CHAPTER-THREE

Theories of Economic growth and

 development
The post-world war II literature on Economic development has
been dominated by four major and sometimes competing strands
of thought: Namely:

 The linear stages - of -growth model (1950-60),

 Theories and patterns of structural change(1970),
 The international -dependence model(1970)
 The neo-classical, free -market counter-revolution
(1980/90).
 In addition, the past few years have witnessed the beginnings of
a potential fifth approach associate primarily with the so- called
new theory of economic growth. 1
 Components of Economic Growth
 Three components of economic growth which are of prime
importance:

1. Capital accumulation: including all new investments in land,

physical equipment, and human resources through improvements in
health, education, and job skills.

2. Growth in population and hence eventual growth in the labor

force.

3. Technological progress—new ways of accomplishing tasks.

2
1. The linear stages of growth
• It were derived largely from the experience of how present
developed countries were transferred from agrarian economy to
modern economy.

• It views the process of development as a series of successive

stages of economic growth through which all countries must pass.

• It was primarily an economic theory of development in which the

right quantity and mixture of saving, investment, and foreign aid
were necessary for economic development.

• It Emphasized the role of accelerated capital accumulation in

economic development
3
Con’
•t We are going to divide the linear stages of growth in to three
main models of growth: Namely:

1. Rostow's stages of growth

2. The Harrod-Domar growth model and
3. The Solow growth model.

4
 Rostow's Stages of growth
• This model is highly influenced by American Economist called Walt
W. Rostow.

• According to the Rostow doctrine, the transition from underdevelopment to

development can be described in terms of a series of steps or stages through
which all countries must proceed.

• Rostow identified stages of economic growth as:

1. The traditional society
2. Pre-condition for the take off
3. Take-off stage
4. Drive to maturity and stages of self-sustained growth
5. The age of high consumption-

All advanced economies have passed the stage of take-off into self sustaining growth
Developing countries are still in the traditional society or the pre-conditions stage.
5
 Traditional society or Pre-Industrial stage
 Traditional Society Characterized by:
 The economy is dominated by subsistence
activity.
 Existence of barter- goods for goods

 Agriculture is the most important industry

 Output is consumed by producers; it is not

traded nor recorded.

 Production is labor intensive using

only limited quantities of capital.

 Technology is limited, and resource allocation

is determined very much by traditional
methods of production. 6
Con’
t  People stick to age old customs and
traditions-no scientific perspective
 Output per worker is very low and
doesn’t change from time to time.
 In this stage, there may be craft
industries with strong social
stratification.
 The world is in this stage before 19th
century "Industrial Revolution"

7
 Transitional Stage (Preconditions for
Takeoff)
• Improvements and investment in
infrastructure begins (roads, water etc)
• Development of mining industries

• Increase capital use in agriculture & turning

agriculture in to business
• Moves up with social and political reforms

• Necessity of external funding

• Increased specialization generates surpluses for
trading.
• Emergence of a transport infrastructure to
support trade.
• Entrepreneurs beginning to develop money
making industries, then savings & investment
grow.
8
Con’
t • External trade also occurs concentrating on
primary products.

• A strong central government encourages private

enterprise: in this stage the economy is more open
to modern technology and preparing itself for take
off.

• There is a start of construction of roads and

railways, growing export, new political and
economic elites and high external influence.

• Investment ranged around 5% of the GNP in this

stage.

9
 The take-off stage
 Rapid and dynamic economic growth:
 Transition of a traditional economy to modern
 Growth in industrialization/manufacturing

sectors
 Increases in savings and investment
 Number employed in agriculture declines
 At this stage, industrial growth may be linked to
primary industries.

 Industrialization increases with workers

switching from the agricultural sector to the
manufacturing sector.

 Growth is concentrated in a few regions of the

country and within one or two manufacturing
industries. 10
Con’
t  Group of entrepreneurs to pursue innovation
 Agriculture progressed to commercial than subsistence

 The level of investment reaches over 10% of GNP/GDP.

 Any remaining barriers to growth are overcomed and growth becomes

a normal condition at least in one sector of the economy (the leading
sector—agriculture in Ethiopia???)

 In this stage, political, social and institutional setup favors dynamic

growth – development in these framework
 The growth is self-sustaining as investment leads to increasing incomes
in turn generating more savings to finance further investment.

 A country may be in the take-off period for two to three decades.

11
 Conditions for take off
 A rise in the rate of productive investment from, 5
% or less to over 10% of national income.

 The development of one or more substantial

manufacturing sectors with a high rate of growth
i.e development of leading sectors.

 The quick emergence of a political, social, and

institutional framework that exploits expansion.

12
 Drive to Maturity
 Standard of living rise

 Growth becomes self-sustaining – wealth

generation enables further investment in value
adding industry and development
 Expansion of more diversified industry
 Use of technology increases

 The economy is diversifying into new areas.

 Technological innovation is providing a diverse

range of investment opportunities.
 The economy is producing a wide range of
goods and services and there is less reliance on
imports.
 Urbanization increases.
 Increases percentage of nation’s wealth-invested
in to developing to it’s economy.
13
 High Mass Consumption
• High output levels

• Mass consumption of consumer durable goods

• High proportion of employment in service sector

• In this stage, the per capital income becomes so

high that the consumption transcends beyond
food, clothes and shelter to goods of comforts
and luxuries.

• A mass scale urbanization and industrialization

change the values of the society and
development.

• In this stage people do not feel any pinch of

shortages. i.e Very high levels of consumption
and physical quality of life are achieved.
14
 Con’
tthe level of economic activity is very high.
• The economy is geared towards mass consumption, and Economy
flourishes

• Technology is extensively used but its expansion slows.

• The service sector becomes increasingly dominant.

• Urbanization is complete.

• Now, multinationals emerge.

• Increased interest in social welfare.

• Individuals income are greater than necessary for
buying essentials.
• Growing demand for additional consumer goods and
services.
15
Criticism
s• Economists criticized:
Are these stages inevitable like birth and death?

Do the stages follow a set of sequence like

childhood, adolescence, maturity and old age?

 Can one tell with sufficient precision that one stage

is complete and the other has begun?

• These questions are not stated in this model.

16
 con’
t limitations of this model:
• Major

 Traditional society is not essential for development: a

number of nations such as the USA, Canada, New Zealand,
and Australia are borne of free of traditional societies, b/c
this peoples are migrated from Europe. Not universally
applicable. And also Asian tigers….
 It is too rigid (linear conception), and it is too simplistic.

 Preconditions may not precede the take off stage.

 Overlapping in the stages: development in agriculture
continued even in the take of stage
 Growth rate of investment 5% to over 10% of NI is arbitrary.
17
 The Harrod-Domar Growth model
• The model takes its name from a synthesis of analyses of the growth
process by two economists, Roy Harrod of Britain and Evsey Domar
of the United States.

• Itis based on the experience of advanced economies.

 Economic growth can be thought of a result of
abstention from current consumption i.e. saving matter.

 The principal strategy for development is mobilization of saving

and generation of investment to accelerate economic growth.
 Investment comes from savings.

 The model argued that rate of economic growth depends on: saving
rate, capital productivity, capital depreciation, and population.
18
 Assumptions:
• The economy operates at full employment and makes full use of available capital
goods.
• Productivity and savings rate are the main determinants of economic growth.
• The model assumes constant returns to scale for the capital-output ratio and the
propensity to save.
• Investment is net, that is, gross investment minus depreciation. Thus, the capital
stock changes by net investment.
• There is no government interference in the functioning of the economy.
• The economic variables such as savings, investment, income, expenditure adjust
themselves completely within the same period of time.
• The exogenous factors do not influence the growth variables.
• Saving and investment are equal 
• Labour force equals population….etc 19
 Building the model
• Every society must save a certain proportion of its national income,

• However, in order to grow, new investments representing net additions to the

capital stock are necessary.

• Suppose that the national output is a direct function of capital stock: Yt = f(K)

• Net saving (S) is some proportion, s, of national income (Y) such that we have
the simple equation: S =sY

• Net investment (I) is defined as the change in the capital stock, K, and can be
represented by ΔK such that: I = ΔK

• But because the total capital stock, K, bears a direct relationship to total national
income or output, Y, as expressed by the capital-output ratio, c, it follows that:
or finally, ΔK = cΔY

20
 Cont.
• Finally, because net national savings, S, must equal net investment, I, we can
write this equality as:
• S=I sY = ΔK sY = cΔY =

• Note that the left-hand side of Equation Y/Y, represents the rate of change or rate
of growth of GDP.

• It is a simplified version of the famous equation in the Harrod-Domar theory of

economic growth, states simply that the rate of growth of GDP(Y/Y) is
determined jointly by the net national savings ratio, s, and the national capital-
output ratio, c.
• More specifically, it says that in the absence of government, the growth rate of
national income will be directly or positively related to the savings ratio (i.e., the
more an economy is able to save—and invest—out of a given GDP, the greater
the growth of that GDP will be) and inversely or negatively related to the
economy’s capital-output ratio (i.e., the higher c is, the lower the rate of GDP
growth will be).
21
 Cont.
• The economic logic of the above Equations is very simple. To grow, economies
must save and invest a certain proportion of their GDP. The more they can save
and invest, the faster they can grow.

• To sum up, if the model considers depreciation of capital, labor force and
technological progress, we can write the formula as:

= -δ-n

• In addition to investment, two other components of economic growth are labor

force growth and technological progress. In the context of the H-D model, labor
force growth is not described explicitly. This is because labor is assumed to be
abundant in a developing-country context and can be hired as needed in a given
proportion to capital investments (this assumption is not always valid).

• In a general way, technological progress can be expressed in the H-D context as

a decrease in the required capital-output ratio, giving more growth for a given
level of investment, as follows from H-D Equation.

22
 Con’t
• For a given c, given the domestic saving, one can see the resource gap (St – It) for
a targeted level of growth rate.

• Examples* : Calculate the rate of growth of output if the saving rate is 6%, capital output ratio is
3% and rate of deprecation and population is zero.
Solution: Given s = 6%, c = 3%, n=0 and d = 0
• From Harrod -Domar model we have:
g = 6/3 = 2%

i.e. GDP growth rate is 2%

** What if the s = 15% and n =2.5%? What is the implication towards growth?

g = 15/3 = 5%

• In fact, Rostow and others defined the takeoff stage in precisely this way. Countries that were
able to save 15% to 20% of GDP could grow (“develop”) at a much faster rate than those that
saved less. Moreover, this growth would then be self-sustaining.

• The mechanisms of economic growth and development, therefore, are simply a matter of
increasing national savings and investment. 23
 Con’
t
 The main obstacle to development, according to this theory, is the
relatively low level of new capital formation in most poor countries.
But if a country wanted to grow at, say, a rate of 7% per year and if
it could not generate savings and investment at a rate of 21% of
national income (assuming that c, is 3) but could only manage to
save 15%, it could seek to fill this “savings gap” of 6% through
either foreign aid, loan or private foreign investment.

 Thus the “capital constraint” stages approach to growth and

development became a rationale and (in terms of Cold War politics)
an opportunistic tool for justifying massive transfers of capital and
technical assistance from the developed to the less developed
nations.

24
 Con,t
*Assume that Ethiopia's target of per capita income growth rate is 4% c =3%,
n=3%, and s = 7%, then what is the required saving rate and financial gap to
achieve the stated per capita income growth rate? (Assuming that δ =0)
• Solution:
s = c(g+n+δ)
• s = 3 (4+3) = 21%, that is the required saving rate = 21%

• Therefore, The financial gap = Required saving rate - Actual Saving rate:

• Saving gap = 21-7 = 14%

• The gap, which should be fulfilled by foreign aid, loan or private foreign
investment to grow at 4%, is 14 percent.

25
 Cont’
• Constraints to implement this model in developing
countries due to:

 Low rate of savings in developing countries gives rise to

savings gap and capital constraint.

 Savings and investment is a necessary condition for

accelerated economic growth but not a sufficient
condition.

 Capital formation is the main motor which is very

difficult.
26
 Limitations of the model
• Investment and saving rate are the necessary conditions and
not sufficient condition for economic growth. (the necessary
structural, institutional, and attitudinal conditions like well-integrated
markets, highly developed transport facilities, a well-trained and
educated workforce, the motivation to succeed, an efficient
government bureaucracy) matters to convert new capital
effectively into higher levels of output.

• Saving, population, capital output ratio are not exogenous

but actually they are endogenous i.e. these parameters
themselves are affected by economic growth.

• H-D is a neutral theory. It doesn't explain why growth rate

at different levels of per capita income differs.
27
 Cont.
• Capital output ratio is assumed fixed in the H-D model. But from
microeconomics if we apply more and more labor in to a fixed
capital the diminishing return to scale operates. If there is a
diminishing return to scale, the efficiency of capital to produce
output may be diminishing.

• The model excludes technology progress, human capital formation

and fails to consider changes in the general price.

28
 The Solow Growth Model
• The Solow Growth Model is an exogenous model of economic growth that
analyzes changes in the level of output in an economy over time as a result of
changes in the population growth rate, the savings rate, and the rate of
technological progress.

• The theories of Solow growth model is similar with the H-D model of economic
growth and development. That means the growth rate of the economy is mainly
determined by the factors of:
 Saving – Investment - causes capital accumulation

 The use of capital in production or production is a direct or positive

functions of capital stock. Y = f(K)

 The proportion of the labor force which is engaged in the economy.

 The use of technological progresses.

29
 Building the simple Solow Growth Model
• The Solow growth model which is the formal starting point of modern growth
theory which is based on two fundamental equations.
• Production function (from the supply side)
• Capital accumulation (from the demand side)

The Production Function

• He used the Cobb-Douglass production function: Y =
f(L, K)
𝑌 = 𝐾 𝛼 L 1−𝛼
• Where Y= output, K = capital, L = labor.

• Assumptions:
1. Constant returns to scale: The production function is homogenous of degree
one (jointly for L and K).
2. Diminishing returns to factor inputs: As factor inputs (L &K) increase, output
increases but the rate at which output increases tends to decline as more of
each input is used while either of the two is held to be constant.
3. Labor force equals population, no gov’t, and no international trade. Etc
30
4. Technology is exogenous –explains long term growth
 Con,
•
t
Because of constant returns to scale, if all inputs are increased by the same amount, say 10%, then
output will increase by the same amount (10% in this case).

• More generally, ϒY = (ϒK, ϒL)

• where ϒ is some positive amount (in the case of a 10% increase).

• We can express output and capital per capita as: Y/L = ƒ(K/L, 1) or y = ƒ(k) or y = kα

• Where, y is output per worker and k is capital per worker.

• The concave shape of ƒ(k)—that is,

increasing at a decreasing rate—reflects
diminishing returns to capital per
worker.

• It tells us the change in output per

worker that results when we increase
the capital per worker by one.
31
 The Capital Accumulation Equation
• Output per worker is a function that depends on the amount of capital per
worker. The more capital with which each worker has to work, the more output
that worker can produce.

• The labor force grows at rate n per year, and after capital widening, that is,
providing the existing amount of capital per worker to net new workers joining
the labor force, nk.

• The total capital stock grows when savings are greater than depreciation, but
capital per worker grows when savings are also greater than what is needed to
equip new workers with the same amount of capital as existing workers have.
32
 Con,
t is equal to the previous
• Capital accumulated at time t, K t period’s level of
capital Kt-1 plus gross investment It less depreciation of previous capital
stock Dt and nk amount of capital per worker to net new workers joining the
labor force
• Let the previous capital stock depreciates at a constant rate 𝛿 of so that Dt =
Kt-1. Then we have:
𝐾𝑡 = 𝐾𝑡−1 + 𝐼𝑡 − 𝛿𝐾𝑡−1 − nKt
• Rearranging this equation
∆𝐾𝑡 = 𝐼𝑡 − 𝛿𝐾𝑡−1 − nKt
• In continuous form, we have:

• ∆𝐾= 𝐼 − 𝛿𝐾 = 𝑠𝑌 − 𝛿𝐾 − nK = s*f(k) − (𝛿+n)k

This is capital accumulation equation

33
 Steady State Equilibrium
• To find the steady state, set Δk=0; sf(k*) = (δ+n)k*

• It is a state in which output per worker and capital per worker are no longer
changing.

The notation k* means the level of

capital per worker when the economy
is in its steady state.

If Δk>0, as a result, k in the economy

is growing toward the equilibrium
point k* vice-versa.

34
Cont…
• What happens in the Solow neoclassical growth model if we increase the
rate of savings, s???

• The key implication is that unlike in the Harrod-Domar (K) analysis, in the Solow model
an increase in s will not increase growth in the long run; it will only increase the
equilibrium k*. That is, after the economy has time to adjust, the capital-labor ratio
increases, and so does the output-labor ratio, but not the rate of growth.
• But, in developing countries, even if the
Solow model is an accurate depiction of
the economy, an increase in savings
may substantially increase the growth
rate for many decades to come.

• (Both theoretically and empirically, the

link between the rate of savings and the
rate of growth remains controversial.)

35
 Intuition
• Why are some countries rich (have high per worker GDP) and
others are poor (have low per worker GDP)? How poor countries
catch up?

• Solow model: if all countries are in their steady states, then:

 Rich countries have higher saving (investment) rates than poor

countries

 Rich countries have lower population growth rates than poor countries

36
 Cont.
• There is no growth in the long term. If countries have the same g (population
growth rate), s (savings rate), and d (capital depreciation rate), then they have
the same steady state, so they will converge, i.e., the Solow Growth Model
predicts conditional convergence. Along this convergence path, a poorer
country grows faster.

• Countries with different saving rates have different steady states, and they will
not converge, i.e. the Solow Growth Model does not predict absolute
convergence. When saving rates are different, growth is not always higher in a
country with lower initial capital stock.
 
37
 Cont.
• Besides,
• The Solow model also predicts conditional convergence. Basically, when two
countries have similar characteristics (for example, similar technology, savings
rate) but one happens to be poorer than the other, that poorer country tends to
grow faster than the richer country. In other words, it catches up.

• However, When two countries are fundamentally different (different

technology, different institutions and so on), no reason exists to expect the
poorer country to catch up. In other words, the Solow model doesn’t predict
absolute convergence.

38
 Main message
• In Solow model, the savings rate determines level of steady–state income per
capita but does not produce sustained (long–run) economic growth.

• Investment (increase capital per worker) increases income per capita.

• Accumulation produces higher (average) income, but not persistent growth.

• Higher population growth, lowers the steady–state level of per capita income.

• Rather, Technical change, innovation, produces sustained economic growth.

• Thus, Solow model with technological progress yields sustained per capita growth
of capital and income.

39
 Cont.
• The more that people in an economy save of their income, the greater the
amount of investment. This leads to economic growth and higher future living
standards.

• When the population growth rate falls, more capital is available for each person
to use. This increases income per person.

• When a firm uses a machine, it depreciates over time: that is, it’s not in as good
a condition at the end of the year as it was at the beginning. The slower that
capital (remember machines are capital) depreciates, the more capital exists per
person and the higher living standards are in an economy.

40
 Cont.
• All these effects, however, are temporary. As the economy reaches its new
‘steady state’, it stops growing again. Thus increasing savings, reducing the rate
of population growth or reducing the rate at which capital depreciates in an
economy only temporarily increases economic growth.

• The only means to increase long-run living standards in the Solow model is
through continual technological progress, so economies need to get better at
turning inputs (such as land, labour and capital) into outputs (things that people
want to buy).

41
 Limitations of the Solow model
• Narrow in Scope and inadequate: According to them, the main
determinants of economic development are changes in the size of
population, capital stock, natural resources and technology.

 They have minimized the significance of non-economic

factors as the degree of political stability, the attitude of
population, legal and social institutions etc. 

• They believe that economic development is a gradual, continuous

and harmonious process and hence they could not correctly analyze
the possibilities of cyclical fluctuations in the process of
development.

 Historically, economic development has been a

discontinuous process. 42
 Cont.
• Its assumption of full employment which is very unrealistic.
 Much of the assumptions are unrealistic

• The model could not recognize the important role which

government can play in creating conditions for economic
development. In the present era intervention of Govt., is must to
solve various problems of the UDC’s.

• Finally, the analysis also suffers from the drawback that they were
mainly concerned with their own developed economies and hence
their ideas and policies have little relevance for under-developed
countries – not-contextual.

 For instance, their policy of free trade and international specialization

can hardly solve the problems of under-developed countries. 43
 Structural Change Models
 Focused on the mechanism by which underdeveloped economies transform
their domestic economic structures from a heavy emphasis on traditional
subsistence agriculture to a more modern, more urbanized, and more
industrially diverse manufacturing and service economy.

• Two well-known representative examples of the structural-change approach

are the “two-sector surplus labor” theoretical model of W. Arthur Lewis and
the “patterns of development” empirical analysis of Hollis B. Chenery and his
co-authors'
 Development therefore requires more than just accelerated
capital formation.
44
 A. The Lewis Theory of Development
• Prof. Arthur Lewis has developed a very systematic theory of economic
development with unlimited supply of labour.
• Lewis' model starts with the assumption of a dual economy:
 A traditional, overpopulated rural subsistence sector characterized by zero
MPL- a situation that permits Lewis to classify this as surplus labor in the
sense that it can be withdrawn from the traditional agricultural sector without
any loss of output,
 A high-productivity modern urban industrial sector into which labor from the
subsistence sector is gradually transferred.
• Lewis' believed that in the traditional sector of many underdeveloped countries
there is unlimited supply of labour at subsistence wage.

• Lewis two-sector model: A theory of development in which surplus labor from

the traditional agricultural sector is transferred to the modern industrial sector, the
growth of which absorbs the surplus labor, promotes industrialization, and
stimulates sustained development. 45
• Surplus Labour means the existence of such a large population in the rural sector

so that the MPL has fallen to zero. This condition is also called disguised
unemployment.

• The essence of the development process in this type of an economy is the transfer

of labor resources from the agricultural sector where they add nothing to
production to the more modern industrial sector, where they create a surplus.

• Economic development takes place when capital accumulates as a result of

withdrawal of surplus labour from the subsistence to the modern industrial sector.

• The primary focus of the model is on both the process of labor transfer and the
growth of output and employment in the modern sector. 46
The main assumptions of this model:

• Because of the high density of population in less developed countries, many people are disguisedly
unemployed. Marginal productivity of these people is zero.

• The supply of labor is perfectly elastic at the subsistence rate of wages.

• Less developed economies are dual economies. There is coexistence of capitalist sector and
subsistence sector.

• Wage rate is higher in the capitalist sector compared to subsistence sector, wage rate stagnates at
the subsistence level

• Finally, Lewis assumed that the level of wages in the urban industrial sector was constant. At the
constant urban wage, the supply curve of rural labor to the modern sector is considered to be perfectly elastic.

• It employs the tools of neoclassical price and resource allocation theory (PCM).

• There is also capital reinvestment to produce more and to accumulate more capital stock. 47
 All rural workers
share equally in the
output, so wage is
determined by AP
not MP, MP = 0.

Profit maximizing
modern sector hires
labour when MPL = w.
K increases from i.e. F,
Km1 to Km2 employment = L1
Output = TPm1 (0D1Fl1)
Total output paid to
worker in the form of
wage = 0WmFL1
Profit = WmD1F -
reinvested

48
• The countries to bring economic development, should:

 The process of self-sustaining growth and employment expansion continues in the

modern sector until all of the surplus labor is absorbed.

 Thereafter, additional workers can be withdrawn from the agricultural sector only at a higher
cost of lost food production because the declining labor-to-land ratio means that the marginal
product of rural labor is no longer zero. This is known as the “Lewis turning point.”

• Structural transformation of the economy has taken place with the growth of the modern industry.
or

•
(shifting from traditional rural agriculture to modern urban industry).
49
 Criticisms
1. Lewis assumes that due to competitive labour market, the wage
rate remains constant in the urban sector for a long time. It is an
unrealistic assumption.

2. If the method of production in the industrial sector is capital

intensive and labour saving, this theory will not work -what if
capitalist profits are reinvested in more sophisticated labor saving capital
equipment rather than just duplicating the existing capital.

3. It considers lack of skilled laborers as a temporary bottleneck in

the development process of underdeveloped countries. But it is a
serious problem.

50
4. Lack of entrepreneurial initiative is another problem that affects
5. It is unrealistic to assume that there is high unemployment in rural
areas and full employment in urban areas. In most developing
countries the reverse is true.

6. Schultz argued that MP of labour in the over-crowded agricultural

sector is not zero. So, when there is shift the workers from
agricultural to industry, the agricultural production decreases.

7. Mobility of labour from agriculture to industrial sector is not easy.

Differences in language and customs, problem of housing, high
cost of living in urban sector and the attachment of the people to
their family land are some factors that affect the labour mobility.

8. It is a one sided theory because the theory does not consider the
possibilities of progress in the agricultural sector. etc
51
 cont.,.
• Labor demand curves do not shift uniformly outward but in fact cross – b/se
additions to the capital stock embody labor saving technical progress—that is,
KM2 technology requires much less labor per unit of output than KM1
technology does.

• The model is widely considered relevant to recent experiences in China, but

requires considerable modification in assumptions and analysis to fit the reality
of most contemporary developing nations.
• (take into account the labor saving bias of most modern technological transfer, the
existence of substantial capital flight, the widespread nonexistence of rural surplus labor,
the growing prevalence of urban surplus labor, and the tendency for modern-sector
wages to rise rapidly even where substantial open unemployment exists).
52
 B. Structural Changes and Patterns of Development:
Chenery’s Model
• Key messages

• The model focuses on the sequential process through which the economic, industrial, and
institutional structure of an underdeveloped economy is transformed over time to permit
new industries to replace traditional agriculture as the engine of economic growth.

• However, in contrast to other models, increased savings and investment are necessary but
not sufficient condition for economic development.

• In addition to the accumulation of capital, both physical and human, a set of

interrelated changes in the economic structure of a country are required.

53
• Empirical structural-change analysts emphasize both domestic and
international constraints on development.

 Domestic constraints: population size, economic constraints

like resource endowment, institutional factors such as
government policies and aims.

 International constraints: access to external capital,

technology and foreign trade.

 The model recognizes the fact that developing countries are part of an integrated
international system that can promote (as well as hinder) their development.

• 54
In general , structural-change policy supporter believe that the “correct mix” of
economic policies will generate beneficial patterns of self-sustaining growth.
 Cont.
• Chenery and his colleagues examined patterns of development for many developing countries at

different per- capita income levels during the post-war period;

• The empirical studies identified several features to economic development process (attributes of

structural changes):

 Shift from agriculture to industrial production

 Steady accumulation of physical and human capital

 Change in consumer demands (from food and basic necessities to desires for diverse manufactured goods
and services).

 Increased urbanization (growth of cities and urban industries)

 Decline in family size

 Demographic transition 55
 The international-dependence Revolution
• The dependency theory states that the dependence of LDCs on DCs

is the main cause for underdevelopment of the former.

• Definition: dependency is a situation in which the economy of certain
countries is conditioned by the development and expansion of another
economy to which the former is subjected.

 It is explained in the following characteristics:

 Dependency: a historical international process: the present economic and

socio-political conditions prevailing in LDCs is a result of a historical
international process.

56
  Dependency: foreign capital
• LDCs depend on DCs on foreign capital

• The foreign investors exploit LDCs by insisting on the choice of projects, making

decisions on pricing, supply of equipments, knowhow, and personnel etc.

• The dependency on foreign capital leads to a much higher outflow in the form of

declared profits, royalties, transfer of pricing, payment of principal and interest to

foreign investors of DCs.

 Technological dependence;
• LDCs use excessively capital intensive technologies imported from DCs.
• These technology are inappropriate to the production & consumption of
LDCs.

57
 Trade And Unequal Exchange
• LDCs export primary products with inelastic demand and
import manufactured goods.

58
 Cont.
 The IDR theory gained increasing support especially among developing
countries intellectuals, as a result of growing disenchantment with both
previous models.

 The IDR theory reject the exclusive emphasis on GNP growth rate as the
principal index of development.

 Instead they place emphasis on international power balances and on

fundamental reforms world-wide.

 IDR theory view developing countries as explained by institutional, political,

and economic rigidities in both domestic and international setup. 59
 Cont.
• NB. Within the international dependency revolution, there
are three major streams of thought:

• The neocolonial dependence model,

• The false-paradigm model,

• dualistic-development thesis

60
 A. Neocolonial dependence model
• A model whose main proposition is that underdevelopment exists in developing
countries because of continuing exploitative economic, political, and cultural
policies of former colonial rulers toward less developed countries. Because …..

 Rich nations are intentionally exploitative of poor countries by unequal distribution

growth of the poor as MDCs form the “center” of global economic relations and
technological advancement, and LDCs serving as the “periphery” are dominated by:

 unequal trade and finance relations

 domestic politico-economic elite
 multinational corporations, foreign aid, WB, IMF

 Under these conditions economic development is impossible

 Renders attempts by poor nations to be self-reliant and independent difficult for
LDCs.
61
 Cont..
• Certain groups in developing countries like landlords, merchants,
military rules, entrepreneurs, salaried public official's and trade
unions who enjoy high incomes,
• Social status and political power constitute a small elite ruling class whose principal
interest knowing or not, is in the perpetuation of the international capitalist system
of inequality and conformity by which they are rewarded.

• Therefor, Underdevelopment is thus seen as an externally induced

phenomena, but not in linear and structural theories of internal
constrains:
• Such as low saving and investment or lack of education and skill.

• So, revolutionary struggles or at least major restructuring of the

world capitalist system are therefore required to free dependent
developing nations from direct and indirect economic control of their
62
 B. False-paradigm model
 False-paradigm model: The proposition that developing countries have failed to

develop because their development strategies (usually given to them by Western

economists) have been based on an incorrect model of development, one that, for
example,
 Overstressed capital accumulation or market liberalization without
giving due consideration to needed social and institutional change.

 Underdevelopment comes by Faulty and inappropriate advice provided by no

appropriate design of uninformed, biased and ethnocentric international expert

advisers from developed country, Assistances agencies and multinational donor
organizations.
63
 Con’
• These experts are said to offer complex but ultimately misleading
tmodels of development that often lead to inappropriate or incorrect
policies. And apply different own policy.

• Institutional factor such as the central and the remarkable resilient

role of traditional social structures(tribe, caste, class, etc),

• The highly unequal ownership of land and other property right, the
disproportional control by local elite over domestic and international
financial assets, and

• The very unequal access to credit, these polices, based as they often
are on mainstream,

64
Cont.
 In addition, according to this argument, leading universities
intellectual, trade unions, high government economists and other
civil servant all get their training in developed countries institutions
where they are:

 Unwitting or ignorant individuals for their home countries,
 Apply unhealthy dose of alien concepts and
 Elegant but inapplicable theoretical models.

 By taking the western economic and social model that implement in

developing countries and so…

 Leads apply false or fake policies to developing countries.

 Finally, it does not represent the real situation of developing countries
and did not bring development.

65
 C. Dualistic development model
• Dualism is the coexistence of two situations or phenomena (one desirable and the
other not) that are mutually exclusive to different groups of society.

• Dualism represents the existence and persistence of increasing divergences

between rich and poor nations at all levels.

The concept embraces four key arguments:

1. Superior and inferior conditions can coexist in a given space:

Examples: Lewis’s notion of the coexistence of modern and traditional

methods of production in urban and rural sectors; the coexistence of wealthy,
highly educated elites with masses of illiterate poor people; wealthy –peasant..

66
 Cont.
2. This coexistence is chronic and not merely transitional.

3. Not only do the degrees of superiority or inferiority fail to show any signs of
diminishing, but they even have an inherent tendency to increase.

 For example, the productivity gap between workers in developed countries

and their counterparts in most LDCs seems to widen with each passing year.

4. The interrelations between the superior and inferior elements are such that the
existence of the superior elements does little or nothing to pull up the inferior
element, let alone “trickle down” to it.

 In fact, it may actually serve to push it down to “develop its

underdevelopment.”

67
 Summary
• Whatever their ideological differences, the advocates of the neocolonial
dependence, false-paradigm, and dualism models reject the exclusive emphasis on
traditional neoclassical economic theories designed to accelerate the growth of
GDP as the principal index of development.

• Instead, dependence, false-paradigm, and dualism theorists place more emphasis

on international power imbalances and on needed fundamental economic,
political, and institutional reforms, both domestic and worldwide.

• The new developing countries are getting underdeveloped b/se of the exploitation
of developed countries.(the now developed countries are developed by
exploitation of resources of developing countries).

• There is no need to follow the path followed by developed countries. The developed countries have
68
their own path of development. (cut the r/ship).
The Neoclassical Counterrevolution: or
Market Fundamentalism
 It is a neoclassical counterrevolution in the 1980s called for free
markets, and the dismantling of public ownership, and
government regulations.
 The central argument is that underdevelopment results from poor
resource allocation due to incorrect pricing policies and too
much state intervention by overly active developing-nation
governments.

 Because of the heavy hand of the state (creates corruption,

inefficiency, and lack of economic incentives that permeate the
economies of developing nations).

69
 Con’
• tWhat is needed, therefore, is not a reform of the international
economic system, a restructuring of dualistic developing
economies, an increase in foreign aid, attempts to control
population growth, or a more effective development planning
system.

• Rather, it is simply a matter of promoting free markets and laissez-

faire economics within the context of permissive governments that
allow the “magic of the market place” and the “invisible hand” of
market prices to guide resource allocation and stimulate economic
development.

70
 Cont.
• It has four approaches:
 Free-market analysis - markets alone are efficient

 Public-choice theory- governments can do nothing

right

 Market- friendly approach- governments have a

key role to play in facilitating operations of
markets through non-selective interventions

 New-institutionalism- success or failure of

developmental efforts depend upon the nature,
existence, and functioning of a country’s
fundamental institutions. 71
Cont.
Other development theories…

72
 The theory of big -

push
The theory of the big push is developed by prof. Rosenstien-
Rodan

 The theory of the model emphasizes that underdeveloped countries

require large amounts of investments to embark on the path of
economic development from their present state of backwardness.
i.e it needs big investment.

• It states that a big push or a large comprehensive program is needed

to overcome obstacles of growth.

• It also states that proceeding “bit by bit” will not launch the
economy successfully on the development path rather a minimum
amount of investment is a necessary condition for development.
73
 Criticism
 Developing countries do not have big capital to assure this
investment. They cannot afford. However development process
require good amount of investment.

 Minimum effort could be possible over time, but the issue is the
question of how to identify, when to identify a time and what is
the amount of investment needed?

 These issues should be identified to bring development. Of course

this depends upon the planners capacity. The focus is on the
investment need.

74
 The Balanced Growth
• ThisTheory
theory was advocated mainly by Rosenstein-Rodan (1943),
Ragnar Nurkse (1953) and Arthur Lewis (1954).

• But their view about balanced growth theory was different.

• To some writers, balanced growth means investing in a lagging sector

of the national economy or industry so as to ensure that it catches up
with others.

• To others, balanced growth implies that investment takes place

simultaneously in all sectors of the national economy.

• Still to others, it implies the balanced development of

agricultural and industrial sectors of the economy.
75
 Con’
• t To this extent, balanced growth calls for maintaining the balance
between the different consumer and capital good industries.

• It also calls for ensuring balance between agriculture and industry

and between the domestic and export sectors of the national
economy.

• Moreover, the economists in favor of the balanced growth

postulated the balance between supply side and demand side.

76
 Con’
 tTo sum up in the words of Lewis, “in development Programme all
sectors of the economy should grow simultaneously so as to keep
a proper balance between industry and agriculture and between
production for home consumption and production for exports”.

77
 Criticisms
 Balanced growth strategies are beyond the capability of UDCs. In
these nations, the availability of resources for simultaneous
development on many fronts are generally lacking.

 The doctrine of balanced growth presupposes increasing returns.

But this is a wrong assumption.

 Disproportionalities in factors of production and shortage of

resources make the theory unrealistic in LDCs.

 This theory is applicable in a developed country.

78
 The Unbalanced Growth Model
• It is the opposite of the doctrine of balanced growth.

• The dissatisfaction with the theoretical underpinnings of the balanced

growth theory gave rise to a new school of thought that of unbalanced
growth which has an intellectual as well as a practical appeal.
• The deliberate unbalancing of the economy in accordance with a pre-
designed strategy is the best way to achieve rapid economic
development in the less developed countries.

• Investments in strategically selected industries or sectors of the

economy, will lead to new investment opportunities and so pave the
way for further economic development.

• According to this theory investment should be made in selected

sectors rather than simultaneously in all sectors of the economy. 79
 New growth theory: Paul Romer
The theory that our unlimited wants may lead us to ever greater
productivity and perpetual economic growth.

According to new growth theory, real GDP per person grows

because of the choices people make in the pursuit of profit.

New growth theory predicts that national growth rates depend on

national incentives to save, invest, accumulate human capital, and
innovate.

The theory emphasizes the importance of entrepreneurship,

knowledge, innovation, and technology, rejecting the popular view
that economic growth is determined by external, uncontrollable
forces. 80
 Cont.
• It is a view of the economy that incorporates two important points:

 First, it views technological progress as a product of economic

activity. Previous theories treated technology as a given, or a
product of non-market forces. New Growth Theory is often
called “endogenous” growth theory, because it internalizes
technology into a model of how markets function. Technology still
plays an important role in these models, it is no longer necessary to explain
long-run growth.
 Second, New Growth Theory holds that unlike physical objects,
knowledge and technology are characterized by increasing
returns, and these increasing returns drive the process of growth.

• This new theory addresses the fundamental questions about what

makes economies grow: Why is the world measurably richer today
than a century ago? Why have some nations grown more 81 than
 Cont..
• The essential point of New Growth Theory is that knowledge drives
growth. Because ideas can be infinitely shared and reused, we can
accumulate them without limit. They are not subject to what
economists call “diminishing returns.” Instead, the increasing returns
to knowledge propel economic growth.

• New Growth Theory helps us make sense of the ongoing shift from a
resource-based economy to a knowledge-based economy. It
underscores the point that the economic processes which create and
diffuse new knowledge are critical to shaping the growth of nations,
communities and individual firms.

82
 For state and local governments, New Growth Theory
suggests five broad strategies:
• Economic strategies should focus on creating new knowledge, not
just in universities and laboratories, but by businesses as well.

• States and communities are not powerless to influence their

economic destiny. Positive feedbacks and chaotic development
patterns of knowledge-based growth mean that some actions will
have big paybacks.

• The path dependent quality of growth means that even in an Internet

economy, the opportunities for future growth will depend, in large
part, on the current local base of knowledge and expertise, and
communities should seek to build on this in their strategies.
83
 Cont.
• It also emphasizes the role that institutions and policies can play in
creating the circumstances for innovation and the diffusion of
knowledge.

• Ideas of all kinds, large and small, play a role in economic growth.
In many ways, structuring businesses to encourage innovation by
front-line workers is as important to the knowledge economy as
undertaking scientific research.

• Economic development is not a zero sum game; knowledge-based

growth can stimulate a self-reinforcing cycle, in which faster
growth triggers additional knowledge creation, and more growth.
84
 cont.
• New Growth Theory emphasizes that economic growth results from
the increasing returns associated with new knowledge.

• Knowledge has different properties than other economic goods

(being non-rival, and partly excludable). The ability to grow the
economy by increasing knowledge rather than labor or capital
creates opportunities for nearly boundless growth.

• Policy makers will need to pay careful attention to all of the factors
that provide incentives for knowledge creation (R&D, the education
system, entrepreneurship and the tolerance for diversity,
macroeconomic expectations, openness to trade).

85
Con’
t
End for ….

???

Thanks !!!
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