The new growth theory is a branch of economic theory which proposes that economic growth is not solely dependent on the accumulation of capital or physical resources, but arises from an increase in the quality or quantity of knowledge, technology and innovation. The theory was developed by economist Paul Romer in the late 1980s and has been influential in policy-making in recent years, as governments increasingly emphasise knowledge-based industries as a source of growth in the economy.

The new growth theory goes beyond the prevailing view of neoclassical economic growth which focused on increasing quantities of physical capital and labour inputs as key drivers of economic growth. Rather the emphasis shifts to the importance of ideas and knowledge. As Romer famously stated, “ideas have a special property – they can be used over and over again without being used up.” This idea is not new – economists such as Schumpeter have long since acknowledged the importance of innovation as a source of new economic products and services – but Romer was the first to develop a formal theory to explain how knowledge can be harnessed to generate economic growth.

The new growth theory focuses on two main ideas; firstly, on the importance of knowledge-based capital, and secondly, the need for a competitive environment in order to foster innovation. On the first point, Romer discusses the idea of knowledge as a form of capital that can be invested in, and which can generate returns over time. This capital may take the form of investments in research and development, or in the training of skilled employees. On the second point, Romer highlights the need for a competitive marketplace in order to spur innovation. While in the traditional neoclassical view, competition led to diminishing returns and therefore acted as a disincentive, under the new growth theory; competition has the effect of energizing innovation and spurring the development of new products and services.

One of the key implications of new growth theory is that policy makers have increasingly focused on encouraging entrepreneurship, innovation, and research and development as key elements of economic growth. Rather than just employing more people or building more factories; governments have sought to foster a culture of innovative thinking and risk taking. From tax incentives for start-ups to subsidies for technological research, governments around the world have embraced the concept of “new growth”, believing that knowledge and innovation can be greater sources of economic growth than physical capital.

In conclusion, the new growth theory has revolutionised thinking on economic growth, emphasising the importance of knowledge and innovation over capital investments as the key driver of economic progress. It has provided insights into how innovators and entrepreneurs can be supported, and how policy makers can create an environment that encourages the development of new ideas and products. By understanding the importance of an innovative and competitive environment for economic growth, governments can ensure that the economy is able to continue to grow and offer better opportunities for people in the long term.