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6 Main Features of Neo-Classical Growth Model

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The following points highlight the six main features of the Neo-Classical growth model.

Feature # 1. Theory of Capital Accumulation:

Among the neo-classical economists differences arises about capital theory but the general approach was the same.

They abandoned the classical idea that fixed proportions of capital and labour are required in production within a given technology.

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They accepted the possibility of the substitution of capital for labour.

This implies that the society can accumulate capital without increasing the labour force. Capital theory is thus liberated from the population theory. An increased accumulation of capital with population remaining constant results in increasing national and per capital incomes. However, with a given state of technology the marginal utility of capital declines as more capital is accumulated.

According to neo-classical, the rate of interest and the level of income are the main determinants of the rate of savings in the society. Due to uncertainties and risks of the future, a person generally prefers the present to the future. Thus, the rate of interest must be positive in order to induce the people to save.

The higher the preference for the present, the higher should be the rate of interest to induce savings. Rate of interest also determines the rate of investment. A lower rate of interest is required to increase the rate of investment. Due to the reason, the yield on any given type of capital falls as the supply of that type of capital is increased. Again the high rates of investment are bound to increase the prices of capital goods.

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The neo-classical economists have also analysed the process of capital formation. Given the size of population, the process of capital accumulation is initiated by an improvement in technology which leads to an increased investment opportunity. The demand for capital goods increased. Rate of interest is pushed up and rate of saving is increased.

The relative prices of capital goods also rise as investment is increased because of the limited supply of factors used for the production of capital goods. The high rate of interest and high prices of capital goods restrict investment only to the highest yielding projects, when as these projects are completed, both the interest and relative prices of capital goods are fall.

In other words, the rate of interest falls to such a low level that community becomes unwilling to save, stage of accumulation ends and the economy reaches a stationary state.

Feature # 2. Effects of Population Increase:

The neo-classicals also analysed the effects of a given increase in population within a given state of technology. An increase in population will increase labour supply which will lower money wage rate and will lead to an increase in employment. The demand schedule is assumed as fixed inspite of a fall in wages.

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Thus, the producers find it more profitable to expand output by employing more labour and thus employment is increased. The more intensive utilisation of capital equipment increases the marginal productivity of capital which leads to increased demand for capital goods. The rate of interest is increased which leads to more saving and greater investment and the economy is again on the path of progress.

Technological progress is also a factor stimulating the growth of national income. According to neo-classicals, technological progress meant the application of labour-saving devices. In this way, technological progress leads to lower cost and an improvement in productive methods which encourage the producers to increase output.

Feature # 3. Development: A Gradual and Continuous Process:

According to classicals, development is a gradual and continuous process of change in the economy. They also emphasize the harmonious and cumulative nature of the development process. According to Prof. Marshall, development takes place in a gradual and continuous manner.

He seems to have been influenced by the evolution theories of Darwin and Spencer. Marshall frequently uses biological analogies to explain the organic and evolutionary character of the economic system. He says that the Mecca of the economist lies in economic biology rather than in economic dynamics. Emphasising that economic development is a gradual and continuous process.

Marshall observed that “nature does not willingly make a jump ………. is specially applicable to the process of development.” To the neo-classicals, the acts of invention and adoption of new techniques are also gradual and continuous. They regard technological progress as stemming from the gradual progress and diffusion of knowledge which has been a major force in economic development.

Feature # 4. Harmonious and Cumulative Process:

The neo-classical economists maintained that economic development is a harmonious and cumulative process. Contrary to the classical and the Marxian view, the neo-classicals thought that economic development benefits all major income groups in the society and particularly the labour class.

They also believed that the economic system has a strong tendency to attain full employment, and, therefore, while temporary unemployment is possible, long run unemployment equilibrium is an impossibility. Moreover, economic development is beneficial to labour class because it tends to raise the level of real wages as the prices of commodities are much reduced due to improved technology.

In the neo-classical scheme of development, there is no possibility of class conflict as was visualised by Ricardo and Marx. According to neo-classical economists, absolute income shares received by landlords and capitalists also rise along-with that of labour during the process of economic development and hence, there is no possibility of class conflict. Development has got beneficial effects on all sections of the society.

In explaining the harmonious nature of the development process, they stressed for the role of “external economics”. Resulting from ‘the growth of correlated branches of industry which mutually assist one another, perhaps being concentrated in the same localities, but anyhow availing themselves of the modern facilities for communication offered by steam transport, by the telegraph and by the printing press.’

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The emergence of an industry in a particular locality not only creates the conditions of its own growth and expansion but it also exercises an expansionary effect on other industries. The rate of technological progress is increased because of greater facilities of interchange of knowledge.

Expansion of an industry not only lowers its own costs but also those of others. Similarly, the development in one sector of the economy induces growth in other sectors. The growth of knowledge is a consequence as well as a cause of the growth of industry.

Feature # 5. Optimism about Development:

The neo-classicals are generally optimistic about the future possibilities for continued development. They have got faith in man’s ability to overcome the limitations imposed by nature on the development of a society. This can be done through technological progress and improvements in the quality of labour.

Unlike Ricardo, they are not worried about the approaching stationary state. Marshall observes in this connection that “there seems to be no good reasons for believing that we are anywhere near a stationary state.” They are also not haunted by the Ricardian fear of the operation of the law of diminishing returns. According to them, technological progress and improvements in quality of labour will produce a general tendency towards increasing returns.

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They strongly emphasise the importance of the process of capital deepening and hence according to them savings are very essential for economic development. They regard economic development as a race between capital accumulation and population growth.

Even with constant technology and given labour supply, it is possible to increase national income by capital accumulation. Assuming that there is a gradual and autonomous growth of technological knowledge and wants in the society, willingness to save becomes a major requirement for development. Thrift is the great virtue.

Feature # 6. Significance of International Trade:

In the neo-classical theory of economic development, international trade plays a crucial role to raise the national income of an economy and can thus put it on a higher level of development. International trade leads to greater specialisation and division of labour which results in better and more efficient allocation of world’s productive resources and greater output.

By enlarging the size of the market, it enables a country to get the benefits of further specialisation. A country can thus raise its national income by participating in international trade. The resultant increase in national income leads to greater savings and capital formation which creates conditions for rapid rate of economic development.

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The neo-classical also felt the significance of protective tariff under certain circumstances. They accept the “infant industry” argument and are in favour of protective tariff for the expansion and strengthening of the home industry.

They believed that “there is some force in the claim that a protective tariff is needed to aid giant businesses in establishing complete standardisation on the most advanced modern model”. But justified protective duties on the ground that “the energy developed in a few high class progressive industries may spread over a great of the industrial system of the country.”

Despite this support for protective duties, the neo-classicists generally favoured free trade policy. Most neo-classicists believed that ‘free trade, like honesty, still remains the best policy’.

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