INTERNATIONAL

DEVELOPMENT STUDIES &

DEVELOPMENT THEORIES
Ralph Lagrada & Jeff Dela Cruz
SCHUMPETER’S

THEORY OF ECONOMIC
DEVELOPMENT
UNDERSTANDING
JOSEPH ALOIS SCHUMPETER
He was an economist and is
regarded as one of the 20th
century's greatest
intellectuals.

He is best known for his

theories on business cycles
and capitalist development
and for introducing the
Joseph Alois Schumpeter
concept of
(1883 - 1950)
entrepreneurship.
Schumpeter was born in
what is now the Czech
Republic in 1883, learning
economics from the
progenitors of the Austrian
school tradition, including
Friedrich von Wieser and
Eugen von Bohm-Bawerk.
Joseph Alois Schumpeter
(1883 - 1950)
MAIN FEATURES

1 Circular Flow of Income 2 Role of the Entrepreneur

3 Cyclical Process/
4 End of Capitalism
Business Process
1. Circular Flow
“The circular flow is a stream that is fed from the continually
flowing springs of labour power and land and flow in every
economic period into the reservoir which we call income, in
order to be transformed into satisfaction of wants”.
Features:

(a) All economic activities are

essentially repetitive and
follow a familiar routine
course.

(b) All the producers know the

aggregate demand for goods
and adjust the supply of
output accordingly. This
means demand and supply
are in equilibrium at each
point of time.
Features:

(c) The economic system has the

optimum level of output and
its maximum use and there is
no possibility of wastage of
resources.

(d) The firms working in a system

are in a state of competitive
Equilibrium

(e) Under the stationary

equilibrium, the prices are
equal to the average cost.
In its simplest version, the
economy is modeled as consisting
only of households and firms
However, actual money flows
through the economy are far
more complicated.

Economists have expanded on

the ideas of the circular flow of
income model to better depict
the complexity of modern
economies by including more
sectors that affect money flow.
In its simplest version, the
economy is modeled as consisting
only of households and firms thus
Income (Y) = Output (O) =
Expenditure (E)

Y=E
LEAKAGES AND INJECTIONS
Now there are two types of
expenditure: consumption (by
households) and investment (by
firms), So E = C + I. Also, the
households? income is not all
spent anymore. Some of it is
saved, so Y = C + S.

Y=E
C+I=C+S
I=S
For the purposes of the circular flow
diagram, governments do two
things: they tax businesses and
consumers, and they then spend
this money on consumers (benefits
and pensions) and businesses
(subsidies).

Y=E
C+I+G=C+S+T
I+G=S+T
The black line for imports (M)
comes out of the red consumption
(C) line. This is because it is the
consumers who buy these imports
(like German and Japanese cars)
which means that money leaks out
of the economy.

Y=E
C+I+G+X=C+S+T+M
I+G+X=S+T+M
When changes take place in the economy,
circular flow is disturbed and the
development process starts.
 INNOVATION
Innovation may be defined as a change in existing
production system to be introduced by the entrepreneur
with a view to make profits and reduce costs.
 (a) The introduction of a new product

(b) The introduction of a new method of

production

(c) The opening up of a new market

INNOVATION (d) The conquest of a new source of supply of
raw materials or semi manufactured goods.

(e) The carrying out of the new organisation of

any industry like the creation of a monopoly.
2. Role of the Entrepreneur
Entrepreneurship is different from managerial activity.
 As in economic system, there is high degree of
risk, thus entrepreneur is motivated:

(a) The desire to find a private commercial

THE kingdom.

ENTREPRENEUR (b) The will to conquer and prove his superiority.

(c) The joy of creating, getting things done or

simply of exercising one’s energy and ingenuity.
Three things are necessary for the performance of
the entrepreneurial function:
1. Technical Know-how
2. Capital Resource
3. Credit Creation
Profits arise due to dynamic changes resulting
from an innovation.
Breaking the Circular Flow
Schumpeter regards economic
development as a dynamic and
discontinuous process. The
society progresses through trade
cycles. In order to break the
circular flow, the innovating
entrepreneurs are financed by
bank credit expansion.
3. Business Cycle or Cyclical
Process
Schumpeter believes that business cycle or crisis is not merely the result of
economic factors but also of non-economic factors.
In the Schumpeterian analysis of
development entrepreneurs have to
play the central role in business cycles.
They initiate the economic
development in the spontaneous and
discontinuous manner.
4. Creative Destruction
"process of industrial mutation that incessantly revolutionizes
the economic structure from within, incessantly destroying
the old one, incessantly creating a new one."
Due to its drawbacks, capitalism
(a) The Obsolescence of Entrepreneurial Function
disintegrates and yields place to
socialism, Schumpeter gives the (b) Destruction of Institutional FrameWork
following reasons for the (c) Destruction of Protecting Political Strata
disintegration of capitalism:
SCHUMPETER vs. MARX vs. KEYNES
WHO IS

THE HERO?
 Schumpeter Marx Keynes
Entrepreneur Radical The Economist
Intellectual

WHO IS

THE HERO?
 SCHUMPETER MARX
Its very success undermines the social
institutions which can protect it, and inevitably
creates conditions in which it will not be able to
live and which strongly point to socialism as heir
apparent.
Capitalism destroys the old pre-capitalist society
and consistently revolutionizes it, tearing down all
the barriers which hem in development of forces of
production, the expansion of needs, the all-sided
development of production and the exploitation and
exchange of mental forces.
 KEYNES SCHUMPETER
Keynes explicitly attacks the classical framework Schumpeter on the other hand implicitly accepts it and
(Dillard, 1948) uses it as a base to explain his own dynamic model
(Velde, 2001).

Keynes believed that government policies are Schumpeter however, believed that the process of
essential to sustain a capitalistic economy capitalistic development is initiated by the introduction
(Dillar, 1948). of new combination through innovation (Velde, 2001).
 KEYNES SCHUMPETER
Both state the diffusion of money induces a radical modification into the way in which an
economy works (Bertocco, 2006).

They both describe reasons why money and financial aggregates are not neutral, they
highlight the crucial role of the credit market and the banks (Bertocco, 2006).
 1. Role of innovator emphasized
2. Role of savings ignored
3. Analysis of capitalist process not
convincing

CRITICISMS 4. Emergence of socialism not based on

sound reasoning
5. Innovations is not the main cause of
economic development
6. Little relevance for underdeveloped
countries
AMARTYA SEN’S
DEVELOPMENT AS FREEDOM
UNDERSTANDING
AMARTYA SEN
Amartya Sen

- Indian economist who was

awarded the 1998 Nobel Prize
in Economic Sciences for his
contributions to welfare
economics and social choice
theory

-the first Indian and the first

Asian to win the Nobel prize
for economics.
 THE ARGUMENT

Freedom is both the primary end and the

principal means of development.
 THE REASONS

The only acceptable evaluation of human progress is primarily

1
and ultimately enhancement of freedom.

2 The achievement of development is dependent on the free

agency of people.
The Lee Thesis

● Named after Lee Kuan Yew, the leader and former president of
Singapore
● Economic growth is stimulated by denial of political & civil liberties.
● Poor people will choose economic needs over political freedom.
Development as Freedom

Capability Approach
Social arrangements should be primarily evaluated according to the extent of
freedom people have to promote or achieve functionings they value

The basic concern of human development is ‘our capability to lead the kind of
lives we have reason to value’, rather than the usual concentration on rising
GDP, technical progress, or industrialization.

Progress, or development, or poverty reduction, occurs when people have

greater freedoms
Development as Freedom

Functionings

● Reflective of the various things a person may value doing or being

Capability

● Refers to the ability to achieve alternative functioning combinations or

various lifestyles.
● Also called as Opportunity Freedom
Development as Freedom

Freedoms

● Sen argues that the importance of many aspects of human

development is that they have intrinsic and instrumental value at the
same time. (Example: Education)
● Freedom “is not only the ultimate end of development; it is also a
crucially effective means.”
● Instrumental Freedom - “tend to contribute to the general capability of
a person to live more freely.”
Development as Freedom

Instrumental Freedoms
● Political Freedoms (e.g. democracy)
● Economic Facilities (e.g. access to economic resources or entitlements)
● Social Opportunities (e.g. health care, education, etc.)
● Transparency guarantees (e.g. information is honestly disclosed)
● Protective security (e.g. social protections for vulnerable people)
Development as Freedom

Human Development
● Takes place as a process that aims at expanding substantive freedoms
and this can come about only through the intervention of human
agency as the very means to achieve it.
● Development requires the removal of major sources of unfreedom:
(poverty as well as tyranny, poor economic opportunities as well as systematic social deprivation,
neglect of public facilities as well as intolerance or overactivity of repressive states.)
Development as Freedom

Poverty and Availability Deprivation

● Poverty must be seen as the deprivation of basic capabilities.
● There is a correlation between income poverty and capability poverty

Advantages of Capability Approach

● Income is not the only instrument in generating capabilities

● Impact of income on capabilities is contingent and conditional
Development as Freedom

3 Roles of Freedom

1. As a the principal ends of development

2. As the primary means toward achieving development
3. Constructive role in the organization of societal arrangements
Development as Freedom

As the principal ends of development

Development must be assessed primarily in terms of whether people’s real

freedoms are expanded by societal arrangements and not merely by looking
at proxy-indicators such as income, utilities, nor primary goods no matter
how much easier they are to measure.
Development as Freedom

As the primary means toward achieving

development
The instrumental role of freedom where the expansion of freedom of one
kind leads to the expansion of freedoms of other kinds because of the
mutually reinforcing connections between these different kinds of
freedoms.
Development as Freedom

Constructive role in the organization of societal

arrangements
Has to do with the formation and reorientation of values which mediate the
exercise of people’s freedom toward nation-building.
Development as Freedom

Concept of Freedoms
Freedoms are linked together and affect one another.

Example:

● Political freedoms (free speech, elections) promote economic security

● Social freedoms (education, health facilities) promote economic participation
● Economic facilities, generate personal abundance as well as public resources for
social facilities
Development as Freedom

Concept of Freedoms
Freedom is a central process of development.

● Evaluative Reason
○ Assessment of progress has to be done primarily in terms of whether the
freedoms that people have are enhanced

● Effectiveness Reason
○ Achievement of development is thoroughly dependent on the free agency of
people
Development as Freedom

Concept of Freedoms
Freedom includes:

● Processes
○ Allow freedom of actions (i.e. voting privileges, political & civil rights)

● Opportunities
○ Available to people given their social circumstances
■ (i.e. capability– to escape premature mortality, involuntary starvation)
INEQUALITY IN ASIA AND THE
PACIFIC
Technological change, globalization, and
market-oriented reform have been the key drivers
of Asia’s remarkable growth and poverty reduction, as
they are the sources of productivity improvement in the
quality of life.
Asia’s rising inequality amid
rapid economic growth
From 1990 to 2010, the average annual growth rate of
the gross domestic product (GDP) for developing Asia
reached 7.0% in terms of 2005 purchasing power parity
(PPP) dollars,

This rapid growth has significantly improved living

standards and reduced
extreme poverty
Asia’s rising inequality amid
rapid economic growth
This performance in growth and poverty reduction has,
however, been accompanied by rising inequality in a
large part of the region. Of the 30 countries that have
comparable data, 12 – accounting for about 82% of
developing Asia’s population in 2010 – experienced
rising inequality of per capita expenditure or income, as
measured by the Gini coefficient,
Inequality of Opportunity
vs. Inequality of Outcome
Inequality of opportunity is the portion of the inequality
of outcome that can be attributed to differences in
“individual circumstances” (Roemer 1998)

Public policy must be put in place to reduce or

eliminate inequality of opportunity
Why rising inequality
matters
Rising inequality hampers poverty reduction.

Not only does inequality dampen the poverty

reduction impact of growth, it can
also affect growth itself, through a number of
economic, social, and political
mechanisms.
Inequality on the policy
agenda
Governments are not blind to the problem. Indeed, in
recent years, more have embraced the concept of
inclusive growth to make income distribution more
equitable:
 1. What have been the trends of inequality
in Asia and the Pacific?
2. What are the key drivers of rising
QUESTIONS? inequality in the region?
3. How should Asian countries respond to
the rising inequality?
Determining Trends of Inequality in
Asia and the Pacific
Statistics show that 12 of the 30 Asian economies
with comparable data experienced an increase in
inequality in the past two decades. . The increase
was more pronounced when measured by the
ratio of the income share of the richest 20% of
households to that of the poorest 20% than by the
Gini coefficient.
Determining Trends of Inequality in
Asia and the Pacific

The Gini coefficient is a measure of dispersion of a frequency distribution,

for example, of how income or consumption expenditures are
distributed across households.
 Determining Trends of Inequality in
Asia and the Pacific:
The Gini Coefficients
The Gini coefficient is a measure of dispersion of
a frequency distribution, for example, of how
income or consumption expenditures are
distributed across households.
Determining Trends of Inequality in
Asia and the Pacific:
The Gini Coefficients
Of the 37 economies with available data in the 2000s (Table 2.2),1 14
had a Gini coefficient of or greater than 40, widely considered the
threshold for “high inequality.”
Determining Trends of Inequality in
Asia and the Pacific:
The Gini Coefficients
Twelve of the 30 economies with comparable data showed an
increase (worsening) in the coefficient in the past two decades.
These 12 cover 82% of the region’s population.

The trend of rising inequality is widespread in the region, yet 14

economies with comparable data (five in Central Asia) recorded an
improvement in their Gini
Determining Trends of Inequality in
Asia and the Pacific:
The Gini Coefficients
There appears to be a positive and
statistically significant relationship between
the increase in the Gini (rising inequality) and
gross domestic product (GDP) growth
(Figure 2.1). The economies where growth
has been higher tend to experience large
increases in inequality; however, there are
large variations in this relationship.
Determining Trends of Inequality in
Asia and the Pacific:
The Quintile Ratio
Quintile ratios – the ratio of the per capita expenditure of the top
20% to that of the bottom 20%

In the late 2000s, 13 out of the 33 economies with available data

had a quintile ratio of or above 7; that is, the average per capita
expenditure of the richest 20% households was at least seven times
as high as that of the poorest 20%

The mean quintile ratio for the 33 economies was 7.2.

Asia’s inequality in a global context
Despite recent increases, Gini coefficients in developing Asia are
still on average lower than in other regions of the developing world.

Compared with OECD countries, however, developing Asia’s

inequality is much higher overall. Of the 34 OECD countries with
comparative data, most countries had a Gini in the range of 25–35

High taxes and transfers are key reasons for their low income
inequality. Thirty-one OECD countries had a Gini coefficient before
taxes and transfers greater than 40 in the late 2000s
Key drivers of rising inequality in Asia

Technological Globalization Market-oriented Inequality of

Change Reforms Opportunity
Key drivers of rising inequality in Asia

This can impact the distribution of

income among different factors of
production if it favors skilled labor
(more educated or more
experienced) over unskilled labor by
increasing its relative productivity.

Technological Change
Key drivers of rising inequality in Asia

Globalization could magnify the

distributional impact of
technological progress.

Globalization
 Decrease No Increase Inclusive or Varying
Financial Trade Trade liberalization may decrease or
integration liberalization increase wage differentials.
can spur
growth and Financial integration may increase
benefit the access to finance by the poor, but
poor. gains may be captured by the elite:
inequality increases at low income
levels and decreases as income
rises.
Trade openness benefits the rich
more than the poor in very poor
countries; it benefits the poor and
middle class more as income rises
Financial globalization increases
Gini coefficient by about 0.04; trade
globalization decreases Gini
coefficient by about 0.05.
Increase
Foreign direct investment (FDI) increases demand for
high-skilled workers.
FDI increases demand for skilled workers,
explains 11% of wage inequality
FDI increases demand for high-skilled workers, and
thus explains 50% of the increase in share of skilled
labor.
Trade induces skill intensification in the
traded manufacturing sector, resulting in a 0.1%
change in wage premium.
The trade index explains 10–12% of the wage gap
between workers with different
schooling; the financial index explains 12–33% of the
gap; and the capital account index explains 25–30%.
Financial integration may lead to crises that hurt
the poor: poverty incidence increased in Republic of
Korea, Malaysia, Thailand, and some Latin American
countries.
Key drivers of rising inequality in Asia

An important driver of growth, but it

can also have significant
distributional consequences.

Market-oriented
Reforms
Key drivers of rising inequality in Asia

The impacts of the three drivers of

growth can be geographically
uneven, leading to a further channel
of changing income distribution:
spatial inequality.

Inequality of
Opportunity
Asian Countries Response to Rising
Inequality
While technological progress, globalization, and market-oriented
reform are the basic driving forces behind rising inequality in Asia,
these forces cannot be reversed because they generate productivity
growth that underpins Asia’s poverty reduction, economic expansion,
and improvements in living standards.
Asian Countries Response to
Rising Inequality
They propose that Asian governments should respond
to rising inequality via three sets of policy measures:

(i) efficient fiscal policy

(ii) interventions to support lagging regions
(iii) more employment-friendly growth
Asian Countries Response to Rising Inequality:
Efficient Fiscal Policy
Increasing spending on education and health,
developing better targeted social protection programs,
switching from inefficient general subsidies to targeted
transfers, and greater and more equitable revenue
mobilization
Asian Countries Response to Rising Inequality:
Efficient Fiscal Policy
Asian Countries Response to Rising Inequality:
Interventions to support lagging regions
Improving regional connectivity, developing new
growth centers, more effective fiscal transfers, and
removing barriers to migration
Asian Countries Response to Rising Inequality:
Interventions to support lagging regions
Improving regional connectivity

Poor connectivity due to lack of adequate transport and

communication infrastructure is often a major constraint
for interior states or provinces in engaging in global
trade and attracting investment.
Asian Countries Response to Rising Inequality:
Interventions to support lagging regions
Developing Growth poles in lagging regions

Countries can identify areas of potential growth poles

and use policy tools and public investment to trigger
growth
Asian Countries Response to Rising Inequality:
Interventions to support lagging regions
Transferring fiscal resources for greater investment in
human capital and better access to public services in
poor regions
Asian Countries Response to Rising Inequality:
Interventions to support lagging regions
Reducing barriers to within-country migration

Migration from poor to prosperous areas is one of the

major means for reducing regional inequality. Migration
and labor mobility often come up against significant
barriers. One comes from the bureaucratic and
administrative obstacles to moving from one part of the
country to another.
Asian Countries Response to Rising Inequality:
More Employment-Friendly Growth
Maintaining a more balanced sectoral composition of
growth, supporting the development of small and
medium-sized enterprises, removing factor market
distortions that favor capital over labor, and
strengthening labor market institutions.