth in a closed economy. These will, in turn, become useful in thinking about open economies in chapter 9. Second, the chapter aims to highlight the links between these macroeconomic models and the microeconomic concepts from parts I and II. At the outset, we should make clear that innovation is central to economic growth. Microeconomists define an innovation as something that increases “value” to an enterprise, perhaps by raising sales or lowering costs (see chapter 1). At the economy level, GDP measures the aggregate value created by all enterprises (see section 3.5). Hence, innovation at the firm level will be an important driver of GDP growth.
Section 8.2 describes the neoclassical model of economic growth, which is also called the Solow-Swan model. This model assumes there is a positive relationship between the capital and labor employed in an economy and the value or “output” (GDP) produced by that economy. The growth-generating process in the model is the way savings are invested, which leads to an increase in the capital stock, and thereby economic growth. New technology can also raise output, but the model assumes that the growth rate of technology is determined outside the model. Given this basic framework the model analyzes the implications of different rates of saving, population growth, depreciation, and technology growth. The major implication of this model is that long-run economic growth cannot be supported by capital investment alone. Only when there is a positive rate of growth of technology can increases in