Theories Fisher Clark's Theory of Structural Change

Next theory - The Harrod-Domar Model >> Two economists, Fisher and Clark, put forward the idea that an economy would have three stages of production

Primary production is concerned with the extraction of raw materials through agriculture, mining, fishing, and forestry. Low-income countries are assumed to be predominantly dominated by primary production. Secondary production concerned with industrial production through manufacturing and construction. Middle income countries are often dominated by their secondary sector. Tertiary production concerned with the provision of services such as education and tourism. In high-income countries the tertiary sector dominates. Indeed having a large tertiary sector is seen as a sign of economic maturity in the development process.

Countries are assumed to first pass through the primary production stage then the secondary stage and finally the tertiary stage. As economies develop and incomes rise then the demand for agricultural goods will increase but due to their low income elasticity of demand at a proportionally lower rate than income. However, the demand for manufactured goods will have a higher income elasticity of demand. So as incomes grow further the demand for these goods will grow at a proportionately higher rate. Hence the secondary industry will grow. As incomes continue to grow then people will start to consume more services as these have an even higher income elasticity of demand. Thus the tertiary sector will then grow and develop. However, this may be misleading. Some LDCs may have a large tertiary sector due to a large tourist industry without having developed a secondary industry. Economists argue that this could be somewhat risky. If the economic base is dominated by an economic activity such as tourism that has a high income elasticity of demand then a recession in the consuming nations will have a disproportionately large impact on the export earnings. A fall income will bring about a proportionately greater reduction in demand for the service and this will have severe impact on the economy. If it does not have a primary or secondary production to fall back on then borrowing and debt might be the only prospect. Next theory - The Harrod-Domar Model >>

Related Glossary Items: Primary Industry Secondary Industry Tertiary Industry Income Elasticity of Demand Related Theories: The Harrod-Domar Model The Lewis Model of Development Rostow's Model - the Stages of Economic Development Economic Growth and the Production Possibility Frontier

Theories Harrod-Domar Model

Next theory - The Lewis Model of Development >> This model, developed independently by RF Harrod and ED Domar in the l930s, suggests savings provide the funds which are borrowed for investment purposes. The model suggests that the economy's rate of growth depends on:

the level of saving the productivity of investment i.e. the capital output ratio

For example, if $10 worth of capital equipment produces each $1 of annual output, a capitaloutput ratio of 10 to 1 exists. A 3 to 1 capital-output ratio indicates that only $3 of capital is required to produce each $1 of output annually. The Harrod-Domar model was developed to help analyse the business cycle. However, it was later adapted to 'explain' economic growth. It concluded that:

Economic growth depends on the amount of labour and capital. As LDCs often have an abundant supply of labour it is a lack of physical capital that holds back economic growth and development. More physical capital generates economic growth. Net investment leads to more capital accumulation, which generates higher output and income. Higher income allows higher levels of saving.

Implications of the model The key to economic growth is to expand the level of investment both in terms of fixed capital and human capital. To do this policies are needed that encourage saving and/or generate technological advances which enable firms to produce more output with less capital i.e. lower their capital output ratio. Problems of the model

Economic growth and economic development are not the same. Economic growth is a necessary but not sufficient condition for development Practically it is difficult to stimulate the level of domestic savings particularly in the case of LDCs where incomes are low. Borrowing from overseas to fill the gap caused by insufficient savings causes debt repayment problems later. The law of diminishing returns would suggest that as investment increases the productivity of the capital will diminish and the capital to output ratio rise.

Next theory - The Lewis Model of Development >>

Theories Lewis's Dual Sector Model of Development: The theory of trickle down
Next theory - Rostow's Model >> Lewis proposed his dual sector development model in 1954. It was based on the assumption that many LDCs had dual economies with both a traditional agricultural sector and a modern industrial sector. The traditional agricultural sector was assumed to be of a subsistence nature

characterised by low productivity, low incomes, low savings and considerable underemployment. The industrial sector was assumed to be technologically advanced with high levels of investment operating in an urban environment. Lewis suggested that the modern industrial sector would attract workers from the rural areas. Industrial firms, whether private or publicly owned could offer wages that would guarantee a higher quality of life than remaining in the rural areas could provide. Furthermore, as the level of labour productivity was so low in traditional agricultural areas people leaving the rural areas would have virtually no impact on output. Indeed, the amount of food available to the remaining villagers would increase as the same amount of food could be shared amongst fewer people. This might generate a surplus which could them be sold generating income. Those people that moved away from the villages to the towns would earn increased incomes and this crucially according to Lewis generates more savings. The lack of development was due to a lack of savings and investment. The key to development was to increase savings and investment. Lewis saw the existence of the modern industrial sector as essential if this was to happen. Urban migration from the poor rural areas to the relatively richer industrial urban areas gave workers the opportunities to earn higher incomes and crucially save more providing funds for entrepreneurs to investment. A growing industrial sector requiring labour provided the incomes that could be spent and saved. This would in itself generate demand and also provide funds for investment. Income generated by the industrial sector was trickling down throughout the economy. Problems of the Lewis Model

The idea that the productivity of labour in rural areas is almost zero may be true for certain times of the year however during planting and harvesting the need for labour is critical to the needs of the village. The assumption of a constant demand for labour from the industrial sector is questionable. Increasing technology may be labour saving reducing the need for labour. In addition if the industry concerned declines again the demand for labour will fall. The idea of trickle down has been criticised. Will higher incomes earned in the industrial sector be saved? If the entrepreneurs and labour spend their new found gains rather than save it, funds for investment and growth will not be made available. The rural urban migration has for many LDCs been far larger that the industrial sector can provide jobs for. Urban poverty has replaced rural poverty.

Next theory - Rostow's Model >>

Theories Rostow's Model- the Stages of Economic Development

Next theory - Models of Demographic Transition >> In 1960, the American Economic Historian, WW Rostow suggested that countries passed through five stages of economic development. Stage 1 Traditional Society The economy is dominated by subsistence activity where output is consumed by producers rather than traded. Any trade is carried out by barter where goods are exchanged directly for other goods. Agriculture is the most important industry and production is labour intensive using only limited quantities of capital. Resource allocation is determined very much by traditional methods of production.

Stage 2 Transitional Stage (the preconditions for takeoff) Increased specialisation generates surpluses for trading. There is an emergence of a transport infrastructure to support trade. As incomes, savings and investment grow entrepreneurs emerge. External trade also occurs concentrating on primary products. Stage 3 Take Off Industrialisation increases, with workers switching from the agricultural sector to the manufacturing sector. Growth is concentrated in a few regions of the country and in one or two manufacturing industries. The level of investment reaches over 10% of GNP. The economic transitions are accompanied by the evolution of new political and social institutions that support the industrialisation. The growth is self-sustaining as investment leads to increasing incomes in turn generating more savings to finance further investment. Stage 4 Drive to Maturity The economy is diversifying into new areas. Technological innovation is providing a diverse range of investment opportunities. The economy is producing a wide range of goods and services and there is less reliance on imports. Stage 5 High Mass Consumption The economy is geared towards mass consumption. The consumer durable industries flourish. The service sector becomes increasingly dominant. According to Rostow development requires substantial investment in capital. For the economies of LDCs to grow the right conditions for such investment would have to be created. If aid is given or foreign direct investment occurs at stage 3 the economy needs to have reached stage 2. If the stage 2 has been reached then injections of investment may lead to rapid growth. Limitations Many development economists argue that Rostows's model was developed with Western cultures in mind and not applicable to LDCs. It addition its generalised nature makes it somewhat limited. It does not set down the detailed nature of the pre-conditions for growth. In reality policy makers are unable to clearly identify stages as they merge together. Thus as a predictive model it is not very helpful. Perhaps its main use is to highlight the need for investment. Like many of the other models of economic developments it is essentially a growth model and does not address the issue of development in the wider context. Next theory - Models of Demographic Transition >>

Theories Models of Demographic Transition

Next theory - Measuring the Circular Flow of Income >> The Classic Model of Demographic Transition The model of demographic transition proposed in the 1940s describes the stages in the relationship between birth and death rates and the overall population change. The growth in the population due to changes in the birth and death rates is called the natural rate of population growth. The model of demographic transition suggested that a population's mortality and fertility would decline as a result of social
Reverend Thomas Malthus

and economic development. It predicted that all countries would over time go through four demographic transition stages. However with all models it has its limitations and the model has been developed to consider the demographic changes that many LDCs are experiencing.

The tables below summarise the factors affecting birth rates and death rates in each stage
Stage 1 : Pre industrialisation: Stable population growth High Birth rates Stage 2: Rapid population growth High Birth rates Stage 3: Continued and decreasing population growth Falling Birth rates Family Planning utilised , contraceptives, abortions, sterilisation and other government incentives A lower infant mortality rates means less pressure to have children Increased mechanisation and industrialisation means less need for labour Increased desire for material possessions and less desire for large families Emancipation of women High Death Rates Disease and plague (e.g. bubonic, cholera, kwashiorkor) Famine , uncertain food supplies and poor diet Poor hygiene, no piped clean water or sewage disposal Falling Death Rates Improved medical care e.g. vaccinations , hospitals, doctors, new drugs and scientific inventions Improved sanitation and waters supply Improvements in food production in terms of quality and quantity Death rates Low As stage 2 Death rates Low Stage 4: Stable low population growth Low Birth rates

No or little Family Planning As stage 1 Parents have many children because few survive Many children are needed to work the land Children are a sign of virility Some religious beliefs and cultural traditions encourage large families

Improved transport to move food and doctors A decrease in child mortality

The model predicts that eventually industrialised countries will have low stable population growth. Demographic transition in LDCs If we examine the economy of Zambia it could be argued that they have moved through stage 1 and stage 2. There is also some evidence of a decline in the birth rate, characteristic of stage three, however there are certain fundamental differences between population growth in MDCs and LDCs.

The Birth and Death rates in stage 1 are higher in LDCs that in MDCs Stage 2 seems to have taken a much shorter time that it took with the MDCs

These two features have been included in a demographic transition model for LDCs by Berelson

Berelson suggests that

There are 3 clear stages rather than 4. LDCs fall into two categories, Type A and Type B.

Type A countries are those that have experienced economic development and have seen a fall in their birth rate together with a decline in their death rate in Stage 3. Type B countries, typical of many low income LDCs such as Zambia have maintained a high birth rate with a death rate that is levelling off albeit at a higher rate than Type A countries. Observation of mortality rate statistics in Zambia suggests that the death rate is starting to increase. The Aids epidemic and the worsening poverty are taking their toll.

Theories The National Income Accounts: Measuring the Circular Flow of Income:
Next theory - Neo-classical Theory >>

The circular flow of income is a simple model of the economy showing flows of goods and services and factors of production between firms and households. In the absence of government and international trade this simple model shows that households provide the factors of production for firms who produce goods and services. In return the factors of production receive factor payments, such as wages, which in turn are spent on the output of firms. This basic flow is shown in the diagram below.

In reality the households do not spend all their current income. Some is saved. This represents a leakage from the circular flow. In addition to the consumer spending, firms also carry out investment spending. This is an injection to the circular flow of income, as it does not originate from consumers' current income. In the real world the government and international trade sectors must also be included. Economic systems are in reality three sector open economies. Consequently there will be additional leakages and injections. Government spending will be injected into the circular flow and taxation will leak from it. Export flows will be injected and imports flows leaked. A full circular flow with leakages and injections is shown below.

This model of the economy demonstrates that economic activity is a flow. In actual fact it can be considered two flows, one of goods and services and a flow of money. The size of these flows is an indicator of the amount of economic activity. The circular nature of the flows means that there will be a number of different ways of measuring the size of the flow. Economists maintain that there are three possible ways of measuring this flow with each way looking at a different part of the circular flow of income. However all should give the same answer:

The output method: the total amount of goods and service produced in one year The expenditure method: the total amount of domestic spending by consumers, firms, government and foreigners The income method: the total incomes earned by the factors of production involved in the production of goods and services in one year

National income accounting is the process whereby countries attempt to measure these flows. The result of each the three methods is the gross domestic product. An examination of the national income accounts gives an insight into the economy. It provides data which governments and external agencies can use in a variety of different ways. These include:

to to to to

determine the extent of economic growth measure changes in living standards over time make comparisons of economic performance and living standards between countries examine and judge the performance of different sectors of the economy

Next theory - Neo-classical Theory >>

Theories Neo-Classical Theory of Growth

Next theory - Population Pyramids >> Neo classical theory maintains that economic growth is caused by:

increase in the labour quantity (population growth) improvements in the quality of labour through training and education increase in capital (through higher savings and investment) improvements in technology

Underdevelopment is seen as the result of the government's inefficient utilisation of resources and state intervention in markets through regulation of prices. The neo classical lobby argue that government control inhibits growth because it encourages corruption, inefficiency and offers no profit motive for entrepreneurship. They argue therefore, that the root cause of underdevelopment lies with the governments of the LDCs themselves. Only when governments adopt polices that aim to free up markets and improve the supply side, will the economy grow and development occur. This results in a shift of the long-run aggregate supply as shown in the diagram below. The potential level of output of the economy is then higher.

Neo classical economists advocate the following strategies should be encouraged:

Competitive free markets Privatisation of state owned industries A move from closed (no trade) to open (trading) economies Opening up the domestic economy through encouraging free trade (i.e. abolish tariffs and quotas) and foreign direct investment.

These policies will stimulate investment, higher output and income and hence higher savings. Problems of the model This model makes a number of unrealistic assumptions and ignores a number of crucial issues

The assumption is that the creation of a free market and a private enterprise culture is possible and desirable. The existence of market failure such as externalities associated with economic growth are ignored The problem of uneven distribution of income is ignored

Next theory - Population Pyramids >>

Theories Population Pyramids

Next theory - Price Movements of Primary Commodities >> How the population is structured is also of importance to economists. The structure of the population can be considered in terms of:

the proportion of different age groups the proportion of males and females

This information is often illustrated using a population pyramid.

The x-axis shows the population in millions whilst the y-axis shows different age ranges. The higher up the y-axis the older the population. The left half of the pyramid shows age distribution of the male population and the right half the female distribution. It is useful to examine the changes in these pyramids over time as they give clues to how the population is changing and how these changes may impact on the economy. The key points to note about the population pyramid of Zambia are that the wide base of the pyramid indicates a large proportion of the population is young. This is an indicator of a high birth rate. The narrow top indicates a small proportion of the population is old implying a high death rate. Impact on the economy Ageing or youthful populations may have implications for the following:

labour availability and unemployment? economic growth? the size and nature of markets dependency ratios welfare services such as pensions, old peoples homes educational provision i.e. primary , secondary and tertiary education housing market

Next theory - Price Movements of Primary Commodities >>

Theories The Dependency Ratio

Next theory - Dependency Theory >> A rapidly growing population with a high fertility rate will mean that a relatively large proportion of the population consists of children. An examination of the population pyramid for Zambia shows the high proportion of under 15-year-olds making up the population - the pyramid has a large base. The children will be dependent on the land and their families for sustenance. In addition to children, adults who have left the labour force because of their advanced age are also dependent. The dependency ratio is calculated by the following formula: population under age 15 and above age 65 working-age population (those aged 15-64)

A dependency ratio of 0.9 means there are 9 dependants for every 10 working-age people. It indicates the economic responsibility of those economically active in providing for those that are not. One should bear in mind that in many LDCs that there is a large number of people who are underemployed who would be counted amongst the working age population however have very low levels of productivity. It should also be remembered that many children in Zambia are economically active either working on the land or in the informal sector of the economy. The dependency ratio is a measure of the dependence that non-working people have on working people.

One of the results of the AIDS/HIV epidemic in Zambia is the increased mortality rate amongst working age population. The dependency ratio would be expected to rise. The larger the dependency ratio, the greater the responsibility the government has to provide basic consumption needs for those people who are dependent. There is also need to invest in social infrastructure such as schools and health care to those people who are dependent. Next theory - Dependency Theory >>