Question

Hong Kong: Economic Development and Economic Freedom

1) What are the 3 central questions of neoclassical growth theory? How does the theory answer them?

2) What is economic freedom? Study the EFW rating of your own country. What policy changes would you recommend to increase economic freedom in your country?

3) What is entrepreneurship? What role did entrepreneurs play in Hong Kong’s economic development?

Answer 1

Neoclassical growth theory is an economic theory that outlines how a steady economic growth rate results from a combination of three driving forces: labor, capital, and technology.

The theory states that short-term equilibrium results from varying amounts of labor and capital in the production function. The theory also argues that technological change has a major influence on an economy, and economic growth cannot continue without technological advances. Neoclassical growth theory outlines the three factors necessary for a growing economy. These are labor, capital, and technology. However, neoclassical growth theory clarifies that temporary equilibrium is different from long-term equilibrium, which does not require any of these three factors.

• Robert Solow and Trevor Swan first introduced the neoclassical growth theory in 1956.
• The theory states that economic growth is the result of three factors: labor, capital, and technology.
• While an economy has limited resources in terms of capital and labor, the contribution from technology to growth is boundless.

This growth theory posits that the accumulation of capital within an economy, and how people use that capital, is important for economic growth. Further, the relationship between the capital and labor of an economy determines its output. Finally, technology is thought to augment labor productivity and increase the output capabilities of labor.

Therefore, the production function of neoclassical growth theory is used to measure the growth and equilibrium of an economy. That function is Y = AF (K, L).

• Y denotes an economy's gross domestic product (GDP)
• K represents its share of capital
• L describes the amount of unskilled labor in an economy
• A represents a determinant level of technology.

However, because of the relationship between labor and technology, an economy's production function is often re-written as Y = F (K, AL).

Technology's Influence on the Growth Theory

Increasing any one of the inputs shows the effect on GDP and, therefore, the equilibrium of an economy. However, if the three factors of neoclassical growth theory are not all equal, the returns of both unskilled labor and capital on an economy diminish. These diminished returns imply that increases in these two inputs have exponentially decreasing returns while technology is boundless in its contribution to growth and the resulting output it can produce.

Economic freedom, or economic liberty, is the ability of people of a society to take economic actions.

Economic liberty as the freedom to produce, trade and consume any goods and services acquired without the use of force, fraud or theft.