BEE 221
MODULE 2
ECONOMIC
DEVELOPMENT
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BEE 221: Module 2
Classic Theories of Economic Growth and Development
Hours Topic Learning Outcomes Activities
Engage: The students will be asked their opinion
Hours 10-16 Explain the classical theories of as to how they can improve their lives, the
growth and development processes they have to undergo and the decisions
they have to make and the resources they need to
use.
Explore: The students will be asked to look into
what are their present capacities in relation to the
requisites to improve their lives.
Explain: The faculty will then expound on the need
for a scientific process to develop as persons as
nations with emphasis to classical theories that
have been developed by economists to explain the
process of development.
Elaborate: The faculty will expound on the
similarities and differences among the classical
theories.
Evaluate: A quiz will be administered to test the
students’ comprehension of each theory and for
students to expound on their application to the
development process of the Philippines or their
locality.
Hour 17 Do Graded Quiz
Hour 18-20 PRELIM EXAMINATION
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Chapter 3
Classic
Theories of
Economic
Growth and
Development
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INTRODUCTION
EVERY NATION STRIVES FOR DEVELOPMENT
But economic progress is not the only
component
DEVELOPMENT > material & financial
Widespread realization = national context +
international economic + social system
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• Economic progress is an essential
component, but not the only
component.
• Development should be seen as a
multidimensional process involving
the reorganization and reorientation
of entire economic and social systems
• Typically involves radical changes in
institutional, social, and
administrative structures
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3.1 Classic Theories of Economic
Development: Four Approaches
• Linear stages of growth model
• Theories and Patterns of structural change
• International-dependence revolution
• Neoclassical, free market counterrevolution
Primarily, economic theory of development was
about having the right quantity and mix of saving,
investment and foreign aid for developing nations
Development became = rapid, aggregate economic
growth
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There are different theories that attempt to explain
underdevelopment, the differences in the levels of
development within a country or among countries as well
the processes involved in developing a countries.
As pointed out in Module 1 there are differences among the
commonalities of poor countries. No two countries have
similar political, social, cultural, environmental and
economic milieus within which and for which they decide on
their own process of development hence there are variety of
approaches to development posited.
Moreover, the theories have different experiences,
expertise and interest which make their theories contextual
and with biases.
Hence a theory only partially explains economic
development and no theory is perfect.
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• Linear-stages approach was replaced in the
1970s by two competing thoughts:
– One focused on theories and patterns of
structural change, used modern economic
theory and statistical analysis in an attempt to
portray the internal process of structural change
that a “typical” developing country must
undergo if it is to succeed in generating and
sustaining economic growth.
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–The other, the international-dependence
revolution, was more radical and political.
Development= International and domestic
power relationships, institutional, and
structural economic rigidities, and the
resulting proliferation of dual economies and
dual societies within and among the nations
of the world.
Emphasis = policies to eradicate poverty,
provide employment opportunities and
reduce income inequalities
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3.2 Development as Growth and
Linear-Stages Theories
• A Classic Statement: Rostow’s Stages of
Growth
• Harrod-Domar Growth Model (sometimes
referred to as the AK model)
– Emphasis on central role of accelerated
capital accumulation (capital
fundamentalism)
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Rostow’s Stages of Growth
• most influential advocate of stages-of-growth
model - American economic historian, Walt W.
Rostow.
• He said the transition from underdevelopment
to development can be described in terms of
a series of steps or stages through which all
countries must proceed.
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• It is possible to identify all societies in five
categories:
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The Harrod-Domar Growth Model
• the rate of growth of GDP ( change in Y as
a portion of Y) is determined jointly by the
net national savings ratio, s, and the
national capital-output ratio, c. It means
that if a part of the GDP is saved and not
all of it is spent, then the savings can be
used to invest in long-term goods which
can aid in increasing output.
• To grow, economies must save and invest
– Other components: labor force growth &
technological progress
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• Countries able to save 15% to 20% would
develop faster
• PROBLEM: relatively low level of new
capital formation in most poor countries
• ANSWER: through either foreign aid or
private foreign investment
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The Harrod-Domar Model
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The Harrod-Domar Model
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Criticisms of the Stages Model
• Necessary versus sufficient conditions. For
example, in Rostow are clearly defined yet not all
countries may undergo the stages in linear
manner as development concerns and factors
affecting development may not be similar for
countries. In the Harrod-Domar, the necessary
condition is savings, or borrowings to finance
capital formation but borrowings have negative
implication and there can be internal and external
factors that can prevent the financing of capital
formation or that the capital formation done has
not lead to sustainable increase in output.
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Mechanisms of development embodied in the
theory DOES NOT ALWAYS WORK
WHY? More savings and investment are not
sufficient
It worked for Europe because of necessary
structural, institutional, and attitudinal
conditions.
It may not work for countries where there
are a lot of political, socio-cultural issues to
with as consequence of adverse geography
and social fractionalization.
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3.3 Structural-Change Models
• The Lewis two-sector model
– Structural transformation of a subsistence economy
– Presence of 2 sectors: overpopulated rural sector w/ zero
marginal labor productivity and a high-productivity
industrial sector. The case of zero productivity is also
known as disguised unemployment where there are more
workers added to work in farms yet the output remains
the same as when the farm has only few workers thus
removing them from the farm is a much better option
because there capacity to produce is made useful in the
modern sector.
– Transfer of labor from traditional to modern leading to
growth of product output
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Figure 3.1
The Lewis
Model of
Modern-Sector
Growth in a
Two-Sector
Surplus-Labor
Economy
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Lewis Two sector model (video)
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Criticisms of the 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 and full employment in urban is
not an assured effect because sometimes specific skills and
knowledge is required in the modern sector which the
surplus labor in rural areas may not have.
• Institutional factors such as the close family ties which
prevent workers migrating to modern areas, difficulty of
finding jobs in modern sector due to stringent company
policies and companies’ cultural biases, among others.
• Assumption of diminishing returns in modern industrial
sector. As more people and employed in the modern sector,
the companies may find themselves spending more to pay
workers even if the additional output that they produce may
not have revenues that can pay for the wages.
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Figure 3.2 The Lewis Model Modified by Laborsaving
Capital Accumulation: Employment Implications
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PATTERNS OF DEVELOPMENT
ANALYSIS
• Economic, industrial and institutional
structure of an economy transformed to
permit new industries as engine of growth
• Capital accumulation + changes in
economic structure needed
• Constraints (affect level of dev’t): Internal
resources- population size, government
policies; External – access to capital,
technology, trade (countries as part of
international system)
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Empirical Patterns of Development -
Examples
• Empirical (based on actual experience and
observation of economies) work of Harvard
economist Holllis Chenery and his colleagues,
cross-sectional and time-series studies of
countries at diff. levels of per capital income,
identified characteristic features of the
development process:
– Switch from agriculture to industry (and services)
– Rural-urban migration and urbanization
– Steady accumulation of physical and human capital
– Population growth first increasing and then decreasing
with decline in family size
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INTERNATIONAL-DEPENDENCE
REVOLUTION
• 1970s – International-dependence models gained
support because of disenchantment w/ stages and
structural-change models
• Resurgence in various forms in the 21st century
– Developing countries caught in a dependence
and dominance relationship with rich countries
because of institutional, political and economic
rigidities = difficulty for poor nations to be
self-reliant and independent
– Relates to the concept of colonial mentality, the
term“Uncle Joe” and the use of “conscience
money”closely associated with “Utang na loob”.
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3.4 The International-Dependence
Revolution
• The neocolonial dependence model
– Legacy of colonialism, Unequal power, Core-periphery, Front
yard-backyard, North-South which show that there are places
that are centers of development and their neighbors are
dependent on them.
– Underdevelopment as result of historical evolution of highly
unequal international capitalist system of rich country-poor
country relationships.
– Regardless if intentional, nations are under unequal power
relations between the center and the periphery
– Small elite ruling class (landlords, entreps, military rulers,
merchants, public officials, etc.) interests (knowingly or not) to
perpetuate the international capitalist system of inequality
– The elite serve or are rewarded by international special interest
power groups tied by allegiance or funding to wealthy capitalist
countries
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• The false-paradigm model
– Focuses on the pitfalls of using “expert” foreign advisors
who misapply developed-country models
– Underdevelopment as result of faulty and inappropriate
advice by well-meaning, though uninformed or biased
advisers from developed country agencies and
organizations. For example, WB, IMF and the ADB,
engage economic experts to help borrower countries to
plan their development process based on the experiences
of other countries especially that of rich countries,
forgetting the unique context and milieus of the borrower
countries.
– Inappropriate policies merely serve vested interests of
existing power groups, whether in the domestic and
international context.
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• Dualistic development models
Dualism – divergence between rich and poor nations, rich
and poor peoples on various levels. Difficulties in the
process of development exist because the following
conditions exist:
a. The co-existence of two condition: the superior and inferior
conditions.
b. The coexistence is chronic.
c. The superiority increases and the inferiority increases.
d. The superior does not do anything to help the inferior.
Criticisms and limitations
– Does little to show how to achieve development in a
positive sense; accumulating counter examples shown in
the incressing income inequality as a nation achieves
economics growth.
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INTERNATIONAL-DEPENDENCE
REVOLUTION
• Based on dependency theory, countries
could pursue a policy of autarky or inwardly
directed development & trade w/ other
developing countries
• In autarky, for example, a country that is
poor may try to solve its own problems if it
has doubts of the reasons for the support
that international agencies and countries.
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3.5 The Neoclassical Counterrevolution:
Market Fundamentalism
• Challenging the Statist Model, it has three
approaches: Free Markets, Public Choice,
and Market-Friendly Approaches
• Developed nations favored supply-side
macroeconomic policies, rational
expectations theories and privatization of
public corporations while developing
countries freer markets and dismantling of
public ownership, statist planning and
government regulation.
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The Neoclassical Counterrevolution:
Market Fundamentalism
Argument
•Underdevelopment resulted from poor resource allocation
because of incorrect pricing policies and state intervention
(corruption, inefficiency, lack of incentives, etc.)
•State intervention slows economic growth
•It posits the ideas of Neoliberals that economic efficiency and
growth will be stimulated by free markets, privatizing state
enterprises, export expansion and eliminating government
regulation and price distortions
•Hence it proposes to allow “magic of the marketplace” which
means the demand and supply must determine the prices of
goods ; and the “invisible hand” which emphasizes on making
people decide on their self-interest to guide resource allocation
and stimulate economic dev’t.
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The Neoclassical Counterrevolution:
Market Fundamentalism
3 component approaches:
1. Free-market approach - markets alone are efficient;
competition is effective, technology and information freely available
and costless; gov’t intervention/management of the economy is
counterproductive
2. Public choice approach – also known as new political economy
approach; governments do nothing right because of politicians and
decision makers focus on selfish interests; misallocation of resources
take place foregoing its duty of stewardship of common resources
3. Market-friendly approach – imperfections in economy
and need gov’t for market-friendly interventions where the
government fulfills economic functions such as providing the legal
framework of the economy, maintaining competition, redistributing
income and wealth through social services, reallocating
resources/dealing with externalities and market failures and
stabilizing the economy in case of inflation and unemployment
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• Main Arguments of market fundamentalism
– Denies efficiency of intervention
– Points out state owned enterprise failures
– Stresses government failures
– Traditional neoclassical growth theory
with diminishing returns cannot sustain
growth by capital accumulation alone
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Traditional Neoclassical Growth
Theory
• Liberalization – opening up of markets,
drawing/attracting investment and increasing the
rate of capital accumulation
• Solow neoclassical growth model - economies to
converge to same income level if same rates of
savings, depreciation, labor force and productivity
growth.
• Source of output growth: labor quantity and
quality, increase in capital and technology
improvement
• Openness – encourages access to foreign
production ideas, technological progress
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RECONCILING THE DIFFERENCES
• Each approach has strengths and weaknesses
• Each has controversies – ideological, theoretical or empirical
– makes the study of economic development challenging
• There are evolving patterns of insights and understandings
• CONSENSUS? Significance from each approach:
- Linear stages: crucial role of savings and investment
- Two-sector model: transfer of resources from low to
highproductivity activities, linkages between traditional &
modern
- Dependence theory: importance of world economy and
decisions of developed world affecting developing
economies
- Neoclassical: efficient production, proper price systems
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3.6 Classic Theories of Development:
Reconciling the Differences
• Governments do fail, but so do markets; a balance is
needed
• Development planning and processes must attend to
institutional and political realities in developing world
• Development economics has no universally accepted
paradigm
• Insights and understandings are continually evolving
• Each theory has some strengths and some weaknesses
• The development process for each nation is not
universal but unique.
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Concepts for Review
• Autarky • Dualism
• Average product • False-paradigm model
• Capital-labor ratio • Free market
• Capital-output ratio • Free-market analysis
• Center • Harrod-Domar growth
• Closed economy model
• Comprador groups • Lewis two-sector model
• Dependence • Marginal product
• Dominance • Market failure
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Concepts for Review (cont’d)
• Market-friendly approach • Production function
• Necessary condition • Public-choice theory
• Neoclassical • Self-sustaining growth
counterrevolution • Solow neoclassical growth
• Neocolonial dependence model
model • Stages-of-growth model of
• Net savings ratio development
• New political economy • Structural-change theory
approach • Structural transformation
• Open economy • Sufficient condition
• Patterns-of-development • Surplus labor
analysis • Underdevelopment
• Periphery
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Appendix 3.1: Components of Economic
Growth
• Capital Accumulation, investments in
physical and human capital
– Increase capital stock
• Growth in population and labor force
• Technological progress
– Neutral, labor/capital-saving, labor/capital
augmenting
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Figure A3.1.1 Effect of Increases in Physical and Human
Resources on the Production Possibility Frontier
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Figure A3.1.2 Effect of Growth of Capital Stock and
Land on the Production Possibility Frontier
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Figure A3.1.3 Effect of Technological Change in the
Agricultural Sector on the Production Possibility
Frontier
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Figure A3.1.4 Effect of Technological Change in the
Industrial Sector on the Production Possibility Frontier
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Appendix 3.2: The Solow
Neoclassical Growth Model
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Appendix 3.2 The Solow
Neoclassical Growth Model
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Appendix 3.2 The Solow
Neoclassical Growth Model
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Figure A3.2.1 Equilibrium in the Solow
Growth Model
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Figure A3.2.2 The Long-Run Effect of Changing the
Saving Rate in the Solow Model
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Appendix 3.3: Endogenous Growth
Theory
• Motivation for the new growth theory
• The Romer model
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