Classic Theories of Development: A comparative

Analysis

Copyright © 2007 Eijaz Ahmed Khan. 2-1

 Classic Theories of Economic Development:
Four Approaches

■ 1950s and early 1960s viewed the process of development

as a series of successive stages of economic growth through
which all countries must pass___high quantity and mixture of
saving, investment and foreign aid
■ The linear stages approach largely replaced in the
1970s___1 focused on theories and patterns of structural
change (used modern economic theory, and statistical
analysis an attempt to portray the internal process of
structural change)___2 international dependence revaluation
in terms of…..international and domestic power relationship,
institutional and structural economic inflexibility, proliferation
of dual economic and dual societies,
■ 1980s to 1990s neoclassical emphasized the beneficial role
of free markets, open economy, privatization of inefficient
public enterprise.

Copyright © 2007 Eijaz Ahmed Khan. 2-2

 Development as growth, the linear stages
theories

■ Second world war__ poor nations___

industrialization nation__ no concept to analyze
the process of economic growth in largely
agrarian societies modern economic structures
■ Marshall Plan
■ It was not true all modern industrial nations were
once underdevelopment agrarian societies?
Important lesson for backward countries of Asia,
Africa, Latin America

Copyright © 2007 Eijaz Ahmed Khan. 2-3

 Rostow’s Stages of Growth

■ The traditional society

■ Pre conditions for take-off into self-
sustaining growth
■ The take off
■ The drive to maturity
■ The age of high mass consumption

Copyright © 2007 Eijaz Ahmed Khan. 2-4

 The Harrod-Domar Growth Model

■ From GDP to Disposable income

■ National income
Represents the total factors incomes received by labor, capital, and land.
NI= total wages + profits + rents + Interest.
NI= GDP-(depreciation + indirect taxes)
Disposable Income
Take home pay, or that part of the total national income that is available to households for consumption
or saving. It is equal to GNP less all taxes, business saving, and depreciation plus government and
other transfer payments and government interest payment.

Net Export Depreciation

Indirect taxes
Government
National Direct Transfer
Investment Income Taxes payment
Net business saving
Consumption

GDP
Copyright © 2007 Eijaz Ahmed Khan.
NI DI 2-5
 The Harrod-Domar Growth Model

■ Save a certain proportion of its national income

■ New investment representing net additions to the
capital stock are necessary.
■ Direct economic relationship between the size of
the total capital stock, K and total GNP, Y
Example: $3 of capital is always necessary to produce a $1
stream of GNP__it follows that any net additions to the
capital stock in the form of new investment will bring about
corresponding increases in the flow of national output,
GNP.

Copyright © 2007 Eijaz Ahmed Khan. 2-6

 The Harrod-Domar Growth Model

■ Capital-output ratio 3 to 1
■ We define capital- output ratio as k
■ Assume further national saving ratio, s, is a fixed portion of national
output
■ And total new investment is determined by the level of total saving

■ 1. Saving (S) is some proportion, s, of national income (Y) such that

we have the simple equation S=sY
■ 2. Net investment (I) is defined as the change in the capital stock, K
and can be represented by ^K such that I=^K
But because the total capital stock, K bears a direct relationship to total
national income or output, Y, as expressed by the capital-output ratio,
k, it follows that K/Y=k or ^K/^Y=k or finally ^K=k^Y

Copyright © 2007 Eijaz Ahmed Khan. 2-7

 The Harrod-Domar Growth Model

■ 3. finally because net national saving, S, must equal net investment, I,

we can write this equality as S=I
■ But from equation one we know that S=sY and form equation two and
three we know that I=^K=k^Y
■ It therefore follows that we can write the identity of saving equaling
investment shown by equation fourth as
■ S=sY=k^Y=^K=I

Or simply sY=k^Y
Dividing both sides of equation sixth first by Y and then by k we obtain the
following expression
^Y/Y=s/k
Left hand side of equation ^Y/Y, represents the rate of change or rate of
growth of GNP
_____The rate of growth of GNP is determined jointly by the national
savings ratio, s, and the national capital output ratio, k.

Copyright © 2007 Eijaz Ahmed Khan. 2-8

 The Harrod-Domar Growth Model

■ Obstacles and Constrains

■ Example:
■ National capital output ratio in some less developed country is say 3 and the
aggregate saving ratio is 6% of GNP it follows from equation sixth that this
country can grow at a rate of 2% per year ^Y/Y=s/k=6%/3=2%
■ It the national net saving rate can somehow be increased from 6% to , say 15%
through increased taxes, foreign aid and or general consumption sacrifices
GNP growth can be increased from 2% to 5%
■ ^Y/Y=s/k=15%/3=5%
_____Low level of formation
_____capital constraint stages approach to growth and development became a
rational and in terms of cold war policies and opportunist tool for justifying
massive transfers of capital and technical assistance from the developed to
less developed countries.

Copyright © 2007 Eijaz Ahmed Khan. 2-9

 Necessary vs Sufficient conditions: Some
Criticisms of the Stages Model

The theory of stages of growth did not always work.

More saving and investment is not necessary condition for
accelerated rates of economic growth.

Marshall plan (Europe)__well integrated, transport etc.

Developing nations failed to take account in highly integrated
and complex international system

Copyright © 2007 Eijaz Ahmed Khan. 2-10

 Structural Change Models

■ Structural change theory

-focuses on the mechanism by which underdeveloped economics
transform their domestic structures from a heavy emphasis on
traditional subsistence agriculture to a more modern, more
urbanized, and more industrially diverse manufacturing and
service economy.
■ The Lewis Theory of Development (Arthur Lewis)
-basic model: two sectors-a traditional, overpopulated rural
subsistence sector characterized by zero marginal labor
productively-it can be withdrawn from the agricultural sector
without any loss of output-and a high productivity modern urban
industrial sector .
-primary focus of the model is on both the process of labor transfer
and the growth of output and employment.

Copyright © 2007 Eijaz Ahmed Khan. 2-11

 Structural Change Models (cont…)

-Both labor transfer and modern sector employment growth are brought
about by output expansion
_ the speed of expansion determined by rate of industrial investment and
capital accumulation
-Investment is made possible by the excess of modern sector profits over
wages
-urban wages higher than average rural income to induce workers to
migrate from their home areas.
- Figure:4.1 Page 118
■ Two assumptions about the traditional sector

-surplus labor
-all rural workers share equally in the output so that the rural real wage is
determined by the average and not the marginal product labor
Self-sustaining growth and employment expansion is assumed to
continued until all surplus rural labor is absorbed in the new industrial
sector.
Copyright © 2007 Eijaz Ahmed Khan. 2-12
 Structural Change Models (cont…)

■ Criticisms of the Lewis Model

-assumes that the rate of labor transfer and employment creation in the modern
sector is proportional to the rate of modern-sector capital accumulation. The
faster the rate of capital accumulation, the higher the growth rate of the modern
sector and the faster the job creation. But capitalist profits are reinvested in
more sophisticated laborsaving capital equipment rather than just duplicating
the existing capital.
-total output has grown substantially, total wages and employment remain
unchanged. All of the extra output accrues to capitalist in the form of profits
-surplus labor exists in rural areas while there is full employment in the urban
areas. There are both seasonal and geographic exception
-Competitive modern sector labor market that guarantees the continued existence
of constant real urban wages up to the point where the supply of rural surplus
labor is exhausted. /Labor saving bias union bargaining power, civil service
wage scales and multinational
-diminishing returns in modern industrial sector

Copyright © 2007 Eijaz Ahmed Khan. 2-13

 Structural Change Models (cont…)

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 Structural Change Models (cont…)

Copyright © 2007 Eijaz Ahmed Khan. 2-15

 Structural Change Models (cont…)

■ Structural Change and Patterns of Development

■ Increased saving and investment are perceived by patterns of development
analysis as necessary but not sufficient conditions for economic growth.
-the structural changes involves (transformation of production
and changes in the composition demand of consumer
demand, international trade, and resource use as well as
changes in socioeconomic factors such as urbanization
and the growth and distribution of a country’s population)

Copyright © 2007 Eijaz Ahmed Khan. 2-16

 Structural Change Models (cont…)

■ Structural Change and Patterns of Development

■ Domestic constraints on development
-Countries resources endowment
-Physical and population size
-govt polices and objectives
■ International constraints on development

-access to external capital

-technology
-international trade

Copyright © 2007 Eijaz Ahmed Khan. 2-17

 Structural Change Models (cont…)

■ Structural Change and Patterns of Development

■ B. Chenery (cross sectional and time series)
-Shift from agricultural to industrial production
-steady accumulation of physical and human capital
-change in consumer demands from emphasis on food and
basic necessities to desires for diverse manufactured
goods and services
-the growth of cities and urban industries as people migrate
from farms and small towns
-decline in family size and overall population growth as
children lose lose their economic value

Copyright © 2007 Eijaz Ahmed Khan. 2-18

 Structural Change Models (cont…)

■ Structural Change and Patterns of Development

■ Conclusion and Implications
-growth and change whose main features are similar in all
countries
-factors-resource endowment and size, government’s
policies and objectives, availability of external capital and
technology and international trade
-emphasizing patterns rather than theory (causality and
effect)-agriculture and education

Copyright © 2007 Eijaz Ahmed Khan. 2-19

 The International Dependence Revolution

■ Structural Change and Patterns of Development

■ Conclusion and Implications
-growth and change whose main features are similar in all
countries
-factors-resource endowment and size, government’s
policies and objectives, availability of external capital and
technology and international trade
-emphasizing patterns rather than theory (causality and
effect)-agriculture and education

Copyright © 2007 Eijaz Ahmed Khan. 2-20