What is Economic Growth Theory

If discussing the theory of economic growth, of course we will understand that economic growth itself is interpreted as an increase in value and also the amount of production of goods and services that are generally calculated by a country in a certain period of time. A country’s economy can be said to grow when the economic activities of its people have a direct impact on increasing the production of goods and services. This activity is also a factor in increasing national income.

In its development, there are several theories of economic growth put forward by experts. These theories appear to explain the growth cycle and also the factors that have a direct influence on the improvement of the national economy. Among the many theories that have sprung up from time to time, you can get to know more about the following five popular theories, including:

1. Classical Theory

One of the oldest theories of economic growth that has existed since the 18th century is the classical theory. The leading figure who is often associated with this theory is Adam Smith, in which he has the notion that the economy of the population in a country will be able to reach its highest point through a liberal system. This system consists of the main elements, namely population growth and output growth.

Even so, the initial concept of this theory received opposition from another figure, namely David Ricardo. He believes that this population growth actually does not have a positive influence on national economic growth. On the contrary, it will only increase the number of productive workers. So that it can have an impact on reducing workers’ wages.

2. Neoclassical theory

This theory of economic growth is actually a development of the classical theory that was introduced by Adam Smith. The figures who put it forward were two senior economists named Robert Solow and SW Swan. Therefore, this theory is also known as the Solow-Swan economic growth model.

The Neoclassical school will focus its theory on three factors that influence economic growth, namely capital, labor, and also technological developments. This theory believes that an increase in the number of workers can increase per capita income. However, without developing modern technology, this increase will not be able to provide positive results for national economic growth.

3. Neo Keynesian theory

The Neo Keynesian theory was coined by an economist named Roy F. Harrod and Evsey D. Domar, the Neo Keynesian theory argues that national economic growth is influenced by demand, capital, and investment. All three have an important role in increasing national production in a country which will also affect the improvement of the economy in that country. This can take place in the short or medium term.

Some supporters of the Neo Keynesian theory also highlight the importance of investment activity in supporting economic growth. They think that investing will help to increase national production, whether on a small or large scale.

4. New Economic Theory

This new economic theory is also known as the endogenous growth model, where this theory was developed by Robert Lucas and Paul Romer. This new economic theory focuses its cycle on human resources which are the main capital for increasing production and also the national economy. According to Lucas and Romer, a workforce that has broad insight, higher education, and training can accelerate industrial and technological development. As a result, national production activities can also be increased more quickly.

5. Historical Theory

As one of the most popular economic theories, historical theory was developed by a number of economists who have different views, but both are centered on the economic activities of society. Several well-known experts as developers of the theory of economic growth are Karl Bucher, Werner Sombart, and Frederich List.

Karl Bucher here coined his theory that national economic growth is influenced by the relationship between producers and consumers through the closed household level, community, city, to the world. Not much different from Bucher’s theory, Werner Sombart also classifies the role of society in economic growth, starting from the closed economic stage, the industrial growth stage, to the capitalist stage.

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Definition of Economic Growth

Prof. Simon Kuznet explains economic growth as a long-term increase to provide people with an ever-increasing variety of economic goods. This ability grows on the basis of technological, ideological, and institutional advancements that it requires. This definition has three important components. The first is that economic growth in a country can be seen from the continuous increase in the supply of goods. Second, advanced technology is a factor in economic growth that determines the degree of growth in the ability to supply various kinds of goods to the public. Then the third is that the use of technology widely and efficiently requires adjustments in the institutional and ideological fields.

Economic growth is one indicator of successful development in an economy. The progress of an economy is determined by the amount of growth indicated by changes in national output. This change in output in the economy is a short-term economic analysis. In general, theories that discuss economic growth can be grouped into two, namely classical economic growth theory and modern economic growth theory. In classical economic growth theory, the analysis will be based on trust and also the effectiveness of free market mechanisms. This theory is a theory coined by classical economists, namely Adam Smith and David Richard.

Another theory that explains economic growth is modern economic theory. The Harrod-Domar growth theory is one of the modern economic growth theories, where this theory emphasizes the importance of investment formation for economic growth. So, the higher the investment, the better the economy will be. Investment here does not only affect aggregate demand, but also aggregate supply through its effect on production capacity. In a longer perspective, investment will increase the capital stock.

Economic growth is an effort to increase production capacity in order to achieve additional output, which is measured using the Gross Domestic Product or GDP or Gross Regional Domestic Product or GRDP in a region. This economic growth is a process of increasing output per capita in the long run. Where the emphasis is on three aspects, namely process, per capita output, and also the long term. Economic growth is a process, not a picture of the economy at one time. Here, we can see the dynamic aspects of an economy, namely how an economy develops or changes from time to time. The emphasis itself is on change as well as development itself.

According to Prof. Simon Kuznets, economic growth is an increase in the long-term capacity of a country concerned to provide various kinds of economic goods to its people. This increase in capacity is made possible by advances or technological, institutional, and ideological adjustments to various existing conditions. This economic development has a broader meaning and includes changes in the economic structure of society as a whole. Where economic development is usually defined as a process that causes an increase in the real per capita income of the people of a country in the long term which is also accompanied by improvements in the institutional system.

In this case, it means that economic development is an active action effort that needs to be carried out by a country in order to increase per capita income. That way, the participation of the community, government, and all elements within a country is needed to actively participate in the development process.

From the various theories of economic growth described above, there are three main factors or components involved in economic growth, including:

1. Accumulation of capital, which includes all forms or types of new investments invested in land, capital or human resources, and physical equipment.
2. Population growth in the next few years will increase the number of labor force.
3. Advances in technology are increasingly advanced.

Regional development is carried out to achieve three important goals, namely to achieve growth, equity or sustainability, and sustainability.

1. Growth or growth: the first objective is growth which is determined to the extent where scarcity of resources can occur for human resources, natural resources, and humans can be optimally allocated and utilized to increase productive activities.
2. Equity or equity: in this case it has implications for achieving the third goal, where resources can be sustainable, so you shouldn’t focus on just one area. So that the benefits obtained from growth can be enjoyed by all parties with equity.
3. Sustainability: while the goal of sustainable regional development must fulfill various conditions, the use of resources, whether transacted through the market system or outside the market system, must not exceed production capacities.

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Regional development as well as sectoral development must always be carried out in harmony. So that the sectoral development that takes place in the regions is indeed true to the potential and also the priorities of the area. For overall development, the region really is a political, social, cultural and economic unit as well as defense and security in realizing national goals.

Relationship Between Variables and Economic Growth

The following are some of the relationships between variables and economic growth, including:

1. Investment and Economic Growth

Investment is one of the factors that can contribute to economic growth. With investment, a company can automatically increase both in terms of productivity and technology, because the investment itself is additional capital for the company that receives the investment. Harrod-Domar conducted a study on the effect of investment on economic growth by building a model based on the experience of developed countries.

This research reveals that the effect of investment on the process of economic growth is positive and also significant, especially regarding the dual effect that investment has through the acceleration process and also the multiplier process. First, it creates income which is also called the “demand impact”. Second, increasing the production capacity of the economy by creating a capital stock, which is also called the “supply effect” of investment. As long as the net investment continues, real income and output will also always increase.

Capital is the most important factor, because with capital, various other factors of production will be fulfilled. Investments invested in economic development prioritize service motives, namely providing services, encouraging the community, although economic considerations are also considered.

The low equilibrium level trap theory reveals that at a low level of per capita income, the level of investment will also be low and cause growth in national income to be lower than the rate of population growth. Under these conditions, the level of social welfare will tend to return to the subsistence level. Therefore, even greater investment is needed, which can guarantee that in the long run, the rate of economic growth is always greater than the rate of population growth. So that it will create improvements in the level of social welfare.

2. Labor and Economic Growth

According to Todaro, population growth is closely related to the number of available workers and is one of the factors that will affect economic growth. In addition to production factors, the number of available labor will also increase from year to year. So that if utilized optimally, it will increase economic growth.

Then when referring to Adam Smith’s theory, namely about the assumption that economic conditions are always in full employment conditions, then automatically everyone or labor can be productive, whether in the form of goods or services. Then, the theory put forward by David Ricardo who is considered to represent the classics in building his theory. As the characteristics of Ricardo’s classical school focus attention on the role of humans in economic growth or in other words, national output depends on labor.

3. Government Spending and Economic Growth

Government investment made through local government spending has a fairly close contribution to economic growth in an area. This government expenditure will be realized in the form of public facilities such as roads, airports, bridges, and so on. In addition, government spending will also be realized in the form of assistance, such as to finance productive communities and so on.

According to Sukirno and Sitaniapessy, government spending is part of fiscal policy, namely a government action that aims to regulate the course of the economy by determining the amount of government revenue and spending each year, which is reflected in the State Budget or APBN document for the national and Revenue Budget documents. Regional Expenditure or APBD for regional or regional. The purpose of this fiscal policy is to stabilize prices, output levels, or employment opportunities and spur or encourage economic growth.

Thus the explanation of what is the theory of economic growth. Hope it is useful.