Development Economics explains why the world has become sharply divided into rich and poor

nations. It answers the question of what can be done to improve our living conditions (standards). It
guides us to learn about how the economic growth rates in the poorer countries of the world might be
increased.
Development Economics is interested in economic growth; equality; poverty; and economic behavior
of the lower-income countries.
Development: a process or a state. Either the act of developing or else the state of having
developed. This can be demonstrated when recognizing the following terms.
Developing: the most common use of “developing” is in developing countries. It is one that expresses
optimism. In practice, it means relatively poor but carries an understone of hope. This term covers
both low-income and middle-income countries.
Development and growth: growth (economic growth) indicates increase in a country’s total national
income, while development means the increase in its national income per head of population (per
capita). From the computable side of economic advance growth can be taken to denote an increase in
national income per capita, however development is broader taking into account not only this per
capita material growth but also how additional income per capita is distributed (with equality).
Economic Development: refers to growth in per capita (head) income.
Social Development: is used to cover all aspects counted as components of “development”; degree of
equality in income distribution, proportions of population below international poverty lines,
educational enrolments, literacy rates, life-expectancy, infant and maternal mortality, nutrition
standards, gender equality.
Underdevelopment: it is used for a state not a process. An underdeveloped country lacks the
attributes of a developed society. It is poor in a range of capabilities such as poor in income terms,
weak on most of other items of social or political development such as educational institutions and
enrolments, health statues, life expectancy, infant mortality, nutrition, accessibility of safe water,
sewerage provision, housing quality, extent of literacy, extent of technical skills of the industrial and
post-industrial age, opportunity for political participation, gender equality.
Low-income, Lower-middle-income, Upper-middle-income, and High income countries:
According to the classification of World Bank (2008):
- Low income (US$905 or less).
- Lower-middle-income ($906 - $3595)
- Upper-middle-income ($3596 - $11,115)
- High-income ($11,116 or more)

1
Developed Countries: high-income countries excluding economies that were heavily dependent for
their high –income on the production and export of one or few primary commodities (like crude oil),
or on government transfers as aid from outside, or on being the site of a major power’s defense
installations.
Industrialized Countries: the usual meaning is the same as “developed countries”, except that a one-
commodity-based economy, or a transfer-based or foreign-defense-based economy.
Third World: it was common for a period in the 1970s and 1980s as a way of referring to the
developing countries (low-and middle-income class).
North-South: North referred to the industrialized countries and South referred to the rest.
The Classical Economists
1. Adam Smith theory of Growth:
 He asked what determines the growth rate, the wealth of nations?
 The expansion process in Smith’s growth model depends on three factors of production –land,
labor, and capital- and on technical progress ; suggesting a basic production function of the
form: Y =f (L , K , H )
 Increases in the size of labor force (L), in the amount of capital (K), and in the available land
(H), all lead to increases in total output (Y).
 Growth in total output (Yg) will be caused by growth in labor force (Lg), in the capital stock
(Kg), and the supply of land (Hg). In addition, improvements in technology (Tg) lead to
expanded output by increasing the productivity of the factor inputs Yg=f ( Lg , Kg , Hg ,Tg )
A Stationary Economy: it is the economy in which the labor force (and the population) and the
capital stock are constant, then output then also be constant – there will be no economic growth.
The real wage earned by labor will be just enough to provide a subsistence living with no surplus
to make possible an increase in population.
Similarly, on the capital side, new investment (I), financed by new saving (S) of capitalists, will be
just enough to replace depreciation of existing capital goods, so there is no growth in the stock
of productive capital goods.
And land, in the absence of new discoveries or improvements in fertility, is also effectively fixed
in quantity.
The scenario starts with a stationary economy as stated. This situation may be disturbed by an
external “shock” such as a new invention.
The invention improves efficiency of production or improved opportunities for international trade.
Increase output makes possible increased saving and investment, which in turn creates conditions
favorable for increasing the extent of specialization and further improving productivity.
This scenario permits a rise in wages above subsistence level, encouraging population growth and
expansion of the labor force – a requirement for continued economic growth.

2
 However, a sustained increase in population and the labor force is likely to exert downward
pressure on the wage rate.
Increased capital accumulation leads to a corresponding downward pressure on the profit rate.
These processes push the real wage rate and the rate of profit back to their original levels. Once
the original levels of wage and profit are re-established, the economy is back a stationary state.
The only difference from the starting point is that the population and the capital stock are now
larger.

2. David Ricardo Growth Theory

Like Smith, Ricardo expected the macroeconomy to end up in a stationary state after a phase of
growth.
Ricardo saw diminishing returns limiting agriculture production.
As agriculture expands, the marginal productivity of labor and the marginal productivity of capital
are driven down.
With wages at minimum subsistence level, increase in output results in a declining rate of profit
and redistribute income towards landlords, who are able to charge progressively higher rents
while showing little interest in spending this income on productive investment.

Iron Law of Wages

An important element in Ricardo’s view of the growth process in his Iron Law of Wages,
formalizing the “Subsistence Theory” of wages which in the future of all classical thinking on
growth.
The Iron Law of Wages suggests that a certain minimum level of consumption is necessary to
sustain life, and that the real wage tends to be driven down towards the floor level.