EconomicDevelopment,12thEd.M.P.TodaroandS.C.SmithSlidesforChapterThree
UpdatedandExpandedStephenC.Smith
3.1ClassicTheoriesofEconomicDevelopment:FourApproaches
• Linearstagesofgrowthmodel• TheoriesandPaIernsofstructuralchange• InternaKonal-dependencerevoluKon• Neoclassical,freemarketcounterrevoluKon
3.2DevelopmentasGrowthandLinear-StagesTheories
• AClassicStatement:Rostow’sStagesofGrowth
• Harrod-DomarGrowthModel(someKmesreferredtoastheAKmodel)
SimplifiedHarrod-DomarGrowthModel
• Harrod-DomarGrowthModelDerivaKon• Y=(1/c)*K• LinearrelaKonshipassumed,so,• ΔY=(1/c)*ΔK;or,• ΔY=SNet/c• DividingbyY:ΔY/Y=(SNet/Y)/c;so,• Growth=(sNet)/c;thatis,• Growth=Netsavingsrate/ICOR
TheHarrod-DomarModel-SimplifiedVersion,AlternateDerivaKon
TheHarrod-DomarModel-SimplifiedVersion
• EquaKon3.7isalsoobenexpressedintermsofgrosssavings,inwhichcasethegrowthrateisgivenby
(3.7’)whereδistherateofcapitaldepreciaKonThederivaKonfollowsinthenexttwoslides:
TheHarrod-DomarModel–Incorpora9ngCapitalDeprecia9on
Harrod-Domar (or “AK”) Model: Derivation of disaggregated treatment of depreciation
€
ICOR ≡ c ≡ΔKΔY
€
ΔY =1cΔK
€
ΔK = I G −δKAnd,
€
ΔY =1cI G −δK[ ]
€
ΔY =1cI G −
1cδK
€
IG ≡ SG( )
€
ΔYY
=SG
Yc−δYY
=
SG
Y%
& '
(
) *
c−δ
€
ΔYY
=sG
c−δSo,
Harrod-Domar (or “AK”) Model: Derivation of disaggregated treatment of depreciation (cont.)
Illustrative Exercise on Growth Potential
‘Back-of-the-envelope’calculaKonswiththeH-D(orAK)growthmodel.
Suppose sG = .125, δ=.04, c =2.5
€
gTOT =.1252.5
− .04 = .01Then,
ButifsG=.175,δ=.03,c=2.5
€
gTOT =.1752.5
− .03 = .04Then,
Consider Waste: Suppose the ‘technical ICOR’ is 2, but 1/5 is wasted.
Effective ICOR is:
€
x45"
# $ %
& ' = 2⇒ x = 2
54"
# $ %
& ' = 2.5
€
sG
c 54"
# $ %
& ' −δSo, growth =
δ=.03sG=.15c=2.5
€
gr =.152.5
− .03 = .03
Illustrative Exercise on Growth Potential (continued)
Illustrative Exercise: Growth Targets (e.g. “India”)
• Supposeacountryhasagrosssavingsrateof20%,adepreciaKonrateof3%,andanlCORof2.5.
• UsingtheHarrod-Domargrowthmodel,findtheimpliedrateofgrowthoftotalGDPin“India.”
• Answer:Growth=.2/2.5-.03=.05(i.e.,5%)• Howmuchwouldtherateofsavingshavetoincreasetoraisethe
growthrateoftotalGDPto9%?(ArecentlydiscussedtargetinIndia)
• Answer:Nowthesavingsrateisyourunknown.• Growth=s/2.5-.03=.09,sos/2.5=.12ors=.3(thatis,up10
percentagepointsfrom20%to30%)• Thisisawaytothinkabouttargetedgrowthratesandrequired
savingsalsowhenthistopicisconsideredfurtherinChapter11
CriKcismsoftheStagesModel
• NecessaryversussufficientcondiKons
3.3Structural-ChangeModels
• TheLewistwo-sectormodel
Figure3.1TheLewisModelofModern-SectorGrowthinaTwo-SectorSurplus-LaborEconomy
CriKcismsoftheLewisModel
• RateoflabortransferandemploymentcreaKonmaynotbeproporKonaltorateofmodern-sectorcapitalaccumulaKon
• Surpluslaborinruralareasandfullemploymentinurban?
• InsKtuKonalfactors?• AssumpKonofdiminishingreturnsinmodernindustrialsector
Figure3.2TheLewisModelModifiedbyLaborsavingCapitalAccumulaKon:EmploymentImplicaKons
EmpiricalPaIernsofDevelopment-Examples
• Processesareverytypicalbutnotuniversal,soobenreferredtoas“stylizedfacts”:
• Switchfromagriculturetoindustry(andservices)
• Rural-urbanmigraKonandurbanizaKon• SteadyaccumulaKonofphysicalandhumancapital
• PopulaKongrowthfirstincreasingandthendecreasingwithdeclineinfamilysize
3.4TheInternaKonal-DependenceRevoluKon
• Theneocolonialdependencemodel– Legacyofcolonialism,Unequalpower,Core-periphery
• Thefalse-paradigmmodel– Pipallsofusing“expert”foreignadvisorswhomisapplydeveloped-
countrymodels• ThedualisKc-developmentthesis
– Superiorandinferiorelementscancoexist;Prebisch-SingerHypothesis• CriKcismsandlimitaKons
– DoesliIletoshowhowtoachievedevelopmentinaposiKvesense;accumulaKngcounterexamples
3.5TheNeoclassicalCounterrevoluKon:MarketFundamentalism
• ChallengingtheStaKstModel:FreeMarkets,PublicChoice,andMarket-FriendlyApproaches– Freemarketapproach– Publicchoiceapproach– Market-friendlyapproach
• MainArguments– DeniesefficiencyofintervenKon– Pointsupstateownedenterprisefailures– Stressesgovernmentfailures– TradiKonalneoclassicalgrowththeory-withdiminishingreturns,cannot
sustaingrowthbycapitalaccumulaKonalone
FromtheAppendix:EquilibriumintheSolowGrowthModel
FromtheAppendix:TheSolowNeoclassicalGrowthModel
( ) ( ) (A3.2.4)k sf k n k = +
( *) ( ) * (A3.2.5)sf k n k= +
Appendix3.2TheSolowNeoclassicalGrowthModel:TheSolowEquaKon
Δk = sf (k)− (δ + n)k (A3.2.4)
EquilibriumisfoundwhereΔk=0,asinequaKonA3.2.5onthenextslide.Note:WecanalsouseequaKonA3.2.4abovetoprovidea“heurisKc”proofbycontradicKon–makinguseofFigureA3.2.1–toseethattheequilibriummustbewhereΔk=0:otherwisekisgrowingtothelebofk*andshrinkingiftotherightofk*.
FromtheAppendix:Interpreting the Solow equilibrium equation
• Interpretating of the Solow Equilibrium in Equation (A3.2.5) and the preceding figure (A3.2.1),
• sf(k*) is savings per worker, and is just equal to the sum of:
• δk*, the amount of capital (per worker) needed to replace depreciating capital, and,
• nk*, the amount of capital (per worker) that needs to be added due to population (labor force) growth.
sf (k*) = (δ + n)k * (A3.2.5)
TheSolowEquaKon:AHeurisKcNumericalExample
• Note:ThisheurisKcexampleaddressesthecapitalperworkercomponent,notproducKon(outputperworker)
• Incomedependsuponcapital(K)perworker(L):i.e.,K/L• BeforeK/Lcangrowwemustinvesttomakeallowancefora)
depreciaKon;andb)growthofthelaborforceL• Toillustrate,considera10-workereconomygrowingto12workers;
iniKallyK/L=2;anddepreciaKon=.05• ToincreaseK/Lto2.5wemustinvest:• 1unitofKfordepreciaKonallowance:(20)*(.05)=1• 4unitsofKfor“capitalwidening”(equippingthenewworkerswith
thesamecapitalastheexisKngworkers)• 6unitsofKfor“capitaldeepening,”tofinallyincreasetheK/LraKo,
uptowhereeachworkerhas2.5unitsofcapitaltoworkwith• Overall,theKstockgrowsfrom20to30,i.e.,30/12=2.5
Contributions and Limitations of the four schools
• Capital Fundamentalism – Points up importance of investment, and of efficiency of capital allocation – Investment may be necessary but is not sufficient. Broader context matters
• Structural/Empirical Patterns of Development – Careful empirical evidence can remove theories from contention – But, still need theory to interpret data, avoid cart-before-horse policies
• Dependency – Existing international relations/ trade/ investment can place constraints on
pattern of development – But, growing number of counter-examples of stronger versions of
dependency theory; good performance of “globally” integrated countries • Market Fundamentalism
– Governments fail (e.g. in SOEs, planning) and we must account for this – But, markets also fail in developing countries; the East Asia experience
shows that government role can be constructive
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-26
3.6ClassicTheoriesofDevelopment:ReconcilingtheDifferences
• Governmentsdofail,butsodomarkets;abalanceisneeded• MustaIendtoinsKtuKonalandpoliKcalrealiKesindevelopingworld• Developmenteconomicshasnouniversallyacceptedparadigm• InsightsandunderstandingsareconKnuallyevolving• Eachtheoryhassomestrengthsandsomeweaknesses
Appendix3.1:ComponentsofEconomicGrowth
• CapitalAccumulaKon,investmentsinphysicalandhumancapital– Increasecapitalstock
• GrowthinpopulaKonandlaborforce• Technologicalprogress
– Neutral,labor/capital-saving,labor/capitalaugmenKng
FigureA3.1.1EffectofIncreasesinPhysicalandHumanResourcesontheProducKonPossibilityFronKer
FigureA3.1.2EffectofGrowthofCapitalStockandLandontheProducKonPossibilityFronKer
FigureA3.1.3EffectofTechnologicalChangeintheAgriculturalSectorontheProducKonPossibilityFronKer
FigureA3.1.4EffectofTechnologicalChangeintheIndustrialSectorontheProducKonPossibilityFronKer
Appendix3.2TheSolowNeoclassicalGrowthModel:TheSolowEquaKon
Δk = sf (k)− (δ + n)k (A3.2.4)
EquilibriumisfoundwhereΔk=0,asinequaKonA3.2.5onthenextslide.Note:WecanalsouseequaKonA3.2.4abovetoprovidea“heurisKc”proofbycontradicKon–makinguseofFigureA3.2.1–toseethattheequilibriummustbewhereΔk=0:otherwisekisgrowingtothelebofk*andshrinkingiftotherightofk*.
Appendix3.2EquilibriumCondiKonfortheSolowNeoclassicalGrowthModel
( *) ( ) * (A3.2.5)sf k n k= +
FigureA3.2.1EquilibriumintheSolowGrowthModel
Interpretation of Solow equilibrium equation
• Interpretating of the Solow Equilibrium in Equation (A3.2.5) and the preceding figure (A3.2.1),
• sf(k*) is savings per worker, and is just equal to the sum of:
• δk*, the amount of capital (per worker) needed to replace depreciating capital, and,
• nk*, the amount of capital (per worker) that needs to be added due to population (labor force) growth.
sf (k*) = (δ + n)k * (A3.2.5)
FigureA3.2.2TheLong-RunEffectofChangingtheSavingRateintheSolowModel
Note: The more detailed general derivations that follow in the next slides is supplemental material for students who are interested
€
YL
= yLet
DefiniKon:K(t+1)–K(t)≡ΔK
€
KL
t +1( ) −KL
t( )#
$ % &
' ( = Δ
KL≡ Δk
Δkk=ΔKK
−ΔLL≡ΔKK
− n
Δkk=sY −δK( )K
− nSubstituting,
Δkk= sy L
K− δ + n( ) = sy
k− δ + n( )
*Note: The first term corresponds to the form on the previous page, because we have just multiplied it by L/L and used the definitions. Now, multiplying through by k, we have:
€
Δk = sf k( ) − δ + n( )kThe Solow Equation
Appendix3.2TheSolowNeoclassicalGrowthModel
( ),Y F K L =
( ),1 or ( )Y L f K L y f k= =
y Ak=
( ) ( )sf k n k = +
( ) ( )k sf k n k = +
( )1( ) ( ) ( ) ( )Y t Y t A t L t =
ComparaKveCaseStudy:SouthKoreaandArgenKna
ComparaKveCaseStudy:ArgenKnaandSouthKorea*SouthKorea• 1:StagesofGrowth:ThetheoryislargelyconsistentwithSouthKorea’s
historicaleconomicgrowthexperience• HugeshareofinvestmentinnaKonalincome-hasbeenamongthehighestin
theworld• ThoughSouthKoreaneconomymaturedmuchfasterthanRostow'stheory
predicted,thegapbetweentradiKonalandadvancedtechnologycanbecrossedmuchfasterwithmoderninternaKonaltrade.
• 2StructuralPaIerns:• TheLewismodelofdevelopmentislargelyconsistentwiththegrowthof
Koreaeconomy• RapidlyincreasingagriculturalproducKvity• Shibsoflaborfromagriculturetoindustry• SteadygrowthofthecapitalstockandofeducaKonandskills• DemographictransiKonfromhightolowferKlity
*ThankstoJinHoKimforpreparingtheChapter3casestudyslides
ComparaKveCaseStudy:SouthKorea,conKnued
SouthKorea(conKnued)• 3:DependencyTheory:• SouthKoreaposesseriouschallengetothedependencerevoluKonmodels• StrongdependenceininternaKonalrelaKons:U.S.militaryinSouthKoreafrom
1950,U.S.aidduring1950s,heavydependenceoninternaKonaltrade:• Dependencytheorywouldpredictretardeddevelopment,but....• SouthKoreaisanexcepKon:Themagnitudeofforeignaid,self-interestofU.S.;
during1960-1990,theKoreaneconomyusedIndustrialpolicythatdependencyschoolapplauds(ex:Samsung,LG,Hyundai);someconsideredthisunfairtradeagainstU.S.
• 4NeoclassicalTheory:• SouthKoreaalsochallengestheseapproaches• Thegovernmentmakingextensiveuseofdevelopmentplanning• WiderangeoftaxbreaksandincenKvestoinducefirmstofollowgovernment
direcKvesandintervenKons• InducingfirmstomoverapidlyuptheladderofdynamiccomparaKveadvantage
withdirectedtechnologicalgrowth
Chapter3CaseStudy:ArgenKna• StagesofGrowth:ThisapproachisinconsistentwithArgenKna’s
economicgrowthhistory
• RostowdatedArgenKna'sprecondiKonsfortakeoffasanextendedperiodbefore1914;andconcludedthattakeoffinsomesensebeganintheFirstWorldWarbutinthemid-1930ssustainedtake-offwasinaugurated,whichhejudgedsuccessfulby1960
• ArgenKnahadanegaKvegrowthratethroughoutthe1965-1990period;inthe1980sdomesKcinvestmentshrankata-8.3%rate
• LikemanyotherLaKnAmericanandAfricancountriesinthe1970sand1980s,ArgenKnademonstrateddevelopmentprogressisnotirreversible,andthatsustainedgrowthcancometoanend
Chapter3CaseStudy:ArgenKna(cont.)
• 2.StructuralPaIerns:• ArgenKnaexhibitedmanyoftheusualstructuralpaIernsofdevelopmentasagriculturalproducKvityrose,industrialemploymentgrew,urbanizaKontookplace,ferKlityfell,amongothers
• However,thesestructuralregulariKeswereobservedevenaslivingstandardsinthecountrystagnated
• Illustratessomeshortcomingsofthemodel
Chapter3CaseStudy:ArgenKna(conclusion)
• 3.DependencyTheory:• ArgenKna’seconomichistoryislargelyconsistentwiththedependencerevoluKon
approach• ArgenKnareliedtoalargeextentonexporKngprimarygoods;andtherealprices
ofthesegoodsfellcomparedtoimports• MulKnaKonalcorporaKonsplayedalargerole;andArgenKnawasunabletocreate
itsownviablemanufacturingexportindustries,ulKmatelyhavingtosubmittostringentstructural-adjustmentprograms.
• 4.NeoclassicalTheory:• ArgenKnaalsoofferssomevindicaKonforneoclassicalcounterrevoluKontheory• FaultyintervenKonistrestricKons,ineffocientstateenterprise,biasagainst
producKonforexports,andunnecessaryredtapeendeduphurKngindustryandentrepreneurship.
• Governmentpolicyconsistentlyseemedtosupportprivilegedinterestsratherthanbroadergoalsofdevelopment;andapparentlygovernmentfailurewasworsethanmarketfailureinArgenKna
ConceptsforReview• Autarky• Averageproduct• Capital-laborraKo• Capital-outputraKo• Center• Closedeconomy• Compradorgroups• Dependence• Dominance
• Dualism• False-paradigmmodel• Freemarket• Free-marketanalysis• Harrod-Domargrowthmodel• Lewistwo-sectormodel• Marginalproduct• Marketfailure
ConceptsforReview(conKnued)• Market-friendlyapproach• NecessarycondiKon• NeoclassicalcounterrevoluKon• Neocolonialdependencemodel• NetsavingsraKo• NewpoliKcaleconomyapproach• Openeconomy• PaIerns-of-developmentanalysis• Periphery
• ProducKonfuncKon• Public-choicetheory• Self-sustaininggrowth• Solowneoclassicalgrowthmodel• Stages-of-growthmodelof
development• Structural-changetheory• StructuraltransformaKon• SufficientcondiKon• Surpluslabor• Underdevelopment
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