UNITY UNIVERSITY

FACULTY OF BUSINESS AND ECONOMICS

DISTANCE AND CONTINUING EDUCATION

DEVELOPMENT ECONOMICS I (Econ ???)

MODULE

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Table of content

MODULE 1: ECONOMICS OF DEVELOPMENT: CONCEPTS AND APPROACHES

MODULE 2: STRUCTURAL FEATURES AND COMMON CHARACTERISTICS OF THE
THIRD WORLD
MODULE 3: GROWTH MODELS AND THEORIES OF DEVELOPMENT
MODULE 4: HISTORIC GROWTH AND CONTEMPORARY DEVELOPMENT: LESSONS
AND CONTROVERSIES
MODULE 5: INCOME INEQUALITY, POVERTY AND DEVELOPMENT:
INTERCONNECTIONS

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A. Course Overview

 Course title: Development economics I

 Course number: Econ ???
 Credit hours: 3
B. Course description

This module provides a brief overview of the development and underdevelopment of

nations and outstanding development theories. It explores the principles, concepts and

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 theories of that have been developed and applied by economists for the study of the
problems of developing nations. In addition, it examines recent developments in theories
of growth and transformation in the context of developing economies and concentrates on
key areas of concern to those responsible for development policy.

Furthermore, it will address the main challenges developing world faces and consider
alternative polices and modern approaches that may contribute to stimulating growth and
speeding economic development in less developed countries. Moreover, it introduces the
student to some of the main development issues that have contributed to the development
paths pursued by developing countries like Ethiopia.

C. Course objectives
 Understand how to formulate, test and measure economic models to undertake
/conduct research.
 Acquire the fundamental developmental concepts to understand contemporary
economic problems of developing countries.
D. Grading :
Group assignment:/worksheet: 25%
Final exam: 50%
Total :100%
E. Required text book:
 Todaro,M.,(1994)EconomicDevelopment,Fiftheditions,Longman:NewYork and
London.

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F. Additional readings:
 TodaroM.P.&SmithS.C.(2006)DevelopmentEconomics,Ninthedition,Harlow,
Pearson & Addison Wesley:London.
 Ray, D.(1998) Development Economics, Princeton UniversityPress.
 Gillis, DwightH. Perkins, MichaelR., Donald R. and Snodgrass, W.W. (1996)
Economics of Development, Malcolm. Norton &Company.
 Meier, Gerald, M. andJames E. Rauch(2000)Leading Issues in Economic
Development, Seventh edition, Oxford UniversityPress:New York and Oxford.
 Ghatak,S.(1995)IntroductiontoDevelopmentEconomics,Thirdedition,Routledge:
London.
 Basu, Kaushik(1997) Analytical Development Economics: The Less Developed
Economy Revisited, TheMIT Press:London.
 Thirlwall,A.P.(2003)GrowthandDevelopment:WithspecialreferencetoDeveloping
countries, Seventh edition, PalgraveMacmillan, UK.
 Jones, introduction to Economic growth
 Bardhan, Pranab and Christopher Udry (1999) Development Microeconomics,
Oxford UniversityPress:
 Deaton,Angus(1997)TheAnalysisofHouseholdSurveys:AMicroeconometricApproa
chtoDevelopment Policy, theWorld Bank, theJohn Hopkins
UniversityPress:Baltimore.
 Dasgupta, Partha (1993) An Enquiry into Well-Being and Destitution, Clarendon Press:
London.
 World Bank, (1990, 1997, 2001)World development report.
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G. Group assignment
With your team relate class discussion with practical applicability especially to
the case of Ethiopia. Students have to provide practical examples followed by
detailed explanation.
H. Individual assignment
Students will submit some written assignment on some development issues as
adviced by the instructor.
Due date: 13th week

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MODULE 1: ECONOMICS OF DEVELOPMENT: CONCEPTS AND APPROACHES
(9 hrs)

Contents:
1.0 Aims and Objectives
1.1 Basic concepts and definition of development economics
1.2 The Scope and Nature of Development Economics
1.3 Three core values of Development
1.4 Economic Growth and Economic Development
1.5 Three Objectives of Economic Development:
1.6 Measurement and international comparison of growth and development.
1..1. Measurement of economic growth (i.e., national income and its measurement)
1..2. Alternative measures of level of development
 Physical Quality of Life Index,
 Human Development Index
 The New Human Development Index (NHDI)
1.7. Obstacles to Development
1.8. Summary and conclusion
1.9. Key Terms
1.10. Answer to Check Your Progress Exercise
1.11. Review Exercises
1.12. References

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1.0 Aims and Objectives

This unit discusses the concepts of Economic Growth and Economic Development, their
differences and similarities and the alternative methods of measurement of economic growth and
economic development and their appropriate indicators.

After completing this chapter you will be able to:

 clearly see the differences and similarities between economic growth and economic
development
 clearly see the alternative approaches to the measurement of economic growth and
economic development
 clearly identify the indicators of economic growth and economic development
 also identify the best modern method of measuring economic development of a country.
 describe the non-economic factors which hinder economic development
 explain the economic factors which hinder development
 analyze the factors which promote economic development and distinguish development
from growth.

1.1. Basic concepts and definition of development economics

The study of economic development is one of the newest, most exciting, and most challenging
branches of the broader disciplines of economics and political economy. Although one could

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claim that Adam Smith was the first “development economist” and that his Wealth of Nations,
published in 1776, was the first treatise on economic development, the systematic study of the
problems and processes of economic development in Africa, Asia, and Latin America has
emerged only over the past five decades or so.

Although development economics often draws on relevant principles and concepts from other
branches of economics in either a standard or modified form, for the most part it is a field of
study that is rapidly evolving its own distinctive analytical and methodological identity

What do we mean by economic development?

Economic development is the primary objective of the world’s nations including the
developing nations. To raise the income ,well being, and economic capabilities of people every
where is easily the most crucial social task facing us today. Every year aid is
disbursed ,investments are undertaken ,policies are framed ,and elaborate plans are hatched to
achieve this goal, or at least to step closer to it, how do we identify and keep track of the results
of these efforts. What characteristics do we use to evaluate the degree of “development” a
country has undergone or how “developed” or “underdeveloped” a country is at any point in
time? In short, how do we measure development?

Other issue in development economics , is the definition of development whose definition is

being refined from time to time. The awarding of the 1979 Nobel Price in economics to two
eminent development economists, W. Arthur Lewis of Princeton university and Professor
Theodore Schultz of the University of Chicago for their pioneering studies of the development

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process , provided dramatic confirmation of the status of economic development as a separate
field within the economics discipline.

We begin, therefore, by contrasting modern development economics with “Traditional”

neoclassical economics.

1.2. The Scope and Nature of Development Economics

The Traditional Economics deals basically with the efficient, least cost allocation of scarce
productive resources and with the optimal growth of these resources overtime so as to produce
an ever-expanding range of goods and services. The traditional economics consists of economic
theory of classical and neo-classical economists. It is concerned with advanced capitalistic world
of perfect markets, consumer sovereignty; free play of forces of demand and supply; utility
calculations, and making of economic decisions on the basis of marginal private benefit. Thus,
according to traditional economic theory, all the economic decisions are made on the basis of
price mechanism and the goods market, resource market and financial markets are cleared on the
basis of demand and supply. Hence, the traditional economics or economic theory believes in
rationality, materialism, self-interest and individualistic approach in respect of economic
decisions. Thus this economics deals the matters subjectively.
 
The 'Political Economy' is also a branch of economics where a relationship is established
between politics and economics. Here the role of power in economic decision making is also
evaluated. Broadly, the political economy analyses the social and institutional processes through

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which certain groups of economic and political elites like feudals, businessmen, industrialists,
politicians, trade unions and bureaucrats etc., influence the scarce productive resources either for
their own vest-interests or perhaps for the interest of the whole economy. This branch of
economics portrays the process of economic and political life where from the nations of the
world like US, UK and France etc. have passed through, and the existing nations are passing
through.
 
Development Economics is beyond traditional economics and political economy. In addition to
efficient allocation and sustained growth of resources, it deals with economic, social, political
and institutional mechanism (both public as well as private) which could bring about rapid and
large scale improvements in levels of living for the masses who are poverty stricken,
malnourished, backward and illiterate peoples of Africa, Asia and Latin America. Quite against
the developed countries (DCs) in the less developed countries (LDCs) the goods and the labor
markets are highly imperfect, consumers and producers have limited information regarding
commodity and factor markets, the society and economy are experiencing structural changes, and
the disequilibrium is often the destiny of the markets. In such poor economies the political
decisions overweigh the economic decisions regarding resource allocation. These economies are
clutched into tribal and ethnic conflicts, sectarianism, cultural, religious and linguistic problems.
More appropriately, development economies deals with poverty alleviation measures, standard of
living improvement methods and creating a harmony between the rich and the poor nations of
the world, rather just following the principles of profit maximization and self-interest.
 

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Thus, the Development Economies is something more than neo-classical economics and Political
Economy. And it is concerned with the economic, cultural and political requirements which are
necessary for structural and institutional transformations of entire societies in a manner that the
fruits of economic growth could be provided to the largest segment of the society the poor class.
For such all, a greater role of government and coordination amongst the decision making unite is
required, rather just depending upon the 'Invisible Hand' and 'Market Forces'.
 Thus, the Development Economies in the light of traditional economic principles (as well as
against them) aims at understanding the Third World economies so that the material lives of
three-quarters of the global population could be improved.

New/Modern Economic View of Development:

 In strictly economic terms, economic development represents a situation whereby the capacity
of an economy changes from long term static situation to generate and sustain an annual increase
in GNP at the rates of 5% to 7% and even more. Again, economic development was associated
with rise in per capita GNP which would occur if growth of GNP is more than growth of
population. However, in these two approaches, commonly known as traditional measures of
economic development, the concepts of real GNP and real GNP per capita were employed.
 
Thus during 1950 and 1960 economic development was evaluated in terms of planned alteration
of structure of production and employment so that the share of agri. in total output could
decrease and that of industry and services could increase. Therefore, the 'Development
Strategies' stressed upon rapid industrialization at the expense of agri. and rural development.
Finally, these traditional measures of economic development were supplemented by non-

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economic, Social Indicators: gains in literacy, schooling, health conditions and services and
provision of water supply and housing etc.
 
But the development experience of 1950s and 1960s in case of LDCs was not encouraging.
They realized their growth targets but the levels of living of the masses of people remained for
the most part unchanged. This showed that something was very wrong with this traditional and
narrower definition of economic development. Then a slogan became popular, "The
dethronement of GNP" and efforts be made to attack directly on widespread absolute poverty,
increasing inequitable income distributions and rising unemployment.
In short, after 1970s the economists and policy makers are redefining economic development in
terms of elimination of poverty, inequality and unemployment within the context of a growing
economy. This new approach to development was given the name of 'Re-distribution from
Growth'.
 In this respect Prof. Dudly Seers writes:
 
"Economic development will be possible if we see (i) What has been happening to poverty? (ii) What has
been happening to unemployment? (iii) What has been happening to inequality? If all three have declined
then it would represent development for the country concerned. If one or two of these central problems, have
been growing worse especially if all three have, it would be strange to call the result 'development' even if per
capita income doubled".
 
Thus the LDCs in 1960s and in 1970s developed on the basis of "Growth Criteria', but they did
not on the basis of poverty, equably and employment criteria. The situation in 1980s worsened
further as GNP growth rates turned negative for many LDCs and governments faced with
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mounting foreign debt problems, were forced to cut back the already limited and poor social
services.
 
It is told that development and under development are not just an economic problems rather they
are very crucial issues of life. More than 3 billion people of the world are living in
underdevelopment, misery and poverty. In this respect, Prof. Denis Govlet Writes:
 
"Underdevelopment is shocking; the squalor, diseases, unnecessary deaths, and hopelessness of it all. Chronic
poverty is a cruel kind of hell, and one can not understand how cruel that hell is merely by gazing upon
poverty as an object".
 
World Bank in its 1991 'World Development Report' asserted on the following:
 
"The challenge of development is to improve the quality of life. Especially in the World's poorest countries a
better quality of life generally calls for higher incomes, but it involves much more. It encompasses as ends in
themselves better education, higher standards of health and nutrition, less poverty, a cleaner environment,
more equality of opportunity, greater individual freedom, and a richer cultural life".

Therefore the present day economists are of the view that:

 
"Development must be conceived of as a multidimensional process which could involve major changes in
social structures, popular attitudes, and national institutions, as well as the acceleration of economic growth,
the reduction in inequality, and the eradication of poverty. Development, in its essence, must represent the
whole gamut of change whereby unsatisfactory life is replaced by a materially and spiritually better life".
 
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Therefore, for the sake of good socio-economic life and to serve as a conceptual basis and
practical guidelines for understanding the "inner" meaning of development Prof. Goulet and
others present three basic components or core values of economic development. These core
values - sustenance, self-esteem, and freedom - represent common goals sought by all
individuals and societies'. They relate to fundamental human needs that find their expression in
almost all societies and cultures at all times.

1.3. Three Core Values/Components of Development:

 
These core values are consisted of (i) Sustenance, (ii) Self - Esteem, (iii) Freedom. They relate to
fundamental human needs of all the societies at all the times.
 
(i) Life Sustenance, i.e., Ability to Meet Basic Needs:
 
It is also known as "the ability to meet basic needs".  All the persons have certain basic needs
which are necessary for the survival. They consist of food, shelter, health and protection. If any
one of them is missing or in short supply in any economy it would represent the state of under-
development. Therefore, the purpose of economic development and economic activity is to make
the possible efforts whereby the helplessness and misery of the people which arises due to lack
of food, shelter, health and protection could be removed. Therefore, if due to economic
development the quality of life is improved, it would really represent economic development.
Therefore, if per capita income increases, absolute poverty is eliminated, greater employment
opportunities are created and income inequalities are lessened, such all would constitute the ,
necessary though not the sufficient condition of economic development.
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(ii) Self-Esteem, i.e., to be a Person:
 
A second universal component of the good life is self-esteem, a sense of worth and self-respect.
It means that the other people could not use him for their own ends. It also means that each
person should be given his due respect and due right. Each person is desirous of his prestige,
identity and recognition, though all f such values differ from country to country and from society
to society. It is being observed now a days that when the process of economic development starts
in a country the inequalities in the distribution of income increase. Because of such inequality the
rich class considers itself superior to the poor. In this way, the poor segment of the society suffers
from inferiority complex which leads to affect their efficiency.
 
Therefore, economic development should aim at removing such like unhealthy social and
economic situation. When the man will be considered man and he is given due place he will be
able to contribute well to economic development. Moreover, in addition to such domestic
situation, such an atmosphere should be created at international level that both rich and the poor
countries could stand side by side. If despite remarkable growth attained by LDCs they are
looked down upon by the developed countries (DCs), it will not represent economic growth.
 
(iii) Freedom from Servitude, i.e., to be Able to Choose:
 
The third universal value required for economic development is concerned with human freedom.
By freedom it means the emancipation from alienating material conditions of life and from social

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servitude to nature, ignorance, other people, misery, institutions and dogmatic beliefs. As Arthur
Lewis says:
 
"Advantage of economic growth is not that wealth increases happiness, but that it increases the range of
human choice".
 
Wealth on the basis of economic growth, enables the people to have a greater control over goods
and services than they would have if they remained poor. It also gives them the freedom to
choose greater leisure. But as a result of such all social, ethical and spiritual life of the people is
shattered, such type of economic development will be of no use. Therefore, due to economic
growth there should be an uplift in social, ethical and spiritual life of the people.
 
The concept of human freedom should also encompass various components of political freedom
like personal security, the rule of law, freedom of expression, political participation, and equality
of opportunity. However, some of notable economic success stories of 1970s and 1980s
regarding Turkey, Indonesia, Chile, South Korea, Singapore, Thailand, Saudi Arabia and China
did not score very high on the 1991, Human Freedom Index compiled by United Nations
Development Program (UNDP).
 
1.4. Economic Development and Economic Growth:

Generally speaking economic development refers to the problems of developing countries and
economic growth to those of developed countries.

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1.4.1. Economic growth

This occurs where there is an increase in the productive potential of the economy and is best
measured by the increase in a country's real level of output over a period of time, i.e. the increase
in real Gross Domestic Product (real means adjusted for inflation).

1.4.2. Economic development

Economic development, on the other hand, is a process where there is improvement in the lives
of all people in the country. This involves not only living standards, such as greater availability
of goods and services (and also the ability to purchase them) but also the promotion of attributes
such as self-esteem, dignity and respect, and the enlarging of people's freedom to choose and to
take control of their own lives. While a country may grow richer therefore, through the growth of
its real output, it does not necessarily mean that it will develop.

For a long period of time economic development was seen to be a factor of economic growth. It
was believed that economic development occurred when there was a high level of
industrialisation and economic growth; social factors, such as poverty and unemployment were
of lesser importance. It was also believed that the material benefits of growth would trickle down
from the better off to the rest of the population, causing development. However, many
developing nations have managed to achieve high rates of economic growth, yet failed to
experience any positive change in standards of living for the majority of their people. It was
realised therefore that the definition of economic development had to be changed. As Dudley
Seers says: "if one or two of the central problems (poverty, unemployment or equality) have been

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growing worse, especially if all three have, it would be strange to call the result 'development'
even if per capita income doubled"(from D.Seers, 'The meaning of economic development').

According to Professor Michael Todaro, development should involve the following objectives:

1. "To increase the availability and widen the distribution of basic life-sustaining goods such
as food, shelter, health and protection.
2. To raise levels of living including, in addition to higher incomes, the provision of more
jobs, better education, and greater attention to cultural and humanistic values, all of
which will serve not only to enhance material well-being but also to generate greater
individual and national self-esteem.
3. To expand the range of economic and social choices available to individuals and nations
by freeing them from servitude and dependence not only in relation to other people and
nation-states but also to the forces of ignorance and human misery."

According to Kindleberger “economic growth means more output, while economic

development implies both more output and changes in the technical and institutional
arrangements by which it is produced and distributed. Growth may well involve not only more
output derived from greater amounts of inputs but also greater efficiency, i.e., an increase in
output per unit of input. Development goes beyond this to imply changes in the composition of
output and in the allocation of inputs by sectors.

Friedman defines growth as an expansion of the system in one or more dimensions without a
change in its structure, and development as an innovative process leading to the structural
transformation of social systems. Thus, economic growth is related to a quantitative sustained
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increase in the country’s percapita output or income accompanied by expansion in its labor force,
consumption, capital and volume of trade. On the other hand, economic development is a wider
term. It is related to qualitative changes in economic wants, goods, incentives and institutions. It
describes the underlying determinants of growth such as technological and structural changes.
Development embraces both growth and decline. An economy can grow but it may not develop
because poverty unemployment and inequalities may continue to persist due to the absence of
technological and structural changes. But it is difficult to imagine development without
economic growth in the absence of an increase in output per capita, particularly when population
is growing rapidly.

Economic growth is uni-dimensional in nature - measured with reference to increase in national

income only. ‘Development’
‘Development’ is multi dimensional evaluated (rather than precisely measured)
with reference to a host of qualitative factors, apart from quantifiable aspects. Improvements in
literacy, education and training levels, improvements in health and nutrition of the people
resulting in reduction in morbidity and mortality and increase in longevity, high levels of living
on all norms, optimum use of all types of resources are indicators of development.

Check your progress – 1.1

1. Define economic growth?

………………………………………………………………………………………………………
……………………………………………………………………………………………

2. What is economic development?

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………………………………………………………………………………………………………
……………………………………………………………………………………………

1.5. Three Objectives of Economic Development:

From the above discussion we conclude that economic development is not only a physical
phenomenon, but it also represents a state of affairs where a society is in a position to have the
means of a better life through some combination of social, economic and institutional changes.
Regarding a better life, following requirements, known as objectives of development, must be
fulfilled.
 (i) Not only the availability of basic needs like food, shelter, health and protection be made
sure, but their distribution should also be widened.
 (ii) To improve the standards of living in addition to higher incomes, more jobs, better education
and greater attention to cultural and humanistic values be given. They will not only increase
material values, but they will also generate individual and national self-esteem.
(iii) The economic and social range available to the people and nations should expand. They
should be freed from miseries, illiteracy, servitude, dependence and narrow mindedness etc.
not only in relation to other people but also to other nations.

Check your progress – 1.2

1. List and explain the major objectives of economic development

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………………………………………………………………………………………………………
………………………………………………………………………………………………………

1.6. Measurement and international comparison of growth and development and their
Limitations:

1.6.1. Measurement of economic growth (i.e., national income and its measurement)
National income is defined as the flow of goods and services, which is available as income to the
people of a nation during the accounting period generally one year. The national income is an
important yardstick of the performance of the whole economy.

Definition: We may define national income as the money value of the annual flow of final goods
and services in the national economy. Since a variety of goods and services which are
heterogeneous in nature are produced in an economy, their physical quantities cannot be
aggregated. Hence, the measuring rod of money should be used for aggregating these diverse
outputs. While estimating the national income, all the goods and services produced during the
year should not be considered. Only the final goods and services can be included in the national
income measurement.

By comparing the present year output, (NI) with that of the pervious year we can measure the
growth of the economy. Hence, growth rate of the economy can be calculated using the
following formula:

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 G t − Gt − 1
Gt = X 100
Gt−1

Gt is the level of National output in the present year.

Gt-1 is the level of national income or output in the previous year.

1.6.2. Alternative measures of level of development:

Economic development can be measured in four alternative ways:

1. GNP. One of the methods to measure economic development is in terms of an increase in the
economy’s real national income over a long period of time. But this is not a satisfactory measure
due to the following reasons:
(a) “Real national income” refers to the country’s total output of final goods and services in
real terms rather than in money terms. Thus, price changes will have to be ruled out while
calculating real national income. But this is unrealistic because variations in prices are
inevitable. In this measure the phrase “over a long period of time” implies a sustained
increase in real income. A short-period rise in national income which occurs during the
upswing of the business cycle does not constitute economic development.
(b) This measure fails to take into consideration changes in the growth of population. If a rise
in real national income is accompanied by a faster growth in population, there will be no
economic growth but retardation.

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 (c) The GNP figure also does not reveal the costs to society of environmental pollution,
urbanization, industrialization and population growth.
(d) Further, it tells us nothing about the distribution of income in the economy.
(e) Another difficulty in calculating GNP is of double counting, which arises from the failure
to distinguish properly between final and intermediate products.
2. GNP Per Capita: The second measure of economic development relates to an increase in the
pre capita real income of the economy over the long period. Meier defines economic
development “as the process whereby the real per capita income of a country increases over a
long period of time. Subject to the conditions that the number of people below an “absolute
poverty line” does not increases, and that the distribution of income does not become more
unequal. This indicator of economic growth seems to emphasize that for economic development
the rate of increase in real per capita income should be higher than the growth rate of population.
But difficulties still remain, such that:
(a) An increase in per capita income may not raise the real standard of living of the masses.
It is possible that while per capita real income is increasing, per capita consumption
might be falling. People might be increasing the rate of saving or the government might
itself be using up the increased income for military or other purposes.
(b) Here is another possibility of the masses remaining poor despite an increase in the real
GNP per capita if the increased income goes to the few rich in stead of going to the many
poor.
(c) The real GNP per capita fails to take into account problems associated with basic needs
like nutrition, health, sanitation, housing, water and education. The improvement in living
standards by providing basic needs cannot be measured by increase in GNP per capita.

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Despite these limitations the real GNP per capita is the most widely used measure of economic
development.

3. Welfare: there is also a tendency to measure economic development from the point of view of
economic welfare. Economic development is regarded as a process where by there is an increase
in the consumption of goods and services of individuals. According to Okun and Richardson,
economic development is a “a sustained, secular improvement in material well-being, which we
may consider to be reflected in an increasing flow of goods and services.” However, this
indicator is also not free from limitations.
The first limitation arises with regard to the weights to be attached to the consumption of
individuals. Consumption of goods and services depends on the tastes and preferences of
individuals. It is therefore, not correct to have the same weights in preparing the welfare index of
individuals.

Second, in measuring economic welfare caution should be exercised with regard to the
composition of the total output that is giving rise to an increase in percapita consumption, and
how this output is being valued.

Third, it is not essential that with the increase in national income, the economic welfare might
have improved. It is possible that with the increase in real national income/per capita income, the
rich might have become richer and the poor poorer. Thus, mere increase in economic welfare
does not lead to economic development till the distribution of national income is equitable or
justifiable.

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We cannot also equate an increase in output per head with an increase in economic welfare, let
alone social welfare without additional considerations. To specify an optimum rate of
development we must make value judgments regarding income distribution, composition of
output tastes, real cost and other particular changes that are associated with the overall increase
in the real income.

4. Social indicators: - Dissatisfied with GNP/GNP per capita and Welfare Index as the measure
of economic development, certain economists have tried to measure it in terms of social
indicators. Economists include a wide variety of items in social indications. Some are “inputs”,
such as nutritional standards or number of hospital beds or doctors per head of population while
others may be “outputs” corresponding to these inputs such as improvements in health in terms
of infant mortality rates, sickness rates, etc. Social indicators are often suffered to as the basic
needs for development. Basic needs, focus on alleviation of poverty by providing basic human
needs to the poor.

The direct provision of such basic needs as health, education, food, water, sanitation and housing
affects poverty in a shorter period and with fewer monetary resources than GNP/GNP per capita
strategy which aims at increasing productivity and incomes of the poor automatically over the
long run. Basic needs lead to a higher level of productivity and income through human
development in the form of educated and healthy people.

The merit of social indicators is that they are concerned with ends, the ends being human
development. Economic development is a means to these ends. Social indicators tell us how
different countries prefer to allocate their GNP among alternative uses. Some may prefer to
spend more on education and less on hospitals.
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1
Hicks and Streeten consider six social indicators for basic needs:

Basic Need Indicator

1. Health Life expectancy at birth

2. Education Literacy signifying primary school
enrollments as percent of population

3. Food Calorie supply per head.

4. Water supply Infant mortality and percentage of
population with access to potable water

5. Sanitation Infant mortality and percentage of

population with access to sanitation

6. Housing None

Limitations: There is no unanimity among economists as to the number and type of items to be
included in such an index. For example, Goldstein takes only infant mortality as an indicator of
basic needs to construct an index. On the other hand, Morris D. Morris used only three items,
i.e., life expectancy at birth, infant mortality and literacy rate in constructing a “physical Quality
of Life Index” relating to 23 developed and developing countries of the world for a comparative
study.

1
Norman L.Hicks and Paul P.Streeten, “Indicators of Development: The search for a Basic Needs Yardstick.”, World
Development, vol. 7, 1979
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Second, there is the problem of assigning weights to the various items which may depend upon
the social, economic and political set-up of the country. This involves subjectivity. Morris D.
Morris assigns equal weights to the three indicators which undermine the value of the index in a
comparative analysis of the different countries. If each country chooses its own list of social
indicators and assigns weights to them their international comparisons would be as inaccurate as
GNP figures.

Social indicators involve value judgments. Therefore, in order to avoid value judgments and for
the sake of simplicity, economists and UN organizations use GNP percapita as the measure of
economic development. Economists have tried to measure social indicators of basic needs by
taking one, two or three or more indicators for constructing composite indices of human
development.

We study below the physical quality of life index (PQLI) of Morris and the Humans
Development Index, (HDI) as developed by the United Nations Development Programe,
(UNDP).

1. Physical Quality of Life Index (PQLI)

As explained above, Morris D. Morris constructed a composite physical Quality of Life Index,
(PQLI) in 1979 relating to 23 developed and developing countries for a comparative study. He
combines three component indicators of infant mortality, life expectancy at age one and basic
literacy at age 15 to measure performance in meeting the most basic needs of the people. This
index represents a wide range of indicators such as health, education, drinking water nutrition
and sanitation.

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Each indicator of the three components is placed on a scale of zero to 100 where zero represents
an absolutely defined worst performance and 100 represents an absolutely defined best
performance. The PQLI index is calculated by averaging the three indicators giving equal weight
to each and the index is also scaled from 0 to 100.

Conclusion: Despite many limitations, the PQLI can be used to identify particular regions of
underdevelopment and groups of society suffering from the neglect or failure of social policy. It
points towards that indicator where immediate action is required. The state can take up such
policies which increase the PQLI rapidly along with economic growth.

2. Human Development Index (HDI)

Economists have tried to measure social indicators of basic needs by taking one, two or more
indicators for constructing composite indices of human development. We study below the
Human Development Index (HDI) as developed by the United Nations Development Programme
(UNDP).

Since 1990, the UNDP has been presenting the measurement of human development in terms of
a Human Development Index (HDI) in its annual Human Report. The HDI is a composite index
of three social indicators. Life expectancy, adult literacy and years of schooling. It also takes into
account real GDP percapita. Thus, the HDI is a composite index of achievements in three
fundamental dimensions a long and healthy life, knowledge and a decent standard of living. The
HDI value for a country is calculated by taking these three indicators.

1. Longevity, as measured by life expectancy at birth 25 years and 85 years.

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 2. Educational attainment, as measured by a combination of adult literacy (two-thirds
weight) and combined primary, secondary and tertiary enrollment ratios (one-third
weight) i.e., adult literacy 0% to 100% and combined enrollment ratio, 0% to 100%.
3. Standard of living, as measured by real GDP per capita based on purchasing power parity
in terms of dollar (PPP$).
The HDI is a simple average of life expectancy index, educational attainment index, and the
adjusted real GDP per capita (PPP$) index. It is calculated by dividing the sum of these three
indices by 3. The maximum and minimum values for each variable which are fixed are reduced
to a scale between 0 and 1 with each country at some point on the scale.

The HDI value for each country indicates how far it has to travel to attain certain defined goals:
an average life span of 85 years, access to education for all and a decent standard of living. The
HDI ranks countries in relation to each other. A country’s HDI rank is within the world
distribution i.e., it is based on its HDI value in relation to each developed and developing country
for which the particular country has traveled from the minimum HDI value of 0 towards the
maximum HDI value of one. Countries with an HDI value below 0.5 are considered to have a
low level of human development, those between 0.5 to 0.8 a medium level, and those above 0.8 a
high level.

The Human Development Report of1996 presented the HDI values, HDI rank and real GDP per
capita ranks for the year 1993 relating to 174 developed and developing countries of the 174
countries for which the HDI was calculated, 57 were in the high development category (0.8 to
0.95); 69 in the medium category (0.5 to 0.79; and 48 in the low category (0.48 to 0.2). Canada,
USA and Japan led the HDI rankings in the high category among 26 developed countries. Among

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26 developing countries, Hong Kong, Cyprus and Barbados led the first three rankings. In the
medium category, there were 16 developed countries mostly belonging to the breakaway USSR
and 53 developing countries. In this category, Brazil led with the HDI rank of 58. Sri Lanka had
a rank of 89 and China 108. In the low category were 48 developing countries led by Cameroon,
Kenya, and Ghana. Pakistan’s HDI rank was 134, India’s 135 Bangladesh’s 143 and Nepal’s 151.
The HDI ranking of countries differ significantly from their ranking by real GDP per capita.
Counties whose GDP rank is higher than their HDI rank have considerable potential for
distributing the benefits of higher incomes more equitably. Countries whose HDI rank is higher
than their GDP rank show that they have effectively made use of their incomes to improve the
lives of their people. There were 16 such countries whose HDI rank was higher than their GDP
rank. Among them were Costa Rica (23) and Vietnam (27). Thus, the HDI reveals that

countries can have similar GDP per capita levels but different human development achievements
or similar HDI but very different GDP per capita levels.

The New Human Development Index (NHDI):

In November 2010, the UNDP introduced its New Human Development Index (NHDI), intended
to address some of the criticisms of the HDI. The index is still based on standard of living,
education, and health. So in the NHDI, instead of adding up the health, education, and income
indexes and dividing by 3, the NHDI is calculated with the geometric mean:

NHDI = H1/3 E1/3 I1/3

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where H stands for the health index, E stands for the education index, and I stands for the income
index. This is equivalent to taking the cube root of the product of these three indexes. The
calculations of the NHDI are illustrated for the case of China in Box 1.1.

Check your progress 1.3

1. What is wrong with per capita income measurement of economic development for a country?
…………………………………………………………………………………………………
…………………………………………………………………………………………………
…………………………………………………………………………
2. Explain the National Income Accounting (NIA) of an economy. What are the limitations
of NIA?

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 …………………………………………………………………………………………………
…………………………………………………………………………………………………
…………………………………………………………………………

1.7. Obstacles or constraints on the path to economic development in developing countries:

We live in a world of haves and have-nots, of abject poverty and astonishing affluence. This is
true of individuals, communities and nations. At the global level, so-called 'developed' countries
sit at one end of the spectrum with 'least developed' countries (LDCs) – demeaning as that
sounds – at the other. The followings are some of the major obstacles on the path to economic
development in developing countries.

1. Political Instability. 

In most of the developing countries, the governments are not stable. A new government comes
into power overnight, either through coup defeat or army take over. The new government
introduces a new system of rules for the operation of business which causes frustration and
discontentment among the people. How does political instability affect growth is discussed in
brief below.

(i)  Influence of political instability. When there is lack of political stability in the country, it

directly affects economic growth. It closes off sources of internal and external investments.

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(ii)  The external investors. The external investors do not invest in a country where there is
political instability. The flow of investment in countries where there is civil war coups, army take
over etc. is either negligible or zero.

(iii)  Internal investment. Political instability also limits internal investment. The wealthy class

in developing countries have enough income to spare. They can invest their savings in profitable
projects. Generally, they avoid investing funds in their own country for fear of nationalization of
their projects, large scale interference by militant trade unions, harsh and exploitative attitude of
the various govt. agencies involved in the setting and operation of the projects etc. The well off
people including the politicians in developing countries prefer to take their money outside the
country or channel their investment out of their own country. The developing countries are
therefore, deprived of investment funds which adversely affect economic growth.

(iv) Internal disorder. The defeated political parties, the rich landlords, the various ethnic
groups etc. who are not able to capture power take up and support anti govt. activities by taking
out processions, making bomb blasts, killing the innocent people by indiscriminate firing etc. All
these activities result in creating political instability in the country and as such adversely affect
economic development.

2. Corruption. 

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Corruption is another obstacle to economic development in developing countries. The bribery or
gift of money has becomes institutionalized. The govt. officials think bribery is built into their
pay structure. The businessmen, if they are to stay in business, have to pay bribes to different
departments of the govt. The employees give gift of money to their superiors. When bribery is an
acceptable practice, it then becomes difficult for businessmen and industrialists to take part, stay
and grow in business. Bribery thus limits economic development.

3. Lack of investment. 

For an economy to grow, it must have investment. The funds for investment can come either
from domestic savings or from abroad. Both these sources of investment funds have their own
peculiar problems which in brief are discussed as under.

(i)  Investment funding by domestic savings.  For economic growth we must give up

unnecessary expenditure so that the economy can achieve even greater consumption in the
future. In developing countries, most people hardly meet the bare necessities of life. They have
little to put into savings. The middle class persons do save for their old age, marriage of children
etc and put their money in saving banks. The rich people prefer to invest their savings abroad.
The overall result is that domestic savings in most of the developing countries is as low around
13% of GDP; whereas it should not be less than 25% of GDP to promote growth.

(ii)  Investment funding from abroad. Another way to generate funds for investment is to
obtain  (a) Foreign loans or (b) foreign private investment or (c) both. The foreign loans or the
foreign private investment has their own peculiar problems.

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(a) Foreign loans.  For financing development of the less developed countries (LDC's) the flow
of capital comes from (i) individual national governments (ii) multinational assistance
organizations and (iii) multinational companies.

(i) The individual national governments give financial assistance to LDC's mainly for their
own economic and political interests. So long as the developing country is protecting the
interest of the donor countries, the flow of capital continues. It is stopped or very much
slowed down when the recipient country is of no benefit to them (America stopped
financial assistance to Pakistan after the Afghan War was over). A developing country,
therefore, cannot rely on such foreign aid for economic growth.
(ii) Same is the position now of the multinational assistance organizations like the Word
Bank and international Monetary Fund (lMF). These organizations which are mainly
funded by the developed capitalists countries of the world are also using these
organizations to promote their own economic and political interests. All the developing
countries are now knee deep in debts of these organizations. The problem of debt
servicing, rescheduling has adversely affected economic growth of the poor countries.
(iii) As regards the flow of capital from multinational companies, they make investment in
those countries where infrastructure facilities such as transportation, power, cheap labour
force, raw material etc. are available. As these companies do not generally help in
establishing infrastructure in poor countries, therefore they do not contribute much to
economic growth of the LDC's. The problem of lack of proper investment, therefore,
remains in developing countries.

4. Right Education. 
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The provision of right education to the citizens of a country is a necessary component of any
successful development strategy. In developing countries, the educational system is defective.
There is mush-room growth of English medium schools in cities. The syllabi taught to the
students at each level of education reflects the Western culture and not the culture and
requirements of their own country.

The result is that the students holding degrees remain jobless which creates discontent and
frustration among them. The brilliant students of the developing countries go outside the country.
The outdated syllabi of various classes, the mass failure of the students in various board and
university examinations, outflow of the brightest students from less developed countries to the
developed countries (Brain drain) create gaps in business, administrative circles and become
obstacles to economic growth.

5.  Over Population. 

In developed countries of the world, only 2 to 4% of the population is engaged in agriculture and
produces enough food and fibre to meet the requirements of their citizens and also earn foreign
exchange by exporting surplus goods. Through technological progress, they have avoided the
fate predicted by Thomas Malthus. The developing countries, on the other hand, are struggling
very hard to avoid the Malthusian fate. In these countries about 50% to 60% of the population is
engaged in agriculture. The diminishing marginal productivity has exceeded technological
change. The result is a falling output per person and a slow economic growth. The rapid
population growth in developing countries is a major obstacle to economic growth.

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6. Inefficient Human Capital.  

In addition to physical capital, human capital is also limited in developing countries. The quality
of population as measured by its skills, education and health is far below the standard in
developed countries of the world. Disease, starvation, glut of unskilled workers stand in the way
of economic development of the developing countries of the world.

7. Dual Economy. 

In developing countries, there are two types of economies which are generally functioning. These
economies are somewhat unrelated to each other. One economy is the market economy and the
other is a traditional non market or subsistence economy. The life style of the people, social
customs, the methods of production etc. differ very much from each other in these two different
economies. The occurrence of dualism stand in the way of optimum utilization of resources.
Thus dualism is also considered an important obstacle to economic growth.

8. Demonstration effect. 

Demonstration effect on consumption level is also a major constraint on the path of economic
development of under developed countries. The international demonstration effect increases
propensity to consume of the people and reduces the rate of saving and investment in the
countries.

9. Inadequate infrastructure facilities.  

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The under developed countries suffer from lack of basic infrastructure such as transport and
communication system, power supply, banking and other financial facilities. The provision of
inadequate infrastructure facilities stand in the way of economic development of the poor
countries.

10. Inappropriate Social Structure. 

Inappropriate social system such as outdated religious beliefs, caste system, irrational attitude
toward family planning etc. is also a constraint on the economic development of developing
countries.

11. Market imperfections. 

Market imperfections in the form of immobility of factors of production, ignorance of market

conditions, price rigidity etc. are serious obstacles in the path of economic development of the
backward countries.

Summing up we can say that economic development is a complete process. It is directly

influenced by economic, social, cultural, administrative and political factors. Ragnar Nurkse
has rightly said, ''Economic development has much to do with human endowments, social
attitudes, political conditions and historical accidents. Capital is necessary but not a sufficient
condition of progress.''

Basic needs vs economic growth:

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Is there any conflict between economic growth and basic needs strategy?

Basic needs are concerned with ends and economic growth is a means to these ends. So there is
no conflict between basic needs and economic growth Goldstein found a strong correlation
between economic growth and basic needs as measured by infant mortality rates. He identifies
economic growth with efficiency. To him, efficiency is the level of GDP required to reach the
infant mortality target of below 5 percent.

Countries that spend a large percentage of their GDP for public health are more efficient because
they are able to reduce their infant mortality rates. He found that a few developing countries have
used very modest resources to meet the basic needs of health and education. He came to the
conclusion that those LDCs that concentrate on primary school education and women’s
education can develop more by spending less to meet these basic needs.

1.8 Summary and conclusion

In this unit we tried to examine the various ways of measuring economic growth and economic
development, the factors involved in each measure, the defects on each measure and the modern
methods of measuring development.

1.9 Key Terms

 Gross National Product GNP)

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  Gross Domestic Product  National income at a factor
(GDP) cost

 Net National Product (NNP)  Per capital income

 Personal income  Disposable income

1.9 Answer to Check Your Progress Exercise

Answer to Check Your Progress Exercise 1.1

1. Economic growth is the increase in output of an economy e.g. GDP, National income etc.
Hence, economic growth is measurable and it is simply an output growth of an economy.
2. Economic development is economic growth plus some qualitative changes in the living
conditions of the people, heath, education, standard of living, housing etc. Hence, economic
development is a multi-dimensional aspect wheel economic growth is a uni-dimensional
phenomena. There can be economic growth without economic development but not the vice
versa is true.

Answer to Check Your Progress Exercise 1.2

1. The various objectives of economic growth/development can be of two types. Short-term and
long-term objectives. The long-term objectives indicate the direction of the economy over a
long-period of time and the short-term objectives which deal with particular problems that are
thought to be urgent by the planners.
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Some of these various objectives are mentioned below

- Increasing the rate of growth of the national economy, seems to be the foremost
aim of underdeveloped countries.
- Raising the investment rate
- Increasing of employment opportunities
- Social justice or securing of poverty
- Realizing self-sufficiency, which would mean lesser dependence on imports,
substitution policies, planned expansion in exports and the building up of
sufficient foreign exchange reserves.

Answer to Check Your Progress Exercise 1.3

1. Until late 1980s, per capita income figure has been used, even by UN, to measure
development achievement of a country and different countries, (developed or developing), were
ranked by these figures, compiled in World Development every year. Later it was discovered
particularly by UN, that studies made in different developing countries on per capita income and
its reflection on development and the improvement of living conditions of the poor, in very poor
countries, indicated clearly, that the per capita income figure and the real conditions of the poor
didn’t go together. Where in these developing countries the percapita figure indicated high
growth, the actual conditions of the poor was observed to be the opposite. Hence, the UN,
flinching indicated that the p er capita figure alone is not a good indicator of development.
Hence, instead the Human Development Indese (HDI) was devised and from 19909s, on wards
this figure is applied as a modern method of development and countries, since then were ranked
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their development by this figure. Here, three elements are taken to calculate the HDI figure, life
expectancy, literacy rate and per capita income.

2. National Income is defined as the flow of goods and services which is available as income to
the people of a nation during the accounting period generally one year.
The important concepts in national income accounting are the following:
Gross National Product (GNP)

Gross Domestic Product (GDP)

Net National Product (NNP)

National income at a factor cost

Per capital income

Personal income

Disposable income

In LDCs, some transactions are omitted from the calculation of the GDP or GNP, such as
household activities and children’s care, the underground economy and similar other activities.

1.11 Review Exercises

1. Name and explain two methods of measuring economic development and economic
growth.
2. What are the defects of PQLI and the Basic Needs approach to the measurement of
Economic development in a country?

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1.12 References:

 Todaro,M.,(1994)EconomicDevelopment,Fiftheditions,Longman:NewYork and London.

 TodaroM.P.&SmithS.C.(2006)DevelopmentEconomics,Ninthedition,Harlow, Pearson &
Addison Wesley:London.
 Ray, D.(1998) Development Economics, Princeton UniversityPress

MODULE 2: STRUCTURAL FEATURES AND COMMON CHARACTERISTICS OF

THE THIRD WORLD (3 hrs)

Contents:
2.0 Aims and Objectives
2.1 Structural features and common characteristics of the third world
2.1.1 Introduction
2.1.2 Characteristics of underdeveloped countries
2.1.2.1. Economic features
2.1.2.2. Demographic features
2.1.2.3. Socio-political
Socio-political features
2.1.2.4. Historical features
2.2 Summary and conclusion
2.3 Key Terms
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 2.4 Answer to Check Your Progress Exercise
2.5 Review Exercises
2.6 References

2.0 Aims and Objectives

This unit explains the characteristics of under developed economies in general with particular
examples of any developing country.

After completing this section, you will be able to:

 Broadly categorize the characteristics of underdeveloped countries, (economies),

 Identify the economic features of developing countries or economies
 Recognize the demographic features of underdeveloped countries
 Explain the socio-political features of underdeveloped countries and analyze the
historical factors of underdeveloped countries.

2.1 Structural features and common characteristics of the third world

2.1. 1 Introduction
Looking at the economic conditions of the world today, we see the countries of the world divided
into two broadly distinguishable groups. In one of the groups are find the people enjoying a very
high standard of living and in the other the majority of them living in great poverty and suffering

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from illiteracy, unemployment and malnutrition. The former, we know, are “developed or
advanced countries,” while the later are the “underdeveloped or backward countries.” When
some countries of the latter group show development they are described as “developing
countries”. How is it that some countries are rich while the other are struggling to provide their
populations with at least the bare necessaries of life? What are those factors, which have helped
the former, while keeping the latter at low levels of living? How can the underdeveloped
countries better themselves and what are those areas they should concentrate on?

These are the kinds of questions which will be examined in this analysis on “Economics of
Development.”

What are the chief features, which distinguish an advanced country from an underdeveloped
country? We have mentioned that the standard of living of the majority of the people is very low
in underdeveloped countries. This is just one of the characteristics, and if we look at the different
countries grouped under what is called “The Third World”, we find that in spite of many
differences they share some common features. In 1998 G.C. about 141 countries were grouped
under this category, spread over Asia, Africa and South America. Some like Middle East
countries are quite rich, while others like some African countries are extremely poor. Let us
examine the common characteristics before we go on to define “underdevelopment”.

2.1.2 Characteristics of underdeveloped countries:

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Underdeveloped countries range from large countries with high population number to small
countries with very low population number. Some of these developing countries richly endowed
with natural resources while others are quite barren. However, all these countries share certain
common characteristics, which have been classified by Leibenstein as follows:

2.1.2.1. Economic features

2.1.2.1.1. Low standards of Living
This feature is the most striking one in contrast to that of the developed countries, where the
average citizen enjoys a fairly high standard of living. The per capita income (i.e., the national
income of the country divided by its population) is an old index of the standard of living of the
people. A comparison of the per capita incomes of some of the underdeveloped countries with
those of the advanced countries shows the vast difference in living standards. For instance, in
1976 G.C., India had a percapita income of $150, Bangladesh $110 and Sri Lanca $200, while
USA’s percapita income was $ 7,900, U.K. $ 4,020 and Japan $ 4,900. Although per capita
income alone is not taken in the modern world as a sufficient measure of standard of living of the
people, however, the above figure in each country gives a rough picture of the levels of living in
the underdeveloped countries as compared to those of the developed countries.

The percapita income figure has become a defective measure of economic development in a
country because the figure alone does not indicate the real living conditions of people. There are
times in many developing countries where the percapita income of each country has shown very
high increase but living conditions of people have been observed being deteriorating. This could

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be mainly from defective distribution problems and also whether or not the percapita income
growth is the result of real output growth or not.

Modern economics uses new methods of measuring living standards of people such as the
Human Development Index (HDI). It includes percapita income, (PCI), literacy rate, and infant
mortality rate, which are very important indicators of changes in living conditions of people.
Hence, country comparisons using HDI figures has become the most realistic method of
measuring development in each country in the modern world.
In the developing countries, there is also widespread poverty, with a large section of its
population, some 40 to 50 percent, living in a state of miserable poverty. In adequate housing,
poor health, limited or no education, unemployment and malnutrition are prevalent among large
sections of the population.

2.1.2.1.2 Law Rates of Growth of the Economy:

Not only is per capita income is low in the old method of measurement or not only the HDI
figure is low in the modern method of measuring improvement or development of an economy,
but the rate of growth of the economy is also very low. This low rate of growth widens the
existent large gap between the advanced and the underdeveloped countries. The low rate of
growth in primarily due to a slow increase in the national income. The per capita income is also
affected by a high growth of population.

2.1.2.1.3 Preponderance or Dominance of Agriculture and Primary Sector

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In most of the under developed countries, agriculture, mining, fishing and forestry are the main
sources of livelihood. These are known as the “primary sector”, i.e., the production or extraction
of raw materials directly from nature.

In most underdeveloped countries agriculture is the main or dominant occupation giving

employment to the bulk of the population. For example in 1970, 68% of the population in India,
71% in Pakistan and 64% in Burma were engaged in agriculture and related industries (i.e. agro-
industries), while only 3% in the U.K., 4% in the USA and 8% in Canada were engaged in this
sector. In Ethiopia 85% of the population is engaged in agriculture.

This shows that in the advanced countries the bulk of the production comes from the industrial
sector, and hence the greater importance of industry and manufacturing in the developed
countries.

2.1.2.1.4. Low Levels of Productivity

Although the underdeveloped countries are agrarian as far as production is concerned,
productivity in agriculture is very low when compared to that of the developed countries.

There are many reasons for this, low level of production. The size of holdings is very small in the
underdeveloped countries some times highly uneconomical, in accessible and of very low
fertility. Besides, the production is mostly for self-consumption or what is called “subsistence
farming”. Lack of proper irrigation facilities or no or small scale irrigation practices even if
potentiality is there, great dependence on rain fed agriculture and use of inferior techniques are
other reasons for the low productivity of agriculture in the underdeveloped countries. The bulk of
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the population tends to depend on agriculture because of lack of employment opportunities in
other sectors. Thus, agriculture in developing countries is over populated leading to what is
called “disguised unemployment. “This means that the work that can be done by two persons is
done by four or five persons. The manland ratio is very high in most underdeveloped countries
because of the concentration of workers in the agricultural sector. Ignorance of the benefits of
rotation, crops, use of modern methods of cultivation, crop intensity and storage, lack of
marketing facilities, and the presence of “middle men” who also exploit both the farmers and the
consumers are the other marked features of agriculture in underdeveloped countries.

2.1.2.1.5 Use of Inferior Techniques of Production

A part from there being overcrowding in agriculture, in many of these developing countries the
techniques used are very old and outdated or highly interior nature. This results in low
productivity per man. In advanced countries high output levels are achieved by the use of capital-
intensive techniques. They had to use these techniques because of shortage of labor. However, in
underdeveloped countries where labor is abundantly available, techniques used should be labor
intensive. Improved labor intensive techniques better inputs (like improved plough, irrigation
facilities and fertilizer) should be used to achieve higher yields.

2.1.2.1.6 Low Rates of Capital Formation

This is one of the most important characteristics of underdeveloped countries, (lack of capital).
The growth of the capital sector or capital formation includes the growth of (a) basic industries
which produce the basic requirements of industrial growth such as steel, electricity, coal,
aluminum, copper and other metals and minerals. (b) the heavy sector which includes heavy

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machines and equipment like the mining machinery, metallurgicsal maidens(c) infrastructural
facilities like railways, roads, water and air transport, communications through news papers,
radio telegraph telephone and postal services.

In most underdeveloped countries these sectors are either absent or growing at very low rates.
Since these factors form the foundation for the industrial development of the economy, their rate
of growth has to be stepped up or fastened.

2.1.2.1.7. Low Rate of Investment

The low rate of capital formation is due to the fact that investment in these sectors is very low as
can be seen from the data given above. Since the majority of the people live in great poverty,
they are incapable of increasing investment in the production sectors. However, a high rate of
investment does not automatically guarantee a high rate of growth. If investment is done in
highly mechanized techniques, then the rate of growth will be low. Thus, not only the rate but the
form of investment is also equally important in determining the growth. Further, for the richer
sections in the underdeveloped countries investment buying of gold or property and not in
manufacturing or in furthering production through improvements in productive capacity. Thus,
even though surpluses are available they are used only for an extended form of consumption.
Hence, production and capital formation suffer in these countries.

2.1.2.1.8 Export of Primary Products

Turning to the foreign trade of the undeveloped countries, most of the exports from these
countries are of primary agricultural products. The bulk of the world’s supply of natural
resources comes from these countries. Tin, rubber, tea, coffee, sugarcane, tobacco, cotton and

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other metals and minerals are exported from the undeveloped countries to the developed
countries.

Except for the oil-producing nations, who are able to dictate their own terms to the importing
nations to some extent, the other underdeveloped countries are unable to hold their own in this
respect. The foreign exchange earnings fluctuate greatly, and if the advanced countries for some
reason stop imports, the economy of the underdeveloped countries will be adversely affected.

Competition and rivalry among suppliers, overproduction, unstable political connections and
discovery of substitutes (e.g., plastics, greatly affected the rubber industries of the East Indies)
are the other factors that make export earnings of the underdeveloped countries very uncertain.
Moreover, the underdeveloped countries import expensive capital equipment from the advanced
countries, and thus generally suffer from balance of payments problems.

Check your progress – 2.1

1. List and briefly explain the major economic characteristics of developing countries.
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………….

2. Explain the primary sector of an economy.

………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………….

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3. List the major exports and imports of developing countries. What are the problems with the
exports and imports of developing countries?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………….

2.1.2.2. Demographic features

Most of the underdeveloped countries are highly populated, and their populations are increasing
at very fast rates. Let us now examine some of the features connected with the demographic or
population problems of the underdeveloped countries.

2.1.2.2.1 High Birth Rates

Population expands due to high birth rates, which is about 35 to 40 per thousand per year in
underdeveloped countries as against 10 to 15 per thousand per year in the advanced countries.
The high birth rate results in a large percentage of children being under 15 years of age. As this
children grow and reaches reproductive age, the population increases further at an increasing
rate, (population explosion), continuously.
2.1.2.2.2 High Death Rates
Birth rates are high and so also death rates. The prevalence of many fatal or killer diseases like
HIV AIDS, Malaria, Tuberculosis etc. reduce the life expectancy of the population. Lack of
medical facilities poor sanitation and malnutrition account for high mortality rates in these
developing countries. The death rate in the underdeveloped countries is as high as 17 to 20 per
thousand persons, while in the developed countries it is about 7 to 8 per thousand. However, the
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present death rate has been greatly reduced from what it was about half a century ago. The
eradication of a number of total diseases like small pox, plague, etc. has reduced the death rate in
many developing countries like India. However, the death rate in developing countries is still
quite high as compared to that of the developed countries. Life expectancy in developing
countries is about 50 to 52 years as against 70 to 75 years in the advanced countries.

2.1.2.2.3 High Growth of Population

The rate of growth of population in the underdeveloped countries is now about 2.5 to 3 percent
as against 0.3 to 0.8 percent in developed countries. At this rate the population will double itself
in the underdeveloped countries in 25 to 28 years thereby imposing a great burden on the
economy of the developing countries. The high level of population growth reduces the growth of
the percapita income and will also be a burden to the services sector, schools, hospitals,
transportation facilities etc.

2.1.2.2.4 High Rates of Unemployment

As population increases, the labor force increases but with a slower rate of economic growth,
employment opportunities do not appreciate by increase. Hence, the result is a great deal of
unemployment in the underdeveloped countries’ economies. This takes the form of disguised
unemployment, underemployment and open unemployment.

2.1.2.3. Socio-political
Socio-political features

The non-economic features also are important in classifying a country as underdeveloped. The
behavior, social organization, literacy levels, political and historical background will now be
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examined to trace the common features of the underdeveloped countries.

2.1.2.3.1 Inequalities of Income and consumption

We have seen already that the national income of these countries is low and that it grows at a
very slow rate. Usually, there is a very uneven and unequal distribution of national income in the
underdeveloped countries. The land and asset holding classes receive the bulk of the national
income. The few rich class gets or receives the highest portion of the national income while the
majority, which is the lowest poor class gets the minimum share and lives in miserable poverty.
This results in a great disparity in the living standards of the people with a small section enjoying
a very high standard of living and the rest living in miserable poverty.

There is thus a “dualistic” feature in the underdeveloped country with the wealthy or affluence
living side by side \with poverty. Thus, there is a striking contrast between urban and rural
standards and between one region and another.

2.1.2.3.2 Social Behavior

Social inequalities of caste, rank and status are predominant in the underdeveloped countries.
This results in the suppression and exploitation of the lowest classes. Usually, employment is
restricted to what is allowed within one’s caste – and this kills initiative and enterprise, social
and religious taboos, and superstition are also prevalent to a large extent in these countries.

2.1.2.3.3 Conspicuous Consumption

Any surplus generated is used for conspicuous consumption, i.e., to show off one’s status either
by buying houses or property, jewelry, cars or spending lavishly and wastefully on religious and
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social ceremonies like weddings, festivals, etc. This boosts up the person’s prestige in society.
Unfortunately, such expenditures are unproductive to a very large extent in these countries.

2.1.2.3.4 Illiteracy
The level of education is a fairly reliable indicator of the level of development of a country. Most
underdeveloped countries suffer from having illiterate and uneducated population.
In the late 1990s, the literacy rate was 34% in India, 16% in Pakistan, 25% in Ghana, while it
was 98% in Japan and 99% in the USA and the UK. The low level of literacy spells traditional
modes of behavior in respect of a majority of the population, lack of knowledge of new methods
of production and so on.

Check your progress – 2.2

1. List and briefly explain the demographic features of underdeveloped countries.

………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………….

2. What are the major non-economic socio-political characteristics or features of developing

countries?

………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………….

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3. Compare and contrast the socio-political features of developing countries with that of the
developed or advanced countries.

………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………….

2.1.2.4. Historical features

It is important to note that most of the underdeveloped countries were former colonies of
advanced countries like Britain, France, Holland or Spain. The advanced countries used their
colonies for two main economic purposes: first to secure the raw materials required for their own
industrial sectors and secondly, to provide the market for the sale of their finished products. This
resulted in the complete suppression of the domestic economy, the discouraging of the local
industries there by destroying the market for local products. After these underdeveloped
countries have got their independence, they have to start their development from scratch and they
have to bring about their balanced economic development. All these indicate the tremendous
changes that are to be carried out before these countries can become “developed countries.”

Even after independence most of these underdeveloped countries did not break ties with their
former colonizers. Their economic and political ties are continuing which some how also
contributes to their underdevelopment or to the lag in their development.

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2.2. Summary and conclusion

In this chapter we have examined the various characteristic features of the underdeveloped
countries such as economic, demographic, socio-political and historical characteristics. However,
these do not bring out the causes of underdevelopment, as the main factors hindering
development. They only help us to identify an underdeveloped country. For development to take
place the main obstacles should be identified and minimized or removed. How this can be done
will be discussed in the next unit.

2.3. Key Terms

 Economic Features  Socio-Political Features

 Demographic Features  Historical Features

2.4. Answer to Check Your Progress Exercise

Answer to Check Your Progress Exercise 2.1

1. Major economic characteristics of developing countries. Low income low savings, agriculture
dominancy, very low level of industrialization, poor health conditions, very high population
growth rates, very low level of literacy rate, very low level of technology development, very low
level of educational enrollments etc.

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2. The primary sector or the agricultural sector of an economy plays a dominant sector in less
developed countries, because more than 50% of the GDP is obtained from this sector. The
growth and development of such an economy also depends on the growth of the primary sector
because the potential for surplus production is also from this sector. In developed economies the
role the primary sector palsy in the national economy is less than the secondary and tertiary
sectors. The output from manufacturing has growth very highly than the primary sector, taking
the leading position for contributing form national development. However, at the initial stage of
development, the primary sector is a dominant sector contributing the highest for national
economy development particularly in those agricultural based developing countries.

3. Major exports of developing countries arte normally primary agricultural products like coffee,
co-coa, oil seeds and pulses, sisal, and livestock products like leather and leather products, hides
and skins etc. whose prices on international markets are highly fluctuating. On the other hand,
the imports of these countries are processed products, (industrial) like machinery and equipment,
spare parts, goods transport and building materials, fertilizer, fuel, communication equipment
etc. whose prices on international markets are rising from time to time and stable. How to
balance between the exports and imports is a major problem in developing economies.

Answer to Check Your Progress Exercise 2.2

1. Underdeveloped countries have a rapidly growing population with very high growth rate, 3%
such a level of population growth rate is much higher than the economic growth rate and hence is
a burden to the national economy. There is a very high rate of unemployment in such countries,
poor environmental conditions and poverty stricken. Shortage of almost all types of services such

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as educational services, transportation, housing, health care and similar other conditions are
prevailing in these countries.

2. The socio-cultural factors are backward, with very high illiteracy rate of the population very
low or non-entrepreneurial development situation and the value given to grow through work is
very low in these developing countries. Social inequalities of caste, rank and status are
predominant in the underdeveloped countries. This results in the suppression and exploitation of
the lowest classes. Usually, employment is restricted to what is allowed within one’s caste – and
this kills initiative and enterprise, social and religious taboos, and superstition are also prevalent
to a large extent in these countries.

3. The socio-political features of developed or advanced countries have been refined and
achieved a very high standard which facilitates and promotes development while on the other
hand, these conditions in developing countries are at a very low stage of development and hence
have become obstacles to development.

2.5. Review exercises

Attempt each of the following questions

1. What are the factors required for economic development?

2. What are the disadvantages of keeping growth rate as the objective of economic
development?
3. How does increase in employment lead to economic development?
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 4. Explain the demographic features of economic development.

5. Explain the main economic characteristics of developing countries

2.6. References:

 Todaro,M.,(1994)EconomicDevelopment,Fiftheditions,Longman:NewYork and London.

 TodaroM.P.&SmithS.C.(2006)DevelopmentEconomics,Ninthedition,Harlow, Pearson &
Addison Wesley:London.
 Ray, D.(1998) Development Economics, Princeton UniversityPress.

MODULE 3: GROWTH MODELS AND THEORIES OF DEVELOPMENT (20 hrs)

Contents:

3.0. Aims and Objectives

3.1. Factors of Economic growth and development

3.2. Models and theories of economic growth and development
3.2.1. Linear stages of growth models
3.2.1.1. Rostow’s stage of growth
3.2.1.2. Harod Domar growth model

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 3.2.1.3. Solow growth model
3.2.2. Structural change models: Lewis theory of Development
3.2.3. Dualistic Theories
3.2.3.1. Social Dualism
3.2.3.2. Technological Dualism
3.2.3.3. Financial Dualism
3.2.4. The process of Cumulative Causation
3.2.5. A Model of Low Level Equilibrium Trap by Nelson
3.2.6. The Big-Push Theory.
3.2.7. The Balanced Growth
3.2.8. Unbalanced growth
3.2.9. The international dependence model
3.2.10. The Neoclassical counterrevolution
3.2.11 The new growth theories
3.3 Summary and conclusion
3.4 Key Terms
3.5 Answer to Check Your Progress Exercise
3.6 Review Exercises
3.7 References

3.0. Aims and Objectives

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This unit discusses models and theories of economic growth and development and analyses the
applicability of these theories to today’s developing counties.

After completing this chapter, you will be able to:

 Understand the various growth and development theories and analyses the applicability
of these growth theories to today’s developing counties.

3.1. Factors of economic growth and development

Economic development requires resources. These consist of natural and human resources, capital
and technology. These are the technical inputs for production also in the developed countries.
The less-developed countries additionally need to provide for appropriate development
promoting institutions and social conditions, which are generally taken for granted in the
developed countries.

The major economic – factors which are essential for growth and development are natural
resources, human resources, physical capital and technology. These resources are of key
significance, particularly in the beginning phase of economic growth. To start the process of
capital formation, it is necessary that a country should produce surplus. This surplus in the
beginning of the growth process is nothing else but food over and above the subsistence level of
living of the people in underdeveloped countries. This releases some laborers form the need to
produce food. The labor thus available, can be used for the production of capital goods. Thus, at
the beginning stage of growth agricultural land helps start off capital formation. Besides starting
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the growth process, natural resources, if available in sizeable quantities can sustain the pace of
growth. Certain types of natural resources provide basis for transportation and communication.
Land plains, for instance, lend themselves for the construction of roads and railroads. As against
this mountains are a barrier to the creation of these facilities. Rivers also act as highways that
facilitate trade and commerce.

Natural resources also promote industrial development. Natural resources provide a base for
industrial development in two important ways. One a country can enlarge its industrial activity
by producing raw materials in particular minerals, and export them. Two, along with exports or
alternatively, a country may produce raw materials, process them and fabricate them into final
goods.

Natural resources determine options. Depending upon the size of availability, natural resources
set the limit and pace of a country’s development. Larger the resources, greater the scope or
freedom of action in terms of the activities to be developed and the efforts these involve. A
country with abundant resources of large variety and with suitable climate can hope for a rich
diversified economic structure with less toil and trouble. Countries like the U.S., Canada,
Australia and Argentina, for example, have virtually unlimited supplies of land. As such they can
play about with a variety of crops and other uses to which land can be put to, and there by
achieve large and varied growth.

On the other hand, countries with scarce land resources or countries over-crowded with human
population and therefore, with small per capita resources have fewer options open to them. Over
– populated countries cannot even use their labor force efficiently.

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While the above listing of benefits of natural resources are there it also needs to be stressed that
the mere availability of natural resources, however, abundant, is not by itself a sufficient
condition of economic growth. For example, some less developed countries have rich resources.
Some of them also export these resources. But these countries have not developed. There are, for
example, petroleum-exporting countries which have been selling oil to many countries, in
particular to high – income countries.

There are then countries like Liberia, Brazil, and India which export iron ore in considerable
quantities. Countries like Chile, Zambia and Zaire are the largest producers of copper next only
to the U.S.A. so is the case, Burma, which has resources in abundance. The potential for
development of these countries in terms of natural resources can be realized only if other
conditions are fulfilled. These are, for example, a proper management of export earnings,
suitable technologies to make use of the resources within the countries, and above all an
appropriate set of institutions and attitudes to realize benefits from these resources.

In brief, natural resources are important for development. Since these are of key significance in
the early phase of development, their availability is of special relevance for the less – developed
countries which are beginning to develop. However, they are helpful only if these are properly
made use of. Despite their scarcity, their inadequacy does not constitute a barrier to development.

Human resources, (Physical labor, skilled labor, managerial ability and entrepreneurship) is thus
of basic significance so far as no production can take place without it. In the initial stages of
growth, as is the case of the less – developed countries at present, it is the physical labor that
alone is responsible for extracting material things from nature.
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As surpluses accumulate, the human factor plays still more important role when it becomes more
healthy, educated and trained. Another aspect of the contribution of human resources to
development in when it acts as manager and entrepreneur.

Another factor of growth/development is physical capital. This consists of buildings, machines,

equipment and inventories. These are the producer goods which help in the production of further
goods. These are durable or long-lived goods with a life longer than a single accounting period
(usually one year). This should be distinguished from human capital which also helps in further
production, but is embodied in human beings. It should also be differentiated from financial
capital which is constituted of liquid assets that can be exchanged for goods but which are not
themselves physical goods. Capital goods are of great help in raising the capacity of a country to
produce more goods. First, these permit capital-deepening i.e., giving each worker more capital
to work with.

Secondly, the availably of capital can promote specialization and division of labor to a much
larger extent than the increase in the labor-force can by it self do. Capital may also be the main
factor for the introduction of technical progress in the productive system. Capital contributes to
growth by overcoming the handicaps of agriculture. For example, an important constraint on
agricultural growth is the limited availability of fertile land for cultivation. Since available land
cannot be increased agricultural production can be raised by intensive farming only. This is
possible with such capital equipment as tractors, metal ploughs, dams for irrigation etc.

Technology pertains to methods of production. Technology is defined as “any systematized

practical knowledge based on experimentation and/or scientific theory, which enhances the
capacity of a society to produce goods and services.” Improved technology can add to growth

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rate in several spheres which involves no or minimal additions to factor – inputs. Besides
economic factors, (technical inputs), appropriate institutional and social factors contribute a lot to
development. These factors have to be of right quantity and right quality to ensure a proper
utilization of economic factors, (technical inputs), and to provide a favorable atmosphere for
development. Culture, attitudes, to work and growth, motives, aspirations, (entrepreneurship),
are some of the most important social factors which can influence growth/development.

In the next section, we explore the historical and intellectual evolution in scholarly thinking
about how and why development does or does not take place. We do this by examining four
major and often competing development theories. You will see that each offers valuable insights
and a useful perspective on the nature of the development process.

Check your progress – 3.I

1. List the major economic and social factors, which enhance economic growth and economic
development.
………………………………………………………………………………………………………
……………………………………………………………………………………………

2. Availability of natural resources, however, abundant in a country is not by itself a sufficient

condition of economic growth. Explain this statement.
………………………………………………………………………………………………………
………………………………………………………………………………………………………

3.2. Models and theories of economic growth and development

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3.2.1. Development as Growth and the Linear-Stages Theories:

3.2.1.1. Rostow’s stage of growth

One of the first growth theories was that proposed by American economic historianWalt
Rostow in the early 1960s. He took a historical approach in suggesting that developed
countries have tended to pass through 5 stages to reach their current degree of economic
development.As a vigorous advocate of free market capitalism, Rostow argued that economies
must go through a number of developmental stages towards greater economic growth. He argued
that these stages followed a logical sequence; each stage could only be reached through the
completion of the previous stage.

These are:

1. Traditional society. This is an agricultural economy of mainly subsistence farming,

little of which is traded. The size of the capital stock is limited and of low quality
resulting in very low labour productivity and little surplus output left to sell in domestic
and overseas markets. More than 75% of the working population was engaged in
agriculture
2. Pre-conditions for take-off. Agriculture becomes more mechanised and more output is
traded. Savings and investment grow although they are still a small percentage of national
income (GDP). Some external funding is required - for example in the form of overseas

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 aid or perhaps remittance incomes from migrant workers living overseas. Investment
ranged around 5 percent of the GNP in this stage.
3. Take-off. Manufacturing industry assumes greater importance, although the number of
industries remains small. Political and social institutions start to develop - external
finance may still be required. Savings and investment grow, perhaps to 15% of GDP.
Agriculture assumes lesser importance in relative terms although the majority of people
may remain employed in the farming sector. There is often a dual economy apparent
with rising productivity and wealth in manufacturing and other industries contrasted with
stubbornly low productivity and real incomes in rural agriculture.
4. Drive to maturity. Industry becomes more diverse. Growth should spread to different
parts of the country as the state of technology improves - the economy moves from being
dependent on factor inputs for growth towards making better use of innovation to bring
about increases in real per capita incomes.In this stage, the rate of investment increases
from 10 percent of the GNP to higher limits up to 20 percent even. Important industries
come up, including many imports replacement and exports replacement industries.
Technical knowledge spreads to the rest of the economic sectors. Production of anything
if not everything, becomes possible.
5. Age of high mass consumption. Output levels grow, enabling increased consumer
expenditure. There is a shift towards tertiary sector activity and the growth is sustained by
the expansion of a middle class of consumers.In this stage, per capita real income
becomes so high that the consumption grows beyond food, clothes and shelter to goods of
comforts and luxuries on a mass scale. Urbanization and industrialization change the
values of the society and development consciousness increases. Leading sectors change

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 the basic structure of the society and new types of durable consumer goods industries
become the leading sectors, very high levels of consumption and physical quality of life
are achieved.

Rostow’s work, like many other accounts of growth, points to the significance of the
accumulation of savings to achieve take-off – in this case as a necessary condition for the
movement from traditional to developed societies

Evaluation of Rostow's Five Stages of Economic Growth Model:

 There is overlap with the Harrod-Domar model i.e. stages 2 and 3 require increased

saving and investment; Stage 4 requires improvements in technology, which reduces the
capital-output ratio.
 Stages 2 and 3 call for increased savings and investment but many households may not
have the funds to save; the banking channel between savers and firms may be inadequate;
the productivity of individual investment projects may depend upon complementary
investment in infrastructure.
 Some Sub Saharan African countries have received significant external finance but have
been slow to generate growth - many have remained stuck in Stages 1 or 2.
 When the external finance has come in the shape of loans from developed countries,
interest charges have been incurred which have acted as a drag on economic growth.
 Simon Kuznets threw doubts upon Rostow's theory. He argued that many countries
which have now reached developed status did so without seeing a significant increase in
their savings rate.
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  The theory does not account for exceptions, e.g. falling output in the USSR under a
communist regime; the corrupt and failing government in Zimbabwe has reversed
development advances; increased globalisation means that a country's growth rate does
not lie solely in its own hands and international competition and protectionism may
prevent an economy from moving through the latter stages.

Check your progress – 3.2

1. Briefly explain Rostow’s five stages of economic growth.

………………………………………………………………………………………………………
………………………………………………………………………………………………………

2. Discuss the relevance of Rostow’s stages of economic growth to today’s developing

countries.
………………………………………………………………………………………………………
………………………………………………………………………………………………………

3.2.1.2. Harod-Domar growth model:

A functional economic relationship in which the growth rate of gross domestic product (g)
depends directly on the national net savings rate (s) and inversely on the national capital-output
ratio (c).

The importance of savings and investment is also central to the work of Harrod andDomar.
According to this theory, and those derived from Harrod and Domar’s work, there are two
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determinants of the rate of growth of a country. The first looks at the relationship between
changes in the capital stock (K) of a country, that is its capital investment, and its output (Y),
called the capital-output ratio. This shows how much new capital, such as £10, is needed to
create a given amount of new national income, such as £2.

The second element of the model considers the relationship between savings(S) and national
income(Y) is called the savings ratio, and this shows how much is saved, such as £10, from a
given amount of national income, such as £100. The model indicates how these two ratios affect
the rate of growth. Essentially, the higher the savings ratio, the more an economy will grow; and
the higher the capital-output ratio, the higher the rate of growth.

If we define the capital-output ratio as k and assume further that the national net savings ratio, s,
is a fixed proportion of national output (e.g., 6%) and that total new investment is determined by
the level of total savings, we can construct the following simple model of economic growth:

1. Net saving (S) is some proportion,s, of national income (Y) such that we have the simple
equation

S = sY (1)

2. Net investment (I) defined as the change in the capital stock, K, and can be represented by K
such that

I = ΔK (2)

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 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,c, it follows that

k
=c
y

ΔK / ΔY =c
Or

ΔK =cΔY
Or, finally, (3)

3. Finally , because net national savings, S, must equal net investment, I, we can write this
equality as

S=I (4)

But from equation (1) we know that S = sY, and from equation (2) and (3) we know that

I =ΔK =cΔY

It therefore follows that we can write the “identity” of saving equaling investment shown by
equation (4) as

S=sY =cΔY =ΔK =I (5)

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Or simply as

sY =cΔY (6)

Dividing both sides of equation (6) first by Y and then by c, we obtain the following expression:

ΔY s
=
Y c (7)

Note that the left- hand side of equation (7). ΔY/Y, represents the rate of change or rate of growth
of GDP.

Equation (7) which is a simplified version of the famous equation of in the Harrod- Domar
theory of economic growth, states simply that the rate of growth of GDP (ΔY/Y) is determined
jointly by the net national savings ratio, s, and the national capital-output ratio, c.

More specifically, it says that in the absence of government , the growth rate of national income
will be directly or positively related to the savings ratio (i.e.,the more an economy is able to save
– and invest – out of a given GDP, the greater the growth of that GDP will be) and inversely or
negatively related to the economy’s capital-output ratio (i.e.,the higher c is, the lower the rate of
GDP growth will be.)

The economic logic of Equations (7 ) is very simple. To grow, economies must save and invest a
certain proportion of their GDP. The more they can save and invest, the faster they can grow. But
the actual rate at which they can grow for any level of saving and investment—how much
additional output can be had from an additional unit of investment—can be measured by the

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inverse of the capital-output ratio, c, because this inverse, 1/c, is simply the output-capital or
output-investment ratio.

For Harrod and Domar, economies must save and invest a certain proportion of their income to
grow at a certain rate – failure to develop is caused by the failure to save, and accumulate capital.
For take-off to happen, savings must be accumulated.

Evaluation of linear stage theory

The theories of Rostow, Harrod and Domar, and others consider savings to be a sufficient
condition for growth and development. In other words, if an economy saves, it will grow, and if
it grows, it must develop. Aggregate savings are largely determined by national income, so if
income is low, savings will not be accumulated. According to Rostow’s theory, saving between
15% and 20% of income (a savings ratio of 0.15 – 0.2) would be enough to provide the basis for
growth. If this level of saving is maintained, growth would also be sustained.

Major criticisms of this approach include:

1. Although saving is regarded as highly significant, modern growth theory takes into

account a broad set of growth factors.
2. Other criticisms of stage theory point to general weakness in terms of the unrealistic
assumptions of these models, such as perfect knowledge, stable exchange rates, and
constant terms of trade.
3. Most analysis was based on the reconstruction of Europe after World War II, but most
developing countries do not have Europe’s institutions, attitudes, financial markets, levels

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 of education, and desire to succeed as found inEurope.
4. Modern theory tends to see savings as a necessary but not sufficient condition for growth.

3.2.1.3. Solow growth model:

• The Solow growth model shows how saving, population growth, and technological
progress affect the level of an economy’s output and its growth over time. ( for the
details refer to your macroeconomics II module)

3.2.2. Structural change models: Lewis Model of Unlimited Supply of Labor:

 The Nobel Laureate, W. Arthur Lewis in the mid 1950s presented his model of unlimited supply
of labor or of surplus labor economy. By surplus labor it means that part of manpower which
even if is withdrawn from the process of production there will be no fall in the amount of output.
 
Assumptions of the Lewis Model:
 Lewis model makes the following assumptions:
 (i) There is a duel economy i.e., the economy is characterized by a traditional, over-populated
rural subsistence sector furnished with zero MPL, and the high productivity modern urban
industrial sector.
 (ii) The subsistence sector does not make the use of 'Reproducible Capital', while the modern
sector uses the produced means of capital.
 (iii) The production in the advanced sector is higher than the production in traditional and
backward sector.

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 (iv) According to Lewis, the supply of labor is perfectly elastic. In other words, the supply of
labor is greater than demand for labor.
 
The followings are the sources of unlimited supply of labor in UDCs.
 (i) Because of severe increase in population more, than required number of labors are working
with lands, the so called disguised unemployed.
 (ii) In UDCs so many people are having temporary and part time jobs, as the shoe-shines,
loaders, porters and waiters etc. There will be no fall in the production even their number
are one halved.
 (iii) The landlords and feudals are having an army of tenants for the sake of their influence,
power and prestige. They do not make any contribution towards production, and they are
prepared to work even at less than subsistence wages.
 (iv) The women in UDCs do not work, but they just perform house-hold duties. Thus they also
represent unemployment.
(v) The high birth rate in UDCs leads to grow unemployment.
Basic Thesis of the Lewis Model:
Lewis model is a classical type model which states that the unlimited supplies of labor can be
had at the prevailing subsistence wages. The industrial and advanced modern sector can be
developed on the basis of agri. to traditional sector. This can be done by transferring the labor
from traditional sector and modern sector.
 
Lewis says that the wages in industrial sector remain constant. Consequently, the capitalists will
earn 'surplus'. Such surplus will be re-invested in the modern sector leading to absorb the labor

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which are migrated from subsistence sector. In this way, the surplus labor or the labor which
were prey to disguised unemployment will get the employment. Thus both the labor transfer and
modern sector employment growth are brought about by output expansion in that sector. The
speed with which this expansion occurs is determined by the rate of industrial investment and
capital accumulation in the modern sector. Though the wages have been assumed constant, yet
Lewis says that the urban wages are at least 30% higher than average rural income to induce the
workers to migrate from their home areas. The process of migration and capital formation is
shown with the help of fig 3.1(a).

 Figure:3.1(a)

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In the above figure., the production function regarding traditional sector has been demonstrated.
Here in the upper part of the figure 3.1(a), by employing LF of labor, the OT of food production
has been produced, while the amount of capital is fixed here. In the lower part of figure 3.1(a) we
have APL and MPL in the subsistence farming sector which have been derived from the TPF
curve in the upper part of the figure 3.1(a). This is the behavior of a UDC where 80% to 90% of
population lives and works in rural areas.
 
Lewis makes two assumptions regarding traditional sector:
 (i) There is surplus labor because MPL = 0 (as MPLF curve cuts x-axis).
(ii) All rural workers share equally in the output so that rural real wage is determined by the
APL, and not by MPL. Thus it is OA, which has been attained by dividing OT by OLF labor
in subsistence sector.

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Figure: 3.1(b)

In the fig 3.2(b) the upper segment we have the production functions regarding modern industrial
sector. In case OL, labor are employed, having the production function TPM (K 1), TP1 is being
produced. In the lower segment of fig.3.2 (b), the demand for labor is D1 (K1) at the constant
wages (OW) which are 30% higher than the average rural wages.

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 In the Lewis model, the modern sector capital stock is allowed to increase from K 1 to K2 and
K3 as a result of reinvestment of profits by capitalist industrialists. This causes the TP curve in
the upper part of fig., to shift upward from TPM (K 1) to TPM (K2) and to TPM(K3). The process
that will generate these capitalistic profits for reinvestment and growth is illustrated in the lower
part of fig.3.2 (b). The modern sector MPL curves have been derived from the TPM curves of the
upper part of the fig.3.2 (b). These curves are demand for labor curve because of assumption of
perfect competition.
 
The OA in both lower parts of fig 3.1(a) and 3.2(b) represents the average level of real
subsistence income in the traditional rural sector. But in the modern sector the real wages have
been represented by OW (the 30% higher than rural wages).
 
At such wages the supply of rural labor is assumed to be unlimited or perfectly elastic as shown
by WSL curve in fig (b). This means that modern sector employer can hire as much labor as he
likes without any fear of rise in wages. It is also told that in traditional sector the supply of labor
is in the millions, while the employment in modern sector is in thousands. In the modern sector
the employment is made by the employer to the point where MPL = W. (the point F in the lower
part of fig. 3.2(b). Thus the basic employment is OL1, with this employment of labor CD1FL ,
output in manufacturing sector is being produced. While the share of such employed labor will
be OWFL1.
 
The balance of output shown by the shaded area WD 1F would be the total profits (surplus) that
accrue to the capitalists. As Lewis assumes that all of these profits are reinvested, the total stock

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of capital in the modern sector will rise from K 1 to K2. As a result, TPM will shift from TPM (K 1)
to TPM(K2) which in a turn leads to increase MPL. In other words, the demand for labor will
increase as shown by the curve D2 (K2) in the lower part of fig 3.2(b).
 
Now the new equilibrium in the modern sector takes place at point G where OL 2 labor is being
employed. The total output rises to OTP2 or OD2GL2 while total wages and profits increase to
OWGL2 and WD2G, respectively. Once again, these larger (WD2G) profits are reinvested; the
total stock of capital will increase to K3. Again the TP curve will shift upward, as the TPM (K 3),
and demand for labor curve will shift to D3 (K3).
 
This process of modern self sustaining growth and employment expansion will remain continue
till all the surplus rural labor is absorbed in the new industrial sector. Thereafter, additional
workers can be withdrawn from agri. sector only at a higher cost of lost food production because
this will decrease the labor to land ratios. In this way, the MPL will be no more zero. Here, labor
supply curve will become positively sloped along with the growth of modern sector. The
structural transformation of the economy will take place through shifting traditional rural
agriculture to modern urban industry.
 
Criticism on the Lewis Model:
 Although Lewis two-sector development model is simple and roughly it is in conformity with
the historical growth in the West, but it has following flaws and most of its assumptions do not fit
in the institutional and economic realities of UDCs.

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(i) Proportionality between Employment Creation and Capital Accumulation: Lewis model
assumes that there exists a proportionality in the labor transfer and employment creation in
modern sector and rate of capital accumulation in the modern sector. The faster the rate of capital
accumulation, the higher the growth rate of the modern sector and faster the rate of new job
creation.

 But if the capitalists reinvest their profits in the labor-saving capital equipment rather increasing
the labor employment (what has been assumed in Lewis model) the jobs will not be created and
modern sector will not expand. This happened in case of Pakistan where during 2 nd five year
plan, the wages remained constant and the capitalists rather re-ploughing their surplus shifted it
to the 'Swiss Banks'. All this led to a resentment against the strategy of increasing the surpluses
of capitalistic class. Now we employ a diagram where we shall show that labor demand curves
do not shift uniformly outward. It is so because that increase in capital stock will embody labor
saving technology.

Figure 3.3

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In fig.3.3, it is obvious that even though the total output has grown substantially, i.e., OD 2 EL* >
OD1EL*. But the total wages remained OWEL* and the employment also remained OL* . Both
remained unchanged. All of increase in output has accrued to capitalists in the form of excess
profits. This may be given the name of "Anti-development" economic growth, all the extra
income and output growth went to a few capitalists while the income and employment levels for
the masses of workers remained unchanged. In this way, total GNP would rise, but there would
be no or little improvement in aggregate social welfare.

(ii) Peak Harvesting and Sowing Season: Lewis did not pay attention to the pattern of
seasonality of labor demand in traditional agri. sector. According to Mehra, labor demand varies
considerably and such demand is at its peak during the sowing and harvesting season. Thus
during some months of the year the MPL may be above-zero. In such situation, the positive
opportunity costs will involve in transferring the labor from agri. sector. As a result, the labor
transfer will reduce agri. output.
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(iii) Rise in Urban Wages: According to Prof. Mabro the absorption of surplus labor itself may
end pre-maturely because competitors (producers) may alter wage rates and lower the share of
profit. It has been shown that rural-urban migration in Egyptian economy was accompanied by
increase in wage rate of 15% and a fall in profits by 12%. Moreover, the wages in industrial
sector were forced up directly by unions, civil service wage scales, minimum wage laws and
MNCs (multi-national corporations) hiring practices tend to negate the role of competitive forces
in the modern sector labor market. Again, the wages in subsistence sector may go up indirectly
through rise in productivity in this sector.
 
(iv) Full Impact of Growing Population: Lewis model underestimates the full impact on the
poor economy of a rapidly growing population, i.e., its effects on agri. surplus, the capitalist
profit share, wage rates and overall employment opportunities. Similarly, Lewis assumed that the
rate of growth in manufacturing sector would be identical to that in agri. sector. But, if industrial
development involves more intensive use of capital than labor, then the flow of labor from agri.
to industry will simply create more unemployment.

(v) Ignoring the Balanced Growth: Lewis ignored the balanced growth between agri. sector
and industrial sector. But we know that there, exists a linkage between agri. growth and industrial
expansion in poor countries. If a part of profits made by capitalists is not devoted to agri. sector,
the process of industrialization would be jeopardized (perhaps, due to reduced supply of raw
material). Because of this flaw, Ranis-Fei model considers the balanced growth of both sectors.
This will be discussed after this model.

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 (vi) Ignoring the Role of Leakages: Lewis has ignored the role which the leakages can play in
the economy. As Lewis assumed that all of increase in profits are diverted into savings. It means
that savings of producers are equal to one. But, practically it is not so. The increase in profits
may accompany the increase in consumption. As in Pakistan during 2nd plan the capitalistic
class diverted their increased profits to palacious houses and conspicuous consumption. In such
tike situation the MPS out of profits will be less than one.
 
Again, it is not necessary that the capital formation will be made by the capitalistic class. The
same may be done by the farmers producing cash crops. As the small farmers producing cash
crops in Egypt have shown themselves to be quite capable of saving the required capital. Again,
the World's largest Coca industry in Ghana is the result of creation of small enterprise capital
formation.
 (vii) Process of Migration is Neither Smooth Nor Costless: Lewis assumed that the transfer of
unskilled labor from agri. to industry is regarded as almost smooth and costless. But, practically
it is no so as industry requires different types of labor. If this problem is removed with the help of
investment in education and skill formation, the process of migration will become costlier and
expensive.

Conclusion:
Despite several limitations and drawbacks Lewis model retains a high degree of analytical value.
It clearly points out the role of capital accumulation in raising the level of output and
employment in labour-surplus developing countries.

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The model makes a systematic and penetrating analysis of the growth problem of dual economies
and brings out some of crucial importance of such factors as profits and wages rates in the
modern sector for determinating the rate of capital accumulation and economic growth. It
underlines the importance of intersectoral relationship (i.e., the relationship between agriculture
and the modern industrial sector) in the growth process of a dual economy.

3.2.3. Dualistic Theories:

There are different theories which are of the view that the poverty and underdevelopment of poor
countries is attributed to their dualistic character. (1) Social Dualism, (2) Technological Dualism
and (3) Financial Dualism.
 
3.2.3.1. Social Dualism or Sociological Dualism:
 
Definition and Explanation:
 J.H. Boeke is a Dutch Economist who studied Indonesian Economy and presented his theory of
social dualism.He maintains that there are three characteristics of a society in the economic
sense. They are as:
(i) Social Spirit (ii) Organizational Form (iii) Techniques Dominating Them.
 
Their inter-relationship and interdependence is called the social system or social style. A society
is homogeneous if there is only one social system in the society. But the society which has two or
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more social systems is known as dual or plural society.
 
Dr. Boeke says that the dual society is a society which has two full grown social styles which
represent pre-capitalism and post-capitalism. Such a dual society is furnished with the existence
of an advanced imported western system on the one side and endogenous pre capitalistic
agricultural system on the other side. The former is under the western influence which uses the
advance techniques and where standard of living is high. The later is native and it is furnished
with the outdated techniques and low social and economic life. This is called social or
sociological dualism and these two systems are clashing. The imported social system is highly
capitalistic and it may be socialistic as well as communistic system.
 
Characteristics of Dualistic Society:
 On economic basis the dualistic society is classified as by giving the names:
 (i) Eastern Sector and (ii) Western Sector.
 
There are certain characteristics of eastern sector of a dualistic economy which distinguishes it
from western sector. They are as:
 (i) The needs of eastern sector are limited. People pass a contented life.
 (ii) People work for social needs rather for economic needs. For example, if a three acres are
enough to supply the needs of a household he will not cultivate six acres.
 (iii) Goods are cultivated according to their prestige value rather on their use value.
 (iv) As a result of all above, the eastern economies are characterized with backward bending
supply curves of effort and the risk taking.

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 (v) The native industries have neither organization nor capital and they are ignorant of modern
technology and market conditions.
 (vi) People are indulged in speculative activities rather in business enterprises.
 (vii) They do not take risk by making productive investment.
 (viii) They lack the initiative and organizational skill which is a feature of western sector of dual
economy.
 (ix) Labor is unorganized, passive and unskilled. They are reluctant to leave their village and
community. They are fatalist.
 (x) The urban development takes place at the cost of rural life.
 (xi) Exportation is the main objective of foreign trade in the eastern sector while the western
sector believes in imports.
 
Due to these features of eastern society the western economic theory is not applicable as far as
LDCs arc concerned.  The western economic theory is meant to explain capitalistic society
whereas eastern sector is pre capitalistic. The western sector or society is based upon unlimited
wants and money economy etc. Moreover,the MP theory cannot be applied in UDCs for resource
allocation and distribution of income because of immobility of resources. Thus Boeke says:
 
“We should not try to transplant the delicate houseplant of western theory to tropical soils where
an early death awaits for it. If the pre-capitalistic agricultural sector of eastern sector is attempted
to develop along western lines it will create retrogression. The modern agricultural techniques
can not be applied how-long the mental attitudes of the farmers are not changed, otherwise the
increase in wealth following modern technology will result in further growth of population.

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Moreover, in case of failure of modern technology, the indebtedness of the country will increase.
Therefore it is better that these existing agricultural systems should not be disturbed.”
 
As far as industrial field is concerned the eastern producers cannot follow the western technology
on the basis of economic and social reasons. He says that the adoption of western technology to
industrialize Indonesian economy has moved the goal of self sufficiency farther and ruined its
small industry.
 
Boeke refers to five kinds of unemployment in UDCs:
 (i) Seasonal, (ii) Casual, (iii) Unemployment of regular workers, (iv) Unemployment of white
collard class, (v) Unemployment of Eurasians.
 According to Boeke the government is unable to remove such unemployment because of the
reason that it will require the funds which the govt. cannot avail. Boeke says that limited wants
and limited purchasing power in eastern sector hamper economic development. If the food
supply is increased or industrial goods are increased, it will bring a glut of commodities in the
market. The prices will fall and economy will face depression.
 
But this does not mean that Boeke is against industrialization, and agricultural improvement.
Rather he is in favor of slow process of industrialization and agricultural development on small
scale which could have adaptability with the dualistic structure of eastern society. The urge for
development should come from the people themselves. New leaders must emerge who should
work for the goal of development with faith, charity and patience.
 

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Criticism:
 
Professor Bengmin Higgins has criticized the social dualistic theory on the following grounds:
 (i) Wants are not Limited: If we analyze "Indonesia's life" we do not find that the desires of the
people are limited because here the values of MFC and MPM are higher. This is the reason that
the govt. has to impose import restrictions. Moreover, whenever the harvest is good the farmers
become prosperous and the demand for luxurious goods rises.
 
(ii) Casual Labor are not Unorganized: Boeke presented the version that casual workers are
unorganized and passive. But this may be true as far as agricultural sector is concerned but they
are not unorganized in coffee, tea, rubber and plantation etc.
 
(iii) Eastern Labor is not Immobile: Boeke thought that eastern labor is immobile. It is not so
because of attraction of modern facilities of life in the urban areas. Moreover the high income
incentives force the labor to move from rural areas to urban areas.
 
(iv) Dualistic Theory is not Particular To UDCs Only: The eastern society, according to
Boeke, only exists in UDCs. It is not true. It does exist in Canada, Italy and even in the United
States.
 
(v) Applicability to Western Society: According to Professor Higgins most of the
characteristics of eastern society given by Boeke are present even in the western societies. For
example, during hyper inflation, speculation is preferred to investment. This means, the people in

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the western countries also have a strong desire to keep their capital safe and in liquid form, The
western society also believes in conspicuous consumption as discussed by Veblin and Snob
effects. The backward bending supply curve of efforts has been experienced by Australia during
post war period and by US in the fifties.
 
(vi) Not a Theory But a Description: It is objected that the Boeke's dualistic theory is merely a
description rather than a theory. His findings are based upon neo-classical theory which has the
limited applicability in the western world.
 
(vii) Does not Provide Solution to the Problem of Unemployment: Boeke's dualism centers
more on socio-cultural aspects rather on economic. He only says that govt. is not in a position to
remove unemployment. Moreover, he does not mention the situation of under employment.
Therefore his theory is full of shortcomings.
 
Conclusion:
 The main problem of dualistic economies is to provide employment opportunities and Boeke
theory fails to do it. Therefore, Prof. Higgins has developed the theory of technological dualism.
 
3.2.3.2. Technological Dualism:
Definition and Explanation:
Professor Higgins has developed the theory of Technological Dualism. By this we mean: "The
use of different production functions in the advance sector and in the traditional sectors of
LDCs".

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 The existence of such dualism has increased the problem of structural or technological
unemployment in the industrial sector and disguised unemployment in the rural sector. Higgins
theory of technological dualism incorporates the factor proportion problem as discussed by K.S.
Eckaus, which is related to limited productive employment opportunities found in the two
sectors of LDCs because of market imperfections, different factor endowments and different
production functions.
 
The LDCs are characterized with structural disequilibrium at the factor level. This arises,
because a single factor gets different returns in different uses or because price relationship
among factors are out of line with factor availabilities. Such disequilibrium leads to
unemployment or underemployment in two ways. It is as:
 
(i) Imperfection of price system.
(ii) Structure of demand which results in surplus labor in overpopulated backward country.
 
Thus the technological unemployment in LDCs is because of surplus labor which results from
misallocation of resources and structure of demand. Higgins constructed his theory by assuming
two goods; two factors and two sectors and their factor endowments and production functions.
Of these two sectors the industrial sector is engaged in plantation, mines, oil field and large scale
industry. It is capital intensive and characterized by fixed technical coefficients that is, the factors
have to be combined in a fixed proportions.
 

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While the rural sector is engaged in producing food stuffs, handicrafts and very small industries.
It has changeable technical coefficients of production. Hence it has different alternative
combinations of labor and capital. The production functions in the industrial sector are
represented as in figure:
 Figure 3.4:

Here the IQ1, represents the combination of OL1, of labor (L) and OK1, of capital (K) which
produces a certain level of output. While IQ2, IQ3 and IQ4 represent higher level of output which
arc only possible if K and L are increased in the same proportion. Thus the points; A, B, C and D
show fixed combinations of capital and labor which are used to produce different levels of
output.
 

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The line OE represents expansion path in the industrial sector and its slope represents constant
factor proportions. The line K2L2 shows that the production process is capital intensive. To
produce Q1, output OK1, of K and OL1 of L are used. If the actual factor endowment is at S rather
A. It means that more labor are available to produce same amount of output. While here units of
K are OK1. Since there are fixed technical coefficients, the excess labor supply will not affect the
production techniques at all. The L1L2 units of labor will remain unemployed. It is only when
capital stock increases to SF, then it will be possible to absorb this excess labor supply in this
sector. Otherwise it has to seek employment in rural sector. The production functions for rural
sector are shown in figure 3.5 below:

Figure 3.5:

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The isoquants, Q1, Q2, Q3 and Q4 show variable coefficients of production. In order to produce
more output more labor is employed as compared with the capital. As a result the good land
(capital) becomes scarce and all available land is cultivated by high labor intensive techniques.
At point E where maximum output level is reached as shown by Qn.
 
Thus, according to Higgins, because of different production functions the unemployment and
underemployment comes into being in LDCs. According to Higgins the industrial sector uses
capital intensive techniques and fixed technical coefficients and it is not in a position to create
employment opportunities at the same rate at which population grows. Rather, the
industrialization reduces the employment in this sector. Therefore, the rural sector is an
alternative for the surplus labor.
 
In the beginning it is possible to absorb the additional labor by bringing more lands under
cultivation. This leads to optimal combination of labor and capital. Eventually good lands
become scarce. The ratio of labor to capital in that sector rises and the techniques become
increasingly variable in this sector. Ultimately all available lands is cultivated by high labor
intensive techniques and MP of labor becomes zero and negative. Thus with the growth of
population disguised unemployment begins to appear. Under these circumstances farmers have
no incentives either to invest more capital or to introduce labor saving techniques. As a result the
techniques of production, the productivity of labor and socio-economic life is remained at low
level in the rural sector.
 

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In the long run the technological progress does not help in removing the disguised
unemployment. Rather it tends to increase the number of disguised unemployed. The situation is
further aggravated by keeping wage rates artificially high by trade unions or by govt. policies.
For high industrial wages relative to the productivity provide an incentive to the producers for
introducing labor saving techniques and thereby it diminishes the further capacity of the
industrial sector to absorb surplus labor. Accordingly these factors increase the technological
dualism in LDCs.
 
Criticism:
Professor Higgins has attempted to present how disguised unemployment gradually rises in the
rural sector of dualistic society. But the theory has following defects:
(i) Assumption of Fixed Technical Coefficient: Higgins wrongly assumes fixed technical
coefficient in the industrial sector without any empirical verification.
 
(ii) Factor Prices do not Entirely Depend Upon Factor Endowment: This theory indicates
how the factor endowment and different production functions result in disguised unemployment.
So disguised unemployment is connected with the factor prices. But it has been found out that
the factor endowments do not entirely determine the factor prices.
 
(iii) Ignoring The Institutional Factors: There are many institutional and psychological factors
which have been ignored by Higgins in connection with their effect on factor proportion.
 

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(iv) Ignoring the Use of Labor Absorbing Techniques: According to Higgins that industrial
sector employs highly capital intensive techniques which are imported. But practically we find
that all imported techniques are not labor saving. For example, Japan's agricultural development
is not due to capital intensive techniques.
 (v) Size and Nature of Disguised Unemployment is not Assessed: Higgins does not clarify the
nature of disguised unemployment in the rural sector and excess labor supply in the industrial
sector. Moreover, he does not tell about the extent of disguised unemployed due to technological
dualism.
 
3.2.3.3. Financial Dualism:

Definition and Explanation:

 Professor Hala Myint has developed the theory of financial dualism. Such dualism rises
because of division of money markets in unorganized and organized money markets in LDCs.
The rate of interest in unorganized market is higher than the rate of interest in organized money
market which is concerned with modern sector. The unorganized money market consists of
village money lenders, landlords, arties. They charge the high interest because of the following
reasons.
 
(i) The lenders have monopoly and position of the borrowers is very weak.
 (ii) There is a shortage of savings in the traditional sector because most of the savings are made
in terms of land or gold.
 (iii) Due to natural calamities etc. the risk attached with such lending are very high.
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Thus we find that the high interest rate which the farmers have to pay not only consists of formal
interest charges but also the concealed charges obtained through under pricing the grains
purchased by the farmers. On the other hand, in the organized markets of LDCs the interest rates
are low and credit facilities are abundant. The loans are advanced to manufactured sector, export
industry and modern commerce sector.
 
Professor Myint says that there was an old financial dualism which used to exist in the open
economy of colonial period and the financial dualism which now exists. Under colonial system
there was perfect convertibility at fixed exchange rate. Consequently there was no shortage of
foreign exchange and there were no BOP problems. But now a days the LDC's have to face
internal as well as external balance. Thus the poor traders and small peasants not only have to
face high interest rates, but also the shortage of foreign exchange. Then they are not in a position
to get advanced machinery etc.

Under colonial system organized money market of LDCs is consisted of the branches of western
commercial banks which were linked with international financial market. In colonial system the
modern sector consisting of mines, plantation and foreign trade borrowed at low interest rates
both from western banks and the world capital markets. But the present LDCs have attained
monetary independence by establishing their own central banks. They have introduced the
exchange control.
 

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As a result, the organized money market of the LDCs have been separated from the world capital
market. Hence, their central banks are following the cheap monetary policy even when they are
having shortage of funds. They are maintaining over-valued exchange rate on the ground that
devaluation will create inflation. On the other hand there is chronic excess demand for foreign
exchange in these poor countries. To meet this situation, these countries depend upon exchange
controls, direct controls, monetary and fiscal policies. This has led to enhance the economic
dualism between the traditional sector and modern industrial sector. The cheap monetary policy
by maintaining artificial low interest rates has become helpful for the large industrial sector. The
low interest rates have discouraged the flow of funds from abroad and savings from within the
country. But it has created an excess demand for loans. Thus the major part of domestic savings
are flowing towards industrial sector. This has reduced the capital to traditional and agriculture
sector which have to get at higher interest rate.
 
The foreign exchange control to correct deficit in balance of payments (BOP) has also benefited
the modern industrial sector against the traditional sector. It is because that the major share of
available foreign exchange is allocated to the industrial sector to import capital intensive goods.
On the other hand, the agricultural and small scale sector fail to get foreign exchange and import
permits because of red-tapism and corruption in the LDCs.
 
The most of the LDC's have established agricultural banks and cooperative societies. But these
institutions have been found providing loans to the influential people and to the model villages.
 All this has led to misallocation of resources between the modern and traditional sector. So
money markets in the LDCs remain backward. Domestic inflation along with over-valued

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exchange rate have encouraged flight of capital. The countries where this is checked, the capital
moved in the purchase of gold, jewellery, real estates and other speculative activities. This is
because of low rate of interest against investment. Hence the money market remains ineffective.
 
Government controls over the scarce supply of capital have also retarded the growth of financial
intermediaries in the LDCs. These controls favor the large manufacturing units and the banks.
They discriminate against the small borrowers and the money lenders who provide credit to the
small borrowers. In the LDCs government believe that capital funds invested in durable capital
goods are productive while those invested in financing agriculture and trading activities are
unproductive.
 
According to Myint the cheap and easy credit to the traditional sector is not provided because of
following:
 (i) The high over head costs and salaries of officials of commercial banks in the rural areas.
(ii) The red-tapism in dealing with small borrowers according to the rigid rules.
 (iii) The lack of coordination between the head office and the branches.
 (iv) Lack of subsidized loans supplied by the agricultural banks etc.
 
Professor Myint suggest two types of policies to reduce financial dualism in LDCs:
 (i) The official interest rate in the organized capital market be increased. This will attract the
savings both from the country and out of the country. It will also create an equilibrium
between the demand for loan able funds and supply of loan able funds.

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 (ii) There should be free access on equal terms to capital funds by modern and traditional sector.
This will reduce misallocation of resources between the two sectors.

3.2.4. The process of Cumulative Causation: By Gunnar Myrdal

Circular cumulative causation is a theory developed by Swedish economist Gunnar Myrdal in the

year 1956. The idea behind it is that a change in one form of an institution will lead to successive
changes in other institutions. These changes are circular in that they continue in a cycle, many
times in a negative way, in which there is no end, and cumulative in that they persist in each
round. The change does not occur all at once as that would lead to chaos, rather the changes
occur gradually.

When analyzing the socio-economic development at a global level, this theory is based,
according to Blazek (2008), on three facts:

1. There is a small group of wealthy countries and many more extremely poor countries,

2. Wealthy countries continues to grow while poor states stagnate (here Myrdal notices the
paradoxical fact that the stagnating countries are termed developing countries - the countries
which are developing),

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3. From a global point of view the differences between the rich and the poor are growing larger.

Myrdal maintains that economic development results in a circular causation process leading to
rapid development of developed countries while the weaker countries tend to remain behind and
poor.

The cumulative causation action has been built upon spread effect and backwash effects. ( In a
broad sense backwash effects are the negative impacts of the growth of the core region on the
peripheral regions, which tend to be poorer. An example would be the brain drain from many of
the poorer parts of a country to the large cities, which are seen to be profitable and offer better
quality of life.)

In this context Myrdal´s circular cumulative causation differentiates between negative (i.e.

polarized or back-wash effects) effect of more developed regions to underdeveloped regions
and positive effects (spread or trickle-down effects) - e.g. growth of demand in more developed
regions for resources and agricultural products produced in underdeveloped regions or expansion
of technological advancement (Blazek, 1999).

The theory emphasizes that “poverty is further perpetuated by poverty” (BWE > SPE) and
“affluence is further promoted by affluence” (SPE>BWE). In backward regions problem creates
more problems. In developed regions auto solutions solve all problems.

Myrdal contention is that the free play of market forces and operation of profit motive in the
capitalist system normally tends to increase inequalities between regions rather than decrease.
When backwash effect dominates divergence will develop; periphery will remain weak, only
centre will develop and dualism in growth is promoted. When spread effect dominates
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convergence will develop; periphery will develop, there will be economic integration between
centre and periphery.

Cumulative causation theory proves that

• Market mechanism will not bring equality between regions but will increase inequalities.

• Nothing short of govt. intervention will check backwash effect from getting cumulative.
the theory is centre periphery model.

• Centre supplies finished output for consumption and input.

Critical evaluation

• This model combines national and international forces which tend to keep backward
countries in the morass of cumulative process where poverty becomes its own cause.

• Though not a communist he proved that the so called competitive markets instead of
solving the problem of backward region it would accentuate them.

• Myrdal these have made important contributions to the theories of convergence and
divergence, agglomeration and locational economies and the theory of vicious circle.

• myrdal was a supporter of balanced growth and wanted it to be initiated, directed and
sustained by govt. he was a strong supporter of the theory of sponsored growth.

• The analysis part of Myrdal’s writings if found to be much more satisfactory than the
recommendatory part.

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 • The theory has been criticized regarding “accidental factors” as the only factors which
start the growth process.

• There are setbacks in developing regions and there can be development in vicious circle
region.

• The agglomerating factors (same factors which Myrdal emphasized on) can also bring
decreasing returns when diseconomies overcome the economies.

• It can also be argued that even market mechanism can reduce inequalities and disparities
between two regions.

3.2.5. A Model of Low Level Equilibrium Trap by Nelson:

Definition and Explanation:

Nelson has presented the theory of low level equilibrium trap for the LDCs. This theory is based
upon 'Malthus' view that when per capita income of a country rises above the 'Minimum
Subsistence Wage', the population will tend to increase. Initially population grows rapidly with
increase in per capita. But when the growth rate of population reaches an upper physical level, it
starts declining with further increase in per capita.

In other words, in the beginning the increase in per capita income leads to increase the
population. Afterwards, the increase in the per capita income leads to decrease population.

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According to Nelson, the LDCs have a stable equilibrium of per capita income which is close to
subsistence requirements. Hence, the savings and investment remain at very low level. Thus
whenever, the efforts are made to raise the level of national income (NI), savings and investment
they also resulted in increase of the population.

Accordingly, the per capita income remained at its stable equilibrium level. All this means that
LDCs are caught in low level equilibrium trap.

Factors of Nelson's Trap:

According to Nelson the following factors are responsible for such trap:
(i) There is a high correlation between the level of per capita income and rate of population
growth.
(ii) There is a little propensity to direct additional per capita income to increase investment.
(iii) There exists a shortage and scarcity of uncultivable area of land.
(iv) The economy is having inefficient techniques of production.
(v) The economy is furnished with social and economic inertia

Nelson presents three sets of relationships to show the trapping of an economy at a low level of
income:
(i) Y = f (K, L, Tech.).
(ii) The new investment consists of capital which is created out of savings in the form of
additions to the stocks of machine tools etc. in the industrial sector plus the additions of
new lands to the amount of land under cultivation.

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 (iii) With low per capita incomes, short run changes in the rate of population growth are caused
by changes in death rate; and the changes in death rate are caused by changes in the level of
per capita income. Whenever, the per capita income reaches a level above the subsistence
level, further increase in per capita income will have a negligible effect on death rate.

Now we present Fig. 3.6 to demonstrate this theory.

Figure 3.6

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In the (1) part of Fig.3.6 the dP/P curve represents percentage rate of growth of population, while
the Y/P curve represents per capita income. The point J is minimum subsistence per capita
income where dP/P = Y/P.    
 

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Here, the population is stationary. But to left of J, the population is decreasing while to the right
of J, the growth rate of population increases to the upper physical limit, shown by 'U'. This
happened due to increase in per capita income above subsistence level as shown by the arrow
movement on the horizontal axis in the (1) part of Fig.3.6

For some time the population will grow at this level with rise in per capita income and then it
will start falling at point M. In (2) part of Fig.3.6, dK/P is per capita rate of investment out of
savings. The curve dK/P is the growth curve of investment which relates the per capita of
investment to different levels of per capita income.

At point 'X', there are zero savings. While to its left, there are negative savings. If we move
above point 'X' along the growth curve of investment, the per capita rate of investment will rise
beyond the upper physical limit of the growth rate of population as denoted by 'U' in (1) part of
Fig. 3.6.

In (3) part of Fig.3.6, Y/P is again per capita income. While dY/Y is rate of growth of total
income, and dP/P is growth curve of population at various levels of per capita income. The point
'S' is so drawn that it equals the zero savings level of income (point X in (2) part) and minimum
subsistence level of per capita income 'J'. So the situation where J = X = S the low level
equilibrium trap exists in the economy.

Here: dY/Y = dP/P. For any increase in per capita income beyond point S, the growth rate of
population is higher than the growth rate of income, (dP/P > dY/Y). This will push the economy

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back to point S, the point of stable equilibrium. Thus the economy is caught in low level
equilibrium trap. This low level of trap will be stronger the more quickly the rate of population
growth responds to a given rise in per capita income, and more slowly the rate of growth in total
income responds an increase in investment.

Methods to Escape from Trap:

The economy requires a discontinuous jump beyond the per capita income level of (Y/P1). Here,
the national income grows at a higher rate than population growth which is stable at an upper
limit. Ultimately, the economy reaches (Y/P2) level where growth rate of income equals the
growth rate of population, as shown by point 'N' in (3) part of Fig.3.6. Nelson says that, to escape
this trap:
(i) There should be a favorable socio-economic political environment in the country. 
(ii) Social structure be changed by greater emphasis on entrepreneurship.
(iii) The size of the family by reduced.
(iv) Measures be taken to change the distribution of income.
(v) The proportion of public investment be increased.
(vi) In order to enhance capital and investment the loans be obtained from foreign countries.
(vii) Improved techniques of production be used to utilize the existing resources

3.2.6. Big Push Theory by Rosenstein Rodan and Economic Development:

Definition and Explanation:

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 The Big Push Theory has been presented by Rosenstein Rodan. The idea behind this theory is
this that a big push or a big and comprehensive investment package can be helpful to bring
economic development. In other words, a certain minimum amount of resources must be devoted
for developmental programs, if the success of programs is required.
 
As some ground speed is required for the aircraft to airborne. In the same way, certain critical
amount of resources be allocated for development activities. This theory is of the view that
through 'Bit by Bit' allocation no economy can move on the path of economic development,
rather a specific amount of investment is considered something necessary for economic
development. Therefore, if so many mutually supporting industries which depend upon each
other are started the economies of scale will be reaped. Such external economies which are
attained through specific amount of investment will become helpful for economic development.
 
Rosenstein Rodan has presented three types of indivisibilities and economies of scale. They are
as:
 (1) Indivisibilities in Production Function: When so many industries are established the
economies regarding factors of production, goods, and techniques of production are accrued.
Rosenstein Rodan gives more importance to economies which arise due to the establishment of
social overhead capital. The infra-structure consists of means of transportation, communication
and energy resources. They all contribute to development indirectly. They last for a longer period
of time. The SOC can not be imported. To construct it a big amount of capital is required. For
some time, the excess capacity may grow in SOC, but they are very much must. Accordingly,

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LDCs will have to spend 30% to 40% of investment on SOC. The SOC is attached with the
following indivisibilities:
 
(i) The SOC must be provided before Directly Productive Activities (DPA).
  (ii) It is lumpy and it has a minimum durability.
 (iii) It lasts for a longer period of time and it is irreversible.

These indivisibilities serve as big obstacle in the way of economic development of a LDC.
 
(2) Indivisibilities of Demand: The complementarily with respect to demand requires that LDCs
should establish such industries which could support each other. To make investment in one
project may be risky because in LDCs the demand for goods and services is limited due to lower
incomes. In other words, the indivisibilities of demand require that at least a certain amount of
investment be made in so many industries which could mutually support each other. As a result,
the size of market will be extended in LDCs; or the problem of limited market will come to an
end in LDCs. It is shown with Fig.3.7.

Figure: 3.7

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Here D1 and MR1 are the average and marginal revenue curves of a firm when investment is
made in this single firm. This firm sells OQ1 quantity and charges OP1 price. Here it faces losses
equal to P1cab.
 But if investment is made in so many industries the market will be extended. In this way, the
demand will increase as shown by D4 and corresponding marginal revenue curve is MR4. Now
the equilibrium takes place at E where OQ4 quantity is produced and OPb price is charged. As a
result, the industries are having profits equal to P4RST. It means that the greater investment in so
many industries nay convert the losses into profits.
 

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(3) Indivisibility in Supply of Savings: The supply of savings also serves as an indivisibility. A
specific amount of investment can be made in the presence of specific savings But in case of
LDCs because of lower incomes the savings remain low. Therefore, when incomes increase due
to increase in investment the MPS must be greater than APS.
 
In the presence of these indivisibilities and non-existence of external economies only a Big Push
can take the economy out of dole drums of poverty. It means a specific amount of investment is
necessary to remove the obstacles in the way of economic development.
 
Criticism/Demerits:
 Rosenstein theory is better in the sense that it identified that market imperfections are the big
obstacles in the way of economic development. Therefore, a big amount of investment will solve
the problem of limited markets, rather depending upon market mechanism, and such heavy
amounts of investment will become helpful for economic growth. Despite this merit, followings
are the demerits of this theory.

(i) Negligible Economies in Export, and Import Substitute Sectors: The 'Big Push'
infrastructure may be justified on the ground of external economies. But, according to Viner, the
export sector and .import-substitute sectors are so backward in LDCs that they hardly give rise to
economies.
 
(ii) Negligible Economies from Cost Reducing Investment: The goods which are concerned
with public welfare hardly yield external economies. Moreover, the investment which is aimed at

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reducing costs does not yield economies.
 (iii) Neglecting Investment in Agri. Sector: In this theory emphasis has been laid upon making
investment in infrastructure and industries. While it neglects the investment to be made in agri.
and its allied sectors. As the agri. sector is the largest sector in LDCs and it will be a mistake to
ignore it.
 
(iv) Inflationary Pressure: From where the funds will come in LDCs to spend them on SOC. If
the funds are raised through foreign loans and by printing new notes they will create inflation in
the economy.
 
(v) Administrative and Institutional Difficulties: This theory stresses upon state investment to
remove deficiency of capital. But in case of LDCs the machinery is corrupt. There exist a lot of
problems in state machinery. The private and public sectors compete with each other, rather
supporting each other. Consequently, there will not be the balanced growth in the economy.
 
(vi) It is Not a Historical Fact: The Big Push theory is a recipe for the LDCs, but it has not
been derived on the basis of historical experience. As Prof. Hagen says, "the Big Push theory
lacks the historical evidences and facts".

3.2.7. Theory of Balance Growth: Concept, Definition and Basis

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Balanced growth is a dynamic process and as such the meaning of balanced growth continues
changing. The concept of balanced growth is subject to various interpretations by various
authors. It was Fredrick List who for the first time put forward the theory of balanced growth.

According to Fredrick List the theory of balanced growth is of great significance by which a
balance could be established between agriculture, industry and trade.

This concept was endorsed by Rosenstein Rodan in one of his articles titled “Problems of
Industrialisation of Eastern and South Eastern Europe.” Prof. Nurkse, Prof. Lewis and Stovasky
have examined this concept of balance of growth on different bases. In the words of
Kindleberger, “Balanced Growth has so many meanings that it is in danger of losing them all.”

Definitions:
1. P.A Samuelson, “Balanced Growth implies growth in every kind of capital stock constant
rates.”

2. U.N Publication, “Balanced Growth refers to full employment, a high level of investment,
overall growth in productive capacity, equilibrium.”

3. Alak Ghosh, “Planning with balanced growth indicates that all sectors of the economy will
expand in same proportion, so that consumption, investment and income will grow at the
same rates.” It can be expressed as:

∆C/C = ∆I/I = ∆Y/Y

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4. Benjamin Higgins, “A wave of capital investment in a number of industries is called Balanced
Growth.”

5.W.A.Lewis, “In development programmes, all sectors of economy should grow simultaneously
so as to keep a proper balanced between industry and agriculture and between production for
home consumption and production for exports the truth is that all sectors should be expanded
simultaneously.”

6. C.P. Kindleberger, “Balanced Growth implies that investment takes place simultaneously in all
sectors or industries at once, more or less along the lines of the slogan, ‘You can’t do anything
until you can do everything.”

7. R.F. Harrod, “Balanced Growth aims at equality between growth rate of income, growth rates
of output and growth rate of natural resources i.e.

Gy = Gw = Gn
Here Gy stands for growth rate of income, G w stands for growth rate of output and G n stands for
growth rate of natural resources.

8. Mrs. Joan Robinson’s concept of golden age also implies balanced growth. It states that there
must be equality between growth rate of capital and labour force i.e.

∆K/K =∆N/N

Conclusion:
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From the above cited definitions, we stand by the views of Kindleberger who rightly observed
that “balanced growth has so many meanings that it is in danger of losing them all.” However,
the most widely discussed and accepted meaning of balanced growth is that there should be
simultaneous and harmonious development of different sectors of the economy, so as to make
available a ready market for the products of different sectors. It is, thus, confirmed that balanced
growth is not a static term, but it refers to its dynamism.

Basis of the Theory:

The doctrine of balanced growth requires the balance of three types which is discussed
below:
1. Supply Side:
Supply or production in an underdeveloped country is low. The reason behind it is that saving in
these countries is low because of low income. Low savings results in low investment. Low
investment leads to low capital formation and low productivity. Low productivity leads to low
income, i.e.

Low Income→Low Savings→Low Investment→Low Capital Formation→Low

Productivity→Low Income:
So, it is imperative to increase investment in order to increase demand. But investment will
increase when the entrepreneurs will get impetus to invest. In other words, their products will
sell and they will earn profit. Therefore, it becomes essential that several industries are set up
simultaneously.

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Thus, the concept of balanced growth from the supply side is that various sectors of an
underdeveloped economy should be developed simultaneously so that no difficulty in the path of
economic development is created. For example, agriculture, industry, internal trade, transport,
etc. should be developed simultaneously. According to Prof. Lewis, “The various sectors of the
economy must go with the right relationship to each other or they cannot go at all.”

2. Demand Side:
In the underdeveloped countries, people have low purchasing power because of their low
income. So, their demand is also low. Low demand results in less expansion of market. Small
market inspires low investment i.e.,

Low Income → Low Purchasing Power → Low Investment → Low Productivity

Therefore efforts should be made to increase the demand in these countries. The concept of
balanced growth from the demand side is that several industries should be developed
simultaneously so that all can be the customers mutually and the products of all can be sold. In
this regard Rosenstein Rodan has given an example. According to him, if a shoe making industry
is set up all people linked with it will get income. But they will not spend all of their income only
on buying shoes. They will buy goods manufactured by other industries.

Similarly if only one sided development is made it will not succeed. Contrary to it, if several
industries are developed simultaneously and harmoniously, this difficulty can be removed.
Therefore, Prof. Nurkse says, “Most industries catering for’ mass consumption are
complementary in the sense that they provide a market for and thus support each other.”

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3. Sectoral Balance:
Sectoral balance means economic development of all the sectors in an economy. As agriculture
and industry are complementary to each other. Thus, expansion of industry will require
expansion of agriculture and vice-versa. Again expansion of industrial sector will raise the
demand for raw-material which will only be supplied by expanding of agricultural sector. Prof.
Lewis maintained that if these sectors are simultaneously developed, the relative price among
them can be maintained.

There may be any unfavorable terms of trade among them. In the same manner, a balance
between domestic trade and foreign trade becomes essential during the process of economic
development. Thus, according to Prof. Lewis, the domestic sector must grow in balance with the
foreign sector.

As a matter of fact, the doctrine of balanced growth has been strongly criticized by Prof.
Hirschman, Singer, Kurihara, and many other economists.

“Balanced growth can neither solve the problem of underdeveloped countries, nor do they have
sufficient resources to achieve balanced growth”-Prof. Singer.

The points of criticism are given as under:

1. Wrong Assumptions:
Prof. Singer argues that the doctrine of balanced growth is based on wrong assumptions. Every
underdeveloped country starts from a position that reflects previous investment decisions—and
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previous development. The theory of balanced growth requires balanced investment to meet the
growing demand and as a result there is existence of increasing returns. If simultaneous
investments are made in all related fields, bottlenecks arise, due to the shortage of raw materials,
prices, factor shortages etc. There is ever likelihood of operating decreasing returns.

2. Administrative Difficulties:
The principle of balanced growth overlooks the inefficient administrative capacity of
underdeveloped countries. The administrative machinery is overloaded which causes
maladjustment in the smooth functioning of the economy.

3. Rise in Costs:
The foremost, drawback of the concept is that the establishment of number of industries will
raise the real and money cost of production. It is economically unprofitable to operate in the
absence of sufficient capital equipment, skills, cheap power, finance and other necessary raw
materials.

4. Against the Capabilities of Underdeveloped Countries:

According to Hirschman, “The doctrine combines a defeatist attitude towards the capabilities of
underdeveloped economies with completely unrealistic expectations about their creative
abilities.” It involves the simultaneous start of several productive activities at one instance. But
in an underdeveloped country, there is an acute shortage of capital resource, technical and
managerial skills etc. The whole system is self-contradictory.

5. Danger of inflation:

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Balanced growth doctrine advocates simultaneous investment in a number of industries. As such
when demand increases owing to huge investment outlays made in different sectors and
corresponding supply fails to cope up with it, resulting in inflation. Thus, under these
inflationary situations, balanced growth fails to deliver fruitful results.

6. Factors Disproportionalities:
Another drawback of the theory is disproportionality in the factors of production due to
deficiency of capital and surplus manpower. In some less developed countries too much labour is
employed against too little capital. In such countries, labour is in abundance but capital and
entrepreneurial skill are scarce. This disproportionality in factors of production creates several
practical hindrance in the implementation of successful operation of balanced growth theory.

7. Ignores potentialities of Foreign Market:

Prof. Nurkse’s principle of balanced growth is based on the fact that inducement to invest is
limited by the size of the market. According to him, size of the market can be enlarged through
simultaneous and uniform growth of complementary industries. In this way, he ignores
potentialities of foreign market. Furthermore, this is against the principle of comparative
advantage where one country enjoys the benefits of specialization over the other country.

8. Planning Aspect is not given Due Consideration:

The theory of balanced growth is mainly concerned with private enterprise economy where the
need of planning does not occur. Thus, it ignores the role of planning in an underdeveloped
country where simultaneous investment in every sector needs planning, direction and co-
ordination by government.
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9. Based on Say’s Law of Markets:
Prof. Nurkse’s balanced growth is based on the famous doctrine of J.B. Say’s ‘Supply creates its
own demand.’ But after world depression of the thirties, this principle lost its validity. Moreover,
supply of complementary factors is generally inelastic in underdeveloped countries and it faces
many serious bottlenecks. Thus, demand cannot be made effective.

10. More Suitable to Advanced Countries:

Balanced growth theory is more suitable to the well advanced countries as these countries
possess sufficient resources, machines and entrepreneurs. Thus, underdeveloped economies are
not safer for balanced development on account of scarcity of basic pre-requisites and
infrastructures.

11. Deficiency of Capital:
In the path of balanced growth huge amount of capital investment is required. While UDCs
cannot afford such heavy capital due to low savings and market imperfections etc. Thus, the
doctrine of balanced growth becomes an exercise in futility.

12. Lacks Historical Sense:

Prof. Singer also argues that the theory of balanced growth lacks historical sense in
underdeveloped countries. A study of economic history of developed nations reveals that the
process of economic growth in almost all countries was initiated the of rough development of
few sectors. Benjamin Higgins stated that “Growth does not take place in a balanced way but in
unbalanced ones. When one sector proceeds faster the other sectors then try to catch up”. Thus,
the need is to try to make unbalanced investment to complement existing imbalance.
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13. Role of State:
The doctrine of balanced growth in also criticised as against its role assigned to state. However
Prof. Nurkse maintains that inducement to invest is relevant primarily to a private enterprise. But
economists like Hirschman, Singer and Kurihara firmly believe that the state has a positive role
in controlling the private enterprises and planning various strategies for development.

14. Development from Zero Level:

According to Fleming and Singer, balanced growth is based on the assumption that in the
underdeveloped countries, the development starts from a zero level. But in reality it is not so.
Each underdeveloped country starts from a point where some economic development has already
taken place. Thus, it is not essential to give equal importance to all the sectors. If we make equal
investment in all the sectors, it will result into big difference in the development of different
sectors.

Further even if we accept that economic development starts from a scratch in UDCs even then
more and heavy investment will be made in the most urgent sectors which is contrary to the
strategy of balanced growth. Thus, we find that the theory of balanced growth is based on
unrealistic assumption that the economic development starts from zero level of economic
development.

15. Represents only Gloomy Picture:

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Another attack is made by H.W. Singer and Kindleberger who claims that Prof. Nurkse’s
fundamental concept is nothing but represents only gloomy picture. In fact, underdeveloped
countries lack in the basic skill for development which puts ceiling on the number of projects to
be undertaken simultaneously.

16. Not a Theory of Development:

Prof. Hirschman is of the view that the strategy of balanced growth is not a theory of economic
development. By development, we mean to change the economy from one type to another type
which is more advanced. But under balanced growth, there would be altogether a new industrial
sector over the existing traditional sector.

It will give birth to dual economy. This does help in the acceleration of economic development.
This will not be called development but only a transformation from backward to modern
economy. In this way, we cannot call it a theory of development at all.

Check your progress – 3.3

1. Explain balanced growth and the problems involved with it.

………………………………………………………………………………………………………
………………………………………………………………………………………………………

3.2.8. Unbalanced Growth Theory: Explanation, Process and Priorities

According to Hirschman, “Development is a chain of disequilibria that must be kept alive rather
than eliminate the disequilibrium of which profits and losses are symptoms in a competitive

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economy. If economy is to keep moving ahead, the task of development policy is to maintain,
tension, disproportions and disequilibria.”

“Unbalanced growth is a better development strategy to concentrate available resources on

types of investment, which help to make the economic system more elastic, more capable of
expansion under the stimulus of expanded market and expanding demand”-H.W.Singer.

According to Alak Ghosh,

“Planning with unbalanced growth emphasizes the fact that during the planning period
investment will grow at a higher rate than income and income at a higher rate than
consumption.”

It explains the unbalanced growth in terms of the growth rates of investment, income and
consumption. If ∆I/I, ∆Y/Y and ∆C/C denote the rate of investment, income and consumption,
then unbalanced growth implies

∆I/I > ∆Y/Y > ∆C/C

i.e., the growth rates are not uniform.

According to Benjamin Higgins, “Deliberate unbalancing of the economy, in accordance with a

pre-designed strategy is the best way to achieve the economic growth.”

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According to H.W.Singer, “Unbalanced growth is a better development strategy to concentrate
available resources on types of investment, which help to make the economic system more
elastic, more capable of expansion under the stimulus of expanded market and expanding
demand.”

Meier and Baldwin are also of the opinion that “Planners should concentrate on certain focal
points, so as to achieve the goal of rapid economic development. The priorities should be given
to those projects which ensure external economies to the existing firms, and those which could
create demand for supplementary goods and services.”

Explanation of the Theory:

Albert O. Hirschman in his strategy of economic development goes a step further from Singer
when he says that for accelerating the pace of economic development in the underdeveloped
countries, it is advisable to create imbalances deliberately.

He also recognized the inter-relatedness of different economic activities as done by Ragnar

Nurkse. But he asserts that investment in selected industries or sectors would accelerate the pace
of economic development.

He regarded, “Development is a chain disequilibria that must keep alive rather than eliminate the
disequilibria, of which profits and losses are symptoms in a competitive economy”. There would
be ‘seasaw advancement’ as we move from one disequilibrium to another new disequilibrium
situation.

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Thus Hirschman argued that, “To create deliberate imbalances in the economy, according to a
pre-designed strategy, is the best way to accelerate economic development.” Hirschman is of the
confirmed view that underdeveloped countries should not develop all the sectors simultaneously
rather one or two strategic sectors or industries should be developed by making huge investment.
In other words, capital goods industries should be preferred over consumer goods industries.

It is because capital goods industries accelerate the development of the economy, where
development of consumer goods industries is the natural outcome. Hirschman has stated that, “If
the economy is to be kept moving ahead, the task of development policy is to maintain tensions,
disproportions and disequilibria.”

Process of Unbalanced Growth:

The strategy of unbalanced growth is most suitable in breaking the vicious circle of poverty in
underdeveloped countries. The poor countries are in a state of equilibrium at a low level of
income. Production, consumption, saving and investment are so adjusted to each other at an
extremely low level that the state of equilibrium itself becomes an obstacle to growth. The only
strategy of economic development in such a country is to break this low level equilibrium by
deliberately planned unbalanced growth.

Prof. Hirschman is of the opinion that shortages created by unbalanced growth offer considerable
incentives for inventions and innovations. Imbalances give incentive for intense economic
activity and push economic progress.

According to Prof. Hirschman, the series of investment can be classified into two parts:

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1. Convergent Series of Investment:
It implies the sequence of creation and appropriation of external economies. Therefore,
investment made on the projects which appropriate more economies than they create is called
convergent series of investment.

2. Divergent Series of Investment:

It refers to the projects which appropriate less economies than they create.

These two series of investment are greatly influenced by particular motives. For instance,
convergent series of investments are influenced by profit motive which are undertaken by the
private entrepreneurs. The later is influenced by the objective of social desirability and such
investment are undertaken by the public agencies.

In the words of Prof. Hirschman, “When one disequilibrium calls forth a development move
which in turn leads to a similar disequilibrium and so on and infinitum in the situation private
profitability and social desirability are likely to coincide, not because of external economies, but
because input and output of external economies are same for each successive venture.” Thus,
growth must aim at the promotion of divergent series of investment in which more economies are
created than appropriated.

Development policy, therefore, should be so designed that may enhance the investment in social
overhead capital (SOC) is created external economies and discourage investment in directly
productive activities (DPA).

Unbalancing the Economy:

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Development, according to Hirschman, can take place only by unbalancing the economy. This is
possible by investing either in social overhead capital (SOC) or indirectly productive activities
(DPA). Social overhead capital creates external economies whereas directly productive activities
appropriate them.

(i) Excess of investment in Social Overhead Capital:

Social over-head capital are concerned with those series without which primary, secondary and
tertiary services cannot function. In SOC we include investment on education, public health,
irrigation, water drainage, electricity etc. Investment in SOC favorably affect private investment
in directly productive activities (DPA).

Investment in SOC is called autonomous investment which is made with the motive of private
profit. Investment in SOC provide, for instance, cheap electricity, which would develop cottage
and small scale industries. Similarly irrigation facilities lead to development of agriculture. As
imbalance is created in SOC, it will lead to investment in DPA.

(ii) Excess of Investment in Directly Productive Activities:

Directly productive activities include those investments which lead to direct increase in the
supply of goods and services. Investment in DPA means investment in private sector which is
done with a view to maximize profit. In those projects, investment is made first where high
profits are expected. In this way, DPA are always induced by profits.

Priorities: Excess SOC or Excess DPA:

(a) Unbalancing the economy with SOC:

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Imbalance can be created both by SOC and DPA. But the question before us is that in which
direction the investment should be made first so as to achieve continuous and sustained
economic growth. The answer is quite simple. The government should invest more in order to
reap these economies, the private investors would make investment in order to enjoy profits. This
would raise the production of goods and services. Thus investment in SOC would bring
automatically investment in DPA. If investment is made in SOC, the economy will follow
DEGHK route of development as shown in figure 3.8. Increase in investment in SOC from D to
E will induce greater investment in DPA up to point F because transportation and power will
become cheaper. Investment in DPA increases until balance is restored at G. However G is
located at higher iso-quant BB which implies that there will be an increase in the level of output
in the economy.

Figure 3.8: Development via excess capacity of SOC

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(b) Unbalancing the economy with DPA:
In case investment is made first in DPA, the private investors would be facing a lot of problems
in the absence of SOC. If a particular industry is setup in a particular region, that industry will
not expand if SOC facilities are not available. In order to have SOC facilities, the industry has to
put political pressure. That is really a tough job. Thus, excess DPA path is full of strains or
pressure- creating whereas excess SOC path is very smooth or pressure relieving. In figure 3.9,
investment is made first in DPA, the route of development is DFGJK. We increase DPA from D
to F. This result in increase in production costs and DPA producers would realize the possibility
of considerable economies through more investment in SOC facilities. Thus, SOC would
increase to point E and then to equilibrium point G on BB curve implying the higher level of
output. If investment is further increased from G to J, this would create pressure for more

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investment in SOC shifting G to H and like this the equilibrium will be struck at point K on
higher isoquant curve CC the path of growth being DGK.

Figure 3.9: Development via shortage of SOC

Balanced Vs. Unbalanced Growth for Economic Development

Having critically examined the comparative analysis of balanced and unbalanced growth
strategies, a logical question arises: which of these two strategies provide greater stimulus of
economic growth?

The unbiased and impartial opinion is that there is no need to the debate on the controversy. It is
strictly based on empirical evidence and political motivation. While Paul Streeten contends that
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it is possible to reformulate the choice between balanced and unbalanced growth.

But Ashok Mathur argues that, “balanced and unbalanced growth need not be mutually
conflicting and an optimum strategy of development should combine some elements of balance
as well as unbalance.”

Both the theories are based on the theory of Big Push which advocates investment to break the
vicious circle of poverty. The balanced growth aims at the development of all sectors
simultaneously but unbalanced growth recommends that the investment should be made only in
leading sectors of the economy.

Underdeveloped countries have insufficient resources in men, material and money for
simultaneous investment in number of complementary industries. The investment made in
selected sectors leads to new investment opportunities. The aim is to keep alive rather than to
eliminate the disequilibrium by maintaining tensions and disproportions.

Balanced growth aims at harmony, consistency and equilibrium whereas unbalanced growth
suggests the creation of disharmony, inconsistency and disequilibrium. The implementation of
balanced growth requires huge amount of capital.

On the other hand, unbalanced growth requires less amount of capital, making investment in only
leading sectors. Balanced growth is long term strategy because the development of all the sectors
of economy is possible only in long run period. But the unbalanced growth is a short term
strategy as the development of few leading sectors is possible in short span of period.

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The doctrine of balanced growth and unbalanced growth have two common problems on relating
to role of state and the role of supply limitations and supply inelasticity’s. The private enterprise
is only incapable of taking investment decisions in underdeveloped countries. Therefore,
balanced growth presupposes planning. In unbalanced growth strategy, the states play a pioneer
role in encouraging SOC investments, there by creating disequilibrium.

If the development starts via Investment in DPA, political pressures force the state to undertake
investment in SOC. The theory of balanced growth is mainly concerned with the lack of demand
and neglects the role of supply limitations.

This is not true as underdeveloped country lacks in supply of capital, skills, infrastructures and
other resources which are- inelastic in supply. Similarly, unbalanced growth doctrine also
neglects the role of supply limitations and supply in elasticity’s. Under such situations, a
judicious compromise has to be made between the benefits from balanced growth and
unbalanced growth.

There is no second opinion that the developing countries are wedded to democracy who should
try to control the twin evils of inflation and adverse balance of payments during the course of
pursuing any strategy of economic development. The need of the hour is that it should be done to
make the doctrine effective as a vehicle of economic development with added strength and
vigour.

In this context, Prof. Meier has rightly observed that, “From the discussion we may also now
recognize that the phrases balanced growth and unbalanced growth initially caught on too

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readily, and that each approach has been overdrawn. After much reconsideration, each approach
has become so highly qualified that the controversy is essentially barren.

Instead of seeking to generalize either approach we should more appropriately look to the
conditions under which each can claim some validity. It may be concluded that while a newly
developing country should aim at balance in an investment criterion, this objective will be
attained only by initially following, in most case, a policy of unbalanced investment.”

Check your progress – 3.4

1. What is social overhead capital?

………………………………………………………………………………………………………
………………………………………………………………………………………………………

2. Explain the forward linkage and the backward linkage in industrial development activities.
………………………………………………………………………………………………………
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3.2.9. International Structuralist Models:

 

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Definition and Explanation:
There is another approach regarding the study of international underdevelopment which came
into being as a result of dissatisfaction against the 'Stages approach'. Such approach is given the
name of "International Structuralist Model". According to this approach:
 
"The international poverty of LDCs is due to a variety of institutional and structural economic
rigidities. As a result, the LDCs are caught up in a dependence and dominance relationship to
rich countries".
 
The structuralist model is divided into two streams of thoughts which are discussed below:
 
3.2.9.1. Neo-Colonial (Neo-Marxist) Dependence Model:
This model is the result of Marxian thinking. This approach is of the view that underdevelopment
of LDCs is due to the historical evolution of a highly unequal international capitalist system of
rich and poor countries relationship. According to this model, the capitalistic system is furnished
with exploitation. As a result, some people get rich while majority of the people suffer from
backwardness due to dependencies.
 
In the same way, the international capitalistic system operates in such a way that the benefits are
accrued by the rich nations of the world. Moreover, the development efforts on the part of LDCs
do not become fruitful because of exploitive international economic system. Paul Baran
explains this theory as:
 

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The certain groups in LDCs like landlords, entrepreneurs, merchants, public officials and trade
union leaders who enjoy high incomes, social status and political power constitute a small elite
ruling class are desirous to perpetuate the international capitalistic system of inequality, perhaps
for their self-interest.
 
These people of LDCs serve, as well as are rewarded by the special interest power groups in the
rich nations which comprise of multinational corporations (MNCs), multi-lateral aid agencies,
IMF and IBRD etc. Their activities and viewpoints often check the reform efforts which can be
beneficial for the majority of the population. Thus, according to

3.2.9.2. Neo-Marxist theory:

 "The poverty of LDCs is attributed to the policies pursued by industrial countries and their
extensions in the form of small, but powerful 'comprador' groups in LDCs".
 
In this respect Dos Santos Writes:
 
"Under-development is a consequence and particular form of capitalist development known as
dependent capitalism. The dependence causes the poor countries to be both backward and
exploited. Dominant countries are endowed with technological, commercial capital and socio-
political pre-dominance over dependent countries. Dependence 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".

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3.2.9.3. False Paradigm Model:
 This approach attributes the underdevelopment of 3rd world countries to inappropriate advice
which is so often given by uniformed international 'experts' and advisors from both developed
countries (DCs) assistance agencies and multi-lateral donor organizations such as; World Bank,
IMF, UNDP, ILO, UNCIEF and FAO etc. These experts offer sophisticated concepts, elegant
models and complex technical methods of Economics and other social sciences which can lead to
inappropriate policies. Because of institutional and structural factors such as the highly unequal
ownership of land, disproportionate control over domestic and international financial assets and
very unequal access to credit etc., these policies often serve the vested interests of existing power
structures, both domestic and global.
 
Moreover, according to this argument, leading university intellectuals, trade unionists, future
high level govt., economists and other civil servants all get their training in developed-country
institutions where they are injected with the foreign ideas, concepts and models which have least
relevance for their own countries. In such state of affairs, the prestigious planning is made which
could safeguard the interests of the elites, whereas the desirable institutional and structural
reforms are neglected, or they are given the least and traditional attention.
 
Both the streams of 'International Structuralist Model' are of the view that it is the capitalism, its
policies and its followers which have promoted the international poverty. Therefore, the
supporters of this model reject the philosophy of accelerating the growth of GNP as an index of
development. On the contrary, they emphasize upon the structural and institutional reforms both

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at domestic and at international level. Such reforms will be helpful in eradicating absolute
poverty, increasing job opportunities, removing the income inequalities, and raising the general
life standard of the masses by providing them necessary food, health care and clean water. Thus,
the structuralists are of the view that the growth does not matter, it is the character of the growth
process itself which counts much so that the wider segments of 3 rd world countries could benefit
from growth.

Check your progress – 3.5

1. Explain the views of dependency theory advocates.

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3.2.10. Neo-Classical Counter Revolution Theory:

Approach to Privatization and Free Market:

During I980's when conservative governments were in power in USa, UK, Canada and Western
Germany the neo-classical counter revolution theory and policy was revitalized. This counter
revolution favored supply-side macro economics and privatization of state-owned corporations in
DCs, and it stressed upon dethronement of public-ownership and govt. regulations in LDCs. This
theory of denationalization under the disguise of privatization, and deregulation got much more
importance in Washington at the headquarters of IMF and IBRD, UNDP and other international

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agencies which are engaged in the stabilization and structural adjustment like programs. Such
neo-classical theory is a reaction to the interventionist arguments of dependence theorists.
 
The Dependencia Models of International Poverty are of the opinion that the poverty of LDCs
can be attributed to exploitation of the poor countries by the rich countries. But the proponents of
neo-classical counter-revolution theory like Lord Peter Bauer, Deepak Lai, Ian Little, Harry
Johnson, Bela Blassa, Julian Simon, Jagdish Bhagwati, and Anne Krueger are of the view that
under-development results from poor resource allocation due to incorrect pricing policies and too
much state intervention on the part of LDCs in their economic activities. Thus it is the state
intervention or the greater role of state in the economic life which has slowed down the pace of
economic growth in the LDCs. Therefore, the non-interventionist or neo-conservatives
emphasize that if free markets are allowed to flourish, public enterprises are privatized, free trade
is promoted consequent upon export expansion, foreign investors are welcomed, plethora of
governments regulations is eliminated, and the price distortions in goods, labor and financial
markets are removed, such all will stimulate economic efficiency and economic growth. Thus
against the view of Dependencia Models whereby poverty of Third World is attributed to
predatory activities of the First World and International Agencies, the neo classical counter-
revolution theory says that:
 
"It is heavy hand of state and corruption, inefficiency and lack of economic incentives that permeate the
economies of LDCs. Therefore, rather reforming international economic system, or restructuring of dualistic
economies, or increasing the flow of foreign aid to LDCs, or attempting to control population growth, or
emphasizing upon more effective central planning the LDCs should stress upon Free-Markets, and Laissez-
Faire Economies".
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The governments of the poor countries should allow the "magic of the market place" and
invisible hand to guide to resource allocation and promote economic development. Thus the neo-
classical counter-revolution theory is an attempt to restore private capitalism through the slogan
of "privatization".
 
The neo-classical economists (counter-revolutionists) give the examples of Asian Tigers (South
Korea, Taiwan, Hong Kong and Singapore etc.) who marvelously stimulated their economics on
the basis of "free markets and price mechanism", whereas the economies of Africa and Latin
America worst failed even they depended upon 'interventionist policies'.
 
The neo-classical challenge to present orthodoxy can be bifurcated into three compositional
approaches, as:
 
3.2.10.1. Free Market Analysis:
 According to this approach, the markets alone are efficient, as the goods markets provide
reasonable signals for investment in new activities. Again, the labor markets show the reaction
properly automatically in new industries. Moreover, the entrepreneurs know better that what to
be produced and how they are to be produced, as the factor and goods prices reflect the true
scarcity of their present and future prices. Even if there is no perfect competition such remains
effective. People have complete freedom to invent new goods. In the same way, each economic
agent easily avails of all information more or less freely. In such like stale of affairs, any govt.
intervention will not only be unproductive but it will also lead to create distortions. Thus the

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development economists who support free markets are of the view that if we implement the free
market economic system all over the world it will result in more efficient situation, and the
market imperfections will be of least importance.
 
3.2.10.2. Public Choice Theory/Modern Political Economy:
 This approach is also known as Modern Political Economy. This theory states that governments
fail to do anything good. As this theory accepts that the politicians, bureaucrats, citizens and the
state function just on the ground of their interests. In other words, they use the government
authority and power for their personal interests. The citizens get their certain objectives (which
are called rent) with their political influence though governments policies, as they are often
found engaged in getting import licenses or scarce foreign exchange . Whereas the politicians use
the government resources to cumulate or maintain their power or authority. While the states are
always found desirous to confiscate private properties. Such all leads to misallocation of
resources as well as losing of personal freedoms. Thus, this theory advocates the limited-or
minimal size of the government.

 3.2.10.3. Market Friendly Approach:

This is a present variant of the Neo-Classical counter revolution theory which is available in the
writing of WB and its economists who were present in the catnips of free markets and public
choice during 1980s. This approach accepts that there do available the imperfections in the
product and factor markets of LDCs. Accordingly, government has to play an important role in
this regard so that the markets could function well. But, the governments will have to play this
role through Market Friendly Approach. As it will have to create a suitable and favorable

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environment for private enterprises by providing them physical infrastructure, health-care and
educational facilities.

The market friendly approach is different from free market approach and the public market
approach, as this theory admits that there is a greater role of market imperfections in the
developing countries, particularly, when we see that there exists lack of coincidence between
investment activities. Again, one finds externalities due to investment. Moreover, the
imperfections are either available in a limited amount, or they remain missing. Furthermore, one
finds externalities regarding learning, and the attainment of scale economies become weaker in
the markets of LDCs.
 
Criticism:

During 1970's Dependence Revolution was observed in the literature of development economics
where the dependence theorists considered underdevelopment as an externally induced
phenomenon. But in 1980's the proponents of free markets brought a counterrevolution which
has been given the name of neo-classical counter-revolution. The neoclassical revisionists
consider underdevelopment as internally induced LDC's phenomenon which is surrounded by
govt. interventionists and bad economic policies. Now there rises the question whether free
markets and less govt. intervention will serve the purpose of attaining economic development on
the part of LDCs. In other words, whether market allocation will perform a better job than state
intervention? The answer is not positive. In this respect following arguments are given.

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The economic, social, political, institutional and organizational structure of LDCs are different
from their western counter parts. Accordingly, the assumptions and policy percepts of neo
classical theory will hardly be applicable in case of LDCs. The LDCs lack competitive markets.
Consumers are not sovereign. The economies of LDCs are furnished with market imperfections.
The markets are fragmented, the limited information are available regarding employment,
investment opportunities and techniques of production. The money market is divided into
organized and unorganized markets. The people are highly illiterate. Their economies are still
non-monetized. The speculative activities are preferred over manufacturing. The land is a token
of prestige, rather a source of income. There exists big divergence in between private benefits
and social benefits. The poor societies have to face both consumption and production
externalities. There exist discontinuities in production and indivisibilities (i.e., economies of
scale) in technology. Producers, whether private and public have a great power in determining
market prices and quantities sold. The Utopia and idealism of competitiveness is hardly available
in LDCs. In case of LDCs the markets are characterized with disequilibrium and structural
bottlenecks.

Accordingly, in these countries the responses to price and wage movements can be "perverse"
(i.e., not in the direction of equilibrium). There exists monopolies in connection with resource
purchase and product sale. In the countries where there is excess supply of labour Lewis model
of unlimited supplies of labor applies, i.e., the unlimited amount of labor is available at the
prevailing wage rate. In such situation, the wages will remain depressed benefiting the profit
earners at the cost of wage earners. Thus the invisible hand in the poor countries will not act to
promote the general welfare but rather it will lift up those who are already well-off by pushing

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down the vast majority. In other words, the resources of the poor economies will shift in favor of
rich elites.

The liberalization of 'International Payments System', i.e. the convertibility of currency in dollar
in poor countries and open sale and purchase of dollars will put them in trouble given a poor
export base and a higher import-base. Again, poor economies do not possess anything to meet
the challenges which would arise after the promulgation of WTO rules. In such state of affairs,
their dependence on international agencies like IMF and IBRD will increase where they will be
victimized by their conditional ties. Such scenario will be nothing more than what has been told
to this by 'the Neo-Marxist theory of growth'.

3.2.11. Modern/New/Endogenous Growth Theory:

 
The traditional neo-classical growth theory stressed upon foreign inflow of capital to meet the
saving gap in LDCs. But practically, such all led to 'debt crises' in Latin American and African
countries etc. during 1980's and 1990's. In such situation the disparities between the rich and the
poor countries widened, rather decreasing. The World Bank and IMF imposed free market
reforms on highly indebted countries. Such all should have promoted the higher investment,
higher productivity and improved standard of living for the masses of the 3 rd world countries. But
after such prescribed liberalization of trade markets, many LDCs experienced little or no growth
and failed to attract new foreign investment or to halt the flight of domestic capital. With this
back ground the economists have presented a new approach to the economics of growth and
development which is known as 'Endogenous Growth' or 'New Growth Theory'. Now we discuss
its features.
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 The New Growth Theory or the Endogenous Growth Theory provides a theoretical framework
to analyze the endogenous growth, i.e., the increase in GNP of a country. Here the growth of
GNP depends upon the system of production function where the variables of the system are
endogenous rather than exogenous. Contrary to traditional neo-classical growth theory the
supporters of the New Growth Theory are of the view that the increase in the GNP of a country is
the natural result of long run equilibrium. The endogenous growth theory analyses what
determines the growth rate in a country and why the growth rates differ among the countries. In
other words, in this theory, it is analyzed that what are the determinants of the rate of growth of
GDP which Solow calls Residual Factor in his model.
 
Difference between Old and New Growth Theories:
 Despite certain resemblances with neo-classical theory, the new growth theory is different from
the neo-classical theory on the basis of its assumptions and implications. The differences in these
two theories occur due to three factors:
 
(i) The new growth theory rejects the neo-classical assumption that the marginal returns decrease
along with increase in investment.
 (ii) This theory stresses upon increasing returns to scale.
 (iii) The externalities also play their role in the determination of returns from investment.
 
As the supporters of this theory are of the opinion that there arise so many externalities due to
public and private investment in human capital. They increase productivity. Hence, the natural
tendency of falling or diminishing returns can be checked. Thus, when there applies increasing

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returns to scale, the incomes of the countries will move away from equilibrium levels of the
income. The role of technology in the endogenous growth theory, but it does not play necessary
role in the determination of equilibrium level of national income.

Like H-D model, the new growth theory is also expressed with this simple equation:
Y = AK
Where A is some factor which influences technology, while K represents the physical and human
capital. This equation does not show the decreasing returns from the capital. Thus there exists the
possibility that because of investment in physical and human capital the External Economies and
Productivity increases could occur which offset the decreasing returns. As a result, an economy
experiences a sustainable growth in long run which is not accepted by traditional growth theory.
 
The new growth theory, in order to attain rapid economic growth not only stresses upon the
capital formation in human capital and savings, but it also describes following implications for
growth which are contrary to the traditional theory.
 
(i) In closed economies there does not exist any force which could take the economy to
equilibrium level.
(ii) National growth rates remain constant and differ across countries depending upon national
saving rates and technology levels.
(iii) There is no tendency for per capita income levels in capital poor countries to catch up with
those in rich countries with similar saving rates. As a result of these facts a temporary or a

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 prolonged recession in one country leads to a permanent increase in the income gap between
itself and the richest countries.

The different models of 'New Growth' theory also give this view that the international capital
flows increase the wealth disparities between the First World and Third World. This theory thinks
that the expected higher rates of return on investment in LDCs which have low K/L may be
offset by the lower levels of 'Complementary Investments' in human capital (education and
training), infra-structure and research and development. Again, it has also been found out that the
poor countries benefit less from the capital expenditures made on human capital formation etc.
As the individuals receive no personal gain from the positive externalities created by their own
investments, the free market leads to the accumulation of less than the optimal level of
complementary capital.

Where complementary investments produce social as well as private benefits, governments may
improve the efficiency of resource allocation by providing public goods or encouraging private
investment. Therefore, the new growth theory on the contrary to counter revolution theory,
suggests for an active role for public policy in promoting economic development. Thus, the new
growth theory, despite similarities with neo-classical theory, is a departure, from dogma of 'free
markets' and 'passive role of governments'.
 
According to New Growth Theory (NGT), the complementarily investment results in private and
public investment. The complementarily investment can do so by providing infrastructure and

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promoting private investment in knowledge-based industries. As a result, not only the human
capital formation will increase, but increasing returns will also emerge.
 Thus, quite against Solow model, the models of NGT accord the technical progress as an
endogenous result of public and private investment in human capital and the existence of
knowledge-based industries. Hence, the NGT models emphasize upon enhancing investment in
human capital directly and indirectly for the sake of economic growth. Again, these models
encourage the foreign direct investment in the fields of computer software while establishing
knowledge or information-based industries.

Criticism of New Growth Theory:

(i) The main flaw of NGT is this that it is also based upon so many traditional neoclassical
assumptions which are not applicable in case of LDCs. As, here it has been assumed that there is
a single production sector or all the industries are alike. Therefore, because of growth, the re-
allocation of labor and capital amongst different industries and sectors is not entertained by the
NGT. Moreover, in case of LDCs, the economic growth is also affected by weak infrastructure,
inadequate institutional setup and ineffective capital and goods markets. As the NGT ignores
such like powerful factors, therefore, when we analyze the growth rate of different countries, we
will not be able to implement this theory.
 
(ii) The backward countries are not only poor because of reduced savings and investment in
human capital but also because they have a backward system of incentives. The developing
countries often experience the allocate inefficiencies, particularly when they transform
themselves from traditional economists to commercialized market system.

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(iii) The NGT is concerned with the determination of long run growth rate whereas as far as
developing countries are concerned, it is more important for them to determine the short term
and medium term growth rate. Moreover, the NGT fails to get the empirical support.

3.3 Summary and conclusion

 Both economic and social factors are equally important for economic growth and
development of a country. Where economic resources are available naturally or man made,
and social factors are conducive for development, high level of economic growth or
development can be achieved. Where these two factors are lacking growth and development
is lagging behind.

3.4 Key Terms

 Linear stages of growth models  Lewis two-sector model

 Marginal product
 Structural change models
 Market failure
 Dependence
 Neoclassical
 Dominance counterrevolution
 Dualism  Neocolonial dependence model
 False-paradigm model
 Free market  Periphery
 Free-market analysis  Production function
 Public-choice theory
 Harrod-Domar growth model
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Stages-of-growth model of developmen

t
3.5. Answer to Check Your Progress Exercise

Answers to check your progress exercise 3.1

1. The major economic factors are natural resources, human resources, physical capital and
technology. These resources are of key significance, particularly in the beginning phase of
economic growth of a country or nation. Time has passed, in the present day development of an
economy non availability of natural resources cannot limit the development or the growth
process of a nation, simply because of the availability of manmade resources or inputs and
many wyes of getting resources for development from the rest of the world, when not available
within a country.

Availability of economic factors alone cannot ensure economic growth and development in an
economy. Besides economic factors, (technical inputs), appropriate institutional and social
factors like cultural values, attitudes to work and growth, motivations and aspirations,
(entrepreneurships and innovation reactivity), are some of the most important social factors that
enhance and promote the growth and development processes of a country’s economy.

2. As already explained above, both the economic factors and social factors are equally
enhance and promote economic growth and development. When there is a deficiency in any one
of them the growth and development process lags behind. Hence, availability of natural
resources alone cannot bring growth and development in a country or in any economy. It is like

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the two fingers of a scissor, that if one of the two fingers has a problem, the scissor cannot cut
into pieces what we wanted to cut.

Answer to check your progress exercise 3.2

1. Professor Rostow analyzed the five stages that a country’s economy passes in its development
effort as (i) Traditional society or economy (ii) Pre-industrial stage or pre-conditioning for Take-
off stage (iii) Take-off stage (iv) “Drive to Maturity stage.” (v) Age of High Mass consumption
In each stage there are conditions that are required to develop before transformation to the next
stage. Rostow has provided in his analysis the time spend of the already highly developed
countries like U.K., U.S.A., France, Canada, and others for their “take-off” and “Maturity stage”
periods. However, he is not again free from certain criticisms.

2. Particularly, the “Take-off stage” of Rostow is believed to be applicable to today’s developing

economies, because it deals with mobilization of available resources for development and the
selection of “leading sectors” in an economy to produce surplus and increase investment in the
industrial sector in particular to bring a sustained development. With this, an economy can grow
its output and bring structural changes which is the “Take-off stage.”

Answer to check your progress exercise 3.3

1. Economist like Nurkse have suggested a lump sum of investment in many industries which
can be complements to each other to be invested simultaneously in these industries and produce
goods which have markets in the society. Such investment can break the vicious circle poverty or

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deficiency of capital in low income countries and can bring the initial growth of the economy.
Hence, according to these economists, a bit by bit approach cannot bring growth and
development in a backward economy. The problem is where to get the lump sum, (huge
investment), by these capital deficiency backward economies.
Other economists like Hirschman, who is an advocate of the unbalanced growth theory,
confirms, that developing countries cannot afford to get a lump sun investment fund, hence the
best alternative is to apply the unbalanced growth theory in their investment activities. Leading,
(surplus potential), sectors should be carefully selected in the economy, and that available
resource be invested in these sectors and produce surplus in the economy. Then, the surplus
produced can be again reinvested into these primary sectors in the economy so that more surplus
is produced, this cycle of operation leads to capital accumulation which will be invested in other
sectors and finally leads to economic growth and development of the national economy.

Answer to check your progress exercise 3.4

1. Social overhead capital, (SOC), is the basic infrastructural facilities such as power,
communications, roads, bridges, canals, airports etc. which are the basic minimum means for
investment or development. The government of a country has the responsibility to build such
infrastructural facilities. The government can obtain resources for building SOC, through loans,
aid or even domestic borrowings.

2. If farmers’ income increases because of improvements in farm inputs, (fertilizer, high breed
seeds, better farm implements etc.), then the farmers’ demand for consumer goods increases and
there will be a high demand for manufactured goods. To satisfy this demand investors increase

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their investment level and produce more consumer goods, hence there will be an expansion in
manufacturing industries which in turn creates or increases the demand for raw materials which
are inputs to the sector. In this, way forward and backward linkage in industrial development
continues to expand. However, the proper selection of such industrial establishments which
creates forward and backward linkages between the enterprises is the most important task.

Answer to check your progress exercise 3.5

1. The developing or the underdeveloped world depends on the economy of the developed
world for its development and well-being. It is world capitalism that resulted in the
development of the developed world and at the same in the underdevelopment of the
developing world – through exploitation of labor by capital and accumulation of the surplus to
one part of the Globe at the cost of the other part of the Globe. Dependency, according to
Dependency theorists, is not simply lack of means of production, but it has become a way of
life, that the dependent has become subordinate to the developed economy with surplus capital,
higher technology and owner of research and development.

3.6. Review Exercises

I. Attempt the following essay questions:

1. Compare and contrast the balanced growth with that of the unbalanced growth theory
2. What is capital? Explain the importance of capital to economic development
3. Explain how surplus labor can be used for accumulation of capital
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II. Give short or brief explanations for each of the following

1. Does an increase in savings cause an increase in capital formation?

2. Explain the balanced growth theory
3. Explain Hirschman’s idea of unbalanced growth
4. Social overhead capital and directly productive activities
5. Explain how a rapid population growth/unlimited supply of labor/is both a burden and a
blessing at the same time, to economic development of the country concerned.

3.7. References:

 Todaro,M.,(1994)EconomicDevelopment,Fiftheditions,Longman:NewYork and London.

 TodaroM.P.&SmithS.C.(2006)DevelopmentEconomics,Ninthedition,Harlow, Pearson &
Addison Wesley:London.
 Ray, D.(1998) Development Economics, Princeton University Press.

MODULE 4: HISTORIC GROWTH AND CONTEMPORARY DEVELOPMENT:

LESSONS AND CONTROVERSIES (6 hrs)

Contents:

4.0 Aims and Objectives

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4.1. Historic Growth and Contemporary Development: Lessons, controversies, and Relevance
4.1.1 The Growth Game
4.1.2 The Economics of Growth: Capital, Labor, and Technology
4.1.2.1 What is Capital Accumulation?
4.1.2.2 Population and Labor Force Growth
4.1.2.3 Technological progress
4.1.3 The Historical Record: Kuznets’s Six Characteristics of Modern Economic
Growth
4.1.3.1 High Rates of Per Capita Output and Population Growth
4.1.3.2 High Rates of Total Factor Productivity Increase
4.1.3.3 High Rates of Economic Structural Transformation
4.1.3.4 High Rates of Social, Political, and Ideological Transformation
4.1.3.5 International Economic outreach
4.1.3.6 Limited International Spread of Economic Growth
4.1.4 The Limited Value of the Historical Growth Experience: Differing Initial
Conditions
4.1.4.1 Physical and Human Resource Endowments
4.1.4.2 Relative Levels of per Capita Income and GNP
4.1.4.3 Climatic Differences
4.1.4.4 Population Size, Distribution, and Growth
4.1.4.5 The Historical Role of International Migration
4.1.4.6 The Growth Stimulus of International Trade
4.1.4.7 Stability and Flexibility of Political and Social Institutions

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 4.1.5 Why is not Africa (sub – Sahara Africa) Growing?
4.1.5.1 Is SSA's Economic Growth Constrained by Too Little Human Capital?
4.1.5.2 Globalization and SSA
4.1.5.3 Is There Too Much Inequality in Sub-Saharan Africa?
4.1.5.4 Reviewing Economic Growth in Sub-Saharan Africa
4.1.6 Many paths to development (Alternative Growth Strategies)

4.1.6.1 Classification of strategies

4.2 Summary and conclusion

4.3 Key Terms
4.4 Answer to Check Your Progress Exercise
4.5 Review Exercises
4.6 References

4.0 Aims and Objectives

In this chapter we will briefly look into some basic concepts of the theory of economic growth
using simple production function. This will complement our previous understanding on how to
link production with economic growth. We will use this preliminary knowledge to look into the
historic growth process and records of contemporary developed countries to analyze important
economic, structural and institutional components that characterize rich countries and deduce on
the relevance of this historical growth experiences and the development policies to the plans and
strategies of developing nations of today. To build our theoretical knowledge, we will discuss
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why economic growth in sub-Sahara Africa is slow and then we will review alternative growth
strategies that developing countries could adopt to impart positive change to the socio-economic
environment in which their citizens live.

After completing this chapter you will be able to:

 You will be acquainted with the basic components of economic growth (capital
accumulation, growth in labour force, and technology) and analyze how important they
are for any society.
 You will understand the economic, institutional and structural characteristics that
facilitated the historic growth experience of contemporary developed nation.
 Analyze the relevance of the historic growth process to the current prospects of
developing countries.
 Understand why economic growth is slow? or why economic decline in Africa?
 You will be able to compare the relevance of alternative development strategies to the
realities of developing countries.

4.1. Historic Growth and Contemporary Development: Lessons, controversies, and

Relevance

4.1.1 The Growth Game

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For the past four decades, a primary focus of world economic attention has been on ways to
accelerate the growth rate of national income. Economists and politicians from all nations, rich
and poor, capitalist, socialist, and mixed, have worshipped at the shrine of economic growth.
Third world development programs are often assessed by the degree to which their national
outputs and incomes are growing and in one way or another they were forced to follow the
footsteps of the growth strategies of contemporary rich countries. In fact, for many years the
conventional wisdom equated development almost exclusively with the rapidity of national
output growth.

4.1.2 The Economics of Growth: Capital, Labor, and Technology

Three factors or components of economic growth are of prime importance in any society:
1. Capital accumulation, including all new investments in land, physical equipment, and human
resources
2. Growth in population and hence eventual growth in the labor force
3. Technological progress

Now let us look briefly at each.

4.1.2.1 What is Capital Accumulation?

Capital accumulation results when some proportion of present income is saved and invested in
order to augment future output and income. New factories, machinery, equipment, and materials
increase the physical capital stock of a nation (the total net real value of all physically productive
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capital goods) and make it possible for expanded output levels to be achieved. These directly
productive investments are supplemented by investments in what is known as social and
economic infrastructure - roads, electricity, water and sanitation, communications, and the like-
which facilitates and integrates economic activities. For example, may increase the total output
of the vegetables he can produce, but without adequate transport facilities to get this extra
product to local commercial markets, his investment may not add anything to national food
production.

For example, investment by a farmer in a new tractor, the supply of irrigation facilities, use of
chemical fertilizers and the control of insects with pesticides improve the quality of existing land
resources. Similarly, investment in human resources can improve its quality and thereby have the
same or even a more powerful effect on production as an increase in human numbers. Formal
schooling, vocational and on-the-job training programs, and adult and other types of informal
education may all be made more effective in augmenting human skills and resources as a result
of direct investments in buildings, equipment, and materials.

All of these phenomena and many others are forms of investment that lead to capital
accumulation. Capital accumulation may add new resources (e.g., the clearing of unused land) or
upgrade the quality of existing resources (e.g., irrigation, fertilizer, pesticides).

Check your progress exercise 4.1

1. Explain how capital accumulation and technological progress contribute to development
process of a nation.

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4.1.2.2 Population and Labor Force Growth

In traditional economics, population growth, and the associated eventual increase in the labor
force has been considered a positive factor in stimulating economic growth. A larger labor force
means more productive workers, and a large overall population increases the potential size of
domestic markets. However, the role of growing supplies of workers in surplus-labor developing
countries will depend on the ability of the economic system to absorb and productively employ
these added workers – an ability largely associated with the rate and kind of capital accumulation
and the availability of related factors, such as managerial and administrative skills. Now
disregarding for a moment the third (technology), and given an initial understanding on the first
two (capital accumulation and labour force growth), let us see how they interact via the
production possibility curve to expand society’s potential total output of all goods.

For a given technology and a given amount of physical and human resources, the production
possibility curve portrays the maximum attainable output combinations of any two commodities,
say, rice and radios, when all resources are fully and efficiently employed. Figure 4.1 shows two
production possibility curves for rice and radios. Suppose now that with unchanged technology,
the quantity of physical and human resources were to double as a result of either investments that
improved the quality of the existing resources or investment in new resources – land, capital,
and, in the case of larger families, labor. Figure 4.1 shows that this doubling of total resources
will cause the entire production possibility curve to shift uniformly outward from pp to p’p’.

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Because these are assumed to be the only two goods produced by this economy, it follows that
the gross national product (the total value of all goods and services produced) will be higher than
before. In other words, the process of economic growth is under way.

Figure 4.1: Effect of increases in Physical and Human Resources on the Production Possibility
Frontier
Note that even if the country in question is operating with underutilized physical and human
resources as at point X in Figure 4.1, a growth of productive resources can result in a higher total
output combination as at point X’, even though there may still be widespread unemployment and
underutilized or idle capital and land.

Check your progress exercise 4.2

1. Discuss how growth in population influences the overall economic development of a country.
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4.1.2.3 Technological progress
Technological progress, for many economists is the most important source of economic growth.
In its simplest form, technological progress results from new and improved ways of
accomplishing traditional tasks such as growing crops, making clothing, or building a house.
There are three basic classifications of technological progress: neutral, laborsaving, and capital-
saving.

Natural technological progress occurs when higher output levels are achieved with the same
quantity and combinations of factor inputs. Simple innovations like those that arise from the
division of labor can result in higher total output levels and greater consumption for all
individuals. In terms of production possibility analysis, a neutral technological change that, say,
doubles total output is conceptually equivalent to a doubling of all productive inputs. The
outward-shifting production possibility curve of Figure 4.1 could therefore also be a
diagrammatic representation of neutral technological progress.

By contrast, progress may either be laborsaving or capital-saving technological progress (i.e.,

higher levels of output can be achieved with the same quantity of labor or capital inputs).
Modern machinery and equipment can be classified as products of laborsaving technological
progress. Capital-saving technological progress is a much rarer phenomenon. But this is
primarily because almost all of the world’s scientific and technological research is conducted in
developed countries, where the mandate is to save labor, not capital.

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In the labor-abundant (capital-scarce) countries of the Third world, however, capital saving
technological progress is what is needed most. Such progress results in more efficient (lower-
cost) labor-intensive methods of production such as foot-operated bellows pumps, and back
mounted mechanical sprayers for small-scale agriculture. Indigenous LDC development of low-
cost, efficient, labor-intensive (capital – saving) techniques of production is one of the essential
ingredients in any long-run employment-oriented development strategy.

Check your progress exercise 4.3

1. Discuss whether there is any deterministic relationship (law) between resource growth and
output growth. What is the short-run and long-run effect of existing potential resource?

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4.1.3. The Historical Record: Kuznets’s Six Characteristics of Modern Economic Growth

Now, let us discuss the most important factors that have facilitated the growth process of
contemporary developed countries (rich countries) since the 1770s. Professor Simon Kuzents has
developed pioneering work in the measurement and analysis of the historical growth of national
incomes in developed nations. He defined a country’s economic growth as “a long-term rise in
capacity to supply increasingly diverse economic goods to its population. According to him, this
growing capacity depends on advancing technology and the institutional and ideological
adjustments that it demands. Now let us critically look all three principal components of his
definition
1. The sustained rise in national output is a manifestation of economic growth, and the ability to
provide a wide range of goods is a sign of economic maturity.
2. Advancing technology provides the basis or preconditions for continuous economic growth – a
necessary but not sufficient condition.
3. To realize the potential for growth inherent in new technology, institutional, attitudinal, and
ideological adjustments must be made. Technological innovation without associated social
innovation will be meaningless.

In his exhaustive analysis, Kuznets has isolated six characteristic features manifested in the
growth process of almost every developed nation: high rates of growth of per capita output and
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population; high rates of increase in total factor productivity; high rates of structural
transformation of the economy; high rates of social and ideological transformation; the
propensity of economically developed countries to reach out to the rest of the world for markets
and raw materials; the limited spread of this economic growth to only a third of the world’s
population.

Let us briefly examine each of these five characteristics.

4.1.3.1 High Rates of Per Capita Output and Population Growth

In the case of both per capita output and population growth, all contemporary developed
countries have experienced large multiples of their previous historical rates during the epoch of
modern economic growth, roughly form around 1770 to the present. For the now industrialized
countries, annual growth rates over the past 200 years averaged almost 2% for per capita output
and 1% for population, or 3% for total output (real GNP). These rates, which imply a doubling
time of roughly 36 years for per capita output, 72 years for population, and 24 years for real
GNP, were far greater than those experienced during the entire era before the industrial
revolution began in the late eighteenth century.

4.1.3.2 High Rates of Total Factor Productivity Increase

The second aggregate economic characteristic of modern growth is the relatively high rate of rise
in total factor productivity (TFP), the output per unit of all inputs. Many finding have confirmed
that total factor productivity growth is what determines the rate of growth in developing
countries. Because TFP shows the efficiency with which all inputs are used in a production
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function, economists often measure its growth separately from the growth of factor inputs. An
increase in TFP would cause the production possibility frontier to shift outward without any
increase in labor or capital. Kuznets found substantial rises in TFP during the modern growth era.

4.1.3.3 High Rates of Economic Structural Transformation

The historical growth record of contemporary developed nations reveals a third important
characteristic: a high rate of structural and sectoral change inherent in the growth process. Some
of the major components of this structural change include the gradual shift away from
agricultural to nonagricultural activities and, more recently, away from industry to services; a
significant change in the scale or average size of productive units (away from small family and
personal enterprises to the impersonal organization of huge national and multinational
corporations); and finally, a corresponding shift in the spatial location and occupational status of
the labor force away from rural, agricultural, and related nonagricultural activities toward urban
oriented manufacturing and service pursuits. For example, in the United State, the proportion of
the total labor force engaged in agricultural activities was 53.5% in 1870. By 1960, this figure
had declined to less than 7%.

4.1.3.4 High Rates of Social, Political, and Ideological Transformation

For significant economic structural change to take place in any society, concomitant
transformations in attitudes, institutions, and ideologies are often necessary. Obvious examples
of these social transformations are the general urbanization process and the adoption of the
ideals, attitudes, and institutions of what has come to be known as “modernization.” Gunnar

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Myrdal has provided a list of these modernization ideals in his seminal treatise on
underdevelopment in Asia. They include the following:

1. Rationality- the substitution of modern methods of thinking, acting, producing, distributing,

and consuming for age-old, traditional practices. Accordingly, what underdeveloped nations
need is a scientific and technological society. It employs new techniques which follows
modern thinking. In addition the quest for rationality implies that opinions about economic
strategies and policies should be logically valid inferences rooted as deeply as possible in
knowledge of relevant facts.
2. Economic planning- the search for a rationally coordinated system of policy measures that
can bring about and accelerate economic growth and development
3. Social and economic equalization- the promotion of more equality in status, opportunities,
wealth, incomes, and levels of living.
4. Improved institutions and attitudes- necessary to increase labor efficiency and diligence;
promote effective competition, social and economic mobility, and individual enterprise;
permit greater equality of opportunities; make possible higher productivity; raise levels of
living; and promote development.

Among the social institutions needing change are outmoded land tenure systems, social and
economic monopolies, educational and religious structures, and systems of administration and
planning. In the area of attitudes, the concept of “modern workers” embodies such ideals as
efficiency, diligence, orderliness, punctuality, frugality, honesty, rationality, change orientation,
integrity and self-reliance, cooperation, and willingness to take the long view.

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4.1.3.5 International Economic outreach
These relates to the historical and ongoing propensity of rich countries to reach out to the rest of
the world for primary products and raw materials, cheap labor, and lucrative markets for their
manufactured products. Such outreach activities are made feasible by the increased power of
modern technology, particularly in transport and communication. The propensity of rich
countries to look outwards also opened the possibilities for political and economic dominance of
poor nations by their more powerful neighbors.

4.1.3.6 Limited International Spread of Economic Growth

In spite of the enormous increases in world output over the past two centuries, the spread of
modern economic growth is still largely limited to less than one-fourth of the world’s population.
The minority of the world’s population enjoys almost 80% of the world’s income. Moreover,
unequal international power relationships between developed and underdeveloped countries have
a tendency to exacerbate the gap between rich and poor. The further economic growth of the
former is sometimes achieved at the expense of the growth of the latter.

The six characteristics of modern growth reviewed here are interrelated and mutually
reinforcing. High rates of per capita output result from rapidly rising levels of factor productivity.
High per capita incomes in turn generate high levels of per capita consumption, thus providing
the incentives for changes in the structure of production (because as incomes rise, the demand for
manufactured goods and services rises at a much faster rate than the demand for agricultural
products). Advanced technology needed to achieve these output and structural changes causes

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the scale of production and the characteristics of economic enterprise units to change in both
organization and location. This in turn necessitates rapid changes in the location and structure of
the labor force and in status relationships among occupational groups. It also means changes in
other aspects of society, including family size, urbanization, and the material determinants of
self-esteem and dignity. Finally, the inherent dynamism of modern economic growth, coupled
with the revolution in the technology of transportation and communication, necessitates an
international outreach on the part of the countries that developed first. But the poor countries
affected by this international outreach may for institutional, ideological, or political reasons
either not be in a position to benefit from the process or simply be weak victims of the policies of
rich countries designed to take advantage of them economically.

Check your progress exercise 4.5

1. Analyze how the six characteristics conditions have reinforced each other to speed-up or
facilitate economic growth in the contemporary rich counties.
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4.1.4 The Limited Value of the Historical Growth Experience: Differing Initial Conditions

One of the principal failures of development economics of the 1950s and 1960s was its inability
to recognize and take into account the limited value of the historical experience of economic
growth in the west for charting the development path of contemporary developing nations.
Stages-of-growth economic theories and related models of rapid industrialization discussed in
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the previous unit gave too little emphasis to the very different and less favorable initial
economic, social, and political conditions of developing countries. The fact is that the growth
position of these countries today is in many important ways significantly different from that of
the currently developed countries when they embarked on their era of modern economic growth
prospects and requirements of modern economic development. The differences are in terms of
physical and human resource endowments; per capita incomes and levels of GNP in relation to
the rest of the world; climate; population size, distribution, and growth; historical role of
international migration; international trade benefits; basic scientific and technological research
and development capabilities; and stability and flexibility of political and social institutions.

Let us discuss each of these conditions with a view to formulating a more realistic set of
requirements and priorities for generating and sustaining economic growth in the twenty-first
century.

4.1.4.1 Physical and Human Resource Endowments

Contemporary developing countries are often less well endowed with natural resources than the
currently developed nations were at the time when the latter nations began their modern growth.
A few developing nations are blessed with abundant supplies of petroleum, other minerals, and
raw materials for which world demand is growing; most less developed countries, however-
especially in Asia, where almost one-third of the world’s population resides- are poorly endowed
with natural resources. Moreover, in parts of Latin America and Africa, where natural resources
are more plentiful, heavy investments of capital are needed to exploit them. Such financing is not
easy to come by without sacrificing substantial autonomy and control to the powerful developed-

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country multinational corporations that alone are currently capable of large-scale, efficient
resource exploitation.

The difference in skilled human resource endowments is even more pronounced. The ability of a
country to exploit its natural resources and to initiate and sustain long-term economic growth is
dependent on, among other things, the ingenuity and the managerial and technical skills of its
people and its access to critical market and product information at minimal cost. The populations
of today’s developing nations are generally less educated, less informed, less experienced, and
less skilled than their counterparts were in the early days of economic growth in the West.

According to economist Paul Romer, today’s developing nations “are poor because their citizens
do not have access to the ideas that are used in industrial nations to generate economic value. For
Romer, the technology gap between rich and poor nations has two components, a physical object
gap, involving factories, roads, and modern machinery, and an idea gap, including knowledge
about marketing, distribution, inventory control, transactions processing, and worker motivation.
It is idea gap between rich and poor nations that lies at the core of the development divide.

4.1.4.2 Relative Levels of per Capita Income and GNP

The four-fifths of the world’s population at present living in developing countries have on the
average a much lower level of real per capita income than their counterparts had in the
nineteenth century. Over 70% of the population of Third World countries is attempting to subsist
at bare minimum levels. Obviously, the average standard of living in, say, early nineteenth-
century England was nothing to envy or boast about, but it was not as economically debilitating

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or precarious as it is today for most people in the Third world, especially those in the 40 or so
least developed countries.

Second, at the beginning of their modern growth era, today’s developed nations were
economically in advance of the rest of the world. They could therefore take advantage of their
relatively strong financial position to widen the income gaps between themselves and less
fortunate countries. By contrast, today’s LDCs begin their growth process at the low end of the
international per capita income scale. Not only is such backwardness economically difficult to
overcome or even reduce, but psychologically it creates a sense of frustration and a desire to
grow at any cost. This can in fact inhibit the long-run improvement in national levels of living.

4.1.4.3 Climatic Differences

Almost all developing countries are situated in tropical or subtropical climatic zones. It has been
observed that the economically most successful countries are located in the temperate zone. This
indicates some relation to the special difficulties caused directly or indirectly by differing
climatic conditions. It is undeniable that the extremes of heat and humidity in most poor
countries contribute to deteriorating soil quality and the rapid depreciation of many natural
goods. They also contribute to the low productivity of certain crops, the weakened regenerative
growth forests and the poor health animals. Finally, extremes of heat and humidity not only
cause discomfort to workers but can also weaken their health, reduce their desire to engage in
strenuous physical work, and generally lower their levels of productivity and efficiency.

4.1.4.4 Population Size, Distribution, and Growth

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Third World population size, density, and growth constitute another important difference
between less developed and developed countries. Before and during their early growth years,
Western nations experienced a very slow rise in population growth. As industrialization
proceeded, population growth rates increased primarily as a result of falling death rates but also
because of slowly rising birthrates. However, at no time during their modern growth epoch did
European and North American countries have natural population growth rates in excess of 2%
per annum.

By contrast, the populations of many developing countries have been increasing at annual rates
in excess of 2.5% over the past few decades, and some are rising even faster today. Moreover,
the concentration of these large and growing populations in a few areas means that most LDCs
today start with considerably higher person-to-land ratios than the European countries did in
their early growth years.

4.1.4.5 The Historical Role of International Migration

Of perhaps equal historical importance to the differing rates of natural population increase is the
fact that in the nineteenth and early twentieth centuries, there was a major outlet for excess rural
populations in international migration, which was both widespread and large-scale. In countries
such as Italy, Germany, and Ireland, periods of severe famine or pressure on the land often
combined with limited economic opportunities in urban industry to push unskilled rural workers
toward the labor-scare nations of North America and Australia.

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The period since the Second World War has witnessed a resurgence of international migration
within Europe itself, which is essentially over short distances and to a large degree temporary.
However, the economic forces giving rise to this migration are basically the same; that is, during
the 1950s and especially the 1960s, surplus rural workers from southern Italy, Greece, and
Turkey flocked into areas of labor shortages, most notably West Germany and Switzerland. This
migration provided a valuable dual benefit to the relatively poor areas from which these
unskilled workers migrated. The home governments were relieved of the costs of providing for
people who in all probability would remain unemployed, and because a large percentage of the
workers’ earnings were sent home, these governments received a valuable and not insignificant
source of foreign exchange.

Then, you might reasonably ask why the large numbers of poor and less educated peoples in
Africa, Asia and Latin America do not follow the example of workers form southeastern Europe
and seek temporary or permanent jobs in areas of labor shortage. There is very little scope for
reducing the pressures of overpopulation in Third World countries today through massive
international emigration. The reasons for this relate not so much to a lack of local knowledge
about opportunities in other countries as to the combined effects of geographic (and thus
economic) distance and, more important, the very restrictive nature of immigration laws in
modern developed countries.

Despite these rustications, at least 46 million legal and illegal migrants from the developing
world have managed to migrate to the developed world since 1960. From the point of view of
recipient industrialized nations, the problem of illegal Third World migrants has become so

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serious that drastic action is being called for. These migrants are perceived as taking jobs away
from poor, unskilled citizen workers. Moreover, illegal migrants and their families are believed
to be taking unfair advantage of free local health, educational, and social services, causing
upward pressure on local taxes to support these services. As a result, major debates are now
under way in both the United States and Europe regarding the treatment of illegal migrants.
Then again ask yourself “what is so unique in the modern international migration?”

The irony of international migration today, however, is not merely that this traditional outlet for
surplus people who migrate legally from poor to richer lands are the very ones that developing
countries can least afford to lose: the highly educated and skilled. Since the great majority of
these migrants move on a permanent basis, this perverse brain drain not only represents a loss of
valuable human resources but could prove to be a serious constraint on the future economic
progress of Third World nations. For example, by the late 1980s, Africa had lost nearly one-third
of its skilled workers, with up to 60,000 middle and high-level managers migrating to Europe
and North America between 1985 and 1990. Sudan, for example, lost 17% of its doctors and
dentists, 20% of its university teachers, 30% of its engineers, and 45% of its surveyors and 60%
of Ghanaian doctors now practice abroad.

4.1.4.6 The Growth Stimulus of International Trade

International free trade has often been referred to as the “engine of growth” that propelled the
development of today’s economically advanced nations during the nineteenth and early twentieth
centuries. Rapidly expanding export markets provided an additional stimulus to growing local
demands that led to the establishment of large scale manufacturing industries. Together with a
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relatively stable political structure and flexible social institutions, these increased export earnings
enabled the developing country of the nineteenth century to borrow funds in the international
capital market at very low interest rates. This capital accumulation in turn stimulated further
production, made possible increased imports, and led to a more diversified industrial structure. In
the nineteenth century, European and North American countries were able to participate in this
dynamic growth of international exchange largely on the basis of relatively free trade, free
capital movements, and the unfettered international migration of unskilled surplus labor.

Today developing countries face formidable difficulties in trying to generate rapid economic
growth on the basis of world trade. Many developing countries have experienced a deteriorating
trade position. Their exports have expanded, but usually not as fast as the exports of developed
nations. Their terms of trade (the price they receive for their exports relative to the price they
have to pay for imports) have declined steadily. Export volume has therefore had to grow faster
just to earn the same amount of foreign currencies as in previous years. Moreover, the developed
countries through their advanced science and technology remain more competitive, develop more
new products, and obtain international financing on much better terms. Finally, where
developing countries are successful at becoming lower-cost producers of competitive products
with the developed countries, the latter have typically resorted to various forms of tariff and non-
tariff barriers to trade, including import quotas, sanitary requirements, and special licensing
arrangements.
4.1.4.7 Stability and Flexibility of Political and Social Institutions

The final distinction between the historical experience of developed countries and the situation
faced by contemporary developing nations relates to the nature of social and political institutions.
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One very obvious difference between the now developed and the underdeveloped nations is that
well before their industrial revolutions, the former were independent consolidated nation-states
able to pursue national policies on the basis of consensus toward modernization. Modern
scientific thought developed in these countries (long before their industrial revolutions) and a
modernized technology began early to be introduced in their agriculture and their industries,
which at that time were all small scale.

In contrast, Third World countries of today have only recently gained political independence and
have yet to become consolidated nation - states with an effective ability to formulate and pursue
national development strategies. Moreover, the modernization ideals embodied in the notions of
rationalism, scientific thought, individualism, social and economic mobility, the work ethic, and
dedication to national material and cultural values are concepts largely alien. Until stable and
flexible political institutions can be consolidated with broad public support, the present social
and cultural fragmentation of many developing countries is likely to inhibit their ability to
accelerate national economic progress.

The critical importance of political stability for economic growth is underlined by a number of
recent quantitative studies. Researchers have found that growth is more influenced by the
stability of the political regime than by its type (democracy or dictatorship). They also found that
in the transition from dictatorship to democracy, the tremendous pressures from competing
interest groups tend to slow down economic growth, but in the longer run, stable democracies
experience higher growth than dictatorships.

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We may conclude that due to very different initial conditions, the historical experience of
Western economic growth is of only limited relevance for contemporary Third World nations.
Nevertheless, one of the most significant and relevant lessons to be learned from this historical
experience is the critical importance complementary technological, social, and institutional
changes, which must take place if long-term economic growth is to be realized. Such
transformations must occur not only within individual developing countries but, perhaps more
important, in the international economy as well. In other words, unless there is some major
structural, attitudinal, and institutional reform in the world economy, one that accommodates the
rising aspirations and rewards the outstanding performances of individual developing nations,
internal economic and social transformation within the Third World may be insufficient.

4.1.5 Why is not Africa (sub – Sahara Africa) Growing?

In the 1950s and 1960s, sub-Saharan Africa (SSA) held great promise. Countries in the region
had natural resources, extensive land, and in many cases peasant agriculture that seemed to fit
well with capitalist development. Two world wars had left SSA generally unscathed; destructive
civil wars had been uncommon and independence brought a wave of optimism that anything
could be achieved. But the promise has gone unfulfilled. Modern economic growth has
succeeded in raising the well-being of hundreds of millions of people in many developing
economies throughout the world, but it has sputtered throughout most of Africa. Why has
economic growth taken hold in many Asian and Latin American countries? Why not in Africa?

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SSA has had periods of moderate economic growth. In 1996 GDP grew by 4.4 percent, a rate
unprecedented in recent decades. But 1997 brought another downturn, with growth estimated at
under 4 percent following extended periods of economic decline that could not propel countries
into the modern economic world. A longer term perspective reveals that even with recent
improvements in GDP, Africans have lost immense ground in the past several decades.

Other indicators also show substantial economic retrogression: massive drops in modern sector
employment as a share of the labor force; real wages of urban workers falling to subsistence
levels; reverse migration from cities to rural areas; loss of shares of world trade and of foreign
investment; absolute poverty rates climbing above 50 percent; and declines in food production
per capita. Many economists have analyzed SSA's poor economic performance. One group of
explanations focuses on factors associated with more rapid growth in other regions that SSA
appears to lack. Among these factors, three stand out: (1) low levels of human capital; (2) lack of
openness to trade and foreign capital; and (3) urban bias and high income inequality. Another set
of explanations focuses on features which are SSA specific: high degrees of ethnic
fractionalization, frequency of land-locked states and high concentration of land in the tropics.

The stress on investments in education as a prerequisite for more rapid growth is misplaced.
Many developing nations have progressed with limited investments in schooling. Others have
failed to progress with substantial investments. Trade and foreign capital inflows are important to
growth but are far from a sufficient condition for economic progress. Inward-looking policies
have failed, but simply lowering trade barriers or properly realigning exchange rates does not
guarantee prosperity. As for urban bias and inequality, the urban bias that once characterized SSA

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has disappeared and income inequality, though high in some SSA countries, is not so extreme as
to foreclose successful growth and poverty alleviation. Similarly, the Africa-specific explanations
reveal real constraints but are not the core explanation for SSA's growth tragedy.

4.1.5.1 Is SSA's Economic Growth Constrained by Too Little Human Capital?

SSA's low stock of human capital – reflected in relatively high rates of adult illiteracy and low
school enrollment rates would seem a natural cause for SSA's lack of economic growth. A great
deal of micro and macro evidence has been accumulated linking education, productivity and
growth. But closer inspection of the micro evidence on the returns to education in the region and
of cross-country growth regressions which include schooling as an independent variable suggests
another interpretation. An expansion in human capital is neither sufficient for more rapid growth
nor is SSA's lack of human capital necessarily a barrier to accelerated growth.

What do microeconomic empirical economic assessments show? Estimates reviewed by

Psacharopoulous (1994) indicate that rates of return to education in Africa are high relative to the
social opportunity cost of capital and to rates prevailing in other regions. The highest returns are
for primary school education. If the claim that educational investment is a sufficient condition for
growth were true, this would have produced sizeable growth in SSA since most African countries
have increased lower level school enrollments rapidly. To the other extreme, detailed
econometric analysis by Glewwe (1991) on Ghana indicate private returns to primary education
of only a few percentage points, far lower than those usually cited for SSA and other regions.

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Glewwe also reports returns for secondary and tertiary education that are higher than at the
primary level. This "convexity" of returns by education level has been found in many other
studies of SSA and contrasts with patterns elsewhere.

But according to Glewwe, why has primary education yielded so low a return in Africa? One
possible explanation is the low quality of schooling. Counting years of schooling is a rough
approximation for the accumulation of productive human capital. If teachers know little more
than their students, or if the curriculum is irrelevant to employment opportunities and market
realities, then years of schooling produce little educational capital. Concern over school quality
is raised throughout the world. Rapidly expanding school systems, as in Africa, suffer from
quality problem.

Rosenzweig (1995) presents another possible explanation: "Schooling investments are not a
universal panacea; reaping returns from such investments requires that the scope for productive
learning be expanded via either technical innovation or changes in market and political regimes.
In SSA this may explain the pattern of low returns that have constrained the region's
accumulation of years of schooling from contributing more to the region's economic growth. The
problem has been a lack of opportunities rather than a lack of schooling.

Another explanation that fits the African experience is that the return to schooling requires stable
property relations and a safe economic environment, which have been lacking in most African
states. Wars, corruption, revolutions, and other instabilities that disturb or distort the normal
functioning of markets make the value of schooling less than it would be in a more stable world.

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What do growth regressions (macroeconomic studies) say? Many analysts, for example Denison
(1967), have identified education as an important determinant of aggregate economic growth.

Many economists believe that modern growth regressions show that education is a sufficient
factor for increasing per capita incomes. This conclusion is derived from a production function
approach to growth accounting which implicitly assumes a technological relationship where
increases in the stock of human capital, ceteris paribus, yield economic growth. If this were true,
SSA's low stock of human capital could readily explain at least some of the region's poor growth
record. But regressions relating human capital to growth across countries do not tell a clear and
convincing story. For example, Barro (1997) finds that the level of human capital for men has a
positive effect on growth while that for women has a negative effect. Pritchett (1997) directly
incorporates the accumulation of years of schooling by regressing growth in GDP per worker on
growth of physical and human capital, and finds that physical capital dominates the growth
equation while growth in the education levels of the work force is weakly and negatively
correlated with economic growth.

In sum, the equivocal effects of education on productivity found in the micro evidence for SSA
reappear in the macro studies on all countries. Changes in the level of absolute years of
schooling of workers seem to have some positive link to growth, but the link varies with
specification and, at best, is far from overwhelming; changes in the percentage growth of
schooling are not positively related to growth; while countries with high initial levels of
schooling generally grow faster than others. In all calculations investments in physical capital are
more strongly and robustly related to economic growth than are investments in human capital.

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Empirical evidence:
There are many counter-cases to the claim that education per se produces economic growth. In
1965, Indonesia and Thailand had enrollment rates in primary school that were not much greater
than those in Ghana and Zaire, yet the Southeast Asian nations grew and the two African states
did not (Perkins and Roemer 1994). Despite effectively destroying much of its human capital
during the Cultural Revolution and having a very low rate of return to schooling during the
1980s (Freeman 1999), China has managed to grow extremely rapidly.

The good news for Africa from the diverse studies is that investment in physical capital is well
correlated with growth, and physical capital can be more readily accumulated than can human
capital. In the right environment, domestic and foreign savings can be redirected toward
productive opportunities rapidly. By comparison, it may take a decade or more to produce a
significant increase in the mean education level of the labor force. This does not mean that
African countries should not invest in schooling. With a resumption of economic growth parents
in Africa will find schooling a worthwhile investment and will send their children to school.
Schooling has significant benefits that do not show up in national accounts. Education, especially
of girls, reduces own and child mortality. It may also foster the evolution of democratic
institutions. But the expansion of education should not be viewed as a sufficient condition for
achieving individual or economy-wide prosperity, nor should slow expansion of education be
seen as an absolute barrier to SSA's growth.

Check your progress exercise 4.4

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1. Relate the role of investment at different level of education (human capital) for economic
growth
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4.1.5.2 Globalization and SSA

Is greater openness to trade and foreign capital the key to economic growth in Africa? Or is the
opposite true -- that African prospects have been diminished by globalization of the world
economy?

The view that openness is the key to economic prosperity is part of the “Washington Consensus”
about economic development. Here ask your instructor what Washington Consensus mean? This
view gains some support from cross-country growth regressions. Sachs and Warner (1995, 1997)
identify openness to world markets for capital, goods and technology as "crucial elements of any
pro-growth package and thus recommend for many African countries to liberalize markets for
foreign exchange and traded goods.

Once again the growth regression literature is not sufficiently compelling. Openness has the
potential to increase investment, improve resource allocation and facilitate the transmission of
new ideas and technology. But even in the growth regressions that lend most support for the role
of greater openness, the lion's share of the variance in cross country growth rates is not explained
by openness. The implication is that domestic markets and policies matter as well.

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Other studies, for example, by Feldstein and Horioka (1980) indicate that there is strong
evidence linking domestic investment is correlated with domestic savings. This home country
bias in investment highlights the importance of domestic market conditions and institutions in
capital accumulation. Relative to other regions, moreover, SSA displays less home country bias
in investment. Studies have found that despite a lower level of wealth per worker than in any
other region, Africa's wealth owners have relocated 37 percent of their wealth outside the
continent. This compares to a ratio of 17 percent in Latin America and only 3 percent in East
Asia. Protection of property rights and an overall reduction in the riskiness of the domestic
economic environment are probably more important factors in encouraging domestic savings to
be invested in SSA's economies than more open economies, though the latter might help as well.
In any case, most SSA countries have moved toward greater openness. The import substitution
strategies of the past, including reliance on highly over-valued exchange rates, failed. Today
black market premiums on foreign exchange have almost disappeared and some of the region's
recent positive growth rates may be linked to the gradual abandonment of inward-looking
strategies and the policies that supported them. Still, Africa remains marginalized in the world
economy.

There is also a different view about the relation between world trade and African economic
progress. This is the argument that competition from other low-income economies today
forecloses African countries from advancing through the global trading system. In the 1960s and
1970s a low-income SSA nation could have prospered by exporting labor-intensive goods. But
today, the argument goes the entry of China, India and other large labor abundant economies, has

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depressed the prices of labor intensive goods and thus cut-off the chances for SSA's labor force
of about 200 million.

Openness to trade and the outside world can help Africa develop. Foreign savings can finance
much needed investments. Ideas, information and technology from abroad can increase the
returns to schooling, physical capital and infrastructure. But openness alone is not sufficient to
guarantee growth.

4.1.5.3 Is There Too Much Inequality in Sub-Saharan Africa?

At one stage growth economists believed that inequality contributed to growth. Kaldor (1955-56)
and Lewis (1954) saw income inequality as a source of added savings for investment and growth.
The Harris-Todaro (1970) model, developed with SSA in mind, was driven by assumptions about
the rural-urban income gap which fueled rural to urban migration, exacerbated urban
unemployment and generated a misallocation of resources that inhibited economic growth. For
Lipton (1977), "urban bias" drained the rural economy's surplus, regressively allocated
government expenditures to the minority of the population living in cities and was the core
reason.

Recent empirical analysis of the impact of inequality on growth suggests the opposite: that high
level of inequality adversely affects economic growth. Beginning with Alesina and Rodrik
(1994) and Person and Tabellina (1994), analysts have entered measures of inequality in standard
growth regressions and found that their effect is negative. Benabou (1996) lists twenty-three
studies that link inequality either to growth of GDP per capita or to investment. The regressions

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give a consistent message: low inequality improves growth with a fairly robust coefficient. The
divergent growth performance of the Philippines with its high level of inequality and Korea, with
its low inequality, or between East Asia and Latin America underlie these regression results.

One possible reason for this outcome is that lower inequality can increase political and
macroeconomic stability, hence investment and growth. When the interests of rich and poor are
closer together, policies stand a better chance of avoiding the wide swings caused by trying to
serve the needs of one group versus another. If Africa had extremely high levels of inequality and
suffered from excessive urban bias, inequality could be a substantial drag on growth. Data
compiled by Deininger and Squire (1996) permit a comparison of income inequality both within
SSA and between SSA and other regions. The data indicate that inequality in SSA varies a great
deal.Some economies (Guinea Bissau, South Africa) have income inequality comparable to the
highly regressive outcomes in Brazil and other countries in Latin America. But SSA also has its
share of more equal distributions with Ghana, Niger and Tanzania falling within the inequality
range associated with East Asia.

The traditional criticism of African countries as suffering from extreme urban bias also does not
hold up today, if it was ever true. Jamal and Weeks (1993) provide compelling evidence
contradicting the conventional wisdom on African inequality. They show that the extent of urban
bias in SSA, even in the immediate post independence period, was probably exaggerated due to
failure to adjust for differences between rural and urban prices; and that the subsequent
macroeconomic decline in SSA has eroded much of whatever urban bias once existed. The
decline of urban bias in SSA is evident in some of the policy reversals that have accompanied

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structural adjustment. In the past, overvalued exchange rates and high export taxes on cash crops
favored urban over rural areas; but devaluation and a move toward paying farmers border prices
has narrowed the earlier gap. The conclusion is that Africa might do better if it had lower levels
of inequality, but there is nothing exceptional in its levels to serve as a barrier to economic
growth.

4.1.5.4 Reviewing Economic Growth in Sub-Saharan Africa

The preceding analysis suggests that the standard reasons given for poor growth in SSA do not
constitute iron-clad barriers. The region may have a poorly educated labor force but the activity
of African traders, or the success of African immigrants in advanced economies, demonstrates
the labor skills that are waiting to be called upon, given capital and a modern economic
environment. African capital flight and the resource rents of its mineral wealth offer large pools
of latent savings for productive investments at home. Africa may not have an ideal set of
“building blocks” for successful growth, but neither do most other developing economies.

Why then has Africa failed to grow?

African growth has been stifled by political turmoil, often the result of non-democratic unstable
regimes, and by the accompanying absence of protection of property and capital. The
determinants of growth and that first and foremost are political stability and the security of
property. Without this base, investments in education, openness, and levels of income equality
have little effect on growth. The reason returns to schooling are low in Africa, that capital flight

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is high, and that the shift toward free trade has not created growth miracles is that schooling,
investment, and trade operate successfully only in a peaceful, stable, environment for economic
activity.

Consider first the most extreme form of political turmoil, war. War plagues the region. By our
count, twelve SSA countries representing one quarter of the region's total population, were war-
torn usually for prolonged periods, between 1975-1995. The Economist (1998) reports "nearly a
third of sub-Saharan Africa's 42 countries [today] are embroiled in international or civil wars."
The burden of war is reflected in another statistic. SSA accounts for 10 percent of the world's
population but harbors 46 percent of the world's refugees and those internally displaced by war
(Haughton 1997).

Just as war discourages the productive accumulation that SSA needs, corruption plays a similar
role. According to a study of corruption in 54 countries, including 30 low and middle income
economies, the four SSA nations in the sample (Nigeria, Kenya, Cameroon and Uganda) ranked
1st, 3rd, 6th and 12th, respectively. Dictatorships need not be inimical to economic growth. But
African dictators have a particularly poor record in choosing policies that are growth-
augmenting. They are among the world’s best examples of rent-seeking political actors.

The result of war, corruption, dictatorship is that sub-Saharan Africa ranks low in the basic
economic protections that are necessary for economic growth. The Heritage Foundation/Wall
Street Journal has developed an Index of Economic Freedom that demonstrates this proposition.
In 1998, just three African countries ranked in the top 50 countries by economic freedom –

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Botswana, Namibia, and Swaziland – while 50 percent of African countries fit in the lowest
grouping of countries.

There is no simple nor single recipe for achieving economic growth, but there is one way to
prevent growth: though instability and absence of property rights. SSA needs peace, less
corruption, and secure property rights so that its people can invest in productive activities.
Capitalism is a sturdy economic system, permissive of a variety of permutations. If African
countries can establish a stable political environment which enables people to gain the rewards of
investment in physical or human capital, the alleged barriers to growth – education, trade,
inequality, geography, and climate – will, prove surmountable.

4.1.6. Many paths to development (Alternative Growth Strategies)

The experience of economic development in Third World countries since independence is varied
and rich and it is possible to learn much from it, both analytically and in terms of economic
policy. Already it is clear that there are many paths to development although some no doubt are
more circuitous than others.

It should be said straight away that few countries have followed a distinct strategy of
development. Some have adopted internally consistent set of economic measures which at least
in retrospect can be seen to have constituted an identifiable approach to the problems of their
own development. Most countries are confused and inconsistent borrowing bits and pieces from
a number of different strategies, and they are unsteady fast, chopping and changing with shifts of
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political opinion. Policy confusion, inconsistency, eclecticism and the reasons for lack of
steadiness of purpose are themselves worthy topics for study by economists. We are interested in
something rather different, namely, the theoretical review of adopting coherent development
policies over a long period of time, say, a quarter of a century.

Check your progress exercise 4.6

1. What is the relevance of western development economics to the realities of poor nations?
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4.1.6.1 Classification of strategies

Six distinct strategies of development have been identified. The first is called a Monetarist
strategy. It is distinctive in that it concentrates on increasing the efficiency of market signals as a
guide to an improved allocation of resources. In practice the strategy often is introduced during a
period of crisis, and consequently measures to improve relative prices usually are accompanied
by measures to control the rate of increase in the general level of prices. Emphasis, then, is
placed on monetary and fiscal policies and on financial reforms.

Monetarist strategies are concerned only with short-run adjustment, with reducing inflation and
restoring macroeconomic balance, after which longer term policies can be resumed At the same
time, the strategies are deeply concerned with microeconomic issues, with getting markets to

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work properly, with removing distortions and establishing the correct set of relative prices that
will permit efficient, long-run growth.

A major feature of this strategy is it grants abundant space to the private business sector. In the
economically more advanced Third World countries the strategy implies placing reliance on
private industry and takes on the role of the dynamic sector, responsible for generating backward
and forward linkages with the rest of the economy. The role of the state is reduced to a minimum
and confined to providing a stable economic environment in which the private sector can
flourish. By using stabilization policy the state attempts to reduce fluctuations of the economy as
much as possible, thereby helping the private sector to make reliable forecasts and undertake
accurate planning. Policies to privatize state-owned enterprises and legislation to reduce trade
union power may also be part of this strategy.

The objectives of monetarist strategies are, first, to stabilize the economy and produce well-
functioning markets, to improve the allocation of resource, to achieve high levels of savings, and
to ensure a more efficient use of capital. The strategy is noninterventionist in spirit and relies on
individual initiative and entrepreneurship to move the economy forward.

The second distinct strategy is an outward-looking strategy of development which shall be called
the Open Economy. The open economy shares some of the features of a monetarist strategy, but
not all of them. It too relies on market forces to allocate resources and on the private sector to
play a prominent role, but it differs from monetarism in part by placing special emphasis on
policies that directly affect the foreign trade sector, i.e., exchange rate policy, tariff regulations,

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quotas and non-tariff barriers to trade and policies which regulate foreign investment and profit
remittances.

Foreign trade supplemented by foreign private direct investment is seen as the leading sector or
engine of growth. Particularly for small countries, the world market is regarded as a source of
demand for exports of virtually infinite elasticity. Thus the constraints imposed by a small
economy and domestic market, undiversified resources endowment, inability to exploit
economies of scale can be overcome by exporting. The pressure of international competition is
thought to be vital because it provides a strong incentive to producers to keep costs low, to use
capital and labor efficiently, to innovate, improve quality standards and sustain high rates of
investment.

An outward-oriented strategy of development should raise not only the level of income but also
the level of savings and possibly the rate of saving too. This, in turn, permits a faster rate of
accumulation of capital and hence faster growth. In addition, the incentives to increase efficiency
associated with export-led growth are likely to result in a more efficient pattern of investment.

The open economy is also open to international movements of factors of production, capital and
labor. Foreign direct investment, commercial lending, knowledge, technology and management
skills is seen as increasing factor productivity in the Third World and thereby contributing to
higher levels of output and a faster growth of incomes.

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Outward-looking strategy of development normally implies an active role for the state. First,
government policy is involved in removing obstacles restraining a country’s capacity to export
(e.g., inadequate infrastructure) and in promoting those activities which will increase exports.
Second, the state is responsible for removing price distortions in the economy, due to previously
inappropriate policies of import substituting industrialization. In general terms, the state is
expected to be concerned with “getting prices right”, in particular the key prices of the exchange
rage, interest rates and wage rates.

The third strategy is Industrialization. The emphasis here as with the previous strategy, is on
growth but the vehicle for achieving growth is rapid expansion of the manufacturing sector. The
immediate concern is acceleration of the aggregate rate of growth of gross domestic product.
This is achieved by a strategy of industrialization typically in one of three ways: (i) by producing
manufactured consumer goods largely for the domestic market, usually behind high tariff walls;
(ii) by concentrating on the development of the capital goods industries, usually under the
direction of the state; or (iii) by deliberately orienting the manufacturing sector towards
exporting, usually under some combination of indicative planning and either direct or indirect
subsidies.

Industrialization strategies in practice tend to place much stress on raising the level of capital
formation, on introducing modern technology, and on promoting the growth of a small number of
large metropolitan areas. Urbanization and the industrialization strategy tend to go together.
Government intervention is pervasive with the objective to increase production and distribute

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income from sector to sector (agriculture to industry) and from low-income to high-income
households, distribution of income toward those groups with high marginal propensities to save.

Fourth, there is the Green Revolution strategy. The focus under this strategy is on agricultural
growth. One purpose of the strategy is to increase the supply of food, especially grains, the most
important wage good. An abundant supply of grains will force down the relative price of food
and this, in turn, will help to lower unit labor costs. Low unit costs will raise the general level of
profits in non-agricultural activities and this should permit higher savings and more investment
by stimulating the demand for agricultural inputs, capital and intermediate goods (fertilizer,
irrigation pumps, construction materials) and by creating a larger market for simple consumer
goods consumed in the countryside. Many of these industries tend to be more labor intensive
than the industries promoted under an industrialization strategy and hence greater employment
opportunities are created in both rural and urban areas.

In the rural areas, technical change is seen to be the key to accelerating agricultural growth and it
is this of course that gives the strategy its name. Emphasis is on improved crop varieties, greater
use of fertilizer and other modern inputs, investment in irrigation, transport and power, more
ergonomically based research and improved extension services and credit.

The strategy is intended to alleviate mass poverty in several different ways. First, the poor are
thought to benefit directly from a greater abundance of food. Second, because of the increased
agricultural output, there will be greater employment in agriculture. Third, because of the high
income elasticity of demand for non-food items of consumption, large numbers of jobs will be

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created in non-agricultural rural activities and in urban industry. Fourth, because of the high
labor intensity of the strategy, real wages in both the cities and the countryside should rise and
this is likely, finally, to result in a more equal distribution of income.

Redistribute strategies of development start where the green revolution strategy finishes, namely,
with a concern to improve the distribution of income and wealth. The strategy is designed to
tackle head-on the problem of poverty by giving priority to measures which benefit directly low-
income groups. There are three distinct strands which have shaped thinking about redistribute
strategies. First, there are those who place great emphasis on creating more productive
employment for the working poor. Second, there are those who advocate redistributing to the
poor a part of the increment to total income that arises form growth. Third, there are those who
urge that top priority should be given to the satisfaction of basic needs. These include the need
for food, clothing and shelter as well as the provision by the state of primary health care
programs and universal primary and secondary education.

Interest in redistribute strategies arose as a reaction to what their proponents perceived as a

failure of growth-oriented strategies to reduce significantly over a reasonable period of time the
number of those living in poverty or to improve their well being. Unlike the other strategy
outlined above, a redistribute strategy aims to improve the distribution of income and wealth
through direct intervention by the state. This objective of policy does not necessarily imply a
larger role for government (as measured, say, by the ration of public expenditure to GDP) but it
does imply a change in the composition of government expenditure and a qualitative
transformation of the relationship between the governed and those who govern them.

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A comprehensive redistributive strategy of development contains five central elements: (i) an
initial redistribution of assets; (ii) creation of local institutions which permit people to participate
in grass roots development; (iii) heavy investment in human capital; (iv) An employment
intensive pattern of development, and (v) sustained rapid growth of per capita income.

Finally, there are socialist strategies of development. These strategies are distinctive in that
private ownership of the means of production is of relatively little significance. Almost all large
industrial enterprises are in the state sector, while medium and small sized enterprises may be
organized along co-operative principles; private ownership, where tolerated, often is limited to a
few services and small workshops employing only a small number of people. In agriculture, state
farms, collectives, co-operatives and communes predominate, although in some countries
collectively owned land is cultivated by individual peasant households.

Socialist strategies of development seem to be characterized by high rates of capital formation,

low ratio of household consumption to national income, high rate of state consumption and
mainly for public consumption (health, education, public transport) at the expense of private. The
result is a scarcity of personal services, a fairly uniform distribution of consumption goods
among households and a relatively even spread of the benefits of growth.
4.2. Summary and conclusion

 We briefly looked into some basic concepts of the theory of economic growth using simple
production function. This complemented our previous understanding on how to link
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 production with economic growth. We use this preliminary knowledge to look into the
historic growth process and records of contemporary developed countries to analyze
important economic, structural and institutional components that characterize rich countries
and deduce on the relevance of this historical growth experiences and the development
policies to the plans and strategies of developing nations of today. To build our theoretical
knowledge, we discussed why economic growth in sub-Sahara Africa is slow and then we
reviewed alternative growth strategies that developing countries could adopt to impart
positive change to the socio-economic environment in which their citizens live.

4.3. Key Terms

 Production possibility frontier

 Capital accumulation

 Total factor productivity

4.4. Answer to Check Your Progress Exercise

Answer to check your progress exercise 4.1

1. Capital accumulation results when some proportion of present income is saved and invested
in order to augment future output and income. New factories, machinery, equipment, and
materials increase the physical capital stock of a nation (the total net real value of all physically
productive capital goods) and make it possible for expanded output levels to be achieved. For

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example, investment by a farmer in a new tractor, the supply of irrigation facilities, use of
chemical fertilizers and the control of insects with pesticides improve the quality of existing land
resources.

Answer to check your progress exercise 4.2

1. In traditional economics, population growth, and the associated eventual increase in the labor
force has been considered a positive factor in stimulating economic growth. A larger labor force
means more productive workers, and a large overall population increases the potential size of
domestic markets. However, the role of growing supplies of workers in surplus-labor developing
countries will depend on the ability of the economic system to absorb and productively employ
these added workers – an ability largely associated with the rate and kind of capital accumulation
and the availability of related factors, such as managerial and administrative skills.

Answer to check your progress exercise 4.3

1. This is not an economic law, as attested by the poor growth record of many contemporary
developing countries. Nor is resource growth even a necessary condition for short-run economic
growth because the better utilization of idle existing resources can raise output levels
substantially, as portrayed in the movement from X to X’ in the Figure below.

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Nevertheless, in the long run, the improvement and upgrading of the quality of existing resources
and new investments designed to expand the quantity of these resources are principal means of
accelerating the growth of national output.

Answer to check your progress exercise 4.4

1. The equivocal effects of education on productivity found in the micro evidence for SSA
reappear in the macro studies on all countries. Changes in the level of absolute years of
schooling of workers seem to have some positive link to growth, but the link varies with
specification and, at best, is far from overwhelming; changes in the percentage growth of
schooling are not positively related to growth; while countries with high initial levels of
schooling generally grow faster than others. In all calculations investments in physical capital are
more strongly and robustly related to economic growth than are investments in human capital.

Answer to check your progress exercise 4.5

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1. The six characteristics of modern growth outlined by kuznet are interrelated and mutually
reinforcing. High rates of per capita output result from rapidly rising levels of factor productivity.
High per capita incomes in turn generate high levels of per capita consumption, thus providing
the incentives for changes in the structure of production (because as incomes rise, the demand for
manufactured goods and services rises at a much faster rate than the demand for agricultural
products). Advanced technology needed to achieve these output and structural changes causes
the scale of production and the characteristics of economic enterprise units to change in both
organization and location. This in turn necessitates rapid changes in the location and structure of
the labor force and in status relationships among occupational groups. It also means changes in
other aspects of society, including family size, urbanization, and the material determinants of
self-esteem and dignity. Finally, the inherent dynamism of modern economic growth, coupled
with the revolution in the technology of transportation and communication, necessitates an
international outreach on the part of the countries that developed first. But the poor countries
affected by this international outreach may for institutional, ideological, or political reasons
either not be in a position to benefit from the process or simply be weak victims of the policies of
rich countries designed to take advantage of them economically.

Answer to check your progress exercise 4.6

1. Due to very different initial conditions, the historical experience of Western economic growth
is of only limited relevance for contemporary Third World nations. Nevertheless, one of the most
significant and relevant lessons to be learned from this historical experience is the critical
importance complementary technological, social, and institutional changes, which must take
place if long-term economic growth is to be realized. Such transformations must occur not only
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within individual developing countries but, perhaps more important, in the international
economy as well. In other words, unless there is some major structural, attitudinal, and
institutional reform in the world economy, one that accommodates the rising aspirations and
rewards the outstanding performances of individual developing nations, internal economic and
social transformation within the Third World may be insufficient.

4.5. Review Exercises

1. What does the historical record reveal about the nature of the growth process in the now
developed nations? What were its principal ingredients?
2. Of what relevance is the historical record of modern economic growth for contemporary
developing nations? How important are differences in "initial conditions"? Give some
examples of the initial conditions in a developing country with which you are familiar that
make it different from most contemporary developed nations at the beginning of their modern
growth experience.
3. "Social and institutional innovations are as important for economic growth as technological
and scientific inventions and innovations." What is meant by this statement? Explain your
answer.
4. What do you think were the principal reasons why economic growth spread rapidly among the
now developed nations during the nineteenth and early twentieth centuries but, with the
exception of parts of Asia, has failed to spread to an equal extent to contemporary LDCs?
5. Explain the negative and positive effects of labour saving technology for developing countries
like Ethiopia.
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4.6. References:

 Todaro,M.,(1994)EconomicDevelopment,Fiftheditions,Longman:NewYork and
London.
 TodaroM.P.&SmithS.C.(2006)DevelopmentEconomics,Ninthedition,Harlow, Pearson &
Addison Wesley:London.
 Ray, D.(1998) Development Economics, Princeton University Press.

MODULE 5: INCOME INEQUALITY, POVERTY AND DEVELOPMENT:

INTERCONNECTIONS (10 hrs)

Contents:
5.0 Aims and Objectives
5.1 Income Inequality, Poverty and Development: Interconnections
5.1.1. Overview on Income distribution, poverty and economic growth
5.1.2. Measures of Income Inequality and poverty
5.1.2.1. Approaches to measures of Income Inequality
5.1.2.2. Approaches to Measures of Absolute Poverty
5.1.3. Income Inequality and Economic Growth
5.1.3.1. Kuznets Inverted U-hypothesis
5.1.4. Poverty Reduction and Economic Growth
5.1.5. Economic Characteristics of poverty groups
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 5.1.5.1. Rural poverty
5.1.5.2. Women and poverty
5.1.5.3. Ethnic Minorities, Indigenous Populations, and Poverty
5.1.6. Policies Options for Poverty Reduction and enhance income Distribution

5.2. Summary and conclusion

5.3. Key Terms
5.4. Answer to Check Your Progress Exercise
5.5. Review Exercises
5.6 References

5.0. Aims and Objectives

We begin the chapter by defining inequality and poverty, terms that are commonly used in
informal conversation but need to be measured more precisely to provide a meaningful
understanding of how much progress has already been made. You will see that the most
important measures of poverty and inequality used by development economists satisfy properties
that most observers would agree are of fundamental importance. After a discussion of why
attention to inequality as well as poverty is important, we then use the appropriate measures of
poverty and inequality to evaluate the welfare significance of alternative patterns of growth.
After reviewing the evidence on the extent of poverty and inequality in the developing world, we
conclude with an overview of the key issues in poverty policy.

After completing this chapter, you will be able to:

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  Understand the extent of relative inequality in developing countries, and how is this
related to the extent of absolute poverty.

 Discuss whether rapid growth achievable only at the cost of greater inequalities in the
distribution of income, or can a lessening of income disparities contribute to higher
growth rates.

 Explain why extreme inequality is so bad.

 Understand what kinds of policies are required to reduce the magnitude and extent of
absolute poverty.

5.1 Income Inequality, Poverty and Development: Interconnections

5.1.1. Overview on Income distribution, poverty and economic growth

Development requires a higher GNI, and hence sustained growth. The basic issue, however, is
not only how to make GNI grow but also who would make it grow, the few or the many. If it
were the rich, it would most likely be appropriated by them, and progress against poverty would
be slow, and in-equality would worsen. But if it were generated by the many, they would be its
principal beneficiaries, and the fruits of economic growth would be shared more evenly.

Because the elimination of widespread poverty and high and even growing income inequality are
at the core of all development problems and in fact define for many people the principal

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objective of development policy, we begin by focusing on the nature of the poverty and
inequality problem in developing countries.
Although our main focus is on economic poverty and inequalities in the distribution of incomes
and assets, it is important to keep in mind that this is only part of the broader inequality problem
in the developing world.

Of equal or even greater importance are inequalities of power, prestige, status, gender, job
satisfaction, conditions of work, degree of participation, freedom of choice, and many other
dimensions of the problem that relate more to our second and third components of the meaning
of development, self-esteem, and freedom to choose.

After introducing appropriate measures of inequality and poverty, we define the nature of the
poverty and income distribution problem and consider its quantitative significance in various
developing nations.

We then examine in what ways economic analyses can shed light on the problem and explore
possible alternative policy approaches directed at the elimination of poverty and the reduction of
excessively wide disparities in the distributions of income in developing countries.

A thorough understanding of these two fundamental economic manifestations of

underdevelopment provides the basis for analysis in subsequent topics (to be discussed in the
second part of this course) of more specific development issues, including population growth,
education, health, rural development, and foreign assistance.

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In this chapter, therefore, we will examine the following critical questions about the relationship
among economic growth, income distribution, and poverty:

1. What is the extent of relative inequality in developing countries, and how is this related to
the extent of absolute poverty?

2. Who are the poor, and what are their economic characteristics?

3. What determines the nature of economic growth—that is, who benefits from economic
growth, and why?

4. Are rapid economic growth and more equal distributions of income compatible or
conflicting objectives for low-income countries? To put it another way, is rapid growth
achievable only at the cost of greater inequalities in the distribution of income, or can a
lessening of income disparities contribute to higher growth rates?

5. Do the poor benefit from growth, and does this depend on the type of growth a
developing country experiences? What might be done to help the poor benefit more?

6. What is so bad about extreme inequality?

7. What kinds of policies are required to reduce the magnitude and extent of absolute
poverty?

5.1.2. Measures of Income Inequality and poverty

5.1.2.1. Approaches to measures of Income Inequality

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Economists usually distinguish between two principal measures of income distribution for both
analytical and quantitative purposes: the personal or size distribution of income and the
functional or distributive factor share distribution of income.

(1) Size Distributions. The personal or size distribution of income is the measure most
commonly used by economists. It simply deals with individual persons or households and the
total incomes they receive. The way in which that income was received is not considered. What
matters is how much each earns irrespective of whether the income was derived solely from
employment or came also from other sources such as interest, profits, rents, gifts, or inheritance.
Moreover, the locational (urban or rural) and occupational sources of the income (e.g.,
agriculture, manufacturing, commerce, services) are ignored.

Economists and statisticians therefore like to arrange all individuals by ascending personal
incomes and then divide the total population into distinct groups, or sizes. A common method is
to divide the population into successive quintiles (fifths) or deciles (tenths) according to
ascending income levels and then determine what proportion of the total national income is
received by each income group.

Table 5.1 shows a hypothetical but fairly typical distribution of income for a developing country.
In this table, 20 individuals, representing the entire population of the country are arranged in
order of ascending annual personal income, ranging from the individual with the lowest income
(0.8 units) to the one with the highest (15.0 units). The total or national income of all individuals
amounts to 100 units and is the sum of all entries in column 2. In column 3, the population is
grouped into quintiles of four individuals each. The first quintile represents the bottom 20% of
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the population on the income scale. This group receives only 5% (i.e., a total of 5 money units)
of the total national income. The second quintile (individuals 5 through 8) receives 9% of the
total income. Alternatively, the bottom 40% of the population (quintiles 1 plus 2) is receiving
only 14% of the income, while the top 20% (the fifth quintile) of the population receives 51% of
the total income.

Table 5.1: A hypothetical distribution of income for a developing country.

A common measure of income inequality that can be derived from column 3 is the ratio of the
incomes received by the top 20% and bottom 40% of the population. This ratio, sometimes called
a Kuznets ratio after Nobel laureate Simon Kuznets, has often been used as a measure of the

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degree of inequality between high- and low-income groups in a country. In our example, this
inequality ratio is equal to 51 divided by 14, or approximately 3.64.
To provide a more detailed breakdown of the size distribution of income, decile (10%) shares are
listed in column 4. We see, for example, that the bottom 10% of the population (the two poorest
individuals) receives only 1.8% of the total income, while the top 10% (the two richest
individuals) receives 28.5%. Finally, if we wanted to know what the top 5% receives, we would
divide the total population into 20 equal groups of individuals (in our example, this would simply
be each of the 20 individuals) and calculate the percentage of total income received by the top
group. In Table 5.1, we see that the top 5% of the population (the twentieth individual) receives
15% of the income, a higher share than the combined shares of the lowest 40%.

Lorenz Curves. Another common way to analyze personal income statistics is to construct what
is known as a Lorenz curve. Figure 5.1 shows how it is done. The numbers of income recipients
are plotted on the horizontal axis, not in absolute terms but in cumulative percentages. For
example, at point 20, we have the lowest (poorest) 20% of the population; at point 60, we have
the bottom 60%; and at the end of the axis, all 100% of the population has been accounted for.
The vertical axis shows the share of total income received by each percentage of population. It is
also cumulative up to 100%, meaning that both axes are the same length.

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Figure 5.1: Lorenz curve

The entire figure is enclosed in a square, and a diagonal line is drawn from the lower left corner
(the origin) of the square to the upper right corner. At every point on that diagonal, the
percentage of income received is exactly equal to the percentage of income recipients—for
example, the point halfway along the length of the diagonal represents 50% of the income being
distributed to exactly 50% of the population. At the three-quarters point on the diagonal, 75% of
the income would be distributed to 75% of the population.

In other words, the diagonal line in Figure 5.1 is representative of “perfect equality” in size
distribution of income. Each percentage group of income recipients is receiving that same
percentage of the total income; for example, the bottom 40% receives 40% of the income, while
the top 5% receives only 5% of the total income.

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The Lorenz curve shows the actual quantitative relationship between the percentage of income
recipients and the percentage of the total income they did in fact receive during, say, a given
year. In Figure 5.1, we have plotted this Lorenz curve using the decile data contained in Table
5.1. In other words, we have divided both the horizontal and vertical axes into ten equal
segments corresponding to each of the ten decile groups. Point A shows that the bottom 10% of
the population receives only 1.8% of the total income, point B shows that the bottom 20% is
receiving 5% of the total income, and so on for each of the other eight cumulative decile groups.
Note that at the halfway point, 50% of the population is in fact receiving only 19.8% of the total
income.

The more the Lorenz line curves away from the diagonal (line of perfect equality), the greater the
degree of inequality represented. The extreme case of perfect inequality (i.e., a situation in which
one person receives all of the national income while everybody else receives nothing) would be
represented by the congruence of the Lorenz curve with the bottom horizontal and right hand
vertical axes.

Because no country exhibits either perfect equality or perfect inequality in its distribution of
income, the Lorenz curves for different countries will lie somewhere to the right of the diagonal
in Figure 5.1.The greater the degree of inequality, the greater the bend and the closer to the
bottom horizontal axis the Lorenz curve will be. Two representative distributions are shown in
Figure 5.2, one for a relatively equal distribution (Figure 5.2a) and the other for a more unequal
distribution (Figure 5.2b).

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Figure 5.2: Lorenz curves for two economies

Gini Coefficients and Aggregate Measures of Inequality: A final and very convenient
shorthand summary measure of the relative degree of income inequality in a country can be
obtained by calculating the ratio of the area between the diagonal and the Lorenz curve divided
by the total area of the half square in which the curve lies.

In Figure 5.3, this is the ratio of the shaded area A to the total area of the triangle BCD. This ratio
is known as the Gini concentration ratio or Gini coefficient, named after the Italian statistician
who first formulated it in 1912.

Figure 5.3: Estimating the Gini coefficients

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Gini coefficients are aggregate inequality measures and can vary anywhere from 0 (perfect
equality) to 1 (perfect inequality). In fact, as you will soon discover, the Gini coefficient for
countries with highly unequal income distributions typically lies between 0.50 and 0.70, while
for countries with relatively equal distributions, it is on the order of 0.20 to 0.35.The Gini
coefficient is among a class of measures that satisfy four highly desirable properties: the
anonymity, scale independence, population independence, and transfer principles

1. The anonymity principle simply means that our measure of inequality should not depend on
who has the higher income; for example, it should not depend on whether we believe the rich or
the poor to be good or bad people.

2. The scale independence principle means that our measure of inequality should not depend on
the size of the economy or the way we measure its income; for example, our inequality measure
should not depend on whether we measure income in dollars or in cents or in rupees or rupiahs or
for that matter on whether the economy is rich on average or poor on average—because if we are
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interested in inequality, we want a measure of the dispersion of income, not its magnitude (note
that magnitudes are very important in poverty measures).

3. The population independence principle is somewhat similar; it states that the measure of
inequality should not be based on the number of income recipients. For example, the economy of
China should be considered no more or less equal than the economy of Vietnam simply because
China has a larger population than Vietnam.

4. Finally, we have the transfer principle (sometimes called the Pigou-Dalton principle after its
creators); it states that, holding all other incomes constant, if we transfer some income from a
richer person to a poorer person (but not so much that the poorer person is now richer than the
originally rich person), the resulting new income distribution is more equal.

If we like these four criteria, we can measure the Gini coefficient in each case and rank the one
with the larger Gini as more unequal.

Coefficients of variation (CV), which is simply the sample standard deviation divided by the
sample mean, is another measure of inequality that also satisfies the four criteria. Although the
CV is more commonly used in statistics, the Gini coefficient is often used in studies of income
and wealth distribution due to its convenient Lorenz curve interpretation.

Note, finally, that we can also use Lorenz curves to study inequality in the distribution of land, in
education and health, and in other assets.

Check Your Progress Exercise 5.1

1. What are the four highly desirable properties the Gini coefficient satisfy?

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(2) Functional Distributions: The second common measure of income distribution used by
economists, the functional or factor share distribution of income, attempts to explain the share of
total national income that each of the factors of production (land, labor, and capital) receives.

Instead of looking at individuals as separate entities, the theory of functional income distribution
inquires into the percentage that labor receives as a whole and compares this with the
percentages of total income distributed in the form of rent, interest, and profit (i.e., the returns to
land and financial and physical capital).

A sizable body of theoretical literature has been built up around the concept of functional income
distribution. It attempts to explain the income of a factor of production by the contribution that
this factor makes to production. Supply and demand curves are assumed to determine the unit
prices of each productive factor. When these unit prices are multiplied by quantities employed on
the assumption of efficient (minimum-cost) factor utilization, we get a measure of the total
payment to each factor. For example, the supply of and demand for labor are assumed to
determine its market wage. When this wage is then multiplied by the total level of employment,
we get a measure of total wage payments, also sometimes called the total wage bill.

Figure 5.5 provides a simple diagrammatic illustration of the traditional theory of functional
income distribution. We assume that there are only two factors of production: capital, which is a
fixed (given) factor, and labor, which is the only variable factor. Under competitive market
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assumptions, the demand for labor will be determined by labor’s marginal product (i.e.,
additional workers will be hired up to the point where the value of their marginal product equals
their real wage). But in accordance with the principle of diminishing marginal products, this
demand for labor will be a declining function of the numbers employed. Such a negatively
sloped labor demand curve is shown by line DL in Figure 5.5. With a traditional neoclassical
upward-sloping labor supply curve SL, the equilibrium wage will be equal to WE and the
equilibrium level of employment will be LE.

Figure 5.5: Functional income distribution in a market economy: An illustration

Total national output (which equals total national income) will be represented by the area 0RELE.
This national income will be distributed in two shares: 0WEELE going to workers in the form of
wages and WERE remaining as capitalist profits (the return to owners of capital).Hence in a

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competitive market economy with constant-returns-to-scale production functions (a doubling of
all inputs doubles output), factor prices are determined by factor supply and demand curves, and
factor shares always combine to exhaust the total national product. Income is distributed by
function— laborers are paid wages, owners of land receive rents, and capitalists obtain profits. It
is a neat and logical theory in that each and every factor gets paid only in accordance with what
it contributes to national output, no more and no less.

5.1.2.2. Approaches to Measures of Absolute Poverty

Now let’s switch our attention from relative income shares of various percentile groups within a
given population to the fundamentally important question of the extent and magnitude of
absolute poverty in developing countries.

Absolute poverty is the number of people who are unable to command sufficient resources to
satisfy basic needs. They are counted as the total number living below a specified minimum level
of real income—an international poverty line. That line knows no national boundaries, is
independent of the level of national per capita income, and takes into account differing price
levels by measuring poverty as anyone living on less than $1.25 a day or $2 per day in PPP
dollars. Absolute poverty can and does exist, therefore, as readily in New York City as it does in
Kolkata, Cairo, Lagos, or Bogotá, although its magnitude is likely to be much lower in terms of
percentages of the total population

Absolute poverty is sometimes measured by the number, or “headcount,” H, of those whose

incomes fall below the absolute poverty line, Yp. When the head count is taken as a fraction of
the total population, N, we define the headcount index, H/N. The poverty line is set at a level that

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remains constant in real terms so that we can chart our progress on an absolute level over time.
The idea is to set this level at a standard below which we would consider a person to live in
“absolute human misery,” such that the person’s health is in jeopardy.

Certainly one would not accept the international poverty level of $1.25 a day in an unquestioning
way when planning local poverty work. One practical strategy for determining a local absolute
poverty line is to start by defining an adequate basket of food, based on nutritional requirements
from medical studies of required calories, protein, and micronutrients. Then, using local
household survey data, one can identify a typical basket of food purchased by households that
just barely meet these nutritional requirements. One then adds other expenditures of this
household, such as clothing, shelter, and medical care, to determine the local absolute poverty
line.

Depending on how these calculations are done, the resulting poverty line may come to more than
$1.25 per day at PPP. In many respects, however, simply counting the number of people below
an agreed-on poverty line can have its limitations. For example, if the poverty line is set at U.S.
$450 per person, it makes a big difference whether most of the absolute poor earn $400 or $300
per year. Both are accorded the same weight when calculating the proportion of the population
that lies below the poverty line; clearly, however, the poverty problem is much more serious in
the latter instance.

Economists therefore attempt to calculate a total poverty gap (TPG) that measures the total
amount of income necessary to raise everyone who is below the poverty line up to that line.
Figure 5.6 illustrates how we could measure the total poverty gap as the shaded area between
poverty line, PV, and the annual income profile of the population.
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Figure 5.6: Measuring the Total Poverty Gap

Even though in both country A and country B, 50% of the population falls below the same
poverty line, the TPG in country A is greater than in country B.Therefore, it will take more of an
effort to eliminate absolute poverty in country A.The TPG—the extent to which the incomes of
the poor lie below the poverty line—is found by adding up the amounts by which each poor
person’s income, Yi, falls below the absolute poverty line, Yp , as follows:

We can think of the TPG in a simplified way (i.e., no administrative costs or general equilibrium
effects are accounted for) as the amount of money per day it would take to bring every poor
person in an economy up to our defined minimum income standards. On a per capita basis, the
average poverty gap (APG) is found by dividing the TPG by the total population:

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Often we are interested in the size of the poverty gap in relation to the poverty line, so we would
use as our income shortfall measure the normalized poverty gap (NPG):

NPG = APG/Yp ;

This measure lies between 0 and 1 and so can be useful when we want a unit less measure of the
gap for easier comparisons.

Another important poverty gap measure is the average income shortfall (AIS), which is the
total poverty gap divided by the headcount of the poor:

AIS = TPG/H.

The AIS tells us the average amount by which the income of a poor person falls below the
poverty line. This measure can also be divided by the poverty line to yield a fractional measure,
the normalized income shortfall (NIS):

NIS = AIS/ Yp.

The Foster-Greer-Thorbecke Index: A well-known poverty index that in certain forms satisfies
all four criteria (the anonymity, population independence, monotonicity, and distributional
sensitivity principles) is the Foster-Greer-Thorbecke (FGT) index, often called the Pα class of
poverty measures. The Pα index is given by:

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where Yi is the income of the i th poor person, Yp is the poverty line, and N is the population.
Depending on the value of α, the Pα index takes on different forms. If α = 0, the numerator is
equal to H, and we get the headcount ratio, H/N. if α = 1, we get the normalized poverty gap. If
α = 2, the impact on measured poverty of a gain in income by a poor person increases in
proportion to the distance of the person from the poverty line. If α = 2, the resulting measure, P ,
can be rewritten as

P2 has become a standard of income poverty measure used by the World Bank and other
agencies, and it is used in empirical work on income poverty because of its sensitivity to the
depth and severity of poverty.

The Newly Introduced Multidimensional Poverty Index:

Poverty cannot be adequately measured with income. Income is imperfectly measured, but even
more important, the advantages provided by a given amount of income greatly differ, depending
on circumstances. To capture this idea the United Nations Development Program used its
Human Poverty Index from 1997 to 2009. In 2010, the UNDP replaced the HPI with its new
Multidimensional Poverty Index (MPI)

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MPI is A poverty measure that identifies the poor using dual cutoffs for levels and numbers of
deprivations, and then multiplies the percentage of people living in poverty times the percent of
weighted indicators for which poor households are deprived on average

Check Your Progress Exercise 5.2

1. What Multidimensional Poverty Index (MPI)?
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5.1.3. Income Inequality and Economic Growth

What’s so bad about Extreme Inequality?

Social welfare depends positively on the level of income per capita but negatively on poverty and
negatively on the level of inequality. If our top priority is the alleviation of absolute poverty, why
should relative inequality be a concern? There are three major answers to this question.
First, extreme income inequality leads to economic inefficiency.This is partly because at any
given average income, the higher the inequality, the smaller the fraction of the population that
qualifies for a loan or other credit. Indeed, one definition of relative poverty is the lack of
collateral. When low-income individuals (whether they are absolutely poor or not) cannot borrow
money, they generally cannot adequately educate their children or start and expand a business.

Moreover, with high inequality, the overall rate of saving in the economy tends to be lower,
because the highest rate of marginal savings is usually found among the middle classes, seek
safe havens abroad for their savings in what is known as capital flight. Such savings and
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investments do not add to the nation’s productive resources; in fact, they represent substantial
drains on these resources. In short, the rich do not generally save and invest significantly larger
proportions of their saving than the middle class or even the poor.

Furthermore, inequality may lead to an inefficient allocation of assets. The result of these factors
can be a lower average income and a lower rate of economic growth when inequality is high.

The second reason to be concerned with inequality above the poverty line is that extreme income
disparities undermine social stability and solidarity. Also, high inequality strengthens the political
power of the rich and hence their economic bargaining power. Usually this power will be used to
encourage outcomes favorable to themselves. High inequality facilitates rent seeking, including
actions such as excessive lobbying, large political donations, bribery, etc. When resources are
allocated to such rent-seeking behaviors, they are diverted from productive purposes that could
lead to faster growth. In sum, with high inequality, the focus of politics often tends to be on
supporting or resisting the redistribution of the existing economic pie rather than on policies to
increase its size

Finally, extreme inequality is generally viewed as unfair. For all these reasons, for this part of
the analysis we will write welfare, W, as
W = W(Y, I, P)
where Y is income per capita and enters our welfare function positively,
I is inequality and enters negatively, and
P is absolute poverty and also enters negatively.

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These three components have distinct significance, and we need to consider all three elements to
achieve an overall assessment of welfare in developing countries.

5.1.3.1. Kuznets Inverted U-hypothesis

Simon Kuznets suggested that in the early stages of economic growth, the distribution of income
will tend to worsen; only at later stages it will improve. This observation came to be
characterized by the “inverted-U” Kuznets curve because a longitudinal (time-series) plot of
changes in the distribution of income—as measured, for example, by the Gini coefficient—
seemed, when per capita GNI expanded, to trace out an inverted U-shaped curve in some of the
cases Kuznets studied, as illustrated in the Figure 5.7 below.

Explanations as to why inequality might worsen during the early stages of economic growth
before eventually improving are numerous.
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 a. They almost always relate to the nature of structural change. Early growth may, in
accordance with the Lewis model, be concentrated in the modern industrial sector, where
employment is limited but wages and productivity are high.
b. As just noted, the Kuznets curve could be generated by a steady process of modern-sector
enlargement growth as a country develops from a traditional to a modern economy.
Alternatively, returns to education may first rise as the emerging modern sector demands
skills and then fall as the supply of educated workers increases and the supply of unskilled
workers falls.
So while Kuznets did not specify the mechanism by which his inverted-U hypothesis was
supposed to occur, it could in principle be consistent with a sequential process of economic
development.

Growth and Inequality

Clearly, it is not necessary for inequality to increase for higher growth to be sustained. it is not
just the rate but also the character of economic growth (how it is achieved, who participates,
which sectors are given priority, what institutional arrangements are designed and emphasized,
etc.) that determines the degree to which that growth is or is not reflected in improved living
standards for the poor.

5.1.4. Poverty Reduction and Economic Growth

Absolute Poverty: Extent and Magnitude

It is extremely difficult to arrive at a tight estimate of the extent of global poverty at any point in

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time. Major World Bank reports issued within a couple of years of each other have provided
estimates of the dollar-a-day headcount that differ by tens of millions of people. This reflects the
difficulty of the task.

Another difficulty is determining the most appropriate cutoff income for extreme poverty. The
$1-a-day line was first set in 1987 dollars, and for years the standard was $1.08 in 1993 U.S.
purchasing power parity. In 2008, the equivalent line was reset at $1.25 at 2005 U.S. purchasing
power.

In its 2010 World Development Indicators, the World Bank estimated that the number of people
living in extreme ($1.25-a-day) poverty was approximately 1.4 billion in 2005. This gave a
headcount ratio of just over 18%, reflecting the steady progress against poverty of recent years;
in 1987, over 28% of the world’s people lived below this same poverty line.

Growth and Poverty

Are the reduction of poverty and the acceleration of growth in conflict? Or are they
complementary? Traditionally, a body of opinion held that rapid growth is bad for the poor
because they would be bypassed and marginalized by the structural changes of modern growth.
Beyond this, there had been considerable concern in policy circles that the public expenditures
required for the reduction of poverty would entail a reduction in the rate of growth.

There are at least five reasons why policies focused toward reducing poverty levels need not lead
to a slower rate of growth.

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First, widespread poverty creates conditions in which the poor have no access to credit, are
unable to finance their children’s education, and, in the absence of physical or monetary
investment opportunities, have many children as a source of old-age financial security. Together
these factors cause per capita growth to be less than what it would be if there were greater
equality.

Second, a wealth of empirical data bears witness to the fact that unlike the historical experience
of the now developed countries, the rich in many contemporary poor countries are generally not
noted for their frugality or for their desire to save and invest substantial proportions of their
incomes in the local economy.

Third, the low incomes and low levels of living for the poor, which are manifested in poor
health, nutrition, and education, can lower their economic productivity and thereby lead directly
and indirectly to a slower-growing economy. Strategies to raise the incomes and levels of living
of the poor would therefore contribute not only to their material well-being but also to the
productivity and income of the economy as a whole.

Fourth, raising the income levels of the poor will stimulate an overall increase in the demand for
locally produced necessity products like food and clothing, whereas the rich tend to spend more
of their additional incomes on imported luxury goods. Rising demand for local goods provides a
greater stimulus to local production, local employment, and local investment. Such demand thus
creates the conditions for rapid economic growth and a broader popular participation in that

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growth.

Fifth, a reduction of mass poverty can stimulate healthy economic expansion by acting as a
powerful material and psychological incentive to widespread public participation in the
development process. By contrast, wide income disparities and substantial absolute poverty can
act as powerful material and psychological disincentives to economic progress. They may even
create the conditions for an ultimate rejection of progress by the masses, impatient at the pace of
progress or its failure to alter their material circumstances.

We can conclude, therefore, that promoting rapid economic growth and reducing poverty are not
mutually conflicting objectives.

Check Your Progress Exercise 5.3

1. What are the reasons why policies focused toward reducing poverty levels need not lead to a
slower rate of growth?
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5.1.5. Economic Characteristics of High Poverty Groups

Painting a broad picture of absolute poverty is not enough. Before we can formulate effective
policies and programs to attack poverty at its source, we need some specific knowledge of these
high poverty groups and their economic characteristics.

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5.1.5.1.Rural Poverty:
Perhaps the most valid generalizations about the poor are
- that they are disproportionately located in rural areas,
- that they are primarily engaged in agricultural and associated activities,
- that they are more likely to be women and children than adult males, and
- that they are often concentrated among minority ethnic groups and indigenous peoples

It is interesting to note, in light of the rural concentration of absolute poverty, that the majority of
government expenditures in most developing countries over the past several decades has been
directed toward the urban area and especially toward the relatively affluent modern
manufacturing and commercial sectors.

In view of the disproportionate number of the very poor who reside in rural areas, any policy
designed to alleviate poverty must necessarily be directed to a large extent toward rural
development in general and the agricultural sector in particular

5.1.5.2. Women and Poverty:

Women make up a substantial majority of the world’s poor. If we compared the lives of the
inhabitants of the poorest communities throughout the developing world, we would discover that
virtually everywhere, women and children experience the harshest deprivation. They are more
likely to be poor and malnourished and less likely to receive medical services, clean water,
sanitation, and other benefits.

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The prevalence of female-headed households, the lower earning capacity of women, and their
limited control over their spouses’ income all contribute to this disturbing phenomenon. In
addition, women have less access to education, formal-sector employment, social security, and
government employment programs.

The fact that the welfare of women and children is strongly influenced by the design of
development policy underscores the importance of integrating women into development
programs. To improve living conditions for the poorest individuals, women must be drawn into
the economic mainstream. This would entail increasing female participation rates in educational
and training programs, formal-sector employment, and agricultural extension programs.

It is also of primary importance that precautions be taken to ensure that women have equal access
to government resources provided through schooling, services, employment, and social security
programs. Legalizing informal-sector employment where the majority of the female labor force is
employed would also improve the economic status of women.

5.1.5.3. Ethnic Minorities, Indigenous Populations, and Poverty:

A final generalization about the incidence of poverty in the developing world is that it falls
especially heavily on minority ethnic groups and indigenous populations. Some 40% of the
world’s nation-states have more than five sizable ethnic populations, one or more of which faces
serious economic, political, and social discrimination.

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In recent years, domestic conflicts and even civil wars have arisen out of ethnic groups’
perceptions that they are losing out in the competition for limited resources and job opportunities.
The poverty problem is even more serious for indigenous peoples, whose numbers exceed 300
million in over 5,000 different groups in more than 70 countries.

The results of empirical data in Latin America clearly demonstrate that a majority of indigenous
groups live in extreme poverty and that being indigenous greatly increases the chances that an
individual will be malnourished, illiterate, in poor health, and unemployed. For example, the
research showed that in Mexico, over 80% of the indigenous population is poor, compared to
18% of the non indigenous population.

5.1.6. Policy Options on Income Inequality and Poverty: Some Basic Considerations

Areas of Intervention:
Developing countries that aim to reduce poverty and excessive inequalities in their distribution of
income need to know how best to achieve their aim. What kinds of economic and other policies
might governments in developing countries adopt to reduce poverty and inequality while
maintaining or even accelerating economic growth rates?

We can identify four broad areas of possible government policy intervention, which correspond
to the following four major elements in the determination of a developing economy’s distribution
of income.
1. Altering the functional distribution—the returns to labor, land, and capital as determined
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by factor prices, utilization levels, and the consequent shares of national income that accrue to
the owners of each factor. We may conclude that there is much merit to the traditional factor-
price distortion argument and that correcting prices should contribute to a reduction in poverty
and an improved distribution of income. How much it actually contributes will depend on the
degree to which firms and farms switch to more labor-intensive production methods as the
relative price of labor falls and the relative price of capital rises.

2. Mitigating the size distribution through increasing the assets of the poor—the functional
income distribution of an economy translated into a size distribution by knowledge of how
ownership and control over productive assets and labor skills are concentrated and distributed
throughout the population. The distribution of these asset holdings and skill endowments
ultimately determines the distribution of personal income.

It follows that the second and perhaps more important line of policy to reduce poverty
and inequality is to focus directly on reducing the concentrated control of assets, the unequal
distribution of power, and the unequal access to educational and income-earning opportunities
that characterize many developing countries. A classic case of such redistribution policies as they
relate to the rural poor, who comprise 70% to 80% of the target poverty group, is land reform.

3. Moderating (reducing) the size distribution at the upper levels through progressive taxation
of personal income and wealth. Such taxation increases government revenues that decrease the
share of disposable income of the very rich—revenues that can, with good policies, be invested
in human capital and rural and other lagging infrastructure needs, thereby promoting inclusive

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growth. (An individual or family’s disposable income is the actual amount available for
expenditure on goods and services and for saving.)

4. Moderating (increasing) the size distribution at the lower levels through public expenditures
of tax revenues to raise the incomes of the poor either directly (e.g., by conditional or
unconditional cash transfers) or indirectly (e.g., through public employment creation such as
local infrastructure projects or the provision of primary education and health care). Such public
policies raise the real income levels of the poor above what their personal income levels would
otherwise be, and, can do so sustainably when they build the capabilities and assets of people
living in poverty.

Check Your Progress Exercise 5.4

1. What are the broad areas of possible government policy intervention to reduce poverty and
excessive inequalities?
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5.2. Summary and conclusion

• Though the task of ending extreme poverty will be difficult, it is possible, if we can only
muster the will. As noted by James Speth, the executive director of the United Nations
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Development Program, “Poverty is no longer inevitable. The world has the material and natural
resources, the know-how and the people to make a poverty-free world a reality in less than a
generation. This is not wooly idealism but a practical and achievable goal.”

5.3. Key Terms

 Income inequality

 Absolute poverty

 Lorenz curve

 Gini coefficients

5.4. Answer to Check Your Progress Exercise

Answer to Check Your Progress Exercise 5.1

1. - The anonymity principles

- Scale independence principles,
- Population independence principles, and transfer principles

Answer to Check Your Progress Exercise 5.2

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1. MPI is A poverty measure that identifies the poor using dual cutoffs for levels and numbers
of deprivations, and then multiplies the percentage of people living in poverty times the percent
of weighted indicators for which poor households are deprived on average

Answer to Check Your Progress Exercise 5.3

1. There are at least five reasons
First, widespread poverty creates conditions in which the poor have no access to credit, are
unable to finance their children’s education, and, in the absence of physical or monetary
investment opportunities, have many children as a source of old-age financial security.

Second, a wealth of empirical data bears witness to the fact that unlike the historical experience
of the now developed countries, the rich in many contemporary poor countries are generally not
noted for their frugality or for their desire to save and invest substantial proportions of their
incomes in the local economy.

Third, the low incomes and low levels of living for the poor, which are manifested in poor
health, nutrition, and education, can lower their economic productivity and thereby lead
directly and indirectly to a slower-growing economy.

Fourth, raising the income levels of the poor will stimulate an overall increase in the demand
for locally produced necessity products like food and clothing, whereas the rich tend to spend
more of their additional incomes on imported luxury goods.

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Fifth, a reduction of mass poverty can stimulate healthy economic expansion by acting as a
powerful material and psychological incentive to widespread public participation in the
development process.

Answer to Check Your Progress Exercise 5.4

1. - Altering the functional distribution
- Mitigating the size distribution through increasing the assets of the poor
- Moderating (reducing) the size distribution at the upper levels through progressive
taxation of personal income and wealth
- Moderating (increasing) the size distribution at the lower levels through public
expenditures of tax revenues

5.5. Review Exercises

1. Are rapid economic growth and more equal distributions of income compatible or conflicting
objectives for low-income countries? To put it another way, is rapid growth achievable only at
the cost of greater inequalities in the distribution of income, or can a lessening of income
disparities contribute to higher growth rates?

2. Do the poor benefit from growth, and does this depend on the type of growth a developing
country experiences? What might be done to help the poor benefit more?

3. What is so bad about extreme inequality?

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4. What kinds of policies are required to reduce the magnitude and extent of absolute poverty?

5. What is the extent of relative inequality in developing countries, and how is this related to the
extent of absolute poverty?

6. Who are the poor, and what are their economic characteristics?

7. What determines the nature of economic growth—that is, who benefits from economic
growth, and why?

5.6. References

 Todaro,M.,(1994)EconomicDevelopment,Fiftheditions,Longman:NewYork and
London.
 TodaroM.P.&SmithS.C.(2006)DevelopmentEconomics,Ninthedition,Harlow, Pearson &
Addison Wesley:London.
 Ray, D.(1998) Development Economics, Princeton University Press.

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