Theories of growth and development

Theories of Growth & Development

Classic Theories of Economic Development: Four Approaches

1. The Linear-Stages of growth model
2. Structural change pattern Theories
3. International-Independence
4. 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:

1. Traditional Society
2. Precondition take-off
3. Take-off
4. Drive to Maturity   or sustaining  stage
5. 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

∆K=k∆Y  …………………….(3)

S=I ……………………………(4)

S=sY=k∆Y=∆k……………..(5)

sY=k∆Y ……………………..(6)

∆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:

1. Output is a function of capital stock

Y = f(K)

2. 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

3. Capital is necessary for output

                            f(0) = 0

4. 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:

1. Free Markets,

 

2. Public-Choice or New  Political  Economy,

 

3. Market-friendly   These  are  all challenges  to the Statist  Models of the 1950s-70’s.

2.5.1.1. 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.

2.5.1.2 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.

2.5.1.3 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.