Endogenous Innovation in the Theory

¶ … Endogenous innovation in the theory of growth' Journal of Economic Perspectives, 1994, vol 8

Advising a developing economy: Article review

Grossman, Gene M. & Elhan Helpman. "Endogenous Innovation in the Theory of Growth."

The Journal of Economic Perspectives. 8. 1. (Winter, 1994), pp. 23-44.

In today's difficult economic climate, the challenges for the developing world, always great, may appear insurmountable. However, Gene M. Grossman and Elhanan Helpman's article entitled "Endogenous Innovation in the Theory of Growth" suggests that the best way to navigate the rocky economic trajectory towards prosperity is to encourage capital accumulation (that is, increasing the incomes of the populace and the government) but above all to develop the human capital of the nation and citizen's technological knowledge. Of course both may be linked -- technological knowledge of local workers may be developed from working for the more technologically sophisticated enterprises of the developed world. Through gaining knowledge and experience, workers can build upon what they have learned and generate new, locally generated means to foster prosperity.

International exchanges and competition are a key factor in spurring indigenous development: "residents of a country that is integrated into world markets are likely to enjoy access to a larger technical knowledge base than those living in relative isolation. Trade itself may help the process of technological dissemination, if foreign exporters suggest ways that their wares can be used more productively or foreign importers indicate how local products can be made more attractive to consumers in their country...exposure to international competition may mitigate redundancy in industrial research. Whereas a firm that develops a product for a protected domestic market need only make use of technologies that are new to the local economy, one that hopes to compete in the international market- place will be forced to generate ideas that are truly innovative on a global scale" (Grossman & Helpman, 1994, p. 40). This last suggestion implies the caveat that while foreign investment and capital from global multinationals is vital, the enthusiasm and wealth sometimes generated from foreign investment must not eclipse the need to generate locally-grown economic roots within the nation. Also, the foreign companies must take an interest in the development of the nation, and provide advice rather than merely seek to use human resources to secure their own marketplace advantage in the short-term.

Most models of development include "human capital as the driving force behind economic" success (Grossman & Helpman, 1994, p. 23). However, this is not simply based upon population size but human capital in terms of the citizen's knowledge of technological development and collective ability to thrive in an increasingly interdependent and technically sophisticated global marketplace. Hence both authors' recommendation to seek exposure to the new technology of more developed nations. Exposure to other nations generates immediate wealth in terms of the purchasing power of employees but also technological wealth as when "individuals or firms accumulate new capital, they inadvertently contribute to the productivity of capital held by others. Such spillovers may occur in the course of investment in physical capital" (Grossman & Helpman, 1994, p. 24). In short, foreign investment in a nation, even in the form of factories that generate exported goods using local, cheaper labor still has a positive effect upon the economy. Workers learn from their new jobs as well as earn more.

A foreign company comes into a nation, but the worker's increase in salary gives them greater buying power, relatively speaking than they had before. They buy more goods from local businesses, can afford more luxuries, and this encourages the growth of local enterprises. The spillover effect must be strong enough for this to work, however. Thus, it may be necessary for the government to fuel the economic development of local production through tax relief and to carefully select certain types of foreign investment to emphasize in its 'recruitment efforts' to ensure that the nation does not simply remain a source of cheap labor. Accumulation of capital is important, but the capital must be used to improve the minds of the populace and the infrastructure of the nation. Still, to achieve this objective, openness rather than protectionism is essential. The downturn in global fortunes may mean that cheaper labor costs are even more desirable on the part of multinationals so allowing such investment to prevent the nation from being even more stricken by economic contraction is more essential than ever before.

Allowing foreign enterprise to come into the nation and keeping government regulation to a minimum remains advisable, except in the very limited case of businesses that might threaten unique arenas of local development. Foreign businesses bring in knowledge as well as Euros and dollars. Developing the knowledge base of technology in the minds of the populace is can only be achieved through exposure -- and this can be fostered by the educational programs of the foreign enterprises for managers as well as in the nations' schools. (Agreements to fund study abroad at foreign universities may also be possible through corporations that take an interest in improving the knowledge of its local managerial force).