Linear Stages of Growth PDF

15/02/2019
Chapter 3
Classic Theories
of Economic
Growth and
Development
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
Class Theories of Economic

Development – Four Approaches
• Structural change model
– Linear stages of growth
– Saving-investment
– Rural-urban migration
• Neocolonial dependence theory

– Dependence: Center vs. Periphery
– False Paradigm
• Neoclassical theory
– Market friendly approach
– Dualistic approach
– Public choice approach
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-2
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Rostow’s Linear-Stages Model
1. Traditional society
2. Pre-condition to take-off
3. Take-off
4. Drive to maturity
5. Age of high mass consumption
1. Traditional society: slow economic and

population growth
2. Pre-condition to take-off: development of

institutions, organizations, and
infrastructure
3. Take-off: large investment in selected

industry (10 to 15% of GDP)
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4. Drive to maturity: sustained growth of the

industry and economy
5. Age of high mass consumption:

production of consumer goods and
services to serve an affluent society
GDP Growth
Economic Growth
Post Take-off
Take-off
Pre Take-off
t1 t2 Time
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Harrod-Domar Growth Model
S = sY S=Saving; Y=Real GDP; s=Saving Ratio
I = ΔK I=Investment; ΔK=Capital Accumulation
S=I Saving-Investment identity
Define the Marginal Capital-Output Ratio as k = ΔK/ΔY

Write ΔK = kΔY or I = kΔY
From S = I, write sY = kΔY or ΔY/Y = s/k
Harrod-Domar Growth Model

The source of growth is saving and investment in
production of goods and services. Accordingly,
GDP growth rate = s/k
s = national saving ratio; k = marginal capital-output ratio
If s=6% and k=3, then GDP growth rate=2%. Given k=3,

to raise growth rate to 4%, we need to increase the saving
ratio from 6% to 12% with 6% of foreign saving
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Criticism of Investment Models
• Many LDCs have not been able to take-off

or achieve maturity despite massive
foreign investment
• Many nations have neglected the

development of institutions, organizations,
and infrastructure required for
industrialization
The Lewis Development Model

• Rural agricultural sector
– Low or even zero Marginal Product of Labor so that
labor is a redundant factor and wage rate is at the
subsistence level
• Urban industrial sector

– Rising demand for unskilled labor to be trained for
industrial growth results in greater employment and
more profits and higher wages
• Rural-Urban migration
– To find jobs and earn higher wages
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Demand for Labor
Wage
R: Rural U: Urban
W: Wage E: Employment
D: Labor Demand S: Labor Supply
Profit
WU SR
WR
Wage Investment in urban areas
increases the demand and
DU1 DU2 employment for rural labor.
E1 E2 Employment
11
Criticisms of Lewis Model
• Industrial technology is generally capital

intensive/labor-saving. Hence, the demand
for unskilled rural labor would not increase
employment
• Industrialization must be supported by

agricultural development to supply an
ever-increasing supply of food items and
raw materials
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Demand for Labor
Wage No increase in employment when

technology is labor saving
Profit
SR
WU
WR Wage
DU1
DU2
E1 = E 2 Employment
13
Neocolonial Dependence Model
• MDCs form the “center” of global economic

relations and technological advancement
• LDCs serving as the “periphery” are dominated by:

– unequal trade and finance relations
– domestic politico-economic elite
– multinational corporations
Under these conditions economic development is

impossible
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Neocolonial Dependence Model
African LDCS
Asian LDCS American

MDCs
Latin American LDCS
European Other
MDCs MDCs
15
False-Paradigm Model
• Economic development relies heavily on funds

from international donor agencies such as the
World Bank and IMF
• The policy of these agencies is to support urban

industrial growth and impose capitalistic
austerity measures
• They reinforce the pattern of “dependent

development”
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Dualistic Development Model
• Structural transformation models create a

“dualistic” pattern of development, resulting in an
ever-increasing degree of economic inequality
both nationally and internationally:
– urban vs. rural

– industrial vs. agricultural
– modern vs. traditional
– rich vs. poor
17
Approaches to Development
• Free-market approach: rely of the allocation role

of markets and limited government involvement in
economics. But, there are several areas in which
markets fail to achieve efficient outcomes:
– income distribution
– public goods
– externalities
– market power
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• Market-friendly approach: improve market

operation through “nonselective”
interventions such as
– income redistribution system

– investment in social and human capital
– environmental protection policy
– anti-trust laws
19
• Public-choice approach: public officials and

bureaucrats in the position of authority are
“rent-seeking” citizens acting on self-interest
rather than public-interest
• Need a system of checks and balances to monitor

the behavior of public officials and bureaucrats
• Need a democratic system to let people choose

public officials and bureaucrats for limited duration
of authority
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Appendix 3.1: Components of

Economic Growth
• Capital Formation
– Physical capital formation: investment in tools,

equipment, machinery, buildings
– Social capital formation: investment in roads, dams,

airports, railroads, bridges
– Human capital formation: investment in education,

training, health, nutrition
– Political capital formation: investment is creating a

secular and democratic government and free mass
media
21
Determinants of Economic
Growth
• Physical Capital Formation
– Increase in the amount of physical

capital per unit of labor
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Determinants of Economic
Growth
• Technological Advancement
– Increase factor productivity (labor,

land, capital)
23
Production Possibilities Curve
• Maximum quantities of two good and

services the economy can produce,
assuming:
– full employment / efficiency

– fixed resources
– constant technology
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PPC Schedule
Combination A B C E
100 90 50 0
Radios
Rice 0 40 80 100
25
PPC Graph
Combinations A, B, C, and E are attainable

Combination D is unattainable given resources
Radios and technology
Combination F is attainable, but inefficient
A
100
B D
90
50 C
F
E
40 80 100 Rice
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Economic Growth
Combination D becomes available with

Radios more resources and better technology
A
100 B D
90
50 C
E
40 80 100 Rice
27
Economic Improvement
Radios Combinations G (or B or C) becomes

efficient with more employment
A and/or improved efficiency
100
B
90
G
50 C
F
E
40 80 100 Rice
28
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Technological Advancement
Neutral: proportional increase in the supply of Rice and Radios
Radios
Rice
29
Capital augmenting: greater increase in the supply of Radios
Radios
Rice
30
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Labor augmenting: greater increase in the supply of Rice

Radios
Rice
31
Advancement only in agricultural production

Radios
Rice
32
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Radios Advancement only in industrial production
Rice
33
Factor Accumulation Accounts for

Only a Fraction of Growth
34
17

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15/02/2019

Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

Class Theories of Economic

• Neocolonial dependence theory

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-2

Rostow’s Linear-Stages Model

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-3

Rostow’s Linear-Stages Model

1. Traditional society: slow economic and

2. Pre-condition to take-off: development of

3. Take-off: large investment in selected

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-4

Rostow’s Linear-Stages Model

4. Drive to maturity: sustained growth of the

5. Age of high mass consumption:

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-5

Rostow’s Linear-Stages Model

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-6

Harrod-Domar Growth Model

S = sY S=Saving; Y=Real GDP; s=Saving Ratio

I = ΔK I=Investment; ΔK=Capital Accumulation

S=I Saving-Investment identity

Define the Marginal Capital-Output Ratio as k = ΔK/ΔY

From S = I, write sY = kΔY or ΔY/Y = s/k

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-7

Harrod-Domar Growth Model

GDP growth rate = s/k

s = national saving ratio; k = marginal capital-output ratio

If s=6% and k=3, then GDP growth rate=2%. Given k=3,

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-8

Criticism of Investment Models

• Many LDCs have not been able to take-off

• Many nations have neglected the

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-9

The Lewis Development Model

• Urban industrial sector

Demand for Labor

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-11

Criticisms of Lewis Model

• Industrial technology is generally capital

• Industrialization must be supported by

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-12

Demand for Labor

Wage No increase in employment when

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-13

Neocolonial Dependence Model

• MDCs form the “center” of global economic

• LDCs serving as the “periphery” are dominated by:

Under these conditions economic development is

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-14

Neocolonial Dependence Model

Asian LDCS American

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-15

• Economic development relies heavily on funds

• The policy of these agencies is to support urban

• They reinforce the pattern of “dependent

Dualistic Development Model

• Structural transformation models create a

– urban vs. rural

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-17

• Free-market approach: rely of the allocation role

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-18

• Market-friendly approach: improve market