Chapter 3

Chapter 3

Classic Theories of Economic

Growth and

Development

Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

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

– False Paradigm

• Neoclassical theory

– Market friendly approach

– Dualistic approach

– Public choice approach


3-2

Rostow’s Linear-Stages Model

1.

Traditional society

2.

Pre-condition to take-off

3.

Take-off

4.

Drive to maturity

5.

Age of high mass consumption


3-3


1.

Traditional society: slow economic and 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)

3-4 Copyright © 2009 Pearson Addison-Wesley. All rights reserved.


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



GDP Growth

Economic Growth

Post Take-off

Take-off

Pre Take-off t

1


t

2 Time

3-6

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


3-7

Harrod-Domar Growth Model

The source of growth is saving and investment in production of goods and services . Accordingly,

GDP growth rate = s/k 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


3-8

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


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

• Rural-Urban migration

– To find jobs and earn higher wages


3-10

Demand for Labor

Wage

R: Rural

W: Wage

U: Urban

E: Employment

D: Labor Demand S: Labor Supply

W

U

Profit

W

R

Wage

E

1

E

2

S

R

D

U1

D

U2

Employment

Investment in urban areas increases the demand and employment for rural labor.


3-11

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


3-12

Demand for Labor

Wage

No increase in employment when technology is labor saving

Profit

W

U

W

R Wage

D

U2

E

1

= E

2

S

R

D

U1

Employment


3-13

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


3-14

Neocolonial Dependence Model

African LDC

S

Asian LDC

S American

MDCs

European

Other

MDCs

MDCs

Latin American LDC

S


3-15

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”


3-16

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


3-17

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


3-18


• 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


3-19


• 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


3-20

Appendix 3.1: Components of

Economic Growth

• 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

– Political capital formation: investment is creating a secular and democratic government and free mass media


3-21

Determinants of Economic

Growth

• Physical Capital Formation

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


3-22

Determinants of Economic

Growth

• Technological Advancement

– Increase factor productivity (labor, land, capital)


3-23

Production Possibilities Curve

•

Maximum quantities of two good and services the economy can produce, assuming:

– full employment / efficiency

– fixed resources

– constant technology


3-24

PPC Schedule

Combination

Radios

Rice

A B

100 90

0 40

C

50

80

E

0

100


3-25

PPC Graph

Radios

100

90

A

50

F

B

Combinations A, B, C, and E are attainable

Combination D is unattainable given resources and technology

Combination F is attainable, but inefficient

D

C

40

E

80 100

Rice


3-26

Economic Growth

Radios

A

100

90

50

B

C

Combination D becomes available with more resources and better technology

D

40 80 100

E

Rice


3-27

Economic Improvement

Radios

100

90

A

50

Combinations G (or B or C) becomes efficient with more employment and/or improved efficiency

F

B

G

C

40

E

80 100

Rice


3-28

Technological Advancement

Neutral: proportional increase in the supply of Rice and Radios

Radios


Rice

3-29


Capital augmenting: greater increase in the supply of Radios

Radios


Rice

3-30


Radios

Labor augmenting: greater increase in the supply of Rice


Rice

3-31


Radios

Advancement only in agricultural production


Rice

3-32


Radios Advancement only in industrial production


Rice

3-33

Factor Accumulation Accounts for

Only a Fraction of Growth


3-34

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