# What Is New Growth Theory? Definition, How It's Used, and Example

## What Is New Growth Theory?

The new growth theory is an economic concept, positing that humans' desires and unlimited wants foster ever-increasing [productivity](https://www.investopedia.com/terms/p/productivity.asp) and economic growth. It argues that [real gross domestic product](https://www.investopedia.com/terms/r/realgdp.asp) (GDP) per person will perpetually increase because of people's pursuit of profits.

### Key Takeaways

*   The new growth theory presumes the desire and wants of the populace will drive ongoing productivity and economic growth.
*   A central tenet of new growth theory is that competition squeezes profit, forcing people to constantly seek better ways to do things or invent new products in order to maximize profitability.
*   The theory emphasizes the importance of entrepreneurship, knowledge, innovation, and technology, rejecting the popular view that economic growth is determined by external, uncontrollable forces.
*   Knowledge is treated as an asset for growth that is not subject to finite restrictions or  
    diminishing returns like other assets such as capital or real estate.

## Understanding New Growth Theory

The new growth theory offered a fresh take on what engineers economic prosperity. It emphasizes the importance of entrepreneurship, knowledge, innovation, and technology, challenging the view of [exogenous growth](https://www.investopedia.com/terms/e/exogenous-growth.asp) in [neoclassical economics](https://www.investopedia.com/terms/n/neoclassical.asp) that economic progress is determined by external, uncontrollable forces.

Competition squeezes profit, so people have to constantly seek better ways to do things or invent new products in order to maximize profitability. This concept is one of the central tenets of the new growth theory.

The theory argues that innovation and new technologies do not occur simply by random chance. Rather, it depends on the number of people seeking out new innovations or technologies and how hard they are looking for them. People also have control over their [knowledge capital](https://www.investopedia.com/terms/k/knowledge-capital.asp)—what to study, how hard to study, etc. If the profit incentive is great enough, people will choose to grow [human capital](https://www.investopedia.com/terms/h/humancapital.asp) and look harder for new innovations.

A significant aspect of the new growth theory is the idea that knowledge is treated as an [asset](https://www.investopedia.com/terms/a/asset.asp) for growth that is not subject to finite restrictions or diminishing returns like other assets such as [capital](https://www.investopedia.com/terms/c/capital.asp) or real estate. Knowledge is an intangible quality, rather than physical, and can be a resource grown within an organization or industry.

## New Growth Theory Example

Under the new growth theory, nurturing innovation internally is one of the reasons for organizations to invest in human capital. By creating opportunities and making resources available within an organization, the expectation is that individuals will be encouraged to develop new concepts and technology for the consumer market.

For example, a large enterprise might allow part of its staff to work on independent, internal projects that may develop into new innovations or companies. In some ways, the enterprise lets them function like [startups](https://www.investopedia.com/terms/s/startup.asp) being incubated inside the organization.

The desire of the employees to launch a new innovation is spurred by the possibility of generating more profits for themselves and the enterprise. This can be especially true in the United States, as commerce is increasingly driven by service-type companies. Software and app development may take place within companies, following the new growth theory.

Achieving such knowledge-driven growth requires a sustained investment in human capital. This can create an environment for skilled professionals to have an opportunity to not only fulfill their primary jobs but also explore the creation of new services that can be of benefit and use to the broader public.

## Special Considerations

New growth theorists believe that companies generally undervalue the usefulness of knowledge and, as a result, argue that it is mainly up to governments to invest in human capital. Governments are encouraged to facilitate access to better education, as well as provide support and incentives for private-sector [research and development (R&D)](https://www.investopedia.com/terms/r/randd.asp).

> **Article Sources**
>
> 1.  Romer, Paul M. "[Increasing Returns and Long-Run Growth](https://rcer.econ.rochester.edu/RCERPAPERS/rcer_27.pdf)." _Rochester Center for Economic Research Working Paper Series 27_, October 1985, pp. 1-53.
>     
> 2.  Sala-i-Martin, Xavier. "[15 Years of New Growth Economics: What Have We Learnt?](https://academiccommons.columbia.edu/doi/10.7916/D8K93KSW)" _Columbia University, Department of Economics_, Discussion Paper #:0102-47, April 2002, pp. 14-15.
>     
> 3.  Sala-i-Martin, Xavier. "[15 Years of New Growth Economics: What Have We Learnt?](https://academiccommons.columbia.edu/doi/10.7916/D8K93KSW)" _Columbia University, Department of Economics_, Discussion Paper #:0102-47, April 2002, pp. 15.