Lecture Economic development - Chapter 3: Classic theories of economic growth

Chapter 3
Classic Theories
of Economic
Growth and
Development

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Class Theories of Economic
Development – Four Approaches
• Structural change model
– Linear stages of growth
– Saving-investment
– Rural-urban migration

• Neocolonial dependence theory
– Dependence: Center vs. Periphery
– False Paradigm

• Neoclassical theory
– Market friendly approach
– Dualistic approach
– Public choice approach

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Rostow’s Linear-Stages Model
1. Traditional society
2. Pre-condition to take-off
3. Take-off
4. Drive to maturity
5. Age of high mass consumption
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Rostow’s Linear-Stages Model
1. Traditional society: slow economic and
population growth
2. Pre-condition to take-off: development of
institutions, organizations, and
infrastructure
3. Take-off: large investment in selected
industry (10 to 15% of GDP)
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Rostow’s Linear-Stages Model
4. Drive to maturity: sustained growth of the
industry and economy
5. Age of high mass consumption:

production of consumer goods and
services to serve an affluent society

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Rostow’s Linear-Stages Model
GDP Growth
Economic Growth

Post Take­off
Take­off
Pre Take­off

t1
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t2

Time

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Harrod-Domar Growth Model
S = sY

S=Saving; Y=Real GDP; s=Saving Ratio

I = ΔK

I=Investment; ΔK=Capital Accumulation

S=I

Saving-Investment identity

Define the Marginal Capital-Output Ratio as k = ΔK/ΔY
Write ΔK = kΔY or I = kΔY
From S = I, write sY = kΔY or
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ΔY/Y = s/k
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Harrod-Domar Growth Model
The source of growth is saving and investment in
production of goods and services. Accordingly,

GDP growth rate = s/k
s = national saving ratio; k = marginal capital-output ratio
If s=6% and k=3, then GDP growth rate=2%. Given k=3,
to raise growth rate to 4%, we need to increase the saving
ratio from 6% to 12% with 6% of foreign saving

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Criticism of Investment Models
• Many LDCs have not been able to take-off
or achieve maturity despite massive
foreign investment
• Many nations have neglected the
development of institutions, organizations,
and infrastructure required for
industrialization
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The Lewis Development Model
• Rural agricultural sector
– Low or even zero Marginal Product of Labor so that
labor is a redundant factor and wage rate is at the
subsistence level

• Urban industrial sector
– Rising demand for unskilled labor to be trained for
industrial growth results in greater employment and
more profits and higher wages

• Rural-Urban migration
– To find jobs and earn higher wages
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Demand for Labor
Wage
R: Rural 
W: Wage 
D: Labor Demand

WU

Profit

U: Urban
E: Employment 
S: Labor Supply

SR

WR
Wage

DU1 DU2
E1

E2

Investment in urban areas
increases the demand and
employment for rural labor.

Employment

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Criticisms of Lewis Model
• Industrial technology is generally capital
intensive/labor-saving. Hence, the demand
for unskilled rural labor would not increase
employment
• Industrialization must be supported by
agricultural development to supply an
ever-increasing supply of food items and
raw materials
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Demand for Labor

Wage

No increase in employment when 
technology is labor saving
Profit

SR

WU
WR

Wage

DU2
E1 = E2

DU1
Employment

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Neocolonial Dependence Model
• MDCs form the “center” of global economic
relations and technological advancement
• LDCs serving as the “periphery” are dominated by:

– unequal trade and finance relations
– domestic politico-economic elite
– multinational corporations

Under these conditions economic development is
impossible
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Neocolonial Dependence Model

African LDCS

Asian LDCS

American 
MDCs

Latin American LDCS

European  Other 
MDCs MDCs

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False-Paradigm Model
• Economic development relies heavily on funds
from international donor agencies such as the
World Bank and IMF
• The policy of these agencies is to support urban
industrial growth and impose capitalistic
austerity measures
• They reinforce the pattern of “dependent
development”

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Dualistic Development Model
• Structural transformation models create a
“dualistic” pattern of development, resulting in an
ever-increasing degree of economic inequality
both nationally and internationally:
– urban vs. rural
– industrial vs. agricultural
– modern vs. traditional
– rich vs. poor
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Approaches to Development
• Free-market approach: rely of the allocation role
of markets and limited government involvement in
economics. But, there are several areas in which
markets fail to achieve efficient outcomes:
– income distribution
– public goods
– externalities
– market power
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Approaches to Development
• Market-friendly approach: improve market
operation through “nonselective”
interventions such as
–
–
–
–

income redistribution system
investment in social and human capital
environmental protection policy

anti-trust laws

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Approaches to Development
• Public-choice approach: public officials and
bureaucrats in the position of authority are
“rent-seeking” citizens acting on self-interest
rather than public-interest
• Need a system of checks and balances to monitor
the behavior of public officials and bureaucrats
• Need a democratic system to let people choose
public officials and bureaucrats for limited duration
of authority
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Appendix 3.1: Components of
Economic Growth
• Capital Formation
– Physical capital formation: investment in tools,
equipment, machinery, buildings
– Social capital formation: investment in roads, dams,

airports, railroads, bridges
– Human capital formation: investment in education,
training, health, nutrition
– Political capital formation: investment is creating a
secular and democratic government and free mass
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Determinants of Economic
Growth
• Physical Capital Formation
– Increase in the amount of physical
capital per unit of labor

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Determinants of Economic
Growth
• Technological Advancement
– Increase factor productivity (labor,
land, capital)

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Production Possibilities Curve

•

Maximum quantities of two good and
services the economy can produce,
assuming:
– full employment / efficiency
– fixed resources
– constant technology

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PPC Schedule

Combination
Radios
    Rice

A

B

C

E

100

90

50

0

0

40

80

100

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