“New“ Growth Theory and Knowledge Externalities in Capital Accumulation

This chapter probes into the pioneering approach of the so-called “new” growth theory, i.e. Romer’s (Journal of Political Economy, 94, 1002–1037, 1986) knowledge externalities in private capital accumulation. After listing the empirical and theoretical shortcomings of the “old” growth theory, the main approaches of the new growth theory are briefly outlined. In Sect. 5.3, knowledge externalities associated with private capital accumulation are introduced into our basic OLG model and the fundamental equation of motion is then derived from the FOCs for utility and profit maximization, and under market clearing. In the subsequent section the deficiencies of the old growth theory are reconsidered from the perspective of the knowledge externalities of new growth theory. In Sect. 5.5, public debt is introduced in our new growth model and the effects of variation in the politically fixed net deficit ratio on capital and public debt are investigated. Finally, it is shown that stochastic shocks to total factor productivity in the CD production function, together with investment adjustment costs, can in fact generate GDP time-series which resemble empirical evidence.