Lecture Economic development - Chapter 3: Classic theories of economic growth

In this chapter: See how economists apply the methods of science, consider how assumptions and models can shed light on the world, learn two simple models - the circular flow and the production possibilities frontier, distinguish between microeconomics and macroeconomics,...

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Class Theories of Economic

Development – Four Approaches

• Structural change model

– Linear stages of growth

– Saving-investment

– Rural-urban migration

• Neocolonial dependence theory

– Dependence: Center vs Periphery

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Rostow’s Linear-Stages Model

population growth

2 Pre-condition to take-off: development of

institutions, organizations, and

infrastructure

3 Take-off: large investment in selected

industry (10 to 15% of GDP)

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Rostow’s Linear-Stages Model

4 Drive to maturity: sustained growth of the

industry and economy

5 Age of high mass consumption:

production of consumer goods and

services to serve an affluent society

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Harrod-Domar Growth Model

S = sY S=Saving; Y=Real GDP; s=Saving Ratio

I = ΔK I=Investment; ΔK=Capital Accumulation

S = I Saving-Investment identity

Define the Marginal Capital-Output Ratio as k = ΔK/ΔY

Write ΔK = kΔY or I = kΔY

From S = I, write sY = kΔY or ΔY/Y = s/k

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Harrod-Domar Growth Model

The source of growth is saving and investment in

production of goods and services Accordingly,

s = national saving ratio; k = marginal capital-output ratio

If s=6% and k=3, then GDP growth rate=2% Given k=3,

to raise growth rate to 4%, we need to increase the saving

ratio from 6% to 12% with 6% of foreign saving

GDP growth rate = s/k

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Criticism of Investment Models

• Many LDCs have not been able to take-off

or achieve maturity despite massive

foreign investment

• Many nations have neglected the

development of institutions, organizations, and infrastructure required for

industrialization

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The Lewis Development Model

• Rural agricultural sector

– Low or even zero Marginal Product of Labor so that

labor is a redundant factor and wage rate is at the

subsistence level

• Urban industrial sector

– Rising demand for unskilled labor to be trained for

industrial growth results in greater employment and

more profits and higher wages

– To find jobs and earn higher wages

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Criticisms of Lewis Model

• Industrial technology is generally capital

intensive/labor-saving Hence, the demand for unskilled rural labor would not increase employment

• Industrialization must be supported by

agricultural development to supply an

ever-increasing supply of food items and

raw materials

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No increase in employment when technology is labor saving

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Neocolonial Dependence Model

• MDCs form the “center” of global economic

relations and technological advancement

• LDCs serving as the “periphery” are dominated by:

– unequal trade and finance relations

– domestic politico-economic elite

– multinational corporations

Under these conditions economic development is

impossible

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Neocolonial Dependence Model

American MDCs

African LDC S

Latin American LDC S

Asian LDC S

European MDCs Other MDCs

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False-Paradigm Model

• Economic development relies heavily on funds

from international donor agencies such as the

World Bank and IMF

• The policy of these agencies is to support urban industrial growth and impose capitalistic

austerity measures

• They reinforce the pattern of “dependent

development”

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Dualistic Development Model

• Structural transformation models create a

“dualistic” pattern of development, resulting in an ever-increasing degree of economic inequality

both nationally and internationally:

– urban vs rural

– industrial vs agricultural

– modern vs traditional

– rich vs poor

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Approaches to Development

• Free-market approach: rely of the allocation role

of markets and limited government involvement in economics But, there are several areas in which markets fail to achieve efficient outcomes:

– income distribution

– public goods

– externalities

– market power

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• Market-friendly approach: improve market

operation through “nonselective”

interventions such as

– income redistribution system

– investment in social and human capital

– environmental protection policy

– anti-trust laws

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• Public-choice approach: public officials and

bureaucrats in the position of authority are

“rent-seeking” citizens acting on self-interest

rather than public-interest

• Need a system of checks and balances to monitor the behavior of public officials and bureaucrats

• Need a democratic system to let people choose

public officials and bureaucrats for limited duration

of authority

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• Capital Formation

– Physical capital formation: investment in tools,

equipment, machinery, buildings

– Social capital formation: investment in roads, dams,

airports, railroads, bridges

– Human capital formation: investment in education,

training, health, nutrition

secular and democratic government and free mass

media

Appendix 3.1: Components of

Economic Growth

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Determinants of Economic

Growth

– Increase in the amount of physical capital per unit of labor

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Production Possibilities Curve

services the economy can produce,

assuming:

– full employment / efficiency

– fixed resources

– constant technology

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B

CED

Combination F is attainable, but inefficient

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A

B

CEDRadios Combination D becomes available with more resources and better technology

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B

CE

Economic Improvement

F

Radios Combinations G (or B or C) becomes

efficient with more employment and/or improved efficiency

G

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Technological Advancement

RiceRadios

Neutral: proportional increase in the supply of Rice and Radios

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RiceRadios

Capital augmenting: greater increase in the supply of Radios

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RiceRadios Labor augmenting: greater increase in the supply of Rice

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RiceRadios Advancement only in agricultural production

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RiceRadios Advancement only in industrial production

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Factor Accumulation Accounts for

Only a Fraction of Growth

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