Four major paradigms form the basis of modern growth economics. They differ primarily in their assumptions about returns to capital and the nature of technological progress.

1. The Neoclassical Growth Model (Solow-Swan)

The Neoclassical model is the starting point for growth analysis, emphasizing capital accumulation under the assumption of diminishing returns.

• Core Mechanism: The model posits that as an economy accumulates capital per worker, the marginal product of that capital declines. This process continues until the capital stock reaches a “steady state” where net investment is zero.
• Source of Long-Run Growth: In the absence of technological progress, per capita income is constant in the long run. Sustained growth is only possible through an exogenous, unexplained force of “technical progress” that continually offsets the effect of diminishing returns.
• Policy Implication: Economic policies, such as increasing the savings rate, can raise the level of per capita income but cannot affect its long-run growth rate. A key quote from the source states: “in this neoclassical model, technical progress cannot be explained or even rationalized. To analyze policies for growth, one needs a theoretical framework in which productivity growth is endogenous.”
• Convergence: The model’s central prediction is conditional convergence: countries with similar savings rates, population growth rates, and technology will converge to the same steady-state level of income. Therefore, a country that starts further below its steady state will initially grow faster.

2. The AK Model

The AK model, the first generation of endogenous growth theory, removes the assumption of diminishing returns at the aggregate level.

• Core Mechanism: The model assumes an aggregate production function of the form Y = AK, where K represents a broad measure of capital (physical, human, and knowledge). The marginal product of this broad capital is the constant A.
• Source of Long-Run Growth: With constant returns, the incentive to accumulate capital does not diminish. The long-run growth rate is determined by the saving rate (s), the productivity of capital (A), and the depreciation rate (δ), according to the formula g = sA – δ.
• Policy Implication: Policies that increase the saving rate or the productivity of capital (A) can permanently increase the long-run growth rate.
• Convergence: The basic AK model predicts no convergence. Two economies with different initial capital stocks will grow at the same rate, meaning the gap between them will persist. An open-economy version can, however, generate convergence through terms-of-trade effects.

3. The Product-Variety Model (Romer)

This model endogenizes technological progress by viewing it as the creation of new varieties of intermediate goods used in production.

• Core Mechanism: Growth is driven by an expansion in the number of specialized intermediate products (N). A greater variety of inputs makes final production more efficient. Innovation is motivated by the prospect of monopoly rents for the inventor of a new product variety.
• Key Features: It emphasizes the role of technology spillovers, where new innovators build on the entire existing stock of knowledge. It also predicts “scale effects,” where larger economies (with more labor or researchers) grow faster.
• Creative Destruction: This model has no role for creative destruction. The obsolescence of old inputs is absent; indeed, the exit of an existing product variety would reduce productivity and be detrimental to growth.

4. The Schumpeterian Model (Aghion-Howitt)

This paradigm frames growth as a process of “creative destruction,” where new, higher-quality products or processes displace existing ones.

• Core Mechanism: Growth is driven by a sequence of quality-improving innovations. Successful innovators earn temporary monopoly rents until they are displaced (“leapfrogged”) by the next innovator. This process explicitly models firm turnover and competition as central to growth.
• Key Concepts:
  • Creative Destruction: The process by which innovation renders old products and firms obsolete is the engine of growth.
  • Advantage of Backwardness: A country lagging behind the technological frontier can achieve larger productivity jumps by adopting leading-edge technologies, allowing for potentially faster catch-up growth.
• Policy Implications: This framework provides a rich basis for analyzing how policies related to competition, entry, finance, and education affect innovation incentives.

Paradigm Comparison