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Classic Theories of Economic Growth

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Presentation on Todaro & Smith's Economic Development (Chapter 3) for Philippine Studies 222, Asian Center, University of the Philippines, Diliman.

Presentation on Todaro & Smith's Economic Development (Chapter 3) for Philippine Studies 222, Asian Center, University of the Philippines, Diliman.


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  • 1. 1950s and 60s 2. 1970s 3. 1970s 4. 1980s and 1990s
  • Photo: Harry Truman museum and library
  • Marshall Plan: Sec. of State George Marshall | in order to prevent the spread of Soviet Communism. [1]  The plan was in operation for four years beginning in April 1948. [2]  The goals of the United States were to rebuild a war-devastated region, remove trade barriers, modernize industry, and make Europe prosperous again. [3]  The term "equivalent of the Marshall Plan" is often used to describe a proposed large-scale rescue program.
  • American economic historian Walt W. Rostow. One of the principal strategies of development necessary for any takeoff was the mobilization of domestic and foreign saving in order to generate sufficient investment to accelerate economic growth
  • Sir Roy Harrod & Evsey Domar, who developed it in 1939 and 1946, respectively. See http://prezi.com/r6qh5t9xracf/harrod-domar-growth-model/ Capital output ratio: if $3 of capital is always necessary to produce an annual $1 stream of GDP
  • formulated by Nobel laureate W. Arthur Lewis in the mid-1950s and later modified, formalized, and extended by John Fei and Gustav Ranis. marginal product of labor  ( MPL ) is the change in output that results from employing an added unit of labor
  • The upper diagram shows how subsistence food production varies with increases in labor inputs. It is a typical agricultural production function in which the total output or product ( TPA) of food is determined by changes in the amount of the only variable input, labor ( LA), given a fixed quantity of capital, KA, and unchanging traditional technology, . In the lower-right diagram, we have the average and marginal product of labor curves, APLA and MPLA, which are derived from the total product curve shown immediately above. In the Lewis model, the modern-sector capital stock is allowed to increase from KM1 to KM2 to KM3 as a result of the reinvestment of profits by industrial capitalists. This will cause the total product curves in Figure 3.1a to shift upward from TPM(KM1) to TPM(KM2) to TPM(KM3).
  • Not just increased savings and investment. Based on empirical work of Harvard economist Hollis Chenery and colleagues.
  • Not just increased savings and investment. Based on empirical work of Harvard economist Hollis Chenery and colleagues.
  • Observing the important role of higher education in developed countries, policymakers may be inclined to emphasize the development of an advanced university system even before a majority of the population has gained basic literacy
  • . . Dependence is a conditioning situation in which the economies of one group of countries are conditioned by the development and expansion of others. A relationship of interdependence between two or more economies or between such economies and the world trading system becomes a dependent relationship when some countries can expand through selfimpulsion while others, being in a dependent position, can only expand as a reflection of the expansion of the dominant countries, which may have positive or negative effects on their immediate development. In either case, the basic situation of dependence causes these countries to be both backward and exploited. Dominant countries are endowed with technological, commercial, capital and sociopolitical predominance over dependent countries—the form of this predominance varying according to the particular historical moment—and can therefore exploit them, and extract part of the locally produced surplus. Dependence, then, is based upon an international division of labor which allows industrial development to take place in some countries while restricting it in others, whose growth is conditioned by and subjected to the power centers of the world.
  • remarkably resilient role of traditional social structures (tribe, caste, class, etc.), the highly unequal ownership of land and other property rights, the disproportionate control by local elites over domestic and international financial assets, and the very unequal access to credit, these policies, based as they often are on mainstream, neoclassical (or perhaps Lewis-type surplus-labor or Chenery-type structural-change) models, in many cases merely serve the vested interests of existing power groups, both domestic and international.
  • c. Productivity gap between developed and developing increases
  • But China and to a significant extent India experienced stagnant growth and eventually decided to open their economies.
  • point both to the success of economies like South Korea, Taiwan, and Singapore as “free market” examples (although, as we shall see later, these Asian Tigers are far from the laissez-faire neoconservative prototype) and to the failures of the public-interventionist economies of Africa and Latin America.
  • 2. Resources to maintain power, bribery for rent-seeking citizens and protected businesses, confiscate private property
  • Nobel prize winner Robert Solow.
  • Transcript

    • 1. Classic Theories of Economic Growth and Development Report: Kristine Sabillo for PS 222 (AY 2012-2013) July 4, 2013 | Asian Center, University of the Philippine - Diliman Todaro & Smith, Ch. 3 of Economic Development, 11th Edition
    • 2. INTRODUCTION EVERY NATION STRIVES FOR DEVELOPMENT But economic progress is not the only component DEVELOPMENT > material & financial Widespread realization = national context + international economic + social system
    • 3. FOUR APPROACHES Post World War II 1.Linear stages of growth 2.Theories and patterns of structural change 3.International-dependence revolution 4.Neo-classical, free market counterrevolution
    • 4. POST WORLD WAR II Context: - Struggle to rebuild - Postwar economic boom - Demand for consumer goods - Flowing foreign aid to countries like PH - PH context: Bell Trade Act (no import duties for US products)
    • 5. I. LINEAR STAGES THEORY
    • 6. I. LINEAR STAGES THEORY DEVELOPMENT AS GROWTH Post-war interest on poor nations - Economists had no conceptual apparatus for largely agrarian countries w/o modern economic structures Strands of thought - Marshall Plan: US financial and technical assistance to war-torn European countries - All modern industrial nations were once underdeveloped agrarian societies
    • 7. I. LINEAR STAGES THEORY Rostow’s Stages of Growth * Developed countries already passed all stages. Underdeveloped in traditional and preconditions stage should just follow rules of dev’t to self-sustaining economy
    • 8. I. LINEAR STAGES THEORY The Harrod-Domar Growth Model • the rate of growth of GDP ( Y/Y) is determined jointly by the net national savings ratio, s, and the national capital-output ratio, c. * To grow, economies must save and invest * Other components: labor force growth & technological progress • Sample: • Countries able to save 15% to 20% would develop faster • PROBLEM: relatively low level of new capital formation in most poor countries ANSWER: through either foreign aid or private foreign investment (justified Marshall plan for developing world)
    • 9. I. LINEAR STAGES THEORY PROBLEMS: • Mechanisms of development embodied in the theory DOES NOT ALWAYS WORK • WHY? More savings and investment are not sufficient • Worked for Europe because of necessary structural, institutional, and attitudinal conditions
    • 10. II. STRUCTURAL CHANGE MODELS
    • 11. II. STRUCTURAL CHANGE 2-SECTOR SURPLUS MODEL/ LEWIS THEORY OF DEVELOPMENT - Structural transformation of a subsistence economy • Presence of 2 sectors: overpopulated rural sector w/ zero marginal labor productivity and a high-productivity industrial sector • Transfer of labor from traditional to modern, growth of product output
    • 12. II. STRUCTURAL CHANGE LEWIS THEORY OF DEVELOPMENT - Growth until surplus labor is absorbed by industrial sector - Lewis turning point: declining labor-to-land ratio (marginal product of rural labor no longer 0) = labor supply curve positively sloped as modern-sector wage & employment grow
    • 13. II. STRUCTURAL CHANGE LEWIS THEORY OF DEVELOPMENT CRITICISMS: 1. Assumes labor transfer & employment creation proportional to capital accumulation. But what if profits invested in labor- saving equipment? 2. Contemporary research show little surplus labor in rural areas (except in some countries like China) 3. Urban surplus labor 4. Wages increase amid unemployment
    • 14. II. STRUCTURAL CHANGE PATTERNS OF DEVELOPMENT ANALYSIS - Economic, industrial and institutional structure of an economy transformed to permit new industries as engine of growth - Capital accumulation + changes in economic structure needed - Constraints (affect level of dev’t): Internal - resources, population size, government policies; External – access to capital, technology, trade (countries as part of internatl system) - Empirical work of Harvard economist Holllis Chenery and his colleagues, cross-sectional and time-series studies of countries at diff. levels of per capital income, identified characteristic features of the development process:
    • 15. II. STRUCTURAL CHANGE PATTERNS OF DEVELOPMENT ANALYSIS • Shift from agri to industrial production • Steady accumulation of physical and human capital • Change in consumer demand from basic necessities to diverse manufactured goods • Growth of cities and urban industries • Decline in family size ad overall population - Proponents of structural change model prefer “facts to speak for themselves” unlike theories such as stages of growth
    • 16. II. STRUCTURAL CHANGE CONCLUSIONS • Major hypothesis: development is an identifiable process of growth and change with features similar in all countries. • Problem: The model does not recognize differences, factors influencing development process. • Limitations of emphasizing patterns over theory. May draw wrong conclusions about causality. • Optimistic that “correct” mix of policies will generate beneficial patterns
    • 17. III. INTERNATIONAL- DEPENDENCE REVOLUTION
    • 18. III. INTERNATIONAL-DEPENDENCE REVOLUTION 1970s – International-dependence models gained support because of disenchantment w/ stages and structural-change models • Resurgence in various forms in the 21st century Developing countries caught in a dependence and dominance relationship with rich countries because of institutional, political and economic rigidities = difficulty for poor nations to be self-reliant and independent
    • 19. III. INTERNATIONAL-DEPENDENCE REVOLUTION 1. NEOCOLONIAL DEPENDENCE MODEL - Indirect outgrowth of Marxist thinking - Underdevelopment as result of historical evolution of highly unequal international capitalist system of rich country-poor country relationships - Regardless if intentional, nations are under unequal power relations between the center and the periphery
    • 20. III. INTERNATIONAL-DEPENDENCE REVOLUTION 1. NEOCOLONIAL DEPENDENCE MODEL - Small elite ruling class (landlords, entreps, military rulers, merchants, public officials, etc.) interests (knowingly or not) to perpetuate the international capitalist system of inequality - The elite serve or are rewarded by international special- interest power groups tied by allegiance or funding to wealthy capitalist countries - Elites’ viewpoints inhibit genuine reform efforts and may lead to even lower levels of living and perpetuation of underdvelopment - External-induced against internal constraints
    • 21. III. INTERNATIONAL-DEPENDENCE REVOLUTION 1. NEOCOLONIAL DEPENDENCE MODEL - Revolutionary struggles or major restructuring of world capitalist system required to free dependent nations - Theotonio Dos Santos: Dependence as conditioning situation ; Expand based on expansion of dominant countries; Dominant countries w/ technological, commercial, capital and sociopolitical predominance can exploit and extract local surplus; Dependence as based on the international division of labor – industrial development in some and restricted in others
    • 22. III. INTERNATIONAL-DEPENDENCE REVOLUTION 1. NEOCOLONIAL DEPENDENCE MODEL • Pope John Paul II: One must denounce the existence of economic, financial, and social mechanisms which, although they are manipulated by people, often function almost automatically, thus accentuating the situation of wealth for some and poverty for the rest. These mechanisms, which are maneuvered directly or indirectly by the more developed countries, by their very functioning, favor the interests of the people manipulating them. But in the end they suffocate or condition the economies of the less developed countries.
    • 23. III. INTERNATIONAL-DEPENDENCE REVOLUTION 2. FALSE-PARADIGM MODEL - less-radical - Underdevelopment as result of faulty and inappropriate advice by well-meaning, though uninformed or biased advisers from developed country agencies and orgs - Inappropriate policies merely serving vested interests of existing power groups (domestic and international) - Intellectuals, economists, civil servants trained in alien and “irrelevant” Western concepts
    • 24. III. INTERNATIONAL-DEPENDENCE REVOLUTION 3. DUALISTIC-DEVELOPMENT THESIS Dualism – divergence between rich and poor nations, rich and poor peoples on various levels
    • 25. III. INTERNATIONAL-DEPENDENCE REVOLUTION 4 KEY ARGUMENTS - Different sets of conditions coexist: rich and poor, modern and traditional (Lewis model), elites and masses, powerful industrialized nations and impoverished peasant societies - Chronic coexistence (not temporary) of wealth and poverty will not be rectified in time. - Degrees of superiority or inferiority show no signs of diminishing and instead increases - Superior element does little to pull up or “trickle down” to the inferior element, may even push it down
    • 26. III. INTERNATIONAL-DEPENDENCE REVOLUTION - IDR models, amid ideological differences, all reject the emphasis on traditional neoclassical economic theories - Question validity of the Lewis-type models, reject Chenery observation of “well-defined empirical patterns” that should be followed by poor countries - Emphasis on international power imbalances and need for economic, political and institutional reforms (internal & world) - Expropriation of private assets w/ expectation that public asset ownership and control will help address poverty & unemployment
    • 27. III. INTERNATIONAL-DEPENDENCE REVOLUTION WEAKNESSES: - Appealing explanation but no insight on how countries initiate and sustain development - Actual economic experience of developing countries that pursued revolutionary campaigns of industrial nationalization and state-run production has been mostly negative * Based on dependency theory, countries could pursue a policy of autarky or inwardly directed development & trade w/ other developing countries
    • 28. IV. NEOCLASSICAL COUNTERREVOLUTION
    • 29. IV. NEOCLASSICAL COUNTERREVOLUTION Neoclassical counterrrevolution - Challenges statist models in favor of free markets, public choice & market-friendly approaches - Developed nations: favored supply-side macroeconomic policies, rational expectations theories and privatization of public corporations - Developing countries: freer markets and dismantling of public ownership, statist planning and government regulation
    • 30. IV. NEOCLASSICAL COUNTERREVOLUTION Context - Emerged in the 1980s during political ascendancy of conservative governments of US, Canada, Britain and West Germany - Neoclassicists on the board of powerful international agencies World Bank and International Monetary Fund as influence of International Labor Organization, United Nations Development Program and United Nations Conference on Trade and Development eroded
    • 31. IV. NEOCLASSICAL COUNTERREVOLUTION Argument - Underdevelopment resulted from poor resource allocation because of incorrect pricing policies and state intervention (corruption, inefficiency, lack of incentives, etc.) - State intervention slows economic growth - Neoliberals: economic efficiency and growth will be stimulated by free markets, privatizing state enterprises, export expansion and eliminating government regulation and price distortions - Allow “magic of the marketplace” and “invisible hand” to guide resource allocation and stimulate economic dev’t
    • 32. IV. NEOCLASSICAL COUNTERREVOLUTION 3 component approaches 1. Free-market approach - markets alone are efficient; competition is effective, technology and information freely available and costless; gov’t is counterproductive 2. Public choice approach - new political economy approach; governments do nothing right because of selfish interests; misallocation of resources 3. Market-friendly approach – imperfections in economy and need gov’t for market-friendly interventions (social services and climate for private enterprise); acceptance of market failures
    • 33. IV. NEOCLASSICAL COUNTERREVOLUTION Traditional Neoclassical Growth Theory Liberalization – opening up of markets, draw investment and increase rate of capital accumulation Solow neoclassical growth model - economies to converge to same income level if same rates of savings, depreciation, labor force and productivity growth. Source of output growth: labor quantity and quality, increase in capital and technology improvement Openness – encourages access to foreign production ideas, technological progress
    • 34. IV. NEOCLASSICAL COUNTERREVOLUTION CONCLUSIONS • Finger-pointing between dependence theorists (many from developing countries, seeing underdevelopment as externally induced phenomenon) and neoclassical revisionists (most from Western economies, blame gov’t intervention and bad economic policies) • Market price allocation may do a better job than state intervention but developing economies have very different structures: • Competitive free markets generally do not exist, information is limited, markets fragmented, etc.
    • 35. IV. NEOCLASSICAL COUNTERREVOLUTION CONCLUSIONS • Invisible hand often lifts those already well-off, failing to offer opportunities for upward mobility of the majority • Lessons from supply-and-demand analysis to arrive at “correct” prices • “In an environment of widespread institutional rigidity and severe socioeconomic inequality, both markets and governments will typically fail.”
    • 36. RECONCILING DIFFERENCES
    • 37. RECONCILING DIFFERENCES • Each approach has strengths and weaknesses • Controversies – ideological, theoretical or empirical – makes the study of economic development challenging • Evolving patterns of insights and understandings • CONSENSUS? Significance from each approach: - Linear stages: crucial role of savings and investment - Two-sector model: transfer of resources from low to high- productivity activities, linkages between traditional & modern - Dependence theory: importance of world economy and decisions of developed world affecting developing economies - Neoclassical: efficient production, proper price systems