CLASSIC THEORIES OF ECONOMIC GROWTH

AND DEVELOPMENT

ROSTOW’S DEVELOPMENT STAGES

In 1960 Walt Whitman Rostow wrote: Economic Growth

– a non-communist manifesto

5 Development Stages
1) Traditional Society
2) Precondition for take-off
3) Take off
4) Drive to Maturity
5) High Mass Consumption
Traditional Society
-Dominated by subsistence agriculture
- Agricultural based economy
- Mainly use subsistence farming and have little surplus output to sell
- People heavily rely on a manual labor and self-sufficiently
- There is limited ability for growth due to lack of modern technology
- Trade is done locally
Precondition for take-off

-Rostow believed that this stage could only be reached by a great

achievement of surplus wealth
- Industrial/manufacturing society begins
- Levels of technology develop
- Trade expands overseas creating an international market
- This stage is preparation for take-off
- Agriculture becomes commercialized and mechanized due to
technological improvements
- Country advances to a more complex economy
- Beginning of economy development
- Development of transport system - TRADE
Take off

-Short period of intensive growth

- Productive investment rises 5% - 10% of national income
- Industrialization begins
- Manufacturing more important part of economy
- Substantial manufacturing sectors become developed so there is
high rate of growth
- Introduction to technical innovations – economic rise
- Technological breakthrough occur (e.g. Great Britain industrial
revolution and the Agriculture/Green Revolution)
- Agriculture progressed to commercial rather than subsistence
Country Take-off Period

Great Britain 1732 – 1802

Russia 1890 – 1914

United States 1843 – 1860

Germany 1850 – 1873

Canada 1862 – 1914

China 1952

India 1952
Drive to Maturity

-Takes place over a long period of time – standard of living rise

- Rostow define “as the period when a society has affectively applied
the range of modern technology to the bulk of its resources
- Use of technology increases
- Steadily growing economy and modern technology
- Agriculture workers decrease dramatically
- Workers acquire greater skills and paid higher wages
- National economy grows and diversifies
- Increased percentage of nation’s wealth invested into developing its
economy
Country Maturity Year

Great Britain 1850

Russia 1950

United States 1900

Germany 1910

Canada 1950
High Mass Consumption

-Individual incomes are greater than necessary for buying essentials

- High valued goods become normalized to purchase
- Consumers have beyond their basic needs
- Growing demand for additional consumer goods and services
- People live in cities creating an urban society
- Society is able to focus on military, security issues, equality, and
welfare issues
- Tertiary sector activity increases
- Improved health care system and education
- Economy flourishes
Example: Japan becoming ahead

-After 1950 Japan entered the High Mass Consumption Stage after
signing the San Francisco Peace Treaty
- This put Japan ahead of Russia
- Russia fell behind due to their own political system which was
totalitarian communism

• The advanced countries, it was argued, had all passed the stage of
“take off into self-sustaining growth”, and
• The underdeveloped countries that were still in either the traditional
society or the “preconditions” stage had only to follow a certain set of
rules of development to take off in their turn into self-sustaining
economic growth
• One of the principal strategies of development necessary for any take
off was the mobilization of domestic and foreign saving in order to
generate sufficient investment to accelerate economic growth
Advantages
1) Highly respected and referred model
2) Primary example of the “intersection of geography,
economic and politics”
3) Most widely cited development theories
Disadvantages/Criticisms

-Has a steady bias towards a western model of modernization

- Assumes that all countries follow the same route of development
- Does not look at variations within a country
- Assumes that each country is economically and politically free
- Too simplistic for human geography
- Perpetuates myth of “developmentalism” – idea that every country
will eventually make progress toward development provided they
compete to the best of their ability in the world economy
- Not reasonable to compare “early starters” to “late starters”
- Early starters were free from competition, obstacles, precedents
- Late starters must compete in competition and face in barriers
HARROD-DOMAR MODEL
-Is an economic growth model not a strategy
- It is developed in 1930s

Assumptions:
1) It assumes that there is a direct relationship between GDP and
capital stock
2) Unlimited supply of labor
3) Production is proportional to the stock of machineries
4) Savings and investments are all that is needed to generate growth
5) Institutional factor have been assumed to be in place
6) No diminishing return to capital
7) Start at full employment level of income
8) No government intervention
9) It’s a close economy
10) Constant price level
11) Savings leads to investment (S = I)
12) Investment leads to changes in capital stock (I = Δk)
e.g. K or solar panel is 1,000 x 10 = 10,000
13) Constant capital-output ratio
e.g. 1000/100 = 10
r = K/Y where Y is GDP
r = Δk/ΔY where Δ in GDP is change in economic growth

Definition:
- The economic growth of a country is determined by the level
of savings and the capital output ratio (efficiency of capital)
 SAVING
RATIO

INCOME INVESTMENT

OUTPUT CAPITAL
STOCK
 INCREASE IN
SAVING RATIO

INCREASE IN
INCOME INCREASE IN
INVESTMENT

INCREASE IN
OUTPUT
INCREASE IN
CAPITAL STOCK
Rate of growth = savings ratio/ capital-output ratio
e.g. 20 capital; 10 output per year
10%/2 = 5% where 10% is the savings ratio

50 capital; 10 output per year

10%/ 5 = 2%

But:
Developing countries:
Increase saving ratio is difficult
Financial system is inefficient
Research and Development often unfunded
External borrowing causes repayment problems later
ΔY . r = Δk
ΔY.r = I
ΔY = I/ r
ΔY = s/r because S = I

e.g. ΔY = s/r
= 0.5/10 = 5%
0r 1/10 = 10%

• The only way to increase GDP is by influencing the savings ratio

because r or capital-output ratio is constant
• GDP growth is determined by savings ratio and capital output
ratio

South Korea Ghana

GDP per capita as of 2015 - $27,211 2015 - $1,381
GDP per capita as of 1960 - $156 1960 - $183
Another way of presenting:

GDP growth is determined by savings ratio and capital output

ratio

S = sy ( Savings is a function of national income)

I = ΔK
I=S
r = K/Y
r = ΔK/ΔY
Δk = r Δy
sy = r Δy
I = S = sy
Δk = r Δy
Divide by y and divide by r
s/r = Δy/y (where Δy/y is the rate of growth of GDP)
Implications of Harrod-Domar Model:
-Developing countries are so poor countries which have fundamental
savings gap or lack of capital accumulation
- Main obstacle of development to development is low levels of
capital formation
- To grow, savings must be increased as well as increase in
productivity of investment
- Increase savings through increase productivity of investment i.e.
technological changes
- Growth or Δy = savings ratio/ capital output ratio or s/r
Necessary and 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. The basic reason they
did not work was not because more saving and investment is not a
necessary conditions for accelerated rates of economic growth but
rather because it is not a sufficient condition
- Necessary condition – a condition that must be present, although it
need not be in itself sufficient, for an event to occur (e.g. capital
formation may be necessary condition for sustained economic growth
(before growth in output can occur, there must be tools to produce it).
But for this growth to continue, social, institutional, and attitudinal
changes may have to occur
-
-The Marshall Plan worked for Europe because the European
countries receiving aid possessed the necessary structural,
institutional, and attitudinal conditions (e.g. well-integrated
commodity and money markets, highly developed transport
facilities, a well-trained and educated workforce, the motivation to
succeed, an efficient government bureaucracy) to convert new capital
effectively into higher levels of output
- The Rostow and Harrod-Domar Models implicitly assume the
existence of these same attitudes and arrangements in
underdeveloped nations. Yet in many cases they are lacking, as are
complementary factors i.e. managerial competence, skilled labor, and
the ability to plan and administer a wide assortment of development
projects
- There was also insufficient focus on another strategy for raising
growth that is apparent in the equation for the ΔY/Y: reducing the
capital-output ratio, r, which entails increasing the efficiency with
which investments generate extra output