Lesson preview · Technology And Growth
Technology & Endogenous Growth
~12 min · Free to read
Two countries start with the same workers, the same machines, and the same farmland. Fifty years later one is rich and one is poor. The Solow model from the last lesson cannot tell them apart on inputs alone. So what made the difference? The answer is technology — and it is the single most important idea in growth economics. This lesson explains why saving more lifts you once and then stops, while better technology keeps lifting you forever.
Start with what saving can do. The last lesson showed that raising the saving rate moves the economy to a higher steady state. Workers get more machines to work with — economists call this capital deepening (each worker is paired with more equipment). Output per worker climbs. So far so good. But it does not climb forever.
Key Term
Why capital deepening fades
Capital runs into diminishing returns — each extra machine adds less than the one before it. Give a worker a first computer and output jumps. Give them a second, a third, a tenth, and the gains shrink to almost nothing.
So raising the saving rate is a one-time level effect: income rises to a new, higher plateau and then flattens out. You get a one-off lift, not a faster pace. Save even harder and you reach a slightly higher plateau, but you still plateau. A country cannot save its way to permanent growth.
Technology is different in kind, not just in size. Technological progress means better ideas, recipes, and know-how — smarter ways to combine the same workers and machines into more output. It shifts the whole production function up. A better idea does not run into diminishing returns the way a tenth machine does. You can keep finding better ideas, and each one lifts output again. That is why technology can sustain growth year after year while saving cannot.
Key Term
Total factor productivity (TFP)
Total factor productivity (TFP) is the part of output growth that is NOT explained by adding more workers or more capital — it is the “how cleverly we combine our inputs” residual.
Economists do growth accounting: they measure how much output grew, subtract the growth they can credit to extra labour and extra capital, and whatever is left over is TFP. When they run the numbers across decades, most of the long-run rise in living standards traces back to TFP — better technology — not to piling up more capital.
Put bluntly: rich countries are mostly rich because they use their inputs cleverly, not because they have more stuff per person.
Key Term
Endogenous growth
In the Solow model, technology fell from the sky — it was an exogenous given, a number that improved on its own with no one deciding to make it happen. Endogenous growth theory drops that assumption. “Endogenous” just means “produced inside the system”: newer theories treat technology as something people CHOOSE to produce — by funding research and development (R&D), educating themselves, and building on ideas that already exist.
The key reason this works is that ideas are non-rival — once an idea is invented, everyone can use it at the same time without using it up. One person reading a recipe does not stop a million others from reading the same recipe.
The payoff: policy can change the long-run growth RATE, not just the level. Fund R&D, school more people, protect inventors with patents — and you can speed up the pace of progress itself.
Key Term
Institutions
Institutions are the rules of the game — secure property rights (you keep what you build), rule of law, competition, and openness to trade and ideas. They decide whether an economy can actually adopt and generate new technology.
Give two countries the same machines and the same blueprints. If one has courts that enforce contracts, lets new firms challenge old ones, and trades freely, it will put those machines to work and invent more. If the other has insecure ownership, monopolies protected by the state, and closed borders, the same machines sit idle. Same inputs, very different growth — because the institutions differ.
Trap · Common Misconception
"Just save more and you'll keep growing"
It feels obvious that a thrifty country that saves and invests hard should grow forever. It will not. Saving more buys you more machines per worker, but diminishing returns mean each extra machine adds less, so income climbs to a higher plateau and then stalls. That is a one-time lift. Sustained, year-after-year growth comes from technology — better ideas that keep shifting output up and do not run into the same wall. Saving sets your level; technology sets your pace.
Tip
So what?
Saving more gives living standards a one-time lift that levels off, but technological progress is the only thing that keeps them rising year after year.
Worked Example
A government has two policy ideas to make its citizens richer over the long run. Plan A: push households to save and invest much more, building up the stock of machines per worker. Plan B: fund research and development, expand schooling, and protect inventors with patents. Which plan delivers a one-time level effect, which can raise the long-run growth rate, and why?
Check yourself · no marks
Two countries buy the exact same factory machines. Twenty years on, one country has used them to grow rich and the other has barely grown at all. The Solow model says they had identical capital, so what could explain the gap?
Commit to one first. Guessing and being wrong beats reading the answer cold.
Practice · 1 / 4
Total factor productivity (TFP) measures which of the following?
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