Chapter 3 Development Theories and Practices

Chapter 3
Driving Factors of Development: Theory

and Practice
Development strategies & Policies: for MSc

Program: Lecture by Berhanu
11/4/2021 G(Ass.Professor) 1
3.1Classic Theories of Economic Development
1. Linear stages of growth models (Rostow model
and Harrod-Domar model, Solow)
2. Theories and Patterns of structural change (The
Lewis two-sector model and Chenery Model)
3. Development strategy theories(Balanced and
unbalanced)
4. International-dependence revolution
(Neoclassical dependence model, The False
Paradigm model, Dualistic development thesis)
5. Pattern of Development Theory
6. Neoclassical, free market counterrevolution
7. Endogenous Development Theory
1) Rostow’s Stages of Growth
• All countries must pass series of successive stages of economic
growth
1. Traditional society
•simple, traditional, labor intensive techniques, traditional social
norms, land owner holds the power, high share of agriculture,
low agricultural productivity
2. Precondition for take-off stage(Transitional
society)
•Development of institutions, organizations, and infrastructure
•Perquisites for “take off ” are installed, traditional boundaries
and norms collapse; modern form of production and
innovations are accepted, consciousness for development and
national spirit
Development strategies & Policies: for MSc Program: Lecture by Berhanu

3.Take off Stage:
•Large investment in selected industry (10 to 15% of GDP)
•Economic growth and technical innovation become a national
phenomena in industry, agriculture and other sectors
•The emergence of new institutions or cultural framework that
exploits expansion.
•Social and political structures become more susceptible to change
Steady growth, use of technical progress
•Broad acceptance of technical progress, wide production base
4. Drive to maturity stage:

•sustained growth of the industry and economy
•Diversification of the industrial base; multiple industries expand &
new ones take root quickly manufacturing shifts from investment-
driven (capital goods) towards consumer durables & domestic
consumption rapid development of transportation infrastructure
large-scale investment in social infrastructure
11/4/2021 Program: Lecture by Berhanu G(Ass.Professor) 4
•The character of labor force changes, be skilled; the
character of entrepreneurship changes; and the society feels
industrialization
5. Age of High mass consumption
• High per-capita-income above the minimum for existence; social
security systems (welfare state), services
• Steady growth, structural changes. And Old industries disappear,
new industries arise
• High technology and social welfare
•The industrial base dominates the economy;
• The primary sector is of greatly diminished weight in economy &
society widespread and normative consumption of high-value
consumer goods consumers typically (if not universally),
•Society with high disposable income, beyond all basic needs, for
additional goods

Figure 3.1 : Rostow’s model

2) Harrod-Dommar Model
• During the 1940s by Roy Harrod and Evsey
Domar developed the model.
• But the H-D model has been used extensively in
LDCs as a simple way to look at the relationship
between growth and capital requirements.
• Every economy must save a certain proportion of
its national income to replace worn-out or
impaired capital goods & to invest for further
growth.
• Assuming a closed economy (no international
trade), total income (Output) -Y is defined as total
consumption plus saving of the society. i.e,
Yt = Ct +St ….. (1)
Cont…
• The other side of the coin is that the value of produced
output (Y) must be matched to goods produced for
consumption (C) plus those needed by investors (I); that is,
Yt = Ct +It ….. (2)
• From equation (1) & (2) we get the balanced Equation
St = It ….. (3)
• “Savings equals investment”, . We can use this
equation to complete our basic argument.
• Investment augments (increases) the national capital Stock
K and replaces that part of it, which is wearing out. Suppose
that a fraction (sigma) of the capital stock depreciates.
Development strategies & Policies: for MSc Program:

Lecture by Berhanu G(Ass.Professor) 11/4/2021
11/4/2021 8
Cont…
Mathematically, Kt + 1 = Kt - δkt + It
Where, δ = rate of depreciation of capital stock
Kt = Capital stock at time t
Kt +1 = Capital stock next Year
It = Investment at time t
Then Kt +1 =(1- δ) kt + It ………….. (4)
• Equation (4) Tell us how the capital stock must
change overtime. Now we introduce two
important Concepts.
•The saving rate-is just savings divided by
income: in our model. Call that s is,
(S ) or St= sYt
t
Yt

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• The second concept is also a ratio.
• The capital output ratio, which we call θ (Teta). It is the
amount of capital required to produce a single unit of
output in the economy, and it is represented by the
ratio:
K or Kt = θYt
θ= t
Yt
Combining (3) and (4), we get,

Kt +1 =(1- δ ) kt + St
Now if savings is a constant fraction of income, then St
= sYt for all dates t, where as if the capital output
ration is θ, then Kt = θYt for all dates t, using these
calculations in the proceeding expression, we see that
11/4/2021 10
Kt+1 = (1-δ)kt + St ------------------ (5)
Kt+1 = (1-δ)kt + sYt ------------- (6)
θYt+1 = (1- s) θYt + sYt ----------- (7)
θYt+1-θYt= sYt - δθYt
Dividing the whole by θYt
θYt+1 −θYt sYt =− δθYt

θYt θYt
y t +1 − y t s
− δ
yt θ
The left hand side of this equation is just the rate of
growth g. That is

11/4/2021 11
Cont…
s s
g = −δ or = g + δ ......... 8
θ θ
Equation 8 is called Harrod-Domar growth equation. It
isn’t difficult to see why the Harrod-Domar equation was
influential. It firmly links the growth rate of the
economy (g) to two fundamental variables: the ability
of the economy to save (s) and the capital -out put ratio (θ).
You can easily grasp from equation (8) that, by pushing up
the rate of savings, it would be possible to accelerate
the rate of growth.
Likewise, by increasing the rate at which capital
produced output (i.e. a lower θ), growth would be
enhanced.
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3. Solow Growth Model
• Solow model differs from the Harrod-Domar
formulation by adding a second factor, labor,
and introducing a third independent
variable, technology, to the growth equation.
• Technological progress become the residual factor
explaining long-run growth, and its level was
assumed by Solow and other growth theorists to
be exogenously determined.
• Technological progress became the residual factor
explaining long-term growth, and its level was
assumed by Solow and other neoclassical growth
theorists to be determined exogenously, that is,
independently of all other factors in the model.
Cont…

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Development strategies & Policies: for MSc Program: Lecture by Berhanu G(Ass.Professor) 11/4/2021
11/4/2021 22
Cont…

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Cont…
Technology and Solow model:

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Cont…

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Cont…
Saving, depreciation, population and technology are crucial
factors that determine economic growth
It is possible that the rate of savings (and hence
investment) is positively related to the rate of
technological progress itself, so that the growth of
technology depends on saving.
The higher level of saving or investment implies higher
percapta income
Higher population growth slows economic growth or
percapita income
Income difference among countries contributes to the
differences in saving/investment and population growth
The higher level of depreciation reduces the economic
growth
The long-run growth in percapita income and economic
growth is exogenously determined by level of technology
4. Structural-
Structural-Change Model:
Model: The Lewis two-
two-
sector model
• Set of changes in the composition of demand, trade, production,
and factor use that takes place as per capita income increases
(consists 6 elements):
1. structural change: shift of resources from low to high
productivity activities (agriculture, industry, services -
associated with goods, welfare state, and informal sector)
2. changes in demand patterns: e.g., changes in income
elasticity of demand for food (0.6%), agricultural raw
materials (0.5%), oil and fuel (2.4%) and other manufactured
goods (1.9%)
3. changes in composition of trade (from exports of
primary agricultural goods to low wage manufacturing
goods)
3. Changes in composition of production factors
(changes in capital labor ratio, and development of
knowledge capital & physical capital)
4. changes in social institutions and attitudes
5. The Need for new structural policies (industrial

policies, technology policies, education policies and
social policies)

Cont…
The model tends to emphasize the transformation
of domestic economic structures from traditional
subsistence agriculture economies to more
modern, urbanized and industrially diverse
manufacturing and service economies.
It is the theory of development in which surplus
labor (the portion of the rural labor force whose
marginal productivity is zero or negative) from the
traditional agricultural sector is transferred to the
modern industrial sector, the growth of which
absorbs the surplus labor, promotes
industrialization, and stimulates sustained
development Program: Lecture by Berhanu
Cont…
• It is a dualism model and provides more emphasis on
industry-agriculture interdependency and said that
the robust connectivity between the two would
encourage and speed up development.
• The three fundamental ideas used this model are:
1. Agricultural growth and industrial growth are both
equally important
2. Agricultural growth and industrial growth are
balanced
3. Only if the rate at which labour is shifted from
agriculture to industry is greater than the rate of
growth of population will the economy be able to lift
itself up from the Malthusian population trap.
Figure 3.2 The Lewis Model of Modern-
Modern-Sector Growth in a Two
Two--
Sector Surplus-
Surplus-Labor Economy

11/4/2021 Program: Lecture by Berhanu G(Ass.Professor) 33
5. Pattern of Development Theory
(Chenery Model)
The patterns of development approach, which is the
empirical analysis of the “sequential process
through which the economic, industrial and
institutional structure of an underdeveloped
economy is transformed over time to permit new
industries to replace traditional agriculture as the
engine of economic growth
• Also necessary are changes in the economic
structure which face constraints in LDCs
• Difference in constraints (domestic and
international) accounts for difference in
development levels among countries
Cont…
International constraints most importance since
transition can occur faster with access to
international sources of capital, technology,
manufactured imports etc.
He identified five characteristic features (not
necessarily stages) of the development process for
countries that have developed:
Shift from agricultural to industrial production
Steady accumulation of physical and human K
Change in composition of consumer demand
Growth of cities and urban areas
Decline in family size and overall population growth
6. The International-
International-Dependence Model
a) The neocolonial dependence model
◦ Legacy of colonialism, Unequal power, Core-
periphery
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

Cont…
b) The false-paradigm model
◦ Pitfalls of using “expert” foreign advisors who misapply
developed-country models
◦ Economic development relies heavily on funds from
international donor agencies such as the World Bank and
IMF
◦ Wrong and incorrect advises that may not work for
developing economies contexts
◦ They reinforce the pattern of “dependent development”
c)The dualistic-development thesis
◦ Superior and inferior elements can coexist; Prebisch-
Singer Hypothesis( the superior elements does little or
nothing to pull up the inferior)
7. Balanced growth model (Nurske
(Nurske))
Developed by Nurske
Pursuit on many fronts “pattern of mutually supporting
investments over a range of industries”
The advocates of balanced growth argued that
countries have to develop a wide range of industries
simultaneously if they have to succeed in achieving
sustained growth.
It requires balance between different consumer goods
industries, and between consumer goods and capital
goods industries.
It also implies balance between the domestic and
export sector.
Further, it entails balance between social and economic
overheads and directly productive investment, and
between vertical and horizontal external economies.
Cont…
It states that there should be simultaneous and
harmonious development of different sectors of
the economy so that all sectors grow in unison.
For this, balance is required between the demand
and supply sides.
The supply side lays emphasis on the simultaneous
development of all inter-related sectors, which
help in increasing the supply of goods.
However, it may be beyond the capabilities of
underdeveloped countries-the initial resources for
simultaneous developments on many fronts are
generally lacking
8. Unbalanced Growth Model (Hirschman)
Developed by Hirschman
The theory of unbalanced growth is the opposite of
the doctrine of balanced growth. According to this
concept, investment should be made in selected
sectors rather than simultaneously in all sectors of the
economy.
No underdeveloped country possesses capital and
other resources in such quantities as to invest
simultaneously in all sectors.
Therefore, investment should be made in a few
selected sectors or industries for their rapid
development, and the economies accruing from them
can be utilized for the development of other sectors.
Thus the economy gradually moves from the path of
unbalanced growth to that of balanced growth.
Cont…
Don’t focus on all at the same time
Provide a boost to leading sectors which will create
the linkages to bring others into existence
‘Backward linkage’: proportion of inputs purchased
from other industries
‘Forward linkage’: proportion of outputs sold to other
industries how?
Import substitution; i.E. Developing domestic
industries replaces imports and so improves the
balance of payments,
By setting up industries, create shortage of key input,
to create incentives for other firms to set up to
produce them (backward linkage)
or create excess capacity, creating incentives for
others to set up production requiring this output as
an input (forward linkage) Development strategies & Policies: for MSc
9. Big Push theory
o In order to economic transformation via
industrialization, we need a big push – a massive
investment o why? industrial development is
characterized by:
complementarities and externalities: mutual dependence
on
suppliers and customers, with benefits from mobility of
workers across firms
indivisibilities: high fixed costs and long gestation
periods
market imperfections: just focusing on the slow
correction of market failures will not achieve much
large infrastructure development with positive
externalities
massive savings requirements
10. Neoclassical Counterrevolutions: The Market
Fundamentalism models
•The 1980s resurgence of neoclassical free-market
orientation toward development problems and
policies, counter to the interventionist dependence
revolution of the 1970s.
•In developing countries, it called for freer markets
and the dismantling of public ownership, statist
planning, and government regulation of economic
activities.
a)Free-market approach: rely of the allocation role
of markets and limited government involvement
in economics.
Cont…
But, there are several areas in which markets fail
to achieve efficient outcomes:
income distribution
public goods
externalities
market power
b)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
Cont…
c) 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

11. Endogenous Development Theory
Knowing the failures the externally induced and
imposed standardized development approaches
prescribed by big international organizations (like
WB and IMF), radical writers presented a new
and potential theory/approach known in various
names as “endogenous development”, “self-
reliant development", and “new growth
theory”.
The new growth theory, however, seems to be a
little broader than the endogenous and/or self-
reliant development" as it further encompasses
such other local and inward-oriented
theories.
Cont…
Endogenous development model is relatively a
self-sustaining model capable of
transforming the local economic system
based on local characteristics with the ability
to control certain fundamental variables.
This includes:
o The use of local resources (capital,
entrepreneurship, specific knowledge of the
production process of professional tasks, material
resources),
o The ability to check the accumulation process,
o The ability to innovate,
o The existence of productive interdependence,


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Chapter 3

Driving Factors of Development: Theory

Development strategies & Policies: for MSc

Development strategies & Policies: for MSc Program: Lecture by Berhanu

4. Drive to maturity stage:

Development strategies & Policies: for MSc

Development strategies & Policies: for MSc

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Combining (3) and (4), we get,

Dividing the whole by θYt

θYt+1 −θYt sYt =− δθYt

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

Development strategies & Policies: for MSc Program:

4. changes in social institutions and attitudes

5. The Need for new structural policies (industrial

Development strategies & Policies: for MSc

Development strategies & Policies: for MSc

Under these conditions economic development is

Development strategies & Policies: for MSc

Development strategies & Policies: for MSc

Development strategies & Policies: for MSc

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