Transcript Development paradigm

ECONOMIC DEVELOPMENT
Classic Theories of Economic Growth
Professor U Kyaw Min Htun
Pro-rector (Retired)
Yangon Institute of Economics
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Economic Development: classic theories
Growth theories in the outset
Newly independent governments in emerging countries and
acceleration of their development at the outset in the 1950s
Grand models of development strategy that involved structural
transformation
 breaking Nurkse's "vicious circle of poverty”
 via Rosenstein-Rodan's "big push" and
 through "balanced growth" that would establish complementarity
in demand,
 achieve Leibenstein's "critical minimum effort”,
 break out of the "low-level equilibrium trap,"
 and fulfill the conditions of Rostow's "takeoff."
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Economic Development: classic theories
Four approaches
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1.
Linear-stages-of-growth models (development as a series of
successive stages; 1950s + 1960s)
2.
Structural change models (internal process of structural changes
that a developing country must go through; 1970s)
3.
International dependence models (underdevelopment in
terms of -international and domestic power relationships; institutional and structural rigidities; -the resulting proliferation of
dual economies; 1970s)
4.
Neoclassical counter-revolution (free markets, open
economies and the privatization of public enterprises; also known as
market fundamentalism; 1980s + 1990s)
Economic Development: classic theories
1. Linear Stages of Growth
 The thinking was that the developing countries could learn a
lot from the historical growth experience of the now
developed countries in transforming their economies from
poor agrarian societies to modern industrial giants.
 Emphasized the role of accelerated capital accumulation
(Capital fundamentalism) and the need for the mobilization
of domestic and foreign investment in order to do so.
 Rostow’s Stages of Growth
 Harrod-Domar’s Growth Model
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Economic Development: classic theories
Rostow’s stages of Growth
Walter W. Rostow, an eminent economic historian, sets forth a new
historical synthesis about the beginnings of modern economic
growth in 1961.
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Five Stages
(1) the traditional society
(2) the preconditions for takeoff
(3) the takeoff
(4) the drive to maturity
(5) the age of high mass consumption
Criticism
 insufficient empirical evidence, imprecise definitions, no theoretical
ground, the mistaken assumption that economic development in LDCs
will parallel the early stages DC development.
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Economic Development: classic theories
Harrod Domar Model (AK Model)
 The AK model describes the mechanism by which more
investment leads to more growth.
 Pointed to the necessity of net additions to the capital stock
 Used to explain an economy's growth rate in terms of the
level of saving and productivity of capital.
 Component Terms
Capital stock (K); Output (Y)= GDP; Capital-Output ratio (k)=
the dollar amount of capital needed to produce a $1 stream of GDP.
K/Y or ΔK/ΔY; Savings (S) and the savings ratio (s)
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Economic Development: classic theories
Harrod Domar Model (AK Model)
 Net savings is a fixed proportion of GDP
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S = sY
(1)
 Net investment is the change in the capital stock
I = ΔK
(2)
 Remember that k = K/Y or ΔK/ΔY, so that
ΔK = kΔY
(3)
 Net savings must equal to net investment so that S = I. Combining (1),
(2) and (3):
sY = kΔY
 The model: s/k = ΔY/Y : ΔY/Y is the growth rate of GDP
The more economies save and invest, the faster they can grow but the
actual rate of growth is measured by the inverse of the capital-output
ratio – the output-capital ratio.
Economic Development: classic theories
Harrod Domar Model (AK Model)
 As LDCs’ savings levels are often not enough, the “savings gaps” were
filled by massive transfers of capital and technical assistance from DCs.
 More savings and investment is not a sufficient condition for
accelerated rates of economic growth. Many LDCs lack the necessary
structural, institutional and attitudinal conditions (well-integrated
commodity and money markets, highly developed transport facilities,
a well-trained and educated workforce, the motivation to succeed, an
efficient government)
 lacked the complementary factors such as skilled labour, managerial
competence, and the ability to plan and administer a wide assortment
of development projects.
 Also the development strategies proposed by the stages models failed
to take into account the global environment in which developing
countries exist – one in which development strategies can be thwarted
by external forces beyond the countries control.
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Economic Development: classic theories
2. Structural Change Models
 These models tend to emphasize the transformation of
domestic economic structures
- from traditional subsistence agriculture economies
- to modern, urbanized and industrially diverse
manufacturing and service economies.
 Lewis Two-Sector Model
 Patterns-of-Development Approach
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Economic Development: classic theories
Lewis Two Sector Model
1. The traditional agricultural sector: low wages, an abundance of
labour, and low productivity through a labour intensive prod process.
2. The modern manufacturing sector: higher wage rates, higher
marginal productivity, and a demand for more workers initially.
 Labour can be withdrawn from the traditional sector without any loss
of output (zero Marginal Productivity of Labour in the traditional
sector = disguised unemployment)
 Labour transfer and output & employment growth in the modern
sector occur. The rate at which this occurs is determined by the rate of
industrial investment and capital accumulation in the modern sector.
 Modern sector wages are fixed at a premium above the traditional
sector wages. Rural labour supply is perfectly elastic.
 Modern sector wages would rise in order for industrial employers to
attract additional workers from the traditional sector.
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Economic Development: classic theories
Lewis Two Sector Model
 Over time as this transition continues until the wage rates
of the traditional and modern sectors will equalize.
-increasing marginal productivity and wages in the
traditional sector
-while driving down productivity and wages in the modern
sector
 The end result of this transition process is that
- the agricultural wage equals the manufacturing wage,
- the agricultural marginal product of labour equals the
manufacturing marginal product of labour,
- and no further manufacturing sector enlargement takes
place as workers no longer have a monetary incentive to
transition.
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Economic Development: classic theories
Problem of Lewis Model
Problems with Lewis’ model is its assumptions:
1. that the rate of labour transfer and employment creation is proportional
to the rate of modern sector capital accumulation.
- No room for the possibility that capitalist profits could be reinvested
in labour-saving capital equipment
- No room for the possibility of capital flight.
2. Diminishing returns in the modern sector
- much evidence that increasing returns prevail
3. Surplus labour in rural areas and full employment in urban areas.
- by and large this is not the case in most developing nations.
4. The assumption of a competitive modern-sector labour market that
allows modern sector wages to remain fixed until the rural sector
labour surplus is exhausted. (unrealistic)
- In reality there is a tendency for urban wages to rise over time, even
when there is considerable urban unemployment.
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Economic Development: classic theories
Pattern of Development Approach
 Hollis B. Chenery and his colleagues, using cross-sectional and time-
series data, identified patterns of development.
 The shift from agricultural to industrial production
 The steady accumulation of physical and human capital
 The shift in consumer demands from basic necessities to desires for
diverse manufactured goods and services.
 The decline in family size and overall population growth
 The main hypothesis of these models is that development is an
identifiable process of growth and main features of the change are
similar in all countries.
 Practitioners of this approach may lead to draw incorrect conclusions
about causality since the approach is based on empirical observation
and less on theory.
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Economic Development: classic theories
3. International Dependence Revolution
These models view developing countries as beset by
institutional, political, and economic rigidities both
domestic and international, and caught up in a dependence
and dominance relationship with rich countries.
 Neocolonial Dependence Model
 False-Paradigm Model
 Dualistic-Development Thesis
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Economic Development: classic theories
Neoclassical Dependence Model
 Direct outgrowth of Marxist thinking: blame for underdevelopment
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on historical evolution of a highly unequal capitalist system.
Unequal power relationships between the center (the rich countries)
and the periphery (the developing countries).
Elite class in the developing countries have interests that help to
perpetuate the international capitalist system of inequality and
conformity. They serve and are rewarded by international specialinterest power groups (e.g. MNCs, IMF), funded by the DCs.
Often, elite activities tend to hinder any reform efforts leading to
perpetual underdevelopment.
Underdevelopment is seen as an externally-induced phenomenon.
Revolutionary struggles or at least the restructuring of the world
capitalist system are therefore required.
Economic Development: classic theories
False Paradigm Model
 attribute underdevelopment to faulty and inappropriate advice
provided by well-meaning but often uninformed, biased and
ethnocentric international advisers from developed-country assistance
agencies and multinational donor organizations.
 The advice given fails to recognize resilient traditional social
structures, the highly unequal ownership of land and other property
rights, the disproportionate control of elites over domestic and
international financial assets and the very unequal access to credit.
 The policy advice generated from classical and neo-classical models in
many cases merely serve to protect the interests of the existing power
groups, both domestic and international.
 Also local university intellectuals, high-government officials and other
civil servants receive training in developed-country institutions where
they learn inapplicable theoretical models.
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Economic Development: classic theories
Dualistic Development Thesis
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
The concept of dualism represents the existence and
persistence of increasing divergences between rich and
poor.
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Four elements of dualism:
1.
Different sets of conditions, of which some are superior and
others inferior, can coexist in a given space.
2.
The coexistence is chronic and not transitional.
3.
The degrees of superiority or inferiority have a tendency to
increase over time.
4.
The superior element does little or nothing to pull up the
inferior element and may in fact serve to push it down.
Economic Development: classic theories
Structuralism versus Dependency
Structural Change
 Emphasis is on traditional neoclassical
theories designed to generate GDP
growth
 Optimistic that the right mix of
economic policies will generate
beneficial patterns of self-sustaining
growth
 Underdevelopment is a result of internal
International Dependence
 Emphasis is on international power
imbalances and the need for fundamental
economic, political and institutional
reforms both domestic and worldwide.
 Pessimistic in that they offer an appealing
explanation of underdevelopment but
they offer little formal or informal
explanation of how countries can initiate
and sustain development.
constraints such as insufficient savings
and investment or lack of education and  Underdevelopment is an externally
skills.
induced phenomenon
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Economic Development: classic theories
Criticism of Dependency Theory
 The actual economic performance of developing countries that
have pursued revolutionary campaigns of industry nationalization
and state-run production has been mostly negative.
 Dependency theory suggests that countries should become more
inward-looking and less entangled (delinking) with developed
countries, trading only with other developing countries.
 Countries like India and China that pursued inward looking
policy experienced stagnant growth and eventually opened up
their economies. On the other side, the Four Asian Tigers
emphasized exporting to developed countries and have
prospered.
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Economic Development: classic theories
4. Neoclassical Counterrevolution
 Called for freer markets and the dismantling of public ownership,
statist planning, and government regulation of economic activities.
 Neoclassicist obtained controlling power of the world’s 2 most
influential international financial agencies - (IBRD) and (IMF).
 Argues that underdevelopment is the result of poor resource allocation
due to incorrect pricing policies and too much state intervention by
overly-active developing-nation governments and that state
intervention often slows the pace of economic growth.
 Allowing free markets to flourish, privatizing state-owned enterprises,
promoting free trade and export expansion, welcoming investment
from developed countries and removing the plethora of government
regulations and price distortions in all markets will stimulate both
economic efficiency and economic growth.
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Economic Development: classic theories
Approaches of Market Fundamentalism
1. The Free Market Approach: markets alone are efficient; competition is
effective if not perfect; technology is freely available and nearly
costless to absorb; information is also perfect and nearly costless to
obtain. So government intervention in this context is distortionary and
counterproductive. Ignores market imperfections in developing
countries.
2. Public-choice theory: Government can do nothing right. Politicians,
bureaucrats, citizens and states are all self-interested and take action to
achieve their own ends. The net result is not only a misallocation of
resources but also a general reduction in individual freedoms. Minimal
government is the best government.
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Economic Development: classic theories
Approaches of Market Fundamentalism
3.Market-friendly Approach: Recognizes the imperfections in
LDC product and factor markets and recognizes the need
for government to facilitate the operation of markets
through non-selective (market-friendly) interventions. Also
recognizes that marker-failures are more prominent in
developing countries.
Phenomena endemic to LDC markets are
- missing and incomplete information
- externalities in skill creation and learning
- economies of scale in production
Recognition of these phenomena gives rise to the newest
schools of development theory, the endogenous growth
approach.
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Economic Development: classic theories
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Reconciling the differences
 In an environment of widespread institutional rigidities and severe
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socioeconomic inequality, both markets and governments will fail.
The linear-stages model emphasizes the crucial role of savings and
investment.
The Lewis two-sector model emphasizes the importance of attempting
to analyze the many linkages between the traditional sector and the
modern industry
International dependence theories highlight the role of the structure and
workings of the world economy and the impact of decisions made in the
developed world on the growth prospects for LDCs.
The neoclassical economic models point to the promotion of efficient
production and distribution through a proper functioning price system
and the damaging effect of government-induced domestic and
international price distortions.
Economic Development: classic theories
Neoclassical growth theory- Traditional
 A direct outgrowth of the Harrod-Domar and Solow models, which both
stress the importance of savings.
 Liberalization (opening up) of national markets draws additional domestic
and foreign investment and thus increases the rate of capital accumulation
 The Solow Growth Model expanded on the Harrod-Domar formulation
by adding a second factor of production – labour – and by introducing a
third independent variable – technology – to the growth equation.
 Technological progress became the residual factor explaining long-term
growth. The level of technological progress was assumed to be
exogenous.

1
Y  K (AL)
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Economic Development: classic theories
Solow Growth Model
Y
sY=Saving
dK=Depreciation
Stationary points
high saving
low saving
sY
δK
K
K*1
K*2
Total capital stock (K) grows when savings are greater than depreciation.
An increase in s will not increase growth, unlike in the HD model, it will
only increase the equilibrium K*
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Economic Development: classic theories
Traditional growth theory
 According to traditional neoclassical growth theory, output growth
results from
 Increases in labour quantity and quality
 Increases in capital
 Improvements in technology
 Closed economies with lower savings rates grow more slowly in the
short run than those with high savings rates and tend to converge to
lower per capita GDP levels. Open economies experience income
convergence at higher levels.
 By impeding the inflow of FDI, heavy-handed LDC governments
retard growth.
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Economic Development: classic theories
New (Endogenous) growth theory
 Economic growth is the result of endogenous and not external forces.
 Investment in human capital, innovation, and knowledge are significant
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contributors to economic growth having positive externalities and
which offsets the diminishing return to capital accumulation.
discarding the assumption of DMR to capital investments
permitting increasing returns to scale in aggregate production
focusing on the role of externalities in determining the ROIs
Implication: an active role for public policy in promoting
economic development through direct and indirect investments in
human capital formation and the encouragement of foreign
private investment in knowledge-intensive industries.
AK Model: y = AK
;A = a positive constant that reflects
the level of the technology, K = capital (including human capital)
Economic Development: classic theories
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The End
 Todaro, Michael P. and Smith, Stephen C., 2012, “Chapter 3: Classic
Theories of Economic Growth and Development” in Economic
Development, 11th ed., pp. 109-154.
 Rostow, W. W., 1960, The Stages of Economic Growth: A Non-Communist
Manifesto, 3rd ed., Cambridge University Press.
 Lewis, W. A., 1954, “Economic development with unlimited supplies
of labour,” Manchester School 22 (1954): 139–191.
 Chenery, Hollis B. and Syrquin, Moshe, 1975, Patterns of Development,
1950–70, London: Oxford University Press.
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Economic Development: classic theories