Theories of Growth & Development
Classic Theories of Economic Development: Four Approaches
- The Linear-Stages of growth model
- Structural change pattern Theories
- Neo-Classical (counter-revolution) Theory
2.0 Development as Growth and the Linear-Stages Theories
1.1. Rostov’s stages of growth
1.2. The Harrod-Domar growth model
1.3. Obstacles and constraints
1.4. Some criticisms of the stages model
2.1 Rostow Stages of Development
Different countries are at different stages of development. Rostow has classified the stages of economic development into five categories as follows:
- Traditional Society
- Precondition take-off
- Drive to Maturity or sustaining stage
- The stage of large scale of mass consumption
2.1.1 Traditional Society
- Dominated by subsistence (defined as no economic surplus, meaning output being consumed by producers rather than traded);
- Trade being carried out by barter, meaning goods being exchanged directly for other goods;
- Agriculture being the most important industry; Production being labour intensive using only limited quantities of capital.
2.1.2 Transitional Stage (the preconditions for take-off)
- Increased specialization starting to generate surpluses for trading.
- an emergence of a transport infrastructure to support trade; External trade also occurs concentrating on primary products; Entrepreneurs emerge
- Savings and investment grow.
2.1.3 Take Off
- Rapid Industrialization or Industrial Revolution
- Growth concentrated in a few regions of the country and in one or two manufacturing industries.
- The level of investment reaches over 10% of GNP.
- The economic transitions are accompanied by the evolution of new political and social institutions that support the industrialization.
- The growth is self-sustaining: investment leads to increasing incomes in turn generating more savings to finance further investment.
2.1.4 Drive to Maturity
Industrial Diversification; producing a wide range of goods and services; reliance on exports and imports may start decreasing
2.1.5 High Mass Consumption
- Domestic Aggregate Demand is the major determinant of Business (Cycles)
- Consumer durable industries; Service sector
2.2 The Harod-Domar Model (the idea that capital and saving is important)
- Savings (S) is a proportion of national income
S = sY ………………………(1)
- Net investment is the change in capital stock (K)
I = ∆K ………………………..(2)
- K bears a direct relationship with Y, therefore
K/Y=k or ∆k/∆Y =k
∆Y/U = s/k …………………(7)
A model of “ capital fundamentalism”
Where s =savings ratio =S/Y,
and k= capital output ratio= K/Y
Yg =growth rate of GDP= s/k
Note: The more economies save and invest, the faster they grow.
e.g. If s=6%, and k=3.0, Yg =6%/3 =2%
Another way of deriving the Harrod-Domar Model
Let Y represent output, which equals income, and let K equal the capital stock. S is total saving, s is the savings rate, and I is investment. δ stands for the rate of depreciation of the capital stock. The Harrod–Domar model makes the following a priori assumptions:
- Output is a function of capital stock
Y = f(K)
- The marginal product of capital is constant; the product function exhibits constant returns to scale. This implies capital’s marginal and average products are the name
DY/DK =c à DY/DK = Y/K
- Capital is necessary for output
f(0) = 0
- The product of the savings rate and output equals of saving, which equals investment
sY = S = 1
5,. The change in the capital stock equals investment less the depreciation of the capital stock
∆k = 1 = δk
2.2.1 Obstacles & Constraints to HarrodDomar Model
- Yg =s/k =6%/3 = 2%
- Suppose ‘s’ increases to 15%, then
- Growth Rate= Yg = 15%/3 = 5%
- Constraint: But there is low capital formation or scarcity in LDCs & African economies
- How can LDCs overcome” capital constraint”? By savings, foreign aid & investment both foreign & domestic …
2.2.2 Harrod-domar Model. Is Savings a necessary & sufficient condition?
- Savings & Capital accumulation may be necessary for economic growth, but NOT a sufficient condition.
- Other factors such as institutions, human capital, skilled labor, transparency, . may be lacking.
- Historical Example: “The Marshall Plan” in Europe/Germany succeeded due to the existence of these other factors such as educated labor and knowledge even though the physical infrastructure was destroyed by the War…
2.3 Structural-Change Models
- The focus of these theories is on the way economies are transformed over time, from traditional to modern/industrial economies..
- The Lewis theory is the Basic
- The Model explains the “structural transformation” of a subsistence/ agricultural economy to a modern/Industrial .
2.3.1 The Lewis Model of Development: Key Assumptions & Implications..
- Two sectors- traditional-labor surplus economy that co-exists with modern/Industrial sector- There is an “economic dualism”.
- Labor surplus in traditional/agricultural Much of this is unskilled.
- The Lewis model implies employment will expand until surplus labor is absorbed in the modern or industrial
2.3.2 Limitations of the Lewis Model
- Model roughly explains the historical growth experience of today’s Industrial
- But, its key assumptions do not reflect the realities of today’s Why?
- Profits may not be re-invested domestically- in LDCs especially in African economics e. there may be “capital flight”
- Surplus labor may not exist in rural
2.3.3 Structural Change & Patterns of Development
- Empirical structural change analysis stresses both domestic and international constraints, including institutional ones for successful .
- Holis Chenery (Havard Economist) used time series & cross-section data of countries to examine key features of the development
2.3.4. Conclusions and Implications
- The major hypothesis of structural analysis is that development is an identifiable process of change with similar features andImplication
- But, these patterns can also vary among Key point. Why do they vary? ( Due to institutions, and human capital, and nature of government)
- It assumes there are “correct” mix of economic growth that will generate sustained growth… It is an approach used by World Bank.
2.4 The International-Dependence Revolution: Various Versions
- LDCs beset by institutional, political & economic rigidities both domestic and international
- The neocolonial dependence model assumes Unequal relationship between the center (developed countries) and the periphery (LDCs).
- The false-paradigm model: inappropriate advice by developed countries experts and
- The dualistic-development thesis: leads to increased inequality and poverty or greater gap between the few rich and a large
- Conclusions and implications: These Dependency models imply pursuit of autarky & anti-globalization These have proved to be a failure in general.
- What countries remain that practice this model?
2.5 The Neoclassical Counter-revolution: Market Fundamentalism
- Challenges the statist model of centralized socialism and centrally planned
- Free market approach –Public choice approach –Market-friendly approach
- Traditional neoclassical growth theory or the Solow Model theory
- Conclusions and implications
2.5.1 The Neoclassical Counterrevolution Market Fundamentalism
Market fundamentalism gained resurgence in the 1980s. It dominated economic policies of the US, Britain, Canada & Germany, as well as the thinking of International Development agencies such as the World Bank & the IMF.
There are three variations or approaches:
- Free Markets,
- Public-Choice or New Political Economy,
- Market-friendly These are all challenges to the Statist Models of the 1950s-70’s.
184.108.40.206. The Free Market Approach
- Assumes markets are Competition is effective. The state or Government intervention is ineffective.
- Given the efficiency of markets, any imperfections in markets are of little significance.
220.127.116.11 Public-Choice or New Political Economy Approach
- Argues that governments can not solve economic problems, since the state itself is dominated by politicians, bureaucrats, that use power for selfish ends.
- State officials extract “rents”, taking bribes, and confiscate or nationalize property, and reduce freedom of citizens. Therefore, it is best to minimize the role of governments.
- Big corporations also suffer from similar problems but market and public policy desciplines them.
18.104.22.168 The Market-friendly Approach
- This is the most recent variant of Neo-Classical It is an approach used by World Bank & IMF economists.
- This approach recognizes market imperfections, missing markets, and Therefore, there is a need for government role in areas such as providing public goods, developing market supporting institutions or rules, and defining and protecting property rights.
- The state or the government has a necessary role of being an “impartial” referee in the economic
2.6 The Neoclassical Growth Theory – The Solow Growth Model
The Solow model expanded the Harrod-Domar Model, that stressed the critical role of savings, Investment & capital accumulation. It formalized & expanded the Harrod Model by adding labor, capital, and technology. Technology is assumed to explain the “residual” factor, and was assumed to be determined exogenously.
2.6.1 Development Policy Implications of the Solow Model for African economies
- Output (GDP) grows as a result of 3 faprogres
- increase in labor quantity and quality, increase in capital (by saving & investment), and by technological
- Closed economies grow more slowly than Open economies. Impeding free trade and foreign investment will slow economic
2.7 Schumpeter’s Theory
- Economic growth is a dynamic process and not continuous – national income does not always increase
- National income exhibit cyclical pattern – increases and
- National income increases when innovations takes place.
- Innovation means the discovery of a new product, a new process or a new market
- Entrepreneurs introduce innovations through new profit opportunities
Therefore, entrepreneurs are central to the development process. As long as innovations proceeds, the economy continues to grow. Leading entrepreneurs are imitated by others, thus prosperity continue. After some time, when banks loans are paid of, depression comes because old firms disappear due to innovations.