3.1.

CLASSIC THEORIES OF ECONOMIC DEVELOPMENT

 The Linear-stage-of-growth model
 Theories and patterns of Structural Change
 The International-Dependence Revolution
 The Neoclassical, free market counterrevolution
3.2. DEVELOPMENT AS GROWTH AND THE LINEAR-STAGES THEORY
Rostow’s Stages of Growth
1. Traditional Society-This is an agricultural economy of mainly subsistence farming, little of which is traded.
2. Pre-conditions for take-off-Agriculture become more mechanized and more output is traded.
3. Take-off-Manufacturing industry assumes greater importance, although the number of industries remains small.
4. Drive to maturity-Industry becomes more diverse.
5. Age of mass consumption- Output levels grow, enabling increased consumer expenditure.
 The Harrod-Domar Growth Model
- This model is based on the capital factor as the crucial factor of economic growth. It concentrates on the possibility of
steady growth through adjustment of supply of demand for capital.
• The Harrod-Domar Model suggests that economic growth rates depend on two things:
a. Level of Savings (higher savings enable higher investment)
b. Capital-Output Ratio. A lower capital-output ratio means investment is more efficient and the growth rate will be
higher.
Necessary versus Sufficient Conditions: Some Criticisms of the Stages Model
Unfortunately, the mechanisms of development embodied in the theory of stages of growth did not always work. And the
basic reason they didn’t work was not because more saving and investment isn’t a necessary condition for accelerated rates of
economic growth but rather because it is not a sufficient condition.
 Necessary Conditions
If we say that "x is a necessary condition for y," we mean that if we don't have x, then we won't have y. Or put differently,
without x, you won't have y. To say that x is a necessary condition for y does not mean that x guarantees y.
 Sufficient Conditions
If we say that "x is a sufficient condition for y," then we mean that if we have x, we know that y must follow. In other words, x
guarantees y.
3.3 THE STRUCTURAL-CHANGE MODELS
-focuses on the mechanism by which underdeveloped economies transform their domestic economic structures to a more modern,
more urbanized, and more industrially diverse economy
-it is the hypothesis that underdevelopment is due to underutilization of resources
 Two important example of such models are:
1. Lewis’s Model
2. The Pattern of Development Empirical Analysis by Chenery
 Lewis’s Structural Change Model
-Nobel laureate Lewis said that underdeveloped economy consists of two sectors. A traditional, over populated rural
subsistence sector with surplus labour and a high productivity modern sector to which this surplus labour is transferred.
-The focus of the model is on the process of surplus labour transfer from the traditional sector which leads to the growth of
output and employment in the modern sector. Lewis calculated that with an increase of 30% or more in the urban wages,
workers will migrate from the rural areas to the urban areas- which would lead to growth in output and employment through
the modern sector.
 Criticisms
-It reflects the historical experience of economic growth in the West
1. Assumes that the faster the rate of capital accumulation the higher is the growth rate of the modern sector and the faster
is the rate of new job creation- but it is not necessary that the capitalist profits will be re-invested in more sophisticated
labour-saving technologies or there will be no capital flight.
2. Surplus labour exists in the rural areas while there is full employment in the urban areas- this un supported by empirical
literature and is generally not valid.
3. Notion of competitive modern-sector labour market that guarantees the existence of  constant real urban wages up to
the point where the supply of rural surplus labour is exhausted – however, urban wages continue to rise even in the
presence of  rising levels of open modern sector unemployment and the existence of surplus labour in the rural sector due
to the presence of unions, civil services wage scales and Multi National Corporations own hiring practices that tend to
negate competitive forces in the LDC  modern sector.
4. Finally evidence suggests that increasing returns prevail in the modern sector instead of diminishing returns, which
means that the modern sector might continue to use more and more of capital instead of labour.
Patterns of Development Analysis
-Economic, industrial, and institutional structure of an economy transformed to permit new industries as engine of growth
-Capital accumulation + changes in economic structure needed
-Constraints (affect level of development)
 Internal (resources, population size, government policies)
 External (access to capital, technology, trade
-Empirical work of Harvard economist Chenery and his colleagues, cross-sectional and time series studies of countries
different levels of per capital income, identifies characteristic features of the development process:
  Shift from agriculture to industrial production
 Steady accumulation of physical and human capital
 Change in consumer demand from basic necessities to diverse manufactured goods
 Growth of cities and urban industries
 Decline in family size and overall population
-Proponents of structural change model prefer “facts to speak for themselves” unlike theories such as stages of growth
Conclusion
-Major hypothesis: development in an identifiable process of growth and change with features similar in all countries
-Problem: The model does not recognize differences, factors influencing development process
-Limitations emphasizing patterns over theory that may draw wrong conclusions about causality
-Optimistic that “correct” mix of policies will generate beneficial patterns
3.4. THE INTERNATIONAL-DEPENDENCE REVOLUTION
During the 1970s, international-dependence models gained increasing support, especially among developing-country
intellectuals, as a result of growing disenchantment with both the stages and structural-change models.
The Neocolonial Dependence Model
•Underdevelopment results from a historical evolution of an unequal international capitalist system consisting of the centre
and the periphery.
•Groups including landlords, merchants, trade union leaders etc. with high incomes political power and social status have their
interests in link with the international capitalist system of inequality.
•Underdevelopment is seen as an externally induced phenomenon.
The False-Paradigm Model
•Underdevelopment is a result of inappropriate advice provided by well-meaning but uninformed, biased experts from
assistance agencies of developed countries and multinational donor organizations.
•Too much emphasis is placed on attempts to measure capital-output ratios, to increase savings and investment ratios or
maximize GDPs divert attention from institutional and structural reforms.
The Dualistic-Development Thesis
•This thesis recognizes the existence and persistence of increasing divergences between rich and poor nations, and between
rich and poor people at various levels. The urban elites in developing countries will remain rich and become richer. The
wealth of these elite will not trickle down to the rest of the society.
•Basically, dependency theories highlight the need for major new policies to eradicate poverty, to provide more diversified
employment opportunities, and to reduce income inequalities.
•Four elements of dualism:
1. Different sets of conditions, of which some are superior and others inferior, can coexist in a given space.
2. The coexistence id chronic and not transitional.
3. The degrees of superiority or inferiority have a tendency to increase over time.
4. The superior element does little or nothing to pull up the inferior element and may in fact serve to push it down.
3.5 THE NEOCLASSICAL COUNTERREVOLUTION: MARKET FUNDAMENTALISM
Neoclassical Counterrevolution
1. Developed Nations
-This counterrevolution favored supply-side macroeconomic policies, rational expectation theories, and the privatization of
public corporations.
2. Developing Countries
- It called for freer markets and the dismantling of public ownership, statist planning, and government regulation of economic
activities.
The neoclassical counterrevolution can be divided into three component approaches:
1. Free-market analysis argues that markets alone are efficient—product markets provide the best signals for investments in
new activities; labor markets respond to these new industries in appropriate ways; producers know best what to produce and
how to produce it efficiently; and product and factor prices reflect accurate scarcity values of goods and resources now and
in the future.
2. Public-choice theory, also known as the new political economy approach, goes even further to argue that governments can
do (virtually) nothing right. This is because public-choice theory assumes that politicians, bureaucrats, citizens, and states
act solely from a self-interested perspective, using their power and the authority of government for their own selfish ends.
3. The market-friendly approach is a variant on the neoclassical counterrevolution associated principally with the 1990s
writings of the World Bank and its economists, many of whom were more in the free-market and public-choice camps
during the 1980s.15 This approach recognizes that there are many imperfections in developing-country product and factor
markets and that governments do have a key role to play in facilitating the operation of markets through “nonselective”
(market-friendly) interventions.
Traditional Neoclassical Growth Theory
In terms of GDP growth, this is equivalent to raising domestic savings rates, which enhances capital-labor ratios and per
capita incomes in capital-poor developing countries.
Capital-labor ratio - the number of units of capital per unit of labor.
Solow Neoclassical Growth Model
-represented the seminal contribution to the neoclassical theory of growth and later earned Robert Solow the Nobel Prize in
economics
-More formally, the standard exposition of the Solow neoclassical growth model uses an aggregate production function
 -The Solow neoclassical growth model implies that economies will converge to the same level of income per worker
“conditionally”—that is, other things equal, particularly savings rates, depreciation, labor force growth, and productivity.
3.6. CLASSIC THEORIES OF DEVELOPMENT: RECONCILING THE DIFFERENCE
 Linear Stages Model
-emphasize the crucial role that savings and investment play in promoting sustainable long run growth.
 Lewis two sector model of structural change
-importance of transfers of resources frow low to high productivity
 International Dependence Theory
-importance of the structure and workings of the world economy.
 Conventional Neoclassic Economic Theory
-needs to be modified to fit the unique social, institutional and structural circumstances of developing nations.

Appendix 3.1 Components of Economic Growth

1 .Capital accumulation
-some proportion of present income is saved and invested in order to augment future output and income
*Capital stock - assets that help with the production
*Economic infrastructure-refers to the facilities, activities and services which support operation and development of
other sectors of the economy.
2.Population and Labor Force Growth
-Population growth, and the associated eventual increase in the labor force, have traditionally been considered a positive factor in
stimulating economic growth.
3. Technological Progress
-Increased application of new scientific knowledge in the form of inventions and innovations with regard to both physical and
human capital.
 Neutral technological progress -Higher output levels achieved with the same quantity or combination of all factor
inputs.
 Labor-saving technological progress -The achievement of higher output using an unchanged quantity of labor inputs as
a result of some invention or innovation
 Capital-saving technological progress -Technological progress that results from some invention or innovation that
facilitates the achievement of higher output levels using the same quantity of inputs of capital
 Labor-augmenting technological progress -raises the productivity of an existing quantity of labor
 Capital-augmenting technological progress -raises the productivity of capital by innovation and inventions
APPENDIX 3.2 SOLOW NEOCLASSICAL GROWTH MODEL
 Robert Solow of the Massachusetts Institute of Technology, received the Nobel Prize
 Best known model of economic growth
 It implies that economies will conditionally converge to the same level of income if they have the same rates of savings,
depreciation, labor force growth, and productivity growth.
 Solow model is the basic framework for the study of convergence across countries
 The aggregate production function, Y = F(K, L) is assumed characterized by constant returns to scale.
Cobb-Douglas production function, at any time t we have
where Y is gross domestic product, K is the stock of capital (which may include human capital as well as physical capital),
L is labor, and A(t) represents the productivity of labor, which grows over time at an exogenous rate.
 More generally,
 where γ is some positive amount (1.1 in the case of a 10% increase). Because γ can be any positive real number, a
mathematical trick useful in analyzing the implications of the model is to set γ = 1>L so that
 In the Harrod-Domar model, this would instead be a straight, upward-sloping line. This simplification allows us to deal
with just one argument in the production function. For example, in the Cobb-Douglas case introduced in Equation
Appendix 3.3 Endogenous Growth Theory
 Motivation for the new growth (endogenous) theory
 Mixed performance of neoclassical theories
 External shocks or technical change necessary (FDI, human investment, etc.)
 Rising output always temporary; convergence to zero growth
 Cannot analyze causes of technological advance
 Cannot explain large residual differences across countries
 Market reforms of LDCS and no convergence
 Solow (exogenous, neoclassical) vs. Romer (endogenous)
 Structural similarities
 DMR (Solow) vs. IR (endogenous)
 Spillovers impact rate of return (endogenous)
 (Y=AK)
 No force leading to equilibrium of growth rates
 No income catch-up based on savings rates (prolonged income gap)