1 classic theories of development a comparative analysis

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Classic theories of Classic theories of Development Development A Comparative AnalysisA Comparative Analysis

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OUTLINEOUTLINE

The Quest for GrowthThe Quest for Growth The financing gap The financing gap Investment in physical and human capitalInvestment in physical and human capital Structural AdjustmentsStructural Adjustments New economic theoryNew economic theory

Four approaches to the Classic Theories Four approaches to the Classic Theories of Developmentof Development

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Classic Theories of Economic Classic Theories of Economic Development: Four ApproachesDevelopment: Four Approaches

Literature on economic development is Literature on economic development is dominated by the following four strands of dominated by the following four strands of thought: thought: Linear-stages-of-growth model: Linear-stages-of-growth model: 1950s and 1950s and

1960s1960s Theories and patterns of structural change: Theories and patterns of structural change:

1970s1970s International-dependence revolution: 1970sInternational-dependence revolution: 1970s Neo-classical, free-market counterrevolution: Neo-classical, free-market counterrevolution:

1980s and 1990s1980s and 1990s

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Linear-stages theoryLinear-stages theory Viewed the process of development as Viewed the process of development as

a series of successive stages of a series of successive stages of economic growtheconomic growth

Mixture of saving, investment, and Mixture of saving, investment, and foreign aid was necessary for economic foreign aid was necessary for economic development development

Emphasized the role of accelerated Emphasized the role of accelerated capital accumulation in economic capital accumulation in economic development development

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Rostow’s Stages of GrowthRostow’s Stages of Growth Rostow identified 5 stages of growth: Rostow identified 5 stages of growth:

1.1. The traditional societyThe traditional society

2.2. The pre-conditions for take-offThe pre-conditions for take-off

3.3. The take-offThe take-off

4.4. The drive to maturityThe drive to maturity

5.5. The age of high mass consumptionThe age of high mass consumption

All advanced economies have passed the All advanced economies have passed the stage of take-off into self sustaining growthstage of take-off into self sustaining growth

Developing countries are still in the Developing countries are still in the traditional society or the pre-conditions traditional society or the pre-conditions stage. Why? stage. Why?

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Rostow’s Stages of GrowthRostow’s Stages of Growth

Lack of adequate investment. Lack of adequate investment. The financing gap exists! The financing gap exists!

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The Harrod-Domar Growth The Harrod-Domar Growth Model Model

The principal strategy for development is The principal strategy for development is mobilization of saving and generation of mobilization of saving and generation of investment to accelerate economic growthinvestment to accelerate economic growth

Importance of H-D growth model (AK model): Importance of H-D growth model (AK model): It explains the mechanism by which It explains the mechanism by which investment leads to growthinvestment leads to growth

Investment comes from savings Investment comes from savings Rate of economic growth (GNP growth rate) Rate of economic growth (GNP growth rate)

is determined jointly by the ability of the is determined jointly by the ability of the economy to save (savings ratio) and the economy to save (savings ratio) and the capital-output ratio capital-output ratio

change in Y/Y=s/kchange in Y/Y=s/k

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The Harrod-Domar Growth The Harrod-Domar Growth Model (continued)Model (continued)

Firms

Households

Wages, Profits, Rents

Consumption Expenditure

Outflow

Inflow

Inflow

Outflow

Investment

Savings

Ray, Debraj p.52

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The Harrod-Domar Growth The Harrod-Domar Growth Model Model

Target growth rate* ICOR= required investmentTarget growth rate* ICOR= required investment ICOR= change in K/change in Y and is lower ICOR= change in K/change in Y and is lower

for a labour surplus economy. for a labour surplus economy. If the rate of new investment (s=I/Y) is If the rate of new investment (s=I/Y) is

multiplied by its productivity (1/k), one can get multiplied by its productivity (1/k), one can get the rate of growth in GNP the rate of growth in GNP

The AK model allows for incorporation of the The AK model allows for incorporation of the effects of population growth (per capita GNP effects of population growth (per capita GNP growth)growth)

The ghost of financing gap once again? The ghost of financing gap once again?

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Obstacles and Constraints Obstacles and Constraints Problem with the argument that GDP Problem with the argument that GDP

growth is proportional to the share of growth is proportional to the share of investment expenditure in GDPinvestment expenditure in GDP

Low rate of savings in developing Low rate of savings in developing countries gives rise to countries gives rise to savings gap and savings gap and capital constraint capital constraint

Savings and investment is a necessary Savings and investment is a necessary condition for accelerated economic condition for accelerated economic growth but not a sufficient conditiongrowth but not a sufficient condition

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Beyond AK model Beyond AK model Endogeneity of savingsEndogeneity of savings

Savings are influenced by percapita incomes and Savings are influenced by percapita incomes and distribution of income in an economydistribution of income in an economy

Both of these are influenced by economic growthBoth of these are influenced by economic growth Economic growth mirrors the movement of savings Economic growth mirrors the movement of savings

with incomewith income Endogeneity of population growthEndogeneity of population growth

Relationship between demographic transition and Relationship between demographic transition and percapita incomepercapita income

External policy can prevent an economy from External policy can prevent an economy from sliding in to a “trap” (process of demographic sliding in to a “trap” (process of demographic transition)transition)

Endogeneity of capital-output ratioEndogeneity of capital-output ratio Captured in Solow’s modelCaptured in Solow’s model

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Structural-Change Models Structural-Change Models Structural-change theory focuses on the Structural-change theory focuses on the

mechanism by which underdeveloped mechanism by which underdeveloped economies transform their domestic economies transform their domestic economic structures from traditional to economic structures from traditional to an industrial economyan industrial economy

Representative examples of this strand Representative examples of this strand of thought are of thought are

The Lewis theory of developmentThe Lewis theory of development Chenery’s patterns of development Chenery’s patterns of development

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Lewis Theory of DevelopmentLewis Theory of Development Also known as the two-sector Also known as the two-sector

surplus labor model surplus labor model Features of the basic modelFeatures of the basic model: :

Economy consists of two sectors- Economy consists of two sectors- traditional and moderntraditional and modern

Traditional sector has surplus of labor Traditional sector has surplus of labor (MP(MPLL=0)=0)

Model focuses on the process of Model focuses on the process of transfer of surplus labor and the transfer of surplus labor and the growth of output in the modern sectorgrowth of output in the modern sector

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Lewis Theory of DevelopmentLewis Theory of Development

The process of self-sustaining The process of self-sustaining growth and employment expansion growth and employment expansion continues in the modern sector continues in the modern sector until all of the surplus labor is until all of the surplus labor is absorbedabsorbed

Structural transformation of the Structural transformation of the economy has taken place with the economy has taken place with the growth of the modern industrygrowth of the modern industry

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Lewis Theory of Development: Lewis Theory of Development: CriticismsCriticisms

Four of the key assumptions do not fit the realities Four of the key assumptions do not fit the realities of contemporary developing countries of contemporary developing countries

Reality is that:Reality is that: Capitalist profits are invested in labor saving technology Capitalist profits are invested in labor saving technology Existence of capital flightExistence of capital flight Little surplus labor in rural areasLittle surplus labor in rural areas Growing prevalence of urban surplus labor Growing prevalence of urban surplus labor Tendency for industrial sector wages to rise in the face of Tendency for industrial sector wages to rise in the face of

open unemployment open unemployment

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Structural Changes and Patterns Structural Changes and Patterns of Development : Chenery’s of Development : Chenery’s

ModelModel Patterns of development theorists view increased savings and Patterns of development theorists view increased savings and

investment as necessary but not sufficient for economic investment as necessary but not sufficient for economic developmentdevelopment

In addition to capital accumulation, transformation of production, In addition to capital accumulation, transformation of production, composition of demand, and changes in socio-economic factors composition of demand, and changes in socio-economic factors are all importantare all important

Chenery and colleagues examined patterns of development for Chenery and colleagues examined patterns of development for developing countries at different percapita income levelsdeveloping countries at different percapita income levels

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ModelModel The empirical studies identified several The empirical studies identified several

characteristic features of economic characteristic features of economic development: development:

Shift from agriculture to industrial productionShift from agriculture to industrial production Steady accumulation of physical and human capitalSteady accumulation of physical and human capital Change in consumer demandsChange in consumer demands Increased urbanizationIncreased urbanization Decline in family sizeDecline in family size Demographic transitionDemographic transition

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ModelModel Differences in development among the countries are Differences in development among the countries are

ascribed to: ascribed to: Domestic constraintsDomestic constraints International constraintsInternational constraints

To summarize, structural-change analysts believe To summarize, structural-change analysts believe that the “correct mix” of economic policies will that the “correct mix” of economic policies will generate beneficial patterns of self-sustaining growthgenerate beneficial patterns of self-sustaining growth

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The International Dependence The International Dependence Revolution (IDR)Revolution (IDR)

The IDR models The IDR models rejecreject the exclusive emphasis on t the exclusive emphasis on GNP growth rate as the principal index of GNP growth rate as the principal index of developmentdevelopment

Instead they place emphasis on international power Instead they place emphasis on international power balances and on fundamental reforms world-wide. balances and on fundamental reforms world-wide.

IDR models view developing countries as beset by IDR models view developing countries as beset by institutional, political, and economic rigidities in both institutional, political, and economic rigidities in both domestic and international setupdomestic and international setup

The IDR models argue that developing countries are The IDR models argue that developing countries are up in a up in a dependence and dominance relationshipdependence and dominance relationship with rich countrieswith rich countries

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The International Dependence The International Dependence Revolution (IDR)Revolution (IDR)

Three streams of thought: Three streams of thought:

Neoclassical dependence modelNeoclassical dependence model False-paradigm modelFalse-paradigm model Dualistic-development thesisDualistic-development thesis

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Neoclassical Dependence ModelNeoclassical Dependence Model

““Dependence is a conditioning situation in which the Dependence is a conditioning situation in which the economies of one group of countries are conditioned economies of one group of countries are conditioned by the development and expansion of others.”by the development and expansion of others.”

““Dependence, then, is based upon an international Dependence, then, is based upon an international division of labor which allows industrial development division of labor which allows industrial development to take place in some countries, while restricting it in to take place in some countries, while restricting it in others, whose growth is conditioned by and subjected others, whose growth is conditioned by and subjected to the power centers of the world.”to the power centers of the world.”

Theotonio Dos SantosTheotonio Dos Santos

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The False-Paradigm ModelThe False-Paradigm Model

Attributes under development to the faulty Attributes under development to the faulty and inappropriate advice provided by well-and inappropriate advice provided by well-meaning but biased and ethnocentric meaning but biased and ethnocentric international “expert advisers”international “expert advisers”

The policy prescriptions serve the vested The policy prescriptions serve the vested interests of existing power groups, both interests of existing power groups, both domestic and international domestic and international

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The Dualistic- Development The Dualistic- Development ThesisThesis

Dualism represents the existence and persistence of increasing Dualism represents the existence and persistence of increasing divergences between rich and poor nations and rich and poor divergences between rich and poor nations and rich and poor peoples at all levels.peoples at all levels.

The concept embraces four key arguments: The concept embraces four key arguments: 1.1.Superior and inferior conditions can coexist in a given space Superior and inferior conditions can coexist in a given space

at given time at given time 2.2.The coexistence is chronic and not transitionalThe coexistence is chronic and not transitional3.3.The degrees of the conditions have an inherent tendency to The degrees of the conditions have an inherent tendency to

increaseincrease4.4.Superior conditions serve to “develop under development”Superior conditions serve to “develop under development”

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Weaknesses of IDR ModelsWeaknesses of IDR Models Do not offer any policy prescription for how poor Do not offer any policy prescription for how poor

countries can initiate and sustain economic countries can initiate and sustain economic developmentdevelopment

Actual experience of developing countries that Actual experience of developing countries that have pursued policy of autarky/closed economy have pursued policy of autarky/closed economy has been negativehas been negative

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The Neoclassical The Neoclassical Counterrevolution: Market Counterrevolution: Market

FundamentalismFundamentalism Neoclassical counterrevolution in the 1980s called for freer markets, and the Neoclassical counterrevolution in the 1980s called for freer markets, and the

dismantling of public ownership, and government regulationsdismantling of public ownership, and government regulations Four component approaches :Four component approaches :

Free-market analysisFree-market analysis- markets alone are efficient- markets alone are efficient Public-choice theory-Public-choice theory- governments can do nothing right governments can do nothing right Market- friendly approach-Market- friendly approach- governments have a key role to play in governments have a key role to play in

facilitating operations of markets through nonselective interventionsfacilitating operations of markets through nonselective interventions New institutionalism-New institutionalism- success or failure of developmental efforts depend success or failure of developmental efforts depend

upon the nature, existence, and functioning of a country’s fundamental upon the nature, existence, and functioning of a country’s fundamental institutionsinstitutions

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Traditional Neoclassical Growth Traditional Neoclassical Growth TheoryTheory

According to the traditional neoclassical growth theory: According to the traditional neoclassical growth theory: Output growth results from one or more of three factors- Output growth results from one or more of three factors-

increases in Labor, increases in capital, and technological increases in Labor, increases in capital, and technological changeschanges

Closed economies with low savings rates grow slowly in the SR Closed economies with low savings rates grow slowly in the SR and converge to lower per capita income levelsand converge to lower per capita income levels

Open economies converge at higher levels of per capita Open economies converge at higher levels of per capita income levelsincome levels

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Traditional Neoclassical Growth Traditional Neoclassical Growth TheoryTheory

Traditional neoclassical theory argues that capital Traditional neoclassical theory argues that capital flows from rich to poor countries as K-L ratios are lower flows from rich to poor countries as K-L ratios are lower and investment returns are higher in the latter and investment returns are higher in the latter

By impeding the flow of foreign investment, poor By impeding the flow of foreign investment, poor countries choose a low growth path.countries choose a low growth path.

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Solow's Neoclassical Model or Solow's Neoclassical Model or Exogenous Growth ModelExogenous Growth Model

Solow’s model of economic growthSolow’s model of economic growth implies that economies will conditionally implies that economies will conditionally converge to the same level of income, given converge to the same level of income, given that they have the same rates of savings, that they have the same rates of savings, depreciation, labor force growth, and depreciation, labor force growth, and productivity growthproductivity growth

Solow’s model differs from Harrod-Domar Solow’s model differs from Harrod-Domar model in the following respects: model in the following respects:

Allows for substitution between labor and capitalAllows for substitution between labor and capital Assumes that there exist diminishing returns to Assumes that there exist diminishing returns to

these inputsthese inputs Introduces technology in the growth equationIntroduces technology in the growth equation

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Impact of increase in savings rate: Impact of increase in savings rate: Temporary increase in per capital K/L and per Temporary increase in per capital K/L and per

capita output. However, both would return to capita output. However, both would return to a steady- state of growth at higher level of a steady- state of growth at higher level of per capita outputper capita output

Savings has no impact on long-run per capita Savings has no impact on long-run per capita output growth rate but has an impact on output growth rate but has an impact on long-run level of per capita outputlong-run level of per capita output

Total output and total capital stock grow at Total output and total capital stock grow at the same rate as the population growth ratethe same rate as the population growth rate

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Impact of increase in population growth Impact of increase in population growth rate: rate:

Population growth rate has a positive effect Population growth rate has a positive effect on the growth of total output on the growth of total output

Results in a lower steady -state growth rate Results in a lower steady -state growth rate with lower levels of per capita capital, output, with lower levels of per capita capital, output, and consumptionand consumption

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Impact of increase in productivity: Impact of increase in productivity: Shifts the per-worker production function to Shifts the per-worker production function to

the right the right Raises steady state per capita output through Raises steady state per capita output through

increase in per capita capital. increase in per capita capital. In the long-run increase in per capita income In the long-run increase in per capita income

takes place at the same rate as productivity/ takes place at the same rate as productivity/ technical progresstechnical progress

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Application: Do Economies Application: Do Economies Converge? Converge?

Unconditional convergenceUnconditional convergence occurs occurs when poor countries will eventually when poor countries will eventually catch up with the rich countries (LR) catch up with the rich countries (LR) resulting in similar living standardsresulting in similar living standards

Conditional convergenceConditional convergence occurs when occurs when countries with similar characteristics will countries with similar characteristics will converge (savings rate, investment rate, converge (savings rate, investment rate, population growth)population growth)

No convergenceNo convergence occurs when poor occurs when poor countries do not catch up over time and countries do not catch up over time and living standards may divergeliving standards may diverge

1 classic theories of development a comparative analysis

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