Classic Growth and Development Models

1. Chapter 3: 1
Classic Theories of Economic
Growth and Development
At the beginning of the 17th Century, the field of economics experienced
numerous surgency of many theories try to explain how countries can
develop economically. Earlier, Adam smith, initiated and brought in his
theory, of market and capitalism. However it was counter attacked by
classical theorists who saw capitalism as the main culprit of human
suffering. The debate lingered on for a long time and still goes on.
Therefore, the chapter is aimed at giving a description and discussion on
many theories of economic development.

2. Classic Theories of Economic Development:
Four Approaches
1. Linear stages of growth models (Rostow
model and Harrod-Domar model)
2. Theories and Patterns of structural
change (The Lewis two-sector model and
Chenery Model)
3. International-dependence revolution
(Neoclassical dependence model, The
False Paradigm model, Dualistic
development thesis)
4. Neoclassical, free market counterrevolution

3. Development as Growth and Linear-
Stages Theories

4. Development as Growth and Linear-
Stages Theories
• A Classic Statement: Rostow’s Stages of
Growth
• Harrod-Domar Growth Model (sometimes
referred to as the AK model)
• All countries must pass series of
successive stages of economic growth.
• Saving, investment and foreign aid are all
that are essential

5. A) Development stages of a Growth (ROSTOW)
1. Traditional society
simple, traditional, labor intensive techniques, traditional
social norms, land owner holds the power, high share of
agriculture, low agricultural productivity
2. Transitional society (precondition for take-off stage)
 Perquisites for “take off” are installed
 Traditional boundaries and norms would get collapsed;
 Modern form of production and innovations are accepted,
 Consciousness for development and national spirit

6. 3. Take off“ phase
•Economic growth and technical innovation become a national
phenomena in industry, agriculture and other sectors
•social and political structures become more susceptible to
change, Steady growth, use of technical progress
•Broad acceptance of technical progress, wide production base
4. Drive to maturity
diversification of the industrial base; multiple industries
expand & new ones take root quickly manufacturing shifts
from investment-driven (capital goods) towards consumer
durables & domestic consumption rapid development of
transportation infrastructure large-scale investment in social
infrastructure

7. 5. Age of High mass consumption
•High per-capita-income above the minimum for
existence; social security systems (welfare state),
services
• Steady growth, structural changes. And Old
industries disappear, new industries arise
•The industrial base dominates the economy; the
primary sector is of greatly diminished weight in
economy & society widespread and normative
consumption of high-value consumer goods consumers
typically (if not universally), have disposable income,
beyond all basic needs, for additional goods

8. Conclusion of Rostow:
1. All the advanced countries had passed the stage of
“take –off into self – sustaining growth”.
2. The underdeveloped countries that were still in either
the traditional society or the “precondition” stage have
only to follow a certain set of rules of development to
take off in their turn into self- sustaining growth.
3. Mobilization of domestic and foreign saving is the
most necessary condition for any take-off in order to
generate sufficient investment & to accelerate
economic growth.
4. The economic mechanism by which more investment
leads to more growth can be described in terms of the
Harrod –Domar growth model.

9. B) Harrod-Dommar Model
• The simplest and best-known model used in analysis of
economic development, developed independently during
the 1940s by Roy Harrod and Evsey Domar, primarily to
explain the relationship between growth and unemployment
in advanced capitalist societies. But the H-D model has
been used extensively in LDCs as a simple way to look at
the relationship between growth and capital requirements.
• Every economy must save a certain proportion of its
national income to replace worn-out or impaired capital
goods & to invest for further growth. New investment
represents net additions to the capital stock.
• Saving (S) is some proportion, s, of national income (Y)
such that we have the simple equation
• Investment (I) is defined as the change in the capital stock,
K , and can be represented by ΔK such that
sY
S  I K c Y
   

10. The Harrod-Domar Model

11. Conclusion from the Harrod - Dommar (old neoclassical
growth theory
The H-D model suggests that in order to grow, economies must
save and invest a certain proportion of their GNP. The more
they can save and invest (increasing capital accumulation and
there by increasing capital-labor ratio), the faster they can
grow (e.g., The Marshall Plan for Europeans in the post WW
II).
Open economies (free trade, foreign investment), technological
progress and liberalized (open up) national markets are the
cornerstone of economic growth

12. Criticisms of the Stages Model
1. Saving and Investment are necessary but not
sufficient condition for accelerated economic growth.
2. Necessary structural, institutional and attitudinal
changes are not in place to stimulate savings and
investment and to effectively convert it into higher
level of output growth in LDC.
3. Well integrated commodity and money market, highly
developed transport facilities, educated work force,
effective governance and motivations are lacking.
4. Resources in the LDC are generally underutilized.
Growth can occur by better use of the existing
resource without further investment. The model does
not consider such possibilities.
5. The model ignores external (international) influences
on the economy and policies of LDCs

13. Structural-Change Models

14. Structural-Change Models
• Introduction about Structural Transformation:
Set of changes in the composition of demand, trade,
production, and factor use that takes place as per
capita income increases (consists 6 elements):
1. Structural change: shift of resources from low to
high productivity activities (agriculture, industry,
services - associated with goods, welfare state,
and informal sector)
2. Changes in demand patterns: e.g., changes in
income elasticity of demand for food (0.6%),
agricultural raw materials (0.5%), oil and fuel
(2.4%) and other manufactured goods (1.9%)

15. 3. changes in composition of trade (from exports of primary
agricultural goods to low wage manufacturing goods)
4. changes in composition of production factors (changes in
capital labor ratio, and development of knowledge capital
& physical capital)
5. changes in social institutions and attitudes
6. The Need for new structural policies (industrial policies,
technology policies, education policies and social policies)
Here we discuss only one element of structural transformation,
i.e., the structural change.

16. A) Structural-Change : The Lewis two-sector model
•The theory focuses on the mechanism by which
underdeveloped economies transformed from a traditional
subsistence agriculture to a more modern, more urbanized and
industrialized diverse manufacturing and service economy.
•The model is also called Dualistic model or the Lewis Two-
sector model.
•Price and efficient resource allocation are the core of the model
•The model assumes that the underdeveloped economy consists
of two sectors, traditional and modern.
•It focuses on the labor transfer, employment and output
growth

17. Zero marginal labor productivity in the traditional sector
implies:
Labor can be gradually transferred from the
agricultural sector without any loss of output to the
industrial sector.
Wage is constant in the urban and is higher than the
fixed average of the subsistence wage in the agriculture.
The pace at which output grows depends on the level of
investment and capital accumulation in the modern
industrial sector, which in turn is determined by the
excess profit generated and reinvested by the capitalists.

18. Assumptions of dynamic dualistic models
(Lewis 1955, Fei & Ranis 1964)
Subsistence agricultural sector
limited supply of land, capital & technology; hence
production is subjected to the law of diminishing return
hidden unemployment and open unemployment
marginal productivity of labor = 0, i.e.,
labor is surplus, hence supply of labor is perfectly
elastic.
family labor is remunerated according to the average
productivity of the family labor

19. Modern industrial sector
higher marginal productivity of labor than in
subsistence sector; full employment in the urban areas
wage labor is paid in cash according to the value of the
marginal productivity of labor
real capital is created by reinvesting profits
reinvestment of profit shifts production function
outwards; hence capital and technology are not limited
Labor demand depends on its marginal value product
(labor market is perfectly competitive)

20. Self sustaining growth and expansion of employment in the
modern sector is assumed to continue until all rural surplus
labor is absorbed in the industrial sector.
Once all the surplus labor is withdrawn from the
subsistence agriculture, thereafter in that agricultural
sector:
•labor-to-land ratio declines;
•the marginal productivity of labor is greater than zero;
•labor supply curve becomes positively sloped;
•further withdrawal of labor reduces output in the
agriculture (food production will be lost)
structural transformation in the economy takes place
(economic activity shifts from traditional rural
agriculture to modern urban industry).

21. Figure The
Lewis Model of
Modern-Sector
Growth in a
Two-Sector
Surplus-Labor
Economy

22. Criticisms of the Lewis Model
• Rate of labor transfer and employment
creation may not be proportional to rate of
modern-sector capital accumulation
• Surplus labor in rural areas and full
employment in urban?
• Institutional factors?
• Assumption of diminishing returns in
modern industrial sector

23. Ranis and Fei (1961) Model:
• It is a dualism model and provides more emphasis on industry-
agriculture interdependency and said that the robust connectivity
between the two would encourage and speed up development.
•The fundamental ideas used this model are:
1. Agricultural growth and industrial growth are both equally
important.
2. Agricultural growth and industrial growth are balanced Only if
the rate at which labor is shifted from agriculture to industry is
greater than the rate of growth of population will the economy be
able to lift itself up from the Malthusian population trap.

24. Phase I
•They assume the economy to be stagnant in its pre-
conditioning stage. The breakout point marks the creation of
an infant non-agricultural sector and the entry into phase one.
Agricultural labor starts to be reallocated to the non-
agricultural sector.
•Due to the abundance of surplus agricultural labour, its
marginal productivity is extremely low and average labor
productivity defines the agricultural institutional wage.

25. Phase II:
•When the redundant agricultural labor force has been reallocated,
the agricultural marginal productivity of labor starts to rise but is
still lower than the institutional wage. This marks the shortage
point at which the economy enters phase two of development.
During phase two the remaining agricultural unemployment is
gradually absorbed.
Phase III:
•At the end of this process the economy reaches the
commercialization point and enters phase three where the
agricultural labour market is fully commercialized

26. • Criticism of Fei and Ranis Model:
1. It does not identify the reasons why the existing
agricultural backwardness was due to the institutional
structure, primarily the system of feudalism that prevailed.
2. They failed to mention the need for capital while
providing the role of high agricultural productivity, it
considers only labour and output as a factor of production
3. They completely negligence of the terms of trade between
agriculture and industry foreign exchange, money and price.
4. The model is important only for the country that they are
in agriculture, that they have land resource

27. Pattern of Development Theory ( Chenery Model)
• The patterns of development approach, which is the empirical
analysis of the “sequential process through which the economic,
industrial and institutional structure of an underdeveloped
economy is transformed over time to permit new industries to
replace traditional agriculture as the engine of economic growth
•Assumes that S and I necessary but not sufficient conditions for
growth.
•Difference in constraints (domestic and international) accounts
for difference in development levels among countries
•International constraints most importance since transition can
occur faster with access to international sources of capital,
technology, manufactured imports etc

28. Chenery He identified five characteristic features (not
necessarily stages) of the development process for countries
that have developed:
• Shift from agricultural to industrial production
• Steady accumulation of physical and human K
• Change in composition of consumer demand
•Growth of cities and urban areas
• Decline in family size and overall population growth
N.B: Linear stages theory (1950s) and structural changes
model (1970s) give emphasis to internal constraints of saving,
investment and skilled personnel

29. • This model have a limitation for its emphasis on urban
development at the expense of rural development which can
lead to a substantial rise in inequality between internal regions
of a country
• The patterns of development approach lacks a theoretical
framework because it only described in analytical analysis.
• It takes long period of time to replace the traditional economic
system by industries.
• It doesn’t describe clearly constraints which are important
factor of development in addition to investment and saving.
• Since the model depends on international constraints in
addition to domestic constraints it may be affected by choice
of development policies.It is beyond the control of an
individual developing nation.
Criticisms

30. International-dependence revolution
1. Neoclassical dependence model
2. The False Paradigm model
3. Dualistic development thesis

31. The International-Dependence
Revolution (1970s)
– External policies, institutional and political
interest of the North are critical to economic
development of LDC.
– Neo-Marxist attributes the worsening poverty
in LDC to the existence and policies of the
capitalist countries. underdevelopment is seen
as externally induced phenomenon.
 Hence, emphasis should be given to policies to
eradicate poverty, unemployment and improve
equity (egalitarian objectives)

32. The neocolonial dependence model
• Legacy of colonialism, Unequal power, Core-periphery
• Underdevelopment is the result of dominance by dependence on
industrialized countries, international special interest groups (foreign
aid agencies, WB, IMF)
• Small, elite ruling class in LDCs perpetuates the dependence
• A large part of underdeveloped world’s continuing poverty due to
the existence and policies of industrial countries
• LDCs can only grow and develop as large countries grow
• Underdevelopment is an externally induced phenomenon
• Revolutionary struggles or major restructuring of world capitalist
system needed to free LDC from economic control of DCs and elite
oppressors.

33. The false-paradigm model
•Pitfalls of using “expert” foreign advisors who
misapply developed-country models
• Underdevelopment the result of faulty or inappropriate
advice and recommendations by well-meaning but often
uniformed, biased, and ethno-centric international
“expert” advisers from DCs
•Advisers base their models and analysis on faulty
assumptions more appropriate for DCs
• Problem perpetuated by DC educational institutions
•Domestic planners and policymakers trained in
“irrelevant” Western concepts

34. The Neoclassical Counterrevolution:
Market Fundamentalism (1980s)
1.Free-markets,
2.public choice, and
3.market-friendly approaches:

35. The Neoclassical Counterrevolution:
Market Fundamentalism (1980s)
A) Free-markets, public choice, and market-friendly
approaches:
• During the 1980s, conservative governments in the US, Canada,
UK, and West Germany, brought their political ascendancy with a
neoclassical counterrevolution in economic theory and policy.
• In DCs, the counterrevolution favored supply-side
macroeconomic policies, rational expectations theories and the
privatization of public corporations.
• In LDCs, it called for freer markets and the dismantling of public
ownership, statist planning, and government regulation of
economic activities.

36. • Central argument of the neoclassical counterrevolution:
1.Underdevelopment results from poor resource allocation due
to incorrect pricing policies and too much sate intervention by
overly active Third World governments.
2. By permitting competitive free markets to flourish,
privatizing sate-owned enterprises, promoting free trade and
export expansion, welcoming foreign direct investment, etc.,
both economic efficiency and economic growth will be
stimulated.
3.Underdevelopment is due to the heavy hand of the state and
the corruption, inefficiency, and lack of economic incentive.

37. • In developed nations, this counterrevolution divided
into other categories as
– Free market approach: the markets alone are efficient
– Public choice approach( an aggregation of individual
choices) government can do nothing right. The theory argue
that politicians, bureaucrats, citizens, and states act solely
from a self-interested perspective, using their power and the
authority of government for their own selfish ends.
– Market-friendly approach: from World Bank economists.
Governments do have a key role to play in facilitating the
operations of markets through market-friendly interventions,
for example, by investing in physical and social infrastructure,
health care facilities, and educational institutions and by
providing a suitable climate for private enterprises.
• Main Arguments
– Denies efficiency of intervention
– Points up state owned enterprise failures
– Stresses government failures
– Traditional neoclassical growth theory - with diminishing
returns, cannot sustain growth by capital accumulation alone

38. •In developing countries, it is called for free markets and
the dismantling of public ownership, statist planning, and
government regulation of economic activities.
•Competitive free market unrestrained by excessive
government regulation are seen as being able to naturally
ensure that the allocation of resources occurs with the
greatest efficiency possible and the economic growth is
raised and stabilized.
•Neoclassicists obtained controlling votes from the World
Bank and the International Monetary Fund (Todaro, M and
Stephen S. 2006)

39. • The central argument of the neoclassical counterrevolution
is presented as follows:
1. underdevelopment results from poor resource allocation
due to incorrect pricing policies and too much state
intervention by overly active developing-nation
governments.
2.Rather, the leading writers of the counterrevolution school,
including Lord Peter Bauer, Deepak, Ian Little, Harry
Johnson, Bela Balassa, Jagdish Bhagwati, and Anne
Krueger, argue that it is this very state intervention in
economic activity that slows the pace of economic growth..

40. •The neoliberals argue that by permitting competitive free
markets to flourish, and
•privatizing state-owned enterprises, promoting free trade and
export expansion, welcoming investors from developed
countries,
•eliminating the plethora of government regulations and price
distortions in factor, product, and financial markets,
•both economic efficiency and economic growth will be
stimulated.
•Markets alone are efficient—product markets provide the best
signals for investments in new activities; labor markets respond
to these new industries in appropriate ways.
•Contrary to the claims of the dependence theorists, the
neoclassical counterrevolutionaries argue that the Third World is
underdeveloped because of the heavy hand of the state and the
corruption, inefficiency, and lack of economic incentives

41. The Neoclassical Counterrevolution:
Market Fundamentalism (1980s)
B) Traditional (Old) Neoclassical growth theory:
• It is another cornerstone of the neoclassical free-market
argument:
1. liberalization (opening up) of national markets draws
additional domestic and foreign investment and thus increases
the rate of capital accumulation.
2. Solow neoclassical growth model: expanded from Harrod-
Domar model by adding a second factor, labor, and introducing
a third independent variable, technology, to the growth
equation. Output growth results from one or more of three
factors: increases in labor quantity and quality, increases in
capital and improvements in technology.

42. Classic Theories of Development:
Reconciling the Differences
• Governments do fail, but so do markets; a balance is
needed
• Must attend to institutional and political realities in
developing world
• Development economics has no universally accepted
paradigm
• Insights and understandings are continually evolving
• Each theory has some strengths and some weaknesses

43. Thanks