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

Conventional economic growth theory assumes that technological progress is exogenous and that resource consumption is a consequence, not a cause, of g rowth. This assumption is built into most, if not all, of the large-scale m odels 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 populati on growth and the traditional savings-investment-capital accumulation mecha nism. Solow added an exogenous residual called 'technical progress'. Howeve r, based on both qualitative and quantitative evidence, physical resource f lows 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 n atural resource) suppliers in the national accounts. This paper shows that the apparent inconsistency between (small) factor payments and the high cor relation between physical resource (energy) inputs and outputs can be trace d to an often forgotten simplification. The standard neoclassical growth mo del produces final products directly from labor and capital without allowin g any role for consumable intermediates. Correcting for the omission of int ermediates by introducing a two-sector or multi-sector production process m ultiplies the impact of primary resource inputs and accounts for the appare nt inconsistency. (C) 2001 Elsevier Science Ltd. All rights reserved.