Welcome To The

Economics of Development:
Unit II: Theories of Economic
Growth and Development

By
Dr. Suvendu Barik
 Classical theory of development:
Smith classical Theory of development
https://www.economicsdiscussion.net/economics-2/adam-smith-theory-of-development-in-economics-main-features/4514

 Adam Smith is considered to be the father of economics. It is not so

because he was first explorer in the field of economics, also not because he
revolutionized economic planning by his maiden ideas, but because he
abbreviated what he had received from his predecessors and handed it down
as a guide to the coming generations.
 He was the editor and not the author, organizer and not the originator of
economic science. Adam Smith contained all his ideas in his “Wealth of
Nations”. The most important aspect of this book was a Theory of
Economic Development.
 Adam Smith’s ‘Wealth of Nations’ was scientific not because it contained
the absolute truth but because it came as a turning point, the beginning of
all that came after, as it was the end of all that came before.
 Adam Smith's theory is based on the principle of 'Laissez-Faire' which
requires that state should not impose any restriction on freedom of an
individual. The theory of economic development rests on the pillars of
saving, division of labour and wide extent of market.
The main points of the theory are as under:
 Natural Law:
Adam Smith believed in the doctrine of ‘Natural law’ in
economics affairs. He regarded every person as the best
judge of his own interest who should be left to pursue it to
her own advantage. In furthering her own self interest
she/he would also further the common good. In pursuance
of this, each individual was led by an ‘invisible hand’
 Laissez Faire:
 No Government Intervention is require for the development. It is an
Automatic Process which will be made by Market forces of demand
and supply.
 Agents of Growth:
 According to Smith, farmers, producers and
businessman are the agents of progress and
economic growth
 • Division of Labour:
Adam Smith in his book ‘Wealth of Nations’ pointed out
three benefits of division of labour:
 1. Increase of dexterity of workers.
 2. Saving time required to produce commodity.
 3. Invention of better machines and equipment.
 Capital Accumulation
 Division of labour leads to capital accumulation and
capital accumulation leads to economics of development
 Production Function:
 Y = ƒ(L, K, T)
 where Y is output, L is labour, K is capital and T is land,
so output is related to labour and capital and land inputs.
 2. Ricardo classical theory of development:
 David Ricardo (1772–1823) was a classical economist
best known for his theory on wages and profit, the labor
theory of value, the theory of comparative advantage, and
the theory of rents.
 David Ricardo and several other economists also
simultaneously and independently discovered the law of
diminishing marginal returns. His most well-known work
is Principles of Political Economy and Taxation (1817).
 Ricardo's widely acclaimed comparative advantage theory
suggests that nations can gain an international trade
advantage when they focus on producing goods that
produce the lowest opportunity costs as compared to other
nations.
 Ricardo suggested that a good's value is determined by
the labor hours invested in its production.
 Notable Accomplishments
Comparative Advantage Theory:
 Among the notable ideas that Ricardo introduced was the
theory of comparative advantage, which argued that countries
can benefit from international trade by specializing in the
production of goods for which they have a relatively lower
opportunity cost in production even if they do not have an
absolute advantage in the production of any particular good.
The Library of Economics and Liberty. "Comparative
Advantage."
 For example, a mutual trade benefit would be realized between
China and the United Kingdom from China specializing in the
production of porcelain and tea and the United Kingdom
concentrating on machine parts. Ricardo is prominently
associated with the net benefits of free trade and the detriment
of protectionist policies. Ricardo's theory of comparative
advantage produced off-shoots and critiques that are discussed
to this day.
 Notable Accomplishments-2
Labor Theory of Value:
 Another of Ricardo's best-known contributions to
economics was the labor theory of value. The labor theory
of value states that the value of a good could be measured
by the labor that it took to produce it. The theory states that
the cost should not be based on the compensation paid for
the labor, but on the total cost of production.
 One example of this theory is that if a table takes two
hours to make, and a chair takes one hour to make, one
table is worth two chairs, regardless of how much per hour
the makers of the table and chairs were paid. The labor
theory of value would later become one of the foundations
of Marxism.
 Notable Accomplishments-3
Theory of Rents:
 Ricardo was the first economist to discuss the idea of rents,
or benefits that accrue to the owners of assets solely due to
their ownership rather than their contribution to any actual
productive activity. In its original application, agricultural
economics, the theory of rents shows that the benefits of a
rise in grain prices will tend to accrue to the owners of
agricultural lands in the form of rents paid by tenant
farmers.
 Ricardo's idea was later also applied to political
economics, in the idea of rent-seeking, where the owners
of assets that benefit from public policies that directly
increased rents toward them have, and act on, an incentive
to influence public policy.
 Notable Accomplishments-4
Ricardian Equivalence:
 In public finance, Ricardo wrote that whether a
government chooses to finance its expenditures through
immediate taxation or through borrowing and deficit
spending, the results for the economy will be equivalent. If
taxpayers are rational, then they will account for any
expected increase in future taxation to finance current
deficits by saving an amount equivalent to current deficit
spending, so the net change to total spending will be zero.
 So if a government engages in deficit spending to boost the
economy, then private spending will just fall by an
equivalent amount as people save more, and the net effect
on the aggregate economy will be a wash.
 Assumptions of the Theory:
 https://www.economicsdiscussion.net/rent/ricardian-theory-of-rent/the-ricardian-theory-of-rent-with-diagram/12612

a) all land is used for production of corn

b) law of diminishing returns operates,
c) supply of land is fixed,
d) demand for corn is perfectly is elastic,
e) labour and capital are variable inputs,
f) state of technical knowledge is given,
g) all workers are paid a subsistence wage,
h) supply price and labour is given and constant,
i) demand for labour depends upon accumulations,
j) capital accumulation results from profit and k) there is
perfect competition.
 Main Features
Rent, Profit and Wages :
(a) rent is that portion of the produce of earth which is paid to
the landlord for the use of original and indestructible powers
of the soil. It is the difference between average (AP) and
marginal product (MP). If all the land had the same
properties of unlimited in supply and uniform in quality, no
charge would make for its use.
(b) The wage rate is determined by wage fund divided by
number of workers employed at the subsistence level.
According to the model, out of the total corn produced rent has
the first right and the residual is distributed between wage
and profit while interest is included in profit.
Ricardo defined rent as, “that portion of the produce of the earth
which is paid to the landlord for the use of the original and
indestructible powers of the soil.” In his theory, rent is nothing but
the producer’s surplus or differential gain, and it is found in land
only.
 A Critical Appraisal
1) Neglects the impact of technology:
2) Wrong Notion of Stationary State:
3) Baseless Notion of Population:
4) Unnecessary Importance to the law of Diminishing Returns:
5) Impracticable laissez-faire Policy:
6) Neglects Institutional factors and Interest-rate:
7) Distribution rather than growth theory:
8) Land also produces goods other that corn:
9) Capital and labour not fixed co-efficients:
 Notable Accomplishments- Short Note
What Did David Ricardo Argue in His Iron Law of Wages
Theory?
 David Ricardo argued that attempts to increase or improve
workers' wages were pointless because wages would, in time,
return to or hover around the subsistence level.
What Is the Economic Theory of David Ricardo?
 David Ricardo, although well known for his vast contributions
to economics, is best known for developing the comparative
advantage economic theory. Comparative advantage theorizes
that, for international trade, countries most benefit from
producing goods with low production opportunity costs.
What Did David Ricardo Contribute to Economics?
 David Ricardo's contributions to economics are immeasurable,
but he is highly regarded for his contributions to major theories
like the law of diminishing returns, comparative advantage,
theory of rents, and the labor theory of value.
 MALTHUSIAN THEORY OF ECONOMIC
DEVELOPMENT
The PPT is Developed By- Dr. Suvendu Barik

The idea about economic development are found in book entitled “The
progress of wealth” of his ‘Principles of Political Economy’
published in 1820.
The Theory or concept of development:
1. Malthus did not regard the process of economic development as
automatic . Rather, it requires consistent efforts on the part of the
people
2. It did not conceive of any movement toward the stationary state but
emphasis that the economy reached the slump many times before
attaining the optimum level of development.
3. Thus per him , The process of development was one of ups and
downs of economic activity rather than smooth.
 A. Population Growth and Economic Development:
 According to him , population growth by itself is not sufficient to bring about
economic development. Rather , it is the result of the development process.
 As Malthus wrote “An increase of population can not take place without
proportionate increase of wealth.” As the rate capital accumulation increases,
the demand for labour also increases. This encourages population growth.
 But mere population growth does not increase wealth. Population growth
increases wealth only if it is increasing effective demand . And it is increase
in effective demand which leads to increase in wealth.
 In his famous work, Malthus posited his hypothesis that (unchecked)
population growth always exceeds the growth of means of subsistence . He
argued that “while population rises geometrically, food supply increases
arithmetically.”
 Actual (checked) population growth is kept in line with food supply growth
by “positive checks” i.e. (Starvation , Disease and the like , elevating the
death rate). “Preventing checks” i .e.( postponement of marriage etc. that
keep down the birth rate), , both of which are characterized by “ Misery and
vice”.
 B. The Role of production and Distribution:

 Malthus regarded production and distribution as “The two

grand elements of wealth“.
 If they are combined in right proportions, They can
increase the wealth of a country in a short time. But if they
are taken separately or combined in undue proportions,
they may take many thousand years to increase the
wealth.
 so Malthus emphasizes maximum production and optimum
allocation of resources for increasing the wealth of the
company during the short run.
 C. Factors in Economic Development:
 Malthus defined the problem of economic development as one of
explaining the difference between potential gross national product
(“power of producing riches”) and actual gross national product
(“actual riches”). But the principal problem is one of achieving a high
level of potential gross national product.
 According to Malthus, the size of Potential gross national product
depends upon land, labour, capital, organisation. When this four
factors are employed in right proportions, they maximise production
in the two major sectors of the economy viz., the agricultural and the
industrial sector.
 It is accumulation of capital, fertility of soil and technological
progress that lead to increase in both agricultural and industrial
production. Malthus also emphasized the importance of non-
economic factors” which come under the head of politics and moral”,
and the security of the property, good constitution and excellent laws.
 D. Process of capital accumulation:
 Malthus has given more importance to the accumulation of capital for
economic development. He regards capital as indispensable to development.
According to him, “no permanent and continued increase of wealth can take
place without a continued increase of capital.”
 Malthus underlined the importance of foreign trade for speeding up
economic development. Foreign trade provides incentives for investing, since
it leads to the extension of the market for the goods produced and for greater
division of labour resulting in increased output.
 Of all the factors, it is the accumulation of capital which is more important
determinant of economic development. The source of capital accumulation is
higher profits. Profits come from the savings of capitalists because worker are
too poor to save. If capitalist save more and spend less and consumer goods in
order to have larger profit, economic growth will be retarded.
 E. Deficiency of effective demand:
 This view of Malthus is based on his denail of Say’s law of market
and belief in the deficiency of effective-demand. (NOTE: Say’s law
of Market: “Supply creates it’s own demand”)

 Since workers, who are consumers, receive less than the value of the
product they produce, they cannot buy all commodities. Thus, there is
an excess supply of commodities in the market in relation to demand.
This gap between supply and demand cannot be filled even by the
demand of the capatilist.

 Thus, there is general over-production and glut of commodities in the

market due to the deficiency of effective demand or under-
consumption.This leads to fall in prices, profits, savings, investments
and capital accumulation.
 F. Economic Stagnation:
 Malthus believed that the supply of labour is inelastic in short run.
But the supply of capital can be increased faster than the increase of
population.

 As capitalist invest on productive labour to increase the supply of

capital, wages rise due to competition. Rise in wages do not increase
effective demand because workers prefers leisure to increased
consumption. So, there is general glut of commodities.

 As a result, prices fall, profits decline, investment falls, and both the
power of accumulation and the motive to accumulate are strongly
checked. Thus, gluts and under-consumption would lead to economic
stagnation.
 The PPT is Developed By- Dr. Suvendu Barik

Policy implications to promote economic

development by Malthus
 Balanced Growth

 Raising Effective Demand

 Maintenance of Unproductive Consumers
 a. Balanced Growth
 Malthus opined, an economy consisting of two sectors i.e.
industrial and agricultural. It is the technological progress which
can lead to economic development in both sectors.
 The agricultural output is subject to diminishing returns. In such an
economy, economic development starts with its capital investment
in agriculture.
 To avoid the operation of the law of diminishing returns in
agriculture, population growth should be absorbed in industrial
sector as more opportunities for profitable investment exist only in
the industrial sector. This requires heavy capital investment and
rapid technological progress in the industrial sector.
 Thus, in a dualistic economy comprising agricultural and industrial
sectors, economic development means the balanced growth of both
the sectors.
 b. Raising Effective Demand
Effective demand: In economics, effective demand (ED) in a market is the
demand for a product or service which occurs when purchasers are
constrained in a different market. In other words, effective demand refers
to the willingness and ability of consumers to purchase goods at different
prices. It shows the amount of goods that consumers are actually buying.
In Keynesian economics, effective demand is the point of equilibrium
where aggregate demand equals aggregate supply. Technological progress
can lead to economic development only when there is increase in
effective demand in an economy.

Measures to Increase Effective Demand by Malthus

1) Equal Distribution of Wealth & Landed Property

 Malthus believed that moderately rich people can raise effective demand
more than one millionaire among the poor masses.
 He favored a more equitable distribution of landed property for that
would increase effective demand as well as production.
2. Expansion of Internal and External Trade
It is the internal as well as external trade that increases wants
and desire to consume which are absolutely necessary to keep
up market prices of commodities and prevent the fall of
profits.
Internal and external trade also increase the value of products
exchanging what is wanted less and what is wanted more.
3. Maintenance of Unproductive Consumers
Unproductive consumers are those persons who do not
produce material objects.
The production can be increased by increasing consumption.
Since capitalists are parsimonious and productive, workers
live upon subsistence wages, unproductive consumption upon
the part of unproductive labourers and landlords will increase
effective demand.
4. Public Works Schemes
Malthus suggested public work schemes to remove
unemployment and increase the effective demand.
Malthus pointed out, “The employment of people on poor roads
and public works and a tendency among landlords and persons
of property to build, to improve and beautify their grounds, and
to employ workmen and menial servants, are the means to
remedy the evils arising from the disturbance in the balance of
produce and consumption.
C. Maintenance of Unproductive Consumers
3.Malthus suggested the maintenance of “unproductive
consumers “ to increase the effective demand . He defined the
unproductive consumers as those persons who does not produce
material objects .
-Malthus suggested public work schemes to remove
unemployment and increase effective demand.
 A Critical Appraisal
1. Secular stagnation not inherent: For Malthus there is the possibility of
permanent under consumption of all commodities . But the fact is that
under consumption is not a permanent phenomenon but a temporary one .
So secular stagnation is not inherent in the process of capital
accumulation.
2. Negative view of capital accumulation: In actuality, capital
accumulation does not lead to a reduction in the demand for consumer
goods and fall in profits.
3. Commodity is not exchanged for commodities directly: In fact, labour
is not a correct measure of commodities. In the real world, commodities
are major by real tangible prices and not by labour.
4. Unproductive consumers retard progress: This remedy tantamounts to
giving dolls to workers and deliberately supporting idle persons. Such a
measure slows down the rate of capital accumulation.
5. One sided saving base: He believed that it is only the landlords who
save. But, this is an errorneous view because the major source of savings
in a society is the income-earners and not profit earners.
 Assessment of Malthus’s Contributions
or Its Applicability to UDCs:
 Malthus was one of the pioneers in the field of economic
development who wrote about the poverty and under development
of underdeveloped countries (UDCs) of his times in his ‘Principles
of Political Economy ’.
 He wrote about economic backwardness of such countries as Spain,
Portugal, Hungary, Turkey, Ireland, together with nearly the whole
of Asia and Africa, and of Latin American countries.
 Hence, his theory of Economic Development has more relevance to
UDCs of today than the theories of other classical writers. There is
no doubt that Malthus made a valuable contribution to the theory of
economic development.
 One important fact was brought by Malthus, that as the economy
moves forward, there is decline in the relative importance of
agriculture.
 Naturally, agriculture disappears by the speedier development of
industries, as in developing countries, Economic development is
regarded as synonymous with the development of industries.
 So, Malthus suggested for land reform for the expansion of
agricultural output. That’s why Malthus advocated for dualism in
the developing countries. He envisaged the economy as consisting
of the two major sectors, viz., the agricultural sector and the
industrial sector.
 The law of increasing returns operated in the industrial sector,
whereas the agricultural sector was subject to the law of
diminishing returns, the rate of technological progress being
responsible for this difference.
 As development of both the sector is dependent on each other, if
one of these sectors lags behind, it retards the development of the
other sector.
 The development of the industrial sector of underdeveloped countries is
limited by the poverty of the agricultural sector. This is due to the fact that
the lack of purchasing power in the rural masses reduces effective demand
in the economy and retards its growth.
 A great deal of what he wrote on the subject is applicable to an
underdeveloped economy, especially relating to the theory of
dualism. It has been pointed out by the critics of Malthus’s theory
of economic development; he concentrates on explaining the factors
which hinder growth rather than the factors that promote economic
progress.
 However, some elements of his theory make positive contribution
to the growth process. For example, he considers production and
distribution as the two grand elements of economic growth.
 The PPT is Developed By- Dr. Suvendu Barik

Rostow’s Theory of Development

Using these ideas, Rostow penned his classic Stages of
Economic Growth in 1960, which presented five steps
through which all countries must pass to become
developed: 1) traditional society, 2) preconditions to take-
off, 3) take-off, 4) drive to maturity and 5) age of high
mass consumption.
ROSTOW’S GROWTH THEORY
He has explained economic development in terms of social
and institutional setup of a society and the attitude of the
people. Rustow believes that development of an economy
depends upon the following 6 propensities:
 A propensity to develop fundamental science
 Propensity to apply science to economic need.
 Propensity to asset innovation
 Propensity to seek material advance
 Propensity to consume
 Propensity to have children
These propensities are governed by attitude, aspiration and
motivation of the people which in turn are influenced by
the economic, social and polititcal environment of a
country.
According to Rostow’s doctrine, the transition from
underdevelopment to development can be described in
terms of a series of steps and stages through which all
countries must proceed.
W.W. Rostow has sought an historical approach to the process of
economic development. He refers five stages of economic growth:
 The traditional society- which rests on static equilibrium until it is
disturbed by some mechanism.
 The preconditions for the take off - Which involve slow changes
especially in attitudes and in organisations.
 The take off - It is a water shed in the life of a society. It involves a
rapid increase in the rate of change as to involve discontinuity. The
period of take off is the interval when the old blocks to steady
growth are finally overcome. The changes during this period are
characterized by a wave light expansion.
 The drive to maturity - It is a period of sustained growth extending
over four decades after the end of take off.
 The stage of mass consumption - during this period, The leading
sectors of the economy shift towards the durable consumer goods
and a large share of the population acquires a high level of living.
 1. The Traditional Society
 The social structure of such societies was hierarchical
inheritance in which families and clan connections play a
dominant role.

 Political power was concentrated in the regions, in the hands

of the landed aristocracy supported by a large retinue of
soldiers and civil servants.

 More than 75 percent of the working population was engaged

in agriculture.
 2. The Pre-conditions for Take-off
The preconditions for industrialization have usually required
radical changes in three non industrial sectors
 A buildup of social overhead capital especially in transport in
order to enlarge the extent of the market, to exploit natural
resources productively and allow the state to rule effectively.
 A technological revolution in agriculture show that
agricultural productivity increases to meet the requirements of
a rising general and urban population.
 An expansion of imports including capital imports financed
by efficient production and marketing of natural resources for
exports.
 3. The Take-off
The take off period is supposed to be short lasting for 2
decades. Conditions for take off:
 A rise in the rate of productive investment from 5 percent to
over 10 percent of national income or net national product.
 The development of one or more substantial manufacturing
sectors with a high rate of growth.
 The existence or quick emergence of a political, social and
institutional framework which exploits the impulses to
expansion in the modern sector and gives to growth an
outgoing character.
 4. The Drive to Maturity
Rate of net investment is well high over 10 percent of
national income. When a country is in the stage of
technological maturity, 3 significant changes take place:
 The character of working force changes. It primarily
becomes skilled. People prefer to live in urban areas
rather than in rural areas. Real wages start rising and the
workers organize themselves in order to have greater
economic and social security.
 The character of entrepreneurship changes. Rugged and
hardworking masters give way to polished and polite
efficient manager.
 The society feels bored of the miracle of industrialization
and wants something new leading to a future change.
 5. The Age of High Mass Consumption
 The pursuit of national policy to enhance power and influence
beyond national frontiers.

 To have a welfare state by a more equitable distribution of

national income through progressive taxation, increased social
security, and leisure to the working force.

 Decisions to create new commercial centres and leading sectors

like cheap automobiles, houses, and innumerable electrically
operated household devices.
 Criticisms
 Traditional society not essential for development
 Pre-conditions may not proceed the take off
 Overlapping in stages
 Criticism of the take off
 The take of dates are doubtful and possibility of failure not
considered.
 Growth rate of investment are arbitrary
 Some specific sectors cannot be the leading sector
 Little difference between the first nd third conditions
 The stage of drive to maturity puzzling and misleading
 The stage of high mass consumption not chronological
 Capital output ratio not constant
 Silence over the removal of unemployment
 Economic development not spontaneous
 Thank You
Everybody for Your
Tolerance to Listen
and
Understand