What is the Exogenous Growth Theory?
The Exogenous Growth Theory is a theory of neoclassical economics that asserts that outside – exogenous – factors are more critical in determining the success of an economy, industry, or individual business than inside – endogenous – factors.
The main implication of the exogenous growth theory is that the determining factors for growth are largely outside of one’s control. For the most part, they cannot be directed, only reacted to.
Both exogenous and endogenous forces can impact the profitability and viability of a company. Neoclassical and Keynesian economists disagree about which forces are the most important in determining economic growth.
A key characteristic of exogenous forces is the fact that they, largely, cannot be controlled by those who hold the reins of production of goods and services. Nonetheless, it is important to be aware of such forces so that one can consciously create and develop strategies to deal with the potential impacts of exogenous forces.
- The Exogenous Growth Theory is a theory of neoclassical economics that posits that external, mostly macroeconomic factors are what drive the economic growth rate.
- The theory implies that the factors that drive growth – such as the rate of technological advancement, and tax and tariff policies – are not within the control of the economy’s primary producers, i.e., individual companies.
- The Exogenous Growth Theory lies in contrast to the endogenous growth theory, which holds that internal forces are more important than external forces in determining the rate of economic growth.
The exogenous growth theory holds that external, primarily macroeconomic variables, rather than industry or business-specific factors, are what ultimately drive growth. Advancements in technology are considered especially important. But again, it is referring to technology advancements overall rather than those that are considered industry-specific.
According to the exogenous growth theory, if rapid technological advances and innovation are occurring within the economy as a whole, then the economy’s overall growth rate (rate of GDP increase) will be high as well. Other key factors driving growth include return on invested capital (ROIC) and savings rates. Political forces, including tax rates, are also considered exogenous forces.
An exogenous factor is one that is independent of factors within a specific economic system. For example, the factors of pest control and the weather are exogenous in relation to the agriculture industry, as they operate independently of whether any type of agricultural production is being undertaken.
In contrast, the endogenous growth theory places much more emphasis on factors that determine supply and demand situations within a specific nation, industry, or business marketplace. Endogenous growth models take into account key economic factors that are specific to a business or an industry.
For example, travel-related businesses, such as ski resorts and cruise lines, are subject to seasonal factors that can significantly affect revenues and profit. Other endogenous forces include how competitive an industry is and technology advances that are specific to an industry or held by a specific company or a limited number of companies.
According to the endogenous growth theory, technological advances should only be considered with respect to their likely impact within an industry. For example, regardless of whether technology is rapidly advancing overall, if there are significant technological innovations in healthcare services, then companies in the healthcare industry are likely to outperform companies in other market sectors, in terms of growth.
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