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M.A. [Economics]
I - Semester
362 12

DEVELOPMENT ECONOMICS
Authors:
Dr Sarita Agrawal, Associate Professor, Faculty of Commerce, M.S. University of Baroda, Vadodara
Units (1.3, 3.2, 4-5)
Dr Rupesh Tyagi, Lecturer Ginni Devi Modi Girls PG College, Modinagar, Ghaziabad
Units (6-14)
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Units (1.0-1.2. 1.4-1.8, 2, 3.0-3.1, 3.3-3.7 )

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 SYLLABI-BOOK MAPPING TABLE
Development Economics
Syllabi Mapping in Book

BLOCK I: ECONOMIC GROWTHAND DEVELOPMENT

Unit-1: Concepts of Economic Growth and Development - Unit 1: Economic Growth
Characteristics of Less Developed Countries - Obstacles to and Development:
Development. An Overview
(Pages 1-9);
Unit-2: Growth-Meaning- Poverty and Income Distribution. Unit 2: Growth, Poverty and
Income Distribution
(Pages 10-20);
Unit-3: Human Development Index - Physical Quality of Life Index Unit 3: Overview of Different
and Human Poverty Index. Development Indices
(Pages 21-29);
Unit-4: Theories of Growth - I: Classical Approach Adam Smith, Unit 4: Theories of Growth - I
Marx and Schumpeter. (Pages 30-46);
Unit-5: Theories of Growth - II: Neo - Classical Approach: Robinson, Unit 5: Theories of Growth - II
Solow, Kaldor and Harrod Domar. (Pages 47-66);
Unit-6: Theories of Economic Development: Rostow - Rosenstein- Unit 6: Theories of Economic
Roden - Nurske, Hirschman - Sen's Capability. Development
(Pages 67-107);
Unit-7: Approach to Economic Development: Developed and Under Unit 7: Approaches to Economic
Developed Countries. Development
(Pages 108-125)

BLOCK II: DEVELOPMENT STRATEGIES

Unit-8: Development Strategies - I: Neumann's Growth Model and Unit 8: Development Strategies - I
Modifications. (Pages 126-132);
Unit-9: Development Strategies - II: Choice of Goods and Unit 9: Development Strategies-II
Techniques. (Pages 133-145);
Unit-10: Development Strategies - III: Mathur's Wage Goods - Light Unit 10: Development Strategies-III
and Heavy Strategies. (Pages 146-154)
BLOCK III: PLANNING MODELS
Unit-11: Planning Models - I: Introduction - Meaning - Objectives Unit 11: Planning Model-I
- Characteristics. (Pages 155-169);
Unit-12: Planning Models - II: Feldman, Mahalanobis - Leontief's Unit 12: Planning Models – II
Input - Output Model. (Pages 170-202);
Unit-13: Planning Models - III: Vahit Brahmananda - Raj - Sen - Unit 13: Planning Models – II
Chakravarthy. (Pages 203-210)

BLOCK IV: PLANNING TECHNIQUES

Unit-14: Planning Techniques: Meaning - Concepts - its Unit 14: Planning Techniques:
importance. Meaning, Concepts
and Importance
(Pages 211-230)
 CONTENTS
INTRODUCTION
BLOCK I: ECONOMIC GROWTH AND DEVELOPMENT
UNIT 1 ECONOMIC GROWTH AND DEVELOPMENT: AN OVERVIEW 1-9
1.0 Introduction
1.1 Objectives
1.2 Concept of Economic Growth and Development
1.3 Obstacles to Development and Characteristics of Less Developed Countries
1.3.1 Characteristics of Less Developed Countries
1.4 Answers to Check Your Progress Questions
1.5 Summary
1.6 Key Words
1.7 Self Assessment Questions and Exercises
1.8 Further Readings
UNIT 2 GROWTH, POVERTY AND INCOME DISTRIBUTION 10-20
2.0 Introduction
2.1 Objectives
2.2 Meaning of Growth
2.3 Poverty and Income Distribution
2.4 Answers to Check Your Progress Questions
2.5 Summary
2.6 Key Words
2.7 Self Assessment Questions and Exercises
2.8 Further Readings
UNIT 3 OVERVIEW OF DIFFERENT DEVELOPMENT INDICES 21-29
3.0 Introduction
3.1 Objectives
3.2 HDI, Physical Quality of Life Index and Human Poverty Index
3.3 Answers to Check Your Progress Questions
3.4 Summary
3.5 Key Words
3.6 Self Assessment Questions and Exercises
3.7 Further Readings
UNIT 4 THEORIES OF GROWTH - I 30-46
4.0 Introduction
4.1 Objectives
4.2 Classical Theory of Development
 4.3 Karl Marx’s Theory of Capitalist Development
4.3.1 Materialistic Interpretation of History
4.3.2 Surplus Value
4.3.3 Process of Production
4.4 Schumpeter Theory
4.4.1 Entrepreneur and Innovations
4.4.2 Bank Credit
4.4.3 Cumulative Process and Creative Destruction
4.4.4 End of Capitalism
4.5 Answers to Check Your Progress Questions
4.6 Summary
4.7 Key Words
4.8 Self Assessment Questions and Exercises
4.9 Further Readings
UNIT 5 THEORIES OF GROWTH - II 47-66
5.0 Introduction
5.1 Objectives
5.2 Robinson’s Model of Growth
5.3 Kaldor’s Model of Growth
5.4 Harrod-Domar Model and Instability of Equilibrium
5.5 Answers to Check Your Progress Questions
5.6 Summary
5.7 Key Words
5.8 Self Assessment Questions and Exercises
5.9 Further Readings
UNIT 6 THEORIES OF ECONOMIC DEVELOPMENT 67-107
6.0 Introduction
6.1 Objectives
6.2 Rostow’s Stages of Economic Growth
6.3 Rosenstein-Rodan Theory
6.4 Hirschman Theory
6.5 Sen’s Capabilities Approach
6.6 Nurkse’s Theory
6.7 Answers to Check Your Progress Questions
6.8 Summary
6.9 Key Words
6.10 Self Assessment Questions and Exercises
6.11 Further Readings
UNIT 7 APPROACHES TO ECONOMIC DEVELOPMENT 108-125
7.0 Introduction
7.1 Objectives
7.2 Developed and Underdeveloped Countries
7.2.1 Criterion for Classifying Economics as Developed and Underdeveloped
 7.3 Diversity among Developing Countries
7.4 Answers to Check Your Progress Questions
7.5 Summary
7.6 Key Words
7.7 Self Assessment Questions and Exercises
7.8 Further Readings
BLOCK II: DEVELOPMENT STRATEGIES
UNIT 8 DEVELOPMENT STRATEGIES - I 126-132
8.0 Introduction
8.1 Objectives
8.2 The von Neumann Growth Model and Modifications
8.3 Answers to Check Your Progress Questions
8.4 Summary
8.5 Key Words
8.6 Self Assessment Questions and Exercises
8.7 Further Readings
UNIT 9 DEVELOPMENT STRATEGIES-II: CHOICE OF
GOODS & TECHNIQUES 133-145
9.0 Introduction
9.1 Objectives
9.2 The Choice of Goods and Techniques
9.2.1 Labour Intensive and Capital Intensive Techniques
9.2.2 Intermediate Technology
9.3 Answer to Check Your Progress Questions
9.4 Summary
9.5 Key Words
9.6 Self Assessment Questions and Exercises
9.7 Further Readings
UNIT 10 DEVELOPMENT STRATEGIES: III: MATHUR’S
WAGE HOODS - LIGHT AND HEAVY STRATEGIES 146-154
10.0 Introduction
10.1 Objectives
10.2 Mathur’s Paradigm of Non-inflationary Growth:
Wage Goods/Light and Heavy Strategies
10.3 The Relative Merits and Relevance of Brahmananda –
Mathur Controversy Under Indian Conditions
10.4 Answers to Check Your Progress Questions
10.5 Summary
10.6 Key Words
10.7 Self Assessment Questions and Exercises
10.8 Further Readings
BLOCK III: PLANNING MODELS
UNIT 11 PLANNING MODEL-I: INTRODUCTION-MEANING,
OBJECTIVES-CHARACTERISTICS 155-169
11.0 Introduction
11.1 Objectives
11.2 Introduction and Meaning of Planning Models
11.3 Elements and Characteristics of Planning Models
11.4 Classification of Planning Models
11.4.1 Aggregative or Macroeconomic Models
11.4.2 Sectoral Models
11.4.3 Comprehensive Inter-industry Models
11.5 Factors Affecting Choice Planning Models
11.6 Uses of Planning Models
11.7 Criticisms of Planning Models
11.8 Answers to Check Your Progress Questions
11.9 Summary
11.10 Key Words
11.11 Self Assessment Questions and Exercises
11.12 Further Readings
UNIT 12 PLANNING MODELS – II 170-202
12.0 Introduction
12.1 Objectives
12.2 Feldman Model
12.3 The Mahalanobis Model
12.4 Input-output Analysis
12.5 Answers to Check Your Progress Questions
12.6 Summary
12.7 Key Words
12.8 Self Assessment Questions and Exercises
12.9 Further Readings
UNIT 13 PLANNING MODELS – II 203-210
13.0 Introduction
13.1 Objectives
13.2 Vakil and Brahamanand
13.3 Raj, Sen, Chakravarthy
13.4 Answers to Check Your Progress Questions
13.5 Summary
13.6 Key Words
13.7 Self Assessment Questions and Exercises
13.8 Further Readings
BLOCK IV: PLANNING TECHNIQUES
UNIT 14 PLANNING TECHNIQUES: MEANING,
CONCEPTS AND IMPORTANCE 211-230
14.0 Introduction
14.1 Objectives
14.2 Planning Techniques
14.3 Need for Planning in Under-Developed Countries
14.3.1 Process of Plan Formulation
14.3.2 Objectives of Planning
14.3.3 Conflict among Different Objectives
14.3.4 Requisites for Successful Planning
14.3.5 Limitations of Planning
14.4 Answers to Check Your Progress Questions
14.5 Summary
14.6 Key Words
14.7 Self Assessment Questions and Exercises
14.8 Further Readings
Introduction
INTRODUCTION

In simple words, economic development is the development of economic wealth

NOTES of countries or regions for the well-being of their inhabitants. Usually, the terms
growth and development are used interchangeably. However, economic growth
and economic development are two different terms used in economics. In common
parlance, economic development refers to the problems of underdeveloped
countries, while economic growth to those of developed countries. When we use
the term economic growth, we simply mean increase in per capita income or increase
in gross national product (GNP). In recent literature, however, the term economic
growth is used to refer to sustained increase in a country’s output of goods and
services, or more precisely product per capita. Output is usually measured in
terms of GNP.
The term economic development is far more comprehensive, implying
progressive changes in the socio-economic structure of a country. If we see
development in this perspective, economic development involves a steady decline
in agricultural shares in GNP and continuous increase in shares of industries, trade
banking construction and services. Further, while economic growth simply refers
to rise in output, development means change in technological and institutional
organization of production and in distributive pattern of income. The process of
development is far more wide-ranging. Besides a rise in output, it involves changes
in composition of output, shift in the allocation of productive resources, and
elimination or reduction of poverty, inequalities and unemployment. In the words
of Amartya Sen: ‘Development requires the removal of major sources of unfreedom
poverty as well as tyranny, poor economic opportunities as well as systematic
social deprivation neglect of public facilities as well as intolerance or over activity
of repressive states.’
This book, Development Economics, is divided into fourteen units that
follow the self-instruction mode with each unit beginning with an Introduction to
the unit, followed by an outline of the Objectives. The detailed content is then
presented in a simple but structured manner interspersed with Check Your Progress
Questions to test the student’s understanding of the topic. A Summary along with
a list of Key Words and a set of Self-Assessment Questions and Exercises is also
provided at the end of each unit for recapitulation.

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 Economic Growth
and Development:
BLOCK - I An Overview

ECONOMIC GROWTH AND DEVELOPMENT

NOTES

UNIT 1 ECONOMIC GROWTH

AND DEVELOPMENT:
AN OVERVIEW
Structure
1.0 Introduction
1.1 Objectives
1.2 Concept of Economic Growth and Development
1.3 Obstacles to Development and Characteristics of Less Developed Countries
1.3.1 Characteristics of Less Developed Countries
1.4 Answers to Check Your Progress Questions
1.5 Summary
1.6 Key Words
1.7 Self Assessment Questions and Exercises
1.8 Further Readings

1.0 INTRODUCTION

A country’s economic growth is usually indicated by an increase in that country’s

gross domestic product, or GDP. Generally speaking, gross domestic product is
an economic model that reflects the value of a country’s output.
Economic growth is the positive change in the real output of the country in
a particular span of time economy. Economic Development involves a rise in the
level of production in an economy along with the advancement of technology,
improvement in living standards and so on.

1.1 OBJECTIVES

After going through this unit, you will be able to:

 Describe the concept of economic growth and development
 Discuss the factors affecting economic growth
 Analyse the prevalence of underdevelopment in different countries
 Explain the various obstacles to development

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Material 1
Economic Growth
and Development: 1.2 CONCEPT OF ECONOMIC GROWTH AND
An Overview
DEVELOPMENT

NOTES Economic development is usually concerned not only with quantitative expansions,
but also with changes in non-quantitative factors such as institutions, organizations
and culture under which economies operate. If we follow this usage, economic
growth is considered to be a quantitative aspect of economic development.
1. In broad terms, one would say that economic development involves a steady
and ongoing activity that leads to a better standard of living and improvement
in the financial health of a particular sector or area of a country’s economy.
Economic development also signifies the quantitative and qualitative changes
that take place in the economy. Such actions can include the development
of human capital, critical infrastructure, regional competitiveness,
environmental sustainability, social inclusion, health, safety, literacy, and other
initiatives.
2. The concept of economic growth is much narrower than the concept of
economic development. As we have already studied, it implies an increase
in a nation’s real level of national output which could have been brought
about by an expansion in the resource quality or quantity, technological
improvements, etc. The principle of economic development is normative.
This means that it finds application in the context of people’s sense of morality
(right or wrong, good or bad). Michael Todaro, an American economist
and a pioneer in the field of development economics, equates economic
development with increasing standards of living, better self-esteem, and
other privileges such as freedom from any and all kinds of exploitation, etc.
3. Economic growth will take place upon a gradual increase in any or all elements
that make up the GDP such as consumption, investment, government
expenditures and net exports. Economic development, on the other hand,
involves an increase in the Human Capital Index; a notable decline in social
and economic inequality; and structural changes that contribute to a basic
improvement in the overall quality of a nation’s population. One must note
that one of the most precise ways of determining economic development is
by using the Human Development Index. This Index includes the literacy
rates and the growth of more employment opportunities in various sectors
such as education, healthcare, employment and the protection of the
environment. This denotes that all citizens of the nation experience a growth
in their per capita income. Other measures of economic development include
gender related index, human poverty index, infant mortality rate and literacy
rate.
4. Economic growth pertains to an increase in the output of an economy,
whereas economic development pertains to structural changes that take
place in an economy.
Self-Instructional
2 Material
 5. Economic growth is a quantitative measurement relating to an increase in Economic Growth
and Development:
Gross Domestic Product and shown Production-possibility Frontier. An Overview
Economic development is measured in qualitative terms. In other words,
whereas economic growth is associated with bringing about quantitative
changes in an economy, economic development is associated with bringing NOTES
about qualitative changes in an economy.
6. In order to measure progress in developed nations, economic growth is a
much preferred indicator. Most nations make use of it for measuring fiscal
growth since growth is a pre-condition for development. Developing
countries make use of economic development in order to measure progress
and quality of life.
7. There are several unrecorded economic activities that characterize an
economy. These activities go unaccounted for in the measurement of
economic growth. These activities are related to an informal or a black
economy. Economic development helps in alleviating people from low
standards of living with the provision of proper employment and suitable
shelter.
8. A major problem with economic growth is not taking into account the
exhaustion of natural resources that may cause pollution, congestion and
the occurrence of various diseases. The concept of development, on the
other hand, is synonymous with sustainability referring to meeting present
needs without having to compromise the future needs.
9. Economic growth is an important, but not an adequate condition of economic
development.
We can say that development economics is that branch of economics that
deals with the economic aspects of development process in nations with
low incomes. Development economics focusses not only on methods that
encourage economic growth and structural changes, but also on the
improvement of the potential for the mass of the population.
Generally, economic development is concerned with growth in such metrics
as literacy rates, life expectancy and poverty rates. GDP disregards other
important components such as leisure time, environmental quality, freedom
or social justice. There are other ways of measuring the economic well-
being of a nation. In a fundamental sense, the economic development of a
nation appertains to its human development, which includes, among other
things, health and education. These determinants are, nevertheless, closely
linked to economic growth in such a way that economic development and
economic growth are complementary concepts.
Factors Affecting Economic Growth
Broadly speaking, there are chiefly three important areas encompassed by the
policies of economic development:
Self-Instructional
Material 3
Economic Growth  Governmental measures undertaken to fulfil broad economic objectives like
and Development:
An Overview price stability, high employment and a sustained rate of growth. These efforts
allow for changes in economic and fiscal policies, the governance and
administration of financial institutions, trade and tax policies, etc.
NOTES
 Procedures that offer infrastructure and services such as highways, parks,
affordable housing, crime prevention and school education.
 Job creation and retention through specific efforts in business finance,
marketing, neighbourhood development, workforce development, small
business development, business retention and expansion, technology transfer
and real estate development.

1.3 OBSTACLES TO DEVELOPMENT AND

CHARACTERISTICS OF LESS DEVELOPED
COUNTRIES

Underdevelopment means having a low level of economic productivity and

technological sophistication within the contemporary range of possibility. The term
‘development’ is generally used to mean industrialization, economic growth and
the living standards associated with prosperity, such as increased life expectancy,
health-care and free education. The countries that have not yet achieved these
objectives are said to be ‘undeveloped’ countries.
Disparity between the rich and the poor and an unhealthy balance of trade
are the characteristics of an underdeveloped country. The trade and commerce
balance is often skewed as the products these countries yield for export, such as
bananas, coffee, sugar, cocoa, tea, are not in great demand in the developed
countries. The products that demand a smaller quantity of raw materials, such as
jute, cotton, etc., are being substituted by synthetic materials. Prices of organic
and natural raw materials cannot be increased as this leads to an industrial clamouring
for the synthetic products. On the other hand, production can also not be increased
as this again brings down the prices. Thus, the developing countries face this elusive
development as the primary commodities used by them are subject to short-term
price inflation.
Different criteria of underdevelopment
Countries are categorized as underdeveloped on the basis of the following criteria:
 Low ratio of industrial output to total output: Countries with a low
ratio of industrial output to total output are considered underdeveloped.
 Low ratio of capital to per head of population: According to Ragnar
Nurkse, ‘Underdeveloped countries are those, which compared with the
advanced countries, are under-equipped with capital in relation to their
population and natural resources.’
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  Poverty: Poverty is one of the main criteria of underdevelopment. Poverty Economic Growth
and Development:
is nothing but lack of basic standards of living. The people of underdeveloped An Overview
countries are characterized by less money or salary, less education, improper
health care, sanitation, etc.
NOTES
 Low per capita income: Most acceptable criterion of underdevelopment
is low per capital real income.
1.3.1 Characteristics of Less Developed Countries
The characteristics of underdevelopment may be summarized as follows:
 General poverty: Most of the people in underdeveloped countries are
poor, leading a wretched life without any norms of standard of living. Poverty
results in low labour productivity, lack of entrepreneurship and poor
specialization.
 Agriculture, the main occupation: An underdeveloped depends largely
on the production of agricultural materials and minerals. Industries in such
countries are mainly agro-based. The share of the primary sector, which
includes the agriculture and allied activities, is larger in the national income
of the underdeveloped country.
 A dualistic economy: An underdeveloped economy is characterized by
the presence of dualistic economy— the existence of both market economy
and subsistence economy at the same time. There is market economy on
one side, where marketing system has developed exceedingly well, catering
to the needs of rich and wealthy class of people. On the other hand, there is
subsistence economy characterized by backward agriculture-oriented
activities in rural areas.
 Underdevelopment of national resources: The natural resources of the
underdeveloped economy are either unutilized or underutilized. For example,
India is a country of vast natural resources, which have not been fully utilized.
 Demographic features: Another feature of underdeveloped countries is
that they are invariable overpopulated. The size of the population in these
countries is increasing at a faster rate than in developed countries.
 Unemployment and disguised unemployment: Excessive pressures on
land and poor industrial development create unemployment problems in
underdeveloped countries. The problem of unemployment has resulted in
underemployment. Owing to population pressure, more persons work on
land than what is actually required. This is referred to as disguised
unemployment.
 Economic backwardness: The people of underdeveloped countries are
economically backward. The economic backwardness is characterized by
lower efficiency, illiteracy, poverty, factor-immobility, lack of
entrepreneurship and ignorance in economic matters.
Self-Instructional
Material 5
Economic Growth  Lack of enterprise and initiative: An important characteristic of
and Development:
An Overview underdeveloped countries is the lack of entrepreneurship and initiative. The
governments of underdeveloped countries are not very encouraging towards
entrepreneurship. The people of such countries are largely risk averse. They
NOTES generally prefer a long-term employment, such as government jobs.
 Insufficient capital equipment: Capital has a strategic role in production
and economic development of a nation. The insufficient amount of physical
capital in existence is also a characteristic feature of underdeveloped
economies. Hence, they are often called simply ‘capital poor’ economies.
One indication of the capital deficiency is the low amount of capital per
head of population.
 Technological backwardness: In underdeveloped countries, the methods
of production are primitive. As a result, the productivity either in agriculture
or in industries is very low. The lack of technical know-how and poor
scientific advancement and obsolete technique result in poor quality products.
 Foreign trade orientation: Underdeveloped countries are usually foreign
trade-oriented. They export raw materials instead of utilizing them at home
and import manufactures instead of making them at home. Excessive
dependence on export makes these countries precarious and unbalanced,
affecting their terms of trade adversely.
Prevalence of underdevelopment
(i) Africa: Africa consists of one-seventh of the world’s population. It is the
second largest continent with fifty-four countries and 800 million people. It
accounts for 20 per cent of the planet. This is the most underdeveloped
continent. The continent had faced 400 years of slavery which has ultimately
resulted in ethnic and political fragmentation. Political and social unrest has
caused economic instability that has left communities unfit for pursuing
economic development.
(ii) Afghanistan: Afghanistan’s underdevelopment has resulted from ineffective
trade policies with little economic growth. 35 per cent of the population is
unemployed. Pervasive military and political corruption has left the economy
of the country shattered and the culture and religion broken. Disruption of
trade and commerce has resulted in the falling of GDP every year. Internal
conflicts have left the country incapable of reviving with domestic and
international aids.
(iii) Latin America: Latin America consists the South American nations where
people primarily speak Spanish, Portuguese and French. The infant mortality
rate here is very high and the life expectancies of people are twenty years
lesser than those of the people in developed countries. Unemployment,
homelessness and malnourishment have become rampant in this part of the
world with many communities being poverty-stricken. The region has
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 suffered due to over population, military dictatorships and wars. It is replete Economic Growth
and Development:
with cases where larger countries have oppressed its smaller neighbours. An Overview
The free trade policies adopted in the nineteenth century prevented the
development of national industries in the region.
NOTES
(iv) South Africa: South Africa is a segregated land of the rich and the poor.
The rich are integrating the country with global economy and adopting
industrialization, agricultural and financial services. The second economy is
the economy of the underprivileged. South African countries nurture
institutionalized apartheid that influences politics, society and economics.
Reforms have further increased the chasm between the rich and the poor
through uneven distribution of wealth. As Hoogeveen and Ozler (2005: 15)
conclude in their paper ‘Not Separate, Not Equal: Poverty and Inequality
in Post-Apartheid South Africa’ that ‘growth has not been pro-poor in South
Africa as a whole, and in the instances when poverty declined for certain
subgroups, the distributional shifts were still not pro-poor’ . The economy
is dictated by those who are incorporated in the mainstream and not by
those living under unfavourable circumstances.

Check Your Progress

1. What are the characteristics of underdeveloped countries?
2. What is the major problem with economic growth?
3. When does economic growth take place?

1.4 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. Disparity between the rich and the poor and an unhealthy balance of trade
are the characteristics of an underdeveloped country.
2. A major problem with economic growth is not taking into account the
exhaustion of natural resources that may cause pollution, congestion and
the occurrence of various diseases.
3. Economic growth will take place upon a gradual increase in any or all elements
that make up the GDP such as consumption, investment, government
expenditures and net exports.

1.5 SUMMARY

 Economic development is usually concerned not only with quantitative

expansions, but also with changes in non-quantitative factors such as
institutions, organizations and culture under which economies operate.
Self-Instructional
Material 7
Economic Growth  In order to measure progress in developed nations, economic growth is a
and Development:
An Overview much preferred indicator. Most nations make use of it for measuring fiscal
growth since growth is a pre-condition for development. Developing
countries make use of economic development in order to measure progress
NOTES and quality of life.
 A major problem with economic growth is not taking into account the
exhaustion of natural resources that may cause pollution, congestion and
the occurrence of various diseases. The concept of development, on the
other hand, is synonymous with sustainability referring to meeting present
needs without having to compromise the future needs.
 Most of the people in underdeveloped countries are poor, leading a wretched
life without any norms of standard of living. Poverty results in low labour
productivity, lack of entrepreneurship and poor specialization.
 Excessive pressures on land and poor industrial development create
unemployment problems in underdeveloped countries. The problem of
unemployment has resulted in underemployment. Owing to population
pressure, more persons work on land than what is actually required.
 Economic growth is a quantitative measurement relating to an increase in
Gross Domestic Product and shown Production-possibility Frontier.
Economic development is measured in qualitative terms.
 In other words, whereas economic growth is associated with bringing about
quantitative changes in an economy, economic development is associated
with bringing about qualitative changes in an economy.

1.6 KEY WORDS

 Development economics: Development economics is a branch

of economics that focuses on improving fiscal, economic and social
conditions in developing countries.
 Demography: It is the study of statistics such as births, deaths, income, or
the incidence of disease, which illustrate the changing structure of human
populations.
 Human Capital Index: It measures how well an organization makes use
of the ability of an individual to perform and create shareholder value through
his/her competencies, knowledge and expertise.

Self-Instructional
8 Material
 Economic Growth
1.7 SELF ASSESSMENT QUESTIONS AND and Development:
An Overview
EXERCISES

Short Answer Questions NOTES

1. How is economic growth considered a quantitative measurement?

2. How are countries categorised as underdeveloped?
3. State the factors affecting economic growth.
Long Answer Questions
1. Analyse the characteristics of underdevelopment.
2. Describe the prevalence of underdevelopment in different countries.
3. What are the different obstacles to development? Discuss.

1.8 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

Self-Instructional
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Growth, Poverty and
Income Distribution
UNIT 2 GROWTH, POVERTY AND
INCOME DISTRIBUTION
NOTES
Structure
2.0 Introduction
2.1 Objectives
2.2 Meaning of Growth
2.3 Poverty and Income Distribution
2.4 Answers to Check Your Progress Questions
2.5 Summary
2.6 Key Words
2.7 Self Assessment Questions and Exercises
2.8 Further Readings

2.0 INTRODUCTION

The aim of all modern economies today is to achieve a certain level of economic
growth. This is because economic growth reflects the situation that the resources
are being used efficiently by the economy to progress. This is seen in terms of
growing employment opportunities, increased investments, and higher living
standards for people. But the rising income of the country does not always denote
that more people are coming out of poverty, it could even take the form of growing
divide between the rich and poor. This is referred to as the inequality of income.
This is evident in most countries including India, where even though the country is
praised for being one of the top fastest growing economies, other studies like
Oxfam report that the 1% of the population takes 73% of the total income
generated! For wholesome economic development, it is important that there is a
balance maintained, in that the economic growth and its distribution is efficient. In
this unit, you will learn about the measurement of economic growth and income
distribution.

2.1 OBJECTIVES

After going through this unit, you will be able to:

 Describe the meaning of economic growth and development
 Discuss the concept of poverty and income distribution
 Explain the different methods of measuring income inequality

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 Growth, Poverty and
2.2 MEANING OF GROWTH Income Distribution

Although in common parlance, there is no difference between economic growth

and economic development, and these terms are used interchangeably. But in NOTES
economics, we differentiate between these two concepts. Economic growth is a
narrower concept between the two, and denotes an increase in a country’s Gross
Domestic Product.
There are two common measures of the rate of economic growth. The first
is the rate of growth of a nation’s real Gross Domestic Product, which tells how
rapidly the economy’s total real output of goods and services is increasing. The
second is the rate of growth of per capita real Gross Domestic Product, which is
a better measure of the rate of increase of a country’s standard of living.
To represent the process of economic growth, it is convenient to use the
production possibilities curve which shows all efficient combinations of output that
an economy can produce. For example, let us suppose that a given society produces
only two goods: food and tractors. If this society has at its disposal a fixed amount
of resources and if technology is fixed, the production possibilities curve shows
the maximum quantity of food that can be produced, given each amount of tractors
produced. This is shown in Figure 2.1.
Quantity
of Food

0 Quantity of Tractors

Fig. 2.1 Production Possibilities Curve

The production possibilities curve shows all efficient combinations of output

that an economy can produce.
Shifts of the Production Possibilities Curve
A country’s potential output increases when its production possibilities curve shifts
outward, as from position A to position B in Figure 2.2. This happens because the
society can produce (and consume) more of one good without having to produce
(and consume) less of the other good. Thus, its productive capacity must be greater.
If the production possibilities curve shifts outward, if the economy is efficient, and
if population remains constant, the per capita GDP increases, thus facilitating
economic growth. Moreover, the faster the production possibilities curve shifts
outward, the greater the rate of economic growth.

Self-Instructional
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Growth, Poverty and Quantity
of Food
Income Distribution

A
NOTES

0 Quantity of Tractors

Fig. 2.2 Outward Shift of Production Possibilities Curve

No Shift of the Production Possibilities Curve

A general decline in the unemployment or inefficiency levels will cause economic
growth even if the country’s production possibilities curve does not shift outward.
If a country allows some of its resources to be unemployed or underutilized because
of an insufficiency of intended spending, this will cause the economy to operate at
a point inside the production possibilities curve rather than on the curve.
Now it is clear that economic growth has a connotation of quantitative
expansions in economic variables, specially aggregate and per capita. National
income is measured by GNP and NNP. Therefore, the analysis of economic growth
is concerned mainly with measuring of growth in economic variables, and identifying
their interrelationships such as between the national income growth rate and the
speed of capital formation.

2.3 POVERTY AND INCOME DISTRIBUTION

Poverty is a multifaceted occurrence which is caused by various factors. There

are different ways of defining poverty. The most common of these are objective
and subjective poverty. Poverty can also be defined as absolute and relative on
the basis of scale of threshold. Another popular way of defining poverty is static
and dynamic. The dynamic studies focus on the length of duration of poverty.
Absolute poverty is a state in which the basic needs of an individual are not
covered. These basic needs include the needs which are related to food, housing
and clothes. This is a widely accepted method of defining poverty across the
world. But the problem with this method is, sometimes it is difficult to measure
absolute poverty. Relative poverty is defined in a different context. It means that
the individual is at a disadvantageous position (financially or socially) in comparison
to other individuals in the same environment. The relative measure of poverty is
used to describe the inequality in distribution of income. The criteria of measuring
relative poverty cannot be same for all the countries. A person who is relatively
poor in America may not be poor in India. Moreover there cannot be a static way
of defining poverty over a period of time. It is a dynamic subject and it keeps on
changing with passage of time.
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 Different poverty lines are drawn to measure the absolute and relative poverty. Growth, Poverty and
Income Distribution
The absolute poverty lines are based on some absolute standard. It is a monetary
threshold used to meet the basic needs. The relative poverty lines are based on
overall distribution of income and overall consumption in a country. The absolute
measure of poverty is considered as a better approach. Further there are different NOTES
approaches to measure absolute poverty. Generally it is measured on the basis of
either food-energy intake method or cost of basic needs method.
Inequality of Income and Wealth
The inequality of income means unequal distribution of income among individual
household of a country. It measures the disparity of income between individual making
most of the money and least of the money. The inequality of income is a relative
measure to study the gap between household incomes of a region or country etc.
Increasing income inequality is a universal phenomenon. The inequality of
income and wealth has increased as a result of increasing globalization. The examples
of income inequality can be seen in the form of, rising corporate profits but decline in
income of employees, higher income of males than females, higher income of urban
people in comparison of rural people, and higher income of developed economies in
comparison to developing and underdeveloped economies, etc.
Majority of the countries of the world are facing the situation of income
inequality. Whether we take the example of US, India or China or other countries,
the recent trends of income inequality have shown that the gap between rich and
poor has increased.
The two measures used to compute the income inequality are Lorenz curve
and Gini Index.
The Lorenz curve explains the percentage of income earned by a percentage
of population. A perfect income distribution will have a Lorenz curve a straight line
showing same percentage change in income caused by same percentage change in
population.
% of income
100%

80% Line of
equality

60%

40%

Lorenz
20%
curve

0%
20% 60%
% of households

Fig. 2.3 A Lorenz Curve Illustrates Inequality

Self-Instructional
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Growth, Poverty and The Gini coefficient is also used to measure the inequality of income. The
Income Distribution
Gini coefficient calculates the deviation of income distribution in a country from a
perfect equity income state in that country. If Gini coefficient is zero then it indicates
the perfect equality and if it is one then it shows perfect inequality of income
NOTES indicating that a single person is holding the whole income. The inequality in income
is an indicator of social welfare of the country. The increasing income inequality
increases the social unrest.

Fig 2.4 Gini Coefficient Graph

Gini coefficient
Gini coefficient is a statistical measure of the degree of variation represented in
a set of values, used especially in analysing income inequality. Gini coefficient of
countries with highly unequal income distribution lies between 0.50 and 0.70 while
the countries with some extent to equal distribution of income lies 0.20 to 0.35.
We can draw four possible Lorenz curve with the help of international data. The
diagram is shown in fig 2.5. In the Lorenz criterion of income distribution, one
Lorenz curve adjacent to other Lorenz curve, the economy corresponding to the
upper curve is equal to the lower curve (Lorenz curve). So in the figure, economy
A may unambiguously be said to be more equal than economy D, as one is lower
and other is upper curve. Whenever two Lorenz curve cross, such curve like B
and C, the Lorenz criterion states that we ‘need more information’. Economy of B
represents more equal economy while we argue on the grounds of the priority of
addressing problems of poverty, since the poorest are richer and riches are richer
(middle class is ‘squared’).

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 100 Growth, Poverty and
Income Distribution
Percentage of income

NOTES
A
B

C D

0 Percentage of income recipients 100

Fig. 2.5 Lorenz Curve and Income Distribution

An economy with a strong middle class is more equal and after observing
the Lorenz curve aggregate might select economy C. One could also measure
aggregate like Gini coefficient to finalize the matter. As it turns out, Gini coefficient
is among a measure that satisfies highly desirable properties. The anonymity principle
simply means that our measure of inequality should not depend on who has the
higher income.
Inequality in India for the period 2000-2011, when measured in terms of
income Gini-coefficient was 36.8 and is more favourable as compared to other
countries like South Africa (57.8) Brazil (53.9), Thailand (53.6) and even the
U.S.A (40.8), Israel (39.2) and Bulgaria (45.3) which are otherwise, ranked very
high in human development. The second indicator increasing the inequality is the
quintile income ratio, which is a measure of average income of the richest 20 per
cent of the population to that of poorest 20 per cent. The quintile income ratio for
India was 5.6 in 2010-11. When compared with other countries, Australia (7-0),
USA (8.5), New Zealand (6.8), Singapore (9.8), The U.K (7.8), Mexico (14.4),
Malaysia (11.8), Argentina (12.3) and Vietnam (6.2) had a higher ratio. This implies
that in terms of inequality between top and bottom, quintiles in India was lower
than a large number of countries.
For the inverse in inequality recorded the past two decades in developed
countries, government makes policies to tax more from the higher income group
and spend more to affect the trends towards more inequality on social issues.
They need to spend more because of the increasing age of the population of such
countries and have to spend more on health care, and pension’s expenditure. The
redistributive effect of government expenditures dampened the rise in poverty in
the decade from the mid 1980 to 1990s. But in these time period, benefits became
less targeted on the poor population. If the government stops trying to manage the
inequalities by spending less on social benefits, or taking taxes from the poor, then
growth of inequalities will be more rapid.
Some points have been made on the number of objections that people
make in response like:
Self-Instructional
Material 15
Growth, Poverty and  Public services are very helpful to reduce inequalities like education and
Income Distribution
health.
 Some people who have assets but are in low income group cannot be
considered as poor.
NOTES
 People have low incomes for long period of time is considered as poor
but for short period is not considered.
 A better way of looking at inequality is seeing if people are deprived of
key goods and services, such as having enough food to eat, or being
able to afford a television or any other luxury items.
 People who work harder or are more talented earn more income as
compared to other. What matters really is the equality of opportunity
and not the equality of outcome.
Some nations have more unequal income distribution than others in which
inequality has little effect on the country rankings. Countries having wider distribution
of income also have higher relative income poverty. This holds true regardless of
relative poverty, which is defined as having income below 40.50 or 60 per cent of
the median income. Income inequality has risen significantly since 2000 in the
countries like, Germany, Norway, the United States, Finland, Italy and declined in
countries like United Kingdom, Mexico, Australia and Greece. Reasons for the
rise in inequality are that rich households have done particularly well in comparison
with middle class income group and those at the bottom like lower income group.
There are four broad areas which correspond to the four major elements
that determine the distribution of income of developing countries.
1. Altering the functional distribution
In functional distribution, the return to land, labour and capital is determined by
factor prices and on the level of utilization of national income that accrue to the
owners of each factor.
2. Mitigating the size distribution
The functional distribution translated into a size distribution by knowledge of how
to control productive assets and also on labour skills are concentrated and
distributed throughout the population in an economy.
3. Moderating (reducing) the size distribution at the upper levels
With the help of progressive taxation of personal income, government revenues
increases and decreases the share of disposable income of the rich income groups.
Revenue can be increased with good policies of government to be invested in
human capital and rural infrastructure, thereby promoting inclusive growth.

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4. Moderating (increasing) the size distribution at the lower levels Growth, Poverty and
Income Distribution
With the help of public expenditures of tax revenues to raise the income of poor
individuals either directly (providing cash transfer) or indirectly (by giving then
opportunity to work and earn income). Such types of public policies help to raise NOTES
the real income level of low income group above what their personal income levels
would be.
Kuznets inverted ‘u’ Hypothesis
Simon Kuznets analysed the historical growth patterns of contemporary developed
countries. He suggested that in the early stage of economic growth, the distribution
of income will tend to worsen, whereas at later stages it will improve. This
observation came to be characterized by the ‘inverted U’ Kuznets curve because
a longitudinal (time-series) plot of changes in the distribution of income is measured
by Gini Coefficient. (the curve shown in fig. 2.6).
Gini coefficient

Gross national produce per capita

Fig. 2.6 The Inverted U Kuznets Curve

In the explanation of ‘inverted U’ shape, inequality seemed first to worsen

during the early stages of economic growth before eventually improving. Early
growth may, in accordance with the Lewis model is concentrated in ‘industrial
sector where employment is limited but wages and productivity are high. The
income gap between the modern and traditional sectors may widen quickly at first
before beginning to converge. Inequality in the expanding modern sector may be
much greater than inequality in the stagnant traditional sector. Income transfers
from the rich to the poor and poverty – reducing public expenditure are more
difficult to undertake by governments in very low income countries. Although in
the long run, data for western nations do seem to support their proposition, studies
of the phenomenon in Third World nations have produced conflicting results. The
problem is methodological because of the absence of time-series data for LDLs
and researchers use longitudinal phenomenon with cross-sectional data.
Disregarding the merits of methodological debate, few development
economists would argue that Kuznets sequence of increasing and then declining
inequality is inevitable. Enough studies have been done on countries like Taiwan,
South Korea, China, Costa Rica and Sri Lanka to demonstrate that higher level of
Self-Instructional
Material 17
Growth, Poverty and income can be accompanied by falling not rising inequality. Theorists argue the
Income Distribution
inevitability of the Kuznets process, especially political leaders in countries with
large and growing inequalities.

NOTES
Check Your Progress
1. What is the analysis of economic growth concerned with?
2. Name the types of poverty lines which are based on overall distribution of
income and overall consumption in a country.
3. Mention the two measures used to computer the income inequality.

2.4 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. The analysis of economic growth is concerned mainly with measuring of

growth in economic variables, and identifying their interrelationships such
as between the national income growth rate and the speed of capital
formation.
2. The relative poverty lines are the poverty lines which are based on overall
distribution of income and overall consumption in a country.
3. The two measures used to compute the income inequality are Lorenz curve
and Gini Index.

2.5 SUMMARY

 Although in common parlance, there is no difference between economic

growth and economic development, and these terms are used
interchangeably. But in economics, we differentiate between these two
concepts. Economic growth is a narrower concept between the two, and
denotes an increase in a country’s Gross Domestic Product.
 There are two common measures of the rate of economic growth. The first
is the rate of growth of a nation’s real Gross Domestic Product, which tells
how rapidly the economy’s total real output of goods and services is
increasing. The second is the rate of growth of per capita real Gross Domestic
Product, which is a better measure of the rate of increase of a country’s
standard of living.
 To represent the process of economic growth, it is convenient to use the
production possibilities curve which shows all efficient combinations of output
that an economy can produce.
 The analysis of economic growth is concerned mainly with measuring of
growth in economic variables, and identifying their interrelationships such
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18 Material
 as between the national income growth rate and the speed of capital Growth, Poverty and
Income Distribution
formation.
 Poverty is a multifaceted occurrence which is caused by various factors.
There are different ways of defining poverty. The most common of these
NOTES
are objective and subjective poverty. Poverty can also be defined as absolute
and relative on the basis of scale of threshold. Another popular way of
defining poverty is static and dynamic. The dynamic studies focus on the
length of duration of poverty.
 Absolute poverty is a state in which the basic needs of an individual are not
covered. These basic needs include the needs which are related to food,
housing and clothes.
 Relative poverty is defined in a different context. It means that the individual
is at a disadvantageous position (financially or socially) in comparison to
other individuals in the same environment.
 The inequality of income means unequal distribution of income among
individual household of a country. It measures the disparity of income between
individual making most of the money and least of the money.
 The Lorenz curve explains the percentage of income earned by a percentage
of population. A perfect income distribution will have a Lorenz curve a
straight line showing same percentage change in income caused by same
percentage change in population.
 The Gini coefficient is also used to measure the inequality of income. The
Gini coefficient calculates the deviation of income distribution in a country
from a perfect equity income state in that country.
 Simon Kuznets analysed the historical growth patterns of contemporary
developed countries. He suggested that in the early stage of economic growth,
the distribution of income will tend to worsen, whereas at later stages it will
improve. This observation came to be characterized by the ‘inverted U’
Kuznets curve because a longitudinal (time-series) plot of changes in the
distribution of income is measured by Gini Coefficient.

2.6 KEY WORDS

 Production possibilities curve: It shows all efficient combinations of output

that an economy can produce.
 Lorenz curve: It explains the percentage of income earned by a percentage
of population
 Gini coefficient: It is a statistical measure of the degree of variation
represented in a set of values, used especially in analysing income inequality

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Growth, Poverty and
Income Distribution 2.7 SELF ASSESSMENT QUESTIONS AND
EXERCISES

NOTES Short Answer Questions

1. What are the two common measures of the rate of economic growth?
2. Which among the two have a narrower concept: economic growth or
economic development?
3. State some of the ways of defining of poverty.
4. Differentiate between absolute and relative poverty lines.
5. What are the forms in which the examples of income inequality can be
seen?
Long Answer Questions
1. Explain how production possibilities curve reflect economic growth.
2. Discuss the broad areas which correspond to the four major elements that
determine the distribution of income of developing countries.
3. Describe the Kuznets inverted ‘u’ hypothesis.

2.8 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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 Overview of Different

UNIT 3 OVERVIEW OF DIFFERENT Development Indices

DEVELOPMENT INDICES
NOTES
Structure
3.0 Introduction
3.1 Objectives
3.2 HDI, Physical Quality of Life Index and Human Poverty Index
3.3 Answers to Check Your Progress Questions
3.4 Summary
3.5 Key Words
3.6 Self Assessment Questions and Exercises
3.7 Further Readings

3.0 INTRODUCTION

Measurement of development is important from the point of view of understanding

whether the economic activities within the economy is bringing any real change in
the lives of the people involved. Besides, these measurement indices allow
economists to compare not only where the company standards in the development
path and which pattern they are on, but also compare the relative development of
different countries. The most basic measure of development is generally the GDP
followed by the per-capita income. But since these are very restricted to only
measuring the economic standards, other indices have been developed to also
bring in other factors which affect human life like life expectancy and literacy as
well as health indicators. In this unit, we will learn about three development indices
and their development: PQLI, HDI and Human Poverty Index.

3.1 OBJECTIVES

After going through this unit, you will be able to:

 Explain the development of the PQLI
 Describe the elements of HDI
 Discuss human poverty index and the newer development indices

3.2 HDI, PHYSICAL QUALITY OF LIFE INDEX

AND HUMAN POVERTY INDEX

The dislike of per capita GDP as an indicator gave rise to a broad based definition
of economic development and indicators of development. Various indicators started
developing. One such indicator was the Physical Quality of Life Index (PQLI).
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Overview of Different The index was developed by Morris D. Morris in 1979. According to him, income
Development Indices
is only an input in the process of economic development and not the output in
itself. Moreover, it also does not explain how the income is distributed in the
society. He takes into consideration three broad indicators that help in explaining
NOTES the quality of life of the people. These are literacy rate, life expectancy and the
infant mortality rate. These three parameters help in understanding the changes in
the basic life of the people during the process of economic development. Equal
weight is assigned to each variable. The maximum and minimum values are measured
on a scale of 0 to 10. The countries are then ranked as per the actual achievements
in these three components. For instance, the minimum value of literacy rate is 0
and the maximum 100. Similarly, the lowest life expectancy was 39 years in Somalia
and 76 in Canada. Similarly, the infant mortality rate was the highest in Bangladesh
at 139 per thousand and the lowest in Denmark at 8 per thousand. Infant mortality
rate is a negative index and hence the country with the lowest IMR will be ranked
higher compared the country with higher IMR. The averages of the three give
PQLI, the Physical Quality of Life Index.
Steps to calculate physical quality of life
The calculation of physical quality of life index involves the following steps:
Step 1: Find percentage of the population that is literate (literacy rate).
Steps 2: Find the infant mortality rate (out of 1000 births). [Indexed infant mortality
rate = (166 – infant mortality) × 0.625]
Step 3: Find the life expectancy. [Indexed life expectancy = (Life expectancy –
42) × 2.7]
Step 4: Now calculate the physical quality of life using the following formula:
Physical quality of life =
HDI
According to the Tenth Plan Report of the Government of India,
Economic growth cannot be the only objective for national planning and indeed
over the years, development objectives are being defined not just in terms of
increases in GDP or per capita income but more broader in terms of enhancement
of human well being. This includes not only an adequate level of consumption
of food and other types of consumer goods but also access to basic social
services especially education, health, availability of drinking water and basic
sanitation. It also includes the expansion of economic and social opportunities
for all individuals and groups, reduction in disparities, and greater participation
in decision making.
Amartya Sen, the Nobel Laureate and one of the pioneers of the concept of
human development, mentions:
The basic purpose of development is to enlarge people’s choices. In principle,
these choices can be infinite and can change over time. People often value
achievements that do not show up at all, or not immediately, in income or growth
figures: greater access to knowledge, better nutrition and health services, more
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 secure livelihoods, security against crime and physical violence, satisfying leisure Overview of Different
hours, political and cultural freedoms and a sense of participation in community Development Indices
activities. The objective of development is to create an enabling environment for
people to enjoy long, healthy and creative lives.
Development should be all encompassing, all nourishing and all pervading. NOTES
Development objectives need to be defined not just in terms of increases in GDP
or per capita income but in broader terms of the enhancement of human well-
being.
UNDP also mentions that human development is a process of expanding
people’s choices in life. These choices can be infinite and can change over time.
However, the three basic capabilities that are universally applicable are the capability
to live a long and healthy life, capability to be knowledgeable and capability to
acquire a decent standard of living. If these essential choices are not available,
many other opportunities will remain inaccessible. HDI, therefore, incorporates
only these three variables (UNDP 1994).
In view of the new dimension of the concept of human development, UNDP
formulated the Human Development Index (HDI). HDI is a summary measure of
human development that measures the average achievement in a country in three
basic dimensions of human development:
 A long and healthy life, as measured by life expectancy at birth (LEB).
 Knowledge, as measured by the adult literacy rate (with two-thirds
weight) and combined primary, secondary, and tertiary gross enrolment
rate.
 A decent standard of living as measured by GDP per capita (PPP US$).
For each of these three dimensions, an EDEP (equally distributed equivalent
percentage) is calculated and HDI is calculated as a simple average of the three
indexed EDEPs as shown in the Table 3.1.
Table 3.1 Calculation of HDI
Minimum Maximum
Index Measure Value Value Formula
Longevity (L) LEB 25 years 85 years Actual – Min
LEB / LEI =
Max - Minn
Education Literacy Rate 0% 100 %
(E) (LR)

Combined Gross 0% 100 %

Enrollment Ratio
(CGER)

GDP GDP per capita 100 US$ 40000 logactual – logmin

(PPP) US$ GDPI =
Logmax – logmin

In case of literacy rate 2/3 weight is assigned to Adult Literacy Rate and 1/
3 weight is assigned to combined Gross enrolment ratio. Equal weight is given to
all three variables viz., life expectancy, literacy rate and PPP PC GDP. HDI is then
calculated as follows:
Self-Instructional
Material 23
Overview of Different HDI= 1/3LEI+1/3 CGER +1/3 GDPI.
Development Indices
The value of HDI would lie between 0 and 1. Higher the value of HDI will
indicate the achievement level of a country.
NOTES Criticism
The Human Development Index has been criticized on a number of grounds,
including failure to include any ecological considerations, focusing exclusively on
national performance and ranking, not paying much attention to development from
a global perspective and based on grounds of measurement error of the underlying
statistics and formula changes by the UNDP which can lead to severe
misclassifications of countries in the categories of being a ‘low’, ‘medium’, ‘high’
or ‘very high’ human development country. Other authors claimed that the Human
Development Reports ‘have lost touch with their original vision and the index fails
to capture the essence of the world it seeks to portray’. The index has also been
criticized as ‘redundant’ and a ‘reinvention of the wheel’, measuring aspects of
development that have already been exhaustively studied. The index has further
been criticized for having an inappropriate treatment of income, lacking year-to-
year comparability, and assessing development differently in different groups of
countries.
Economist Bryan Caplan, has criticized the inclusion of schooling in HDI
with argument that: ‘[...] a country of immortals with infinite per-capita GDP would
get a score of .666 (lower than South Africa and Tajikistan) if its population were
illiterate and never went to school.’
Some economists discuss the HDI from the perspective of data error in the
underlying health, education and income statistics used to construct the HDI. They
identify three sources of data error which are due to (i) data updating, (ii) formula
revisions and (iii) thresholds to classify a country’s development status and find
that 11 per cent, 21 per cent and 34 per cent of all countries can be interpreted as
currently misclassified in the development bins due to the three sources of data
error, respectively. The authors suggest that the United Nations should discontinue
the practice of classifying countries into development bins because the cut-off
values seem arbitrary, can provide incentives for strategic behaviour in reporting
official statistics, and have the potential to misguide politicians, investors, charity
donators and the public at large which use the HDI.
In 2010 the UNDP reacted to the criticism and updated the thresholds to
classify nations as low, medium and high human development countries. In a
comment to The Economist in early January 2011, the Human Development
Report Office responded that they undertook a systematic revision of the methods
used for the calculation of the HDI and that the new methodology directly addresses
the critique in that it generates a system for continuous updating of the human
development categories whenever formula or data revisions take place.

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 However, each year, UN member states have been ranked according to Overview of Different
Development Indices
the computed HDI. If high, the rank in the list can be easily used as a means of
national aggrandizement; alternatively, if low, it can be used to highlight national
insufficiencies. Using the HDI as an absolute index of social welfare, some authors
have used panel HDI data to measure the impact of economic policies on quality NOTES
of life.
Ratan Lal Basu criticizes the HDI concept from a completely different angle.
According to him, the Amartya Sen-Mahbub ul Haq concept of HDI considers
that provision of material amenities alone would bring about human development,
but Basu opines that human development in the true sense should embrace both
material and moral development. According to him, human development based on
HDI alone, is similar to dairy farm economics to improve dairy farm output. To
quote: ‘So human development effort should not end up in amelioration of material
deprivations alone: it must undertake to bring about spiritual and moral
development to assist the biped to become truly human.’ For example, a high
suicide note would bring the index down.
A few authors have proposed alternative indices to address some of the
index’s shortcomings. However, of those proposed alternatives to the HDI, few
have produced alternatives covering so many countries, and that no development
index (other than, perhaps, Gross Domestic Product per capita) has been used so
extensively—or effectively, in discussions and developmental planning as the HDI.
Human Poverty Index (HPI)
The Human Poverty Index (HPI) measures the extent of deprivation in HDI’s
three dimensions. For industrialized countries, it uses as variables the probability
of dying before age 60, functional illiteracy, and the incidence of poverty and long-
lasting unemployment. For developing countries, its variables are the probability
of death before age 40, adult illiteracy, child malnutrition, and the percentage of
population with no access to drinking water.
Gender Development Index (GDI) and Gender Empowerment
Measure (GEM)
Two global gender indices, namely the Gender Related Development Index (GDI)
and Gender Empowerment Measure (GEM), were introduced in the Human
Development Report 1995. GDI was also measured with the help of life expectancy,
education and income, but it was measured after adjusting the HDI for gender
inequality. The greater the gender disparity in basic human development, the lower
would be a country’s GDI compared to HDI.
GEM shows whether women are actively involved in political and economic
field or not. It focuses on political participation, economic participation and power
over economic resources.

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Overview of Different Three drawbacks of GDI and GEM, as pointed out by some critics, are as
Development Indices
follows:
1. The measures combine absolute and relative achievements. Thus, a
country with low absolute income scores poorly, even with perfect
NOTES
gender equity. The GDI adjusts the HDI for gender inequalities, thereby
measuring both total achievements and disparities. However, it is often
misinterpreted as reflecting only disparities.
2. Nearly all indicators in the GEM reflect a strong urban elite bias and use
of some indicators which are more relevant to developed countries.
3. Extensive imputations were needed to fill in missing data. For the relative
income share in both indices, more than three-fourths of a country’s
estimates were partly imputed. With income as the most important driver
of the wedge between the HDI and the GDI, this imputation was
particularly problematic.
Gender Inequality Index (GII)
HDR 2010 introduced a new measure named Gender Inequality Index (GII) in
order to address the above criticisms. GII does not rely on imputations. It includes
three critical dimensions for women: reproductive health, empowerment and
economic activities or participation in labour market.

Check Your Progress

1. Who developed the Physical Quality of Life Index?
2. What is the range in which the value of HDI lies?
3. What does GEM show?

3.3 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. Physical Quality of Life Index (PQLI) was developed by Morris D. Morris

in 1979.
2. The value of HDI lies between 0 and 1.
3. GEM shows whether women are actively involved in political and economic
field or not. It focuses on political participation, economic participation and
power over economic resources.

3.4 SUMMARY

 The dislike of per capita GDP as an indicator gave rise to a broad based
definition of economic development and indicators of development. It was
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 found that per capita GDP can not be a measure to improve the life of the Overview of Different
Development Indices
people at large. Various indicators started developing. One such indicator
was the Physical Quality of Life Index (PQLI). The index was developed
by Morris D. Morris in 1979.
NOTES
 Morris took into consideration three broad indicators that help in explaining
the quality of life of the people. These are literacy rate, life expectancy and
the infant mortality rate. These three parameters help in understanding the
changes in the basic life of the people during the process of economic
development.
 HDI is a summary measure of human development that measures the average
achievement in a country in three basic dimensions of human development:
o A long and healthy life, as measured by life expectancy at birth (LEB).
o Knowledge, as measured by the adult literacy rate (with two-thirds
weight) and combined primary, secondary, and tertiary gross enrolment
rate.
o A decent standard of living as measured by GDP per capita (PPP US$).
 For each of these three dimensions, an EDEP (equally distributed equivalent
percentage) is calculated and HDI is calculated as a simple average of the
three indexed EDEPs.
 The value of HDI would lie between 0 and 1. Higher the value of HDI will
indicate the achievement level of a country.
 The Human Development Index has been criticized on a number of grounds,
including failure to include any ecological considerations, focusing exclusively
on national performance and ranking, not paying much attention to
development from a global perspective and based on grounds of
measurement error of the underlying statistics and formula changes by the
UNDP which can lead to severe misclassifications of countries in the
categories of being a ‘low’, ‘medium’, ‘high’ or ‘very high’ human
development country.
 The Human Poverty Index (HPI) measures the extent of deprivation in HDI’s
three dimensions. For industrialized countries, it uses as variables the
probability of dying before age 60, functional illiteracy, and the incidence of
poverty and long-lasting unemployment. For developing countries, its
variables are the probability of death before age 40, adult illiteracy, child
malnutrition, and the percentage of population with no access to drinking
water.
 GDI was also measured with the help of life expectancy, education and
income, but it was measured after adjusting the HDI for gender inequality.
The greater the gender disparity in basic human development, the lower
would be a country’s GDI compared to HDI.

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Overview of Different  GEM shows whether women are actively involved in political and economic
Development Indices
field or not. It focuses on political participation, economic participation and
power over economic resources.
 GII does not rely on imputations. It includes three critical dimensions for
NOTES
women: reproductive health, empowerment and economic activities or
participation in labour market.

3.5 KEY WORDS

 PQLI: It includes the three measures literacy rate, life expectancy and the
infant mortality rate which help in understanding the changes in the basic life
of the people during the process of economic development.
 HDI: It is a summary measure of human development that measures the
average achievement in a country in three basic dimensions of human
development: capability to live a long and healthy life, capability to be
knowledgeable and capability to acquire a decent standard of living.
 Human Poverty Index (HPI): It measures the extent of deprivation in
HDI’s three dimensions.

3.6 SELF ASSESSMENT QUESTIONS AND

EXERCISES

Short Answer Questions

1. What were the dimensions that were not explained by income which led to
the development of PQLI?
2. List the dimensions which constitute as the summary measure for HDI.
3. What are the variables used by Human Poverty Index for industrialized and
developing countries?
4. Differentiate between the GDI and GEM.
5. What is Gender Inequality index?
Long Answer Questions
1. Explain the development and steps in calculating the PQLI.
2. What is HDI? Discuss the criticism against it.

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 Overview of Different
3.7 FURTHER READINGS Development Indices

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill. NOTES
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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Theories of Growth - I

UNIT 4 THEORIES OF GROWTH - I

NOTES Structure
4.0 Introduction
4.1 Objectives
4.2 Classical Theory of Development
4.3 Karl Marx’s Theory of Capitalist Development
4.3.1 Materialistic Interpretation of History
4.3.2 Surplus Value
4.3.3 Process of Production
4.4 Schumpeter Theory
4.4.1 Entrepreneur and Innovations
4.4.2 Bank Credit
4.4.3 Cumulative Process and Creative Destruction
4.4.4 End of Capitalism
4.5 Answers to Check Your Progress Questions
4.6 Summary
4.7 Key Words
4.8 Self Assessment Questions and Exercises
4.9 Further Readings

4.0 INTRODUCTION

This unit will introduce you to the theories of development. There are many theories
on how desirable change in society can be achieved, such as the Classical Theory,
the development theory of Karl Marx, the Creative Destruction Theory of Joseph
Alois Schumpeter, and others.
Classical economics is widely regarded as the first modern school of
economic thought. Major developers of classical theory of development include
Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John Stuart
Mill. These economists were largely concerned with the dynamics of economic
growth of a capitalist economy. According to them, population growth and capital
accumulation are the prerequisites for growth. The forces of diminishing returns
and technological advancements determine the pace of economic growth.
According to the Marxian theory of development, human civilization has
manifested itself in a series of organizational structures, each determined by its
primary mode of production, especially the division of labour that dominates in
each of the four stages of development: tribal stage, primitive communism stage,
feudal stage and capitalist stage. During the tribal stage, a slave culture was
established. As the population increased, there occurred the growth of wants and
the growth of relations with outside civilizations (through war or barter). During
the primitive communism, the concept of private property began to develop. Like
tribal and communal ownership, feudalism was based again on a community; but
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the directly producing class standing over against it was not the slaves, but the Theories of Growth - I

enserfed small peasantry. In the city, the feudal structure manifested itself in trade
guilds. As a result of the eventual growth of commerce (and of human populations),
feudal society began to accumulate capital, which, along with the increased debt
incurred by the aristocracy, eventually led to the English Revolution of 1640 and NOTES
the French Revolution of 1789. These Revolutions opened the way for the
establishment of a society structured around commodities and profit (i.e.,
capitalism).
Schumpeter, an Austrian-Hungarian-American economist and political
scientist, popularized the term ‘Creative Destruction’ in economics. While he agreed
with the Marxian theory that capitalism will collapse and will be replaced by
socialism, he was of the opinion that this will not come about in the way Marx
predicted. To describe it he borrowed the phrase ‘creative destruction’. According
to the theory of creative destruction, the success of capitalism will give rise to a
type of corporatism and encourage values unsympathetic to capitalism, particularly
among intellectuals. The intellectual and social climate, which is the key to allow
entrepreneurship to prosper, will cease to exist in advanced capitalism. Capitalism
will be replaced by socialism in some form. Schumpeter does not predict a
revolution; but he merely oversees the emergence of a trend in parliaments to elect
social democratic parties of one line or another.

4.1 OBJECTIVES

After going through this unit, you will be able to:

 Explain the classical theory of development
 Examine Karl Marx’s theory of creative destruction
 Discuss Schumpeter’s theory of economic development

4.2 CLASSICAL THEORY OF DEVELOPMENT

The classical school of thought in economic development includes economists

such as Adam Smith, David Ricardo, Thomas Robert Malthus, J.B. Say and J.S.
Mill. The classical economists explain the process and causes of long run growth
in national income.
The basic approach and the broad framework in which the classical theories
have been propounded is similar in most of the writings. Hence, a general framework
of the classical theory is undertaken here. An important assumption in the classical
theory is that of laissez-faire, i.e., no government interference. Smith argued that
economy should be left free and be guided by the invisible hand, i.e., the market
forces.

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Theories of Growth - I According to the classical economists, accumulation of capital is an important
factor determining growth. Capital that includes tools, equipment and machines
helps in boosting production. Capital formation facilitates specialization and division
of labour.
NOTES
In the classical theory, there are three factors of production, viz., land, labour
and capital and hence, the production function would be:
Q = f ( k, l, n) ...(4.1)
where, Q is the amount of output,
k is the stock of capital,
l is the amount of labour, and
n is the amount of land
The classical economists assumed a linear and homogeneous production
function which meant that any change in the amount of factors of production is
followed by an equal amount of production. Adam Smith anticipated increasing
returns in scale owing to division of labour. He argued that the cost of production
tends to decrease with increase in production. With increase in production, the
size of market extends and economies of scale occur. The division of labour is
limited by the extent of market.
Adam Smith recognizes the importance of technology in the process of
growth as it leads to rise in productivity. Hence, in the overall production function
technology is an important factor. The new production function would then be,
Q = f ( k, l, n, S ) (4.2)
where S is the level of technology
In his Wealth of Nations, he explains,
The owner of the stock which employs a great number of labourers, necessarily
endeavours, for his own advantage, to make such a proper division and
distribution of employment that they may be enabled to produce the greatest
quantity of work possible. For the same reason, he endeavours to supply them
with the best machinery which either he or they can think of. What takes place
among the labourers in a particular workhouse takes place, for the same reason,
among those of a great society.
Hence, technology plays a very important role in the process of growth and
as the stock of capital increases in an economy technological know-how will
continue to increase. This will also help in preventing output per labour or labour
productivity to decline. The classical theory also considered profit as an important
source of saving as capital accumulation profits are sort of residual received after
making payments to land, labour and capital (i.e., paying rent, wages and interest).
These are received by those who are willing and able to save. So long as profits
are rising, savings too will rise which will be used for further capital accumulation
or investment.

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 The classical economists further argued that the competition among the Theories of Growth - I

producers or the capitalist class will result in the decline in profits. Further, the
national resources being limited in supply will also narrow down the profitability.
In the long run, the market will be in a stationary state or situation of no growth.
NOTES
To summarize the classical approach to growth, in a less developed economy,
the capital accumulation takes place. This enhances the stock of capital in the
following period through increased investment. Hence, growth will take place with
increase in investment. This results in the division of labour and expansion of market
thus leading to increase in output and national income. But this is not an endless
process. Scarcity of natural resources and exhaustion of profits due to competition
drives the economy into a stationary state, characterized by stable income and
output, subsistence wages, elimination of profits, no further investment. Figure 4.1
explains this process.

G T

0 T0

Fig. 4.1 Classical Approach in a Less Developed Economy

In the figure, X-axis represents the time line and the Y-axis shows the rate of
capital accumulation. The curve GT shows the path of economic progress.
Economy reaches a situation of stationary state at which the rate of capital
accumulation and income are constant.
Critical Evaluation
The classical theory of growth has contributed towards an understanding of the
factors determining the growth of an economy. The classicists argue that basically,
it is the rate of investment that will lead to the division of labour, specialization and
expansion of market. The classical theory further argued that profit is an important
source of savings and investment. However, the later economists argue that it is
not necessary that profit can be the only source of savings and investment. There
can be other sources as well. These may be the savings out of the income of the
middle class or the government savings too. Hence, according to these economists,
the concept of profit adopted in the classical theory is severely limited. Moreover,
the classical theory assumes that savings are always equal to investment but this is
not necessarily true. At times, investment may be less than the savings whenever
there are leakages. At other times, investment may be more than the savings.
According to Schumpeter this is due to the credit creation by the banking system.
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Theories of Growth - I Another criticism of the classical theory relates to the assumption of laissez-
faire or non-governmental interference which seemed quite unrealistic; particularly
in the present times, there are certain sectors where the government interference is
imminent. The growth of these sectors such as education, health, water and
NOTES sanitation or even building up of infrastructure or even removal of income inequalities
and poverty are important for the growth of economy and society. However,
market will not enter into this sector either because of long gestation period or due
to low or no profitability. Therefore, the government has to intervene. Even during
the early stage of growth, the government has to incur investment to give boost to
the economic activities.

Check Your Progress

1. Who are some of the noted economists associated with classical school of
economic development?
2. What is the significance of a linear and homogenous production function?
3. Why is the classical theory’s support for laissez-faire government criticized?

4.3 KARL MARX’S THEORY OF CAPITALIST

DEVELOPMENT

Marxian theory of development is based on the premise of the nature of production

function, technological progress and the way the process of capital accumulation
takes place. All these together influence the wage rate determination and
accumulation of profit in the economy thereby consequent upon the dynamic
behaviour of the economy.
In his Das Kapital, Marx maintains that the production of goods takes
place under the control of a capitalist and on his behalf, does not alter the general
character of that production. According to him, labour is a process in which both
man and nature participate. He argues that the labour power gives value to a
commodity produced. However, the unearned income of the labour is retained by
the capitalist as profit. Karl Marx terms this as the exploitation of labour. This
injustice caused to the labour class can be eliminated only when the factors of
production are transferred from the capitalist to the working class.
According to Marx, technology inevitably replaces labour and machines
help the capitalist to earn greater profits. Thus, technological advancement results
in increase in unemployment and furthering accumulation of capital. But this will
also result in the reduction of investment opportunities and rate of profit. Therefore,
the ruling capitalist class becomes an imperialist class. Under capitalism, income
inequalities will grow. Growth would be unbalanced and business cycles would be
more violent due to increase in unemployment, poverty and under consumption
among the masses. The working class will revolt against the capitalist class thereby
Self-Instructional resulting into an end of capitalism and rise of communism.
34 Material
 The theory of development is based on certain assumptions such as the Theories of Growth - I

capital accumulation, technological progress and the production function.

4.3.1 Materialistic Interpretation of History
According to Karl Marx, the foundation and evolutionary cause of all social life is NOTES
materialism. Historical development is determined and influenced by the economic
condition and non-economic forces have very little influence on these events. The
mode of production determines the general character of social and political process
of life and the class structure is related to the relations of production which is
characterized by the following:
 Division of labour in a society, skills possessed by the labour in the social
content with respect to degree of freedom
 Knowledge about the availability of resources in the economy
 Technological progress
According to Marx the entire history of human kind is divided into four
different social systems.
 Primitive communism
 Slave age
 Feudalism
 Capitalism
During the age of primitive communism, the factors of production belong to
the community which also enjoys control over the resources. Individuals utilize the
resources as per their needs. But in the other stages, the control of resources is
restricted to a smaller class. This class also controls the society. The society gets
divided into two classes, viz., the dominant class and the depressed class.
Such a kind of division of society also creates tensions and conflicts. Hence, the
control of resources results into a change in the structure of the society. But the
basic structure relates to production, exchange and distribution. This also influences
the shape of life. Friedrich Engels mentions that the ultimate cause of social change
and political revolution is sought in the mode of production and exchange.
4.3.2 Surplus Value
According to Karl Marx, labour is the only source of value of a community. The
factors of demand and supply determine the value of a commodity only in the
short run but in the long run the amount of labour used in the production of a
commodity determines this value.
Karl Marx divides the society in two classes, viz., the working class and the
capitalist class. The capitalist class owns the resources and purchases labour
services from the working class and the working class sells its labour to the capitalists.
The commodity produced by the labour is sold at a price in the commodity market
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Theories of Growth - I and the labour is paid some wages for producing the commodity. The difference
between the price by the commodity and the wages paid to the labour is the
surplus value which is retained by the capitalist. According to Marx, capitalists are
interested in producing those goods and services that generate more surplus value
NOTES for them rather than socially useful commodities. Thus capitalism believes in the
exploitation of labour which is nothing but the surplus value generated by the
workers. The surplus value generated by the labour during the process of production
is used by the capitalist class for reinvestment which furthers the process of
production under capitalism.
The capitalist tries to increase the surplus value which leads to the
capitalist development. Hence, it is the surplus values generated by the labour
class which has a great role to play in the development of a society.
4.3.3 Process of Production
According to Karl Marx, it is the process of production in an economy that
determines the evolution of society. Under capitalism, the value of a commodity
consists of three elements. These are the constant capital, variable capital and
surplus value. The constant capital represents machinery and material and remains
constant during the process of production. Labour power represents the variable
capital and changes with production. Finally, the surplus value is the value added
to the production which according to Marx is equal to the profit. This occurs
because the worker is not paid wages equal to the amount of value added during
the process of production, but only subsistence wages.
If we suppose that the following is the production function:
Q = f (K, N, L, T, Z) (4.3)
where Q is the amount of output
K is the capital stock
N is the amount of land
L is the amount of labour
T is the technical knowledge and technical interaction representing relations
of production Z is the entire socio-cultural and institutional set-up of the society
Accordingly,
Q = ( + ) L + yK + nN (4.4)
where, a L is the variable capital (v)
b L is the surplus value (Sv)
and (yK + nN) is constant capital (c).
Since, yK and nN are not separate amount
Thus,
Q = ( +) L + yK (4.5)
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36 Material
 The coefficients of production (,  and y) are responsive to the changes in Theories of Growth - I

the relations of production and thus are not fixed over a period of time. In the
Marxian theory, changes in the techniques of production is not autonomous. As
Marx puts it, the additional capital termed in the course of accumulation serve
mainly as vehicles for the accumulation of new inventions and discoveries, or of NOTES
industrial improvements in general. An increase in the amount of gross investment
is shown by the rate of change of the relations of production. Any change in
technology displaces labour, that is c/v rises over a period of time due to increase
in gross investment. This is known as the organic composition of labour change in
the stock of variable capital determines the demand for labour. Gross investment
also determines the labour capital ratio.
The supply of labour is exogenous and increases with an increase in
population. Because technology displaces labour, with change in technology,
unemployment will increase and create a ‘reserve army of labour’. This reserved
army of labour facilitates movement of capital between the new and traditional
production activities. It also influences the bargaining power of labour and thereby
the amount of money wages. This results in exploitation of labour. Hence, with
growth of capitalism, there is a progressive deterioration in the conditions of the
labour class. According to Marx, ‘with the progress of industry, the modern labour
sinks deeper and deeper below the conditions of existence of his own class,
becomes a pauper and pauperism develops more rapidly than population and
wealth.’
Capital Accumulation
The rate of capital accumulation is an important determining factor of economic
growth in the Marxian theory. Marx argues that the quantity of accumulated capital
is determined by the surplus value generated during the process of production.
This is due to the fact that the wages received by the workers are spent for
consumption. There is reinvestment in the society so as to maintain the stock of
capital. Thus, ‘all the circumstances that determine the mass of surplus value operate
to determine the magnitude of accumulation.’
Another factor contributing to the accumulation of capital is the productivity
of labour. As productivity of labour rises, the surplus value generated by labour
increases and therefore results into accumulation of capital. The capitalist forms
the elite class in the society as he is the owner of the capital. Higher the amount of
capital owned by a capital, higher is the position power and prestige in the society.
As Marx puts it, ‘to accumulate is to conquer the world of social wealth, to increase
the mass of human being exploited by him, and thus to extent both the direct and
indirect sway of the capitalist.’ The capitalist who has more advanced and efficient
technology is also the one who is able to generate larger amounts of surplus and
therefore is able to accumulate larger amount of capital.
After accumulating large amounts of capital, the capitalist spends on luxury
and conspicuous consumption, may be due to necessities of business show off
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Theories of Growth - I that may add to prestige. This kind of expenditure grows with the growth of
accumulated capital. The motive behind this kind of lavish and wasteful expenditure
is also to accumulate more capital.
The tendency to accumulate capital is normal and important features of the
NOTES
working of capitalism. This results in the emergence and expansion of huge
enterprises that gain importance in the economy. This stimulates the concentration
of capital in a capitalist society and gradually results into the emergence of monopoly
power. Gradually, this results into monopoly capitalism and imperialism. But at the
same time, the process of socialization of production is promoted, i.e., a large
group of workers begin to work together. This provides material condition for
transition to socialism.
One important aspect of capital accumulation under capitalism that Marx
mentions is the cyclical nature of accumulation. There are cyclical crises from
one period to another resulting into another kind of crisis. At times, there is a
situation of overproduction or underconsumption or there may be an underutilization
of the capacity resulting in underproduction. There are phases of depression,
recession, recovery and boom through which the economy passes. When capitalism
exhausts its progress there is a collapse of the system and is replaced by a superior
form, i.e., socialism as a result of high level of unemployment, poverty and growing
inequalities.
Critical Evaluation
The Marxian theory of economic development has been criticized on several
grounds. Some of these have been discussed as under:
 Marx argues that there is a tendency for the profit to fall as the organic
composition of capital rises. But Paul Sweezy argues that as organic
composition of capital rises, labour productivity increases. But this should
have the effect of creating an industrial reserve army of labour which results
into lowering of wages which in turn raises the rate of surplus value. Since
both the composition of capital and the rate of surplus value are variable,
the rate of profit would be indeterminate, though falling rate of profit is a
basic feature of capitalism.
 The Marxian theory has also been criticized on the ground that at best it can
be a synthesis of the historical evolution of the society during the process of
economic growth but cannot be a theory of economic growth.
 Marxian theory has been criticized in respect to the wages and poverty
among the working class. He argues that under industrial capitalism wages
tend towards subsistence level. However, the evidences are that in the
industrial societies, wages have had the tendency of upward movement.
 Another important criticism of the Marxian theory pertains to his assumption
about the collapse of the capitalist system being replaced by socialism.

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 Though revolutions have taken place in some countries such as Russia and Theories of Growth - I

China it is not simple to carry through a socialist transformation in the

industrially advanced countries as the employment and wage levels are high.
Ernest Mandel has also argued that there has been a straight line progressive
evolution in the world starting from the first stages of fruit gathering and NOTES
ending with the most advanced capitalist or socialist industry.
 The recent experiences with former USSR, China and the East European
countries have shown that the social ownership of the factors of production
and production decisions have resulted into growing inefficiencies in the
economy and the collapse of the system. There have been government
failures resulting into collapse of economies.
Despite these criticisms the Marxian theory is relevant from the point of
view of the historical evolution of a capitalist society.

Check Your Progress

4. Which are the three aspects of the value of a commodity for capitalists?
5. Which are the two classes society can be divided into, as per Marx?

4.4 SCHUMPETER THEORY

Joseph A. Schumpeter in his Theory of Economic Development provides an

analysis of the origin, operation and evolution of a capitalist economy. But his
approach is more of an explanation of the phases of business cycles rather than a
theory of economic development. With his concepts of ‘innovation’ and
‘entrepreneur’, Schumpeter provides a penetrating analysis of the dynamics of
capitalism. However, his analysis is important in understanding the earlier phase of
a capitalist society during the process of economic development.
4.4.1 Entrepreneur and Innovations
The entrepreneur in Schumpeter’s theory plays an important role. It is the
entrepreneur who introduces innovations, causing shift in the production function.
Schumpeter begins his analysis with a stationary state. A stationary state is a situation
in which there is no population growth, no investment and no profit. With this
assumption, production takes on a circular form, i.e., it repeats itself. The value of
the products determines the rewards to the various factors of production. The
entrepreneur brings a change in such an equilibrium position. Here, the bank credit
plays an important role. This entrepreneur who is willing to take risk introduces
some innovations.
New products are introduced in the market. Innovation adds value to the
product which exceeds the value of the factors of production. Thus, there is a
surplus profit generated by the entrepreneur who has pioneered the product in the
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Theories of Growth - I market. Inspired by the profit of the entrepreneur other firms enter into the market
and output increases.
According to Schumpeter, innovations can take any of the five forms, viz.,
adopting a new method of production, introduction of a new commodity or a new
NOTES
quality of a commodity, locating new sources of supply, locating new market or
even reorganization of an industry such as monopoly.
Schumpeter’s entrepreneur has the risk bearing capacity and also has the
qualities of leadership. His concept of an entrepreneur was quite different from the
Marshallian concept of an entrepreneur who played the role of only an organizer.
But Schumpeter asserts that the entrepreneur is not necessarily a manager of a
firm or the organizer of the various factors of production but the most distinguishing
function of an entrepreneur is to carry out innovation or discontinuous technological
changes resulting in development. He explains,
Because being an entrepreneur is not a profession and as a rule not a lasting
condition, entrepreneurs do not form a social class in the technical sense, as for
instance, land owners or capitalists or workmen do. Of course, the entrepreneurial
function will lead to certain class position for the successful entrepreneur and
his family.
An entrepreneur is not necessarily motivated by profit but is rational in his
approach, which is important in carrying out new plans for breaking up old traditions
and creating new ones. He identifies three motivating factors for an entrepreneur
to undertake a business. These are: (i) the firm desire to set up a private business
kingdom, (ii) will to conquer, the impulse to fight, to prove oneself superior to
others, to success for the sake, not of the fruits of success, but of success itself
and (iii) the pleasure of creating or doing something or simply of exercising one’s
energy and ingenuity.
Further, he mentions that the social climate in an economy has an influence
on the entrepreneurial activities. There has to be a social climate where widespread
entrepreneurial activities can flourish. There should be complete freedom to the
entrepreneur to grow. During the initial phase of industrialization, it is the self interest
that motivates a person. However, capitalism develops rationality and adds new
edge to it in two ways. As Schumpeter puts it:
First it turns the monetary unit into a tool of rational cost profit calculations
which, in turn, react upon that rationality. By crystallizing and defining
numerically, cost profit calculations forcefully propel the logic of enterprise.
Secondly, apart from developing the modern scientific attitudes, the emerging
capitalism also produces the men eager to innovate.

4.4.2 Bank Credit

Another important element in Schumpeter’s analysis is the bank credit. Bank credit
is important in giving freedom to the entrepreneur to take risks involved in
undertaking innovations. With personal savings, the entrepreneur will not undertake
any risk. It is the bank that promotes and shows the risk in addition to the ready
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availability of the credit. This kind of investment financing results into inflationary Theories of Growth - I

situations as the income starts increasing before the actual production of consumer
goods takes place. Hence, people are forced to save and these amounts are available
to the investors for investment purposes. According to Schumpeter, this is an
inflationary process. The situation is self-correcting. Once production takes place, NOTES
the supply of consumer goods increases due to cumulative expansion of output in
the initial and secondary phases.
The credit in an economy ensures the smooth flow of money which is
mandatory to the smooth functioning of business and individual households.
Moreover, the role of credit becomes more significant in case of huge requirement
of funds by both industry and individuals. But it should also be taken care of that
the expansion of credit must be coupled by increase in revenue. More credit means
more flow of ‘future’ money which is unearned.
The demand created by individuals is out of their disposable income. With
more flow of money through credit, it may create artificial increase in demand and
it cannot be sustained for long periods because the disposable income of individuals
is not real. On the other hand, there will be spikes in supply side with more
availability of funds. This unreal demand and supply will result in economic
disequilibrium whenever there is constraint on the credit flow. Other aspect of
credit flow is that when repayment of credit flow takes place then there is loss of
revenue to economy. Therefore, even if the companies do extend credit to their
customers for three months then it may increase demand at once but when the
repayment will be done by the customers then it will surely compress the demand
by customers. Such tendencies in an economy are not considered good because
more demand at one point of time and lesser demand at another point of time will
not cause growth in the economy. Moreover, the assumption on which process of
credit supply is based, which is that the revenue generated from more demand by
increasing credit will be reinvested, may not work all the time.
Therefore, the credit supply is an important parameter which can cause
disequilibrium or equilibrium in economic activities of an economy and so it must
be dealt with utmost care.
4.4.3 Cumulative Process and Creative Destruction
The process of production initiated by an entrepreneur is cumulative. Initially, there
is primary increase in the production of goods in the industry in which innovation
has taken place. Inspired by the supernormal profit, other entrepreneurs also enter
into the industry which results into further increase in output. However, the
innovations in one industry do not remain confined to that industry alone. Other
industries imitate the pioneers and the production rises there too. Thus, according
to Schumpeter, innovations come in clusters and spread to many industries. This
primary expansion in output gives rise to increase in production in the already
existing industries with existing modes of production. Rising prices and increasing
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Theories of Growth - I income of the people emanates impulses and the demand for consumer goods
increase. It is this expanding nature of production that makes growth cumulative.
However, the process of growth is not continuous. It reaches its limits and then
starts again. It reaches a limit when the environment for further innovational
NOTES investment is not favourable. There are two reasons for this. Firstly, the credit
expansion which is responsible for much of the investment reaches a ceiling. There
are repayment obligations on the part of the entrepreneur which restrict further
expansion. Secondly, with the primary and secondary expansion of production,
there is a glut in the market which results in lowering of prices and money income.
Thus, there is a higher risk involved in innovations which affect further entrepreneurial
activities and therefore has an impact on secondary production activities.
Thus, the economy experiences a slump in the economic activities leading
to a recessionary situation. The economy gradually starts moving out of the
recessionary situation as the weak entrepreneurs leave the market during the
adjustments and a new stage is set for further innovative activities and the economy
is again on a growth path. This leads to upward and downward movements in the
economy which are cyclical in nature as shown in Figure 4.2.
The secondary wave is superimposed on the primary wage, with favourable
climate for innovation, development proceeds in the prosperity phase, when the
recession begin, the cycle moves downward below the equilibrium path and
ultimately a new phase of growth begins with new innovations.
4.4.4 End of Capitalism
Schumpeter’s theory predicts that capitalism is destined to destroy itself. The
reason is its success. The expansion of output under capitalism can continue
endlessly. But the system is eliminated as the economic success of the development
front undermines the social institutions that constitute a capitalist society. During
the process conditions that are hostile for the continuance of the capitalist system
are created. The very motivation of the entrepreneur who is the agent of growth
gets eroded. Thus, capitalism is replaced by socialism.

Secondary Wave
Prosperity

Equilibrium Path
Re
ce
ss
ion

ave al
aryW viv
Prim Re
Income

O Time Path

Fig. 4.2 Cyclical Patterns in the Schumpeter’s Theory

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Critical Evaluation Theories of Growth - I

Though Schumpeter’s theory is quite relevant in the real world and regarded as a
major analytical approach to economic growth, the theory has been criticized on
the following grounds. NOTES
 The theory overlooks the problem of economic development as that of
capital accumulation and deals with the growth in general.
 The theory is in appropriate in the present day context because of the changes
that have taken place in the present times. There is no single individual who
can be identified as being responsible for undertaking innovations. They are
normally being undertaken by the firms where a group of individuals are
involved.
 Research and development in the present times is no more considered risky.
Rather, it is considered as a part of investment.
 The creative destruction as mentioned by Schumpeter is no more valid in
the present day context as the large size firms are easily able to absorb the
shocks of readjustments.
 Schumpeter’s idea about the collapse of capitalism and its replacement by
socialism is also subject to criticism. The decline of entrepreneurial activities
alone cannot do much harm to capitalism. There may at times be some
changes in the system but not the collapse of the system as a whole.

Check Your Progress

6. What is stationary state, as per Schumpeter?
7. What makes growth cumulative in an economy?
8. State any one limitation of Schumpeter’s theory.

4.5 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. The classical school of thought in economic development includes economists

such as Adam Smith, David Ricardo, Thomas Robert Malthus, J.B. Say
and J.S. Mill.
2. The classical economists assumed a linear and homogeneous production
function which meant that any change in the amount of factors of production
is followed by an equal amount of production.
3. The criticism of the classical theory for the assumption of laissez-faire or
non-governmental interference seemed quite unrealistic to critics; particularly
in the present times, where there are certain sectors where the government
interference is imminent. The growth of these sectors such as education,
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Theories of Growth - I health, water and sanitation or even building up of infrastructure or even
removal of income inequalities and poverty are important for the growth of
economy and society. However, market will not enter into this sector either
because of long gestation period or due to low or no profitability. Therefore,
NOTES the government has to intervene.
4. Under capitalism, the value of a commodity consists of three elements.
These are the constant capital, variable capital and surplus value. The
constant capital represents machinery and material and remains constant
during the process of production. Labour power represents the variable
capital and changes with production. Finally, the surplus value is the value
added to the production which according to Marx is equal to the profit.
5. Karl Marx divides the society in two classes, viz., the working class and the
capitalist class. The capitalist class owns the resources and purchases labour
services from the working class and the working class sells its labour to the
capitalists.
6. A stationary state is a situation in which there is no population growth, no
investment and no profit. With this assumption, production takes on a circular
form, i.e., it repeats itself. The value of the products determines the rewards
to the various factors of production.
7. The process of production initiated by the entrepreneur is cumulative. Initially,
there is primary increase in the production of goods in the industry in which
innovation has taken place. Inspired by the supernormal profit, other
entrepreneurs also enter into the industry which results into further increase
in output. However, the innovations in one industry do not remain confined
to that industry alone. Other industries imitate the pioneers and the production
rises there too. This leads to cumulative growth.
8. One of the limitations of Schumpeter’s theory is that it overlooks the problem
of economic development as that of capital accumulation and deals with
growth in general.

4.6 SUMMARY

 The classical school of thought in economic development includes economists

such as Adam Smith, David Ricardo, Thomas Robert Malthus, J.B. Say
and J.S. Mill.
 An important assumption in the classical theory is that of laissez-faire, i.e.,
no government interference. Smith argued that economy should be left free
and be guided by the invisible hand, i.e., the market forces.
 Marxian theory of development is based on the premise of the nature of
production function, technological progress and the way the process of
capital accumulation takes place. All these together influence the wage rate
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 determination and accumulation of profit in the economy thereby consequent Theories of Growth - I

upon the dynamic behaviour of the economy.

 According to Marx, technology inevitably replaces labour and machines
help the capitalist to earn greater profits. Thus, technological advancement
NOTES
results in increase in unemployment and furthering accumulation of capital.
 Karl Marx divides the society in two classes, viz., the working class and the
capitalist class. The capitalist class owns the resources and purchases labour
services from the working class and the working class sells its labour to the
capitalists.
 With his concepts of ‘innovation’ and ‘entrepreneur’, Schumpeter provides
a penetrating analysis of the dynamics of capitalism. The entrepreneur in
Schumpeter’s theory plays an important role. It is the entrepreneur who
introduces innovations, causing shift in the production function.
 An entrepreneur is not necessarily motivated by profit but is rational in his
approach, which is important in carrying out new plans for breaking up old
traditions and creating new ones.
 Schumpeter’s theory predicts that capitalism is destined to destroy itself.
The reason is its success. The expansion of output under capitalism can
continue endlessly. But the system is eliminated as the economic success of
the development front undermines the social institutions that constitute a
capitalist society.

4.7 KEY WORDS

 Capitalist Class: Who owns resources and purchases labour services

from the working.
 Stationary State: A situation in which there is no population growth, no
investment and no profit.

4.8 SELF ASSESSMENT QUESTIONS AND

EXERCISES

Short Answer Questions

1. Which are the three factors of production in classical theory?
2. Which are the two main criticisms garnered by the classical theory?
3. What is the materialistic interpretation of history?
4. Write a short note on the concept of creative destruction as described by
Schumpeter.

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Theories of Growth - I Long Answer Questions
1. Summarize classical approach to growth in a less developed economy.
2. Explain the process of production as described by Karl Marx.
NOTES 3. Examine the concept of capital accumulation as described by Karl Marx.
4. Discuss the role of an entrepreneur in Schumpeter’s theory.

4.9 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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 Theories of Growth - II

UNIT 5 THEORIES OF GROWTH - II

Structure NOTES
5.0 Introduction
5.1 Objectives
5.2 Robinson’s Model of Growth
5.3 Kaldor’s Model of Growth
5.4 Harrod-Domar Model and Instability of Equilibrium
5.5 Answers to Check Your Progress Questions
5.6 Summary
5.7 Key Words
5.8 Self Assessment Questions and Exercises
5.9 Further Readings

5.0 INTRODUCTION

There have been many prominent economists who have contributed to developing
economic theories that have resulted in a sustained and constant economic growth.
The main purpose of these theories is to affect a growth in the economic productivity.
We have already seen the classical model, Marxian perspective and Schumpeter’s
theory in the previous unit. In this unit, we take the discussion forwards and, you
will learn about three models of economic growth: Robinson’s model, Kaldor’s
model and Harrod-Domar’s model.
The Joan Robinson assumes that there is a laissez-faire closed economy.
Capital and labour are the two factors of production. National income is distributed
between the two classes of an economy, namely workers and entrepreneurs. The
model of Nicholas Kaldor follows the Harrodian dynamic approach and the
Keynesian techniques of analysis. It attempts ‘to provide a framework for relating
the genesis of technical progress to capital accumulation’. Other neoclassical models,
on the other hand, treat the causation of technical progress as completely exogenous.
According to Kaldor, ‘The purpose of a theory of economic growth is to show the
nature of non-economic variables which ultimately determine the rate at which the
general level of production of economy is growing, and thereby contribute to an
understanding of the question of why some societies grow so much faster than
others.’
The Harrod-Domar Growth model, developed in the late 1930s, explains
how growth has occurred and how it may occur again in the future. It states that
the rate of growth of GDP is determined by the savings ratio (the marginal propensity
to save) in the economy and the capital output ratio (the amount that has to be
spent on capital to produce a given worth of national output. Thus, the rate of
growth in an economy can be increased in one of two ways, namely increasing the
level of savings in the economy or reducing capital-output ratio.
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Theories of Growth - II The neo-classical growth model is an extension to the Harrod–Domar model
(discussed in the previous unit) that included a new term: productivity growth.
However, this model has been criticized on the ground that increasing the savings
ratio, especially in developing countries, may not always be easy. This is due to
NOTES the fact that the majority of developing countries have low marginal propensities
to save. Whatever extra income such countries gain is usually spent on procuring
new assets. When the developing economies deviate even slightly from the natural
growth rate, the consequences would be either growing unemployment or prolonged
inflation. The reason for this is that such economies have no built-in equilibrating
force. Further, the Harrod-Domar model assumes fixed proportions in the
combination of capital and output, which does not always hold good. As a result,
an alternative model—the Neo-Classical Growth Model —has been developed
in which factor proportions are flexible and all rigidities are assumed away.
Neo-classical growth theory is an economic theory that summarizes the
method in which a steady economic growth rate can be achieved with suitable
proportions of the three dynamic forces: labour, capital and technology. The
hypothesis affirms that by altering the quantity of labour and capital in the production
function, a balanced condition can be achieved. When a new technology is
available, labour and capital should be synchronized to sustain the economic growth
equilibrium.
The neo-classical growth model, also referred to as the Solow’s model, is
an alternative workhorse of macroeconomics. This model gives clarity on the future
scenario of economic growth. It covers areas like:
 The reasons for high incomes
 The reasons for extreme variances in incomes in different nations
Thus, the neo-classical growth model is a macro model in which the long-
term rate of progress of output per employee is established by the rate of
technological progress that is external.
In the steady-state equilibrium, there can be consistent economic
development only if there is technical development. An economy will evolve as a
state of increased consistency if there is a rise in its degree of accumulation or a
reduction in its rate of population expansion.
The neo-classical growth theory broadly revolves around the equilibrium of
an aggressive economy through time. It emphasizes on capital accumulation,
population expansion and technological development. It differentiates between
transitory equilibrium (when the capital stock, the operational people and the
technological expertise are fixed) and long-term equilibrium (when any of these
elements are not specified). Long-term equilibrium is not a series of momentary
equilibria, since it exemplifies the logical anticipation of economic instruments. The
philosophy does not have much data about the exuberance that may ascertain an
economy’s prospective development rate, but it offers a sound foundation for
venturing into the learning of specific economies.
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 Theories of Growth - II
5.1 OBJECTIVES

After going through this unit, you will be able to:

 Discuss the Robinson model of growth NOTES
 Examine the Kaldor model of growth
 Evaluate the Harrod-Domar model and instability of equilibrium
 State the essentials of the theories of economic growth
 Explain the neo-classical growth theory
 Prepare a general overview of the neo-classical growth model
 Discuss Solow’s model

5.2 ROBINSON’S MODEL OF GROWTH

In her book entitled The Accumulation of Capital, published in 1956, Joan

Robinson expressed her views on the economic growth.
Assumptions of Robinson’s growth model
The following are the assumptions that Robinson’s model of growth is based on:
(i) A closed economy prevails.
(ii) There is no government interference.
(iii) There are two factors of production viz., labour and capital.
(iv) There are no savings by the labour class. It is the business class that saves
and invests.
(v) The labour capital ratio is given and there are constant returns to scale.
Working of Robinson’s Model of Economic Growth
Since the economy is divided into two sectors i.e., the labour and the business
class and
Q = F(L, K) ...(5.1)
so the income of the economy is also distributed between these two classes.
This can be mathematically expressed by the following equation:
pQ = wL + pK ...(5.2)
where Q is the total output of the economy, L is the amount of labour and K
is the amount of capital. This means that production is dependent on the amount of
labour and capital used. ‘p’ here denotes the average price. Accordingly, pQ is
the average price of output and pK is the average price of capital whereas W is
the wage rate and P is the gross profit.

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Theories of Growth - II Dividing both sides of the equation by p, in real terms:
Q = W/P L + K ...(5.3)
Therefore, the profit would be:
NOTES  = Q – W/P L / K ...(5.4)
= Q/N – W/P / K/L ...(5.5)
If Q/N is denoted by a and K/L as b then
 = Q/N – W/P / K/L = a-W/P/b ...(5.6)
The equation shows that the rate of profit depends on labour productivity
(denoted by a), wage rate (W/P) and capital labour ratio (denoted by b). This
means that the profit is directly related to the net rate of return to capital and is
inversely related to the coefficient of capital intensity.
The capital class will maximize its profit when:
d(a-W/P/P) = 0 ...(5.7)
and where d is subject to the production function.
On the expenditure side,
Y = C + , S = I ...(5.8)
Since consumption takes place only in the labour class and savings by the
business class, we arrive at the following equation:
C = Ct = W/P . L ...(5.9)
and S = Sk = WK ...(5.10)
where, CL is the consumption from the income of the labour class and SK
is the savings from the profits of the business class.
Thus, net investment would be an increase in real capital
i.e., I =  K ...(5.11)
Substituting the values of S and I
K =  K ...(5.12)
Dividing both the sides by Q:
K/K = K/K = 
Substituting the value of  in the equation:
K/K =  = (a – W/P / b) ...(5.13)
Where K/K is the rate of growth of capital and (a – W/P) is the net return
to capital and b is the capital labour ratio. This shows that the rate of growth of
capital tends to rise if the net return to capital increases at a proportion more than
capital labour ratio.

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 An important concept that Joan Robinson describes in her theory is the Theories of Growth - II

golden age in which both the resources labour and capital are fully utilized.
According to her, ‘when technical progress is neutral and proceeding steadily,
without any change in the time pattern of production, the competitive mechanism
working freely, population growing (if at all) at a steady rate and accumulation NOTES
going on fast enough to supply productive capacity for all available labour, the rate
of profit tends to be constant and the level of real wages rise with output per man.
Then there are no internal contradictions in the system. Total annual output and the
stock of capital (valued in terms of commodities) then grow together at a constant
proportionate rate compounded of the rate of increase of the labour force and the
rate of increase of output per man. We may describe these conditions as a golden
age (thus indicating that it presents a mythical state of affairs not likely to obtain in
any actual economy.)’
In addition to the situation of full employment called as golden age, there
can be other possibilities as well.
(a) Limping golden age: When the steady rate of accumulation of capital
is below full employment.
(b) Leaden golden age: When the rate of capital accumulation is low
and unemployment is rising.
(c) Restrained golden age: When the stock of capital is sufficient and
full employment exists but desired rate of growth cannot be realized.
(d) Galloping platinum age: When the business sector is expanding,
more employment is generated and the ratio of gross investment to
the output increases. The rate of profit is also increasing but the real
wage rate is falling.
(e) Creeping platinum age: When there is a deceleration in the rate of
growth of capital accumulation; profits are falling accompanied by
declining marginal efficiency of investment and rising real wage rate.
(f) Bastard golden age: When the rate of accumulation is being held in
check by the threat of rising money wages due to a rise in prices. The
age is characterized by unemployment, inflation and rising money
wages.
(g) Bastard platinum age: When there is an acceleration of capital
accumulation with constant real wages.

Check Your Progress

1. In which book did Joan Robinson express her views on the economic
growth?
2. Which is the important concept that Joan Robinson describes in her theory?

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Theories of Growth - II
5.3 KALDOR’S MODEL OF GROWTH

The ideas put forward by Nicholas Kaldor in fact do not present a theory of
NOTES growth but a model of distribution. According to him, ‘the purpose of a theory of
economic growth is to show the nature of the non-economic variables which
ultimately determine the rate at which the general level of production of an economy
is growing and thereby contribute to an understanding of the question of why
some societies grow so much faster than others’.
Assumptions of Kaldor’s model
Kaldor’s model of economic growth is based on the following assumptions:
(i) The available resources determine the level of output in the economy.
(ii) There is one single relationship between the growth of capital and growth
of productivity that influences both the factors of production.
(iii) The price of real stock of capital is constant.
(iv) The investment in the current period depends on output and profit in the
previous period.
(v) Role of monetary policy is only passive in the sense that the interest rate
influences the investment only in the long run.
(vi) The choice of technique is a matter of the relative prices of various types of
capital goods, which can alter accumulation of capital and the progress of
techniques in the capital goods making industries.
Working of Kaldor’s model
Kaldor presents his model under two hypotheses – one assuming a constant
working population and the other allowing for population growth.
(i) Constant Working Population: In this case, Kaldor mentions that the
proportionate rate of growth in total real income (Yt) will be same as the
proportionate rate of growth in output per head (Ot). To begin with the
model, he considers three functions – savings function, investment function,
and technical progress function. Yt, Kt, Pt, St stand for real income, capital,
profits, savings and investment respectively at a given time t.
Hence, St = It = Kt + 1 – Kt ...(5.14)
As for savings, Kaldor divides income into wages and profit. It is assumed
that the savings propensities for profit earners and wage earners are given. The
savings function is, therefore, expressed as:
St = Pt + (Yt – Pt)
Where, 1 >  >  > o ...(5.15)

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 The equation shows the savings comprising of a proportion a of aggregate Theories of Growth - II

profits (Pt) and a proportion b of wages (Yt – Pt).

Investment function is based on the assumption that the investment decisions
during any given time period is governed by the propensity to maintain the capital
NOTES
stock in a given relationship to turnover, modified by any change in the rate of
profit on capital. The stock of capital in the period t, denoted by Kt here is then
given by:
Kt = ’Yt-1 + (Pt-1 / Kt-1) Yt-1 ...(5.16)
This shows that the stock of capital at the time t (and which is assumed to be
equal to the desired stock of capital at the time t – 1) is a coefficient ’ of the
output of the period (Yt – 1) and a coefficient ’ of the rate of profit on capital of
the previous period, multiplied by the output of the previous period.
With the help of equation (16), one can express Kt +1 as follows:
Kt+1 = ’Yt + ’ (Pt / Kt) Yt ...(5.17)
Where again ’ > o, ’ > o
Kaldor assumes that investment in the period t (denoted by 1t) is equal to
the difference between desired and actual capital at t, as indicated by the following
equation:
It = Kt+1 – Kt
Substitution from (16) and (17) gives:
It = ’ (Yt – Yt-1) + ’ [(Pt / Kt) Yt – (Pt-1)/Kt-1) Yt-1]
Adding and subtracting ’ (Pt-1 / Kt-1) Yt to the right hand side, we arrive
at the following equation:
It = (Yt – Yt-1) (’ + ’ Pt-1 / Kt-1) + ’ (Pt / Kt – Pt-1 / Kt-1) Yt
...(5.18)
On readjustment, equation (18) shows that the investment in period t(It) is
equal to the increment in output over the previous period (Yt – Yt-1) multiplied by
the relationship between desired capital and output in the previous period
(Kt / Yt-1). Equation (16) then can be expressed as:
K) = {’ + ’ (P)-1 / K)-1)}Y)-1
That gives ’ + ’ (P)=1 / Kt-1) = Kt / Yt-1
plus a coefficient ’ of the change in the rate of profit over that period,
multiplied by the output of the current period. Therefore, equation (18) according
to Kaldor implies that, ‘expressed as a proportion of the existing stock of capital,
Kt, the investment of period t is equal to the expected rate of growth of turnover
(which in turn is assumed to be equal to the actual rate of growth in turnover for
the previous period) if the rate of profit on capital is constant; and it is greater (or
smaller) than this if the rate of profit on capital is rising (or falling).’

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Theories of Growth - II The technical progress function is expressed in the following way:
Yt+1 – Yt / Yt = ” + ” It/Kt ...(5.19)
Where ” > o, and I > ” > o.
NOTES Equation (19) shows the rate of growth of labour productivity (and income)
as an increasing function of the rate of net investment expressed as a proportion of
the stock of capital, i.e., of the (proportionate) rate of growth of capital stock.
Suppose t = 1, where the existing capital stock K1, is regarded as a datum.
Now we have:
K1 = {’ + ’ (Po / Ko)}Yo
or K1 / Yo = ’ + ’ Po / Ko
Equation (18) now gives
I1 = (Y1 = Yo) (’ + ’ Po / Ko) + ’ (P1 / K1 – Po / Ko) Y1
or I1/Y1 = Y1 – Yo/Y1 (’ + ’ Po/Ko) + ’ (P1/Ko – Po / Ko)
...(5.20)
= Y1 – Yo / Y1 . K1/Yo + ’ (P1/K1 – Po/Ko)
(Substituting from equation (7), we get:
I1/Y1 = Y1 – Yo/Yg . K1/Y1 + ’ (P1/K1 – Po/Ko) ...(5.21)
This equation shows that the rate of investment in period 1, as a proportion
of the income of the period, equals the rate of growth of income over the previous
period (i.e., Y1 – Yo / Yo) multiplied by the capital output ratio of the current
period (K1 / Y1), plus a term depending on the change of the rate of profit over
the previous period. Equation (21) can be written as:
It / Yt = {Y1 – Yo / Yo . K1/Yo – ’ Po/Ko} + ’ Y1/K1 . P1/Y1
...(5.21a)
While equation (15) can be written as
S1/Y1 =  P1/Y1 +  Y1 – P1 / Y1
=  + ( – ), P1/Y1 ...(5.21b)
These two equations, determine both the distribution of income between
profits and wages, and the proportions of income saved and invested at t = 1. This
can be shown with the help of the following diagram:
In the diagram, profits as a ratio of income (P/Y) are measured on the
horizontal axis while savings and investment as a ratio of income (S/Y and I/Y) are
measured on the vertical axis. Curve SS’ represents the savings equation (21b)
while the curve II’ represents the investment equation (21a). The slopes of these
two curves are given as ( – ) and ’. Y1 / K1 respectively.

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 Theories of Growth - II
S I
Y Y 45o
Saving and investment

Q NOTES
S

I
S
O P/y
Ratio of Income

Fig. 5.1Distribution of income and Proportions of Income Saved and Invested

The point of intersection of the two curves, Q, indicates the short period
equilibrium level of profits and of investment as a proportion of income. If profits
are a lower proportion of income, the investment plans (although lower than the
equilibrium level) will tend to exceed the available savings. In this situation, prices
will rise in relation to costs until the difference is eliminated through the significant
rise in prices. The stability of the equilibrium will require that the slope of SS’ curve
exceeds the slope of the II curve, as expressed by the following equation:
 –  >t .Yt / Kt
Kaldor assumes this restriction to hold. In addition, he assumes two other
restrictions in his model given as follows:
Pt  Yt – Wmin
and Pt / Yt  m
The first of these restrictions will mean that the profits determined by equations
(15) and (18) should not be higher than the surplus available after the labour force
is paid the subsistence wage bill. The second restriction means that the profits
resulting from equations (15) and (18) are greater than the minimum required to
secure a margin of profit over turnover below which entrepreneurs would not
reduce prices, irrespective of the state of demand.
Assuming that these conditions are satisfied, the technical progress equation
(19) indicates the growth of income and capital from t = 1 onwards, and the
gradual movement of the economy from a short period equilibrium of steady growth.
This is shown in the following diagram where the proportionate growth of capital
is measured on the horizontal axis and the proportionate growth of income on the
vertical axis.
At t = 1 where It / Kt = I1 / K1 to the left of I/K, the rate of growth in income
is shown by the points G1, G2, G3, etc. as g1, g2, g3, etc respectively. To begin with,
the initial position at t = 1(I1 /K1 being to the left of I/K) would mean that the
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Theories of Growth - II growth of output, g, in successive units of time will be greater than the growth of
capital, I1 / K1 and in accordance with equation (21), the rate of investment will
grow in the subsequent period so as to make I2 / K2 equal to g1, which in turn will
increase the growth in the second period to g2, and so on, until the point G is
NOTES reached at which the rates of growth of income and capital are equal.
Long-run equilibrium rate of growth of income and capital is independent of
the value of the coefficients of equations (15) and (21) (the savings and investment
functions), and depends only on the coefficients in equation (19), i.e., the technical
progress function. This is given by:
G = ” / 1- ” ...(5.22)
o
45

T
Proportionate Growth of Income

G
G3
G2
B
G1
A
T

O I1 I2 I3 I
K1 K2 K3 K
Proportionate Growth of Capital

Fig. 5.2 Proportionate Growth of Income and Capital

This is the equilibrium rate of growth in productivity since it makes the rate
of growth of capital and income equal, and is equal to both (under the assumption
of a constant population).
Putting ” / 1 – ” = Y” ...(5.23)
The equilibrium ratio of investment to income, the equilibrium share of profits
in income and the equilibrium rate of profit on capital can be derived with the help
of equations (15) and (21) as follows:
I / K = Y” K/Y ...(5.24)
From equation (21b)
S/Y =  P/Y +  (1 – P/Y) ...(5.25)
= ( – ). P/Y + 
Substituting from equation (24)
Y” K/Y = ( – ). P/Y + 
which gives
P/Y = Y” K/Y –  / –  ...(5.26)

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 Multiplying both sides by Y/K, we get: Theories of Growth - II

P/K = Y” –  Y/K /  –  ...(5.27)

Equation (24) along with equation (21b) is an alternative of Harrod’s
‘warranted rate of growth’ while equation (22) is an alternative of Harrod’s ‘natural NOTES
rate of growth’. Harrod’s, argues, ‘the system tends towards an equilibrium rate
of growth at which the “natural” and the “warranted” rates are equal, since any
divergence between the two will set up forces tending to eliminate the difference;
and these forces act partly through an adjustment of the “warranted rate”’.
(ii) Increase in population and Kaldor’s model: Assuming an increase in
population, Kaldor assumes that (i) for any given fertility rate in a society,
the rate of growth of population cannot exceed a certain maximum, however
fast the real income is rising; and (ii) the rate of population growth will rise
only moderately as a function of the rate of growth in income over some
interval of the latter before the maximum is reached. The dependence of
population growth on the growth of income can be shown with the help of
a diagram.
I dL
L dt
o
45
Rate of Growth of Population

Y
L E
Z

I dy
O y dt
Rate of Growth of Income

Fig. 5.3 Dependence of Population Growth on the Growth of Income

In the diagram, proportionate growth of income (I/Y. dy/dt) is shown on the

X axis and proportionate growth of population (I/L. dL/dt) is shown on the Y axis.
The dotted curve represents the population growth curve. When the rate of growth
of income exceeds a certain critical value, the population growth curve becomes
virtually horizontal.
In terms of a linear equation, the relationship can be expressed as follows:
It = gt (gt< )
It =  (gt> ) ...(5.28)
Where, It, is the percentage rate of growth of population and gt is the income
respectively, and  is the maximum rate of growth of population .

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Theories of Growth - II If the rate of growth of population is  (i.e., gt> ) then, It / Kt in equation
(19) will be replaced by It / Kt – .
And Yt+1 – Yt / Yt by (Yt+1 – Yt / Yt – )
NOTES Hence, the long run equilibrium rate of growth of both capital and income
will now be:
G = Y”t +  ...(5.29)
The long run equilibrium values of other ratios are obtained by substituting
(Y” + ) for Y” in the equations (24), (26) and (27).
Initially if gt<  (and therefore It< ), the rates of growth of income and
population will continuously rise till the latter approaches . In the long run, hence,
population should grow at the maximum rate. This is shown by the horizontal part
of the dotted curve.
Here it is assumed that the technical progress function – coefficients ” and
” in equations (19), and thus, ” – remain unchanged due to changes in population.
This would mean constant returns to scale. In other words, an increase in number,
given the amount of per capita capital availability, will leave production per head
unaffected. However, while this assumption may be true in the case of a young
and relatively under populated country, Kaldor argues that it will not hold true in
case of an overpopulated country where there will be a situation of diminishing
returns due to the scarcity of land. This means that, with given techniques and
capital per head, an increase in population will result into a fall in productivity.
Thus, the curve showing the technical change function will be lowered by an extent
depending on the rate of increase in population. Under these conditions, the technical
progress function curve will have a different shape as shown in the second diagram
(with the curve TT’ intersecting the X axis). This means that it will require a certain
percentage growth in capital per head (Ct) even to maintain output per head (Ot)
at a constant level.
The curve TT’ intersects the 450 line at two points: P and P’. P shows a
stable equilibrium while P’ shows an unstable equilibrium. If the economy is towards
the left of P’, the rate of growth of income and capital will steadily decline and the
growth of capital and income will come to a standstill. Naturally, no long run
equilibrium is attainable in this case. The only possibility is complete stagnation.
Therefore, whether a rising population will be consistent with an equilibrium
of growth or not, will depend on the relative magnitude of two factors : (i) the
maximum rate of population rise  and (ii) the rate of technical change that brings
a rise in productivity, ” in equation (19), when both population and capital per
head are constant. According to Kaldor, ‘Since diminishing returns cannot cause
the output of a larger working population to be smaller than that of a smaller
population, the growth of population will not result into lowering of the position of
the curve TT’ by greater than the rate of population growth itself, so that if ” > ,
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then the technical progress function should continue to intersect income axis Theories of Growth - II

positively, and the possibility of a stable equilibrium of growth will be certain.’

Check Your Progress

NOTES
3. What is the purpose of economic growth, according to Nicholas Kaldor?
4. Which assumption is the basis of the investment function?

5.4 HARROD-DOMAR MODEL AND INSTABILITY

OF EQUILIBRIUM

Though this model is known as Harrod-Domar model, yet it was independently

developed by R.F. Harrod and E.D. Domar. But because there are certain common
features in both the models, they are identified together.
According to this model, the rate of economic growth in an economy depends
on firstly the rate of savings and secondly the capital output ratio or the productivity
of investment. For instance, if an investment in capital worth ‘100 can produce
output of ‘10, then the capital output ratio would be 10:1. Hence, the model
suggests that every economy must save a part of the income to replace depreciated
capital. However, in order to grow new investment in capital, stock is imperative.
Assumptions
The following are the assumptions that underlie Harrod-Domar model:
(i) There is an equilibrium level of income and employment.
(ii) There is a closed economy and no foreign trade.
(iii) The average propensity to save is equal to marginal propensity to save and
the coefficient of capital is constant.
(iv) Laissez-faire economy prevails and there is no government interference.
(v) There are no lags in the adjustment in savings investment, expenditure and
income.
(vi) The rate of interest is constant.
(vii) Labour and capital are used in a given proportion.
Domar’s Model
According to Domar, ‘an economy will be said to be in equilibrium when its
productive capacity P equals its national income Y’. To understand this model, let
us first understand the supply side of the model.

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Theories of Growth - II Supply side of Domar’s model
Suppose the investment in the economy is to be made at rate of I per annum and
the productive capacity of the newly created capital is equal to S. According to
NOTES Domar, due to the investment which is equal to S, the productive capacity of the
economy will increase by Is per year. However, the economy has a potential
social average productivity of investment that will actually determine the productivity
of the investment. Suppose this is denoted by s. A high s will show that the economy
is capable of increasing its output relatively fast. Thus, the supply side is I which
shows the increase in output which the economy can produce.
Demand side of Domar’s model
Suppose the investment increases by I and the corresponding rise in income by
y. Then:
y = I i/
Where, i/ is the value of multiplier.
To determine equilibrium condition,
I / I/ = I 
Assuming that the economy can achieve fall employment equilibrium, this would
mean that the national income is equal to the productive capacity of the economy.
This will be maintained if income increases at a rate equal to the productive capacity.
Thus, the fundamental equation in the model is:
 I I/  = I
Multiplying both side of  and dividing it by I, the equation will become:
I / I = 
The left hand side of the equation is the relative increase in investment.
Hence, to maintain a level of full employment, investment should grow at a rate of
 . Since income is a constant multiple of investment, income should also grow
at the same rate  .
As Domar suggests, the maintenance of a continuous state of full employment
requires that investment and income grow at a constant annual relative (or compound
interest) rate, equal to the product by the propensity to save and the average
productivity of investment. The equation also indicates the conditions to be satisfied
for maintaining a level of full employment over a period of time.
Harrod’s Model
Before describing Harrod’s theory of economic growth, it is worthwhile to make
a few remarks concerning the ideas and goals which Harrod had in mind.
1. Harrod has discussed the following three different concepts of the rate of
economic growth.
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 (a) The actual rate of growth which gives the increase in output attained Theories of Growth - II

during any given time period;

(b) The natural rate of growth which is determined by the growth in the
economy’s labour force and technological improvements and which
NOTES
may be called the full employment rate of growth; and
(c) The warranted rate of growth which is that rate of growth which the
entrepreneurs counted on and which, if realized, will be repeated by
them.
2. Harrod attempts to show how the steady–equilibrium–growth may take
place in the system.
3. He also attempts to show that once this steady rate of growth is interrupted,
cumulative factors tend to perpetuate the divergence. As a consequence,
the economy will experience either a secular stagnation or a secular
exhilaration.
4. Harrod’s theory is based on the naive acceleration principle as an explanation
of the level of investment and the additional investment needed to produce
additional output (the capital-output ratio makes it so).
5. Included in Harrod’s warranted rate of growth is the equilibrium rate of
growth between (i) saving and investment, and (ii) total supply and total
demand. Both these equilibrium rates are crucial to his theory. When the
realised investment exceeds or is less than the planned investment, the
warranted rate of growth is interrupted.
6. Under the warranted rate of growth, the net investment equals the amount
necessary to produce the increased output of the period.
7. Under the warranted rate of growth, the production decisions are made
first and thereafter investment is undertaken to satisfy these production
decisions; in a sense, production is assumed to create its own demand.
There are three different concepts used in the Harrod model. The first concept
is the actual rate of growth which is indicated as G. This is determined by savings
ratio S and incremental capital output ratio C.
Another concept is that of the warranted rate of growth indicated by GW. It
is the required rate of growth for the full utilization of rising stock of capital.
The third concept used by Harrod is the natural rate of growth indicated as
Gm. This is the rate of growth by the current growth of labour and the current
potential for technical progress in the economy.
Explanation of the model
Ex-post savings and investment are equal to each other. i.e.,
GL = S
Where G is the actual rate of growth and is equal to y / y.
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Theories of Growth - II C is the ratio of investment to an increase in income and is equal to I/y.
S is the savings as proportion of income and is equal to S/Y.
Substituting these into the equation, we get the following:
NOTES y/y, I/y = S/Y
Or
I/Y = S/Y
Or
S=I
According to Harrod, investment would not take place in a natural course;
it has to be induced, so that this income should grow. Thus, for a steady growth:
Gw Cr = S
Where Gw is the warranted rate of growth and Cr is the required amount of
capital for maintaining the growth rate Gw and S is the savings rate.
Why is the Harrod Model called a ‘razor-edge’ model?
Due to instability of equilibrium, the Harrod model is termed by many economists
as a ‘razor-edge’ model. Harrod mentions that in the long run, it is likely that the
actual rate of growth may deviate from the warranted growth rate. If G is greater
than Gw, it would mean that ex-ante savings are lower than ex-ante investment.
This would mean that production will decline and inflationary situation will occur.
However, any departure from Gw to G would be unstable. If ex-ante
investment is more than ex-ante savings, then further expansion will take place.
This situation will be recessionary in nature and increase in output will be below
Gw. This will retard the economic growth.
According to Harrod, the system cannot advance more quickly than the
natural rate allows. If the proper warranted rate is above this, there will be a
chronic tendency to depression; the depressions drag down the warranted rate
below its proper level and so keep its average value over a term of years down to
the natural rate. But this reduction of the warranted rate is only achieved by having
chronic unemployment.
In short, in Harrod’s dynamic system there are two points of crucial
importance. Firstly, to avoid too much or too little fluctuation in production, income
must rise at an ever increasing rate. All the burden is placed on investment because,
according to Harrod, saving intentions are always realised. Secondly, in Harrod’s
model even a slight deviation from the warranted growth rate path tends to be
“self-sustaining and possibly self-aggravating.” In other words, Harrod’s warranted
rate of growth is a path which, if once lost, is difficult to regain. It is on account of
its precarious balance and volatile behaviour—when there is even a slight deviation
from the path of warranted rate of growth—that this model has been labelled as a
“razor-edge” model.

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 Theories of Growth - II

Check Your Progress

5. Who developed the Harrod-Domar model independently?
6. What is the basis of Harrod’s theory? NOTES

5.5 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. In her book entitled The Accumulation of Capital, published in 1956,

Joan Robinson expressed her views on the economic growth.
2. An important concept that Joan Robinson describes in her theory is the
golden age in which both the resources labour and capital are fully utilized.
3. According to Nicholas Kaldor, ‘the purpose of a theory of economic growth
is to show the nature of the non-economic variables which ultimately
determine the rate at which the general level of production of an economy is
growing and thereby contribute to an understanding of the question of why
some societies grow so much faster than others’.
4. Investment function is based on the assumption that the investment decisions
during any given time period is governed by the propensity to maintain the
capital stock in a given relationship to turnover, modified by any change in
the rate of profit on capital.
5. The Harrod-Domar model was independently developed by R.F. Harrod
and E.D. Domar.
6. Harrod’s theory is based on the naive acceleration principle as an explanation
of the level of investment and the additional investment needed to produce
additional output (the capital-output ratio makes it so).

5.6 SUMMARY

 In her book entitled The Accumulation of Capital, published in 1956,

Joan Robinson expressed her views on the economic growth.
 The assumptions that Robinson’s model of growth is based on are a closed
economy; no government interference; two factors of production: labour
and capital; no savings by the labour class and constant returns to scale.
 Robinson’s model shows that the rate of growth of capital tends to rise if
the net return to capital increases at a proportion more than capital labour
ratio.
 An important concept that Joan Robinson describes in her theory is the
golden age in which both the resources labour and capital are fully utilized.
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Theories of Growth - II  According to Kaldor, ‘the purpose of a theory of economic growth is to
show the nature of the non-economic variables which ultimately determine
the rate at which the general level of production of an economy is growing
and thereby contribute to an understanding of the question of why some
NOTES societies grow so much faster than others’.
 Kaldor presents his model under two hypotheses – one assuming a constant
working population and the other allowing for population growth.
 Kaldor’s model of economic growth is based on the following assumptions:
o The available resources determine the level of output in the economy.
o There is one single relationship between the growth of capital and growth
of productivity that influences both the factors of production.
o The price of real stock of capital is constant.
o The investment in the current period depends on output and profit in the
previous period.
o Role of monetary policy is only passive in the sense that the interest rate
influences the investment only in the long run.
o The choice of technique is a matter of the relative prices of various
types of capital goods, which can alter accumulation of capital and the
progress of techniques in the capital goods making industries.
 Assuming the population to remain constant, Kaldor’s model suggests that
the proportionate rate of growth in total real income (Yt) will be same as the
proportionate rate of growth in output per head.
 Harrod’s, argues, ‘the system tends towards an equilibrium rate of growth
at which the “natural” and the “warranted” rates are equal, since any
divergence between the two will set up forces tending to eliminate the
difference; and these forces act partly through an adjustment of the
“warranted rate”’.
 According to Kaldor, ‘Since diminishing returns cannot cause the output of
a larger working population to be smaller than that of a smaller population,
the growth of population will not result into lowering of the position of the
curve TT’ by greater than the rate of population growth itself, so that if a” >
l, then the technical progress function should continue to intersect income
axis positively, and the possibility of a stable equilibrium of growth will be
certain.’
 Harrod-Domar model was independently developed by R.F. Harrod and
E.D. Domar.
 According to Harrod-Domar model, the rate of economic growth in an
economy depends on firstly the rate of savings and secondly the capital
output ratio or the productivity of investment.
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  The following are the assumptions that underlie Harrod-Domar model: Theories of Growth - II

o There is an equilibrium level of income and employment.

o There is a closed economy and no foreign trade.
o The average propensity to save is equal to marginal propensity to save NOTES
and the coefficient of capital is constant.
o Laissez-faire economy prevails and there is no government interference.
o There are no lags in the adjustment in savings investment, expenditure
and income.
o The rate of interest is constant.
o Labour and capital are used in a given proportion.
 According to Domar, ‘an economy will be said to be in equilibrium when its
productive capacity P equals its national income Y’.
 Domar suggests that the maintenance of a continuous state of full employment
requires that investment and income grow at a constant annual relative rate,
equal to the product by the propensity to save and the average productivity
of investment.
 According to Harrod, investment would not take place in a natural course;
it has to be induced, so that this income should grow. Thus, for a steady
growth: Gw Cr = S, where Gw is the warranted rate of growth and Cr is
the required amount of capital for maintaining the growth rate Gw and S is
the savings rate.
 Harrod mentions that in the long run, it is likely that the actual rate of growth
may deviate from the warranted growth rate. If G is greater than Gw, it
would mean that ex-ante savings are lower than ex-ante investment. This
would mean that production will decline and inflationary situation will occur.

5.7 KEY WORDS

 Labour Force: The sum of those who are employed and those who are
actively looking for work.
 Capital Stock: The economy’s total accumulated stock of buildings, roads,
other infrastructure, machines, and inventories.
 Capital Intensity: The ratio of the capital stock to total potential output
— K/Y – which describes the extent to which capital, as opposed to labor,
is used to produce goods and services.
 Capital Output Ratio: The ratio of capital used to produce on output
over a period of time.
 Laissez-faire economy: An economy that relies chiefly on market forces
to allocate goods and resources and to determine prices.There is no
government intervention in it.
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Theories of Growth - II
5.8 SELF ASSESSMENT QUESTIONS AND
EXERCISES

NOTES Short Answer Questions

1. How does an increase in population affect economic growth according to
Kaldor’s model?
2. Comment on Harrod’s concept of unstable equilibrium.
3. What are the assumptions of Robinson’s model of growth?
Long Answer Questions
1. Explain the working of Robinson’s model of economic growth.
2. Describe Robinson’s concept of the golden age in brief.
3. Discuss the assumptions and working of Kaldor’s model of economic
growth.
4. Discuss Harrod- Domar’s model of economic growth in detail.

5.9 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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 Theories of Economic

UNIT 6 THEORIES OF ECONOMIC Development

DEVELOPMENT
NOTES
Structure
6.0 Introduction
6.1 Objectives
6.2 Rostow’s Stages of Economic Growth
6.3 Rosenstein-Rodan Theory
6.4 Hirschman Theory
6.5 Sen’s Capabilities Approach
6.6 Nurkse’s Theory
6.7 Answers to Check Your Progress Questions
6.8 Summary
6.9 Key Words
6.10 Self Assessment Questions and Exercises
6.11 Further Readings

6.0 INTRODUCTION

Theories of development are a collection of theories about how desirable change

in society is best achieved. Such theories draw on a variety of social science
disciplines and approaches. In this unit multiple theories are discussed.
Rostow’s stages of economic growth model is one of the major historical
models of economic development. It was published by American economist W.W.
Rostow in 1960. The model postulates that economic growth occurs in five basic
stages of varying length: (1) Traditional society, (2) Transitional society, (3) Take
off, (4) Drive to technological maturity, (5) High mass consumption.
According to Prof. Rostow, an economy in traditional societies stage has an
unlimited production function which barely attains the minimum level of potential
output. Trade is predominantly regional and local, largely done through barter, and
the monetary system at this stage is not well developed. Investments share never
exceeds 5% of total economic production and the social structure is generally
feudalistic in nature.
In the second stage of economic growth, the economic development
undergoes a process of change for building up of conditions for growth and take
off. Rostow said that these changes in the society and the economy had to be of
fundamental nature in the socio-political structure and production techniques. The
only change required were in economic and technical improving methods.
The third stage take off is a decisive breakthrough in the economic history
when the vicious circle of poverty is finally broken and growth becomes its normal
condition. The impediments to steady growth are overcome and a process of
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Theories of Economic cumulative economic development starts. Rostow defines take off as the interval
Development
when the old blocks and resistances are finally overcome. The forces making for
economic progress, expand and come to dominate the society.
After the take-off and before the attainment of maturity by an economy,
NOTES
there follows a long period of sustained by fluctuating progress as the growing
economy tries to extend modern technology over the whole field of economic
activity. The economy regularly invest 10% to 20% of its national income, and its
output continuously outstrip the increase in population.
In the fifth stage, the leading sectors of the economy shift towards the
production of durable consumer goods and services, it is characterized by migration
to suburban areas and extensive use of automobiles and household gadgets.
Rosenstein Roden builds up a case for giving a ‘big push’ to the economies
of underdeveloped countries in order to put them on a path of self-sustained growth.
According to him, planning for development is about jerking the entire social system
out of its low level equilibrium and setting of a cumulative process upwards. Smaller
efforts means waste. It is only a ‘big push’ that can release these economics from
the inertia of underdevelopment.
The balanced growth theory is an economic theory pioneered by the
economist Ragnar Nurkse (1907-1959). Nurkse was in favour of attaining balanced
growth in both the industrial and agricultural sectors of the economy. He recognized
that the expansion and inter-sectoral balance between agriculture and manufacturing
is necessary so that each of these sectors provide a market for the products of the
other and in term supply the necessary raw materials for the development and
growth of other sectors. And in the last part of this unit, you will learn about
Hirschman and Sen’s capability approach.

6.1 OBJECTIVES

After going through this unit, you will be able to:

 Define the Rostow's Stage Theory
 Explain Rosenstein Rodam's Big Push approach
 Describe Nurske and Hirschman economic development theory
 Explain Sen's capability approach

6.2 ROSTOW'S STAGES OF ECONOMIC GROWTH

Professor W.W. Rostow has sought an historical approach to the process of

economic development. As seen before, he distinguishes five stages of economic
growth, (1) the traditional society (2) the pre-conditions for take-off (3) the take-
off: (4) the drive maturity; (5) the age of high mass-consumption. Let us have a
detailed look at each of these stages.
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1. The Traditional Society Theories of Economic
Development
A traditional society has been defined ‘as one whose structure is developed within
limited production functions based on pre-Newtonian science and technology and
as pre-Newtonian attitudes towards the physical world’. This does not mean that NOTES
there was little economic cultivation, the scale and pattern of trade could be
expanded manufactures could be developed and agricultural productivity could
be raised along with increase in population and real income. But the undeniable
fact remains that for want of a regular and systematic use of modern science and
technology a ceiling existed on the level of attainable output per head. It did not
lack inventiveness and innovations but lacked the tools and the outlook toward
the physical world of the post-Newtonian era.
The social structure of such societies was hierarchical in which family and
clan connections played a dominant role. Political power was concentrated in the
regions, in the hands of the landed aristocracy supported by a large retinue of
soldiers and civil servants. More than 75 per cent of the working population was
engaged in agriculture. Naturally, agriculture happened to be the main source of
income of the state and the nobles, which was dissipated on the construction of
temples and other monuments, on expensive funerals and weddings and on the
prosecution of wars.
2. The Pre-conditions for Take-off
The second stage is a transitional era in which the pre-conditions for sustained
growth were created slowly in Britain and Western Europe, from the end of the
15th and the beginning of the 16th centuries, when the medieval age ended, and
the modern age began. The pre-conditions for take-off were encouraged or initiated
four forces: the New Learning or Renaissance. These forces led to reasoning and
skepticism in place of faith and authority brought an end to feudalism and led to
the rise of national states; inculcated the spirit of adventure which led to new
discoveries and inventions and consequently the rise of the bourgeoisie-the elite-in
the new mercantile cities. Thus, these forces were instrumental in bringing about
changes in social attitudes, expectations, structure and values. Generally speaking,
the pre-conditions arise not endogenously but from some external invasion. For
example, the pre-conditions ended in Europe (excluding Britain) with the domination
of Napoleon Bonaparte whose victorious armies set in structure of traditional
societies and paved the way for the unification of Germany and Italy.
In any case, the process of creating pre-conditions for take-off from
traditional society follows along these lines:
‘The idea spreads that economic progress is possible’ and is a necessary condition
for some other purpose, judged to be good: be it national dignity, private profit,
the general welfare, or both, willing to mobilize savings and other institutions for
mobilizing capital appear. Investments increase, notably may have an economic
interest. The scope of commerce, internal and external, widens, and here and
there, modern manufacturing enterprise appears, using the new methods.
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Theories of Economic The pre-conditions for sustained industrialization, according to Roots, have
Development
usually required radical changes in three non-industrial sectors:
 First, a build-up of social overhead capital, especially in transport. In order
to enlarge the extent of the market, to exploit natural resources productively
NOTES
and to allow the state to rule effectively.
 Second, a technological revolution in agriculture so that agricultural
productivity increases to meet the requirements of a rising general and urban
population.
 Third, an expansion imports, including capital imports, financed by the
continuous development and expansion of modern industry was mainly
possible by the ploughing back of profits into fruitful investment channels
As Rostow says: ‘The essence of the transition can be described legitimately
as a rise in the rate of investment to a level which regularly, substantially and
perceptibly outstrips population growth.’ The role of social and political factors in
creating the pre-conditions has already been explained in the beginning of this
stage. But the political forces deserve further explanations with reference to under
developed countries and colonial territories. It was reactive nationalism’s reaction
against the fear of foreign domination which acted as a potent force in bringing
about the transition.
In the colonies, the policy followed by the colonial power to build up social
overhead capital, ostensibly to meet its own requirements, helped in moving the
traditional society along the transitional path. The spread of modern education
brought about a gradual transformation in thought, knowledge and attitude of the
people, and a growing spirit of nationalism started resenting the colonial rule. Lastly,
under the influence of a powerful international demonstration effect, people wanted
the products of modern industry and modern technology itself.
3. The Take-off
The take-off is the ‘great watershed’ in the life of a society ‘when growth becomes
its normal condition.... Forces of modernization contend against the habits and
institutions. The value and interests of the traditional society make a decisive
breakthrough: and compound interest gets built into the society’s structure.’ By
the phrase ‘compound interest’ Rostow implies ‘that growth normally proceeds
by geometric progression such as a saving account if interest is left to compound
with principal.’At another place, Rostow defines the take-off, ‘as an industrial
revolution, tied directly to radical changes in the methods of production, having
their decisive consequence over a relatively short period of time.’
The take-off period is supposed to be lasting for about two decades. Rostow
gave the following tentative take-off dates for */those countries which are considered
to be airborne.

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 Country Take off Country Take off Theories of Economic
Development
Great Britain 1783-1802 Japan 1878-1900
France 1830-1860 Russia 1890-1914
Prelgium 1833-1860 Canada 1890-1914
USA 1843-1860 Agrentina 1935 NOTES
Germany 1850-1873 Turkey 1937
Sweden 1868-1890 India 1952
China
The conditions for take-off stage:
(i) A rise in the rate of productive investment from: say, 5 per cent or less to
over 10 percent of national income or net national product
(ii) The development of one or more substantial manufacturing sectors with a
high rate of growth
(iii) The existence of quick emergence of a political, social and institutional
framework which exploits the impulses to expansion in the modern sector
and gives to growth an outgoing character.
Let us examine these conditions in detail.
(i) Rate of net Investment over 10 per cent of national Income: One of
the essential conditions for take-off is that the increase in per capita output
should outstrip the growth of population to maintain a higher level of per
capita income in the economy. As Rostow explains: If we take the marginal
capital output ratio for economy in its early stages of economic development
at 3.5:1 and if we assume, as is not abnormal, a population rise 1-1.5 per
cent annum it is clear that something between 3.5 and 5.25 per cent of
NNP must be regularly invested if NNP per capita is to be sustained. An
increase of 2 per cent per annum in NNP per capita requires, under these
assumptions that something between 10.5 and 12.5 per cent of NNP be
regularly invested Ny definition and assumption, then, a transition from
relatively stagnant to substantial regular rise in NNP per capita under typical
population conditions, requires that the proportion of national product
productively invested should move from somewhere in the vicinity of 5 per
cent to something in the vicinity of 10 per cent.
The typical case explained by Rostow is based on the supposition that the
incremental capital output ratio and the rate of population growth remain
constant. It thus precludes effects of increased labour force and improved
technology on national income. However, during the take-off, capital output
ratio tends to decline with the change in investment pattern and a rise in the
proportion of net investment to national income takes place from 5-10 per
cent, thus definitely outstripping the growth of population.
(ii) Development of Leading Sectors: Another condition for take-off is the
development of one or more leading sectors in the economy. Rostow regards
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Theories of Economic the development of leading sectors as the analytical bone structure of the
Development
stages of economic growth. There are generally three sectors of an economy:
(a) Primary Growth Sectors, where possibilities of innovation or of
exploiting new or unexplored resources lead to a higher growth rate
NOTES
than in the rest of the economy.
(b) Supplementary growth sectors, like the cotton textiles of Britain and
New England in the early stages of growth takes place as a consequence
of development in the primary growth sectors. For example, the
development of railways is a primary growth sector and the expansion
of iron, coal and steel industries may be regarded as a supplementary
growth sector.
(c) Derived Growth Sectors, where growth takes place ‘in some fairly
steady relation to the growth of total income, population, industrial
production of some overall modestly increasing variable.’ For example,
the production of food and the construction of houses in relation to
population.
Historically, these sectors have ranged from textiles in Britain and New
England to railways in the United States, the USSR, Germany and France:
to modern timber cutting in Sweden. In addition, modern agriculture also
forms part of the leading sectors, For example, the rapid growth of Denmark
and New Zealand has been due to the scientific production of bacon, eggs,
and butter, and mutton and butter respectively. Thus, ‘there is clearly, no
one sectoral sequence to take-off, no single sector which constitutes the
magic key.’
According to Rostow, the rapid growth of the leading sectors depends
upon the presence of four basic factors:
(a) First, there must be an increase in the effective demand of their products
generally brought about by dishoarding, reducing consumption,
importing capital or by a sharp increase in real incomes.
(b) Second, a new production function along with an expansion of capacity
must be introduced into these sectors.
(c) Third, there must be sufficient initial capital and investment profits for
the take-off in these leading sectors.
(d) Lastly, these leading sectors must introduce expansion of output in
other sectors through technical transformations.
(iii) Cultural Framework that Exploits Expansion: The last requirement for
take-off is the existence of emergence of cultural framework that exploits
the impulses to expansion in the modern sector. A necessary condition for
this is the ability of the economy to mobilize larger savings out of an expanding
income to raise effective demand for the manufactured products, and to
create external economies through the expansion of leading sectors. As
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Rostow says, take-off requires the massive set of pre-conditions going to Theories of Economic
Development
the heart of a society’s economic organization, its polities and its effective
scale of values– It usually witnesses a definitive social, political and cultural
victory of those who would modernize the economy over those who would
either cling to the traditional society or seek other goals–By and large, it NOTES
persuades the society to persist and to concentrate its efforts on extending
the tricks of modern technology beyond the sectors modernized during the
take off. The take off stage is explained in Fig. 6.1 The horizontal axis
represents NNP and the vertical axis the amount of saving, net investment
and capital, S is; the saving schedule. KOYO and K1Y1 are the curves of
capital output ration drawn as downward sloping to simplify the curves of
capital output ratio drawn as downward sloping to simplify the figure. They
are drawn parallel to each other to indicate a constant capital-output ratio,
OK 0 OK1 TY0
  is the marginal capital output ratio.
OY0 OY1 Y0Y1

K1
Saving net investment capital

K0 S
T2
I2

I1
T1
I0 T

O Y0 Y1 Y2 NNP

To start with the society has a very flat saving curve and a very steep capital
output ratio curve in the pretake-off stage. It implies that people save little
out of their income and the capital output ratio is very high. In the time
period 0 as OI1 net investment is made it tends to increase the capital stock
which becomes productive in time period 1 and raise NNP to OY. Then in
the take of stage when OI1 (= T1Y1) investment takes place, some major
stimulus leads to growth of the productive capital more quickly leading to a
fall in the capital output ratio to T1Y1/Y1Y2. As a result, the investment
pattern changes and the capital output ratio curve becomes flatter. It is
T1Y2 NNP increases to OY2 which further raises net investment to OI2
(T2Y2). The economy has taken off and if this pattern of growth is continued
it will become self-sustained.
Thus, the take off is initiated by a sharp stimulus, such as the development
of a leading sector of a political revolution which brings and outgoing change
Self-Instructional
Material 73
Theories of Economic in the production processes, a rise in proportion of net investment to over
Development
10 per cent of national income outstripping the
4. The Drive to Maturity
NOTES Rostow defines it ‘as the period when a society has effectively applied the range
of (then) modern technology to the bulk of its resources.’ It is a period of long
sustained economic growth extending well over four decades. New production
techniques take the place of the old ones. New leading sectors are created. Rate
of net investment is will high over 10 per cent of national income. And the economy
is able to withstand unexpected shocks.
Rostow gives the symbolic dates for technological maturity of the following
countries:
Grate Britain 1850 Japan 1940
USA 1900 Russia 1950
Germany 1910 Canada 1950
France 1910
Sweden 1930
When a country is in the stage of technological maturity, three significant changes
take place:
 First, the character of working force changes. It primarily becomes skilled.
People prefer to live in urban areas rather than in rural. Real wages start
rising and the workers organize themselves in order to have greater economic
and social security.
 Second, the character of entrepreneurship changes. Rugged and
hardworking masters give way to polished and polite efficient managers.
 Third, the society feels bored of the miracles of industrialization and wants
something new leading to a further change.
Importance and Limitations of take-off for Underdeveloped Countries
The concept of take-off is ideally suited for the industrialization of underdeveloped
countries. As Dasgupta has written, ‘The term lacks precision and yet it is suggestive
and can be given interpretation which is useful for an understanding of the process
of economic development of an underdeveloped country.’ It is indeed the vagueness
of the term that gives it strength for one can put an interpretation upon it to suit the
conditions of the economy in which one is interested.
Of the three necessary conditions for take-off, the first two, namely, capital
formation over 10 per cent of national income and the development of one or
more leading sectors are helpful in the process of industrialization of underdeveloped
countries. So far as the first condition is concerned, there can be little doubt about
achieving that percentage. But the second condition can be molded to suit a country’s
environments. For instance. The leading sectors can be in agriculture or production
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of primary products for exports. The last condition is more important in the context
74 Material
of underdeveloped countries where monetary and political institutions, and skills Theories of Economic
Development
and technology are at a low level whereby the retired the expansion of the modern
sector.
Limitations NOTES
From the standpoint of underdeveloped countries the take-off has the following
limitations.
 Capital-Output Ratio not Constant: In calculating the aggregate capital
requirements of underdeveloped countries, Rostow takes a constant capital-
output ratio. This implies constant returns to scale. This assumption is valid
in the case of advanced economies, but underdeveloped economies are
characterized by the predominance of agriculture and primary production.
Given unchanged techniques and increasing population, their natural
resources result in conditions of diminishing returns to scale for the expansion
of the economy as a whole.
 Silent over the Removal of Unemployment: Dasgupta regards the
elimination of an accumulated backlog of unemployment as ‘the minimum
that the take-off must accomplish in an underdeveloped economy. According
to him, ‘once full employment is secured the economy is raised to a level
where growth is self-sustained and spontaneous.’ Taking India’s case, he
says, ‘Judged by the employment criterion, despite all the investment that
has taken place over the period, our economy seems to be receding.’
Therefore, it is imperative for an over-populated country to have the
elimination of unemployment as one of the conditions for take-off.
 Element of Ambiguity: Besides, there is an element of ambiguity in this
concept of take-off when applied to an underdeveloped country. During
the take-off investment increases with a rise in the national income without
reducing the average propensity to consume. Technically speaking, there is
an ‘excess of the marginal rate of saving over the average rate of saving, so
that the average rate keeps on rising.... (and) the final level is characterized
by a constant, thought high average rate of savings.’ To Dasgupta, ‘This
does not seem to be a sensible interpretation. For even in a highly developed
economy the average rate of saving may not remain constant.’
 Economic Development not Spontaneous: The concept of take-off
suggests an element of spontaneity which is of little significance in the context
of an underdeveloped economy. But ‘a take-off is not an instantaneous
process. It is an exercise that requires time and from which, after a certain
speed has been attained and a portion of the runaway used up, there is no
turning back of even safe throttling down.’
 Aeronautical Concept not Correct: Professor Bicanic, however, does
not agree with the symbolical presentation of the take-off because it appears
to him like a light flying animal just got cut off from the earth and floating in
Self-Instructional
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Theories of Economic the air. It is like creeping over a very difficult threshold of economic
Development
development. One has to creep over it, one can’t fly over it. It is not a take-
off but a very painful process which every underdeveloped country has to
go through.
NOTES
The Take-off and India
According to Rostow, one of the important conditions for take-off is the raising of
saving and investing ration from 5 per cent or less to over 10 per cent of national
income and maintaining it for two or more decades. It is a critical transitional stage
of self-sustained growth. In India at 1960-61 prices, the ratio of investment of
national income increased from 5.5 per cent in 1950-51 to 10.4 per cent in 1964-
65 and the ratio to of domestic savings to national income from 5.5 per cent of
10.5 per cent.
Thus, India which entered the take-off stage in 1950-51 (1952 according
to Rostow), can be definitely said to have taken-off in the year 1964-65 when
both the saving and investment ratios were above 10 per cent. The second condition
for take-off is the development of one or more leading sectors in the economy. By
1964-65 the agricultural, industrial, and tertiary sectors had developed considerably
To illustrate, the index of agricultural production (with June 1950 as the base) rose
from 45.6 in 1950-51 to 158.4 in 1964-65 and the index of industrial production,
(with 1956 as the base) from 73.5 to 186.9 India also seems to fulfill this condition
of take-off.
India also fulfils the third condition for take-off. Planned development has
generated the cultural framework that leads to the expansion of the modern sector.
The skills and attitudes of the people are undergoing changes, modern technology
is permeating the traditional society and the administrative efficiency and honesty
have been showing signs of improvement.
But there is no hard-and-fast rule for the presence of all the three conditions
for take-off. Nor should one jump to the conclusion that India had definitely taken-
off during the Third Plan on the basis of the existence of the three Rostowian
conditions. It appears that India has tried a premature take-off. Professor Myint
warns that a premature attempt at take-off ‘can result not only in wastages of
scarce resources wrongly or inefficiently invested but also in a sense of
disappointment and frustration which may have far-reaching psychological and
political consequences.’ This has actually happened in the case of the Indian
economy. Between 1950-51, India’s net national income (at 1960-61) increased
at a compound rate of 3.8 per cent per annum from Rs 9850 crores to Rs 16,630
crores but per capita income in real terms increased at an annual average rate of
1.8 per cent, the rate of population growth being 2.5 per cent her year. Coupled
with their trends is the existence of inflationary pressures in the economy which
trends is the existence of inflationary pressures in the economy which cast serious
doubts about India having attained the take-off stage. In the last year (1965-66)
of the Third Plan, national income declined by 5.6 per cent, per capita real income
Self-Instructional
76 Material
in 1965-66 was almost the same as in 1960-61, recession in the economy during Theories of Economic
Development
1966-68 made matters still worse. As revealed by the Estimates Committee of
the Lok Sabha in its ninth hand report there was nearly 80 to 90 per cent of
unutilized capacity in some industries in 1965-66 and even in the case of priority
industries, idle capacity was 40 per cent. Further the rate of domestic savings NOTES
declined from a 10.5 per cent. In 1965-66 (at 1960-61 prices) to 8.2 per cent in
1966-67 and to 8 per cent in 1967-68 in real terms, it would be even below the
pre-Plan period.
The Third Plan was conceived as ‘the first stage of a decade or more of
intensive development leading to a self-reliant and self-generating of intensive
development leading to a self-reliant and self- generating economy.’ It aimed at
raising net investment from 11 per cent in 1960-61 to 14-15 per cent of national
income and that of domestic savings from 8 per cent in 1960-61 to 11.5 per cent
of national in by the end of the Third Plan. But the Third Plan failed to bring about
the required rates of growth in savings and investment. Savings rose from 8 to
10.5 per cent and investment from 11 to 13 per cent. Three consecutive crop
failures plunged the economy into a morass. An era of Annual Plans ensued. The
Draft Forth Plan was scrapped and postponed. However, it can be concluded in
terms of Rostow’s main conditions of a rise in the proportion of net investment of
over 10 per cent, that the Indian economy had taken-off during the Third Plan.
5. The Age of Mass Consumption
According to one critic, ‘the period of mass-consumption is nothing else but
communism minus its ideological overtone.’
Rostow has explained the stage of mass consumption in the technical sense.
According to him, ‘The balance of attention of the society, as it approached and
went beyond maturity, shifted from supply to demand, from the problems of
production to the problems of consumption and of the welfare in the widest sense,’
Rostow believed that resources employed in the following three directions could
promote and enhance social welfare.
 First, larger resources be allocated to military and foreign policies for achieving
international and external power and influence
 Secondly, the resources of mature economy are directed to promote welfare
of the society
 Thirdly, the state should direct its resources to the expansion of consumption
levels beyond the basic necessities of the life like food, shelter and clothing.

Check Your Progress

1. State the political factor which led to transition in Rostow’s opinion.
2. Name the period of economic development in which ‘a society has effectively
applied the range of (then) modern technology to the bulk of its resources.’
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Theories of Economic
Development 6.3 ROSENSTEIN-RODAN THEORY

The theory of the ‘big push’ is associated with the name of Professor Paul N.
NOTES Rosenstein-Rodan. The thesis is that a ‘big push’ or a large comprehensive
programmed is needed in the form of a high minimum amount of investment to
overcome the obstacles to development in an underdeveloped economy and to
launch it on the path to progress. To stress big argument, he quotes an analogy
from an MIT Study. ‘There is a minimum level of resources that must be devoted
to .... a development program if it is to have any chance of success Launching a
country into self-sustaining growth is a little like an airplane off the ground. There
is a critical ground speed which must be passed before the craft can become
airborne. The theory 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 this. It necessitates the obtaining of external economies
that arise for the simultaneous establishment of technically interdependent industries.
Rosenstein-Rodan distinguishes between three different kinds of indivisibilities
and external economies. One, indivisibilities in the production function, especially
the indivisibility of the supply of social overhead capital; two, indivisibility of demand;
and three, indivisibility in the supply of saving. Let us analyse the role of the three
indivisibilities in bringing economic development.
Rosenstein Rodan Theory: The Big Push Theory
Indivisibilities in the Production Function
The production function in underdeveloped countries may several indivisibilities
but the indivisibility of the social overhead capital is the most important. Because
of its indivisibility this sort of investment can be a great source of external economies
and increasing returns. The creation of social overhead like power, transport,
communications, housing etc., requires huge initial investment but its most important
advantage is the creation of investment opportunities in other industries. According
to Rosenstein-Rodan, investment in social and economic overheads is irreversible
in time and hence it must precede other types of investment. Since its services
cannot be imported so it must be created within the economy. It has a long gestation
period and an irreducible minimum size and, therefore, this sort of investment
tends to be lumpy. The indivisibility of social overhead capital is great obstacle in
the development of underdeveloped countries. A high initial investment in
infrastructure or a ‘big push’ is a precondition for creating proper climate for
productive investments in the economy.
Indivisibility of Demand
Another important argument in favour of big push theory is the indivisibility of
demand or the complementarity of demand. The indivisibility of demand requires
simultaneous setting up of inter-dependent industries. Individual investment
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78 Material
decisions have a high element of risk because of the uncertainty of finding the Theories of Economic
Development
market for their products. This risk is considerably reduced if decision for the
simultaneous development of interdependent industries is taken. In other words,
investment decisions are inter-dependent or indivisible unless there is assurance
that complimentary investments will be forthcoming, individual investment decisions NOTES
will be highly risky and they may not be undertaken. Thus, a large scale investment
programme is necessary to ensure complimentary investment and to make possible
individual investments.
Indivisibility in the Supply of Savings
The indivisibility in the supply of savings is also put forward as an argument in
favour of ‘big push’ in underdeveloped countries. This indivisibility arises because
of the fact that it is only after a certain level of income has been achieved that there
can be a significant increase in savings. Thus, a high level of income is a pre-
condition for high level of savings and investment. For this it is necessary that
when income increases as a result of investment marginal rate of savings must be
kept higher than average rate of saving. Prof. Rosenstein Rodan states this problem
as a high minimum quantum of investment requires a high volume of savings which
is difficult to achieve in low income underdeveloped countries. The way out of this
vicious circle is to have first an increase in income and to provide mechanisms
which assure that at the second stage the marginal rate of savings be very much
higher than the average rate of savings. This argument is also sometimes used to
justify large minimum foreign aid for poor countries.

MR
C a

P4 R
Price

P1 b ATC
S
T D4
E
E1

MR4
D1
MR1

O Q1 Q4 Quantity

Fig. 6.2

The curves ATC and MC represent the costs of a plant which is a little
smaller than the optimum-size plant. D1 and MR1 are the demand and marginal
revenue curves of the shoe factory when investment is made only in it. It produces
OQ1 (10,000) shoes and sells at OP1, price which does not cover the ATC. So
Self-Instructional
Material 79
Theories of Economic the factory is incurring CabP, losses. But when simultaneous investment is made in
Development
a number of different industries, the market for shoes expands. The demand for
shoes rises to D4 (four times) so that the quantity of shoes expands. The demand
for shoes rises to D4 (four times) so that the quantity of shoes become OQ4
NOTES (40000). Now the shoe factory earns profits equal to P4RST. Similarly, other
industries earn profits.
A Critical Appraisal
Professor Rosensten Rodan regards his theory of development superior to the
traditional static equilibrium theory because it appears to contradict the tatter’s
motto that nature does make jumps. His theory is based on more realistic
assumptions of indivisibilities and ‘non-appropriabilities’ in the production functions.
It examines the path towards equilibrium and not merely the conditions at a point
of equilibrium. It is, thus, primarily a theory of investment concerned with imperfect
markets in underdeveloped countries. It. is a high minimum quantum of investment
rather than price mechanism in such imperfect markets that takes an underdeveloped
economy towards an optimum position. The ‘big push’ theory is, however, not
free from certain defects.
1. Negligible economies from investment in export and import
substitutes: The main justification for a ‘big push’ in investment on social
overhead capital is the realization of extensive external economies. But as
pointed out by Viner, underdeveloped economies realize greater economies
from world trade independently of home investment. Rodan has recognized
this fact but keeps silent over another reality that in the newly developing
countries investment for export and for marginal import substitutes occupies
a large chunk of total investment. The external economies argument for a
‘big push’ losses its justification because external economies are negligible
in the above types of investments.
2. Negligible economies even from cost-reducing investments: Even in
the production of local consumer goods and most public utilities, potential
external economies can be realized in a limited way. Investments in the case
of fairly inelastic demand are cost-reducing rather than output-expanding.
Since external economies accrue from the output-expansion in the initial
industry, they are negligible in the case of cost-reducing investment.
3. Neglects investment in the agricultural sector: One of the principal
defects of the ‘big push’ theory is that it emphasizes the importance of a high
level of investment in all types of industries capital foods, consumer goods
and social overhead capital except the agricultural and other primary industries.
In agriculture-oriented underdeveloped countries, a ‘big push’ of large
investments in irrigation, transportation facilities, land reform and in improving
agricultural practices through better tools, implements, fertilizers, etc., are as
important as investment in other industries. The neglect of the agricultural
sector in such economies will retard rather than accelerate their development.
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 4. Generates inflationary pressures: Even the launching of a high minimum Theories of Economic
Development
amount of investment on social overheads in highly expensive. Moreover,
overhead capital-output ratio and a very long gestation period. This makes
the task of developing LDCs more difficult and longer. This is because such
countries do not possess enough financial resources to provide social NOTES
overhead capital required for the ‘big push’. The period during which social
overhead capital is being formed will also be one of inflationary pressures
because of the shortage of consumer goods. These inflationary pressures,
in turn, would prolong the process of building social overhead capital, thus
making it highly difficult for an LDC to achieve rapid economic development.
5. Low investment leads to large increase in output: Professor John Adler’s
statistical analysis of the economic development of the world reveals that ‘a
relatively low level of investment pays off well in the form of additional
output.’ This conclusion is based on his study of low capital-output ratios in
India, Pakistan and in many other Asian and Latin American countries. Thus,
there appears to be little conclusive proof that a ‘big push’ of investment is
a prerequisite of the economic development of underdeveloped countries.
6. Administrative and institutional difficulties: Further, the ‘big push’ theory
is based upon a burst of state-engineered investment. Rosenstein himself
points out that in the presence of imperfectly developed markets in
underdeveloped countries, state investment itself poses a number of
problems. The administrative and institutional machinery in such economies
is weak and inefficient. Difficulties are bound to arise not only in drawing up
the pans for various projects but also in their execution. Lack of statistical
information, technical know-how, trained personnel and coordination
between the various department are some of the complex problems which
are not easy of solution. Moreover, the majority of underdeveloped countries
have a mixed economy, where the private and public sectors are mostly
competitive rather than complementary. This leads to mutual rivalry and
suspicion which are inimical to a balanced growth of the economy.
7. Not an historical fact: Last but not the least, Professor Rodan’s thesis is
a sort of prescription for launching underdeveloped countries on the part of
progress rapidly in the present. It is not an historical explanation of how
development takes place. Historically, the presence of absence of a ‘big
push’ has not been a distinguishing feature of growth anywhere, according
to Professor Hagen.

6.4 HIRSCHMAN THEORY

In this section, we will first look at the concept of unbalanced growth as presented
by Hirschman and then compare it to the theory of balanced growth.

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Theories of Economic The concept of unbalanced gorwth
Development
Introduction
The theory of unbalanced growth is the opposite of the doctrine of balanced growth.
NOTES According to this concept, investment should be made in selected sectors rather
than simultaneously in all sectors of the economy. No underdeveloped country
possesses capital and other resources in such quantities as to invest simultaneously
in all sectors. Therefore, investment should be made in a few selected sectors of
industries for their rapid development, and the economies accruing from them can
be utilized for the development of other sectors. Thus, the economy gradually
moves from the path of unbalanced growth to that of balanced growth. Economists
Pike Singer, Kindleberger, Straiten, etc. have expressed their views in favor of the
unbalanced growth doctrine which are in fact the criticisms of the theory of balanced
growth. It is, however, Hirschman who has propounded the doctrine of unbalanced
growth in a systematic manner.
Hirschman’s Strategy
The concept of unbalanced growth has been popularized by Hirschman. It is his
contention that deliberate unbalancing the economy, according to a predesigned
strategy, is the best way to achieve economic growth in an underdeveloped country.
According to Hirschman, investments in strategically selected industries or sectors
of the economy will lead to new investment opportunities and so pave the way to
further economic development. He maintains that ‘development has of course
proceeded in this way, with growth being communicated from the leading sectors
of the economy to the follower, from one industry to another, from one firm to
another.’ He regards development as a ‘chain of disequilibria’ that must keep alive
rather than eliminate the disequilibria, of which profits and losses are symptoms in
a completive economy. If the economy is to be kept moving ahead, the task of
development policy is to maintain tension, disproportions and disequilibria,’ this
seesaw advance is induced by one disequilibrium that in turn leads to a new
disequilibrium and so on ad infinitum. According to Hirschman, when new projects
are started they appropriate external economies created by previous projects and
create new external economies that can be exploited by subsequent ones. There
are some projects that appropriate more external economies that they create which
he calls convergent series of investments. Hirschman also calls them induced
investments for they are net beneficiaries of external economies. There are other
projects too that they appropriate which he characterizes as divergent series of
investments.
From the point of view of the economy, the latter may have a greater social
desirability than private profitability, whereas induced investments may be less
desirable from the social viewpoint. In practice, development policy should aim at
(i) the prevention of convergent series of investments which appropriate more
external economies than they create; and (ii) the promotion of divergent series in
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which more economies are created than are appropriated. Development can only Theories of Economic
Development
take place by unbalancing the economy. This is possible by investing either in
social overhead capital (SOC) or in directly productive activities (DPA). The former
creates external economies while the latter appropriates external economies.
NOTES
Unbalancing the Economy with SOC
Social Overhead Capital has been defined as ‘comprising those basic services
without which primary, secondary, and tertiary productive activities cannot function.’
SOC includes investments on education, public health, communications,
transportation and conventional public utilities like light, water, power, irrigation
and drainage schemes, etc.
A large investment in SOC will encourage private investment later in Directly
Productive Activities (DPA). For example, cheaper supply of electric power may
encourage the establishment of small industries. SOC investments indirectly
subsidies agriculture, industry or commerce by cheapening various inputs which
they use by reducing their costs. Unless SOC investments provide cheap or
improved services, private investments in DPA will not be encouraged. Thus the
SOC approach to economic developments in DPA will not be encouraged. The
SOC approach to economic development is to ‘unbalance’ the economy so that
subsequently investments in DPA are stimulated. As Hirschman puts it, ‘Investment
in SOC is advocated not because of its direct effect on final output, but because it
permits and in fact invites DPA to come in–Some SOC investment is required as
a prerequisite of DPA investment.’
Unbalancing the Economy with DPA
An imbalance can also be created via DPA. A government might directly or
indirectly invest in DPA instead of investing in SOC. If DPA investment is undertaken
first, the shortage of SOC facilities is likely to raise production costs substantially.
Political pressures might stimulate investment in SOC also. Investment sequences
are generated by profit expectations and political pressures. Profit expectations
generate the sequence from SOC to DPA and political pressures from DPA to
SOC.
The path to Development, Hirschman calls the first sequence (from SOC to
DPA) ‘development via excess capacity of SOC’ and the second sequence (from
DPA to SOC) ‘development via shortage of SOC.’As to which sequence should
be followed first for economic development, Hirschman prefers that sequence
which is ‘vigorously self-propelling.’

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Theories of Economic This can be explained with the help of Hirschman’s slightly modified diagram.
Development
c
b

a
NOTES
450
C
DPA Cost
B = SOC Cost
DPA Cost

C
B c
B
b
A A

O
SOC Cost

Fig. 6.3

DPA investments are measured along the vertical axis. The curves a b c are
isoquants’ showing various quantities of DPA and SOC which will give the same
gross national product at any point. As we move to a higher curve, it represents a
higher gross national product. The curves are go drawn that the 45° line through
the origin connect the optimal points on the different curves. This line shows the
balanced growth of DPA to SOC.
Hirschman makes two assumptions: firstly, that SOC and DPA cannot be
expanded simultaneously and secondly, that sequence of expansion should be
adopted which maximizes ‘induced’ decision-making.
If the path to development is followed via excess capacity of SOC the
economy will follow the dotted line AA’BB”C. When the economy increases SOC
from A to A’ the induced DPA increase to B’ until balance is restored at B where
the whole economy is on a higher level of output. The higher gross notational
product thus achieved induces government to increase SOC further to B”. DPA
also follows suit to point C Via C,’
If the other path to development via shortage of SOC is followed, the
economy moves along the thick line AB,BC’C. When DPA is increased to B’,.
SOC has to move to A’ and then to B. And when DPA is increased further to C,’
balance requires SOC to increase to C Via B”.
It is to be noted that development path via excess SOC capacity is more
continuous and smooth than the second path. It is in a way what Hirschman calls
‘self-propelling’. The other path via SOC shortage capacity is not so, because if
there is a belated adjustment of SOC, as it is likely to be due to the absence of
political pressures in the beginning. The DPA cost of producing a given output
rises. Accruing to Hirschman, ‘Development via SOC shortage is an instance of
the disorderly, compulsive’ sequence while via ‘excess SOC capacity is essentially
permissive’ linkages. Having studied the virtues of specific imbalance, the problem
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is one of finding the kind of imbalance that is likely to be most effective. Any Theories of Economic
Development
investment may have both ‘forward linkage, and backward linkage’ effects.
Forward linkage effects encourage investment in subsequent stages of
production, and backward linkage effects in earlier stages of production.
NOTES
Development should aim at discovering projects with the largest total linkage.
Such projects very from time to time and country to country, and can be found
only by empirical studies of their input-output tables. Hirschman says, ‘The industry
with the highest combined linkage score in iron and steel. Perhaps the under
developed countries are not so foolish and so exclusively prestige motivated in
abutting prime importance to this industry.’ But he says, ‘everywhere with an iron
and steel industry just because the industry maximizes linkage,’ the reason being
the lack of interdependence and linkage in underdeveloped countries. For example,
agriculture, including primary production, and mining are weak in both backward
and forward linkage effects. The primary production activates mostly of the ‘enclave’
type leading to exports have little development effects on the economy in adding
either to employment or to gross national product in an underdeveloped country.
Last Industries First
Hirschman, therefore, advocates the setting up of ‘last stage industries first.’ In
making industrial products, a developing country need not undertake all the stages
of production simultaneously. It can begin with the manufacture of durable consumer
goods at the final stages of production. It can import many converting, assembling
and mixing plants for final touches to almost finished assembling and mixing for
final touches to almost finished products. In this way, the country can turn out
finished consumer goods that it was previously importing, and then move on to the
higher stages of production to intermediate goods and machines through backward
linkage effects.
‘Backward linkage effects’ are important not only from secondary back to
primary production, but also from tertiary back to both secondary and primary
production, but also from tertiary back to both secondary and primary production.
‘Backward linkage effects’ are the combined result of several last stage industries
in a country. A backward linkage effect is produced by increases in demand.
Therefore, when the demand for import-replacing commodities increases, it justifies
domestic last stage production. In other words, in the makings of some products,
when demand reaches a certain ‘threshold’, it is advantageous to manufacture the
product at home. So long as the threshold is being reached, it pays to import the
product. When the threshold is reached, Hirschman suggests subsidies or protection
to import-replacing industries. But it is not desirable to give infant industry protection
till the industry has been fully established.
Hirschman calls last stage industries as import enclave industries. They are
different from export enclave industries. The latter produce only for exports and
are primarily related to staple products and minerals in LDC. According to
Hirschman, LDCs do not give due importance to the part played by exports in
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Theories of Economic their economic development. They often treat exports like a step child. Their
Development
exports do not expand and fail to produce forward linkage effects within the
economy. Hirschman, therefore, suggests export promotion which is the only
practical way of achieving industrialization via import substitution. Hirschman sums
NOTES up his ‘Strategy of Economic Development’ in these words:
Economic development typically follows a path of uneven growth; that balance
is restored as a result of pressures, incentives, and compulsions; that the efficient
path towards economic development is apt to be somewhat disorderly and that
it will be strewn with bottlenecks and shortages of skills, facilities, services, and
products; that industrial development will proceed largely through backward
linkage, i.e. will works its way from the ‘last touches’ to intermediate and basic
industry.

Limitations
The doctrine of unbalanced growth is not free form certain limitations:
1. Neglects Resistances: Streeten points out that ‘the theory concentrates
on stimuli to expansion and tends to neglect or minimize resistances caused
by unbalanced growth.’ For instance, Hirschman neglects resistances in
attitudes created by an imbalance. When development is the outcome of
deliberate unbalancing the economy, the business attitudes change due to
shortages and tensions, and there is lot of opposition and hostility Hirschman
neglects this type of reaction on the part of the existing institutions in
underdeveloped countries.
2. Inadequate Attention to the Composition, Direction and Timing of
Unbalanced Growth: Paul Streeten criticizing Hirschman’s theory of
unbalanced growth asks, ‘The crucial question is not whether to create
imbalance, but what is the optimum degree of imbalance, where to imbalance
and how much in order to accelerate growth; which are the growing points,
where should the spearhead thrust, on which slope snowballs grow into
avalanches.’ He thus points out that inadequate attention has been paid to
the composition, direction and timing of unbalanced growth.
3. Beyond the Capabilities of Underdeveloped Countries: Hirschman’s
criticism of Nurkse’s doctrine of balanced growth that it ‘combines a defeatist
attitude toward the capabilities of underdeveloped economics with
completely unrealistic expectation about their creative abilities’ applies equally
to his own theory. Investment creates mobilities applies equally to his own
theory. Investment creates imbalances thereby creating pressures and
tensions in the growth process which are overcome by the inducement
mechanism. But pressures and tensions are bound to be serious in
underdeveloped countries thereby hampering the process of development.
4. Lack of basic Facilities: There may be lots of difficulties in procuring
technical personnel, raw materials, and basic facilities like power and
transport and even in finding out an adequate domestic or foreign market
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 5. Lack of Factor Mobility: Inducement mechanism is practicable where Theories of Economic
Development
there is internal flexibility of resources. But in underdeveloped countries it is
difficult, and also impossible, to shift resources form one sector to another.
6. Emergence of Inflationary Pressures: One of the serious limitations of
NOTES
the unbalanced growth doctrine is the development of inflationary pressure
within the economy. When large doses of investment are being injected into
the economy at certain strategic points, income will rise which may tend to
increase the demand for consumer goods relative to their supply. Shortages
arise due to strains, pressures and tensions. Such a situation leads to
inflationary rise in the price level becomes difficult to control prices in
underdeveloped countries, as the governments are incapable of wielding
monetary and fiscal measures effectively.
7. Linkage Effects not Based on Data: Hirschman’s analysis of the ‘linkage
effects’ suffers from the fact that it is not based on data pertaining to an
underdeveloped country where social overhead facilities are not fully
developed for a generation or so.
8. Too much Emphasis on Investment Decisions: Hirschman’s development
strategy is largely related to maximizing investment decisions. No doubt
decision making is a crucial factor in economic development. Yet
underdeveloped countries need not only investment decisions but also
administrative, managerial and policy decisions. Thus, Hirschman lays too
much emphasis on investment decisions essential for development.
Compared to other important decision essential for development
Conclusion
Despite these weaknesses, the technique of unbalanced growth has come to be
recognized as a novel technique for the development of underdeveloped countries.
Russia was the first country to adopt it and has been successful in acceleration its
rate of economic growth within a short-period of time. India has also followed suit
by adopting this technique with the Second Five-Year Plan. Whereas Russia could
succeed by creating large surpluses in the heavy industries sector by keeping down
the consumption levels, in India such an extreme policy is impracticable. Here,
investments in heavy industries are being kept up at a high level in the five-year
plans and at the same time every effort is being made to step up production of
consumer goods. But nothing is done to keep the consumption levels low in order
to generate large economic surplus, the continuous rise in the price level however
tends to keep the real consumption standards low. Unless the government controls
the inflationary pressure, planning with unbalanced growth will fail to achieve the
goal of self-sustaining growth.
Balanced Growth and Unbalanced Growth
Having examined critically the doctrines of balanced and unbalanced growth, we
attempt an overview of these strategies of economic development.
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Theories of Economic The case for balanced growth rests on the fact that vicious circles of poverty
Development
are at work in underdeveloped countries which are responsible for the small size
of the local market for their goods. The solution lies in a balanced pattern of
investment in a number of mutually supporting different industries so that the size
NOTES of the market is enlarged.
Its critics argue that an underdeveloped country does not possess sufficient
resources in men, materials and money for simultaneous investments in a number
of complementary industries. Another serious weakness of this doctrine is that it
emphasizes the complementarity of markets of final goods. Primarily consumer
goods, as an inducement to invest and leaves out intermediate goods markets.
Proponents of unbalanced growth strategy favour investments in selected
sectors rather than simultaneously in all sectors of the economy. Investments in
selected sectors lead to new investment opportunities. This is possible by
deliberately unbalancing the economy. The aim is to keep alive rather than eliminate
the disequilibria by maintaining tensions.
Disproportions and disequilibria
The strategy of unbalanced growth aims at removing scarcities in underdeveloped
countries by induced investment decision-making. Critics point out that in such
countries decision-making itself is scarce along with other resources. Moreover,
creating imbalances within the economy by making investments in strategic sectors
in the face of acute shortage of resources leads to inflationary pressures and balance
of shortage of resources leads to inflationary pressures and balance of payments
difficulties in underdeveloped countries.
Despite these differences in approaches the doctrines of balanced and
unbalanced growth have two common problems; one, relating to the role of the
state, and two, the role of supply limitations and supply in-elasticities.
Nurkse believes that balanced growth is relevant primarily to a private
enterprise system. ‘It is private investment that is attracted by markets and that
needs the inducements of growing markets. It’s her that the element of mutual
support is so useful and for rapid growth, indispensable.’ But critics point out that
private enterprise alone is incapable of taking investment decisions in
underdeveloped countries. Therefore, balanced growth presupposes planning.
On the other hand, in Hirschman’s unbalanced growth strategy, the state
plays an important role in encouraging SOC investments thereby creating
disequilibria. If development starts via investment in DPA. Political pressures force
the state to undertake investments in SOC. Thus unbalanced growth also requires
state planning. Since both balanced growth and unbalanced growth involve lobby
investments in complementary activities they require state planning. In order to get
investment decisions implemented and to benefit from complementarities,
coordination between the private and public sectors is essential in an

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underdeveloped country whether it adopts the strategy of balanced growth or Theories of Economic
Development
unbalanced growth.
The other problem concerning the two strategies is the role of supply
limitations and supply inelasticity. Nurkse’s theory of balanced growth, is mainly
NOTES
related to the lack of demand, and neglects the role of supply limitations. This is
not a correct view because underdeveloped countries woefully lack in the supply
of capital, skills economic infrastructure and other resources which are inelastic in
supply, While the demand for final goods can be created by import restriction and
export promotion without recourse to the strategy of balanced growth.
The unbalanced growth doctrine also neglects the role of supply limitation
and supply inelasticity. Though it emphasizes the scarcity of decision-making, yet
it ingnores scarcity of physical, human and financial resources in an underdeveloped
country.
Thus both strategies are in neglecting supply limitations and base their
arguments on ceiling less economies, of the developed countries which have high
elasticity of supply of resources.
This distinction between balanced and unbalanced growth techniques leads
to certain points of similarities between the two. First, both believe in the existence
of a private enterprise system based on market mechanism under which they operate
at the same time, they imply the operation of state planning. Second, both ignore
the role of supply limitations and supply inelasticity. Last but not the least, both the
doctrines assume interdependence, but of different degrees. In balanced growth
the development of one sector is dependent on the development of other sectors.
On the other hand. Under unbalanced growth the economy gradually moves on
the path of economic development via balanced growth. Thus both the strategies
involve interdependence among different. Sectors of the economy. But the
interdependence is of different degree.
The controversy between balanced and unbalanced growth has been
stretched too far and has become almost barren. Keeping in view the scarcity of
resources in a developing country, the best course is to adopt the strategy of
unbalanced growth. Under this strategy, SOC should be developed first which
will encourage subsequent investments in DPA when the economy will ultimately
move on the path to balanced growth. The experience of many developing
manpower, transport etc. are developed first, the development of agriculture.
Industry and commerce is retarded. The rapid development of Russia has of course
proceeded in this way with growth being communicated from the leading to the
following. But developing countries wedded to democracy should try to control
the twin evils of inflation and adverse balances of payments while pursuing this
strategy of development.

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Theories of Economic
Development
Check Your Progress
3. Which type of investment must precede all other types of investments as
NOTES per Rosenstein-Rodan?
4. Name the factor which creates external economies, and which appropriates
external economies.
5. What generates investment sequences?

6.5 SEN'S CAPABILITIES APPROACH

The capability approach is a theoretical of framework that contains two core

normative claims: first that the freedom of achieving wellbeing is of primary moral
importance and second that freedom to achieve well-being is to be understood in
terms of people’s capabilities.
Sen’s approach is both comprehensive and flexible. It provides dignity to
human race because the economic model of development has reduced people to
the status of producers and consumers. If the GDP growth model dis-empowers
then, the capability approach makes their empowerment a central issue. Rather
than taking of some theoretical equality of people or seeking them in terms of
numbers, the capability approach explicitly recognizes the differences among
individuals. It also accepts that people’s abilities are affected by external factors
coming from interaction with other people, social arrangements, access to
infrastructure and public services, discriminations, opportunities to participate in
social and political activities, freedom to speak and influence state policies.
The capability approach focuses directly on the quality of life that individuals
are actually able to achieve. This quality of life is analysed in terms of the core
concepts of functioning and capability.
Functioning are states of being and doing, such as being well nourished,
having shelter. They should be distinguished from the commodities employed to
achieve them.
Capability refers to the set of valuable functionings that a person has effective
access to. Thus, a person’s capability represents the effective freedom of an
individual to choose between different functioning combinations between different
kinds of life that he has reason to value. (In later work, Sen refers to capabilities in
the plural (or even freedoms) instead of a single capability set, and this is also
common in the wider capability literature. This allows analysis to focus on sets of
functionings related to particular aspects of life. For example, the capabilities of
literacy, health or political freedom.
Thus, Amartya Sen’s capability approach revolves around people as human
being. It sees development as expansion of people’s capabilities, it is an enabling
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(empowering) preposition. It aims to enhance people’s well-being by expanding Theories of Economic
Development
their capabilities which is connected to freedom of choices. It explicitly recognizes
presence of diversities and the multidimensional nature of human well-being. The
emphasis is not only on how people actually function but also on their having
capabilities, which are practical choices. NOTES
It provides a relatively universal grammar for understanding the elements of
human well-being. The capabilities approach offers a systematic way of thinking
and analysing issues in the light of people’s capabilities.
In the capabilities paradigm poverty is understood as deprivation of basic
capabilities. People may get deprived of such capabilities in several ways for
example, ignorance, oppressive state policies, lack of financial resources, lack of
proper education, sudden accidents and so on.
The scope of this approach is quite vast, all factors that can potentially
affect people’s capabilities are relevant for consideration. Included in the domain
capability theory are all possible factors, social and political process, gender,
inequality, discrimination of all types, social exclusion disability, environmental
conditions personal and psychological factors that can possibly influence human
capabilities, which is the prime measure of human wellbeing. In this sense, it is a
complete human development model.
What is Functioning and Capabilities
Sen searched for measure to adequately represent people’s wellbeing and
deprivation and found that neither income and command over commodities, nor
happiness and fulfillment of desires constituted good enough indicator of human
wellbeing or lack of it. Sen argued that people’s wellbeing depends upon what
they are actually capable of doing and being. Thus, he focused on something more
direct such as human functioning and capabilities in terms of which the quality of
life is analysed. In other words, a person’s capabilities offer a perspective in terms
of which his advantages and disadvantages can be reasonably assessed that makes
it highly appropriate for analysing poverty.
Functioning: Functionings are what people really ‘do and are’. They are
achievements of people, their doings or being. Taken together, these doings and
beings achieved functionings give value to life. The functionings may include being
well nourished, having shelter, able to work, rest or being literate or healthy, being
part of a community or group. Being respected, and so on achieving a function
(for example, being adequately nourish) with a given bundle of commodities (say,
bread or rice) depends on a range of personal and social factors (e.g. age, gender,
activity levels, health access to medical services, nutritional knowledge and
education, climatic conditions and so on). A functioning therefore refers to the use
a person makes of what over is at his/her command.

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Theories of Economic Capabilities: Capabilities are different combinations of functions that a person
Development
can achieve; it also reflects his freedom to choose. So, capabilities refers to the set
of valuable functionings that a person has affective access to. They are best thought
to be the equivalent of a person’s opportunity set. In nutshell, capabilities are
NOTES made up of two things; functionings and the freedom to choose from them.
Difference between functionings and capabilities: The distinction between
functionings and capabilities is that between the realized and the effectively possible,
in other words, between achievements, on the one and freedoms or opportunities
on the other. Capabilities are a person’s real freedoms or opportunities to achieve
functionings. For example, while travelling is a functioning, the real opportunity to
travel is the corresponding capability.
Functionings refers to what people really ‘do and are’. Capabilities all note what
people potentially can do and can be. The achieved functionings, the realized
achievements and the capabilities are potentially possible. Functionings are in a
sense, more directly related to living conditions. Since they are different aspects of
living conditions, capabilities are notions of freedom, in the positive sense including
what real opportunities a person has regarding the life he can potentially lead.
Take away the freedom to choose, the two things become sense.

The difference between functioning and capability can be best clarified with
an example. Consider two persons who are not eating. One is a victim of a famine
in Ethiopia and the other decided to sit on a ‘fast’ in the front of the US embassy
in London to protest against its troops in Afghanistan. What distinguishes the two
is the freedom, or availability of option. The first person is badly constrained in
freedom and lacks the capability to achieve the functioning to be well, the second
person has this capability though he decides not to use it.
Sen proposes that people lose capabilities when they lack freedom, having
freedom provides the space to develop capabilities. Therefore, all development,
according to Sen, is development of human capabilities in the enabling environment
of freedom.
Sen proposes that expansion of individual freedom is the goal of
development, freedom is also the principal means of development. Therefore,
development also means remaining the major sources of constraint (lack of freedom)
such as all forms of discrimination- social, religious, gender or community based,
unreliable public facilities and poor in free structure, lack of economic opportunities,
social exclusion and political marginalization, and policies limiting human rights and
so on. In many societies where there is ethnic tension, we can also include the fear
of violence or attacks as freedom restricting factor. Freedom provides the necessary
space to make choices to make one’s life better the way one wanted. It is particularly
relevant for the poor for its enabling and empowering impact.

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Sen’s capability approach and poverty Theories of Economic
Development
In the capability perspective, poverty is seen in terms of a short all of ‘basic
capabilities’- a kind of basic capability failure’. Such failure involves the inability to
achieve certain minimally adequate levels of crucially important functionings, such NOTES
as being nourished and being sheltered.
Poverty experts can point out that this definition of poverty is based on the
ancient Aristotelian notion that a poor person is not free to carry out the important
activities that he wants to. In the other words, poverty is to be seen as living in a
state or restricted freedom. In his book Development as freedom, Sen has talked
about various types of freedoms necessary to increase peoples capabilities (or
reducing poverty) and development is increasing these freedoms. The freedom of
a person is understand as the ability (or opportunity) to choose what one values.
Let’s compare Sen’s capability approach with resources based approaches.
Sen argues that the resource centric approaches don’t distinguish between means
and ends. How the available resources are converted to and used depends upon
personal factors as well as on the environment in which people live including social
and political. For example, a disabled person needs more resources to do a task,
say moving, than a normal person. Another example is presence of social bias in
the society or extreme bureaucracy in the system; these things affect different
people differently. It is non material factor that hardly ever shows up in the GDP
model of development or poverty.
What is Income poverty and capability
Poverty: The traditional income poverty and Sen’s capability poverty are not
entirely distinct from each other. In general, increasing income improves the
capabilities of people and vice-versa. Basic essentials like education and health
directly improve the quality of life and capabilities. They also improve the ability to
earn more.
The issue of unemployment offers an insightful comparison between income
and capability poverty approaches. If unemployment only meant loss income it
could be compensated by some form of income support (say unemployment
allowance), but in reality, look or loss of job has much helper impact on a people’s
life than more economic loss. It might include psychological damage, loss of
motivation and self-confidence, stress, depression, increase in ailments and
morbidity etc. The income poverty approach is blind towards such (human suffering)
which are clearly picked up by the capability approach through their adverse
impact on the capabilities.
Conversion of income into capabilities is an important issue, particularly for
the poor. For example, alcoholism is widespread in some poor communities and if
the income earner habitually spends it on drinking he is doing nothing to improve
his or family’s capabilities, on the contrary he might by degrading his capabilities.

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Theories of Economic A better use would be to raise the nutrition level of family members (but that needs
Development
awareness and information, which the poor often lack). Similarly, there are other
situations where good income does not automatically ensure better capabilities.
For example, in the disadvantaged sections of society, say for instance, the lowest
NOTES caste community in India even good enough income does not automatically ensures
social or political equality. In such case, belonging to a discriminated community
becomes a disability (and a cause for reduced freedom).
Gender inequality is another hurdle when the income distribution within
families is considered. In patriarchal societies, male members always have the first
right leaving the females members rather deprived in everything. This deprivation
ultimately shows up in the later for mortality rates, morbidity, literacy,
undernourishment, medical neglect etc.
Poverty reduction involves more than economic development
The fact that higher capital GDP does not automatically translate into lowered
poverty, is clearly observed in the development status of different states of India.
Kerala is a unique state in India, it has only a moderately developed economy but
has achieved significant poverty reduction. It does so through the expansion of
basic education, healthcare facilities and equitable land distribution to counter
poverty. In comparison, Punjab with much higher per capita GDP also has higher
poverty. Therefore, people’s wellbeing is not directly related with economic growth.
Likewise, through the economic reforms in India have opened up the
economy throwing new opportunities, but majority of the population failed to reap
the benefits because the enabling condition of high literacy level, quality basic
education, good healthcare facilities etc., proved simply for too inadequate.
The presence of poverty even in rich countries
A country has higher per capita GDP and yet has large percentage of people with
poor quality of human life. How to account for low wellbeing of people (poor
people) in rich countries?
Human wellbeing depends upon several things other than wealth or income.
A country obsessed with GDP growth alone may not provide basic infrastructure
of education, healthcare, housing, transport, clean drinking water, sanitation and
so on. Today is a proven fact that economic growth inherently favors the rich and
hence wealth gets increasingly concentrated in few hands. It means rising inequalities,
which leads to social exclusion of the poor class. Social exclusion is not only a
present concern but also has future consequences. It works to sustain and promote
poverty. A rich country can only eliminate poverty if it frames political that focus on
increasing peoples capabilities in place of the fetish for GDP growth.
Implementation of the Capability Approach
Many attempts have been made to implement the capability approach. For instance,
it has been used to investigate poverty, inequality wellbeing social justice, gender,
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social exclusion, health disability child poverty and identity as well as for designing Theories of Economic
Development
policies. It has been related to human needs, human rights and human security as
well as development in general. It has also been seen as a theory of social justice
seeking to reduce social exclusion and inequalities. There have been numerous
attempts to apply the capability approach to the measurement of poverty and NOTES
wellbeing. The capability approach is perhaps best known for having inspired the
creation of the human development India (HDI) in 1990 by the United Nations
development programme (UNDP) to gauge countries level of human development
or people’s wellbeing. The HDI offered an alternative measure of human progress
in terms other than GDP growth and has played a key role in advancing alternative
ideas about development and welfare. The HDI covers dimensions of material
wellbeing, health and education, the Multi-Dimensional Poverty Index (MPI) is
another comprehensive led for evaluating poverty.
Now conclusion is that the wellbeing of people depends upon many things
other than increased income or resources. All such thing get simplified when the
GDP alone is used as proxy for development. The basic objective of development
should bet to create an enabling environment for people to live long health. In
reality, they are only means to expand people’s capabilities and freedom of choices,
not ends in themselves.
The capability approach is more fundamental and comprehensive in nature
as it shifts the focus from the means (resources) to the ends (human wellbeing) by
putting the people in the center. Anti-poverty programmes must not focus on
reduction of income poverty alone. Enhancement of human capabilities must also
go hand in hand with the economic growth for it to be sustainable.

6.6 NURKSE’S THEORY

The explanation of Nurkse theory is based on disguised unemployment. The term

disguised unemployment is generally defined in terms of margined productivity of
labour being zero. This is loose interpretation of the concept. To understand the
meaning of this term, we must address to the questions which arise in explaining
the phenomenon of disguised unemployment. How workers can survive on the
land if their marginal product is zero or even positive but below subsistence? Who
would employ such labour? Could the output in the subsistence sector really remain
unaffected if substantial quantities of labour is withdrawn or migrated? In short,
what is precisely meant by the term disguised unemployment? Can it be quantified?
What are we to make of the argument that industrial development in surplus labour
economies is a relatively painless process?
Measurement: Formally, there are three possible interpretations of the concept
of disguised unemployment that are commonly found in the literature. Look at at
the diagram 6.4.

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Theories of Economic Y
Development

Marginal Product of Labour

MP1

MP
NOTES

W Subsistence wage

O X
S U D
Number of Workers

Fig. 6.4

The number of workers is shown on horizontal axis and marginal productivity

of labour on vertical axis. The marginal productivity line and dotted MP, shows the
marginal productivity of labour with improved techniques. Point A on x-axis indicates
the equal numbers of workers available for employment. One possible measure of
disguised unemployment is the difference between A and S or the gap between the
number of workers available for work and the amount of employment that equates
the marginal product of labour and the subsistence wage. This interpretation of
disguised unemployment conforms to the definition of unlimited supply of labour in
Lewis’s model.
The second possible measure of disguised unemployment is the difference
between A and D or the gap between the actual number of workers available for
employment and the level of employment at which the marginal productivity of
labour is zero. It sometimes is referred to as the state surplus. This surplus is
obviously less if disguised unemployment is defined as labour with marginal product
below the subsistence wage.
A third measure of disguised unemployment is the difference between the
actual number of workers available and the level of employment at which marginal
product of labour would be zero if some change take place that enable the same
level of output to be produced with fewer workers. This is presented by the dotted
marginal product curve MP1 Disguised unemployment is now measured by the
difference between A and U and it is sometimes referred to the dynamic surplus.
The dynamic surplus clearly embraces many types of disguised unemployment
because there are many reasons, particularly in developing countries where labour
may not be working at its potential and where small changes in techniques
organization of production may release substantial quantity of labour.
Estimate
There are three main ways of ascertaining whether surplus labour exists in the
sense that labour’s marginal product is zero. The first is to examine instances
where substantial numbers of the agricultural labour force have been withdrawn
from the land either to work in industrial projects or as a result of illness.
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 This method was followed by Schultz (1964) who examine the effect of Theories of Economic
Development
influences epidemic in India in 1918-19, which killed approximately 8% of the
agricultural labour force. He found there output during the following year declined
and concluded that surplus labour in Indian agriculture did not exist. Schultz
observations were criticized on the ground that he failed to distinguished between NOTES
the summer and winter season of the year following epidemic. S. Mehra (1966)
has shown that summer production, which just followed the epidemic, was not in
fact reduced and that the decline in agricultural product in 1919-20 found by
Schultz was entirely due to reduction in winter crop which could have result from
low rainfall. Notwithstanding the criticize this is one method of approach.
The second method of estimating the static surplus is to take the difference
between labour available and the labour required to produce the current level of
agricultural output with given techniques, making due allowance for the seasonality
of production. The estimate and the magnitude of surplus labour in this case will
vary with local conditions.
The third approach is to estimate agricultural production function to test
whether elasticity of output with respect to labour is significantly different from
zero. This approach indicates whether or not there is surplus labour, but does not
measure it magnitude.
When discussing labour’s marginal product in agriculture and the extent of
disguised unemployment, two important distinctions need to be made between
harvest and non-harvest time and between farms that hire labour and those that
do not. Within the production function approach this distinction is easily made
explicit and it is very fruitful approach for that reason. As for the distinction between
hired and non-hired labour is concerned, the marginal product of family labour
can hardly be zero if workers are hired, nor can be marginal product of the hired
workers be zero if they are paid.
Desai and Mazumdar (1970) have taken a sample of Indian farms and
divided into those who use hired labour and those who do not. The differences
between two groups are striking. The marginal product of labour on the big farms
hiring labour is significantly different from zero, while on farms not hiring labour,
the marginal product is not significantly different from zero.
It should be remembered, however, that zero marginal product per man
hour or per man day is not necessary condition for surplus labour. Surplus labour
can take the form of a small number of hours or days worked. On the other hand
if marginal product per man hour or per man day is zero, there must be some
surplus labour which may be termed as disguised unemployed labour.
S. Nath (1974) has made a distinction between harvest and not-harvest
labour. He suggests that busy-season and stack-season labour inputs should be
included separately in the production function. He adopts the approach of
production function in a cross-section analysis of 150 farms in Ferozepur district
(Punjab), for the period 1966-68, relating annual output to busy-season labour
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Theories of Economic stack-season labour and other inputs using a Cobb-Douglas production function.
Development
Nath finds the marginal product of busy-season labour is indeed positive and the
marginal product of stack-season labour is not significantly different from zero.
The inference that can be drawn from these studies is that marginal product
NOTES
of labour on family farms with no hired labour in the stack season will be zero. In
this sense a static surplus exists, but where agriculture is partly commercialized
particularly in the harvest season, the marginal product of labour positive. The
reduction in agricultural labour during that period of time may impair agricultural
output. Defenders of the classical model of development argue that no one has
ever argued that the withdrawal of labour under all circumstances will not affect
output. The purpose of classical of labour in industry for exceeds the marginal
product of labour in agriculture and those who support and use classical model
normally stipulate some dynamic change as migration takes place. This leads to a
question of measurement of the dynamic surplus, which is the difference between
actual labour employed and labour required when change in technique takes place.
Type: These may be genuine differences in the extent of disguised unemployment
within and between countries and different investigators may have been estimating
different things, but the fact remains that a large past of labour surplus arise from
the seasoned nature of production. Studies that exclude this possibility will certainly
overestimate the existence of disguised unemployment. If disguised unemployment
is interpreted in terms of seasonal unemployment, then dynamic surplus may be
very large. At least five types of disguised unemployment can be distinguished.
 Unrealized potential output per worker due to low nutritional and health
level of the labour force.
 Low level of output per unit of labour input due to inadequate motivation
for the cultivators to pursue maximization.
 Low average product due to low aspirations for material income compared
with leisure.
 Unemployment due to lack of co-operant factor (technological
unemployment).
 Seasonal unemployment.
The above discussion reveals that there are two strands of thought. Those
who believe that disguised unemployment is the result of low marginal product of
labour in agriculture and those who disagree with this type of thinking. A
reconciliation is provided by the distinction between the amount of labour
employed, and the number of persons employed. In a wage payment system it is
extremely unlikely that labour would be employed to the point where its marginal
product is zero. If wage is positive, marginal product will also be positive. Labour
is employed to the point where marginal product of a unit of labour time is equal to
the wage and disguised unemployment takes the form of a small number of hours
worked per person. It is not that there is too much labour terms but too many
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labourers spending it. Total output would fall if workers were withdrawn from Theories of Economic
Development
land unless those remaining worked danger hours to compensate.
A.K. Sen’s view: The precise conditions under which remaining labour force
would supply more work effort have been formalized by Sen (1966), if workers
NOTES
are rational they will work (dv/dl) is equal to the marginal disutility of work (dv/dl).
The marginal utility of income from work can be expressed as under.
dV dY dV
  ...(i)
dL dL dY
Where dy/dl is the marginal product of labour and dv/dy is the marginal
utility of income. Welfare maximization implies that
dY dV dV
  ...(ii)
dL dY dL

dY dV dV
Or  
dL dL dY

marginal disulitity of work

= marginal utility of income ...(iii)

The amount of disguised unemployment is affected by the organization of

agriculture. If the organ is achieve is less capitalist, the amount in utilized labour is
likely to be greater, in a situation of no wage pay meant system (like joint family
system). The distraction between a unit g labour and a unit of labour time becomes
redundant. In a joint family system it is the average product that matters for a
group as a whole and not the product of the last worker or hour (marginal product).
The average product may still be above the subsistence level when the marginal
product of labour time is below it. It may be difficult to represent both cases on the
same diagram.
Disguised Unemployment
Some Related Issues:
Having discussed with meaning and measurement of disguised unemployment.
We will now discuss related issue connected with the concept of disguised
unemployment. The related issues are discussed below:
1. Is disguised unemployment a blessing in disguise? It is said that
disguised unemployment comes to the rescue of backward country when it
makes an attempt to develop itself. It is a known fact that most developed
countries suffer from scarcity of labour and have abundance of other factors.
The under developed countries have scarcity of capital goods and technical
skill with an abundance of manpower. If these countries begin to develop
they can procure capital goods from foreign countries and import technical
skill and the required labour can be got from rural areas where were is
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Theories of Economic disguised unemployment. To that extent disguised employment is helpful for
Development
development purposes. It might, therefore, be regarded as a blessing in
disguise unemployment that is not disguised can also come to our rescue
when we need manpower for development purposes. But there is more
NOTES distress when there is unconcealed or open unemployed. The fact however
remains that unemployment whether disguised or open is an indication of
waste of human productive efficiency.
2. Shift of labour: a loss or gain in output? When there is no disguised
unemployment and if labour is shifted from agriculture to manufacturing
industries, the output of the enterprise where it is drawn decreases. When
there is disguised unemployment such a decrease does not take place this is
the advantage that people have in mind when they say that disguised
unemployment is a help to the country that embarks on a program of
economic development, while this is true as far this argument goes but one
must remember that disguised unemployment causes loss of a productive
factor, without actually remaining idle, the surplus labour in agriculture
remains in employment without adding to the total product of the farms.
Another problem connected with shifting of labour from agriculture to
industries is the availability of food for migrated workers. When there is
disguised unemployment shift of labour from agriculture to other industries
does not decrease output of farms. This is one great advantage. But is
those who still remain employed in agriculture begin to consume more than
before what would those who have been withdrawn for agriculture consume
this is the great advantage. But if those who still remain employed in
agriculture begin to consume more than before what would those who have
been withdrawn for agriculture consume? This is the danger, and something
has to be done to ensure that food and other products of agriculture would
be available for those who have shifted to other industries. The advantage
of disguised unemployment would be partially last if nothing is done to prevent
people in rural areas from consuming more than they were consuming before.
3. Disguised unemployment and capital formation: It has been explained
about that labour is required for development project and this can come
from rural areas where there is surplus labour in the form of disguised
unemployment. Apart from labour other factors of production like capital
goods are also required. When surplus labour shifts from agriculture to
manufacturing industries, it has to be provided with capital goods. Where
from we are to get them capital good can be imported from foreign countries
or where the required raw materials are available or they can be produced
out home supply raw materials to the migrated labour and let them make
capital goods. For development projects, besides machinery we need
transport, communication houses factory building etc.

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 To provide where with all for development projects money is needed. It is Theories of Economic
Development
also needed for buying or hiring factors of production. Let us take the care of the
factor labour wages have to be paid to them for the work they do in their new
employment. This money can come from the savings of the people whether made
by individuals, by companies or by the government. If private individual save money NOTES
and if it is not used up in financing the already existing industry it can (through
capital market) become available for payment of wages to labourers migrated
from agriculture.
Another source of funds is the government money in the form of taxes levied
on the people. When people are taxed they are forced to some extent at least, to
save money. They money thus saved can become available for payment wages.
The government can also borrow money for this purpose. The borrowed money
does not help in increasing the national saving. If borrowed money is used for
productive purpose it would create additional income out of which some amount
could be served.
The main advantage that people generally think is that disguised unemployment
means disguised saving. When disguised unemployment workers are shifted from
agriculture to industries, the total production of agricultural output is not decreased.
The shifted workers get the opportunity to do some work which give their income.
Previously those worker income was zero as their contribution to output was
zero. The process through which disguised workers earn their income leads to
some saving which is termed as disguised saving. Theoretically it may appear an
easy position, but practically it is difficult one.
Critical Appraisal
Nurkse’s concept of disguised unemployment as concealed saving potential has
come in for good deal of criticism from the point of view of its practical utility in
underdeveloped over populated countries. They various difficulties that hinder its
smooth looking are as under:
1. Propensity to consume does not remain constant: Nurkse analysis is
based on the assumption that propensity to consume of the farm workers
and those employed in new projects remain constant. This appear to be an
unrealistic assumption. In underdeveloped countries the living standard of
the people is very low and when their income rise, they tend to satisfy their
pent-up demands and it raises their propensity to consume. The
demonstration effect also helps in raising their consumption expenditure. In
this connection, K.K. Kurihara state propensity to consume for the whole
economy may well rise in consequence of uprising the previously
unproductive but presently productive consumers the disguised unemployed.
In this event, the pressure will for allocating to the consumer goods sectors
those resources which might otherwise be used to increase output of capital
goods.
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Theories of Economic 2. Problems connected with collection and distribution of food not
Development
discussed: Nurkse fails to throw light on the problem as how to collect
surplus food from the forms and distribute that among the newly employed
workers. How much each farmer should contribute? If anyone refuses to
NOTES contribute, what action is to be taken against him? These are certain problems
which Nurkse perhaps failed to visualize.
3. It is difficult to transfer the disguisedly unemployed: It is very difficult
to the disguised unemployed persons as they are generally attached to their
land and kith and kilns and they perhaps might not be prepared to leave
their village and work at new places besides they are under the influence of
social customs and traditions that they tend to stick to their hearths and
homes. It is rightly social that of all the goods, labour is difficult to transport.
4. Problem of inflation: From the definition of disguised unemployed it is
difficult to identify the disguisedly unemployed persons. The migration of
such workers from subsistence sector would be possible when they are
given higher wages in capital project work. But these projects have long
gestated period and as such there remains a danger of inflation any person
on prices. In this connection. This will also import of goods, with adverse
effect on the balance of payment if their effects are relented by strict is to
swell the sun of many circulating at home and so put greater pressure on the
domestic prices. Rising prices might defeat the purpose of capital formation.
5. Unskilled labour along is not needed: The disguisedly unemployed labour
is generally unskilled & nontechnical but capital project need skilled &
technical labour. According to Kurihara, even if the entire surplus labour is
transferred to capital projected which are generally labour instantiate.
Cannot be expected to turn out capital and quality equipment of
industrialisation. Dr. A.M. Khusro observes if you attempt to create only
employment without regard to efficiency, output and surplus you will soon
surplus many labour intensive schemes which seen to be giving a lot of
employment per unit of capital is in fact an optical illusion. It throws back
into unemployment or under-employment all or many of the initially
employed. Employment to be of permanent must be generated in eventually.
Self permanent must be generated in eventually. Self finance, surplus
generating scheme.
6. Directly productive capital is more important for eco development:
Nurkse has suggested the employment disguised employed person in the
constriction of social overhead capital roads dams, building, irrigation project
etc. Hirschman holds a different view.
He is of the opinion that social overhead capital is a permission factor which
serves as an incentive to private investment only whereas directly productive
capital such as machine load and iron and steel industry is a compulsive
factor in economic development and is more significant for economic
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 development. Hence the use of disguised workers for capital formation as Theories of Economic
Development
suggested by Nurkse is applicable to social overhead capital only and not
in directly productive activities which require skilled and technical labour.
7. Unfavourable effect of increasing population on capital formation:
NOTES
In underdeveloped countries population grows at a fast rate and if eats up
surplus likely to be created by labour migration from subsistence to investment
sector. When population growth out strips the growth of capital formation
that implies that disguised unemployment grows faster than can be absorbed
productively by the very stock of capital that he disguised unemployed
increase in total output.
8. Less possibility of significant increase in total output: Kurihara is of
the view that if unskilled and ill equipped labour is put on capital projects. It
may not increase significantly the output of fixed capital which is of great
importance in increasing the level of output besides, the experience of Latin
American states show that the disguisedly unemployed person is in the habit
of abstention and their contribution to total output is negligible.
9. Fall in agricultural productions: It is pointed out by Schultz that transfer
of surplus labour from agricultural to the new capital projects will adversely
affect agricultural production. In his own word, no evidence for any poor
country anywhere that would suggest that a transfer of even some small
factor say percent of the exiting labour force out of agriculture with other
things equal could be made without reducing its production.
10. Additional administration burden: The starting of new capital projects
adds to administrative and financial burden and underdeveloped countries
lack the capacity to cope with the rising burden. When new capital projects
are started. Unskilled burdens tools and equipment are needed along with
capital. But capital scarcity is proverbial in underdeveloped countries. Again,
store houses are got to be constructed for the safe custody of tools and
equipment. All this would put additional financial burden on the administration.
11. Not practicable in democratic states: The mobilization of surplus labour
from the substances to the capital sector might require using of coercive
methods as happed in communist countries. This may not be practicable in
democrat underdevelopment countries. Nurkse himself was not unaware
of this difficulty when he said some of the underdevelopment countries do
have potential domestic resource available for capital construction. But it
may be very hard any way & impossible to mobilize them without resorting
to coercive methods where masses were driven to work on capital formation
where masses were work driven to capital projects just on bare subsistence.
12. Inadequacy of complementary saving: As discussed above the success
of Nurkse depends upon the availability of contemporary saving occurring
in the sector other than subsistence one. It’s a doubtful if contemporary
saving from other sectors. The inadequacy of complementary saving feature
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Theories of Economic stand in the way of an effectively use of disguised unemployment as source
Development
of capital formation Dr. K.N. has observed the answer that the existence of
which is available for practiced action. On the basis of above discussion,
one may say that disguised unemployed as a concerned saving potential is
NOTES of little practical significance for democratic countries. One might conclude
formative in the words of Jokes Viner, ‘There is little or nothing it all the
phenomena disgusted as disgusted unemployment as hidden unemployment
or as under employment which is in for account by competent informed and
compressive analysis of the phenomenon of low productivity & its possible
remedies.’

Check Your Progress

6. Amartya Sen’s capability approach revolves around which factor?
7. Which index’s creation is known to have been inspired by the capability
approach?
8. As per Nurkse, disguised workers can be used for which type of capital
formation?

6.7 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. As per Rostow, the political factor was reactive nationalism’s reaction against
the fear of foreign domination which acted as a potent force in bringing
about the transition.
2. Drive to maturity is the period when a society has effectively applied the
range of (then) modern technology to the bulk of its resources.’
3. According to Rosenstein-Rodan, investment in social and economic
overheads is irreversible in time and hence it must precede other types of
investment.
4. SOC creates external economies while the DPA appropriates external
economies.
5. Investment sequences are generated by profit expectations and political
pressures. Profit expectations generate the sequence from SOC to DPA
and political pressures from DPA to SOC.
6. Amartya Sen’s capability approach revolves around people as human being.
7. The capability approach is perhaps best known for having inspired the
creation of the human development India (HDI).
8. The use of disguised workers for capital formation as suggested by Nurkse
is applicable to social overhead capital only and not in directly productive
activities which require skilled and technical labour.
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 Theories of Economic
6.8 SUMMARY Development

 Professor W.W. Rostow has sought an historical approach to the process

of economic development. As seen before, he distinguishes five stages of NOTES
economic growth, Viz (1) the traditional society (2) the pre-conditions for
take-off (3) the take-off: (4) the drive maturity; (5) the age of high mass-
consumption. Let’s have a detailed look at each of these stages.
 The theory of the ‘big push’ is associated with the name of Professor Paul
N. Rosenstein-Rodan. The thesis is that a ‘big push’ or a large
comprehensive programmed is needed in the form of a high minimum amount
of investment to overcome the obstacles to development in an
underdeveloped economy and to launch it on the path to progress.
 Rosenstein-Rodan distinguishes between three different kinds of indivisibilities
and external economies. One, indivisibilities in the production function,
especially the indivisibility of the supply of social overhead capital; two,
indivisibility of demand; and three, indivisibility in the supply of saving.
 The concept of unbalanced growth has been popularized by Hirschman. It
is his contention that deliberate unbalancing the economy, according to a
predesigned strategy, is the best way to achieve economic growth in an
underdeveloped country. According to Hirschman, investments in
strategically selected industries or sectors of the economy will lead to new
investment opportunities and so pave the way to further economic
development.
 According to Hirschman, when new projects are started they appropriate
external economies created by previous projects and create new external
economies that can be exploited by subsequent ones. There are some
projects that appropriate more external economies that they create which
he calls convergent series of investments. Hirschman also calls them induced
investments for they are net beneficiaries of external economies. There are
other projects too that they appropriate which he characterizes as divergent
series of investments.
 The capability approach is a theoretical of framework that contains two
core normative claims: first that the freedom of achieving wellbeing is of
primary moral importance and second that freedom to achieve well-being
is to be understood in terms of people’s capabilities.
 Sen’s approach is both comprehensive and flexible. It provides dignity to
human race because the economic model of development has reduced
people to the status of producers and consumers. If the GDP growth model
dis-empowers then, the capability approach makes their empowerment a
central issue. Rather than taking of some theoretical equality of people or
seeking them in terms of numbers, the capability approach explicitly
recognizes the differences among individuals. It also accepts that people’s
abilities are affected by external factors coming from interaction with other
people, social arrangements, access to infrastructure and public services,
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Theories of Economic discriminations, opportunities to participate in social and political activities,
Development
freedom to speak and influence state policies.
 The capability approach focuses directly on the quality of life that individuals
are actually able to achieve. This quality of life is analysed in terms of the
NOTES core concepts of functioning and capability. Functionings are states of being
and doing, such as being well nourished, having shelter. They should be
distinguished from the commodities employed to achieve them. Capability
refers to the set of valuable functionings that a person has effective access
to.
 In the capability perspective, poverty is seen in terms of a short all of ‘basic
capabilities’- a kind of basic capability failure’. Such failure involves the
inability to achieve certain minimally adequate levels of crucially important
functionings, such as being nourished and being sheltered.
 The explanation of Nurkse theory is based on disguised unemployment.
The term disguised unemployment is generally defined in terms of margined
productivity of labour being zero. This is loose interpretation of the concept.
 Nurkse’s concept of disguised unemployment as concealed saving potential
has come in for good deal of criticism from the point of view of its practical
utility in underdeveloped over populated countries.

6.9 KEY WORDS

 Traditional society: It has been defined ‘as one whose structure is

developed within limited production functions based on pre-Newtonian
science and technology and as pre-Newtonian attitudes towards the physical
world’.
 Social Overhead Capital: It has been defined as ‘comprising those basic
services without which primary, secondary, and tertiary productive activities
cannot function.’
 Functionings: It refers to states of being and doing, such as being well
nourished, having shelter. They should be distinguished from the commodities
employed to achieve them.
 Capability: It refers to the set of valuable functionings that a person has
effective access to.

6.10 SELF ASSESSMENT QUESTIONS AND

EXERCISES

Short Answer Questions

1. What are the three sectors of the economy as per Rostow?

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 2. Enumerate the factors on which the rapid growth of the leading sectors Theories of Economic
Development
depend as per Rostow.
3. How does Rostow explain the stage of mass consumption?
4. Why does Rodan regards his theory of development superior to the traditional NOTES
static equilibrium?
5. Give a critical appraisal of Rosenstein Rodan’s theory of economic
development.
6. Briefly explain why, according to Hirschman, LDCs do not give due
importance to the part played by exports in their economic development.
7. What are the similarities between balanced and unbalanced growth?
8. Differentiate between functionings and capabilities.
9. What are the different types of disguised unemployment?
Long Answer Questions
1. Describe Rostow’s stages of economic growth.
2. Give a critical appraisal of Professor Ronstein Rodan’s theory of economic
growth.
3. Describe Hirschman’s strategy of unbalanced growth for economic
development.
4. Explain Sen’s capability approach and its relation to income inequality.
5. Discuss the critical appraisal of Nurkse’s theory of undisguised employment.

6.11 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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Approaches to Economic
Development
UNIT 7 APPROACHES TO
ECONOMIC DEVELOPMENT
NOTES
Structure
7.0 Introduction
7.1 Objectives
7.2 Developed and Underdeveloped Countries
7.2.1 Criterion for Classifying Economics as Developed and Underdeveloped
7.3 Diversity among Developing Countries
7.4 Answers to Check Your Progress Questions
7.5 Summary
7.6 Key Words
7.7 Self Assessment Questions and Exercises
7.8 Further Readings

7.0 INTRODUCTION

The primary factor used to distinguish developed countries from developing countries
is gross domestic product (GDP) per capita a figure calculated by dividing a
country’s GDP by its population. For example, a small country with a GDP of $1
billion and a population of 50,000 has a GDP per capita of $20,000.
One unofficial threshold for a country with a developed economy is a GDP
per capita of $12,000. Some economists prefer to see a per capita GDP of at
least $25,000 to be comfortable declaring a country as developed however many
highly developed countries, including the U.S have high per capita GDPs of $40,000
or above.
Exceeding even the $12,000 GDP does not automatically qualify a country
as being developed. Developed countries share several other characteristics: They
are highly industrialized, their birth and death rates are stable, they do not have
excessively high birth rates because thank to quality medical care and high living
standards, infant mortality rates are low. Famines do not feel the need to have high
numbers of children with the expectation that some will not survive. They are more
women working particularly in high-ranking executive positions. These career
oriented women frequently choose to have smaller families or eschew having
children altogether. They use a disproportionate amount of the world’s resources,
such as oil. In developed countries, more people derive cars, fly on airplanes and
power their homes with electricity and gas. Inhabitant of developing countries
often don’t have access to technologies that require the use of these resources.
They have higher levels of debt. Nations with developing economics cannot obtain
the kind of seemingly bottomless financing that more developed nations can.

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 Another measuring device, the human development index (HDI) was Approaches to Economic
Development
developed by the UN as a metric to assess the social and economic development
levels of countries. It quantifies life expectancy, educational attainment and income
into a standardized number between 0 and 1. The closer to 1, the more developed
the country. No minimum requirement exists for developed status, but most NOTES
developed countries have HDIs of 0.8 or higher.
It is important to remember no set minimum or maximums measures exists
for these metrics. Economists look at the totality of a country’s situation before
rendering judgment, and they do not always agree on a country’s development
status. For example, countries such as Mexico, Greece and Turkey are considered
developed by some organizations and developing by others.

7.1 OBJECTIVES

After going through this unit, you will be able to:

 Explain the meaning of underdeveloped countries
 Enumerate the common characteristics of the underdeveloped countries
 Examine the developed countries
 Discuss the characteristics of developed countries

7.2 DEVELOPED AND UNDERDEVELOPED

COUNTRIES

The economies of the world are classified as developed, underdeveloped or

developing economies on the basis of different indicators of economic development.
Considering per capita income as the basis, the World Development report
recognized the economies of the world into high income upper-middle income
and lower middle income and low income economies. The units for this measure
and for the thresholds is current US Dollars.
At the bank, those classifications are used to aggregate data for groups of
similar countries. The income category of a country is not one of the factors used
that influence lending decisions.
Each year on 1st July, bank updates the classifications. They change for
two reasons:
1. In each country, factors such as income growth, inflation, exchange rates,
and population change, influence GNI per capita.
2. To keep the Dollar thresholds which separate the classifications fixed in real
terms, bank adjust them for inflation.

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Approaches to Economic New thresholds are determined at the start of the bank’s fiscal year in July
Development
and remained fixed for 12 months regardless of subsequent revisions to estimates.
As of 1 July 2017, the new thresholds classification by income are:

NOTES Threshold GNI/Capita (current US$)

Low-Income < 1,005
Lower-middle income 1,006-3,955
Upper-middle income 3,956-12,235
High-income >12,235

Usually, high income countries are known as developed economies and

low income level countries are known as under developed economies. However,
all high income economies are not developed countries. For example, middle-east
oil producing countries are high income economies but are not treated as developed
economies. Also, to be noted is the point that some of the middle and low income
economies are developing faster than high income economies. Underdeveloped
economies showing high potential of growth in terms of their natural, physical and
human resources are often referred to as developing economies. Other than high
per capita income, developed or advanced economies are characterized by high
standard of living, universal and quality education, better health care facilities and
high life expectancy, whereas in underdeveloped or developing economies such
characteristics are found only as symptoms.
Another expression, currently in vogue, is ‘South, for less developed
countries and north for advanced countries of the world’. It is because most
underdeveloped fall in the Southern Hemisphere of the globe while most developed
countries fall in the Northern Hemisphere of the globe. Economists often use the
terms, first world, second world, and third world for the developed, communist
and underdeveloped economies respectively. This is one of the broadest
classifications of the different economies of the world. The terms traditional
backward, poor southern-third world etc. are used for the underdeveloped
countries. So far as division of world population on the basis of per capita income
is concerned, it may be noted that nearly 80 per cent of the world population is
living in underdeveloped economies and the rest 20 per cent is living in developed
economies.
7.2.1 Criterion for Classifying Economics as Developed and
Underdeveloped
It is very difficult to suggest a commonly accepted criterion of classifying the whole
economies as developed and underdeveloped. Prof. Samuelson is of the opinion
that every country is an underdeveloped country because a country never achieves
the perfection of development. There is always a scope for further development.
There are plenty of natural resources in USA, Russia and Germany. These
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economies are developed economies. Likewise, there are plenty of natural resources Approaches to Economic
Development
in most countries of Latin America, and African continent, but these are all
underdeveloped economies. So, it is difficult to classify economies as developed
and underdeveloped on the basis of their resources potential. Further, countries
like Canada, Australia, France, Britain and Switzerland thinly populated countries NOTES
and are well recognized as advanced nations. On the other hand, Congo, Guinea,
Sudan, Argentina and Nepal are equally thinly populated and are known as
underdeveloped countries. Thus, on the basis of population also, it is difficult to
characterize different nations as developed and underdeveloped. Some economists
are of the view that the economies with the predominance of secondary and tertiary
activities (such as industries, trade, insurance, banking etc.) are advanced
economies, while the economies with the predominance of primary, fishery, mining
etc.) are underdeveloped economies. This criterion of classifying economies as
developed and underdeveloped may hold good in the case of economies of India,
Pakistan and Bangladesh. But it does not hold good in case of countries like
Australia, Denmark and New Zealand. These countries are developed countries
despite being predominantly agricultural.
Thus, it is not easy to evolve any common criterion to classify economies as
developed and underdeveloped. However, there is a set of common characteristics
of under developed economies such as low per capita income, low levels of living
high rate of population growth, illiteracy, technical backwardness, capital deficiency,
dependence on backward agriculture, high level of unemployment, unfavourable
institutions and the likes. It is on the basis of these characteristics that we draw a
line of distinction between developed and underdeveloped economies.
What are Developed Economies?
A developed country, industrialized country, more developed country, or more
economically developed country (MEDC) is a sovereign state that has developed
economy and advanced technological infrastructure relative to other than less
industrialized nations. Most commonly, the criteria for evaluating the degree of
economic development are gross domestic product (GDP), Gross National product
(GNP), the per capita income, level of industrialization, amount of widespread
infrastructure and general standard of living, which criteria are to be used and
which countries can be classified as being developed are subject of debate.
Economic criteria have tended to dominate discussions. One such criterion
is income per capita; countries with high gross domestic product (GDP) per capita
would thus be described as developed countries. Another economic criterion is
industrialization, countries in which the tertiary and quaternary sectors of industry
dominate could thus be described as developed. More recently, another measure,
the Human Development India (HDI) which combines an economic measure,
national income, with other measures, indices for life expectancy and education
has become prominent. This criterion would define developed countries as those
with a very high (HDI) rating. The index however, does not take into account
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Approaches to Economic several factors, such as the net wealth per capita or the relative quality of goods in
Development
a country. This situation tends to lower the ranking for some of the most advanced
countries. Such as the GT members and others.
A developed country is a nation that offers economic security and a high
NOTES
quality of life to its population.
Features of a Developed Country
The following are the basic features of a developed country:
1. High gross national income per capita: A high per capita income is
calculated as economic output of a nation divided by its population. It should
be noted that in some countries this number is heavily influenced by a small
number of individuals who hold significant wealth.
2. Good Health: Access to modern health care often measured with average
life expectancy under under-five mortality rates. This is developed countries
is higher.
3. Education: Access to education often measured as the percentage of the
population who complete a minimum number of years of school. This
percentage is high in developed countries.
4. Industrialization: An industrialized nation is a country with a large
manufacturing sector. Historically, development and industrialization where
virtually synonymous. A developed economy is thereby considered to be
one that is industrialized.
5. Service Economy: Service economy is a nation’s output of services. For
example, travel, restaurants, software and business services. Developed
nations are experiencing a shift whereby services are increasing important
to economic output.
6. Knowledge Economy: The knowledge economy is the development of
valuable knowledge such as processes, procedures, methods, designs,
formulations and software. This includes creative outputs such as an
advertising campaign that generates feelings for a brand. It is possible that
highly developed nations of the future will mostly shift to services and
knowledge economy and industrial production will be viewed as a smaller
part of the world’s economic output.
7. Infrastructure: Soft infrastructure such as public institutions and hard
infrastructure such as bridge. Infrastructures makes a nation more productive,
efficient, stable and attractive to labour and capital. As such, it is one of the
primary advantages that highly developed nations have over developing
countries.
8. Stability: Another condition for economic prosperity is political, economic
and social stability. This includes physical and information security such as a

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 public health care and pension system shelters people and give them room Approaches to Economic
Development
to pursue the knowledge and experimentation required to innovate.
9. Quality of Life: As the world becomes most economically prosperous,
competition between nations is shifting towards the happiness of people.
NOTES
All else being equal, a nation with clean air is considered more developed
than a nation with polluted air. This is usually captured as a measurement
known as quality of life, that is based of asking a population if they are
happy, quality of life is an economic advantage in a knowledge economy
where global competition for talent can be intense. In many cases, talented
individuals will avoid work in a polluted, dangerous unsightly or uninteresting
city
What is an underdeveloped Economy?
The term underdevelopment refers to that state of an economy where level of
living masses are extremely low due to very low levels of productivity and high
growth rates of population.
Thus, developing country or less developed country, less economically
developed country (LEDC) or underdeveloped country, is a country with a less
developed industrial base and a low Human Development Index (HDI) relative to
other countries. However, this definition is not universally agreed upon. There is
also no clear agreement on which countries fit this category. A nation’s GDP per
capita compared with other nations can also be a reference point.
Features of Developing Economics
Developing countries tend to have some features in common. These characteristics
are as follows:
 Low income and general poverty
 Existence of underdeveloped natural resources
 Primary producing countries
 Existence of over population
 Low expectation of life
 Higher proportion of population in younger age-group
 Backward Human Resources
 Technological Backwardness
 Foreign Trade orientation
 Unfavourable institutional structure

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Approaches to Economic
Development
Check Your Progress
1. What are the terms used for developed, communist and underdeveloped
NOTES countries?
2. Mention the most common criteria for evaluating the degree of economic
development.
3. What does HDI not into account?
4. Define knowledge economy.

7.3 DIVERSITY AMONG DEVELOPING COUNTRIES

It is difficult to generalize 160-member countries of the United Nations (UN) that

constitute the third world. While all are almost poor in money terms, they are
diverse in culture, economic condition and social and political structures.
(i) World Bank Classification
The most common way to define a developing world is by per capita income.
Several international agencies including the Organization for Economic Cooperation
and Development (OECD) and the United Nations have classified development
countries by their economic states. The best known system is offered by the
International Bank for Reconstruction and Development (IBRD), more commonly
as the World Bank Classification. According to this classification system, economies
with a population of at least 30,000 are ranked by their levels of 2008 Gross
National Income (GNI) per capital. On the basis of this criterion, economies are
classified as low income (LIC), Lower-middle income (LMC), Upper middle
income (UMC), high income OECD and other high-income countries.
Income group classified according to the 2008 GNI per capita, Low-income
countries are defied by the world Bank as having a per capita gross national income
(GNI) of $975 or less, lower middle income countries are (LMCs) have incomes
between $976 and $3856 and $11,905 and high-income countries have incomes
of $11,906 or more. This classification has been shown in Table 7.1 sometimes a
distinction is made among upper-middle income economics, that have relatively
achieved advanced manufacturing sectors and are designated as newly industrialized
countries (NICs). These include eleven countries namely, Argentina, Brazil, Greece,
Hong Kong, South Korea, Mexico, Portugal, Singapore, Spain, Taiwan and
Yugoslavia. This table includes a few countries grouped as ‘other high income
economies’ have developed export sectors. But significant part of their population
remains uneducated, unemployment with low per capita income or in poor health.
Oil exporting countries such as Kuwait, Qatar and United Arab Emirates (UAE)
fall in this category.

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 Another way of classifying the developing countries is based on their degree Approaches to Economic
Development
of classifies the countries as severely indebted, moderately indebted and less
indebted.
(ii) OECD Classification NOTES
Organization for Economic Cooperation and Development (OECD) classification
and some other UN agencies offer a separate category for the member of the
Organization of Petroleum Exporting countries (OPEC). OPEC includes low
income countries such as Nigeria and Indonesia, middle-Income countries (MICs)
like Ecuador and Gabon. Even a few high income OECD and other high-income
countries.
(iii) UNDP Classification
Another way of classifying the developing countries has been suggested by United
Nations Development including health and education attainments. Because of its
great importance, Human Development Index (HDI) has been evolved all the
countries with in the range of O (lowest HDI) and 1 (highest HDI) and is based on
the three goals of development: (1) Longevity, measured by the life expectancy of
birth (ii) knowledge, measured by adult literacy (two-third) and schooling (one-
third), (iii) Standard of living, measured by real per capital income. These are main
components of HDI.
Physical size and Income Level: The physical size population and income
levels are the important variables which distinguish one developing country from
another. There are countries with large population like India, Brazil, Egypt and
Nigeria existing side by side with small countries like Nepal, Jordan, Chad and
Paraguay. Out of 160 developing countries that were full members of the United
Nations in 2000, 87 had fewer than 5 million people, 58 had fewer than 2.5
million and 38 had fewer than 5,00,000. Large size usually is a mixed blessing. A
large country gains certain advantages of diverse factor endowment, large potential
markets, and lesser foreign dependence. It also faces certain problems of national
integrations, regional imbalances, administrative control. A small country too enjoys
certain advantages and faces problems. More over the size of the country is not
necessarily related with the level of income. For example, in 2000 India with a
population of over one billion had an average per capita income level of 460
dollars whereas Singapore with only 4 million people had per capita income of
24,740 dollars. Table 7.2 illustrates the point by listing ten most and least populated
countries in 2005 and their respective per capita income.

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Approaches to Economic Table 7.1 Classification of Economies by Region and Income, 2007
Development

East Asia and the Jamaica LMC Rwanda LIC

pacific
NOTES American UMC Mexico UMC São Tomé and LIC
Samoa Pŕincipe
Cambodia LIC Nicaragua LMC Semegal LIC
China LMC Panama UMC Seychelles UMC
Fiji LMC Paraguay LMC Siera Leone LIC
Indonesia LMC Peru LMC Somalia LIC
Kiribati LMC St. Kitts and UMC South Africa UMC
Nevis
Korea, Dem. LIC St. Lucia UMC Sudan LIC
Rep.
Lao PDR LIC St. Vincent and UMC Switzerland LMC
the Grenadines
Malaysia UMC Suriname LMC Tanzania LIC
Marshall LMC Trinidad and LMC Togo LIC
Islands Tobago
Micronesia, LMC Uruguay UMC Uganda LIC
Fed. Sts.
Mongolia LIC Venezuela, RB UMC Zambia LIC
Myanmar LIC Middle East and North Zimbabwe LIC
Africa
Northern UMC Algeria LMC High Income OECD
Mariana Countries
Islands
Palau UMC Djibouti LMC Australia
Papua, New LIC Egypt, Arab LMC Austria
Guinea Rep.
Philippines LMC Iran, Islamic LMC Belgium
Rep.
Papua, New LIC Egypt, Arab LMC Austria
Guinea Rep.
Samoa LMC Iraq LMC Canada
Solomon LIC Jordan LMC Denmark
Islands
Thailand LMC Lebanon UMC Finland
Timor-Leste LIC Libya UMC France

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 Approaches to Economic
Tongo LMC Morocco LMC Germany Development
Vanuatu LMC Oman UMC Greece
Vietnam LIC Syrial Arab LMC Iceland
Republic NOTES
Europe and Central Tunisia LMC Ireland
Asia
Albania LMC West Bank and LMC Italy
Gaza
Armenia LMC Yemen, Rep. LIC Japan
Azerbaijan LMC South Asia Korea, Rep.
Belarus LMC Afghanistan LIC Luxumberg
Bosnia and LMC Bangladesh LIC Netherlands
Herzegovina
Bulgaria LMC Bhutan LIC New Zeland
Croatia UMC India LIC Norway
Czech UMC Maldives LMC Portugal
Republic
Estonia UMC Nepal LIC Spain
Gergia LMC Pakistan LIC Sweden
Hungary UMC Sri Lanka LMC Switzerland
Kazakhstan LMC Sub-Saharan United
Africa Kingdom
Kyrgyz LIC Angola LMC United States
Republic
Latvia UMC Benin LIC Other high
Economics
Lithuania UMC Botswana UMC Andorra
Macedonia, LMC Burkina Faso LIC Antigua
FYR Barbuda
Maldova LMC Burundi LIC Aruba
Poland UMC Cameroon LMC Bahamas, The
Romania LMC Cape Verde LMC Bahrain
Russian UMC Central African LIC Bermuda
Federation Republic
Serbia and LMC Chad LIC Brunei
Montenegro Darussalam
Slovak UMC Comoros LIC Cayman
Republic Islands

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Approaches to Economic
Development Tajikistan LIC Congo, Dem. LIC Channel
Rep. Islands
Turkey UMC Congo, Rep. LMC Faeroe Islands
NOTES Turkmenistan LMC Côte d’Ivoire LIC French
Polynesia
Ukraine LMC Educational UMC Greenland
Guinea
Uzbekistan LIC Eritrea LIC Guam
Latin America and the Ethiopia LIC Hong Kong,
Caribbean China
Argentina UMC Gabon UMC Isle of Man
Barbados UMC Gambia, The LIC Israel
Belize UMC Ghana LIC Kuwait
Bolivia LMC Guinea LIC Liechtenstein
Brazil LMC Guinea-Bissau LIC Macao, China
Chile UMC Kenya LIC Mata
Colombia LMC Lesotho LMC Manaco
Costa Rica UMC Liberia LIC Netherlands
Antilles
Cuba LMC Madagascar LIC New
Caledonia
Dominica UMC Malawi LIC Puerto Rico
Dominican LMC Mali LIC Qatar
Republic
Ecuador LMC Mauritania LIC San Marino
El Salvador LMC Mauritius UMC Saudi Arabia
Grenada UMC Mayotte UMC Singapore
Guatemala LMC Mozambique LIC Slovenia
Guyana LMC Namibia LMC Taiwan, China
Haiti LIC Niger LIC United Arab
Emirates
Honduras LMC Nigeria LIC Virgin Islands
(US)

Source: World Bank data

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Table 7.2 The ten most and least populated countries and their per capita Income, 2005 Approaches to Economic
Development

Most Population GNP Per Least Population GNP Per

populous (Millions) Capita Populous (Thousands) capita
(U.S. $) (U.S. $) NOTES
1. China 1,305 1,740 1-Palau 20 7,670
2. India 1,095 730 2-Saint Kitts 48 7,840
and Nevis
3.United States 296 43,560 3-Marshall 63 2,930
Islands
4. Indonesia 221 1,280 4-Domica 72 3,800
5. Brazil 186 3,550 5-Antigua and 83 10,500
Barbuda
6. Pakistan 156 690 6-Seychelles 84 8,180
7. Russia 143 4,460 7-Kiribati 99 1,210
8.Bangladesh 142 470 8-Tongo 102 1,750
9. Nigeria 132 560 9-Grenada 107 3,860
10. Japan 128 38,950 10-Micronesia 110 2,300

Historical background of third world countries has not been uniform. Most
countries of Africa and Asia remained under the colonial rule of west European
countries primarily Britain and France. The economic structures, educational
patterns and social institutions were influenced by the policies of colonial rulers.
Moreover, the countries of Africa which got their independence in 1950s and
1960s were more concerned with the consolidation of their economic and political
structures than the rapid industrialization. The policies of such countries were
influenced by the economic and political issues. In contrast, the countries of Latin
America have a long history of political independence together with common
colonial heritage (Is Spanish and Portuguese). Despite geographical and
demographic diversity, these countries have similar economic and social institutions
and also face similar problems. Such a similarity is not found in the countries of
Asia as they have been under different colonial heritage. For example, India and
Pakistan have been under the British rule, Laos under the French and Indonesia
under the Dutch rule. Educational patterns, social and institutional systems ae also
diverse in these countries.
Resource Endowments: The economic growth and strength of any country
depends upon physical resource endowments (such as minerals, raw materials,
power etc.) and human resources endowments (quantity and quality of man power).
In the world countries there are extreme cases of resource endowments. For
example, the Persian Gulf states virtually enjoy monopoly in Civil and Latin
American countries Brazil and Chile which are rich in minerals. On the other extreme
are countries like Bangladesh, Togo and Laos where resource endowments of oil
and minerals are relatively small and even negligible. Self-Instructional
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Approaches to Economic In the realm of human resource endowments, not only sheer numbers of
Development
people and their skill levels are important but also are their cultural outlooks altitude
towards work access to information willingness to innovate and desire for self-
improvement. More over the level of administrative skills will often determine the
NOTES ability of the public sector to alter the structure of production and the time in which
such structural alteration can occur. Here one gets involved with the whole complex
of interrelationship between culture, tradition, religion ethnic and tribal fragmentation
for cohesion. Thus, the nature and character of a country’s human resources are
important determinants of its economic structure and these clearly differ from one
country to the other.
Relative Importance of public and private sectors: Most developing economies
have mixed economic systems featuring both public and private ownership and
use of resources. The division between the two and their relative importance are
mostly a function of historical and political circumstances. Thus, in general, Latin
American and south east Asian nations have larger private sectors than South
Asian and African nations. The degree of foreign ownership in private sector is
another important variable to consider when differentiating among LDCs. A large
foreign-owned private sectors usually creates economic and political opportunities
as well as problems not found in countries where foreign investors are less prevalent.
Often countries like those in African with severe shortage of skilled human resource
have tended to put greater emphasis on public-sector activities and state run
enterprises on the amputation that limited skilled manpower can be best used by
coordinating rather than fragmenting administrative and entrepreneurial activities.
The widespread economic failure and financial difficulties of many of these public
concerns in countries such as Ghana, Senegal, Kenya and Tanzania raise questions
about the validity of this assumption. As a result, these and other American countries
have moved in recent years toward less public and more private enterprises. The
most dramatic examples are found in the 15 countries of former Soviet Union and
other once centrally planned economies, which have privatized a majority of their
state-owned economies. Economies policies, such as those designed to promote
more employment, will naturally be different for countries with large public sectors
and once with sizable private sectors. The economies with public sector would
forces on direct government invest projects and rural work program, whereas
private oriented economies would go in for induced investment economies would
go in for induced investment ventures. Finally, the degree of corruption differs
widely across developing countries and may influence both the size of public sector
and the design of privatization program.
Industrial Structure: Most of the third world countries are agrarian in character.
Agriculture is not only a means of subsistence, but it is the principal activity of vast
majority of the people of Asia, Africa and Latin America. In these countries the
agrarian systems and patterns of land ownership quietly differ, but the margins
problems are somewhat similar. Recording industrial structures, a wide variation
exists in the manufacturing and service sectors. Of late; however small in relation
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to its large publication Table 7.3 provides the information regarding the distribution Approaches to Economic
Development
of labour force in agriculture, industry and services sectors. Table 7.3 show the
structure of employment of men and women and value added in the agricultures,
industrial and service sectors, in developed countries, agriculture represent a very
small share of employment and output in U.S.A. and U.K. The share of employment NOTES
in industry in these two countries is actually smaller now than in some developing
countries. However, is the most African and Asian countries agriculture still provide
a substantial share of employment. In Latin America the share of agriculture
employment is smaller but still substantial. With lower industrialization, developing
nation have tended to have a higher dependence of primary exports. Most
developing countries particularly on relative small number of agricultural and mineral
exports. In spite of common problems, the development strategies may vary from
country to country depending upon the degree of independence among its primary,
secondary and tertiary sectors.
Table 7.3 Share of the Population Employed in the Industrial Sector in Selected
Countries, 2000-2005 (%)

Agriculture Industry Services

Males Females Share Males Females Share Males Females Share

Africa
Egypt 28 39 15 23 6 46 49 55 39

Ghana 60 50 38 14 15 23 27 36 39

Madagascar 77 79 28 7 6 16 16 15 56

South 13 7 3 33 14 30 54 79 67
Africa
Uganda 60 77 33 11 5 25 28 17 43

Asia
Bangladesh 50 59 20 12 18 27 38 23 53

Indonesia 43 45 13 20 15 46 37 40 41

Malaysia 16 11 9 35 27 52 49 62 40

Pakistan 38 65 22 22 16 25 40 20 53

South 7 9 3 34 17 40 59 74 56
Korea
Philippines 45 25 14 17 12 32 39 64 53

Thailand 44 41 10 22 19 44 34 41 46

Vietnam 50 60 21 21 14 41 23 26 38

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Approaches to Economic
Development
Latin America
Colomibia 32 8 13 21 16 34 76 53

Costa Rica 21 5 9 26 13 30 82 62
NOTES
Mexico 21 5 4 30 19 26 76 70

Nicaragua 43 10 19 19 17 28 52 53

Developed Countries
Untied 2 1 1 33 9 26 65 90 73
Kingdom
United 2 1 1 30 10 22 68 90 77
States
Source:World Bank, World Development Indicators, 2007 (Washington, D.C. World Bank,
2007), tabs. 2.3 and 4.2.
External dependence: The vast majority of the developing countries are dependent
on external force and their dependence on developed countries is substantial. In
some case the foreign forces touch every fact of life, almost all developing countries
are depend on foreign capital, foreign goods and services. These external forces
influence the consumption pattern, the people in third world countries. The country’s
ability to chalk out its economic density largely depends on the degree of
dependence on external forces.
Political structure: Political structure is another factor differentiating developing
countries. The political structure has largely been determined by the vast countries.
These groups are small but powerful segments of the population and have shaped
the economic, social and political structure the third world countries. The developing
countries have been ruled directly or indirectly by these small and powerful vested
interests to a greater extent than are the developed nations. Todaro’s analysis is
comprehensive in treatment and is based upon statistical facts and ground realities.
It makes a comparison of diversities prevailing in developing countries of Asia,
Africa and Latin America. This analysis correctly depicts the diverse nature of
developing economies.
Conclusion
Despite the obvious diversity most developing nations share a set of common and
well defined goals. These include a reduction in poverty, inequality, and
unemployment, the provision of basic education, health, housing and food of every
opportunity, and the forging of cohesive nation. States related of these economic
social and political goals are hampered by serious and worsening environment
decay, antiquated and inappropriate educational technologies, institute and value
system. Even with these weaknesses. There is so much that developing countries
can do trough appropriate policy strategies to speed up economic and social
progress.
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 Approaches to Economic
Development
Check Your Progress
5. What is World Bank’s classification of economies?
6. What are the endowments on which the economic growth and strength of NOTES
a country depends?

7.4 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. Economists often use the terms, first world, second world, and third world
for the developed, communist and underdeveloped economies respectively.
2. Most commonly, the criteria for evaluating the degree of economic
development are gross domestic product (GDP), Gross National product
(GNP), the per capita income, level of industrialization, amount of
widespread infrastructure and general standard of living, which criteria are
to be used and which countries can be classified as being developed are
subject of debate.
3. HDI index does not take into account several factors, such as the net wealth
per capita or the relative quality of goods in a country.
4. The knowledge economy is the development of valuable knowledge such
as processes, procedures, methods, designs, formulations and software.
5. As per World Bank’s classification, economies are classified as low income
(LIC), Lower-middle income (LMC), Upper middle income (UMC), high
income OECD and other high-income countries.
6. The economic growth and strength of any country depends upon physical
resource endowments (such as minerals, raw materials, power etc.) and
human resources endowments (quantity and quality of man power).

7.5 SUMMARY

 A developing country (or a low and middle income country) less developed
country, less economically developed country or under developed country
is a country with a less developed industrial base and a low human
development index (HDI) relative to other countries.
 The Term developing describes a currently observed situation and not a
changing dynamic or expected direction of progress.
 Developing countries tend to have some characteristics in common. For
example, with regards to health risks, they commonly have: low levels of
access to safe drinking water, sanitation and hygiene, energy poverty, high
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Approaches to Economic level of pollution, high proportion of people with tropical and infectious
Development
diseases, high number of road traffic accidents often there is also widespread
poverty, low education levels and a lack of so-called good governance.
Effects of global warming (climate change) are expected to impact
NOTES developing countries more than wealthier countries, as most of them have a
high climate vulnerability.
 Developed countries are the countries that enjoy certain high standards.
Such countries generally have a good infrastructure stable economy with
very high per capita income. The degree of development industrialization
and generally standard of living for its citizens is very high. In developed
economies the service sector generally generates more wealth than the core
industrial sector. The exports of a developed economy are very robust.
 There are other non-economic factors as well that play a crucial role in
making a country a developed one. The Human Development Index (HDI)
is one of the most important parameters. HDI reflects the relative level of
education that is prevalent, literacy rate and availability Health care services.
Due to this, the life expectancy of the citizens of these developed countries
is more. The birth rate and death rate of such countries is less. The population
burden on the infrastructure of such countries is less that helps in better
chances of a good life style.
 Developed countries generally have a stronger base of skilled work force
that earns descent wages which are generally higher than their counter parts
in developing nations.

7.6 KEY WORDS

 GDP (Gross Domestics Product): The market value of all officially

recognized final goods and services produced within a country in a given
period.
 Under development: It implies a low level development compared to the
developed countries of the world. They typical indicators of development
is: per capita income, literacy rate, life expectancy etc. are found to be
floating at their base level, implying a poor quality of life.
 Birth rate: Birth rate is the term used to define the number of babies born
every year per 1000 people in a population.
 Death rate: Death rate is the term used to define the number of death
every year per 1000 people in a population.

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 Approaches to Economic
7.7 SELF ASSESSMENT QUESTIONS AND Development

EXERCISES

Short Answer Questions NOTES

1. What is the meaning of quality of life?

2. How does the Organization for Economic Cooperation and Development
work?
3. State the relative importance of public and private sectors in developing
and developed countries.
4. How is political structure a differentiating factor in developing countries?
Long Answer Questions
1. What are the main characteristics of a developing economy? To what extent
are they found in Indian Economy?
2. Explain the main features of an underdeveloped economy.
3. What is an underdeveloped economy? Discuss the main features of an
underdeveloped economy.
4. Write a long essay on underdeveloped countries.
5. Distinguish between a developed and underdeveloped economy.
6. What are the criteria for classifying economies as developed and
underdeveloped?
7. Define developed countries. What are the common characteristics of these
countries?

7.8 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press. Self-Instructional
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Development Strategies - I

UNIT 8 DEVELOPMENT
STRATEGIES - I
NOTES
Structure
8.0 Introduction
8.1 Objectives
8.2 The von Neumann Growth Model and Modifications
8.3 Answers to Check Your Progress Questions
8.4 Summary
8.5 Key Words
8.6 Self Assessment Questions and Exercises
8.7 Further Readings

8.0 INTRODUCTION

John von Neumann was a renowned mathematician, physicist and computer

scientist. His contributions are immense in these fields. In economics, his contribution
was in the form of his growth model which is said to be based on the game theory.
The development strategy presented by him is considered to have been a watershed
movement to separating the classical and newer models. In fact, formalism as a
movement too has gained much from his growth model theory. Neumann model is
also known significantly for providing a theorem to explain equilibrium. In this unit,
we will have a look at development strategies in economics through Neuman’s
growth models and modifications.

8.1 OBJECTIVES

After going through this unit, you will be able to:

 Discuss the von Neumann Growth Model
 Explain the Neumann theorem

8.2 THE VON NEUMANN GROWTH MODEL

John von Neumann works with the theory that equilibrium of the economy expands
at a uniform rate. For this he makes several assumptions to ensure the equilibrium
including: constant returns to scale; pure and perfect competition; no consumption
from producers who save the totality of their income and unlimited quantities of
goods available through the productive process (this applies to land and labour,
no primary factors existing in the model). The von Neumann growth model is
defined by a technology of the standard activity analysis with an output matrix B
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and an input matrix A. It is assumed that every good in the system is the output of Development Strategies - I

some activity and that every activity requires some good in the system as an input.
It can be viewed as a closed model in which even labour is produced by an
activity, using consumer goods as inputs or as an open model in which labour is
never scarce and no activity has labour as its only input. NOTES
We shall make use of the idea of indecomposable as applied to this system.
The system (B, A) is said to be indecomposable, if there is no subset of goods
which can be produced without using at least one input not in the subset. The
decomposability of the system depends on the relationship between the zero in
the B and A matrixes. Von Neumann’s original assumption was that the place (I, j)
was occupied by a non zero in either the B or the A matrix, a very strong assumption
that rules out may interesting economic models.
We shall construct a simple growth model by assuming that the activities
y(t) require the whole of the time period to produce their output, so that the inputs
have to be in existence at the commencement of the perish.
Because of the possibility of joint outputs, the von Neumann model is
particularly adapted to a true capital model with depreciation by use, as opposed
to invert or external capital models. Consider, for example simple model with two
capital goods, both in the production of either. We suppose that either type of
capital is part out after one use, completely worn out after two uses. Four goods
in the system as follow;
x1; New type capital
x2; Once used type I capital
x3; New type II capital
x4; Once- used type II capital
Then an activity using new capital will give an output of used capital of the
same kind jointly with its new product. If one used capital is an input, it does not
reappear.
Such a model would have a technology of the following kind, where the first
four activities producing new type I capital are shown:

 b12 b12 b13 b14  1 1 0 0 

   
 1 1 0 0  0 0 a23 a24 
B=  0 0 0 0 ,A= 1 0 1 0 
   
 1 0 1 0   0 a42 0 a44 

This kind of capital model can not be developed unless joint products are
permitted.
the basic constraints of the von Neumann are therefore,
Ay  t   B y  t  1 y  t  , y  t  1  0

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Development Strategies - I we are interested in the balanced growth mode of the model, with y(t – 1)
= y(t). We are dating of y and investigate the following problem the technological
expansion problem.
Find a positive or which is a maximum subject to the constraints.
NOTES
Ay  By , y  0

This is a nonlinear problem since , y, both unknown, appear multiplied

together in the constraint. To show that we can find a positive  and that this A a
maximum, write the constraints in the form
 B  A y  0, y 0

Since By >> for some y  0 (because every good is the output of some
activity, we can find some positive a small enough to satisfy the constraints.
On the other hand,  is bounded and so has a maximum since, by making it
large enough, we can make (B – A)y contain at least one negative element for
every y 0.
We shall denote the maximum value of by and the associate vector y
by y*.
The real insights into the working of this model are obtained by setting up a
dual problem, the interpretation of which will be apparent later.
Find *, P* such that * is the minimum of all ’s which satisfy
 p A  PB , P  0

We can use the same kind of arguments as, those used for the primed
problem to convince ourselves that  has a minimum which is positive.
We shall now show that   * .
It is clear that (B – *A) y >> 0 has no non-negative solution since, if it has,
we could increase *, contradicting its maximum property. Using a property of
linear inequalities, we can therefore assert that P  B     0 has a semi-positive
solution. It follows that, since  * is the minimum of all ’s satisfying P  B  A  0
for P 0 we have  *   * .
Using the materials we have assemble we are now ready to stats and prove
the following fundamental theorem.
Von Neumann Theorem: For the model defined by the technology (B, A) in
which every good is the output of some activity and every activity requires some
good as input, there exist semi-positive vectors y, P and a positive scalar Y such
that:

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 Development Strategies - I
(a) AY  BY ; (b) PA pB ; (c) P  A  B  y  0 ; and (d) *** the technology
(B, A) is indecomposable, g has a unique value *   *  * , where * and *
are as defined earlier.
NOTES
Result (c), which implies that if Ai  P then P1 = 0 or if Ai  PB i then yj = 0
has a resemblance to the equilibrium theorem of linear programming which should
be noted.
To prove the theorem, put  *    * , which is possible since  *  * .
Then , along with the vectors y*, p* associated with *, * certainly satisfy (a)
and (b).
To prove (c), we have PB PA and since y  0, this implies PBy  PAy , so
that we must have PBy = PAy or P(y .
In the general case any value of  between  is a solution, and there will
usually be vectors P, Y other P* and Y* are semi-positive.
 * P * Ay *  P * By *  & P & Ay *

So that  *  * P * AY *  0 .

If we can show that P* AY* > 0, then we will have shown that  *   * . But
we have already shown that *  *, so this will imply that * = *.

It is obvious that Bi Y *  0 for every I and that Biy*>= 0 for at least one I
sine Y* is semi-positive and every good appears as the output of some activity.
Suppose that we had BiY* = 0 for some i. Since BiY *   * AiY * for all I we could
only have BiY* = 0 if we also had AiY* = 0. This would imply that activity vector
Y* neither produced nor used good i and therefore that all gods other than i
formed an independent subset. Thus if the system is indecomposable, we must
have Y* << 0 and since P*  0, P* Y* > 0. But  * P * AY *  P & Y * and *
> 0, so that P*AY* > 0.
This if the system is indecomposable A = * so that result (d) of the
theorem is proved.
We can interpret the theorem, for the indecomposable case, in the following
way.
From (a), the output of each good is at least equal to Y* times the input of
that good, which is assumed not greater than its output in the previous period.
Thus the output of every good is growing at rate at least 1 – 1. From (c) any good
whose output is growing a rate greater than Y* - 1 will have a zero price. All good
with positive prices will have the same growth rate, Y*.

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Development Strategies - I From (b), the proceeds from operating any act at unit level are less than or
equal to Y* times the cost of the input used, at the equilibrium prices. P*S process
one period earlier, Y* - 1 can be regarded as “shadow” interest rate or rate of
return on investment. From (c), no activity which at the equilibrium price fails to
NOTES give the shadow rate of return will be used. All activities actually used will give the
same rate of return Y* - 1.
Although we have examined only the dynamically simple balanced growth
model – the general idea which emerge from analysis of Von Neumann model are
fundamental to the general theorem of growth in a multi-sector economy.
A simple input-output technology, with B = I and A square, could be treated
as a special case of the Von Neumann model. In this case we would have * = 1/
*, where * is the dominant root of the semi-positive square matrix A, while Y*,
P* would be the associated column and row characteristics vectors (sometimes
called the right and left hand eigenvectors). Otherwise the analysis would basically
the same.

Check Your Progress

1. State the factor on which the decomposability of the system depends in the
von Neumann growth model.
2. Mention the reason because of which the von Neumann model is particularly
adapted to a true capital model with depreciation by use.

8.3 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. The decomposability of the system depends on the relationship between

the zero in the B and A matrixes.
2. Because of the possibility of joint outputs, the von Neumann model is
particularly adapted to a true capital model with depreciation by use, as
opposed to invert or external capital models.

8.4 SUMMARY

 The von Neumann growth model is defined by a technology of the standard

activity analysis kind with an an output matrix B and an input matrix A. It is
assumed that every good in the system is the output of some activity and
that every activity requires some good in the system as an input.
 It can be viewed as a closed model in which even labour is produced by an
activity, using consumer goods as inputs or as an open model in which
labour is never scarce and no activity has labour as its only input.
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130 Material
  The system (B, A) is said to be indecomposable, if there is no subset of Development Strategies - I

goods which can be produced without using at least one input not in the
subset.
 The decomposability of the system depends on the relationship between
NOTES
the zero in the B and A matrixes. Von Neumann’s original assumption was
that the place (I, j) was occupied by a non zero in either the B or the A
matrix, a very strong assumption that rules out may interesting economic
models.
 Because of the possibility of joint outputs, the von Neumann model is
particularly adapted to a true capital model with depreciation by use, as
opposed to invert or external capital models.
 Four goods in the system as follows:
o x1; New type capital
o x2; Once used type I capital
o x3; New type II capital
o x4; Once- used type II capital
 The basic constraints of the Von Neumann are therefore, we are interested
in the balanced growth mode of the model, with y(t – 1) = y(t).
 For the model defined by the technology (B, A) in which every good is the
output of some activity and every activity requires some good as input,
there exist semi-positive vectors y, P and a positive scalar Y such that:
(a) ; (b) ; (c) ; and (d) *** the technology (B, A) is indecomposable, g has
a unique value
 The general idea which emerge from analysis of Von Neumann model are
fundamental to the general theorem of growth in a multi-sector economy.
 A simple input-output technology, with B = I and A square, could be treated
as a special case of the Von Neumann model. In this case we would have
* = 1/*, where * is the dominant root of the semi-positive square matrix
A, while Y*, P* would be the associated column and row characteristics
vectors (sometimes called the right and left hand eigenvectors). Otherwise
the analysis would basically the same.

8.5 KEY WORDS

 Linear inequalities: It refers to an inequality which involves

a linear function.
 Decomposability: It is defined as an inequality measure such that the total
inequality of a population can be broken down into a weighted average of
the inequality existing within subgroups of the population and the inequality
existing between them.
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Development Strategies - I
8.6 SELF ASSESSMENT QUESTIONS AND
EXERCISES

NOTES Short Answer Questions

1. Why is the von Neumann model viewed as a closed model?
2. What is the assumption of the von Neumann growth model?
Long Answer Questions
1. Prove the von Neumann growth model theorem.
2. Interpret the theorem for indecomposable case.

8.7 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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 Development Strategies-II

UNIT 9 DEVELOPMENT
STRATEGIES-II
NOTES
Structure
9.0 Introduction
9.1 Objectives
9.2 The Choice of Goods and Techniques
9.2.1 Labour Intensive and Capital Intensive Techniques
9.2.2 Intermediate Technology
9.3 Answer to Check Your Progress Questions
9.4 Summary
9.5 Key Words
9.6 Self Assessment Questions and Exercises
9.7 Further Readings

9.0 INTRODUCTION

There has been a considerable controversy about the techniques of production

that should be adopted by under developed countries. Whether capital intensive
techniques will be more suitable to them or they should prefer labour intensive
techniques. These countries generally how a large manpower supply and suffer
from scarcity or capital scarcity of capital resources. They are faced with an urgent
problem of accelerating the rate of economic growth which requires a higher level
of productivity for which the use of modern capital intensive techniques is a must.
But their capacity for adopting capital intensive techniques severely limited due to
paucity of capital resources, inadequate supply of modern equipment and scarcity
of technical skills.
The labour intensive techniques of production is that which uses comparatively
larger amount of labour and smaller amount of capital on the other hand, the capital
intensive technique is that which uses comparatively larger amount of capital and
smaller of labour.
The choice of technique in a country is a different and complex problem.
Various factors are to be taken into consideration before deciding in favour of
labour or capital intensive technique and no simple rules can be laid down for such
a decision making.
The best way for these countries is to have such a combination of the methods
of production which could ensure a high rate of growth of income on the one hand,
and a rise in the level of consumption and employment on the other. Both types of
techniques can be used simultaneously. The capital intensive techniques should be
adopted in capital goods industries and the development of infrastructure while
labour intensive techniques should be adopted in agriculture and consumers goods
industries. Self-Instructional
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Development Strategies-II
9.1 OBJECTIVES

After going through this unit, you will be able to:

NOTES  Explain the problem of choice of techniques in LDCs
 Describe the labour-intensive technique
 Describe the capital-intensive technique
 Explain the intermediate and appropriate technique for LDCs
 Interpret the problems and suggestions related to choice of techniques

9.2 THE CHOICE OF GOODS AND TECHNIQUES

The choice of techniques is an area of economics in which the question of the

appropriate capital or labour-intensity of the method of the production of goods is
discussed.
9.2.1 Labour Intensive and Capital Intensive Techniques
One of the problems in front of the underdeveloped countries is how best to utilize
the available resources in order to accelerate the growth rate of the economy. The
majority of such countries have abundant labour but scarce capital. These two
major factors pose the problem of choice of technique – that of using the traditional
or the modern methods of production.
Meaning: The problem of choice of techniques refers to the type of combinations
for any particular project or enterprise. A combination chosen in particular case
gives the type of technique. The number of alternatives open to an under developed
country are between labour intensive and capital intensive techniques, b/w light
and heavy industries and between labour – intensive and capital intensive techniques.
“Different techniques often imply quite different strategies in economic development
with very different efforts on the performance of the economy.”
There is a great controversy on the question of choosing between labour
intensive and capital intensive technique in LDCs. All concerns differ to each other.
Some are in favour of labour intensive technique, while others advocate capital
intensive technique. The ultimate object is to choose that technique which is more
efficient that other technique keeping in view the existing factors proportions. An
efficient technique is one that minimizes the costs of a given output or maximizes
output from given inputs.
Process of Technological Development: For technological development, a
society has to pass through a long historical process – from simple to complex
techniques, from those satisfying local needs to those meant for distant markets
and from those using local resources to those requiring foreign capital. However
Kuznets traces some distinct patterns in the growth of technology: (i) a scientific
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134 Material
the use of already existing knowledge to useful end, (iii) an innovation implying a Development Strategies-II

significant application of an invention to economize production, and (iv) an

improvement, signifying a invention usually accompanied by improvements.
The successful completion of these successive phases in the evolution of
NOTES
technology requires four factors. First, there is the necessary condition of increased
scientific knowledge. Secondly, each phase requires heavy capital investments
and skilled labour force. Thirdly, innovations require entrepreneurial skill and ability
to put invention to beneficial uses. Lastly, the spread of innovation depends on the
willingness of the people to adopt the new product and processes for mass
production. Technological development is thus a necessary condition for economic
growth.
Labour-Intensive Techniques: Keeping these points in view, the problem of
choice of techniques boils down to one of adopting output – increasing techniques
that raises labour productivity per unit of capital and are capital light and labour
intensive. Fig 9.1 explains the impact of labour – intensive techniques on output.
Initially, output represented by the isoquant Q was being produced in the economy
by employing OK amount of capital and OL or labour. Now with the new technique
the same of capital OK helps in producing a larger output represented by a higher
isoquant Q1 and at the same time it uses more labour LL1. Such techniques should
also fulfill the twin objectives of skill and capital formation. Agricultural production
can be increased through the spread of minor irrigation schemes, better tools and
implements, the introduction of short duration crops leading to larger fields from
the same land; the use of fertilizers and high yielding seeds, etc. In India the
substitution of the fly-shuttle for the throw shuttle loom held to the increase in the
productivity of the hand-loom weaver by 50 percent. But if is not true that the
choice of more labour intensive techniques will necessarily lead to either more
consumption or greater employment over a period of time. The problem is one of
evaluating the time streams of consumption associated with the choice of alternative
techniques over the relevant time horizon. Moreover under developed countries
fail to use output – increasing labour intensive technique because of the limits set
by the shortage of capital and lack of skills.
Capital

R2
Capital

R1 Q2
K R
Q1
Q Q
O L L1 O L Labour
Labour

Fig. 9.1 and 9.2

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Development Strategies-II Capital Intensive Modern Techniques: The other alternative commonly
suggested is the use of capital – intensive techniques. Since under developed
countries are unable to follow the path of technological evolution of the advanced
countries they should use the technology of the latter on an extensive scale.
NOTES
Fig. 9.2 depicts the use of advanced technology which is capital – intensive.
It uses more capital OK in relation to labour OL. The level of output is higher in
this technique on the supposition that the isoquant Q2 is above R1 of fig 9.1. As
Galenson and Leibenstein opine: ‘Successful economic development…particularly
in the face of gross backwardness, lingers, largely upon the introduction of modern
technology upon as large a scale as possible’. For a ‘continuing and compounding
effect’ on the growth rate of income, advanced techniques are considered to be in
dispensable. Further, their use will help change customary working habits, living
conditions, social institutions and the very outlook of the people.
But the adoption of modern technology in under developed countries is a
very ticklish question and we should not forget Nurkse’s remarks that ‘the same
capital-intensity as in the economically advanced countries should be neither desired
nor permitted’. First, it is a matter of common knowledge that these countries
have a plethora of the unemployed and an acute shortage of capital. Modern
technology is, however, highly capital-intensive and labour-saving. It involves high
costs and excessively large amount of capital thereby making it unsuitable for
under-developed countries. Second, imports to plant and equipment are not only
costly but also entail a number of difficulties with regard to repair, maintenance
and availability of spare parts. A UN Report observes: ‘Automatic devices suited
to conditions in advanced industrial countries are often left unused in under-
developed countries, while the intricacy of many machines though appropriate to
the type of labour available in industrial countries, tends to magnify repair and
maintenance cost in factories in less developed countries which depend upon a
high proportion of unskilled labour’. As a result, the same equipment produces
less in such countries. It means in terms of our fig. 9.2 that the isoquant Q2 is at a
lower level. Third, heavy imports lead to balance of payments difficulties. And the
net addition to the national income accruing from the use of imported plant and
equipment is less, for a part of the income flows to the technique – exporting
country. Fourth, modern technology also requires complementary supplies of highly
and skilled, technical and managerial personnel not available in less developed
economies. Fifth, it is meant from the setting up of large enterprise whereas the
small size of the market in such countries necessitates the expansion of small
enterprises. In such a situation, write Bauer and Yamey, there is the danger of
confusing standards of technical efficiency with those of economic efficiency. There
is no use recommending techniques which may be efficient technically but are
wasteful in terms of resources and inappropriate at the level of technical achievement
of the local population. Sixth, modern technology was evolved under different
socio-economic and geographical set up. It is meant to accommodate labour
shortages and other requirements of an advanced country. it is appropriate to high
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real wages and a high standard to living. Seventh, the possibility of introducing Development Strategies-II

such technology will, however, depend on ‘technological spread’ – the gap

separating the techniques already in vogue in the less developed country and those
imported from abroad. The larger the gap between the local and the imported
techniques, the greater will be the social discontent and unrest following NOTES
industrialization through the introduction of advanced technology. Last, the adoption
of modern technology presupposes the existence of power, transport and
communications facilities of highly trained technical personnel and a large number
of related services which are non-existent in under developed countries. Under
the circumstances, the use of advanced technology will only result in repeated
breakdown in the machinery, lower production, increase in costs and wastage of
capital.
Use of Abandoned Techniques of Advanced Countries:
But the problem of economic development is concerned with change in factor
proportions and how rapidly they change. It depends on the time – period involved.
Capital light and labour intensive techniques might help in raising the level of output,
employment income during the short period to some extent. Development, however,
aims at their continuous maximization over the long period. The question is whether
an underdeveloped country should go slow or make rapid strides towards
developing its economy. Should it introduce modern technology or continue to use
backward methods of production or adopt obsolete techniques abandoned long
ago by the advanced countries? Taking the last question first, the other two having
been already discussed above, backward economies have frequently make use of
obsolete equipment and techniques of the advanced countries. The history of the
Japanese, textile industry reveals that it developed in its early phase on discarded
British machines. Israel and Argentina have also been importing used equipment
of the advanced countries. Though discarded machines are considered to be
somewhat cheap and of a lower capital intensity, they entail high cost in terms of
repeated breakdowns and constant repairs therefore, prudence demands that
developing countries should benefit from the vast fund of knowledge in the field of
technology of the advanced countries and modify and adapt the techniques of the
latter according to their social, economic and technical absorption capacity and
requirements. These requirements necessitate in the initial stage of development,
the adoption of labour-intensive and capital-saving techniques so that the limited
amount of capital available is broadly spread in utilizing larger human and other
resources.
9.2.2 Intermediate Technology
Professor Schumacher favours intermediate technology for LDCs. According to
him, if we define the level of technology in terms of ‘equipment cost per work
place’, the intermediate technology would be on the level of – symbolically speaking
£100 equipment cost per average work – place, whereas it is £1 for the indigenous
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Development Strategies-II technology of a typical developing country and £1000 – technology for the
developed countries. Such a technology necessitates regional approach to
development and requires four conditions for its success. First, work place should
be created in those areas where the majority of the people live and not in
NOTES metropolitan areas where they tend to migrate. Second, work place should be
cheap so that they can be created in the large numbers without requiring high level
of capital formation and imports. Third, methods of production should be fairly
simple, requiring low skills and suitable for maintenance and repair on the spot.
Fourth, production should mainly depend upon local materials and be mainly for
local use. Thus, the intermediate technology will be ‘labour-intensive’ and will be
suitable in small scale industries. Therefore, such a technology can be used to
produce only those commodities which are urgently needed by the people living in
rural areas.
Such commodities can be building materials, clothing, house old goods, agricultural
implements etc.
Appropriate Technology
There is, however, unanimity among economists over the choice of appropriate
technology. According to Yale Brozen, ‘The appropriate technology for an area
depends on its resources, patterns and its market’. It is, therefore, defined as ‘an
amalgam of skills, methods, techniques appliances and equipment that can contribute
towards solving the basic socio-economic problems of the concerned
communities’. It should be utilized for development purposes in the name of social
justice and should be capable of satisfying the felt needs of the people. It should
be economically viable, technically feasible, and should fit in the socio-economic
fabrics of local communities. It should be able to produce some surplus, so as to
encourage capital formation and stimulate further growth. It should be simple and
comparatively cheap and use local resources. It should ensure dispersal of wealth
among the largest number for people and create a sense of participation and decision
making at the local level. It should be capable of creating self-reliance and should
perpetuate the emotional attachment of the workers with their jobs, tools and
work places. It should encourage production by masses rather than mass
production. It should be ecologically sound and should be in complete harmony
and conformity with local, environments.
Dependence on non-renewable sources of energy should be able to absorb
innovation thus promoting to improve efficiency and productivity. In other words,
appropriate technology should be able to absorb innovation, thus promoting to
improve efficiency and productivity. In other words, appropriate technology should
change with the time, and people should accept improved & latest versions of it
that fit in the new environments. It should neither be based on traditional technology
nor reject modern technology.
In all advanced countries from the US to Japan, there are small industrial
units and agricultural areas where techniques and equipment of low capital-intensity
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are used. Efforts should be directed towards ‘choosing the simplest of such Development Strategies-II

alternative techniques, the sturdiest of available capital equipment, the small the of
plant consistent with technical efficiency, the technology that makes the best use of
the most plentiful factors of production, in certain case much simpler modern
techniques involving small capital may bring about large increments in output in the NOTES
case of small industries.’
Low cost high productivity equipment and machines can be imported from
advanced countries and their prototypes manufactured within the country with
indigenous skill and raw materials. It will serve the dual propose of skill and capital
formation. In the agricultural sphere, the use of power driven pumps, the Japanese
method of rice cultivation, high yielding maize hybrids and improved fertilizer can
go a long way in increasing productivity per workers. In the case of those
underdeveloped countries which have just started on the path of economic
development, it is better to adopt well-tried, capital-saving, labour-intensive
technology. For instance, India manufactures a large number of from implements
indigenously designed, such as the mechanical plough, animal driven. Ploughs of a
number of varieties, hand tools irrigation equipment, dairy and poultry farm
equipment which can fit in the factor proportions of similar country without any
difficulty.
This is nothing except appropriate technology, Vikal and Brahmanand also
favour this when they opine that each country has to work out its own salvation
and particularly find out which production methods are feasible for it. They
recommended the following techniques for use in underdeveloped countries: (a)
those which can be easily learnt in a short time; (b) those requiring small initial
investment; (c) those which reduce the gestation period of investment; (d) those
requiring less investment in specialized and skilled labour; (e) those saving scarce
resource rather than labour; and finally, those which raise the level of production
and increase supplies of minerals or electricity. These guidelines point towards the
use of appropriate technology in developing countries in keeping with their local
conditions.
As Henry Aubrey emphasizes, ‘It may be sound procedure to improve
technology step by step in many places at once, rather than to sink large portions
of a limited capital supply in a few large ventures’. The policy is advantageous in
many ways. It spreads the benefits accruing from the use of different techniques in
the various fields more equally over the entire population; helps in skill formation
at all levels; raises the average productivity income level and the size of market. It
promotes more employment, better distribution of wealth and paves the way towards
self-sufficiency.
The strategy of gradual change over from capital-light and labour intensive
methods of production to produce up-to-date capital-intensive method is best
suited to under-developed countries in the early stages of industrialization. Such a
policy will not economize the use of available capital resources but will also create
large employment opportunities. By increasing the supply of agricultural and Self-Instructional
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Development Strategies-II manufactured consumer goods, it will obviate the necessity of importing food and
raw materials. It will not be essential to import much capital goods either. Thus, its
strategy the choice of techniques will tend to check inflationary tendencies and
balance of payments difficulties inherent in the development process.
NOTES
Labour Intensive v/s Capital Intensive Techniques
A common characteristic of underdeveloped countries is the scarcity of capital
and abundance of labour. In other words, the capital labour ratio is extremely low.
Common sense tells us that in such countries, efficient production calls for labour
intensive techniques. But this is essentially a static argument. It is relevant to
conditions prevailing at a point of time. Therefore, this technique is not very suitable
for a developing country. As Dobb says, ‘It start from a given endowment of
capital in each country, whereas the crucial questions at issue in discussing policies
of economic development concerns change in the capital endowment of country
and how rapidly this capital endowment should be changed.’
Through Professor Nurkse holds the view that underdeveloped countries
should adopt labour intensive techniques of production in the early stages of
industrial development, majority of economists favour the adoption of capital
intensive techniques in such countries. Let us discuss the arguments advanced in
favour of either of these techniques.
Arguments for Labour-Intensive Techniques:
The arguments usually advanced in favour of labor-intensive techniques are the
following:
1. The first is the employment argument. A characteristic feature of
underdeveloped countries is the abundance of ideal manpower. It is only
by using labour intensive technique that increasing employment opportunities
can be provided to the idle or under employed labour force.
2. When employment increases through the adoption of labour intensive
techniques, ‘they spread the total income generated more widely over the
population.’ This powers the way for an egalitarian structure of society.
3. The third is the latent resources argument. In underdeveloped countries
there is an acute shortage of capital and entrepreneurial resources. The use
of labour-intensive techniques would be more appropriate for releasing these
score resources to be used in more important uses.
4. Similarly, labour-intensive techniques are import-light, i.e. they require
simpler tools and implements which need not be imported from abroad,
and thus there is considerable saving in foreign exchange.
5. Labour-intensive techniques are indispensable for counteracting inflationary
pressures in a developing economy. They quickly increase the supply of
consumable goods and thus obviate the danger of inflation.

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 6. The use of labour-intensive techniques is usually found in the villages and Development Strategies-II

small towns. This would mean considerable saving in the community’s

expenditure on social overheads in the initial stages of development which
could be utilized on more important projects.
NOTES
7. Moreover, labour-intensive methods, being spread out into villages and small
towns enjoy all the advantages of decentralization and avoid the evils of the
factory system.
8. The emergence of monopolies and concentration of economic power in the
hands of a few in also avoided.
Arguments for Capital-Intensive Techniques
It has been strongly argued that those investment projects should be chosen which
are capital-intensive rather than labour intensive. According to Galenson and
Leibenstein, ‘Successful economic development … particularly in the face of gross
backwardness, hinges largely upon the introduction of modern technology upon
as large a scale as possible.’ The grounds on which this argument is based are:
1. Enterprises using capital-intensive techniques lead to a large share of the
resulting income going to entrepreneurs and a smaller share going to wage
earners. Since the propensity to save is higher on the part of entrepreneurs,
savings increase and a large proportion of them are utilized for investment.
Thus, the rate of economic growth is accelerated.
2. As a corollary to this, we can say that since growth rate is much faster
under capital-intensive techniques that under labour-intensive techniques,
more employment will be offered to the labour force in the long run.
3. In the majority of underdeveloped countries, the growth rate of population
is very high and unless capital-labour ratio is raised, output per head will not
increase. This will tend to dampen the rate of capital accumulation. So, the
use of capital-intensive techniques is indispensable for increasing, the tempo
of development.
4. Further, capital poor countries can not afford to waste capital though
obsolescence, and depreciation. Under-developed countries should,
therefore, choose highly capital-intensive production techniques that do not
become obsolete soon. Thus, a small production of capital goods is required
to be replaced in the future and more capital is available for further capital
formation.
5. Capital-intensive processes of production are more profitable than labour-
intensive techniques because under the farmer productivity uses more rapidly
in relation to coats. This is due to the economies of large scale production
enjoyed by them.
6. In reality, the use of highly capital-intensive techniques leads to the production
of quality products and lowering of costs. Low costs mean low-price and
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Development Strategies-II provided the basis for a rapid rise in living standards later on. Professor
Hirschman opines: ‘The firm requirement of high standards of quality is an
element in favour of, rather than, as would usually be believed, against the
introduction of this type of production into underdeveloped countries.’
NOTES
7. Capital-intensive techniques have far-reaching effect on the process of
economic growth. A few capital-intensive projects have a greater total impact
on the economy that a number of labour-intensive projects. As Hirschman
points out: ‘When a government undertakes the construction of a large
hydro-electric station or of a steel mill, it cannot afford to let such ventures
go wrong, it places itself under a far stronger compulsion to deliver than if it
were to spend some funds on a large number of projects.’
8. Hirschman further argues that capital-intensive techniques are bound to
enhance skills and efficiency and assist in training management ‘in the
performance of new unfamiliar and perhaps some what uncongenial tasks.
Thus, capital intensive techniques possess the twin-property of ‘efficiency
enhancing and coordination – promoting.’
9. For providing economic and social overheads large capital investments our
essential in under developed countries.
Conclusion
We have studied both sides of the problem and it is rather difficult to decide as to
which technique should be adopted in an underdeveloped country. In fact, the
two approaches are not altogether different from each other. The use of labour-
intensive techniques tends to increase production and employment in the economy.
On the other hand, the adoption of capital-intensive techniques tends to accelerate
the rate of capital formation and then to maximize productive capacity and
employment in the long run. But in making a choice between labour and capital
intensive techniques in the context of an underdeveloped country, it is necessary
to consider a variety of factors: their comparative cost of production; effect on
employment, income, saving, and investment over different time periods; use of
domestic resources; effect on domestic and foreign demand; their ability to ease
inflationary pressures; and balance of payments position. The cost of production
of goods manufactured with labour-intensive methods is higher than that with capital-
intensive techniques because of the inability of the former to realize economies of
scale. But this fact should not deter the planners from deciding upon labour-intensive
techniques which economic on the use of scarce capital resources. Such methods
of production create large employment opportunities and help in increasing the
supply of consumer goods, obviate the necessity of impacting raw materials, food
and capital goods from abroad. Thus, they tend to check inflationary tendencies
and balance of payment difficulties inherent in the development process. But there
is a snag. Use of labour-intensive techniques cannot step up the rate of capital
accumulation as fast as that of capital-intensive techniques. No doubt, labour
intensive methods create more employment and thereby raise income levels, but
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of those whose incomes are low and propensity to consume is high. So a smaller Development Strategies-II

proportion of the incomes generated is available for saving and reinvestment. But
keeping in view the large interest of the masses, labour-intensive techniques should
be used in the consumer goods sector. For a ‘continuing and compounding effect’
on the rate of growth of income, capital-intensive techniques should be confined NOTES
to the capital goods sector.

Check Your Progress

1. Mention two advantages of capital intensive technique.
2. What do you mean by appropriate or intermediate technique.
3. Point out two advantages of labour-intensive technique.
4. Name two factors affecting choice of technique.
5. Give two suggestions to solve the problem of choice of technique in LDCs.

9.3 ANSWER TO CHECK YOUR PROGRESS

QUESTIONS

1. Two advantages of capital-intensive technique are:

(i) Quicker rate of Growth
(ii) Bulk Production possible
2. Technology that is suitable to the social and economic conditions of the
geographic area in which it is to be applied, is environmentally sound, and
promotes self-sufficiency on the part of those using it.
3. Two advantages of labour intensive technique are:
(i) Employment
(ii) Encouragement to collage industries.
4. Factors affecting choice of technique are: (i) factor endowment
(ii) Technological level already attained.
5. Suggestions to solve the problem of choice of technique are: (i) Co-ordination
of different Techniques (ii) Appropriate plants.

9.4 SUMMARY

 One of the problems facing the underdeveloping countries is how best to

utilize the available resources in order to accelerate the growth rate of the
economy. The majority of such countries have abundant labour but scarce
capital. These two major factors the problem of choice of techniques – that
of using the traditional or the modern methods or production.

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Development Strategies-II  The problem of choice of technique refers to the type of combinations for
any particular project or enterprise. A combination chosen in any particular
case gives the type of technique. The number of alternatives open to an
under developed country are between labour intensive and capital intensive
NOTES techniques.
 It is proposed that appropriate technologies are those technologies which
are appropriate for the promotion and maintenance is sustainable culture. A
developing country’s choice of an appropriate technology from among those
available for use in a particular industry is critical: alternative technological
strategies that involve varying mixes of capital, labour and social costs could
have significantly different impacts not only on the industry but also on the
country itself, especially one whose industrial base is restricted.
 The appropriate technology for an area depends on its resources, patterns
and its markets. It is therefore, defined as an amalgam of skills, methods,
techniques appliances and equipment that can contribute towards solving
the basic socio-economic problems of the concerned communities.
 It should be utilized for development purposes in the name of social justice
and should be capable of satisfying the felt needs of the people. It should be
economically viable, technically feasible and should fit in the socio-economic
fabrics of local communities. it should be able to produce some surplus, so
as the encourage capital formation and stimulate further growth. It should
neither be based on traditional technology nor reject modern technology.

9.5 KEY WORDS

 Choice of technique: It refers to the type of combinations for any particular

project or enterprise.
 Labour intensive technique: It refers to a process or industry that require
a large amount of labour to produce its goods or services.
 Capital-intensive techniques: It refers to business processes or industries
that require large amounts of investment to produce a good or service.

9.6 SELF ASSESSMENT QUESTIONS AND

EXERCISES

Short Answer Questions

1. What are the factors which pose the problem of choice of technique?
2. Mention Kuznets’ distinct patterns in the growth of technology.
3. Write a short-note on the use of abandoned techniques of advanced
countries.
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 4. What are Vikal and Brahmanand’s views on appropriate technology for Development Strategies-II

underdeveloped countries?
5. Write short notes on:
(i) Capital intensive technique NOTES
(ii) Labour intensive technique
Long Answer Questions
1. Critically define labour intensive techniques.
2. Explain the intermediate or appropriate techniques of production for LDCs.
3. Evaluate the merits and demerits of capital intensive technique.
4. What do you mean by choice of technique? What are the factors affecting
it?
5. Explain the problems in the choice of technology. Give appropriate suggest
for these.
6. Suggest appropriate technique for LDCs.

9.7 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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Development Strategies-III

UNIT 10 DEVELOPMENT
STRATEGIES-III
NOTES
Structure
10.0 Introduction
10.1 Objectives
10.2 Mathur’s Paradigm of Non-inflationary Growth:
Wage Goods/Light and Heavy Strategies
10.3 The Relative Merits and Relevance of Brahmananda –
Mathur Controversy Under Indian Conditions
10.4 Answers to Check Your Progress Questions
10.5 Summary
10.6 Key Words
10.7 Self Assessment Questions and Exercises
10.8 Further Readings

10.0 INTRODUCTION

Prof. Gautam Mathur gave emphasis on production and of consumption of

necessary goods with the help of labour intensive mechanized light machinery, to
provide adequate employment and equal distribution of income to contain inflation.
Prof. Mathur also gave the index of Disparity Tax that has no place in wage-good
model. The fact is that Prof. Mathur has given emphasis on consumption necessary
sector.
Mathur’s (1986) assertion of wage-good constraint for employment and
development is still relevant in the Indian economy. It needs to be noted carefully
that a large population of India spend 90% of their income on wage-goods. Due
to increase in prices the real wage decline with distortions on cost of production of
wage goods and creates a situation of crisis which can be averted by resorting to
wage-good sector for the optimal use of labour and other resources including
efficient use of savings which will further lead to non-dependence on foreign loans
and less political interference. The objective of reducing inequalities is possible
only by adopting this strategy.

10.1 OBJECTIVES

After going through this unit, you will be able to:

 Explain the Mathur’s model of non-inflationary growth
 Describe the relative relevance of Mathur’s and Brahamananda model

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 Development Strategies- III
10.2 MATHUR’S PARADIGM OF NON-
INFLATIONARY GROWTH: WAGE GOODS/
LIGHT AND HEAVY STRATEGIES
NOTES
The model of non-inflationary growth is adopted by Prof. Gautam Mathur. In the
context of underdeveloped countries is derived from Saraffa - Neumann-Joan
Robinson approach to steady growth. The model deals with same theoretical
problems of planning non-inflationary growth in underdeveloped countries and the
policy mandates like avoidance of inflation during the process of long-term plan of
economic growth. It highlights the optimum long-term path through which an
underdeveloped economy can reach the stage of optimum golden age, i.e., a state
of steady growth of full employment level.
The essence of planning for non-inflationary growth lies in keeping the
balanced allocation ratio as the parameter of economic planning. The balanced
allocation ratio, according to professor Mathur is to be maintained between
expenditure on quick yielding projects of short gestation period, producing
consumer necessaries on the one hand and the expenditure on long gestation period
projects, producing capital goods on the other. Thus the two streams of expenditure,
are inflation dampening and inflation creating. They must maintain a reasonable
ratio between them. This ratio is called the ‘Balanced Allocation Ratio’ therefore
a long-term strategy of economic planning must at Balanced Allocation Ratio
between inflation creating and inflation-dampening type of investment. Mod-
allocation of resources in designing of the plan frame may lead to unbalanced
growth which is not a proper mode of growth for the optimum path of development.
The allocation of resources, according to Prof. Mathur must be consistent
with the long-term strategy of growth. Because it is the nature of the ends towards
which these resources are allocated that determines whether we have balanced
growth or inflation. For example, if resources are allocated to unproductive schemes
like beautifying of city streets or public celebration, there is bound to be inflation
even if resources are raised through taxation. On the other hand, if the resources
are created by deficit financing and is entirely used in producing consumer
necessaries (in Cn sector) through short gestation period projects, the commodity
side may be larger than its money counterpart resulting disinflation. Hence deficit
financing need and necessarily be inflationary. It is the wrong application of this
instrument which is responsible for high degree of inflation in India not the instrument
itself. As such, quantity of money in any economy is not a crucial variable that can
be treated as a factor in inflation. At the same time, the public borrowing which is
generally accepted as an anti-inflationary device cannot be proved anti-inflationary
because it cannot reduce the consumption level of any section of the society. In the
absence of the consumer goods, even cash losses its convertibility, hence liquidity.
Moreover, with periodic accrual of interest, the total claim on goods would be
much more than otherwise. According to Prof. Mathur, borrowing could be more
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Development Strategies-III inflationary while deficit financing could be dis-inflationary. The determining variable
is not the source of expenditure, not even the level of expenditure, but the pattern
of expenditure.
Hence neither the level of expenditure nor the means adopted to maintain
NOTES
the level, is the cause of inflation in India, but a fairly allocation of resources between
inflation creating and inflation dampening investment together along with a rise in
money wages is the main cause of inflation in our country. Other factors like wrong
fiscal and monetary policies, administrative lapses leading to unavoidable delays,
misspending and over-spending and unsocial activities of the business community
have been aggravating the situation. But these are not the basic cause of inflation.
The basic cause lies in inability to maintain the “Balanced Allocation Ratio” between
inflation-creating techniques like the Heaving-Investment sector and the inflation
dampening techniques like the spends in the sector for consumption necessaries.
For an underdeveloped country like India, with a sufficient larger non-
employed population, the heavy investment strategy, according to Prof. Mathur is
considered to be the optimum. In the optimum strategy we should allow the fast
expansion of the Heavy-Investment industries referred to as the H-sector. For this
purpose, we would require consumption goods for the workers engaged in heavy
investment sector. Unless these consumption goods are available in sufficient
quantities, scarcity will occur and prices of necessaries will rise. To ensure a non-
inflationary growth, there ought to be investment in the consumption goods sector
in line with extra demand created by the heavy-investment sector that is satisfied
by the surplus created above consumption within the sector of production of
necessaries. Thus, Heavy-investment industries which are basic to the production
of all capital goods forms a subset. Capable of reproducing themselves no diversion
of heavy output should be permitted, because such diversion of H-sector output
into luxury consumer durable sector (L Sector) has resulted in less-employment,
slow growth of H-sector and more inequitable distribution of income and wealth
in the society. On the other hand, to meet the growing demand for consumption
necessaries (Cn). Only de-mechanized techniques should be used. For the
expansion of Cn sector, the labour-intensive techniques which are not only H-
conserving but inflation dampening should be selected. The sophisticated luxury
consumption durable (Cn) which have a tremendous snob appeal in our society
should be discouraged. The existing unit of production in this sector should be
allowed to produce only for purpose of exports to earn foreign exchange.
The fiscal policy required for an optimum non-inflationary growth strategy,
as suggested by Prof. Mathur, is entirely different from the existing policy. In the
context of non-inflationary growth, the tax mechanism should be used primarily to
maintain the “Balanced Allocation Ratio” between the inflation creating and inflation
dampening expenditure. The “Disparity Tax” that encourages and reward
investment and consumption in the right direction and discourage and penalize
investment and consumption in the unwarranted lines is best suited to realize the
objectives in a mixed economy like ours.
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 Thus allocation of resources of the H-Sector as well as the low mechanized Development Strategies- III

consumption goods sector will be the logical outcome of adopting the disparity
tax. In this system it is consumption that is the base of taxation rather than income.
As such, the Disparity Tax simultaneously acts as a misconsumption tax, a
misexpenditure tax and a procurement incentive. It is an antimonopoly device, by NOTES
penalizing all those who are acting against the interest of the optimum strategy.
Thus in achieving the desire “Balanced Allocation Ratio” for an optimum non-
inflationary growth strategy. The Disparity Tax measure according to Prof. Mathur,
may prove invaluable.

10.3 THE RELATIVE MERITS AND RELEVANCE

OF BRAHMANANDA – MATHUR
CONTROVERSY UNDER INDIAN
CONDITIONS

The apparent difference between the wage-goods model and the model of non-
inflationary growth is largely on the role of quantity of money as well as the policy
measures suggested for long-term plan of economic development.
Brahmananda considers changes in the growth of money supply without
corresponding to production of wage-goods resulting in rapidly growing
unemployment, acute poverty and a severe and prolonged inflation in the economy.
Hence, according to him the supply of money which is the major casual source of
inflation is to be regulated at the same average rate at which output and supply of
wage-goods are growing. Thus, in the context of non-inflationary price level path,
they call for a parity between money supply and maximum short period of feasible
rate of expansion in the index of basic consumption necessaries and suggests that
only with a higher growth rate of wage-goods, it is possible to achieve targets of
both acute poverty eradication and employment expansion more easily and more
definitely.
In contrast, Mathur believes that the quantity of money in any economy is
not a crucial variable and can be treated as the casual factor in inflation. Because
the determining variable of inflation is neither the source of expenditure (whether
created through deficit financing, public borrowing or taxation) nor the level of
expenditure, but the pattern of expenditure. In this sense borrowing or taxation
can be more inflationary while deficit financing can be disinflationary. Hence it is
the faulty allocation and such resources is responsible for inflation not the resources
itself.
Mathur suggests that the allocation of resources should be maintained between
expenditure on quick-yielding projects of short gestation period producing
consumers necessaries and the expenditure on long gestation period projects
producing capital goods so that the two stream of expenditure, one inflation
dampening and other inflation creating may be maintained at a reasonable rate.
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Development Strategies-III This ratio according to Mathur is the Balanced Allocation Ratio.
Thus, opposed to Brahmananda, Mathur attributes the supply of money is
not the basic casual factor of inflation. The basic cause lies in inability to maintain.
The balanced Allocation Ratio during the process of plan economic development.
NOTES
Another area of disagreement between these two models lies in their policy
recommendation regarding the effectiveness and practicability of monetary and
fiscal policies in the context of a non-inflationary price level path.
Wage goods modelists want to regulate money supply through an appropriate
monetary policy so that there may be balance between the scale and rate of growth
of bank credit allocation with the stock and the rate of growth of basic goods or
wage goods. Besides restricting the money-supply, the model also refers to a
programme of population stabilization saving promotion and an adequate public
distribution system along with priority attention towards investment in agriculture
so that the capacity for large volume of employment in each short period can be
built up in the context of a non-inflationary price level path under Indian conditions
of development.
While the fiscal policy for an optimum non-inflationary path as suggested by
Mathur is entirely different from this policy. According to him tax mechanism has a
vital and crucial role in the process of an optimum inflationary growth. Guidance of
allocation through inductive and punitive measures, therefore, should be the primary
goal of taxation. Hence, the development-oriented tax policy should operate as an
allocative instruments in various sector in way that the ‘Balanced Allocation Ratio’
between inflation dampening and inflation creating expenditure can be maintained
at a reasonable ratio during the process of an optimum non-inflationary growth.
For this goal, the Disparity Tax according to Mathur, is best suited to realize the
objective in a mixed economy like ours. Because in this system of taxation, the tax
payable will not only depend upon the type of goods as well as the consumption
level of the persons buying it but will also treat rates of profit in essential and non-
essential industries differently. Thus, the ‘Disparity Tax’ may encourage investment
and consumption in the right direction and discourage and penalize investment and
consumption in the unwanted lines.
The controversy of wage-goods model and the model of non-inflationary
growth reflects a deep difference of attitudes forwards the effectiveness of monetary
and fiscal policies in the context of a non-inflationary path of development. Wage
goods model prescribes monetary regulation along with other measures like
population stabilization, saving promotion and an adequate public distribution system
to regulate and control excess demand as well as proper allocation of resources in
favour of production of wage-goods for creating larger volume of employment,
income generation and poverty eradication as the main goal of this strategy.
Similarly, the model of non-inflationary growth also supports allocation of
resources in favour of production of consumption necessaries for the vast majority
of population so that the nation may free from a ‘Glass curtain Economy’. Where
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the whole economic structure of production is for a particular class and the Development Strategies- III

government is also trying to satisfy the demand for an affluent section of the society
by increasing luxury production.
But Mathur did not want to regulate money supply or deficit financing as he
NOTES
through that the determining variable of inflation is not the source of expenditure,
nor even the level of expenditure but the pattern of expenditure. Therefore, he
wanted to regulate the pattern of expenditure in a reasonable ratio between
consumption goods sector and capital goods sector through the regulating
mechanism of fiscal policy like that of disparity tax.
Conclusion
In the light of the discussion, we may conclude that so far the relevance and
practicability of both the methods in the context of poverty alleviation, mass
unemployment and the non-inflationary path of development are concerned, the
wage-goods strategy of development is more relevant, consistent optimal, practical
and best suited to the specific requirements of larger over-populated countries
like India. It has identified the real cause of acute poverty growing unemployment
and severe and prolonged inflation as a result of the existence of wage-goods
supply gap in the system of production in the economy since the inception of
second five year plan and has rightly suggested to regulate the growth rate of
money supply by reference to global rate in the availability of stocks of basic
goods or their rate of growth, on the other hand although the model of non-
inflationary growth seems to be attractive and logical in theoretical foundation, its
practical applicability in the context of the Indian economy is very doubtful. In
essence particularly some peculiar institutional factors and structural bottlenecks
obtained in our economy, make it very difficult for proper functioning of the
‘Disparity Tax’ as an allocative instrument in various sectors in our economy. It is
therefore necessary to bring about an alternative strategy of development in the
formulation of the eight plan in the light of wage-good strategy of development
which can make a significant dent an acute poverty, mounting unemployment and
the high rate of inflation in the years ahead. Not only this strategy would be necessary
for an adequate investment policy, with strong bias in favour of wage-goods
production but also for the optimal utilization of resources under a massive
programme of rural development to lift the weaker sections to a level of living
comparable to the rest of the population as an integral part of the development
plan.
Hence special attention has to be said for rural and agricultural infrastructure
lines like irrigation, afforestation, promotion and retention of soil fertility command
area, facilities for mixed farming, supplies of rural and agricultural tool, etc.,
requirements of power and fuel for rural and agricultural needs and so on. In an
over-populated agrarian economy like India, a sustain increase in agricultural
productivity with related and other wage-goods is an essential condition for
sustaining the momentum of development, for controlling inflationary pleasures
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Development Strategies-III and for expanding the market for industrial products because the categories like
capital stock, resource use pattern, production goods and services, exports and
imports, government expenditures, credit allocation technologies employment
avenues all are directly or indirectly by inevitably involved in the production and
NOTES supplies of subsistence and wage-goods and services on the basis of prevalent
conventional norms regarding the subsistence and wage-goods and services on
the basis of the prevalent conventional norms regarding the subsistence and real
wage components and on efficient production method.

Check Your Progress

1. Which growth model was provided by Mathur?
2. On what economist’s model is Mathur’s growth model based on?
3. What is the full form of W.G.S.?
4. Who gave the idea of disparity tax?

10.4 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. Mathur provided non-inflationary growth model.

2. Prof. Mathur derived his model from Saraffa and Neumann–Joan Robinson’s
model.
3. The full form for of WGS is Wage-goods Sector.
4. Prof. Gautam Mathur gave the idea of disparity tax.

10.5 SUMMARY

 Gautam Mathur has developed a model on the basis of Newsman’s and

Sraff’s analysis. He also given emphasis of adequate production of
consumption necessary goods with the use of labour intensive Mechanized
Light machinery to provide adequate employment favourable distribution
of income and to contain inflation. So he has suggested for a balance allocation
ratio between high order capital (which reproduces itself and makes the
Mechanized Light Machinery) and consumption. Necessary sector and
claimed that with this ratio any size of plan would be non-inflationary
whatever the size of money supply. Because investment in high order capital
is inflation creating and investment in consumption necessary sector in inflation
Dampening.
 Mathur has suggested to adopt the policy of Disparity Tax, i.e.
Misexpenditure/ Misconsumption tax in the place of income tax to channelize

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 the expenditure in the right activities. He has an option that all the traditional Development Strategies- III

models of raising the resources are highly inflationary and only the policy of
deficit financing, which lowers the interest element in cost in anti-inflationary,
if used for the production of consumption necessary goods with quick
yielding techniques, NOTES
 Brahmananda treats deficit financing completely inflationary and is firm on
this point that the prospective growth rate in money supply does not exceed
the prospective growth rate in output. The world/country is fully aware with
the inflationary impact of the deficit financing. Mathur’s proposed of Disparity
Tax also has no place in wage-good model, because the proposal does not
seen to be practicle.
 Wage-goods model has a problem of resource scarcity and so the entire
emphasis is on pinpointed investments on wage-goods sector. But Mathur
has no problem of such type with faith on deficit financing. So he is in favour
of simultaneous investment on high order capital and consumption necessary
sector in a balanced way. But both Brahmananda and Mathur are common
to give importance the consumption necessary sector i.e. wage-goods
sectors.

10.6 KEY WORDS

 Glass Curtain Economy: Glass curtain economy is the economy through

which poor people can only see the consumer durables, but have no entry
to the market, as they do not possess the purchasing power.
 Disparity Tax: The term disparity tax or fiscal disparity refers to the
difference in commercial-industrial tax base wealth between taxing districts.
The fiscal disparities program is a system for the partial sharing of the
commercial-industrial property tax base among all jurisdiction within a
geographic area.

10.7 SELF ASSESSMENT QUESTIONS AND

EXERCISES

Short Answers Questions

1. What is Mathur’s Paradigm of development?
2. Write short notes on:
i. Disparity Tax
ii. Glass Curtain Economy.
3. What is the Mathur’s non-inflationary growth model?

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Development Strategies-III Long Answers Questions
1. Write an essay on ‘The Relative merits and relavance of Brahmananda
Mathur controvercy’.
NOTES 2. Analyse Mathur’s paradigm of non-inflationary growth.

10.8 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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 Planning Models-I

UNIT 11 PLANNING MODELS-I

Structure NOTES
11.0 Introduction
11.1 Objectives
11.2 Introduction and Meaning of Planning Models
11.3 Elements and Characteristics of Planning Models
11.4 Classification of Planning Models
11.4.1 Aggregative or Macroeconomic Models
11.4.2 Sectoral Models
11.4.3 Comprehensive Inter-industry Models
11.5 Factors Affecting Choice Planning Models
11.6 Uses of Planning Models
11.7 Criticisms of Planning Models
11.8 Answers to Check Your Progress Questions
11.9 Summary
11.10 Key Words
11.11 Self Assessment Questions and Exercises
11.12 Further Readings

11.0 INTRODUCTION

In the previous unit you learned about the strategies of planning. In this unit, you
will learn about planning models.
Planning models have been increasingly used in LDCs for the drawing up of
plans for economic development. A model expresses relationships among economic
variables which explain and predict past and future events under a set of simplifying
assumptions. In other words, a model consists of a series of equations, each of
which represents association among certain variables. A planning model is a series
of mathematical equations which help in the drawing up of a plan for economic
development. Broadly a model may have endogenous and exogenous variables.
Endogenous variables are those whose values are determined from within the
system such as national income, consumption, savings, investment etc. On the
other hand, exogenous variables are determined from outside the system such as
prices, exports, imports technological changes etc.
In the present unit we will explain the elements, types, uses and criticisms of
planning models. Different countries use planning models depending upon the nature
of the economy, the availability of the information, the capacity to use and manage
such models. Some of the major models are;
(i) The H-D. Growth model: The H-D. model is a simple analysis of
capital accumulation in the absence of technological progress. The
simple version H-D model is given by the following equation:
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Planning Models-I Y – k/a
where Y is the rate of growth, k = the savings (investment) rate and a
= the capital–output ratio. The equation simply says that the rate of
economic growth is determined given the technology, by the rate of
NOTES
investment.
(ii) Input-output model: I/O model provides a microscopic view of the
national economy. It is a statement of the output goods and services
produced by a sector, the volume of goods and services produced by
a sector and the volume of goods and services which are consumed
to produce a given unit of production in that sector. Since different
sectors of the economy are inter-related, and each sector will depend
on other sectors for input and to sell output goods.
There are other models such as linear programming, computable general
equilibrium model and so on.

11.1 OBJECTIVES

After going through this unit, you should be able to:

 Explain the meaning of the planning models
 Describe the elements of planning models
 Mention the types of planning models
 Interpret the uses of planning models
 Critically evaluate the planning models

11.2 INTRODUCTION AND MEANING OF

PLANNING MODELS

In economics, a model is a theoretical construct representing economic processes

by a set of variables and a set of logical and/or quantitative relationship.
Planning (development) models are economic models which are defined as
an organised set of relationships that described the functioning of an economic
entity, whether it is an individual household or firm. The national economy or the
world economy, under a set of simplifying assumptions of growth models, explain
the process of economic growth in a mature economy. They seek to analyse the
inter-relationship among critical variables under the assumption that during the
process of growth, state intervention was absent and growth process could unfold
itself within a capitalistic framework. On the other hand, a development model
seeks to analyse the inter-relationship among those critical variables that might
play an important role in the development process, including structural change, in
the currently underdeveloped countries. The latter models take an explicit notice
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of state intervention as a critical exogenous variable in the development process. Planning Models-I

Thus while growth models are mainly descriptive models, development models
may be considered as operational, decision or policy models, when development
models are used to solve certain planning problems, they may also be referred to
as planning models. NOTES

11.3 ELEMENTS AND CHARACTERISTICS OF

PLANNING MODELS

Most of the planning models are operational, decision or policy models. They
seek to analyse the relationship between plan objectives and the policy measures
that might be adopted to attain the former. The following are the important elements
of planning models:
1. Objectives of Economic Policy: When a plan is formulated, the planner
must explicitly lay down the goals of the economic policy to be pursued or
maximised under the plan. Normally a plan in LDCs may have one or more
of the following objectives:
i. A stipulated increase in per capita income
ii. A stipulated increase in employment
iii. A relatively stable price level
iv. Equilibrium in the balance of payments
v. Reduction of in equalities in income distribution
vi. Balanced regional development
vii. Diversification of the economy through structural change.
These objectives of the plan are specified as dependent variables of the
model.
2. Instrument Variables: These are the policy measures which need to be
adopted to achieve the specified objectives of a plan. The policy measures
or instrument variables would depend upon the objectives of the plan. Raising
the saving-income and the investment-income ratios population policy, import
substitution and export promotion, achieving a certain sectoral and regional
balance in development, etc. could be some of the independent variables of
the model since their values are exogenously specified by the planner.
3. The functional relationship: The objectives and the policy instruments
(the dependent and independent variables of the model) are functionally
related to each other in the form of structural or behavioural equations of
the model. These functional (i.e. causal) relationship are expressed in the
form of coefficients. These coefficients show the response of the dependent
variables as specified. If for example, in the model, the change in the national
income is exogenously determined, then marginal propensity to save or the
saving coefficients shows how much change in aggregate savings would be Self-Instructional
Material 157
Planning Models-I required. Here while national income is an independent variable, the functional
relationship between the two is specified in the form of the saving coefficient.
In a planning Model, the values of the policy instruments may be
independently determined and these may be functionally related to the dependent
NOTES
variables or the objectives so as to obtain the values of the latter.

11.4 CLASSIFICATION OF PLANNING MODELS

Planning models are classified under different categories. These may be classified
as optimisation and consistency models. An alternative classification is descriptive
or projection models, and operational, decision or policy models. However, a
more acceptable classification is on the basis of the comprehensiveness or
complexity of these models. According to this classification planning models are
of three types, viz aggregative or macroeconomic models, sectoral models, and
comprehensive inter-industry models. These three types of models are discussed
below:

11.4.1 Aggregative or Macroeconomic Models

In the initial stages of the process of plan formulation, the planner may be interested
in finding answers to some simple macroeconomic problems. For instance, the
problem may be to work out the rate of growth of national or per capita output
when the size of the plan in terms of savings and investment is exogenously specified.
Alternately, the decision regarding the growth rate may be independently taken at
the political level and then it may be left to the planner to work out the saving or
resource requirement to attain that growth rate. Thus, the problem at hand is of an
aggregative, macroeconomic nature where it may not be necessary to go into the
sectoral details.
Harrod-Domar model, which was initially developed as a growth model to
specify the requirements of steady growth at full employment in a developed
capitalist economy, it has come to be increasingly used as a simple aggregative
macroeconomic planning model. The overall growth rate of the economy or the
size of the plan can be worked out with the help of the Harrod-Domar growth
equation.
The Harrod-Domar Equation can be derived as below:
S = sY, where is the average propensity to save. ...(i)
I
K -= KY, where k is incremental capital – output ratio i.e.
Y
...(ii)
I= K=K Y, where I or K is net investment ...(iii)
It is assumed that S = I
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 Therefore, sY = K Y (From equation (i) and (iii) (iv) Planning Models-I

Y S
Or which is the Harrod-Domar growth equation.
Y K
In a planning model like this, the growth rate of income, Y/Y may be NOTES
taken as a dependent variable, so that the independently determined values of S
and K assumed to be constant, the growth rate of income can be workout.
Alternatively, Y/Y may be independently determined (As a political decision
that during the plan the national income has to grow by a given percentage per
annum). In this case, the Harrod-Domar model may be employed to deal with
some simple macroeconomic problems like the ones indicated here, for instance,
if in a typical LDC, the incremental capital-output ratio (k) = 3, and net foreign aid
is 2% of its GNP, then for Y/Y = 4%, a saving income ratio of 10% is needed
and for Y/Y = 6%, a saving income ratio of 16% is needed and so on.
In the Harrod-Domar model, the key constraint to development is low saving
income ratio. Besides, other constraints like the scarcity of foreign exchange or
skilled labour, can also be introduced into the model. The model could be used to
determine other plan objectives like level of employment or balance of payments
equilibrium etc. The model being a macroeconomic exercise, does not go into
sectoral details, which is its merit as well as a short coming.
11.4.2 Sectoral Models
The sectoral models are of two types: (i) Single-Sector project models and (ii)
complete main sector models. In the case of former a single-sector is treated as
huge project individually. Such separate projects are individually appraised for
requirements of capital, skilled labour, foreign exchange etc. By aggregating the
requirements of individual sectors, the total resource requirements are arrived at.
If the aggregate resource requirements turned out to be more than the available
resources, some of the projects may be excluded from the plan. Yet there are
always the possibilities that the plan may merely remain a bundle of several projects.
The complete main-sector planning models are a more developed from of
sectoral models. In most LDCs, the main planning problem is that of bringing
about structural change. Therefore, it is necessary to specify in the plan the
appropriate growth rates of each sector. Thus, the main sector planning models
are based on differentiation of main sectors of the economy, specification of their
individual growth rates, taking an explicit note of their inter-dependence.
The main-sector planning models will satisfy certain general conditions as
below:
(i) The models should be complete, it must cover the entire economy.
Even a two-sector model can be complete. For example, in a bi-
sector model, the differentiation of sectors may be: agricultural sector
and non-agricultural sector, so that the latter includes all the residual
sectors. Self-Instructional
Material 159
Planning Models-I (ii) The model should be realistic. Realism can be built into the model in
two ways. Firstly, the aggregate resources requirement of the plan
should not be more than what is available. Secondly the model must
specify the important relationships among various variables.
NOTES
(iii) The model must be internally consistent. The inter-sectoral relations
must be such that, non-agricultural sector should not demand more
raw material from agricultural sector than the latter can supply.
Besides the division of main sectors into agricultural and non-agricultural
sectors, some other paid of sectors could be consumption goods and investment
goods sectors or exports and home market sectors. In the four sector Mahalanobis
model, the main sectors are: capital good sector, factory consumer goods sector,
agriculture and household industries sector and service sector.
The following is a simple main sector planning model.
Suppose the entire economy is divided into the consumer goods sector and
the investment good sector. Then,
X1 X2 GDP Y

Where X1 is the total output of the consumer goods sector, X2 is the total
output of the investment goods sector, and GDP is the Gross domestic product.
Further suppose that C denotes the marginal (= average) propensity to
consume. Then it is clear that

X1 C
X2 1– C

where 1 – C is the marginal propensity to save. If C = 0.8 then,

X1 0.8 4
X2 0.2 1.
If the relative growth rates of the two sectors can be determined during the
plan period by the propensities to consume and save, there would be little, if any,
structural change. Such a structural change is necessary for a faster rate of growth
of the entire economy. For, if the investment goods sector grows faster, the
consumer sector would also grow faster through the increased supply of capital
goods. The model must take an explicit notice of the inter-dependence of the two
sectors. Thus, the growth targets of the two sectors cannot be set independently.
The target must be mutually consistent. This would need the following Harrod-
Domar types of information:
Y X1 X 2
(i) A target growth rate of GDP : Y X1 X 2

(ii) The propensity to consume and save, c and 1 – C;

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 (iii) The sectoral incremental capital-output ratios (ICOR) K1 and K2 Planning Models-I

The Harrod-Domar growth equation would yield the value of (i), if the
value of (ii) and (iii) are known.
Thus, suppose that c is expected to remain constant at 0.8, then 1 – C NOTES
(1C .8) = 0.2.
The sectoral incremental capital-output ratio is empirically ascertained from
the current behaviour of the economy, and suppose K1 = 3 and K2 = 6. The global
incremental capital-output ratio would be the weighted average of the sectoral
ICORs. Thus,
k ck1 (1 c) k2

0.8 3 0.2 6
2.4 1.2 3.6
The Harrod-Domar model may be written as,

Y X1 X2 s 1– c
Y X1 X2 k ck1 (1 C )k 2

By substituting the respective values in the above equation, we get

Y 0.2
5.6%approx.
Y 3.6

Thus, we get a growth rate of output of 5.6% per annum.

Instead of taking only two main sectors, the number of sectors could be
increased depending upon the availability of reliable sectoral data. The main sector
models are more complex and elaborate in comparison to the simple
macroeconomic models. But even the former does not unfold the inter and intra-
sectoral relationships which may be important from the point of view of internal
consistency of a plan. It is for this reason that inter-industry models are used in
planning.
11.4.3 Comprehensive Inter-industry Models
The inter-industry models make use of two important techniques of economic
analysis viz;
(ii) input-output technique
(ii) the linear programming technique.
While the first technique may be used for purposes of setting consistent sectoral
targets and thus for ensuring the internal consistency of a plan, the latter technique
may be utilised for optimisation of an objective function like output or consumption
in the terminal year of the plan, or over the plan period.
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Planning Models-I Consider a static inter-industry planning model making use of the input-
output technique such a model may be used to produce an internally consistent
plan. The problem is that keeping in view the inter-industry relations the targets for
different industries or sectors must be mutually consistent so that both shortages
NOTES and surpluses are avoided.
The static input-output model is made up of two sets of equations:
(i) the balance equations
(ii) the structural equations.
There would be a balance equation for the product of each ‘sector’ or
‘industry’. It shows that the output of a given industry is used in the following
manner:
n
Xi xij xic xi1 xix ...(i)
i 1

Where xi = total output of industry; xij denotes the total of inter-

i 1

industry transactions or delivery of the ith sector output to j sectors which are n in
number; xic = the use of the ith product for consumption; xi1 = use of the ith
n

product for investment purposes; and xix = export of the ith product. While xij is
i 1

the total inter-industry use of the ith good, xic xi1 xix is the total final use or
demand for the ith good. Such a disposal of the sectoral outputs may be expressed
for all the n sectors in the economy.
The objective of constructing an inter-industry model of this type may be to
formulate an internally consistent plan. For this purpose, the technological relations
in the economy should be specified in the form of the following type of structural
equations.
Xij = aijXj ...(ii)
Where aij is the technological coefficient or input coefficient, showing the
amount of ith input needed to produce each unit of ith good. Equation (ii) shows
that if the output target of the jth good (ie xj) is independently determined then if
we multiply it by the input coefficient, we get the total amount of the ith input that
would have to be delivered to jth industry to enable the latter to fulfil its output
target. By substituting equation (ii) in equation (i), we get–
n
Xi aijx j xic xi1 xix ...(iii)
j 1

In equation (iii), if the final demand for the ith good as shown by
X ic X iI X ix is exogenously determined, the output of the ith good needed for
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inter-industry deliveries to enable all the j sectors of the economy to fulfil their Planning Models-I

output targets can be determined with the help of the input-output model. The
model would be a system of n simultaneous equations, one for each sector or
industry with n unknown variables which can be solved to find consistent output
targets for each industry. NOTES
The above is a static model. The inter-industry model may also be a dynamic
one in which an explicit notice is taken of the need to build up stock of capital
goods out of current output to attain higher output level in future. Thus, in the
Leontief dynamic input-output model, the current output can be used for current
inter-industry use as an input, for current final use (such as for current consumption,
investment and exports as in the static model), and for building up stock of capital
for future use.

11.5 FACTORS AFFECTING CHOICE PLANNING

MODELS

There are different types of planning models available to a developing country. An

intelligent and informed choice of planning models or framework depends on four
main considerations:
1. Stage of Development: The choice of a plan model obviously depends
on the exiting level of country’s economic development. If a country is
dominated by subsistence agriculture, has a limited monetary sector and
little or no inter-industry relations, then, it may have either aggregative or
sectoral model of planning. However, in the later stages of development,
inter-industry planning model may become more feasible.
2. Institutional structure: The institutional structure of the economy is another
important consideration. If private sector plays a relatively passive role,
then the public sector is expected to provide the initial stimulus and continued
overall direction. So, public investment projects will get greater attention.
However, if private sector is more active, then the plan strategy will
concentrate on the creation of favourable conditions for private economic
activity. In the case of conflict between public and private interests the former
will normally take precedence over the latter.
3. Availability and Reliability of Data: It is the third factor in the formulation
of development plan. If the existing data are the in adequate and unreliable,
then there is little scope for using inter-industry or sectoral planning models.
The planner may have to resort to aggregative planning model till such time
when the empirical information is both adequate and reliable to warrant the
adoption of detailed planning model.
4. Resource Constraints: The resource constraints or bottle necks impinging
on the economy also influence the character of a development planning
model. In general, capital and foreign exchange are the principal bottle necks
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Planning Models-I to rapid economic development. In such a situation, labour-intensive projects
may have to be stressed to economise the use of limited capital and foreign
exchange resources.

NOTES
11.6 USES OF PLANNING MODELS

Models have been used in different contexts in actual planning. According to Ashok
Rudra, the following are the uses of models in planning:
1. To provide a frame for checking the consistency or optimality of
plan targets: The inter-industry models, can be used to check the
consistency of various targets set in a plan and optimality of such targets
can also be ensured. According to Ashok Rudra “A model can be used to
generate a whole set of alternative development programmes by varying
over appropriate ranges the value of all the parameters and exogenous
variables that are subject to uncertainty and also by changing the objective
functions or numerical weights of composite objective functions.
2. To provide a frame for the Actual Setting of Targets: Model building
activity in LDCs may lead to a stage where actual targets for the plan may
be set with the help of computers by feeding relevant data into them and
receiving back readymade plans.
3. To provide a frame for the Evaluation and Selection of Projects:
Plan model could be designed which would provide a justification for the
selection of some and rejection of other projects. In project evaluation and
cost-benefit analysis, use of shadow prices is sought to be made in the
interest of optimum use of resources. Shadow prices for the economy may
be estimated with the help of programming models. However, a problem
that arises in this connection is that in the case of inter-temporal programming
models, it has been noted that there is a good deal of inter-temporal instability
in the shadow prices yielded by such models. So the question would be as
to which shadow price to use for project evaluation.
4. To help make better Policy Decisions: Ashok Rudra observes that, “…
the principal contribution of plan models is to provide such s insight into the
working of an economy as to make official plan makers better equipped to
take policy decision than they could possibly without the help of any such
models.”
The planner can make alternative assumptions about the values of the
instrument variables of the model and then work out the result in each case.
Thus, a rational basis can be provided for the policies chosen during a plan.
The models therefore, provide intellectual backbone to each plan in the
matter of choice of policies.

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11.7 CRITICISMS OF PLANNING MODELS

Analytically, planning models have several drawbacks, Paul Streeten observes in

this connection that “the trouble with many current models is that they are shapely NOTES
and elegant but lack of the vital organs.” The main drawbacks in plan models have
been grouped under four heads by Paul Streeten which are as below:
1. Neglect of Non-economic Factors: The planning models do not consider
non-economic factors, such as attitudes social satisfaction, quality of the
political leadership and civil administration as important in the process of
development. These are not, therefore, taken as the instrument variables of
the models. The non-economic factors, being generally non-quantifiable
are taken by the model builders as something which would adopt themselves
to the change in important, quantifiable, economic variables or that the former
would automatically be modified to suit requirements of economic
development. The neglect of economic factors by the planning models’
builders is a serious lapse which greatly impairs the usefulness of such models.
2. One-Factor Analysis: There is a tendency on the part of economists to
isolate a single factor as the critical instrument variable. This is especially the
case in the aggregative models. In the Harrod-Domar model, for instance,
saving-income or investment income ratio is taken as the most important
instrument variable, to the alter neglect of other factors. Such one-factor
analysis in the models may land a country using such models in trouble.
3. Misplaced Aggregation: There is a tendency on the part of model builders
and planners in LDCs to build models in terms of national aggregates like
unemployment, savings, investment, etc. as if these variables are
homogeneous in character. Such an assumption may be justified in the
developed countries where there is greater degree of specialisation among
factors of production and this economics also happen to have a more
homogenous socio-economic structure. In LDCs however, such aggregation
is misplaced. For instance, savings and investment take a different form in
the corporate sector than what happens in that part of the farming sector
which is engaged in subsistence agriculture. Saving and investment in the
two sectors cannot be clubbed together.
4. Illegitimate Isolation: The development process is a complex of inter-
relationships among a large number of variables. However, different planning
models illegitimately isolate a few variables of economic policies as the critical
variables in the process of planned development. The result is that some
important complementary relationships may be overlooked. For instance,
the variable which are excluded from the model may be the ones which, if
included, might have led to a faster rate of development.
Ashok Rudra enumerates those important parts of the economy which the
Indian plan models left out of account, or the errors of omission which were
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Planning Models-I committed by such models. These are: neglect of institutional factor, resource
endowment of the country, skilled man-power, and infrastructure. Other
draw backs of Indian plan models are: their exogenous treatment of final
demand, their neglect of behaviouristic propensities of different classes of
NOTES consumers their assumption of linearity (e.g. the assumption of fixed input
co-efficients in the input-output models), etc.
Conclusion
In spite of the above mentioned criticism against the plan models, it cannot be
denied that these models impart an element of rationality to the process of plan-
making. In the absence of plan models, this process would lack the objectivity
which is essential for the quantitative analysis contained in plans. Richard Eckaus
is right in observing that “development models are one but by no means the only
method of knowing more about the detailed structure and working of a developing
Economy”.

Check Your Progress

1. Define the Planning Model.
2. Name the two types of Planning Models.
3. Mention two uses of Planning Model.
4. State two demerits of Planning Models.
5. State the main elements of Planning Model.

11.8 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. A planning model expresses the relationships among economic variables

which explain and predict past and future events under a set of simplifying
assumptions.
2. The two types of Planning Models are (i) Aggregative model, (ii) Sectoral
Model.
3. The two uses of Planning Models are (i) To help make better policy
decisions, (ii) To provide a framework for checking the consistency or
optimality of plan targets.
4. The two demerits of Planning Models are: (i) One factor analysis, (ii) Multi
placed Aggregation.
5. The main elements of Planning Models are:
 Balanced regional development
 A relatively increase in per capita
Self-Instructional  Equilibrium in the BOP.
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 Planning Models-I
11.9 SUMMARY

 A planning model specifies relationships between endogenous and exogenous

variables and aims at ensuring the consistency of the proposed plan for NOTES
economic development. “It is meant to yield an optimally balanced collection
of measures, known as Model Targets, which can help the planning authority
in the drawing of an actual plan.”
 A U.N. study defines a planning model as that based on precise knowledge
of medium and long-term economic aims, which is mathematically expressed
in the form of a preference function and reflects the initial conditions of the
economy including economic policy measures already proposed and show
the most probable path of economic development.
 Planning models are of three types: aggregate, multi-sector and
decentralisation. Aggregative models trace the optimal path of development
overtime of such economy-wide aggregates as income, saving, consumption,
investment, etc. The Harrod-Domar Models and the two gap models are
of this type. But it is not possible to build highly aggregative models in LDC,
because of the lack of accurate data computational devices. Therefore,
multi-sector models are designed which connect macroeconomic aggregates
with the sectors constituting the operational content of the plan.
 The Mahalanobis two sector and four sector models are of this type. Multi
sector models are also set in terms of input-output models. They are
consistency models based on the Leontief inter-industry system. The
consistency, model for India’s fourth plan by Manne, Rudra and others,
and the model of Indian fifth plan were framed in terms of the input-output
models.
 Further optimising or Linear Programming models are also multi sector
planning models. They extend the consistency models of the input-output
types to optimisation of income or employment or any other quantifiable
plan objective under the constraints of limited resources and technological
conditions of production. Such models can be static or dynamic. Static LP
models solve the systems of equations for optimal solutions in relation to a
single year, while dynamic LP models explain the optimal growth path over
the entire plan period.
 Decentralised models have sector or project level variables which are used
to prepare models for individual sectors or projects. Such models are useful
in the early stages of a country’s economic development when information
is available for only individual sectors or projects.
 The usefulness of planning models in actual plan-making are (a) to provide
a frame for the checking of the consistency or the optimality of the official
plan targets, (b) to provide a frame for the actual setting of targets, (c) to
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Planning Models-I provide a frame for the evaluation and selection of projects and (d) to
provide an insight into the structure of the economy and its dynamics to
help better policy decisions.

NOTES
11.10 KEY WORDS

 Planning models: A planning models is a series of mathematical equations

which help in the drawing up of a plan for economic development.
 Endogenous variables: Endogenous variables are those whose values
are determined from within the system such as national income, consumption,
saving, investment etc.
 Exogenous variables: Exogenous variables are deformed from outside
the system such as prices exports, imports, technological change etc.

11.11 SELF ASSESSMENT QUESTIONS AND

EXERCISES

Short Answer Questions

1. Bring out the difference between a growth models and a development model.
2. What factors influence the choice of a planning model?
3. With the help of an inter-industry model show how internal consistency of
an economic plan can be ensured.
Long Answer Questions
1. Discuss the important merits and drawbacks of planing models as a tool of
plan formulation.
2. Derive Harrod-Domar growth equation. If the ICOR is estimated at 3, and
the net inflow of foreign capital is estimated to be 3% of the national income,
what rate of domestic saving would be needed to achieve 5% growth rate?
3. Write short notes on–
i. Uses of planning models
ii. Factors affecting choice of planning models
iii. Sectoral Models
4. Write a descriptive essay on ‘Classification of Planning Models’.

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11.12 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill. NOTES
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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Planning Models – II

UNIT 12 PLANNING MODELS – II

NOTES Structure
12.0 Introduction
12.1 Objectives
12.2 Feldman Model
12.3 The Mahalanobis Model
12.4 Input-output Analysis
12.5 Answers to Check Your Progress Questions
12.6 Summary
12.7 Key Words
12.8 Self-Assessment Questions and Exercises
12.9 Further Readings

12.0 INTRODUCTION

The Feldman-Mohalanobis model is a Neo-Marxism model of economic

development, created independently by soviet economist Grigory field in 1928
and Indian statistician Prasanta Chandra Mahalanobis in 1953, Mahalanobis
become essentially the key economist of India’s second five year plan, becoming
subject to much of Indian’s most dramatic economic debates.
The essence of the model is a shift in the pattern of industrial investment
toward building up domestic consumption goods sector. Thus the strategy suggests
in order to reach a high standard in consumption, investment in building a capacity
in the production of capital goods is needed first. A high enough capacity in the
capital goods sector in the long-run expands the capacity in the production of
consumer goods. The distinction between the two different-types of goods was a
clearer formulation of Marx’s ideas in Das Kapital, and also helped people to
better understand the extent of the tradeoff between the levels of immediate and
future consumption. These ideas were however first introduction in 1928 by
Feldman, an economist working for the GOSPLAN planning commission,
presenting theoretical arguments of two-department scheme of growth. There is
no evidence that Mahalanobis knew of Feldman approach, being kept behind the
border of the USSR.
Input-output model is a qualitative economic technique that represents the
interdependencies between different branches of a national economy or different
regional economies. Wassily Leontief (1906-1999) created a model by developing
this type of analysis and earned the Nobel Prize in Economics for his development
of this model.

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12.1 OBJECTIVE

After going through this unit, you will be able to:

 Describe the Feldman growth model NOTES
 Explain the Mahalanobis growth model
 Describe the Leontief’s input output model

12.2 FELDMAN MODEL

1. Introduction
G.A Feldman, a Russian economist, constructed his model of growth, which served
as a launching pad for the Russian First Five Year Plan. This model is based on the
concept of unbalanced growth stressing priority for the capital goods sector in
investment allocation for speedy development. The main thrust of this model has
been to transform the backward Russian peasant economy into a developed
industrial economy. Investment plays a dual role. On one hand, it creates productive
capacity and on the other hand, it has income-generating effect. This model is
based on the productive capacity effect of investment with a view to give momentum
to capital goods production. This model was formulated in the context of socio-
economic environment prevailing around 1928 in Russia, and it rejects the scenario
of soviet economy on the eve of its First Year Plan.
2. Explanation of the Model
This model is based on following assumptions:
1. It is a closed economy. It means that international trade and foreign capital
do not influence the growth of an economy.
2. The economy is divided into two sectors-Capital goods sector and consumer
goods sector.
3. It rules out the role of private capitalism. There is a role of state capitalism.
4. Production is marked by constant returns to scale.
5. Production is assumed to be independent of consumption.
6. There are no time lays in the adjustment process of growth variables.
7. Supply of labour is assumed to be limited.
8. Prices are assumed to be constant in the economy.
9. Capital formation is considered an engine of growth. As such, it assumes
the role of a key variable.
10. There is no full employment in the economy.

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Planning Models – II This model highlights two important features. One is the concept of unbalanced
growth and second is the Marxian scheme of production. The first feature i.e.
unbalanced growth implies higher proportion of investment for capital goods
industries. This sector has been looked upon as a source of vast growth of national
NOTES income in the long period. The key variable in the proportion of investment allotted
to the capital goods sector. This sector occupies a core position in Feldman model
of growth.
The other important feature is that this model is based on Marxiam scheme
of production. Under this scheme, the total output of an economy (y) is divided
into two categories.
Category I, comprise the output of capital goods sector and category II,
includes the output of consumer goods sector. The production of each sector is
composed of three elements constant capital (C), variable capital (V) and surplus
value (S). The total output of each sector is represented by the equations given
below:
Y1 = C1 + V1 + S1 …… (capital goods sector)
Y2 = C2 + V2 + S2 ….. (consumer goods sector)
It should be noted that division of total output between the two sectors
depends upon the productive capacity of each sector. With this background, we
now proceed to discuss the mathematical interpretation of this model.
The basic equations of this model are expressed as under:
K1 +  · I (1)
K1 = the annual rate of net investment allocation in capital goods sector.
 = Proportion of total investment allocated to capital goods sector.
I = annual rate of investment of the whole economy.
The increment in the stock of capital in ‘t’ period of time is determined by
dividing K1 by its capital output ratio V1 & is expressed as under:
dI K1

dt V1

Substituting the value of K1 (from equation (1) in the above equation we

get)
dI   I
 (2)
dt V1

Cross multiplying
dI 
  dt (3)
I V1

Integrating equation (3), we get

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172 Material
 Planning Models – II
I I
dI 
 I
   dt
V
I0 I 1
0

[I0 is the lower limit and represents the investment in initial period of time. NOTES
I is the upper limit and represents investment in current period of time.]
t
 
log eI II0   t
V1  0

 dx 
   x  log e ] dx  x,  dt  t 
x
 


log eI  log eI 0  t  0 
V1

I 
log e  t
I 0 V1

 m

m n
log e  log e  log e n 
 


t
I
 eV1
I0


t
I  I0  e V1 (4)

This equation reveals that total investment (I) in ‘t’ period of time is equal to

initial investment (I0) multiplied by the exponential coefficient V  t . It shows that
1

total investment varies directly with b and inversely with V1 (capital output ratio).
To simplify the calculations, let us assume that initial investment I0 is unity. On this
assumption, the equation (4) can be expressed as:

I = e V1 t (5)

So far, we have discussed the case of produce goods sector. Now we

takes up the discussion of consumer goods sector. Taking the clue from equation
(1), the basic equation of the consumer goods sector can be expressed as under:
K2 – (1 – )I (6)
The notations used in the above expression carry the some meaning.
Substitute value of I (from equation 5) in equation 6, we get

t
K2- = 1     eV1 (7)
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Planning Models – II This equation reveals that constant exponential growth rate of investment


e V1
t
is also applicable to the investment in consumer goods sector and (1 – ) is
the fraction of investment in this sector. The increment in the stock of capital in
NOTES respect of category II, is determined by dividing K2 by its capital output ratio and
is expressed as under:
dC K 2

dt V2
Substituting the value of K2 (from equation (7) in above expression, we get

dC 1    V1 t
 e (8)
dt V2
This equation reveals that increment of investment in consumption goods in
 dC 
‘t’ period of time  dt  is equal to the exponential rate of growth of fraction of
 

t
investment i.e. 1     eV1 divided by the capital coefficient (V2) of this category..
Cross multiplying we get,

1    V1
t
dC  e  dt
V2
Integrating the above expression, we have

C
1    t
 dC  
V2
 eV3  dt
C0


1    t t
 .e 1  dt
V
C= V
2 0

1   
]Constant V has been taken out of integration]
2

t
  t 
1    eV1   3x e3 x 
C CC0  
 
 e dx  
V2    3 
 V1  

t
  t 
1    V
=  1 eV1 
V2  
 0

  
1    V1  V1 t 
C – C0 =  e 1
Self-Instructional V2  
 
174 Material
 [anything raised to power zero in unity] Planning Models – II

  
1    V1  V1 t 
C – C0 =  e 1
 V2  
 
NOTES
  
1    V1  V1 t 
C = C0  

V2 
e 1
 (9)
 

This equation reveals that total consumption (C) is equal to the initial
consumption (C0) plus exponential growth rate of the proportion of investment (b,
1 V 
(1- b) multiplied by the ratio of capital coefficient  V  minus one.
 2 

The annual output of the economy is composed of the output of capital

goods sector (I) and consumption goods sector (C). This can be expressed in the
form of an equation given below:
y=C+1 (10)
Differentiating it w.r.t ‘t’ we have
dY dC dI
 
dt dt dt
dC dI
Substituting the values of (from equation 8 and (from equation 2) in
dt dt
the above expression, we get

dY 1    V1 t   I
 e 
dt V2 V1

 
dY 1    V1 t  V1 t 
 e  e [I = e V1 t from equations]
dt V2 V1


dY  1      V1 t
   e
dt  V2 V1 


dY  V1 1     V2  V1 t
  e
dt  V1V2 

t
V1
dY e
 V1 1     V2 
dt V1V2 


t
V1
dY e
 V1  V1  V 2 
dt V1V2  
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Planning Models – II

t
V1
dY e
 V1   V1  V2   (11)
dt V1V2 

NOTES This equation expresses the incremental output of an economy in ‘t’ period
of time in terms of incremental output attributing to consumption goods and producer
goods sector.
Reverting back to equation (10) which states that
Y=C+I
Substituting the value of C & I (from equations 9 and 5 in the above
expression, we get
   
1    V1  V1 t  V1 t
Y= cot  e 1  e
 V2  
 
Adding and subtracting 1 on the RHS of expression, we get
   
1    V1  V1 t  V1 t
Y = C0  1  1  

V2 
e 1  e

 

  t  1     t 
  V1
= C0  1  eV1  1   eV1  1
   V2  
   

  t  1  1  
  V1 
= C0  1  eV1  1    
    V2 
 
For the sake of simple calculations, it was assumed that initial investment I-0
may be treated as one. Now converting one into initial investment, we get
  t  1  1  
  V1 
Y= C0  I 0   eV1  1    
    V2 
 

  t  1  1  
  V1 
Y= Y0  eV1  1     (12)
    V2 
 
[C0 + I0 = Y0]
This is the fundamental mathematical equation of Feldman model. It indicates
that equation of Feldman model. It indicates that total output of an economy is
  t 
 eV1 
dependent on the initial output (Y0), exponential growth   , proportions of
 
investment allocated to capital goods sector ()and consumer goods sector
Self-Instructional
176 Material
(1 – ) and their capital output ratios (V1 and V2). However, the important factor Planning Models – II

influencing the total output is the productive capacity of capital goods sector.
This model therefore, conveys a message that to raise the national output,
planners should focus their attention to the productive aspects of investment in
NOTES
producer goods industries. In other words, the planner should concentrate on the
strategy of unbalanced growth for raising the level of national output and self-
sustained growth of an economy.
3. Implications
Having study, the explanation of Feldman model of growth, one can sort out the
main points to understand its implications.
1. Two sector model: According to the model, the economy has been divided
in two sectors – capital goods sector and consumer goods sector. This
model is therefore, bisector model. With modifications, this model can
address to the problems confronting the developing countries.
2. Unbalanced growth: It has already been discussed that this model does not
propose to develop all the sectors simultaneously; rather it stresses on the
principle of unbalanced growth i.e. priority and preference be given to the
development of capital goods sector in the matter of investment allocation.
Indian planners, too adopted the strategy of unbalanced growth in the Second
Five Year Plan. The main focus of this point is that manufacturing sector has
the maximum total linkage effect and this sector can create external
economies. This model, therefore, speaks in favour of unbalanced growth.
3. State participation: This model was designed by Feldman to suit the
conditions and requirements of Russian economy on the eve of First Five
Year Plan. At that time, it was the regime of state monopoly which controlled
and directed all the factors of production. The role of private entrepreneurs
in the growth of an economy was altogether absent. However, in the modern
day developing countries, the governments have diluted this implication of
the model to suit the requirements of their economies. With the disintegration
of USSR, the independent federal units are allowing the participation of
private sector in the development and progress of their economies.
4. Propensity to save: In this model, a distinct role has been assigned to average
propensity to save and marginal propensity to save. The average propensity
to save determines the rate of growth of income, whereas marginal
propensity to save determines the rate of growth of investment of these
two, marginal propensity to save occupies an important place in the Feldman
model to promote and accelerate growth, the level of investment is to be
raised which in turn depends on marginal propensity to save and it is in tune
with the dynamic process of development.
The study of the above implications reveals that Feldman model of growth,
with necessary modifications suiting, the requirements of an economy, can
Self-Instructional
Material 177
Planning Models – II be used by the planners for solving the problems of underdevelopment. It
can be employed as one of the strategies of development for rapid growth.
4. Critical Appraisal
NOTES Feldman model of growth provides guidelines for the promotion of development
and has made significant contribution in the field of operational model of growth,
yet it is not free from criticism. The main points of criticism are as under:
1. The concept of closed economy is not relevant: This model is based on the
assumption of a closed economy, having no economic relations with outside
world. It means this model does not recognize the role of international factors.
In the present day world, the economic thinkers and development writers
talk of the global economy. A closed door economy cannot enjoy the fruits
of international economic relations and it is difficult to visualize that an
economy can develop in isolation. So the assumption of closed economy is
irrelevant and in appropriate.
2. Division of economy illogical: One of the assumptions of Feldman model is
that economy is divided into two sectors – capital goods sector and
consumption goods sector. This division seems to be irrational as it makes
the model a bi-sector model. In actual practice, economy may comprise of
a number of sectors like primary, secondary and territory sectors. When an
economy is divided into two sectors, obviously the planners would focus
their attention on the development of those two sectors and other sectors
development will be ignored. Such a view will lead to top-sided development.
Division of the economy into only two sectors, therefore, appears to be
illogical and an over simplification.
3. Emphasis on capital goods unwarranted: In this model, more emphasis has
been given to the development of capital goods sector as higher proportion
of investment is allocated to this sector. The consumption goods sector, on
the other hand has been accorded law priority, resulting in the scarcity of
consumption goods and inflation. In a regimented society, the interests of
consumers may be scarified but in a mixed economy like India, such a
situation is not likely to be tolerated by the people. Moreover, development
in a situation of inflation may not be a smooth of fair. There may be tensions
and pressures when one sector is developed at the cost of other. The growth
model which accords priority to capital goods sector at the cost of
consumption goods sector can not help in realizing the goals of development.
4. Marxian frame work is open to question: Feldman model has been prepared
and developed in the Marxian framework. It is considered an extension of
Marxian model, because of its emphasis on capacity creation rater than
income generation aspect of investment. Marxian framework may have its
relevance on appeal to people in a system of command economy. In a
democratic country like India, this model may find itself out of place.
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178 Material
 5. Theoretical model: The basic mathematical equation (12) of this model Planning Models – II

explains that total output of an economy is dependent on initial output (Y0),

  t 
 eV1 
exponential growth   , investment allocation to the two sector NOTES
 
(b, (1 – b) and capital output ratios (V1 and V2) these determinants may
appear to be sound, but practically, it may not be an easy exercise to calculate
their values. There may arise a need for making use of electronic devices
either may not be available in poor developing economies on their use may
require professionals who can handle them. The availability of such
professionals may also be a problem. Veering all aspects, one can infer that
this model may be theoretically sound but it may not be feasible proposition
in actual practice.
Conclusion
The discussion of this model can be summed up in the words of Prof. Domar who
says that, “this model contains an important element of truth; a closed economy,
without well developed metal, machinery and subsidiary industries, is unable to
produce a sizeable quantity of capital goods and thus, to invest a high fraction of
its income, however, high its potential saving propensity may be. In Soviet economic
thinking, the former consideration has to be predominant. In our recent literature,
the ability to save has been emphasized.” The basic propositions of this model are
relevant in the system of a command economy. With necessary modification,
Feldman model can address to the problems of development of underdeveloped
economies.

Check Your Progress

1. What are the two main features of the Feldman Model?
2. What is a bi sector model?
3. Why is division of sector in Feldman model illogical?

12.3 THE MAHALANOBIS MODEL

Introduction
In October 1952, Mahalonobis developed a single sector model based the variable
of national income and investment. It was further developed into a two sector
model in 1953 where the entire net output of the economy was supposed to be
produced in only two sectors – the investment goods sector and the consumer
goods sector. Next he develops the famous four – sector model in 1955. We
discuss this two sector and four sector models.
Self-Instructional
Material 179
Planning Models – II 1. Two Sector Model
It was Mahalanobis’ s two sector model which became the basis for his formulation
of the four sector model for the Second Five Year Plan. The Mahalanobis two
NOTES sector model was based on the following assumptions:
(a) It is related to a closed economy where there is no foreign trade.
(b) The economy consists of two sectors: the consumer goods sector and the
capital goods sector. There is no intermediate sector. The industries producing
intermediate goods are grouped together with the consumer goods and the
capital goods which they help to produce.
(c) There is total non-shift ability of capital equipment once installed in any of
the sectors. But products of the capital goods sector can be used as inputs
in the two-sectors.
(d) There is full capacity production in the consumer goods sector as well as in
the capital goods sector.
(e) Investment is determined by the supply of capital goods.
(f) There are no changes in prices.
Given these assumptions, Mahalanobis divided the economy into two parts:
K, the proportion of net investment used in the capital goods sector and
C, the proportion of net investment used in the consumer goods sector.
K + C = 1 (1)
Further, net investment (I) can be divided into two parts at any point of time
(t): one, Kt to increase the productive capacity of the capital goods sector
and CC of the consumer goods sector. In this way
t = Kt + Ct (2)
Taking K and C as the output – capital ratios of the capital goods sector
and the consumer goods sector respectively &  as the total productivity
coefficient, the latter can be shown as
 K  K  C C
=  K  C

But K + C = 1
 = KK + cC (3)
The income identify equation for the entire economy is
Yt = It + Ct (4)
Now, When national income changes, investment and consumption also
change. The change in investment depends upon previous year’s investment
(It- – 1) and so does consumption on previous year’s consumption (Ct – 1).
So the increase in investment in period t, is It = It – It – 1, and increase in
Self-Instructional
180 Material
consumption is Ct = Ct – Ct – 1. As a matter of fact, the increase in the two Planning Models – II

sectors is related to the linking up of productive capacity of investment and

the output – capital ratio. First, the investment growth path is determined
by the productive capacity of investment in the capital goods sector (KIK)
and its output – capital ratio (K), so that NOTES
It – It – 1 = KKIt – 1
It = It – 1 + KKIt – 1
or, It = (1 + KK)It – 1 (5)
Putting different value for t(t = 1, 2, 3, ……) the solutions of equations (5)
are
I1 = (1 + KK)I0
I2 = (1 + KK)I1
= (1 + KK) (1 + KK)I0
= (1 + KK)2I0 [I1 =(1 + KK)I0]
In the same manner by putting the value of t in equation (5)
we get
It = I0 (1 + KK)t
It = I0 = I0 (1 + KK)t – I0
It – I0 = I0 (1 + KK)t – 1 (6)
similarly, by putting the value of t (t = 1, 2, 3 ….) in the consumption growth
path C1 = Ct – Ct–1 = ccIt–1, we get
C1 – C0 = ccI0
C2 – C1 = ccI1
an finally Ct – C0 = cc(I0 + I1 + I2 +……. It)
By substituting the value of I1, I2 …. It in equation (6) and its related equation,
the above equation can be solved as
Ct – C0 = cc[I0 + (1 + kk)I0 + (1 + kk)2I0 + ….+(1 + kk)tI0]
= ccI0 [1 + (1 + kk) + (1 + kk)2 + ….+(1 + kk)t]
 (1  )t 1 
k k
=  c c I 0  
 (1 k k ) 1 

 (1  )t 1 
k k
or Ct – C0 =  c c I 0 
 k k
 (7)
 

Now, the growth path of income for the whole economy on the basis of
equation (4) is
yt = It + Ct

Self-Instructional
Material 181
Planning Models – II or yt – y0 = (It – I0) + (Ct – C0)
by substitution the values of equations (6) and (7) in the above equation,
we get
NOTES  (1  )t 1
yt  y0   I0 (1 k k )t 1 cc I0  k k 
    k k 

   
 I 0 (1 k k )t 1  1 c c 
    k k 

     
 I 0  (1k k )t 1   k k c c 
    k k 

supposing I0 = 0y0 and substituting it in the above equation, we have

    c ) 
yt  y0 0 y0 (1 k k )t 1   k k c 
    k k 

or

    c ) 
yt 0 y0 (1 k k )t 1   k k c   y0
    k k 

or
    
t 
yt  y0 10 K K C C 1 K  K  1 
  K K 
 (8)

where YT = gross domestic national income Pn year t;

0 = the rate of investment in the basic year;
K = the share of net investment used in the capital goods sector;
C = 1 = K = the share of net investment going to the consumer goods
sector;
K = incremental output – capital ratio in the capital goods sector;
-C = incremental output – capital ratio in the consumer goods sector.
The interpretative value of this model is that investment in the economy
consists of two parts: one part lK is used to increase the production of
capital goods, and the other part C to increase the production of consumer
goods. Thus, the total investment is K + C = 1.
 K  K   C C
The ratio  K K of the equation is over all capital coefficient.
Assuming K and C to be given, the growth rate of income will depend
upon 0 and K. Further assuming 0 (the rate of investment the base year)
to be constant, the growth rate of income depends upon the policy instrument
 K.

Self-Instructional
182 Material
 Given that C > K, it implies that the larger the percentage investment in Planning Models – II

consumer goods industries, the larger will be the income generated. The
expression on 1   K K t of the equation shows, however, that after a
critical range of time, the larger the investment in capital goods industries, NOTES
the larger will be the income generated. In the beginning, a high value of the
K increases the magnitude 1   K K  t , and lowers the over-all capital co-
efficient
 K  K   C C
 K k

But as time passes, a higher value of K would lead to higher growth rate of
income in the long run.
If c = K, then the reciprocal of the over all capital coefficient.
 K K
 K
 K k  C C

= marginal rate of sawing. This leads us to an important policy implication

of the model that for a higher rate of investment (K), the marginal rate of
saving must also be higher. A higher rate of investment on capital goods in
the short run would make available a smaller volume, of output for
consumption, but in the long run, it would lead to a higher growth rate of
consumption.
Relation of the Mahalanobis Two Sector Model with the Doman Modal
Mahalanobis derived his two-sector model from the Doman Model Therefore,
both model have a close relation.
First, we present the Doman model in terms of the parameters of the
Mahalanobis Model.
The equilibrium equation for determining investment in the Doman Model is
I = Y
where I is investment,  is the saving – income ratio and Y is the national
income
The growth of investment in period t is
It = Yt (1)
By taking investment in the initial period I0 = 0Y0 (2)
Dividing (1) by (2),
I t  Yt
 
I 0  0 Y0

Self-Instructional
Material 183
Planning Models – II
Yt  I t
or,  
Y0 0 I 0

Yt  Y0 0 It  I t
NOTES or, 
Y0  I0

 [Yt = Yt - Y0 and It = It – I0]

Yt  Y0 0  I t 
or,    1
Y0   I0 

Yt  Y0 0
or,  1     1
Y0   t 

I
[ I  1    and  is output – capital ratio]
t t

0 
Y0 1     1
t
or, Yt  Y0 
  

0 
Y0 1     1  Y0
t
or, Yt 
  

  
Yt  Y0 1  0 1    1
t
or, 
(3)
 

On the other hand, the final equation of the two-sector Mahalanobis mode
is

  K  K   C C  
Yt = Y0 1  0 

1   K  K t  1  (4)
  K K 

There are certain similarities between the two models, first, the last expression
of the two equations (3) and (4) are similar i.e., (1 + )t and (1 + KK)t, since
Domar’s  is Mahalanobis ‘s KK conclusion of both are the same, investment
can be increased by raising the marginal saving rate.
Despite these similarities, there is some difference between the two models.
The Domar model is a single – sector and the consumer goods sector. On the
other hand, Domar treats the whole economy as one sector.
2. Four Sector Model
The Mahalanobis model is not a growth model in the real sense, rather it is an
allocation model. Being associated with the Planning Commission, Mahalanobis
knew that the maximum funds available for net investment during the Second Five
Year Plan would be approximately Rs. 5,600 crores and the aim was to provide
addition employment to 10-12 million people. To these, he added a 5 percent per
Self-Instructional
annum increase in national income during the Plan Period. He further estimated
184 Material
one-third of the total investment in investment goods industries, leaving two-thirds Planning Models – II

for investment in the remaining three-sectors of the economy.

He put all this data in a simple simultaneous equation system given below
and obtained the solution which became the basis of India’s Second Five Year
NOTES
Plan.
The Mahalonobis model takes a four-sector economy consisting of:
(a) the investment goods sector (K);
(b) the factory produced consumer’s goods sector (C1);
(c) the small household produced (including agricultural products)
consumer goods sector (C2); and
(d) the services (health, education, etc.) producing sector (C3).
These subscripts K, 1, 2 and 3 are used respectively in the model for the
industries producing investment goods, consumer goods (both factor and
household) and services.
For each of these four sectors a set of three parameters is introduced; ’s
(beta), i.e., K, 1, 2, 3 – the ratios of net income generated to investment or
output – capital ratios.
’s (theta), i.e., K, 1, 2, 3 – the net investment required per engaged
person are capital labour ratios.
’s (lambda), i.e., K, 1, 2, 3 – the proportion of investment allocated to
each sector or allocation ratios.
Further, A stands for the total amount of investment to be made for the plan
– period of five years, E for the total increase in income and n for the total increase
in employment over the plan period.
Given these parametric ratios (’s, ’s and ’s) and the total amount to be
invested (A), an estimate of total income (E) and employment (N) generated in the
different sectors of the economy during the plan period can be had on the basis of
the system of equations.
The equations of the model are:
E = EK + E1 + E2 + E3 (1)
N = nK + n1 + n2 + n3 (2)
A = KA + 1A + 2A + 3A (3)
Now the increase in employment (n) is each sector is
nk = KA/K or nkK = KA (4)
n1 = 1A/1 or n11 = 1A (5)
n2 = 2A/2 or n22 = 2A (6)
n3 = 3A/3 or n33 = 3A (7)
Self-Instructional
Material 185
Planning Models – II Substituting the value of KA, 1A, 2A, and 3A in equation (3), the total
investment equation becomes
A = nKK + n11 + n22 + n33
NOTES Similarly, the increase in income (E) generated in each sector can be estimated
as follows:
EK = KA.K (8)
E1 = 1A.1 (9)
E2 = 2A.2 (10)
E3 = 3A.3 (11)
Also, E = nKKK + n111 + n222 + n333 [KA = nKK and so on
form equation 4, 5, 6 and 7]
= Y0 [(1 + n)5 – 1) (12)
In the Mahalanobis model the above equation is the final one when e, 
(eta) is given 5 per cent annual growth rate of income, Y0 the initial income per
year, the E° is derived by applying  rate to Y0. In the system of equations give
above, A, E and N are the boundary conditions. They are constants, but at the
same time they are the target variables to be achieved during the plan-period. The
’s, ’s and ’s are the instrument variables.
The ’s and ’s are, however, the structural parameters, determined by
technological conditions and assumed to remain constant during the plan period.
The ’s are the allocation parameters which are at the choice of the planner within
certain limits.
In the Mahalanobis model, the allocation parameter (ratio) K for the
investment goods sector is given and the remaining ratios for the other three sectors
(1, 2, 3) are obtained as solutions of the set of simultaneous equations given
above. For example, as Mahalanobis explains, “the rate of increase of income or
the employment generated may be treated as variables to which desired value
may be assigned. The model would then enable us, with the help of numerical,
estimates of the various parameters, to study how the allocation ratios ’s that is,
the proportions of total investment going into the different sectors should be chosen
so that the desired aim can be realized.”
Professor Mahalanobis gives the following numerical solution of his model
where
A (total investment) = Rs. 5,600 crores
h (percentage increase in national income) = 5 per cent per annum
N (total employment to be created) = 110 Lakhs (11 million)
K proportion of investment in investment goods industries 1/3 (or
0.33)

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186 Material
 The sectoral values of ’s, ’s and ’s are taken as Planning Models – II

Sectors Parameters
  
Investment goods (K) K = 0.33 K = 0.20 K = Rs. 20,000
NOTES
Factory consumer goods (C1) 1 = 0.17 1 = 0.35 1 = Rs. 8,750
Small and household 2 = 0.21 2 = 1.25 2 = Rs. 2,500
industries including
agriculture (C2)
Services (C3) 3 = 0.29 3 = 0.45 3 = Rs. 3,750

On the basis of the given data, the amount of investment in sector K is KA
33
= × 5,600 = 1,850 crores; the increase in income as a result of this investment
100
20
comes to EK = KAK = 1850 × = Rs. 370 crores, while the increase in
100
1
employment is sector K is of the order of nK = KA/K = 1850 × = 0.9
20000
million (9 lakhs). Similarly, the allocation of increase in income, employment
generated and investment for the other sectors during the planning period of 5
years in rounded figures, as calculated with the help of simultaneous equations are:
Increase in
Sectors Investment (A) Income (E) (Rs. Employment (N)
(Rs. Crores) Crores) (Million)
K 1850 370 0.9
C1 980 340 1.1
C2 1180 1470 4.7
C3 1600 720 3.3
Total 5610 2900 10.0

We can sum up the Mahalanobis model thus:

In a given time period, in order to achieve a certain growth rate for the
economy, the total investable amount has been divided in such a way that it leads
to the required growth rate. But since the required growth rate is to be reasonably
high, it can be achieved by expanding sector K and there by producing larger
quantities of investment goods. However, investment in sector K is bound to
generate increased purchasing power and hence demand for consumer goods
which require comparatively less capital but employ more goods which require
comparatively less capital but employ more labour. In this way a balance is sought
to be established between the investment goods sector and consumer goods sector.
3. Critical Appraisal
The above solution of the Mahalanobis model and its practical application to India
in the form of the Second five Year Plan proves that it possess great utility as an
instrument to development planning. But it has its limitations and weaknesses.
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Material 187
Planning Models – II 1. Fails to solve any Definite Welfare Junction: It is essentially an operational
model. As already explained, it arrives at an optimal solution out of a
multiplicity of solutions in relation to a preference or welfare function already
prescribed. The numerical solution of the model, however, does not point
NOTES towards any definite welfare function without which it is not possible to
arrive at an optimum allocation of resources.
1
2. Arbitrary value of lK: Mahalanobis assumes the value  K  3 but he does
not ascribe any cogent reason for this, and simply says that it would not be
possible to go beyond this value under present conditions.” He could very
well choose any other value or any value for any other allocation parameter
1
with perhaps better results. The assumption of   is, therefore, somewhat
3
arbitrary and may not help the planners is arriving at correct solutions for
the optimum allocation of investments of the different sectors of the economy.
3. Technique not applicable to open Economy: Moreover, the use of l technique
suggests that investment is a single homogenous fund which is utilized for a
single type of investment goods. Since investment goods are of
heterogeneous type, this requires the use of an investment matrix. The 
technique can be applied as long as constant relative prices are assumed. It
cannot, therefore, be applied to a model of open economy where the system
is not homogenous.
4. Supply of Agricultural Produce not Infinitely Elastic: The Mahalanobis model
is based on the supposition that the supply of agricultural produce is infinitely
elastic. This is untenable for the supply of agricultural produce has failed to
meet the increase demand for food and raw materials ever since the beginning
of the Second Five Year Plan.
5. Supply of Labour also not Infinitely Elastic: It also assumes an infinitely
elastic supply of labour which does not seem to be correct even though an
under developed country like India is faced with the serious problem of
unemployment and under employment. What is required for productive
structure is not simply labour but skilled and trained labour and management.
6. Production technique not constant: Like Harrod, Mahalanobis assumes the
techniques of production of production to be constant during the Plan Period.
In fact, technological change is bound to occur during the process of
development. Thus his model does not seem to take us very far.
7. Arbitrary Values for Structural Parameters: The values assigned to the
structural parameters (the ’s and ’s) are also arbitrary. In fact, it is
extremely difficult to have a correct estimate values of ’s and ’s is an
under developed country which completely lacks in sufficient reliable data.
Moreover, the assumption of independence between capital output ratios
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188 Material
 and capital labour ratios is not realistic. These parameters may change in Planning Models – II

the process of development.

8. Silent over Investment in a Mixed Economy: Further, the Mahalanobis model
fails to guide the planners in deciding the share of investments in the private
NOTES
and public sectors. It is silent with regard to this important problem of
development planning in a democratic country with a mixed economy.
9. Ignores Factor Prices: Another important defect of this model is that
Mahalanobis ignores the pattern of factor prices while fixing targets on the
basis of his model.
10. Closed Model: This model is confined to a closed economy. Mahalanobis
assumed “that there will be no imports or exports of investment goods.”
Thus he ignored the impact of foreign trade on the variables of the model
and deprived it of the element of reality.
11. Neglects Demand Function: The Mahalanobis model concentrates
exclusively on the supply functions and neglects the demand function
altogether. This is an unrealistic assumption and makes the growth model
incomplete. “Actually speaking, many important considerations connected
with market forces, psychological environment, popular enthusiasm and
the emergence of specific pressure point are unavoidably involved in the
course of development planning in a backward economy. The Mahalanobis
model quietly ignores these important problems for the sake of mathematical
simplicity.”
12. Failure to link up Investment Decisions with the Rates of Saving Required:
According to K.N. Raj, one of the weaknesses of the Mahalanobis model
is its failure to link up investment decisions with the rates of saving required.
The necessity of high marginal rates of saving is one of the main considerations
in favour of capital – intensive techniques of production.
13. Failure to Explain the Problem of Choice of Techniques: Professor Raj
further points out that from the theoretical angle, the Mahalanobis model
fails to explain the problem of choice of techniques satisfactorily. He asks,
if sector C is divided according to techniques of production, why should
not sector K be similarly divided? Even the manufacture of machine tools
there are more or less capital intensive techniques. The case of labour
intensive techniques could have perhaps stated more pointedly.
Conclusion
Despite these practical and theoretical weaknesses, the Mahalanobis model was
instrumental in putting the Indian economy on the right path to development planning
with the Second Five Year Plan and paved the way for the subsequent bolder
plans.

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Planning Models – II

Check Your Progress

4. Mahalanobis model is derived from which model?
NOTES 5. When was four-sector model invented? Why is it important to India?
6. What parameters needs to be considered in four-sector model?

12.4 INPUT-OUTPUT ANALYSIS

Meaning
Input-Output is a novel technique invented by Professor Wassily W. Leontief in
1951. It is used to analysis inter-industry relationship in order to understand the
inter-dependences and complexities of the economy and thus the condition for
maintaining equilibrium between supply and demand. It is also known as “inter-
industry analysis”.
Before analyzing the input-output method, let us understand the meaning of
the terms, “input” and “output”. According to Professor J.R. Hicks, an input is
“something which is bought for the enterprises” while an output is “something
which is sold by it”. The input represents the expenditure of the firm and output its
receipts. The sum of the money values of inputs is the total cost of a firm and the
sum of the money values of the output is its total revenue.
The input-output analysis tells us that there are industrial inter-relationships
and inter-dependencies in the economic system as a whole. The inputs of one
industry are the outputs of another industry and vice versa, so that ultimately their
mutual relationships lead to equilibrium between supply and demand in the economy
as a whole. Coal is an input for steel industry and steel is an input for coal industry,
though both are the output of their respective industries. A major part of economic
activity consists in producing intermediate goods (input) for further use in producing
final goods (output). There are flows of goods in “whirlpools and cross currents”
between different industries. The supply side consists of large inter-industry flows
of intermediate products and the demand side of the final goods. In essence, the
input-output analysis implies that in equilibrium, the money value of aggregate
output of the whole economy must equal the sum of the money values of inter-
industry inputs and the sum of the money values of inter industry outputs.
Main Features
The input-output analysis is the finest variant of general equilibrium. As such, it has
three main such elements: First, the input-output analysis concentrates on an
economy which is in equilibrium. It is not applicable to partial equilibrium analysis.

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190 Material
Secondly, it does not concert itself with the demand analysis. It deals exclusively Planning Models – II

with technical problems of production. Lastly, it is based on empirical investigation.

Assumptions: This analysis is based on the following assumptions:
(i) The whole economy is divided into two sectors – “inter-industry sector” NOTES
and “final demand sector,” both being capable of sub-sectoral division.
(ii) The total output of any inter-industry sector is generally capable of
being used as inputs by other inter industry sectors, by itself and by
final demand sectors.
(iii) No two products are produced jointly. Each industry produces only
one homogenous product.
(iv) Prices, consumer demands and factors supplies are given.
(v) There are constant returns to scale.
(vi) There are no external economies and diseconomies of production.
(vii) The combinations of inputs are employed in rigidly fixed proportions.
The inputs remain in constant proportion to the level of output. It
implies that there is no substitution between different materials and no
technological progress. There are fined input coefficients of production.
The input-output analysis consists of two parts: the construction of the input-
output table and the use of input-output model.
The use of Input-Output Model in Planning
The input-output tables relates to the economy as a whole in a particular year. it
shows the values of the flows of goods and services between different productive
sectors especially inter-industry flows. For understanding, a three-sector economy
is taken in which there are two inter-industry sectors, agriculture and industry and
one final demand sector.
Table 12.1 provides a simplified picture of such economy. In this table, the
total output of the industrial, agricultural and household sectors is set in rows (to
be read horizontally) and has been divided into the agricultural, industrial, and final
demand sectors.
The inputs of these sectors are set in columns. The first row total shows that
altogether the agricultural output is valued at Rs. 300 crores per year. Of this total,
Rs. 100 crores go directly to final consumption, that is household and government,
as shown in the third column of the first row. The remaining output from agriculture
goes as inputs; 5-0 to itself and 150 to industry. Similarly, the second row shows
the distribution of total output of the industrial sector valued at Rs. 500 crores per
year.

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Planning Models – II Table 12.1 Input-Output Table (In value terms) Rs. Crores)

Purchasing Sector
Sectors Inputs to Inputs to Final Total output
Agriculture industry Demand or Total
NOTES Revenues
Selling Agriculture 50 150 100 300
Sectors
Industry 100 250 150 500
Value added* 150 100 0 250
Total Input or 300 500 250 1050
Total Cost

*Value added refers to payment to the factors of production.

Column 1, 2 and 3 show that 100 units of manufactured goods goes input
to agriculture, 250 to industry itself and 150 for final consumption to the household
sector.
Let us take the columns (to be read downwards). The first column describes
the input or cost structure of agricultural industry. Agricultural out valued at Rs.
300 crores is produced with the use of agricultural goods worth Rs. 50,
manufactured goods worth Rs. 100 and labour or/and management services value
at 150. To put it differently, it costs Rs. 300 crores to get a revenue of Rs. 300
crores from the agricultural sector. Similarly, the second column explains the input
structure of the industrial sector. (i.e.) 150 + 250 + 100 = 500). Thus “a column
gives one point on the production function of the corresponding industry” the “final
demand” column shows what is available for consumption and government
expenditure. The third row corresponding to this column has been shown as zero./
This means that the household sector is simply a spending (consuming) sector that
does not sell anything to itself. In other words, labour is not directly consumed.
Feasibility and Consistency of the Plan
An economy behaves and assumes a certain pattern of the flows of resources in
two ways: They are: (a) the internal consistency or balance of each sector of the
economy, and (b) the external stability of each sector or inter-sectoral relationship.
Leontief calls them the “fundamental relationship of balance and structure. When
expressed mathematically they are known as the “balance equations” and “structural
equations.”
If the total output of says xi of the ith industry be divided into various number
of industries 1, 2, 3, ..n, then we have the balance equations:
xi = xi1 + xi2 + xi3 + ……. xin + Di ….. (1)

and if the amount say yi absorbed by the “outside sector” is also taken into
consideration, then the balance equation of the ith industry becomes

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 xi = xi1 + xi2 + xi3 + ……. xin + Di + xi Planning Models – II


or xij  xi  xi (2)

j=i NOTES
It is to be noted that yi stands for the sum of the flows of the products of ith
industry, to consumption, investment and exports, net of import, etc. It is also
called the “final bill of goods” which it is the function of the output to fill. The
balance equation shows the conditions of equilibrium between the supply and
demand. It shows the flows of outputs and inputs to and from one industry to
other industries and vice-versa. The system of a balance equations in analysis
presents the conditions of internal consistency of the plan. The plan would not be
feasible without them because of these equations are not satisfied, there might be
excess of some goods and deficiency of others. Since x-i2 stands for the amount
absorbed by industry 2 of the ith industry it follows that xij stands for the amount
absorbed by the jth industry of ith industry.
The “technical coefficient” or “input coefficient” of the ith industry is denoted
by:
Xij
aij  (3)
Xj

where xij is the flow from industry I to industry j, xj is the total output of
industry j and aij, as already noted above, is a constant, called “technical coefficient”
or “flow coefficient” in the ith industry. The technical coefficient shows the number
of units of one industry’s output that are required to produce one unit of another
industry’s output. Equations (3) is called a “structural equation”. The structural
equation tells us that the output of one industry is absorbed by all industries so that
the flow structure of the entire economy is revealed. A number of structural equations
give a summary description of the economy’s existing technological conditions.
The matrix of technical coefficient of production for any input output table
with n sectors would consists of nx n elements. There being two sectors in our
example, 2 × 2 technical coefficients of the matrix would be arranged symbolically
as follows:
Table 12.2 Technology Matrix A

Agriculture Industry
Agriculture a11 a12
Industry a21 a22
Using equation (3) to calculate the aij for our example of the two sector
input-output Table 12.2, we get the following technology matrix.

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Planning Models – II Table 12.3 Technology coefficient Matrix A

Agriculture Industry
Agriculture 50 150
= .17 = .30
NOTES 300 500
Industry 100 250
= .33 = .50
300 500

These input coefficients have been arrived at by dividing each item in the
first column of table 12.1 by first row total, and each item in the second column by
the second row, and so on. Each column of the technological matrix reveals how
much agricultural and industrial sector require from each other to produce a rupee’s
worth of output. The first column shows that a rupee’s worth of agricultural output
requires input worth 33 paise from industries and worth 17 paise from agriculture
itself.
The Leontief Solution
The table can be utilized to measure the direct and indirect effects on the entire
economy of any sectoral charge in total output of final demand.
Again using equation (3)
xij
aij 
xi

Cross multiplying xij = aij · xj

By substituting the value of xij into equation (2) and transposing terms, we
obtain the basic input – output system of equations.
x j   n  aij  j  yi

i=1
In terms of our two-sector economy, there would be two linear equations
that could be written symbolically as follows:
x1 – a11x1 – a12 x2 = y1
x2 – a21x1 – a22x2 = y2
The above symbolic relationship can be shown in matrix from:
x – [A]x = y
x – [I – A] = y
Where matrix (I – A) is known as the Leontief Matrix
(I – A)-1 (I – A)x = (I – A)-1y
x = (I – A)-1y [ (I – A)-1 (I – A)]

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 Planning Models – II
1 0 
and I, the identity matrix 0 1
 
1
 x1   1 0   y1 
Hence  x  =  0 1    A  y  NOTES
 2      2 
Numerical Solution:
Our technology matrix as per table 56.3 is
1 3 100
A = 3 5 and y =  50 
   

9  3
(I – A) = 3  5 
 
Adjoint Adj
The value of inverse = Determinant  | A |

5 3
[Aij] = 3 9 
 

5 3
By transposing, Aij = 3 9 
 
The value of determinant = ·9(·5) – (-·3)(- ·3)
=·45 - ·0.9 = ·36
 x1  1 5 3 100 
  x  = 36 3 9  150 
 2   
The total output of agriculture sector (x1)
5  100  3  150
= = 264
36
The total output of industrial sector (x2)
3  100  9  150
= = 458
36

The Dynamic Input-Output Model

So far we have studied an open static model. “The model becomes Dynamic
when it is closed by the linking of the investment part of the final bill of goods of
output. The dynamic input–output model extends the concept of inter sectoral
balancing at a given point of time to that of inter-sectoral balancing at a given point
of time to that of inter-sectoral balancing our time. This necessarily involves the
concepts of durable capital.
The Lenotief dynamic input-output model is generalization of the static model
and is based on the same assumption. In a dynamic model the output of a given
period is supposed to go into stocks i.e. capital goods and the stock in turn are
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Material 195
Planning Models – II disturbed among industry. The balanced equation is:
xi(t) = xi1(t) + xi2(t) + x-i3(t) ….. + xin(t) + s’i1 + s’i2 + s’i3 + s’i4 + ……
s’in + Di(t) + yi(t)
NOTES Here xi(t) represents the total flow of output of ith industry in period t,
which is used for 3 purposes (i) for production in the economy’s industries xi1(t),
x-i2(t) etc., in that period; (ii) as net audition to the stock of capital goods in n
industries e., s’t which can also be written as Dsi(t) = si(t + 1) – si(t), where (sit)
indicates the accumulated stock of capital in the current period (t), and si(t + 1) is
next years stock, and (iii) as consumption demand for the next period Di(t + 1). If
we ignore depreceation and wear tear, then si (t + 1) – si(t) is the next audition to
capital stock out of current production equation (4) can therefore be written as:
xi(t) = xi1(t) + xi2 + x-i3 + ….. + xin + si(t + 1) + si(t) + Di(t) + yi(t)
yi(t) stands for the amount absorbed by the outside sector in period t. Just
as the technical co-efficient was devided in the case of the static model of the
capital co-efficient can be found out in a similar manner, capital co-efficient of the
ith product used by the jth industry is denoted by
sij
bij 
xj
cross multiplying we have sij = bij · j
where sij represents the amount of capital stock of the ith product used by
the jth industry. xj is total output of industry j and bij is a constant called capital
co-efficient or stock co-efficient, equations (5) is known as the structural equation
is a dynamic model.
If the sij co-efficient is zero it means that no stock is required by an industry
and the dynamic model becomes a static model. Moreover, bij can neither be
negative nor infinite. If the capital co-efficient is negative, the input is in fact an
output of an industry.
Limitations of Input-output Analysis
The output analysis has its shortcomings, Its framework rests an Leontief’s basis
assumption of constancy of input co-efficient of production which was split up
above as constant return to scale holds and in a stationary economy, while that of
constant technique of production in stationary technology. these assumption sacrifice
realities. They do not treat the inter-industry analysis dynamically even in that so
called “dynamic mode”. It tells us nothing as to how technical co-efficient would
change with changed condition. Again some industries have may use no capital.
Such variations in the use of techniques of production make the assumption of
constant co-efficient of production unrealistic.
Again, the assumption of fixed co-efficients of production ignores the
possibility of factor substitution. There is always the possibility of some substitution
even in a short period, while substitution possibilities re likely to be relatively greater
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196 Material
 The assumption of linear equations which relates output of one industry to Planning Models – II

input of others, appears to be unrealistic. Since factors are mostly invisible, increases
in output do not always require proportionate increases in inputs.
Moreover, the rigidity of the input-output model cannot reflect such
NOTES
phenomena as bottlenecks, increasing costs, etc.
The input-output model is severely simplified and restricted as it lays exclusive
emphasis on the production side of the economy. It does not tell us why the inputs
and outputs are of a particular pattern in the economy.
Another difficulty arises in the case of “final demand” or “bill of goods”. In
this model, the purchases by the government and consumers are taken as given
and treated as a specific bill of goods. Final demand is regarded as an independent
variable. In might, therefore, fail to utilize all the factors proportionately or need
more than their available supply. Assuming constancy of co-efficiency of production,
the analysis is not in a position to solve this difficulty. There is no mechanism for
price adjustment in the input-output analysis which makes it unrealistic. “The analysis
of cost-price relations proceeds on the assumptions that each industrial sector
adjusts the price of its output by just enough to cover the change in the case of its
primary and intermediate output.” The dynamic input-output analysis involves
certain conceptual difficulties (i) The use of capital in production necessarily leads
to stream of output at different points of time being jointly produced. But the
input-output analysis rules out joint production. (ii) it cannot be taken, for investment
and output will necessarily be non-negative.
The input-output model thrives on equations that cannot be easily arrived
at. The first thing is to ascertain the pattern of equations, then to find out the
necessary voluminous data. Equations pre-suppose the knowledge of higher
mathematics and correct data are not easy to ascertain. This makes the final output
model abstract and difficult. In the above analysis we have presented a highly
simplified model of input-output of analysis. To be useful for planning purposes
the input-output table should be divided into thirty of more industries or sectors.
In many underdeveloped countries reliable data needed to construct a large input-
output table are not easily variable. In small countries only a few industries or
sector exist and the input-output table is of little use. A number of cells in it as
shown is zero. Moreover, in case of the subsistence agriculture sector of, labour is
the only input and output sold in the market sector is insignificant, while commercial
crops are sold to the consumption sector. The input-output table is useless in such
economies. Thus for the input-output table is useless in such economies. This for
the input-output analysis to be useful for an undeveloped country. It is essential
that it must be a large economy where the number of industries or sectors is quite
large for substantial inter-industry transactions to take place and for reliable
statistical information to the available. But all these condition are not met in the
majority of underdeveloped countries which limit the use of input-output analysis
as a technique in development planning.
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Material 197
Planning Models – II Use of Input-Output Technique in Planning
The knowledge of both the fundamental relationship of “flow coefficients” of the
static model and of “capital co-efficients” of the dynamic model is required for the
NOTES development plans. The input-output table tells us about the inter-relationships
between various sectors and the structural relationships within each sector. On the
basis of this information, the planning authority can determine the effect of a change
in one sector on all other sectors of the economy and thus plan accordingly.
With the help of the static analysis “flow co-efficients” of each industry can
be calculated and known during a given period of time. But in an economy fast
moving towards economic development, the flow structure of the economy does
not remain stable. Again, a static model takes the capital structure of the economy
as given. In fact, the capital requirement of the economy change with economic
development.
It is only “when we properly harmonize the capital structure with the flow
structure that we get a comprehensive input-output system which is very useful for
dynamic analysis in connection with planning. given the basic conditions and also
time period one can calculate the flow co-efficient and the capital co-efficient of
the economy. In addition to all this if the time shape of the final demand is also
known, one could find out definitely. What should be the consistent and optimum
levels of output of various industries after five years.”
The input-output technique with its basic assumptions of constant “technical
co-efficient” is of much help to a planning authority is an underdeveloped country.
A linear homogeneous input-output model fits in an underdeveloped economy
where reliable statistical data about technical coefficients are not easily available.
By assuming constant “flow” and “capital coefficient” the need for collecting and
computing vast statistical data is greatly reduced. Since inputs are considered
proportional to outputs, this technique is certainly of immense help in determining
the amount of inter-industry flows of goods and services in an underdeveloped
country.
“From the planning point of view, the dynamic input-output model has much
appeal; it helps in identifying a moving equilibrium of outputs. Investments is specified
of a disaggregate level in terms of specific investment goods and is treated
endogenously. The planner is help to see more clearly the implications of raising
the level of investment in a particular sector, given the requirements of inter-sectoral
balancing.”
The input-output analysis is also used for national economic planning. The
static and dynamic models can be applied in preparing the ‘plan-frame’ in
underdeveloped economies. The input-output model provides the necessary
information about the structural coefficients of the various sectors of the economy
during a period of time or at a point of time which can be utilized for the optimum
allocation of the economy which can estimate through the input output table the
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198 Material
impact of different growth rate of the various sectors of the economy and thus Planning Models – II

choose the most desired one.

A United Nation study lists the following uses of input-output models in
developing programming:
NOTES
(i) They provide for individual branches of the economy’s estimates of
production and import levels that are consistent with each other and
with the estimates of final demand.
(ii) The solution to the model aids in the allocation of the investment
required to achieve the production levels in the programme and its
provides a more accurate test of the adequacy of available investment
resources.
(iii) The requirements for skilled labour can be evaluated in the same way.
(iv) The analysis of import requirements and substitution possibilities is
facilitated by the knowledge of the use of domestic and imported
materials in different branches of the economy.
(v) In addition to direct requirements of capital, labour and import, the
indirect requirements in other sectors of the economy can also be
estimated.
(vi) Regional input-output models “can also be constructed for planning
purposes to explore the implications of development programmes for
the particular region concerned, as well as for the economy as a whole”.
It concludes that these models are primarily applicable in economies that
have achieved a certain degree of industrial development and hence have a
substantial volume of inter-industry transactions.

Check Your Progress

7. State the main features of the input output model.
8. Who is the creator of input-output analysis?

12.5 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. This model highlights two important features. One is the concept of

unbalanced growth and second is the Marxian scheme of production
2. According to the model, the economy has been divided in two sectors –
capital goods sector and consumer goods sector. This model is therefore,
bisector model
3. In actual practice, economy may comprise of many sectors like primary,
secondary and territory sectors. When an economy is divided into two
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Material 199
Planning Models – II sectors, obviously the planners would focus their attention on the
development of those two sectors and other sectors development will be
ignored.
4. Mahalanobis derived his two-sector model from the Doman Model.
NOTES
5. The four-sector model was invented in 1955. It became the basis of second
five-year plan hence very significant to India.
6. Four parameters considered in the four-sector model, the investment goods
sector (K); The factory produced consumer’s goods sector (C1); the small
household produced (including agricultural products) consumer goods sector
(C2); and the services (health, education, etc.) producing sector (C3).
7. The main features of input-output model are:
It is not applicable to partial equilibrium analysis
It deals exclusively with technical problems of production
It is based on empirical investigation
8. M. Leontief is the creator of the input-output model

12.6 SUMMARY

 Feldman’s approach to growth is mainly of investment and not the its income
creating effect. He lays down that is capacity is made to grow uninterruptedly
the rising surplus in the economy will be continuously absorbed and the
process of reproduction would continue unchecked. As a matter of fact,
field man’s approach is representative of the needs of the Russian society
under the circumstances prevailing around 1928. Rapid economic
development was the compelling need of that time and hence the model
concentrates on capacity creation through utilisation of the surplus generated
in the economy.
 The model is stands for the technique of unbalanced growth with
concentration of investment on producer – goods industries. Given the rate
of investment a higher proportion of investment allotted to the producer
goods industries will, as rule, result in higher rate of growth of national income
in the long run. On the other hand if higher proportion of investment is
allotted to consumer – goods industries, it will result in a higher rate of
growth of nation income in the short run. This represents the core of
Feldman’s model of economic growth, in which the proportion of investment
at located to the producer-goods sector is the key variable.
 Feldman’s model is based on Marxian scheme of simple reproduction.
 Prof. P.C. Mahalanobis was associated with the work of the planning
commission from the very beginning. at the time of the formulation of second
five year plan, he was asked to prepare a draft plan frame which was
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 submitted to the planning commission in March 1955. In the formulation of Planning Models – II

this plan frame, he provided the basis for planning in India. Mahalanobis
model though based on the famous Harrod Domar model for closed
economy as he assumed that there would be no imports or exports of
investment goods. NOTES
 At first Mahalanobis developed a single sector model in Oct 1952 based
on variables of national income and investment. In 1953 it was developed
in a two sector model in which the economy is divided into two different
sectors – The investment good sector and the consumer goods sectors.
 In 1953, Prof Mahalanobis developed four-sector econometric model which
served as a basis for the formulation of second five year plan.
 Input-output analysis is the name given to the attempts to take account of
general equilibrium phenomenon in the empirical analysis of production W.
Leontief is the sole and unchallenged creator of input – output theory. The
input-output analysis or inter – industry analysis is the study of mutual
interdependence of the various sectors of the economy. It is an empirical
study of the quantitative inter-dependence between inter-rated economic
activities. The inter dependence between the individual sectors of a given
system is described by a set of linear equations. Such an analysis helps to
understand the inter-dependencies and complexities of the economy and
can provided us better understanding of the conditions for maintaining
equilibrium between supply and demand.

12.7 KEY WORDS

 Input: An input is something which is brought for the enterprise in other

words on input is obtained. Thus input represents the expenditure of the
firm, the sum of the money values of input s the total cost of a firm.
 Output: Output is something which is sold by the firm, output its receipts,
the sum of the money values of the output is its total revenue.
 Four sector model: A model which includes four sector; household sector,
business sector, the government sector, foreign sector. The household sector
includes everyone in an economy who consumes goods and services.

12.8 SELF-ASSESSMENT QUESTIONS AND

EXERCISES

Short Answer Questions

1. What is the Feldman growth model?
2. State the main features of the Feldman growth model.
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Planning Models – II 3. Write short notes on:-
 The dynamic input-output model
 Limitations of Input – output model
NOTES Long Answer Questions
1. Describe the Mahalanobis four sector model.
2. Critically explain the Mahalanobis second five year plan mode.
3. Write a long essay on use of Input-Output Techniques in Planning
4. Describe the Input-output model.

12.9 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.

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 Planning Models – II

UNIT 13 PLANNING MODELS–III

Structure NOTES
13.0 Introduction
13.1 Objectives
13.2 Vakil and Brahamanand
13.3 Raj, Sen, Chakravarthy
13.4 Answers to Check Your Progress Questions
13.5 Summary
13.6 Key Words
13.7 Self Assessment Questions and Exercises
13.8 Further Readings

13.0 INTRODUCTION

In the present unit, you will study the various planning models by Vakil Brahmananda
– Raj – Sen – Chakravarthy. Professors Vakil Brahmanand proposed a model for
growth of income and employment in the context of developing countries in contrast
to Mahalanobis plan which emphasized more on fixed capital. According to the
model: For removal of poverty and increment of economic growth the capital
stock is not alone enough. They specially put stress on agriculture. Thus, agriculture
and other wage-good sectors should be given top priority in investment schedule.
In this way unemployment, specially disguised unemployment which is large in
country like India, can be minimized.
Wage-good sectors include sugar, cotton textile, agriculture which has quite
good export demands so there will be a good chance of earning foreign exchange
which can be used for expansion of industrial and agricultural development.
Development of wage sectors will ensure the industrial development to fulfil the
emerging needs of relating manufacturing equipment.
Prof K.N. Raj played an important role in India’s planning and development,
drafting sections of India’s first five-year plan, specifically the introductory chapter
when he was only 26 years old. He was a veteran economist in the planning
commission. Dr. Raj was a Keynesian economist.
The third five-year plan consists of no specific plan model. It is simply based
on the different relations expressed by Prof S. Chakravarthy in his famous article,
“The Mathematical Framework of Third Model”. It consists of thirteen equations
describing the various relationships. The assumptions of the third plan model were
not fully achieved and they remained well below the targets.
Amartya Sen believes that India should invest more in its social infrastructure
to boost the productivity of it its people and thereby raise growth.

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Planning Models – II
13.1 OBJECTIVES

After going through this unit, you will be able to:

NOTES  Explain the Vakil-Brahmananda planning strategy
 Describe the views of K.N. Raj about Indian planning strategy
 Explain the Sen-Chakravarthy planning strategy

13.2 VAKIL AND BRAHAMANAND

Prof. Vakil and Brahamanand proposed a model for growth of income and
employment in the context of developing countries in contrast to Mahalanobis
plan. Mahalanobis Model put more emphasis in the fixed capital goods. But Vakil
and Brahamanand put more emphasis on wage goods and for removal of poverty
and for the increment of economic growth, the growth in capital stock is not alone
enough. For this wage goods gap is to be eliminated.
Vakil and Brahamanand model put stress on agriculture, so agriculture and
other wage good sectors should be given top priority in investment schedule.
Vakil and Brahamanand model’s emphasis was more on unemployment removal
and minimization as they know disguised unemployment was main hindrance in
developing countries.
According to Vakil and Brahamanand economic growth will be fast and
self-sustaining if wage good sector is improved in terms of investment and more
emphasis is on them. Wage good sector include sugar, cotton, textile, agriculture
which has quite good export demands so there will be a good chance of earning
foreign exchange which can be used for expansion of industrial and agricultural
development.
Vakil and Brahamanand said if any economy increases its export then it will
earn more foreign exchange for economy. This currency can be used for expansion
of industrial agricultural development.
If agriculture sector is developed more, in other words if rate of growth in
agriculture related sectors becomes high, it can lead to increase in circulating capital.
Unemployment and specially disguised unemployment can be eradicated when
most of the population get employment.
Development of wage good sector will be ensuring the industrial development
to fulfil the merging need of relating manufacturing equipment.
Arguments in favour of Vakil and Brahamanand Model
Brahamanand has further develop and modified his wage goods model and now it
is called “Extended wage goods strategy”. In this extended wage goods strategy,
he also gave place to capital goods on priority sector as capital goods are also
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204 Material
plant, tools and raw materials are directly or indirectly involved in the production Planning Models – II

of process of wage goods. Priority of the capital goods must be assigned to those
capital goods whose supply leads to the production of wage goods. Prof.
Brahamanand later realized the importance of capital goods and modified his model.
As the model has modified so many arguments are there in its favour: NOTES
1. Highest priority is given to wage goods along with capital goods (necessary
for production of wage goods). So, capital output ration is much lower in
wage good industries, especially agriculture than in basic heavy industries
sector so achievement of higher growth rate becomes possible because of
lower capital output ratio.
2. High rate of growth of agriculture and related sectors would provide
increasing amount of wage goods.
3. Wage good model puts emphasis on agriculture sector. So, it develops
other industries like cotton, textiles, sugar. And developing those industries
will promote more exports. Export promotion will bring more foreign
exchange in return and economy will start to grow and other sectors will
also grow along with that.
4. Most importantly, as the majority of new workers get employment that will
reduce poverty and lead the workers to spend more on their well-being.
So, wage goods model will provide economic growth with social justice.
5. Expansion of wage goods sector that is agriculture will generate a large
demand for manufacturing industries. This will ensure rapid industrial
development with proper linkage with agriculture. The manufacturing
industries would obtain food grains and new material from agriculture and
in turn would feed latter with inputs and industrial consumer goods.
The most important kind of wage goods are food grains which are the product of
agriculture and for which income elasticity of demand in the less developed countries
is very high. So, by approaching unemployment that visualizes wage goods gap as
the cause of unemployment assigns a paramount role to agriculture. Development
is the strategy of growth so that food surpluses are made available to the newly
employed workers outside the agriculture sector.
Along with agriculture sector growing, it impacts other sectors as well, leading
to overall development, bringing social justice, economic growth, increase in income
due to increase in employment.
Critical Approach
That the growth of non-agricultural sector depends on the availability of food
grains or wage goods is obvious. When people are employed in rural public works
and in industries producing capital goods outside agriculture, there will be need
for food to feed them, if food is not made available to them directly through market
mechanism, there employment can’t be sustained– it may be asked even when
employed they must be consuming food to make their living possible and so no
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Planning Models – II extra food would be required when they are given employment. So that is if employed
or unemployed people must consume food in order to live.
Basically, emphasis on agricultural development in wage goods approach
has been laid for increasing supply of wage goods so that they can be used for
NOTES
employment creation in non-wage sector. Especially the rural public works on
accumulation of capital.
A great weakness of the strategy proposed by Vakil and Brahamanand is that
it ignores the need for bringing about appropriate technological and institutional
changes to generate enough employment opportunities in the agriculture sector itself.
Where I represent the annual rate of investment, the potential social
productivity of investment, the marginal propensity to save and I the increase
in investment.

13.3 RAJ, SEN, CHAKRAVARTHY

The model was not worked out explicitly but was implicit in the numerical figures
of the perspective plan. It worked out in the first five year documents. The basic
equation, as worked out by K.N. Raj later on, were
It = St ……………….. (1)
St = ayt – b ……………….. (2)
It = Kt ……………….. (3)
It = Kt – b ……………….. (4)
Where It is investment in period t, St is the saving, Yt is the income and Kt
is the capital stock in the corresponding period. Unlike the Harrod-Domar Model
in which MPS = APS, the relation between the two is shown by equation (2).
Alpha ( ) is the capital-output ratio. Given these relations the growth process is
given by the equation: Kt ( K o – b / a )ea b / ad
Where a is the asymptotic relative rate of growth of the system.
Assumptions
The model is based on the following assumptions:
(a) The marginal propensity to same is greater than the average propensity to
same
(b) There is no difference between the marginal capital output ratio and the
average capital output ration
(c) The economy is closed
(d) Prices are stable.
Prof S. Chakravarthy provided base for third Five Year Plan. This plan was simply
base on the different relations expressed by Prof S. Chakravarthy in his famous
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article, ‘The Mathematical Framework of Third Model’.
206 Material
It consists of thirteen equations describing the various relationships; Planning Models – II

1. The total investment is equal to the sum of the total domestic saving net
foreign aid is : I It St F
I – Investment NOTES
S – Saving
F – Foreign aid
2. The net increase in the national income is equal to investment over whole
period multiplied by output capital ration i.e.:
Y 1

Y = Increase in investment
= Output capital ratio
3. Saving time at t is equal to the period of saving plus saving in period t
St = So + ta
a = annual increase in national savings.
4. The demand for agricultural production depends upon the level of population
as well as per capita income.
Yt
DA ( ) Pt
P

5. The increase in agricultural production is equal to investment in agricultural

sector multiplied by capital output ratio
YA AIA

6. The total tax revenue is equal to the autonomous tax revenue plus tax revenue
which depends upon time

It nTt Tt
7. The increase in tax revenue is equal to the weighted average of the rates at
which consumption, agricultural and non-agricultural income are increasing.
T C YNA YA
Yt Y2 Y3
T C YNA YA

8. Total gout expenditure is equal to the sum of the current expenditure plus
the proportion of total investment exp. That is to be taken

E (t ) EC (t ) Pi I
9. The total increase in gout kept is equal to the total expenditure minus total
tax revenue and total amount of surpluses of public exp.
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Planning Models – II
D Et – Tt Rt

10. Total increase in output is equal to the increase in agriculture output and the
non-agriculture output.
NOTES
Y YA YNA

11. Total investment is equal to investment in agriculture sector plus investment

in non-agriculture sector.
12. Increase in output is either consumed or saved.

Yt C1 St

13. Increase in demand for agri. Goods is equal to increase in supply of agri.
goods.

DA YA

This model was the decision model as the number of unknown is more than
the equations. So, the value of two variables must be taken from outside arbitrarily
and the remaining would be determined from the equation.
Prof K. Sen favoured the socialism in the Indian economy. Sen believed
that one should invest more in social infrastructure to boost the productivity of its
people and thereby raise growth. Investing in health and education to improve
human capabilities is central to Sen’s scheme of things. Without such investments
equality will widen and growth process itself will falter, Sen believes.

Check Your Progress

1. Who gave the wage-good model?
2. What are the components of wage-goods?
3. State the meaning of disguised unemployment.
4. What are the two arguments in favour of wage-goods strategy?
5. State two main elements of wage-good strategy.

13.4 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. Prof Vakil and Brahamanand gave the wage-goods model.

2. Components of wage-goods are: (i) Food grains, cereals, pulses; (ii) milk
and milk product; (iii) edible oils; (iv) fish, eggs and meat; (v) sugar and
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 sugar products; (vi) fruits and vegetable; (vii) spices; (viii) tea, coffee; (ix) Planning Models – II

cloth; (x) matches; (xi) soap; (xii) salt; (xiii) kerosene.

3. Disguised unemployment is also known as under employment. In this kind
of unemployment, more than the required people of a few people will not
NOTES
affect the productive capacity of that field.
4. Two arguments in favour of wage-goods model are:
 The implementation of the wage-goods model will not involve much
foreign exchange.
 Wage-goods model gives stress on the production of wage-good
industries such as agriculture, cotton textile, sugar had a large export
potential.
5. Two main elements of wage-good strategy are:
 The poverty and unemployment exist because there is a wage-goods
gap.
 To secure a rapid increase in the supply of wage-goods, capital stock
(or productive capacity) designed for the production of wage goods
must be expanded.

13.5 SUMMARY

 C.B. Vakil and P.R. Brahamananda of Bombay school constituted a plan

for an alternative development for India challenging the Mahalanobis plan.
 In contrast to capital goods and heavy goods sector being the core of Nehru-
Mahalanaobis strategy. The centre piece of the Vakil-Brahamananda plan
was ‘wage-goods-sector’. They focussed on unemployment and were of
the view that employment can’t expand without wage goods. They accorded
a prime importance to agriculture.
 Second plan model was based on the Mahalanobis model known as Heavy
industry model. It was a practical application of the Harrod Model. Third
plan model was also supplementary to the Mahalanobis model known as
Sen and Raj Model.
 The fourth plan was also started in 1969, after a lapse of three years of plan
holiday period. Fourth plan model prepared by Chakravarthy, Eckaus,
Lefeber and Parikh was known as CELP model. The model had three sub-
models i.e. the macro model, the input-output model and consumption model.

13.6 KEY WORDS

 Wage-goods: Wage goods are goods that a worker with wages might
buy, perhaps now more commonly called consumption goods.
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Planning Models – II  Non-wage goods: Non-wage-goods are goods that a rentier receiving
profits or interest might buy, including what might now be called capital
goods or investment goods.
 Disguised unemployment: Disguised or hidden unemployment is a kind
NOTES
of unemployment where some people seem to be employed but are actually
not.

13.7 SELF ASSESSMENT QUESTIONS AND

EXERCISES

Short Answer Questions

1. Critically examine the wage-goods model given by Vakil and Brahamananda.
2. What is wage-goods model? In what way is it better from Mahalanobis
Model?
3. Write short notes on: (i) Wage-goods, (ii) Non-wage-goods, (iii) Raj
Planning strategy.
Long Answer Questions
1. Write a descriptive essay on Sen Chakravarthy planning strategy of
development.
2. Highlight the contribution of K.N. Raj to the first five-year plan.
3. Critically examine the Sen-Chakravarthy strategy of development.
4. Discuss the arguments in favour of and against the wage-goods model.

13.8 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Self-Instructional Press.
210 Material
 Planning Techniques:

UNIT 14 PLANNING TECHNIQUES: Meaning, Concepts

and Importance

MEANING, CONCEPTS
NOTES
AND IMPORTANCE
Structure
14.0 Introduction
14.1 Objectives
14.2 Planning Techniques
14.3 Need for Planning in Under-Developed Countries
14.3.1 Process of Plan Formulation
14.3.2 Objectives of Planning
14.3.3 Conflict among Different Objectives
14.3.4 Requisites for Successful Planning
14.3.5 Limitations of Planning
14.4 Answers to Check Your Progress Questions
14.5 Summary
14.6 Key Words
14.7 Self Assessment Questions and Exercises
14.8 Further Readings

14.0 INTRODUCTION

In the present unit, you will study economic planning techniques. Economic planning
is a process under which a central authority defines a set of targets to be achieved
within a specified time frame related to growth and development of the country
keeping in view the needs and means of the country or it refers to the method
under which the central planning authority enforces economic programs and policies
keeping in view the resources of the country, with a view to achieve a set of
objectives related to growth and development of the country.
There are many notable features of the economic planning in India. Planning
in India is comprehensive planning as it is not only focused on economic parameters
but also on social parameters of growth and development. Economic planning in
India confirms to a democratic pattern at the formulation level as well as the
implementation level. Indian Economic planning is both prospective and perspective
in nature. It covers economic as well as social spheres areas of activity. It is a sort
of financial planning. It implies a focus on the allocating funds to various sectors
and activities, rather than achieving the physical targets of the plan. Objectives of
Indian Economic planning is to be condensed into one overall objective, that would
be termed as ‘Growth with social justice’.

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Planning Techniques:
Meaning, Concepts 14.1 OBJECTIVES
and Importance

After going through this unit, you will be able to:

NOTES  Describe the meaning of the planning technique
 Explain the objectives of the economic planning
 Explain the importance of economic planning
 Describe the need for planning

14.2 PLANNING TECHNIQUES

The concept of planning (or economics planning) is widespread in both developed

countries and less develop countries. But the meaning nature and scope of planning
varies considerably from one countries to another, mainly due to multiple reasons.
Firstly, it depends on the institutional framework of the economy which is
going to practice planning for instance, planning under a socialist system is materially
different from planning under democratic, this system depends a great deal on the
political view of person trying to define the term and the social political system
where it must be practiced. At first you must specify, how much visible control
over the economics system you would favour as against the invisible control of the
economics forces under Laissez-fair, before you offer a definition of planning.
Secondly even under similar economics systems, the multiplicity of the
practice of planning has rendered a single definition of planning difficult.
W.A Lewis remarked regarding the plans “One Differ so much in structure
and content that the title development plan no longer conveys a meaning”. A.D.
Dickinson defines economics planning is the making of major economics decision
what and how much is to be produced, when and where to be produced and to
whom to be allocated by a determinate authority based on comprehensive survey
of the system as a whole.
According to levy, “Economic planning means securing a better balance
between demand and supply by a conscious and thoughtful control either of
production or distribution or both rather than leave this distribution or both rather
then leave this balance to be effected by automatically working invisible and
uncontrollable forces” (i.e. the forces of demand and supply in the unplanned
economy operating though free market mechanism).
To sum up, we can take Michal P. Todaro’s definition according to him,
economic planning may e defined as “the conscious effect of a central authority to
influence, direct and in some cases even control changes in the principle economy
variable e.g. GDP consumption investment saving etc. of a certain country or
region over the course of time in accordance with a predetermine set of objective”
it would be noted that according to this definition of planning mainly three things
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constitute planning viz (i) economic planning is a conscious effort on the part of Planning Techniques:
Meaning, Concepts
some specified central origination in the economy to burning about desired and Importance
economic changes (ii) conscious effort are taken from the influence of directed or
controlling changes in the major economic variables of the economic system and
(iii) these changes in the major economics variables of the economics system secure NOTES
to attain certain predetermined goal.
In simple words, when the government of a countries wants to achieve
certain nation objectives with the help fast of a set economics policies it may be
called economic planning especially if the objectives are sought to be achieved
with in a specified time frame.
It is to be noted that the above definition fits into every socio – economic
environment. The only difference to be observed is that as we move from a relatively
capitalized environment to a socialistic framework the emphasis shifts from
“influencing changes in the principle economic variables to direct control”
Then essential features of economic planning are discussed below.
1. Institutional set up: The planning process presupposes the existence of
appropriate institutions through which its prepared and implemented. Planning
involves four main activities preparation of plans by planning commission.
Planning boards etc; taking of decision in respect of plans by institutions
such as parliament government etc; implementation of plans through ministries
directorates local government etc. and control of plans by institutions such
as ministry of finance central bank, statistical offices etc.
2. Goal and Resources: Given the philosophical and ideological backdrop
for a plan. Planning involves quantification of goals like targets of production
in a plan are nothing but the quantified goals in respect of what goods are to
be produced and how much of each good is to be produced for quantifying
goals, it is essential the resource availabilities be given number. It includes
physical resource such as natural and manpower resources and financial
resources such as bank deposits, gold, foreign exchange in setting limits to
objectives and prepare a more realistic plan.
3. Programme of Action: The goal chosen and means available present the
line of action along which the economy is to be guided. The pace is decided
by the period during which the goals are to be fulfilled. The movement of
the economy in the indicated direction is made possible through the policies
and instruments. Thus a plan become a preconceived programme of action.
4. Specific Period and Definite Area: Planning involves a time dimension.
It is in this context that plans are formulated with programmes to be achieved
and measures for their achievement within a specific time and space frame
work.
The time envisaged can be any period one year for annual plan, five to
seven years for medium term plan, ten to twenty years and even more for
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Planning Techniques: long term plans. Each plan apart from signifying the different periods denotes
Meaning, Concepts
and Importance the specific beginning and ending dates of a plan. This enables to establish a
link between the past and the present functions. Thus plans are from are
like pictures painted on the canvas of time.
NOTES
The area of planning indicates a geographical limit within which planed action
takes place. Of course, this does not mean that planning enables to establish
a link between past and present on the one hand and present and future
market on the other hand. Thus, plans are like picture painted on the conveys
of time.
The area of planning indicates the geographical limit within which planned
action needs to take place. This does not mean that differences are planned,
like for the district or nation difference in plans. All these could be
complementary parts one comprehensive plan. Area plans are thus full plans
as well as part plans.
5. Rational Socialized Activity: The planning process involves the choice
of goals which are compatible with one another and together they make a
sensible whole. Further these goals are so tailored as to match the resources
available over the plan period in the most efficient and are thus the hallmark
of any meaningful plan. This process a rational activity. In general planning
decisions involve areas conterminous with political boundaries such as nation
plans and the goals chosen belong to the whole groups of people moreover
the resources envisaged for use also go beyond what the individual needs
and to comprehend larger areas and larger populations. Thus government
activity becomes an essential feature of planning.
Planning and programming
The word planning and programming are sometime interchangeably used but the
difference between the two should be carefully noted. The distinction between the
two is made at two different levels. In the first place, the economists in the socialist
countries reserve the word planning to describe the planning process in the centrally
planned economics while that goes by the name of planning, in the capital countries
is called programming. Thus programming and indicative planning are synonymous
under programming. The planning performs the function of co-origination and
forecasting. Here the present market forces are dominant. The plans cannot be
enforced they are merely of an advisory was of time nature.
A second distinction that is made between the two terms is of a technical
nature. Here planning refers to a wider process where national goals are set in
consonance with the social welfare function of the society policy measures are
designed to achieve those goals, and arrangements are made for the implementation
of that policy. However, the policy measures must be internally consistent these
must produce optimal results and it must be feasible to implement the plan. Thus,
the plan must go through the programming process. According to P. N Rosenstein
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Rodan, “programming is just another word far from rational deliberate consistent
214 Material
and coordinated economic policy”. Thus, programming techniques make use of Planning Techniques:
Meaning, Concepts
such methods as econometric model building linear programming input-output and Importance
technique etc. for this purpose.
We might therefore say that while economic planning is the spirit or the
NOTES
philosophy behind any set of economic policies, economic programming is a means
to provide a rational basis to such policies.

14.3 NEED FOR PLANNING IN UNDER-

DEVELOPED COUNTRIES

There is no gain in saying the fact that nearly all the under developed countries
have been practicing economic planning in one form or the other for the last over
four decades. However, the question still remains as the what is the rational basis
of planning in less developed countries (LDCs). The case for planning in these
countries rests on the following grounds:
1. To Remove Market Imperfections: Regarding the imperfections of the
market, WA Lewis observes that the merits of the market depend on the
existence of competition and the perfect competition is rare. It is clear that
nothing in the market mechanism itself either establish or maintain competition.
Only state action can assure competition. So much else in the market
economy cannot function adequately without positive support from the state6.
It is thus interesting to notice that even for brushing up the market or making
it work more efficiently state intervention is needed. This is the minimum
that can be said in favour of planning. When the plans provision is made for
labour training or for the dissemination of labour market intelligence through
employment exchange for the establishment of money and capital market
etc. the market system starts operating more vigorously. Thus the planning
system is LDCs, instead of supplanting the price mechanism indeed
supplements and supports it.
2. To Ensure Socially Optimal use of Resources: It’s argued above that
the market system operates on the basis of votes cast by the consumer.
More of those goods would be supplied which are demanded most. Since
rich people have more income their demands get reflected in the market in
an exaggerated form. Poor people have fewer votes (less income to spend
in the market); and therefore, their wants remain under represented in the
market place. Thus, the more than proportionate resources get allocated to
the rich minority. To meet the requirements of the majority, very little is
allocated. Therefore from the social point of view there is a lack of optimum
resource allocation. To rectify this defect of the market system planning
through the democratic process or some other means tries to assess the
needs of society priorities are established on the devoted to the production
of more urgent good and services. Thus an optimum allocation of resource
is assured. Self-Instructional
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Planning Techniques: 3. To Bring about Major Structured Changes: One of the distinguishing
Meaning, Concepts
and Importance feature of LDCs is that they suffer from structural disequilibria for example
whether judged on the criterion of proportion of labour employed or the
origin of national product agriculture is the dominant sector while the
NOTES secondary and tertiary sectors happen to be in their infancy. Thus marginal
productivity of labour is very low in agriculture while in industry and services
it is relatively high. Clearly for optimum allocation of labour it must move
from the former to the latter. Planning is need for such a structural change.
It is recognised that the market mechanism is incapable of dealing with such
major and sweeping structural changes since these are of a discontinuous
no marginal nature. The planner need not wait for the market to allocate
resources away from agriculture and in favour of industry and services. The
task of allocation of resources in now done within the plan so that the process
of structural changes could be hastened and there by the growth process
accelerated.
4. To Internalize External Economies and Diseconomies: As is observed
above certain structural changes are necessary in LDCs. This means setting
up of industries and sectors. But when these new activities come into existence
they create external economics and in some cases external diseconomies
when an investment is made in a new project it might create profitable
opportunities for other industries (e.g. the opening of a railway system in a
given region might cheaper the cost of transportation for other industries
and increase their profits). These are external economies but sometimes the
starting of a new project may in fact reduce the profitability in another industry
(e.g. an oil refinery may start throwing poisonous effluents into the revers
which would kill fish and thereby reduce the profits of fisherman). This is an
example of external diseconomies. These external economies and
diseconomies by their very nature do not enter into the calculations of private
entrepreneurs under the market system. However in the case of external
economies the social gain is greater than private gain.
It’s only the planner taking a macro economics view, who can internalize
these external economies and diseconomies in his planned calculations and
thus maximize the gains from investment. This creates a strong case for
planning in LDCs.
5. To Provide for the Requirements of Future Generations: Now realized
that the price system suffers from myopia it can register of current
requirement. This enough would be produced to meet such requirement.
Then producers, in the lure of maximization of current profiles ruthlessly
exploit natural resource. It is evident that the higher the current rate of
exploitation of the exhaustible natural resource (like minerals) the less is left
for the use of future generalities. The resources that are launched in the
private sector will not estimate the current demand for water (or at best
force cast the rise in demands in the near future). But a planner can look
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 few generations ahead and provide for their requirements in advance while Planning Techniques:
Meaning, Concepts
planning the water supply scheme. Thus it’s under planning alone that the and Importance
requirements of future generation can be sufficiently provided for.
6. To Cater to Collective and Big Choices: The price system is unable to
NOTES
meet the challenge of big and collective choice which are very necessary for
economics development of LDCs. This is because under market mechanics
all the important decision relative to production and consumption are taken
and macro-level in a decentralized and undesirable consequences such as
production at one time and under-production at anther time. Therefore,
planning is very essential to burning all round, coordinate and consistent
regarding resource utilization are taken at the macro-level by the central
planning authority.
7. To Achieve Important Socio-Economics Goal: According to WA Lewis
under the market system “income is not fairly distributed and as a corollary
of this the less urgent good are produced for wealthy people while poor
people lack education, health, good food, decent house and ordinary comfort
which could be produced through income spent in the market only the
preference of the such get registered because the poor do not possess
income. Thus, planning is needed to look after the interests of the poor.
Besides it’s a mechanism through which consumption of wealth and assets
reduces further, the market may favour the introduction of capital intensive
techniques of productions in the face of rising unemployment, reduction of
poverty only under planning. It’s therefore clear that planning is necessary
to ensure genuine and broad-based development for the realization of socio-
economics goals.
8. To Break low-level Equilibrium trap: In LDCs the problem has been
not only that of initiation of the development process but also of sustaining
that process it was argued during the discussing on the theory of under
development that economist like N. Rosenstein Rodan Harbey Leibenstein
and RK Nelson hold the inadequacy of the development effort responsible
for the resistance of under development in LDCs, thus, there is again and
again a relapse into the state of under development effort responsible because
the development effort was below the critical minimum level required to
space the low level equilibrium trap. A big push is needed to be given to the
economy so that there is no slide back to the state of underdevelopment.
Thus alone can be development process be sub stained over a long period
till the economy has imbibed growth habits.
9. To Facilitate the Flow of Foreign Aid: Even the western aid giving
agencies like the World Bank and the IDA prefer providing aid to those
countries which have drawn up development programmes for their
economies. Most of the aid flowing from these agencies is of the nature of
project aid, that is, aid is provided to finance specific projects. When a plan
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Planning Techniques: is already there, the aid donors find it easy to study the economic
Meaning, Concepts
and Importance programmes of these countries, and in particular examine the socio-economic
relevance of the projects for which aid is sought. Thus, the existence of
economic plan in LDCs facilitates the task of the aid-donors to the extent
NOTES that they are now in a position to satisfy themselves in so far as the soundness
and viability of the programmes and projects are concerned.
14.3.1 Process of Plan Formulation
Plan formulation is a stupendous and very complex process which has several
dimensions. As a first step in the direction of plan formulation, a planning body is
constituted by the government which is known as planning commission or National
Planning Board. It is staffed with economists, statisticians and technical experts in
various fields. Plan formulation broadly compressive spelling out the broad
objectives, laying down the priorities, formulating the objectives, finalizing consistent
targets for different sectors and planning resources mobilization for carrying out
various plan programmes and projects. These dimensions are explained as under:
1. Survey of Resources and collection of Necessary Data: Survey of
resources and availability of data on various aspects of the economy are
important requisites of plan formulation. The size of the plan is often limited
by the availability of resources. Therefore, while formulating a plan, the
planning body must know the volume of material Human and Capital resource
have been properly served & the reliability of data is high. No doubt many
data gaps exist while the reliability of available data gaps is questionable.
Therefore, these countries are trying to overcome data problem by setting
up central with a network of data collection organization.
2. Spelling Broad Objective: Plan formulating involves creation goal which
are broadly but clearly defines & efforts are directly realize them. In a number
of development countries, planning is scuttled at the implementation level
because the rules have no intention to realize the objectives.
The most abstract the aspiration – which reflect the ultimate aim of the
society; the intermediate – The goals – which are still abstract but may be
capable of being reached during the period over which the plan operates
and the last abstract – The target – which are specific, quantitative results
that the plan is designed to achieve.
3. Time frames: Comprehensive plans can be planed into three categories
on the basis of their time frame. Long term or perspective plans usually
cover a period of 15 to 20 year, since uncertainty increase with the passage
of time, goals are highly aggregasive & these plans do not go into deal
details on the industry-by-industries basis.
Since uncertainty increase with the passage of time, goals are highly
aggregative and these plans do not go into great detail on the industry-by-
industry basis. Such plan are particularly useful in planning for social overhead
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 capital (SOC) projects which have a long gestation period. For example, it Planning Techniques:
Meaning, Concepts
takes several years to conduct a pre-feasibility study and then a feasibility and Importance
study for a hydro-electric project. construction may take 5 to 7 years or
even more. This means that the feasibility study requires an estimate of
demand for electricity 20 to 30 years in the future. Perspective plans are NOTES
also useful for determining educations policies.
Medium term plan is that which commonly covers a period of 5 years. it
attracts public attention the most. A good medium term plan is very detailed
specifying year-by-year target variables and describing how investment
variable can be used to achieve the targets. So a good medium targets as
economic conditions change.
Finally, there is the annual operational plan, which is based on goals of
medium – term plan but providing government budget. The medium term
plan or adopt ‘rolling plan’ which each year extend the medium term horizon
by an additional by year but concentrate on the current year.
4. Laying down priorities: Plan formulation requires spelling out of priorities
of the public investment programme. We know that in a developing economy,
infrastructure has to be developed, basic and more particularly the machine-
making industries are to beset up agriculture also need to be developed so
that the supply of food does not become a major constraint and finally the
spread of education and medical facilities has to be taken up in right earnest.
But a developing country seldom has the resources to undertake massive
investment in all these sector. So it must have well-defined priorities in
consonance with the objective of the plan. So laying down priorities is very
essential for successful planning.
5. Formulating strategy & Development: Another step in the plan
formulation involves a strategy for the realization of broader goal. In the
absence of a proper strategy the planning might lack direction which makes
all the alternate goals doubtful. Besides, it should also be chosen between
growth via export promotion or via substitution. These issues along with
other such as rate of capital formation, investment criteria & choice of
technique have to be settled as part of the strategy.
Aruthey Lewis has highlighted the important of development policy in
economic planning the main element of development policy listed by him
are as follows:
(i) Investigation of development potential involving survey of natural
resource; Scientific, research, market research etc.
(ii) Provision of adequate infrastructure such as water, power, transform
& communications etc, whether by public or private agencies.
(iii) Provision of adequate general education and specialized training
facilities, thereby ensuring necessary skills.
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Planning Techniques: (iv) Helping to create more and better markets such as commodity
Meaning, Concepts
and Importance markets, stock market banking and insurance institutions.
(v) Promoting better utilization of resources, both by offering incentives
and through controls to check misuse.
NOTES
(vi) Promoting and assisting potential entrepreneurs, both domestic and
foreign.
6. Balancing in the plan: A plan should always ensure that proper balances
are maintained between saving and investment, demand for and supply of
goods, availability to human resources and man power requirements and
so on, planners’ inability to ensure these balances will result in either shortage
or surplus of productive resources. For instance, most of the savings are
done by the people who hardly participate in investment activity. Therefore
the planners should ensure a proper balance between the two otherwise
inadequate flow of saving will arrest investment activity, and in turn the
growth process. Similarly, imbalance between the demand for good and
services and their respective supplies and their needs to be avoided. Shortage
of wage goods will push up their prices and wage. price spiral may come
into being. This will make cost estimates irrelevant and the entire planning
process may get in jeopardy. Further, imbalance between the supply of
human resources and the demand for them will result in unemployment,
both open and disguised. If the problems of poverty and inequalities are to
be tackled in an effective manner, then unemployment problem has to be
dealt with in a forthright manner.
There are two types of balances that the planners have to attend to in plan
formulation. The first is the financial balance which implies that planned
spending at the macro level has to be equal to disposable income. Failure
to ensure this balance will result in either inflation or deflation. The second is
physical balance which implies inter-sectoral consistency between the
demand and supply. To ensure physical balance, planners often rely on
input-output the technique given by W. W. Leontief.
7. Resource Mobilisation: A plan often lays down investment targets for
both public and private sectors. For public sector outlay, funds are arranged
from both domestic and external sources. the domestic sources of finance
are taxation, markets borrowings and surpluses of public enterprises. In
India, small savings and state provident funds are other domestic sources.
As resources raised domestically fall short of investment requirements in
the public sector most developing countries seek external resources in the
form of foreign assistance for their development. Besides, resource to deficit
financing for raising funds for public sector plan has also become quite
common.
As regards privates sector, the major responsibility for resource mobilization
rests with the private enterprises. These units raise either equity capital or
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 get loans from banks, other financial institutions and the governments it can Planning Techniques:
Meaning, Concepts
also arrange Foreign Direct Investment (FDI). The role of the state in this and Importance
case is secondary as it only facilitates mobilization of savings for investment
in the Private Sector.
NOTES
Check Your Progress
1. Write two features of economic planning.
2. What is the difference between economic planning and programming?

14.3.2 Objectives of Planning

The main objectives of economic planning in a developing country are the following:
1. Rapid Economic Growth: A developing country has mass poverty due to
low level of production and productivity. So the primary objective of
economics is to bring about rapid growth of the country. It means that real
per capita income should grow at a faster rate.
2. Rapid Industrialization: This objective is complementary to the first one
industrialization offers more productive employment opportunities and
thereby, helps in rapid economic development of country. For rapid
industrialization, more emphasis is laid on basic and heavy industries which
will reduce dependence on foreign countries for basic industrial goods.
3. Modernization of Agriculture: Though agriculture is a major sector in a
developing country, it suffers from backwardness and very low productivity.
Therefore, another important objective of planning is the modernization of
agriculture so as to improve its productivity and make the country self-
sufficient in food grains and basic agricultural raw materials required for
developing industries.
4. Greater Employment Opportunities: The basic cause of mass poverty
in a developing country is mass unemployment and underemployment.
Therefore, generation of productive employment opportunities on a large
scale through rapid industrialization and construction of capital projects in
agricultural sector emerges as another major objective of planning techniques.
5. Reduction in Economic Inequalities: UDCs are characterized by glaring
inequalities of income and wealth, both in rural and urban areas which are
likely to grow and create social tensions and political instability, especially
in democratic countries where people’s aspirations tend to rise continually.
Hence, techniques planning should at aim reduction in economic inequalities
as far as possible so that the benefits of economic development percolate
to the common man.
6. Balanced Regional Development: In a developing country, some regions
are relatively more backward as compared to other regions, the objective
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Planning Techniques: of balanced regional development aims at providing employment and income
Meaning, Concepts
and Importance earning opportunities to people in different regions in such a way as to
narrow down regional disparities and to ensure proper utilization of natural
and human resources in each region. This will go a long way in avoiding
NOTES regional rivalries which might under mine national unity, especially in federal
country like India.
7. Expansion of Public Sector: This is an important objective of techniques
planning in private enterprise economies: Expansion of Public Sector will
bring commanding heights of the economy under government control, thereby
influencing the level of economic activities in the country. The profits of
public enterprises will go to state, instead of the private individuals, thus
resulting in reducing inequalities of wealth and income.
8. To control inflation: In a developing country, the fear of inflationary rise in
prices is always there, and, if not controlled. It will adversely affect the
growth of the economy. this is because inflation would feed on itself instead
of resulting in increase in production in response to rise in prices beyond a
certain limit, so control of inflation has to be adopted as an essential objective
of planning.
14.3.3 Conflict among Different Objectives
Some of the above objectives come into conflict with one another when an attempt
made to realize them simultaneously which is quite often the case in developing
countries. The possible conflict between different objectives is examined as under:
1. Rapid economic growth and increase in employment opportunities:
Rapid economic growth requires high rate of investible surplus which in
turn requires the adoption of more capital-intensive techniques of production
in various sector of the economy, especially in industrial sector. But these
techniques, being labour saving, would reduce employment opportunities.
On the one hand, adoption of technology-intensive techniques would increase
employment on a large scale. But such technology, being labour saving
would reduce employment opportunities. On the other hand, adoption of
labour – intensive techniques would increase employment on a large scale.
But such a technology is less efficient and so may fail to give high growth
rate to the economy. Hence the conflict between two main objectives of
techniques planning.
2. Rapid Economic Growth and Reduction in Economic: reduction in
inequalities of income and wealth requires large scale adoption of more
labour – intensive techniques as well as industries. Besides, taxing the richer
sections, having higher saving propensity, at a higher rate and redistributing
income in favour of poorer sections, which higher propensity to consume,
would also help on bringing down economic disparities. But both these
measures may have adverse effect on saving and investment rates in the
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 economy, there by lowering the growth rates of the economy. Thus, the Planning Techniques:
Meaning, Concepts
objective of reduction in economic inequalities, though justified on social and Importance
and moral grounds, is likely to come in conflict with the objective of rapid
economic growth.
NOTES
3. Rapid Economic Growth and Balanced Regional Development: In
the developed regions of a developing country, various infrastructure facilities
are relatively more developed. So a given amount of investment would result
in higher production and a higher rate of economic growth. But under
balanced regional development, resources would be diverted from relatively
developed regions to backward regions where, for want to adequate
infrastructure development, the same amount of investment would mean
lower production and, therefore lower growth rate of the economy.
Thus, in the short run, there might be some degree of conflict among the
various objectives of planning in developing countries which is resolved, not by
giving up of the conflicting objectives, but by deciding a trade off point between
any pair of conflicting objectives e.g. how much growth rate with how much increase
in employment opportunities, how much growth rate with how much reduction in
inequalities of income wealth and so on. However, in the long run, there may be no
conflict among them and different objectives appear to supplement and reinforce
each other. for example, once the objective of full employment or near full
employment is realized. There would be more people contributing to national income.
this would result in higher growth rate. Similarly, as inequalities of income and
wealth get reduced over a period of time, increase in income of poorer sections of
society, increase their efficiency, enabling them to contribute more to national output.
This will push up the growth rate. In this way, the conflict between high growth
rate and reduction in economic inequalities melts down in the long run.
14.3.4 Requisites for Successful Planning
For planning to be effective and successful in a developing country. It is necessary
that certain pre-requisites or conditions must be established for the formulation
and working of plans. The main requisites are examined as under:
1. A Good Plan: The first essential condition for successful planning is that the
plan should be technically sound, economically feasible and within the
country’s capacity to execute. The designing of such a plan requires two
things; realistic goals, and appropriate policies and instruments.
As regards goals, these should keep in view the resources or productive
capacity of the economy and should not merely reflect the aspirations of the
society. However, the existing capacity should not be passively accepted
as the limit.
In fact, the country should plan as to how these resources and capabilities
can be expanded. So, the goals should contain an element of boldness.

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Planning Techniques: Secondly, the goals should be compatible and consistent with one another.
Meaning, Concepts
and Importance For example a faster growth rate is compatible with capital intensive methods
but is incompatible with the goal of higher employment, makers will behave
over the plan period in response to various changes in the pattern of
NOTES governmental regulations. Two private sectors must also have the best
information about the economic development that are likely to flow from
the objectives and means (policies and instruments) of the plan. This clearly
shows that collection and transmission of information from and to the planning
agency and private sector in essential.
The information that is collected, processed and stored should be adequate
for planning to be effective. This implies that the data should satisfy the
following conditions:
(i) It should provide full information for formulating and executing the
plan.
(ii) It should relate to the most recent data i.e. it should be up-to-date.
(iii) It should be accurate to the extent that latest s statistical devices permit
it.
(iv) It should be reliable in the sense that it has been collected through
agencies. Which have the requisite knowledge and resources to collect
it.
(v) Data collection should be on a continuous basis. The adequacy of
statistical information requires that the planning country has a permanent
agency, trained personnel and computational aids not only on private
account but so on public account as a social service like the present,
thirdly, realism of goals also implies their flexibility or changeability in
the upward or downward direction as the situation warrants. Thus, a
good plan requires that the goals should be realistic compatible and
flexible.
The second character of a good plain is to ensure that the goals are fulfilled
through appropriate means i.e. policies and instruments which should conform
to the need of the plan and availability of instruments. When conditions or
circumstances governing a plan changes, new tactics in respect to existing
policies and instruments should be stopped. Thus, like goals means should
also be flexible to import dynamic to the planning process.
2. Adequacy of information: Information about various aspects of the
economy is vital for effective planning information includes statistics showing
factual position of the various facts of the economy such as statistics about
current resources and those likely to be available in future, enquires into the
working of the economy reports about feasibility of projects etc. Apart
from formulation of a plan also and policies, the implementation of a plan
also depends on the ability of the planners to transmit information to others.
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 In mixed economies, the formulation and execution of a realistic plan depends Planning Techniques:
Meaning, Concepts
mainly on successful coordination of plans and intentions of innumerable and Importance
economic units within the country. This requires two things. One, planner
should make the best possible estimates of how private decisions statistical
services. Thus, adequacy of information is a sine qua non of successful NOTES
planning.
3. Rational Institutions: Another requisite for successful and effective
planning is the presence of institutional agreements which are conducive
and responsive to the requirements of a plan. An institution is a process of
combing resources and potentialities primarily through human beings in a
manner befitting the customs and morals of the society. Planners regard
institutions to be amenable to manipulation for the realizations of plan goals.
This implies that certain institutions are more appropriate to the needs of
planning that others one such institution is the public sector.
Economists like Charles Bettleheim reject the institution of private sector in
planning as it is deficient in statistical information in many fields of basic
importance for planning. Moreover, it stands in the way of administrative
institutions in fully mobilizing the national resources for use to the best
advantage of planned growth. As against this, public sector has no such
limitations and is more appropriate from the point of manipulation for planning.
As against public sector that help in planning there are other institutions
which form anti-rational attitude and thereby hinder the planning process.
for example, the institutions like caste system, right of inheritance of property,
female subjugation etc. But under the pressure of exceptional circumstances
like war, revolutions etc. They change rapidly and radically as under such
situations, human being adopt old institutions and establish new ones to
fight out these very crises.
4. Appropriate administrative and technical Apparatus: The existence
of a competent administrative machinery is a must for successful planning,
in this context, W.A. Lewis remarked that “without a reasonably competent
administrative. Machinery, there is no basis for development planning”. This
is because certain tasks, never performed before by Market, have to be
undertaken in a planned economy. Tasks such as preparing plans, changing
economic and social institutions, controlling and directing the activities of
the people, laving down suitable policies and procedures etc. require a
suitable administrative apparatus.
To perform the above mentioned varied job, the administrative machinery
has to be manned by technical experts in various fields such as administrations,
engineers, economists, statisticians, accountants, agricultural and industrial
experts etc. Without these experts, a plan can be neither formulated nor
implemented effectively. The personnel has to be quantitatively adequate
and qualitatively well-trained for these complex and varies tasks.
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Planning Techniques: In a developing country to begin with, competent and key personnel may
Meaning, Concepts
and Importance have to be important from abroad due to their insufficiency in quantity and
quality. But government should not squander its limited resources in these
spheres where private sector has the necessary resources and expertise
NOTES such as consumer goods, commerce etc. It should concentrate on new
spheres, especially those requiring large and long gestation investment. the
extant and nature of control. But it is very important to set up suitable
institutions with in the country to build up an indigenous cadre of
administrative and technical personnel in various fields of activity.
Of all types of personnel, civil administrators, who come into direct contact
with the public, should be honest, efficient and sympathetic to the parties
concerned. Otherwise people will lose faith in planning and turn hostile to it.
One way to minimize corruption is to lay down proper procedure which
will provide minimum scope for corruption, even if an administrator is prone
in indulge in it. In fact, administrators cannot be much better than the
environment from which they come. This means that, in the long run, it is the
environment that need to be changed and made more favourable for a
competent and honest administration which is the crux of successful planning.
5. Public Cooperation: Public cooperation and participation in the planning
process is the most important condition for effective and successful planning.
Arthur Lewis has rightly said that “Popular enthusiasm is both the lubricating
oil of planning and the petrol of economic development – a dynamic force
that makes almost all things possible”.
Planning techniques is not just a business of planners and administrators. It
involves radical changes in social structure attitudes and ways of the people. So
unless people cooperate heartily, planning cannot succeed. If people are associated
in the formulation and execution of the plan and are assured their due share in the
fruits of planning their whole-hearted cooperation will be forth coming. Scarifies
must be appropriately shared by all and benefits such as employment opportunities
and opportunities for highest standard of living must become available to all. In a
developing country, people need to be informed and educated about various aspects
of planning, the costs to be borne and the benefits to be expected.
For ensuring people’s cooperation at village, state and national levels and
from all sections of people, viz. farmers, industrialists, workers, professionals etc.,
it would be necessary to create new local, regional and national institutions such
as village panchayats, block samitis, zial parishads, chambers of commerce and
industry, associations of bankers and merchants etc. to provide opportunities for
cooperation for a maximum number of people. When people’s cooperation is
sought though their participation in the planning process at various levels. It amounts
to decentralized planning in the real sense. This will put a check on bureaucratic
evils of corruption, dehumanization etc. In a country like India where nearly 70
percent of people depend on agriculture for their livelihood. Steps like abolition of
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Zamindari, Fixation of celling on holdings. Special assistance to small and marginal Planning Techniques:
Meaning, Concepts
farmers, regulation of wages of agricultural workers etc. will have to be taken. and Importance
It is only when the gains of planning begin to accrue to the vast majority of
the poor in the country that they will get interested in planning and after their willing
NOTES
and full cooperation to ensure its success.
The five requisites or conditions mentioned above are of general and basic
nature. It is not necessary that a country should start planning only when all these
conditions are fully met. The planning process, in fact, is a learning process. So,
unless a country starts experimenting with economic planning, it cannot know all
the requisites which are necessary and sufficient for the success of planning.
14.3.5 Limitations of Planning
The planning process in LDCs suffer from certain limitations as a result of which it
fails to achieve the intended goals.
These limitations are discussed below:
1. Lack of Suitable Administration: Planning implies administration is not
suitable for planning. Firstly, it is more tuned to the maintenance of law and
order or policing function rather than to the performance of economic
activities like saving, investment production etc. Secondly, Planning requires
strong, competent and incorrupt administration. But unfortunately, majority
of the administrative personnel are incompetent to undertake various tasks
such as preparing economic legislation etc. Moreover, their craze to grab
as much of funds means for development as they can for their personal ends
leads to corrupt practices. Thirdly, there is lack of industrial entrepreneurs
and most of the businessman merely undertake trading activity to make
profits. So administrative personnel has to take up the much needed
entrepreneurial function. But it woefully lacks the requisite entrepreneurial
ability and so faith to fill the gap, especially in the initial stages of planning.
2. Lack of specialized Personnel: Planning requires a variety of specialized
personal such as economists, statisticians, planner cost accountants,
managers, engineers, technicians etc. to visualize long term objectives of
planning, quantity short term goals and to keep a watch on the working of
economic life. But such personnel are not available to the required extent.
Moreover, facilities for their education, training and research are very
inadequate in LDCs. This makes planning difficult partial and limited in scope
as well as success.
3. Lacks of Proper statistics: Planning requires a strong statistical base.
But the non-availability of adequate and reliable statistics relenting to
resources position existing economic structure and past trends poses a major
problem in LDCs. this makes plan evaluation etc. a mere guess work, wishful
thinking and useless activity. The data collecting and processing agencies

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Planning Techniques: are neither adequate nor competent to undertake such an enormous exercise.
Meaning, Concepts
and Importance This rules out comprehensive planning.
4. Lack of Scientific Attitude and Institutions: The dominant characteristics
in these countries are rituals, customs, traditions, fatalist etc. People lack
NOTES
rational attitude, scientific temper and culture and here is absence of scientific
institutions. All this adversely affects the altitude of the people to work,
save, invest, the mobility of labour etc. As a result, it becomes quite difficult
to effectively carry out national planning activities.
Conclusion: From the above analysis, it is clear that LDCs experience
special difficulties in planning a against developed countries which had shed such
traits long ago. It is an irony that LDCs which need planning the most, are also the
countries which are affected the most with limitations in planning. But this is no
cause despair. A beginning has to be made with planning proceeds and experience
grows, the difficulties will gradually within away.

Check Your Progress

3. Mention two objectives of economic planning.
4. Why do developing countries needs planning? Give two points only.
5. State two types of economic planning.

14.4 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS

1. Two features of economic planning are:

(i) Designing suitable schemes for realizing of the objectives.
(ii) Determining the plan outlay and investment.
2. Economic planning is the spirit or the philosophy behind any set of economic
policies; economic programming is a means to provide a rational basis to
such policies. These are different in two levels:
(i) Economic planning is the process of planning and programing is the
execution of the planning.
(ii) The technical nature of planning and programming.
3. Two objectives of economic planning are: (i) Economic development
(ii) Political stability.
4. Developing countries need planning because of (i) to attain steady economic
development in a free market economy.
5. Two types of economic planning are: (i) Perspective plans (ii) Five years
plans.

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 Planning Techniques:
14.5 SUMMARY Meaning, Concepts
and Importance

 Planning technique is the process of conceiving, regulating and controlling

the economic activity by the state to achieve the pre-determined objective NOTES
in accordance with pre-fixed priorities.
 The process of conceiving, regulating and controlling economic activity by
the state according to set priorities with a view to achieving well-defined
objectives during a given period of time.
 The process of deciding what to do and how to do. An economic plan is an
outline of schemes designed to achieve certain pre-determined economic
objectives, in a particular order of priorities within a specified period of
time. This is the technique that a state follows to achieve economic
development.
 The economy which makes efforts to achieve development through economic
plans, it known as planned economy.
 According to Dr. Dalton “Economic Planning in the widest sense is the
deliberate direction by persons incharge of large resources of economic
activity towards chosen ends.”
 Lewis Lordwin defined economic planning as a scheme of economic
organization in which individual and separate plans, enterprise and industries
are treated as coordinate units of one single system for the purpose of utilizing
available resources to achieve the maximum satisfaction of the people’s
needs within a given time.
 One of the most popular definitions is by Dickinson who defines planning as
“the making of major economic decisions what and how much is to be
produced, how, when and where it is to be produced, to whom it is to be
allocated, by the conscious decision of a determinate authority. On the basis
of comprehensive survey of the economic system as a whole.
 Planning is necessary for equitable distribution of economic power. It is a
powerful instrument for eliminating instability, which is necessary concomitant
of a free market economy. It makes possible for optimum, utilization of the
country – as resource. It results in a higher rate of capital formation.

14.6 KEY WORDS

 Economic Planning: An economic plan is an outline of schemes designed

to achieve certain pre-determined economic objectives, in a particular order
or priorities within a specified period of time.
 Perspective Plan: Perspective plan is a long term plan. Generally, it is
formulated for a period ranging from 15 years to 20 years.
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Planning Techniques:  Rolling Plans: Rolling plans do not have a fixed period of time. These
Meaning, Concepts
and Importance plans have only duration and move forward. As it moves forward the year,
which was completed, it deleted and one year is added at the end.

NOTES
14.7 SELF ASSESSMENT QUESTIONS AND
EXERCISES

Short Answer Questions

1. Define economic planning or planning techniques. What are the main
objectives of planning?
2. Mention the features of economic planning.
3. What is economic planning. Mention its objectives.
Long Answer Questions
1. Write an essay on “needs of planning of planning in developing countries.
2. Discuss the main features of economic planning.
3. Write short note on:
 Types of plan
 Objectives of economic planning.
4. Analyse the main objectives of the planning.
5. Explain the concept of planning techniques. Also mention the main features.

14.8 FURTHER READINGS

Van den berg, Hendrik. 2001. Economic Growth and Development. Ohio:
McGraw-Hill.
Weil, David N. 2004. Economic Growth. London: Addison Wesley.
Soubbotina, Tatyana P. 2004. Beyond Economic Growth: An Introduction to
Sustainable Development. Washington: World Bank.
Thingan, M.L 1985. The Economics of Development and Planning. Delhi: Vrinda
Publications.
Mankar, V.G. 1995. Economic Policy and Planning. Delhi: New Age International
Publishers.
Taylor, Edward J and Travis J Lybbert. 2015. Essentials of Development
Economics. California: University of California Press.
Ray, Debraj. 1998. Development Economics. New Jersey: Princeton University
Press.
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