copyright © 2009 pearson addison-wesley. all rights reserved. chapter 3 classic theories of...

Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

Chapter 3

Classic Theories of Economic Growth and Development

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-2

Classic Theories of Economic Development – Four Approaches

1. Linear stages of growth models

2. Theories and Patterns of structural change

3. International-dependence revolution

4. Neoclassical, free market counterrevolution

Observation:

• LDCs have much less capital per worker than rich countries.

• “Capital” = machinery and equipment

• Result: Lower productivity of labor

• And thus Lower wages/incomes.

• LDCs are poor because they lack capital

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-14

sYS

KI

(3.1) Savings rate s

(3.2) Invest = ΔCapital

YkK (3.3) Capital/Output = k

IS (3.4) Closed Economy

The Harrod-Domar Model

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-15

The Harrod-Domar Model

IKYksYS (3.5)

YksY (3.6)

k

s

Y

Y

(3.7)

Growth rate of GDP = savings rate/capital-output ratio=> To increase GDP growth, increase s (or foreign S)

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-16

Criticisms of the Harrod-Domar Model

• Necessary versus sufficient conditions

• Is Saving necessary for growth? – Not if foreign investment or foreign aid (World

Bank Loans, etc.)

• Is Saving (Investment) sufficient for growth?– Are there institutions to channel savings to

productive uses: a well-functioning financial system or government plan?

Observation:

LDCs often have two quite different sectors:

1. Traditional (subsistence) agricultureLow K/L, low Land/L, “old” technology

(NOT: tractors or combines, hybrid seeds, chemical fertilizer, pesticides, herbicides)

Result: VERY low productivity and incomes

“Modern” Industrial Sector

• Higher K/L, more modern technology than traditional sector (tho often low by rich country standards)

• Result: Higher productivity and incomes

• Also: Large Urban-Rural gaps in income result in migration to the cities

Urban-Rural Income Ratio: China

1.8

2.0

2.2

2.4

2.6

2.8

3.0

1978 1983 1988 1993 1998Chen (2002)

Rural vs. Urban Consumption

405

559

779

1,052

0

200

400

600

800

1,000

1,200

1972-73 2004-05

Cons

tant

(200

4-05

) Rup

ees

per P

erso

n pe

r Mon

th

Rural Urban

NSSO

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-29

Figure 3.1 The Lewis Model of Modern-Sector Growth in a Two-Sector

Surplus-Labor Economy

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-30

Criticisms - Lewis Model• Rate of labor transfer and employment

creation may not be proportional to rate of modern-sector capital accumulation

• Surplus labor in rural areas (no) and full employment in urban (no)?

• Institutional factors (unions, min wage)?• Assumption of diminishing returns in

modern sector (agglomeration economies)• BUT: Captures some elements of urban-

rural divide. Chapter 7: Todaro Model

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-31

The International-Dependence Revolution

• The neoclassical dependence model– Unequal power, core-periphery (exploitation)

• The false-paradigm model– Using “expert” advisors who give wrong advice (true!)

• The dualistic-development thesis– Superior and inferior elements can coexist (true)

• Implications– Autarky (end exploitation by “neocolonialists”)– State led development: SOEs, central planning,

regulation

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-32

The Neoclassical Counterrevolution

• Challenging the statist model of government led development– Central planning, SOEs, etc, not usually successful– Free market approach– Public choice approach (not: government is “bad;”

rather, what incentives for politicians/bureaucrats)

• Criticism of Neoclassical Counterrevolution:– Institutional and political realities in developing world

differ from Western world• assume property rights and functioning court systems• ignore power relationships of traditional social systems

based on caste, gender, elites

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-33

Theories of Development: Reconciling the Differences

• Development economics has no universally accepted paradigm

• Insights and understandings are continually evolving

• Each theory has some strengths and some weaknesses

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-34

Case Study: South Korea and Argentina

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-35

Concepts for Review

• Autarky• Average product• Capital-labor ratio• Capital-output ratio• Center• Closed economy• Comprador groups• Dependence

• Dominance• Dualism• False-paradigm

model• Free market• Free-market analysis• Harrod-Domar growth

model

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-36

Concepts for Review (cont’d)

• Lewis two-sector model

• Marginal product• Market-friendly

approach• Necessary condition• Neoclassical

counterrevolution

• Neocolonial dependence model

• New institutionalism• New political

economy approach• Open economy• Patterns-of

Development analysis

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-37

Concepts for Review (cont’d)

• Periphery• Production function• Public choice theory• Savings ratio• Self-sustaining growth• Solow neoclassical

growth model

• Stages-of-growth model of development

• Structural-change theory

• Structural transformation

• Sufficient condition• Surplus labor

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-38

Concepts for Review (cont’d)

• Traditional neoclassical growth theory• Underdevelopment• You are NOT responsible for the appendices