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New Growth Theory (NGT)

The productivity and growth of the economy are tied directly to people – more specifically, to what they want and need

What is the New Growth Theory (NGT)?

The New Growth Theory – sometimes referred to as the NGT – is a fresh take on the drivers behind economic prosperity and growth. The NGT suggests that the productivity and growth of the economy are tied directly to people – more specifically, to what they want and need. The basic underlying reasoning is that people’s wants (which are virtually unlimited or endless) and needs drive their purchasing and investing decisions; purchasing and investing drive the economy.

 

New Growth Theory (NGT)

 

The New Growth Theory’s primary argument is that while in pursuit of personal profit and fulfillment of their needs, the people’s purchases and investments will steadily cause real gross domestic product (GDP) figures, per person, to rise.

 

Summary

  •  The New Growth Theory (NGT) is based on the wants and needs of individuals as the driving factor behind economic growth; individuals buy, sell, and invest based on their personal wants and needs, ultimately causing real gross domestic product (GDP) figures to rise.
  • The theory is a fresh twist on its predecessor, neoclassical economics; while the latter is focused more on external factors, NGT is focused largely on internal (human) factors.
  • The New Growth Theory arguably places the most emphasis on the key factor of knowledge; knowledgeable individuals buy, sell, and invest wisely and push economic growth in a smarter and more substantial way. According to the NGT, knowledge is considered an (intangible) asset with the potential for exponential growth.

 

Understanding the New Growth Theory

The New Growth Theory disputes the traditional view that a successful, growing economy is shaped almost exclusively by outside forces which can’t be determined or controlled. The NGT, in contrast, places emphasis on:

  • Technology as a means through which individuals can innovatively and effectively access the economy and generate profit – the actions of individuals on their own behalf then collectively impact the economy.
  • Knowledge: The new growth theory views knowledge as a commodity that facilitates an individual’s ability to acquire all the information that he or she needs to make informed, intelligent decisions (decisions that will ultimately impact the overall economy).
  • Entrepreneurship is essentially a term that indicates the importance of individuals taking it upon themselves to pursue their physical, personal, and financial wants and needs. They invest in ways that enable them to meet said wants and needs, generate profits or income that they can live off of, and continually bolster throughout the remainder of their lives.

 

New Growth Theory vs. Neoclassical Economics

Again, NGT is – at its core – the theory that personal, individual forces are ultimately the drivers of economic progress. The focus is on the individual (that which fosters individual growth fosters economic growth).

The prevailing theory – prior to the development of NGT – was neoclassical economics. Neoclassical economics is a broad twist on classic economics, with a focus on supply and demand as the primary factors behind economic growth.

Exogenous growth, a key tenet of neoclassical economics, considers a few specific elements within businesses and economies that are the ultimate engineers of economic growth. Among these elements are:

  • Diminishing capital returns
  • Production costs
  • Rate of savings
  • Technological variants (e.g., tools, programs)

 

Neoclassical economics was initially established by forward thinkers such as Carl Menger, William Stanley Jevons, and Léon Walras. At its inception, neoclassical economics assumed that how useful goods and services were to consumers (versus the costs to produce and distribute said goods and services) was the primary factor driving economic growth. This type of economics was later expanded once production costs and other external factors proved to make a significant impact on how an economy grows.

 

The Importance of Knowledge and the New Growth Theory

As we mentioned above, knowledge is a key component of the New Growth Theory. When armed with a wealth of financial knowledge and understanding, well-rounded and better-informed consumers and potential investors develop.

Because knowledge is such a key component of the New Growth Theory, it’s treated as an asset. In addition, the asset is neither subject to commonly considered financial risk factors nor does it see decreasing returns. In fact, the opposite is true. Because knowledge of facts is an intangible quality rather than a physical commodity, it is a resource that can continually be added to and grown.

 

Key Takeaways

The key takeaway from the NGT is the preeminent value of human capital. According to the New Growth Theory, human capital is the most valuable resource in any economy. Therefore, if governments and businesses want to achieve maximum economic growth and prosperity, they will focus their efforts on creating avenues for individuals to maximize their learning and opportunities for individuals to engage in research, exploration, development, and entrepreneurial endeavors.

Examples of economic programs that can be fostered by either government agencies or private businesses include business incubators or programs that offer venture capital to budding entrepreneurs.

 

Other Resources

CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)® certification program, designed to help anyone become a world-class financial analyst. The CFI resources below will be helpful in furthering your financial education and helping you advance your career:

  • Economic Growth
  • Business Incubator
  • Entrepreneur
  • New Keynesian Economics

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes!