Models of Economic Growth and Development

There are different models for economic growth. Growth in GDP is not the only determinant of economic
development, which in order to be measured effectively must account for human welfare determinants such
as life expectancy, literacy rates, child mortality rates, distribution of income, and so on. However, it has been
shown throughout history that economic growth, or the increase in real output and income, correlates directly
with improvements in development factors like those above.

Generally, Increases in national income usually mean at least some levels of improvement in access to basic
necessities for the average citizen in a developing country. Also, higher incomes mean more savings, which
means greater access to capital for investment by entrepreneurs. More investment leads to greater
productivity and rising incomes for those who join the emerging industrial and service sectors that usually
accompany economic growth. Furthermore, rising incomes mean more tax revenue for governments, which
spends on public goods like education, health care, and infrastructure result in real improvements in standard
of living for not just the emerging upper and middle classes, but the poor as well.

Of course, the following models can be observed to varying degrees among the worlds developing economies
today. Some of these models will fail to play out if the institutional and political environment fails to create a
stable atmosphere for savings and investment. What you should notice, however, is the underlying
importance of savings in all three models. Poor countries suffering from low savings and, even worse, capital
flight, are destined to a cycle of poverty, where funds for investment leading to productivity increases are
never made available due to instable institutions like
banking and politics. The models are;

1. Harrod-Domar Growth Model:

The model suggests that the economys rate of growth
depends on:
1. the level of saving
2. the productivity of investment i.e. the capital
output ratio
The Harrod-Domar model was developed to help
analyse the business cycle. However, it was later
adapted to explain economic growth. It concluded that:

Economic growth depends on the amount of labour and capital.

 As LDCs often have an abundant supply of labour it is a lack of physical capital that holds back economic
growth and development.

More physical capital generates economic growth.

Net investment leads to more capital accumulation, which generates higher output and income.

Higher income allows higher levels of saving.

2. Lewis Structural Change (dual-sector)

Model:

Many LDCs have dual economies:

The traditional agricultural sector was

assumed to be of a subsistence nature
characterised by low productivity, low
incomes, low savings and considerable
underemployment.

The industrial sector was assumed to be technologically advanced with high levels of investment operating in
an urban environment.

Lewis suggested that the modern industrial sector would attract workers from the rural areas.

Industrial firms, whether private or publicly owned could offer wages that would guarantee a higher quality of
life than remaining in the rural areas could provide.

Furthermore, as the level of labour productivity was so low in traditional agricultural areas people leaving the
rural areas would have virtually no impact on output.

Indeed, the amount of food available to the remaining villagers would increase as the same amount of food
could be shared amongst fewer people. This might generate a surplus which could them be sold generating
income.

Those people that moved away from the villages to the towns would earn increased incomes:

Higher incomes generate more savings.

Increased savings meant more fund available for investment.

 Increased investment meant more capital and increased productivity in the industrial sector, higher wages,
more incentive to move from low
productivity agriculture to high productivity
industry, the circle continues.

3. Rostows Model the 5 Stages of

Economic Development:
In 1960, the American Economic Historian,
WW Rostow suggested that countries passed
through five stages of economic
development.

According to Rostow development requires substantial investment in capital. For the economies of LDCs to
grow the right conditions for such investment would have to be created. If aid is given or foreign direct
investment occurs at stage 3 the economy needs to have reached stage 2. If the stage 2 has been reached
then injections of investment may lead to rapid growth.

The stages include traditional society, preconditions to takeoff, takeoff, drive to maturity, and age of high mass
consumption.
According to Rostow, the first stage of economic development consists of traditional society. Traditional societies focus
on the most basic of economic activities such as farming and extractive industries like mining and harvesting of timber.
The labor force is pretty much completely unskilled, and scientific and technological development is primitive. Rostow
believes that traditional economies are generally unproductive.
The second stage of economic development is a transitional stage that establishs the conditions necessary for further
growth and development. This stage is referred to as preconditions to takeoff. At this stage, science and technology start
to progress, which aids in economic productivity. The savings caused by increased productivity are saved and invested in
other areas, including technology and infrastructure like roads, bridges, and harbors.
Rostow's third stage is known as takeoff. A handful of key new industries start to emerge in the national economy that
helps drive further economic growth. For example, the development of a steel industry may drive growth in an economy
with ready access to iron ore. At this stage, Rostow claims that economic growth becomes the normal state of the
economy. He also believed that this economic growth becomes self-sustaining at this point in development.
The fourth stage is known as the drive to maturity. This stage is about diversification and expansion. The economy in
this stage of growth will be developing new and more sophisticated industries. For example, going from producing steel
and timber products to producing consumer electronics and computer chips. In other words, the economy moves
beyond the key bread and butter industries that fueled its 'takeoff' into a more diverse and dynamic economic system.
The workforce becomes more skilled due to the technological demands of the emerging industries. Moreover,
economies at this stage become less dependent upon imports as its emerging industries can compete with them.
Rostow's final stage is known as age of mass consumption. A relatively wealthy population enjoying a high standard of
living marks this stage. Services and consumer goods replace heavy industry as the engine or economic growth. The
current state of the economies of the United States and Western Europe fall within this stage of development.
The Solow Economic Growth Model

Robert Solow developed the neo-classical theory of economic growth.