classical theories of development - uw - laramie, theories of...theories of development...

Download Classical Theories of Development - UW - Laramie,   theories of...Theories of development •Classical development theories: 1950s-80s •Contemporary theories: late 1980s-present •The classical theories are mostly optimistic: development will happen  we can promote it •The contemporary theories

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  • Classical Theories of Development

  • Theories of development

    Classical development theories: 1950s-80s

    Contemporary theories: late 1980s-present

    The classical theories are mostly optimistic: development will happen & we can promote it

    The contemporary theories are less confident: there can be poverty traps where low investment incentives keeps countries poor

  • Classical theories

    1. Linear theories (Rostow, Harod-Domar)

    2. The Lewis structural change model

    3. The Solow model

    4. Dependency theory

    5. Market fundamentalism

    --First 3 focus on capital accumulation. 4 focus on political and economic power relations. 5 focuses on letting markets work freely

    --well do H-D, Lewi & Solow on whiteboard

  • Classical theories

    1. Linear theories: Rostow and Harrod-Domar.

    Developed 1940s-60s

    Based on historical experience of todays developed countries.

    Focus on physical capital accumulation

  • The Rostow Theory

    The Stages of Growth book written in 1950s as an anti-communist manifesto

    Meant to encourage developing countries to follow capitalism over socialism

    Used by US/Western governments to justify large amounts of foreign aid (Rostow was an adviser to JFK and LBJ)

    http://www.cambridge.org/us/academic/subjects/economics/economic-development-and-growth/stages-economic-growth-non-communist-manifesto-3rd-edition?format=HB&isbn=9780521400701#HoBtxYtsRbDX5Xzr.97

    http://www.cambridge.org/us/academic/subjects/economics/economic-development-and-growth/stages-economic-growth-non-communist-manifesto-3rd-edition?format=HB&isbn=9780521400701#HoBtxYtsRbDX5Xzr.97

  • Rostows five stages

    Economies go through five stages of growth

    - traditional society

    - preconditions for take-off (foreign and domestic savings mobilization)

    - take-off

    - drive to maturity

    - high mass consumption

  • Rostow

    Traditional

    Devote many resources to agriculture

    Hierarchical social structure

    Political power de-centralized

    Fatalism

    Technology and importance of science: low

  • Rostow

    Preconditions for takeoff

    Notion of progress

    Science, technology advance

    Education culturally more important

    Banks, financial institutions appear

    Centralized government/nationalism

    Increased investment and savings

  • Rostow

    Takeoff

    Technology and science continue to advance

    Political powers regard growth as important

    Entrepreneurial class emerges

    Savings/investment rise to 5-10% of the economy

    Agriculture: new techniques, sell to market

    Industry: a few key sectors

  • Rostow

    Drive to Maturity

    Increased participation in international markets

    Widespread use of new technology

    Broad industrial base

    Investment/savings rise to 10-20% of economy

  • Rostow

    Age of High Mass Consumption

    Masses, not just elites, cover more than basic needs (http://www.bbc.co.uk/history/british/victorians/bsurface_01.shtml)

    Large urban populations

    Work in offices, factories

    Systematic R&D

    Caring for least well-off

    http://www.bbc.co.uk/history/british/victorians/bsurface_01.shtml

  • Critique of Rostow The book makes it sound like development will

    automatically happen and follow the Western path

    But many developing countries remain poor today

    They may need to follow their own path; for example, Japan, Singapore and South Korea used heavy government intervention to develop the countries

  • Critique of Rostow

    Assume you see a society that is stuck in Rostows Traditional stage and the government/aid donors want to help it advance.

    Can they somehow just create the notion of progress, advance technology, make people value education , create banks, centralize the government, and increase savings? to get to the take-off stage

    Imagine you want to do this in Afghanistan, Bolivia or Cambodiaits good if it works, but its not that easy to do

  • The Harrod-Domar mode

    See the course note on the HD model

    Y=(1/k)K, k=the capital-output ratio

    The change in capital=Investment:

    K= I

    Investment = Savings:

    I=S

    Savings=saving rate times income

    S=sY

  • Since Y=(1/k)Y we have Y =(1/k)K

    Therefore Y =(1/k) K=(1/k) I=(1/k)sY

    So Y=(1/k)sY

    Y/Y = s(1/k)

    Y/Y = (s/k)

    %growth of output =savings rate divided by capital-output ratio

  • Ex. Y/Y = (s/k)=0.2/4 = 0.05 = 5%

    GDP will grow at 5% per year

    To raise GDP growth, either increase the saving rate (s) or decrease the capital-output ratio (k)

    As in Rostow, capital accumultion /investment is key to growth

    Double the saving rate doubles output growth: Y/Y= s/k = 2Y/Y=2s/k

  • Implications

    If a country saves too little, it can borrow or use foreign aid

    Fill the financing gap to achieve the desired saving and growth rate

    Alternatively: lower the capital-output ratio -but this may be difficult.

  • Implications Savings, investment, and physical capital

    accumulation are key to growth

    International donors have used the prediction model to justify aid

    Y/Y = (s/k) = (0.2/4) = 5%

    Y/Y=(s/k) = (0.3/4) = 7.5%

    If we supplement the 20% domestic saving rate with 10% of GDP in foreign aid, we will boosts GDP growth to 7.5%

  • Potential Limitations of the HD model It assumes capital accumulation investment- is

    both necessary (we have to invest) and sufficient (if we invest, the country will grow) for economic growth

    In fact, it may be neither (Easterly Ch. 2)

    Many countries have grown because of technology technology growth explains an estimated 2/3 of US GDP per worker growth since WW2

    Many countries invest a lot but fail to grow (the Soviet Union)

  • Put differently:

    Capital may require skilled labor, infrastructure, a legal framework, property rights, corruption control etc. to be productive

    Otherwise, capital gets diminishing returns

  • 2010 data

    United Arab Emirates

    Afghanistan

    Antigua and Barbuda

    AlbaniaArmenia

    Angola

    Argentina

    Austria Australia

    Azerbaijan

    Bosnia and HerzegovinaBarbados

    Bangladesh

    Belgium

    Burkina Faso

    Bulgaria

    BahrainBurundiBenin

    Bermuda

    Brunei DarussalamBolivia

    Brazil

    Bahamas, The

    BotswanaBelarus

    Belize Canada

    Congo, Dem. Rep.

    Central African Republic

    Congo, Rep.

    SwitzerlandCote d'Ivoire

    Chile

    Cameroon

    China

    ColombiaCuba

    Cabo VerdeCyprusCzech Republic

    Germany

    DenmarkDominica

    Dominican Republic

    AlgeriaEcuadorEstonia

    Egypt, Arab Rep.

    Eritrea

    Spain

    Ethiopia

    FinlandFrance

    Gabon

    United Kingdom

    Grenada

    GeorgiaGhana

    Gambia, The

    Guinea

    Equatorial Guinea

    Greece

    GuatemalaGuinea-Bissau Guyana

    Hong Kong SAR, China

    Honduras

    Croatia

    Haiti

    Hungary

    Indonesia

    Ireland

    Israel

    India

    Iraq Iran, Islamic Rep.

    Iceland

    Italy

    Jamaica

    Jordan

    Japan

    Kenya

    Kyrgyz Republic

    Cambodia

    Comoros

    St. Kitts and Nevis

    Korea, Rep.

    Kuwait

    KazakhstanLao PDRLebanon

    St. Lucia

    Sri Lanka

    Liberia Lesotho

    Lithuania

    Luxembourg

    Latvia

    Morocco

    Moldova

    Montenegro

    Madagascar

    Macedonia, FYR

    MaliMongolia

    Macao SAR, China

    MauritaniaMalta

    Mauritius

    MalawiMexico

    MalaysiaMozambiqueNamibia

    NigerNigeria

    Nicaragua

    NetherlandsNorway

    Nepal

    New Zealand

    OmanPanama

    PeruPhilippines

    Pakistan

    Poland

    Puerto Rico

    West Bank and Gaza

    Portugal

    Paraguay

    Qatar

    RomaniaSerbia

    Russian Federation

    RwandaSmall statesOther small states

    Saudi ArabiaSeychelles

    Sudan

    Sweden

    Singapore

    Slovenia

    Slovak RepublicSierra LeoneSenegal

    SurinameSouth Sudan

    El Salvador

    Swaziland

    Chad

    Togo

    ThailandTajikistan

    Timor-Leste

    TunisiaTonga

    Turkey

    Trinidad and Tobago

    Tanzania

    UkraineUganda

    United States

    Uruguay Uzbekistan

    St. Vincent and the Grenadines

    Venezuela, RB

    Vietnam

    Vanuatu

    Latin America & Caribbean (excluding high income)Yemen, Rep.

    South Africa

    Latin America & Caribbean

    Zambia

    Zimbabwe

    -10

    010

    20

    30

    GD

    P g

    row

    th (

    ann

    ua

    l %

    )

    0 10 20 30 40 50Gross capital formation (% of GDP)

    n = 177 RMSE = 4.2747613

    GDPgrowth = 2.763 + .06895 InvRate R2 = 1.6%

  • The relationship between investment rates and GDP growth is pretty loose but positive

    10% rise in investment rate linked to 10*(0.07)=0.7% more GDP growth

    This is something, if not everything; in 30 years your GDP level is (1+0.007)^30 - 1 = 23% higher than otherwise

    However:

  • 1. Correlation does not imply causation technology, education, demographic, legal-system, trade openness etc. differences might explain both GDP growth and investment differences and be the real growth driver

    2. Low R-squared =1.6% implies that differences in investment rates only explain 1.6% of d