Here is the question and options:
Baroque’s comment regarding foreign direct investment (FDI) is most consistent with which economic growth model?
A. Classical
B. Neoclassical
C. Endogenous
The answer is (C). I understand the explanation, which is “The possibility for permanent higher growth in per capita output exists within endogenous growth theories, but not in neoclassical growth theory or classical growth theory.”
But doesn’t the sentence “More rapid capital accumulation by itself cannot result in a permanently higher rate of per capita growth” contradict the Endogenous model which says that increase in savings results in a permanently higher growth rate?
The statement “More rapid capital accumulation by itself cannot result in a permanently higher rate of per capita growth” does not contradict the endogenous growth model. Here’s why:
Capital Accumulation vs. Innovation:
Endogenous growth theory emphasizes that long-term economic growth is driven by factors like innovation, technological progress, and increases in total factor productivity (TFP), not just capital accumulation. While an increase in savings (and thus capital accumulation) can temporarily boost growth, it is innovation and advancements in technology that sustain higher growth rates over the long term.
Baroque’s Comment and Endogenous Growth:
Baroque’s assertion aligns with endogenous growth theory because he highlights the importance of innovative products and processes (linked to TFP) for achieving sustained growth. Endogenous models incorporate mechanisms where innovation is endogenously generated (e.g., through R&D, learning by doing, or spillovers from FDI).
FDI and Endogenous Growth:
Foreign direct investment facilitates the transfer of technology, knowledge, and innovative practices, which contribute to TFP. This aspect of FDI driving innovation and not merely increasing capital stock is consistent with endogenous growth theory, differentiating it from neoclassical models that emphasize diminishing returns to capital.
