Classic Theories of Economic Development

1
Classic Theories of Economic Development

• Todaro Chapter 3
• Part I

2
Overview

• Four Approaches
• Linear-Stages-of-Growth Models
• Structural-Change Models
• International Dependence Revolution
• Market Fundamentalism

3
Four Approaches

• Four major and often competing development
  theories, all trying to explain how and why
  development does or does not occur.
• Newer models often draw on various aspects of
  these classical theories.
• In the 1950s and 1960s, linear-stages-of-growth
  models were popular. They described the process
  of development as a series of successive stages.

4

• These models were replaced in the 1970s by
  Structural Change and International Dependence
  models.
• Structural change models emphasized the internal
  process of structural changes that a developing
  country must go through, while international
  dependence models viewed underdevelopment in
  terms of international and domestic power
  relationships, institutional and structural
  rigidities and the resulting proliferation of
  dual economies and dual societies both within and
  among nations of the world.

5

• In the 1980s and 1990s the neoclassical
  counterrevolution focused on the beneficial role
  of free markets, open economies and the
  privatization of public enterprises and suggested
  that the failure of some economies to develop is
  a result of too much government intervention and
  regulation.

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Linear-Stages-of-Growth Models

• Rostows Stages of Growth
• Harrod-Domars Growth Model
• The thinking here was that the developing
  countries could learn a lot from the historical
  growth experience of the now developed countries
  in transforming their economies from poor
  agrarian societies to modern industrial giants.
• Emphasized the role of accelerated capital
  accumulation.

7
Rostows Stages of Growth

• Rostow argued that economic development can be
  described in terms of a series of steps through
  which all countries must proceed
• The Traditional Society
• The Pre-conditions for take-off into
  self-sustaining growth
• The Take-off
• The Drive to Maturity
• The Age of High Mass Consumption
• Advanced nations were considered well beyond the
  take-off stage while underdeveloped nations were
  seen as still in the traditional or
  pre-conditions stages.
• Emphasized the need for the mobilization of
  domestic and foreign investment in order to
  accelerate growth.

8
Harrod-Domar Growth Model(AK Model)

• Following on Rostows theory the AK model
  describes the mechanism by which more investment
  leads to more growth.
• Pointed to the necessity of net additions to the
  capital stock
• Components
• Capital stock (K)
• Output (Y) - GDP
• Capital-Output ratio (k) the dollar amount of
  capital needed to produce a 1 stream of GDP. K/Y
  or ?K/?Y
• Savings (S) and the savings ratio (s) the fixed
  proportion of national output that is used for
  new investment.

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• So S sY (1)
• Net investment is the change in the capital stock
• I ?K (2)
• Remember that k K/Y or ?K/?Y, so that
• ?K k?Y (3)
• Net savings must equal to net investment so that
  S I. Combining (1), (2) and (3)
• sY k?Y
• s/k ?Y/Y
• ?Y/Y is the growth rate of GDP.

10

• So the growth rate of GDP is determined jointly
  by the savings ratio, s, and the national
  capital-output ratio
• So the rate of growth of GDP is positively
  related to the economies savings ratio and
  negatively related to the economies
  capital-output ratio.
• The more economies save and invest, the faster
  they can grow but the actual rate of growth is
  measured by the inverse of the capital-output
  ratio the output-capital ratio.

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• The fact that LDCs savings levels are often not
  enough to meet the levels suggested by the
  linear-stages models, the need to fill the
  savings gap was used to justify massive
  transfers of capital and technical assistance
  from developed countries to LDCs.
• More savings and investment is not a sufficient
  condition for accelerated rates of economic
  growth. Many LDCs lack the necessary structural,
  institutional and attitudinal conditions to
  convert new capital effectively into higher
  levels of output. They also lacked the
  complementary factors of production (e.g. skilled
  labour and managerial competence).
• Also the development strategies proposed by the
  stages models failed to take into account the
  global environment in which developing countries
  exist one in which development strategies can
  be thwarted by external forces beyond the
  countries control.

12
Structural Change Models

• Lewis Two-Sector Model
• Patterns-of-Development Approach
• These models tend to emphasize the transformation
  of domestic economic structures from traditional
  subsistence agriculture economies to more modern,
  urbanized and industrially diverse manufacturing
  and service economies.

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Lewis Two-Sector Model

• The economy consists of two sectors
• An overpopulated, traditional rural subsistence
  sector with zero marginal productivity of labour
  and surplus labour
• A high-productivity modern urban industrial
  sector.
• Labour can be withdrawn from the traditional
  sector without any loss of output
• Focus is on labour transfer and output and
  employment growth in the modern sector. The rate
  at which this occurs is determined by the rate of
  industrial investment and capital accumulation in
  the modern sector.
• Wages in the industrial sector are fixed at a
  premium above wages in the traditional sector. It
  is assumed that rural labour supply is perfectly
  elastic.

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• Lewis assumed that with the urban wage above the
  average rural wage, that the modern-sector
  employers could hire as many surplus rural
  workers as the wanted without fear of rising
  wages
• The successive reinvestment off profits from the
  modern sector would increase the production
  possibilities of that sector leading to
  successive increases in the demand for labour.
  The employment expansion in the industrial sector
  would continue until all the excess labour from
  the traditional sector is absorbed. From that
  point onwards, modern sector wages would rise in
  order for industrial employers to attract
  additional workers from the traditional sector.

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• One of the problems with Lewis model is that it
  assumes that the rate of labour transfer and
  employment creation is proportional to the rate
  of modern sector capital accumulation. It does
  not leave room for the possibility that
  capitalist profits could be reinvested in
  labour-saving capital equipment nor does it leave
  room for the possibility of capital flight.
• The model also assumes surplus labour in rural
  areas and full employment in urban areas. By and
  large this is not the case in most developing
  nations.
• The assumption of a competitive modern-sector
  labour market that allows modern sector wages to
  remain fixed until the rural sector labour
  surplus is exhausted is unrealistic. In reality
  there is a tendency for urban wages to rise over
  time, even when there is considerable urban
  unemployment.