Definition
New growth theory, also called endogenous growth theory, explains long-run economic growth as something generated within the economy rather than as an unexplained external force. Its central insight is that ideas, innovation, and knowledge are the engine of sustained growth.
Earlier models treated technological progress as exogenous, a gift that simply arrived. New growth theory, associated with Paul Romer, instead models innovation as the result of deliberate investment by firms and people responding to incentives.
Why it matters
How it works
Physical capital faces diminishing returns: adding machines to a fixed workforce eventually yields less and less. Ideas behave differently. Because knowledge can be used by everyone at once and builds on prior knowledge, returns need not diminish, and growth can be self-sustaining.
This makes incentives crucial. Patents and profits reward innovation; education expands the pool of people who can create ideas; open exchange spreads them. Government policy can speed growth by funding research and protecting the returns to discovery.