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Classic theories of Classic theories of Economic Economic

Development and Development and GrowthGrowth

A Comparative AnalysisA Comparative Analysis

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The Quest for GrowthThe Quest for Growth The financing gap The financing gap Investment in physical and human capitalInvestment in physical and human capital Structural AdjustmentsStructural Adjustments New economic theoryNew economic theory

Four approaches to the Classic Four approaches to the Classic Theories of DevelopmentTheories of Development

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Classic Theories of Economic Classic Theories of Economic Development: Four ApproachesDevelopment: Four Approaches

Literature on economic development is Literature on economic development is dominated by the following four strands of dominated by the following four strands of thought: thought: Linear-stages-of-growth model: 1950s and Linear-stages-of-growth model: 1950s and

1960s1960s Theories and patterns of structural change: Theories and patterns of structural change:

1970s1970s International-dependence revolution: 1970sInternational-dependence revolution: 1970s Neo-classical, free-market counterrevolution: Neo-classical, free-market counterrevolution:

1980s and 1990s1980s and 1990s

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Linear Stages TheoryLinear Stages Theory

Viewed the process of development as a Viewed the process of development as a series of successive stages of economic series of successive stages of economic growthgrowth

Mixture of saving, investment, and foreign Mixture of saving, investment, and foreign aid was necessary for economic aid was necessary for economic development development

Emphasized the role of accelerated capital Emphasized the role of accelerated capital accumulation in economic developmeaccumulation in economic development nt

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Rostow’s Stages of GrowthRostow’s Stages of Growth

Rostow identified 5 stages of growth: Rostow identified 5 stages of growth: 1.1. The traditional societyThe traditional society

2.2. The pre-conditions for take-offThe pre-conditions for take-off

3.3. The take-offThe take-off

4.4. The drive to maturityThe drive to maturity

5.5. The age of high mass consumptionThe age of high mass consumption

All advanced economies have passed the All advanced economies have passed the stage of take-off into self sustaining growthstage of take-off into self sustaining growth

Developing countries are still in the Developing countries are still in the traditional society or the pre-conditions traditional society or the pre-conditions stage. stage.

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The Harrod-Domar Growth The Harrod-Domar Growth Model Model

The principal strategy for development is The principal strategy for development is mobilization of saving and generation of mobilization of saving and generation of investment to accelerate economic growthinvestment to accelerate economic growth

Investment comes from savings Investment comes from savings Rate of economic growth (GNP growth Rate of economic growth (GNP growth

rate) is determined jointly by the ability of rate) is determined jointly by the ability of the economy to save (savings ratio) and the economy to save (savings ratio) and the capital-output ratio the capital-output ratio

ΔΔ Y/Y=s/kY/Y=s/k

Cont…Cont…

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Firms

Households

Wages, Profits, Rents

Consumption Expenditure

Outflow

Inflow

Inflow

Outflow

Investment

Savings

Ray, Debraj p.52

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Obstacles and Constraints Obstacles and Constraints

Problem with the argument that GDP growth Problem with the argument that GDP growth is proportional to the share of investment is proportional to the share of investment expenditure in GDPexpenditure in GDP

Low rate of savings in developing countries Low rate of savings in developing countries gives rise to savings gap and capital gives rise to savings gap and capital constraint constraint

Savings and investment is a necessary Savings and investment is a necessary condition for accelerated economic growth condition for accelerated economic growth but not a sufficient conditionbut not a sufficient condition

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Structural-Change Models Structural-Change Models

Structural-change theory focuses on the Structural-change theory focuses on the mechanism by which underdeveloped mechanism by which underdeveloped economies transform their domestic economies transform their domestic economic structures from traditional to a economic structures from traditional to a developed urbanized industrial economydeveloped urbanized industrial economy

Representative examples of this strand of Representative examples of this strand of thought are;thought are;

The Lewis theory of developmentThe Lewis theory of development Chenery’s patterns of development Chenery’s patterns of development

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a. Lewis Theory of Developmenta. Lewis Theory of Development

Also known as the two-sector surplus labor Also known as the two-sector surplus labor model model

Features of the basic modelFeatures of the basic model: : Economy consists of two sectors- Economy consists of two sectors-

traditional and moderntraditional and modern Traditional sector is overpopulated and has Traditional sector is overpopulated and has

surplus of labor (MPsurplus of labor (MPLL=0)=0) Model focuses on the process of transfer of Model focuses on the process of transfer of

surplus labor and the growth of output in surplus labor and the growth of output in the modern sectorthe modern sector

Cont…Cont…

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The speed of expansion in the modern sector The speed of expansion in the modern sector is determined by the industrial investment is determined by the industrial investment which is possible by the excess profit over which is possible by the excess profit over wages in the modern sector so industrialist re-wages in the modern sector so industrialist re-invest it. invest it.

The process of self-sustaining growth and The process of self-sustaining growth and employment expansion continues in the employment expansion continues in the modern sector until all of the surplus labor is modern sector until all of the surplus labor is absorbedabsorbed

Structural transformation of the economy has Structural transformation of the economy has taken place with the growth of the modern taken place with the growth of the modern industryindustry

Wm > Wa and remain constant until the Wm > Wa and remain constant until the surplus labour is exhaustedsurplus labour is exhausted

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Lewis Theory of Development: Lewis Theory of Development: CriticismsCriticisms

Four of the key assumptions do not fit the realities of Four of the key assumptions do not fit the realities of contemporary developing countries contemporary developing countries

Reality is that: Reality is that: • Capitalist profits are invested in labor saving technology Capitalist profits are invested in labor saving technology • Existence of capital flightExistence of capital flight• Little surplus labor in rural areasLittle surplus labor in rural areas• Growing prevalence of urban surplus labor Growing prevalence of urban surplus labor • Tendency for industrial sector wages to rise in the face of Tendency for industrial sector wages to rise in the face of

open unemployment open unemployment

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Structural Changes and Patterns Structural Changes and Patterns of Development : Chenery’s of Development : Chenery’s

ModelModel Patterns of development theorists view increased savings and Patterns of development theorists view increased savings and

investment as necessary but not sufficient for economic investment as necessary but not sufficient for economic developmentdevelopment

In addition to capital accumulation, transformation of production, In addition to capital accumulation, transformation of production, composition of demand, and changes in socio-economic factors composition of demand, and changes in socio-economic factors are all importantare all important

Chenery and colleagues examined patterns of development for Chenery and colleagues examined patterns of development for developing countries at different per capita income levelsdeveloping countries at different per capita income levels

Cont…Cont…

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Structural Changes and Patterns Structural Changes and Patterns of Development : Chenery’s of Development : Chenery’s

ModelModel The empirical studies identified several The empirical studies identified several

characteristic features of economic characteristic features of economic development: development:

Shift from agriculture to industrial productionShift from agriculture to industrial production Steady accumulation of physical and human capitalSteady accumulation of physical and human capital Change in consumer demandsChange in consumer demands Increased urbanizationIncreased urbanization Decline in family sizeDecline in family size Demographic transitionDemographic transition

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Differences in development among the Differences in development among the countries are ascribed to: countries are ascribed to:

Domestic constraints (economic, political, policy Domestic constraints (economic, political, policy gap, population, institutional) gap, population, institutional)

International constraints (access to external International constraints (access to external capital, technology and trade)capital, technology and trade)

To summarize, structural-change analysts To summarize, structural-change analysts believe that the “correct mix” of economic believe that the “correct mix” of economic policies will generate beneficial patterns of policies will generate beneficial patterns of self-sustaining growthself-sustaining growth

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The International Dependence The International Dependence Revolution (IDR)Revolution (IDR)

The IDR models reject the exclusive emphasis on GNP The IDR models reject the exclusive emphasis on GNP growth rate as the principal index of developmentgrowth rate as the principal index of development

Instead they place emphasis on international power Instead they place emphasis on international power balances and on fundamental reforms world-widebalances and on fundamental reforms world-wide

IDR models view developing countries as beset by IDR models view developing countries as beset by institutional, political, and economic rigidities in both institutional, political, and economic rigidities in both domestic and international setupdomestic and international setup

The IDR models argue that developing countries are up The IDR models argue that developing countries are up in a dependence and dominance relationship with rich in a dependence and dominance relationship with rich countriescountries

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The International Dependence The International Dependence Revolution (IDR)Revolution (IDR)

Three streams of thought: Three streams of thought:

Neocolonial dependence modelNeocolonial dependence model False-paradigm modelFalse-paradigm model Dualistic-development thesisDualistic-development thesis

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1. Neocolonial Dependence 1. Neocolonial Dependence ModelModel

Underdevelopment is the Underdevelopment is the externallyexternally induced phenomenon. induced phenomenon. Historically unequal international capital system is exploiting the Historically unequal international capital system is exploiting the poorpoor

The colonial system developed the “divide and role “ policy and The colonial system developed the “divide and role “ policy and create certain powerful groups and multinational companies and create certain powerful groups and multinational companies and institutions institutions

““Dependence is a conditioning situation in which economies of Dependence is a conditioning situation in which economies of some countries are conditioned by the development and some countries are conditioned by the development and expansion of others.”expansion of others.”

““Dependence, then, is based upon an international division of Dependence, then, is based upon an international division of labor which allows industrial development to take place in some labor which allows industrial development to take place in some countries, while restricting it in others, whose growth is countries, while restricting it in others, whose growth is conditioned by and subjected to the power centers of the world.”conditioned by and subjected to the power centers of the world.”

Theotonio Dos SantosTheotonio Dos Santos

2020

2. The False-Paradigm Model2. The False-Paradigm Model

Attributes under development to the faulty Attributes under development to the faulty and inappropriate advice provided by well-and inappropriate advice provided by well-meaning but biased and ethnocentric meaning but biased and ethnocentric international “expert advisers”international “expert advisers”

The policy prescriptions serve the vested The policy prescriptions serve the vested interests of existing power groups, both interests of existing power groups, both domestic and international domestic and international

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3. The Dualistic- Development 3. The Dualistic- Development ThesisThesis

Dualism represents the existence and persistence of increasing Dualism represents the existence and persistence of increasing divergences between rich and poor nations and rich and poor divergences between rich and poor nations and rich and poor peoples at all levelspeoples at all levels

The concept embraces four key arguments: The concept embraces four key arguments: 1.1. Superior and inferior conditions can coexist in a given space at Superior and inferior conditions can coexist in a given space at

given time given time * * 2.2. The coexistence is chronic and not transitionalThe coexistence is chronic and not transitional3.3. The degrees of the conditions have an inherent tendency to The degrees of the conditions have an inherent tendency to

increaseincrease4.4. Superior conditions serve to “develop under- development”Superior conditions serve to “develop under- development”

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Weaknesses of IDR ModelsWeaknesses of IDR Models

Do not offer any policy prescription for how poor Do not offer any policy prescription for how poor countries can initiate and sustain economic countries can initiate and sustain economic developmentdevelopment

Actual experience of developing countries that have Actual experience of developing countries that have pursued policy of autarky/closed economy has been pursued policy of autarky/closed economy has been negativenegative

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The Neoclassical The Neoclassical Counterrevolution: Market Counterrevolution: Market

FundamentalismFundamentalism Neoclassical counterrevolution in the 1980s called for free markets, and the Neoclassical counterrevolution in the 1980s called for free markets, and the

dismantling of public ownership, and government regulationsdismantling of public ownership, and government regulations Four component approaches :Four component approaches :

Free-market analysisFree-market analysis- markets alone are efficient- markets alone are efficient Public-choice theory-Public-choice theory- governments can do nothing right due to power with governments can do nothing right due to power with

certain groups. certain groups. Market- friendly approach-Market- friendly approach- governments have a key role to play in governments have a key role to play in

facilitating operations of markets through nonselective interventionsfacilitating operations of markets through nonselective interventions New institutionalism-New institutionalism- success or failure of developmental efforts depend success or failure of developmental efforts depend

upon the nature, existence, and functioning of a country’s fundamental upon the nature, existence, and functioning of a country’s fundamental institutionsinstitutions

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Traditional Neoclassical Growth Traditional Neoclassical Growth TheoryTheory

According to the traditional neoclassical growth theory: According to the traditional neoclassical growth theory: Output growth results from one or more of three factors- Output growth results from one or more of three factors-

increases in Labor, increases in capital, and technological increases in Labor, increases in capital, and technological changeschanges

Closed economies with low savings rates grow slowly in the SR Closed economies with low savings rates grow slowly in the SR and converge to lower per capita income levelsand converge to lower per capita income levels

Open economies converge at higher levels of per capita Open economies converge at higher levels of per capita income levelsincome levels

Cont…Cont…

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Traditional neoclassical theory argues that capital Traditional neoclassical theory argues that capital flows from rich to poor countries as K-L ratios are lower flows from rich to poor countries as K-L ratios are lower and investment returns are higher in the latter and investment returns are higher in the latter

By impeding the flow of foreign investment, poor By impeding the flow of foreign investment, poor countries choose a low growth path.countries choose a low growth path.

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Solow's Neoclassical Model or Solow's Neoclassical Model or Exogenous Growth ModelExogenous Growth Model

Solow’s model of economic growthSolow’s model of economic growth implies that economies will conditionally implies that economies will conditionally converge to the same level of income, given converge to the same level of income, given that they have the same rates of savings, that they have the same rates of savings, depreciation, labor force growth, and depreciation, labor force growth, and productivity growthproductivity growth

Solow’s model differs from Harrod-Domar Solow’s model differs from Harrod-Domar model in the following respects: model in the following respects:

Allows for substitution between labor and capitalAllows for substitution between labor and capital Assumes that there exist diminishing returns to Assumes that there exist diminishing returns to

these inputsthese inputs Introduces technology in the growth equationIntroduces technology in the growth equation

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Solow's Neoclassical Model or Solow's Neoclassical Model or Exogenous Growth ModelExogenous Growth Model

Impact of increase in productivity: Impact of increase in productivity: Shifts the per-worker production function Shifts the per-worker production function

to the right to the right Raises steady state per capita output Raises steady state per capita output

through increase in per capita capital. through increase in per capita capital. In the long-run increase in per capita In the long-run increase in per capita

income takes place at the same rate as income takes place at the same rate as productivity/ technical progressproductivity/ technical progress

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Application: Do Economies Application: Do Economies Converge? Converge?

Unconditional convergenceUnconditional convergence occurs occurs when poor countries will eventually when poor countries will eventually catch up with the rich countries (LR) catch up with the rich countries (LR) resulting in similar living standardsresulting in similar living standards

Conditional convergenceConditional convergence occurs when occurs when countries with similar characteristics will countries with similar characteristics will converge (savings rate, investment rate, converge (savings rate, investment rate, population growth)population growth)

No convergenceNo convergence occurs when poor occurs when poor countries do not catch up over time and countries do not catch up over time and living standards may divergeliving standards may diverge