The minimum complexity of endogenous growth models:: the role of physical resource flows

Abstract

Conventional economic growth theory assumes that technological progress is exogenous and that resource consumption is a consequence, not a cause, of growth. This assumption is built into most, if not all, of the large-scale models used for policy guidance by governments. The reality is probably more complex. A ‘growth engine’ is a positive feedback loop involving declining costs and increasing demand. The neoclassical theory was based on population growth and the traditional savings–investment–capital accumulation mechanism. Solow added an exogenous residual called ‘technical progress’. However, based on both qualitative and quantitative evidence, physical resource flows have been, and still remain, a major factor of production. Yet doubts remain because of the small share of direct payments to energy (and other natural resource) suppliers in the national accounts. This paper shows that the apparent inconsistency between (small) factor payments and the high correlation between physical resource (energy) inputs and outputs can be traced to an often forgotten simplification. The standard neoclassical growth model produces final products directly from labor and capital without allowing any role for consumable intermediates. Correcting for the omission of intermediates by introducing a two-sector or multi-sector production process multiplies the impact of primary resource inputs and accounts for the apparent inconsistency.