Classic Theories of Development: A Comparative Analysis

Classic theories of
Development
A Comparative Analysis
OUTLINE
The Quest for Growth
The financing gap

Investment in physical and human capital
Structural Adjustments
New economic theory
Four approaches to the Classic Theories of

Development
Classic Theories of Economic

Development: Four Approaches
Literature on economic development is
dominated by the following four strands of

thought:
Linear-stages-of-growth model: 1950s and
1960s
Theories and patterns of structural change:

1970s
International-dependence revolution: 1970s
Neo-classical, free-market counterrevolution:
1980s and 1990s
3
Linear-stages theory
Viewed the process of development as a
series of successive stages of economic

growth
Mixture of saving, investment, and foreign
aid was necessary for economic
development
Emphasized the role of accelerated capital
accumulation in economic development
4
Rostows Stages of Growth

Rostow identified 5 stages of growth:
1.
2.
3.
4.
5.
The traditional society

The pre-conditions for take-off
The take-off
The drive to maturity
The age of high mass consumption
All advanced economies have passed the
stage of take-off into self sustaining growth

Developing countries are still in the
traditional society or the pre-conditions
stage. Why?
Rostows Stages of Growth
Lack of adequate investment. The

financing gap exists!
The Harrod-Domar Growth Model

The principal strategy for development is
mobilization of saving and generation of

investment to accelerate economic growth
Importance of H-D growth model (AK model):
It explains the mechanism by which
investment leads to growth
Investment comes from savings
Rate of economic growth (GNP growth rate) is
determined jointly by the ability of the
economy to save (savings ratio) and the
capital-output ratio
change in Y/Y=s/k

(continued)
Investment
Outflow
Firms
Wages, Profits,
Rents
Inflow
Consumption
Expenditure
Households
Inflow
Ray, Debraj
p.52
Outflow
Savings

Target growth rate* ICOR= required investment
ICOR= change in K/change in Y and is lower
for a labour surplus economy.

If the rate of new investment (s=I/Y) is
multiplied by its productivity (1/k), one can get
the rate of growth in GNP
The AK model allows for incorporation of the
effects of population growth (per capita GNP
growth)
The ghost of financing gap once again?
9
Obstacles and Constraints
Problem with the argument that GDP
growth is proportional to the share of

investment expenditure in GDP
Low rate of savings in developing
countries gives rise to savings gap and
capital constraint
Savings and investment is a necessary
condition for accelerated economic
growth but not a sufficient condition
10
Beyond AK model
Endogeneity of savings
Savings are influenced by percapita incomes and
distribution of income in an economy
Both of these are influenced by economic growth
Economic growth mirrors the movement of
savings with income
Endogeneity of population growth

Relationship between demographic transition
and percapita income
External policy can prevent an economy from
sliding in to a trap (process of demographic
transition)
Endogeneity of capital-output ratio

Captured in Solows model
11
Structural-Change Models
Structural-change theory focuses on the
mechanism by which underdeveloped

economies transform their domestic
economic structures from traditional to an
industrial economy
Representative examples of this strand of
thought are
The Lewis theory of development
Chenerys patterns of development
12
Lewis Theory of Development
Also known as the two-sector

surplus labor model
Features of the basic model:
Economy consists of two sectorstraditional and modern

Traditional sector has surplus of labor
(MPL=0)
Model focuses on the process of
transfer of surplus labor and the
growth of output in the modern sector
13
Lewis Theory of Development
The process of self-sustaining
growth and employment expansion

continues in the modern sector until
all of the surplus labor is absorbed
Structural transformation of the
economy has taken place with the

growth of the modern industry
14
15
Lewis Theory of Development:

Criticisms
Four of the key assumptions do not fit
the realities of contemporary
developing countries
Reality is that:
Capitalist profits are invested in labor
saving technology
Existence of capital flight
Little surplus labor in rural areas
Growing prevalence of urban surplus
labor
Tendency for industrial sector wages to
rise in the face of open unemployment
16
Structural Changes and Patterns of

Development : Chenerys Model
Patterns of development theorists view
increased savings and investment as

necessary but not sufficient for economic
development
In addition to capital accumulation,
transformation of production, composition
of demand, and changes in socio-economic
factors are all important
Chenery and colleagues examined patterns
of development for developing countries at
different percapita income levels
17

The empirical studies identified several

characteristic features of economic
development:
Shift from agriculture to industrial production

Steady accumulation of physical and human
capital
Change in consumer demands
Increased urbanization
Decline in family size
Demographic transition
18

Differences in development among the

countries are ascribed to:
Domestic constraints
International constraints
To summarize, structural-change analysts
believe that the correct mix of economic

policies will generate beneficial patterns of
self-sustaining growth
19
The International Dependence

Revolution (IDR)
The IDR models reject the exclusive emphasis
on GNP growth rate as the principal index of

development
Instead they place emphasis on international
power balances and on fundamental reforms
world-wide.
IDR models view developing countries as beset
by institutional, political, and economic
rigidities in both domestic and international
setup
The IDR models argue that developing
countries are up in a dependence and
dominance relationship with rich countries
20
The International Dependence

Revolution (IDR)
Three streams of thought:
Neoclassical dependence model
False-paradigm model
Dualistic-development thesis
21
Neoclassical Dependence Model

Dependence is a conditioning situation in which
the economies of one group of countries are

conditioned by the development and expansion of
others.
Dependence, then, is based upon an
international division of labor which allows

industrial development to take place in some
countries, while restricting it in others, whose
growth is conditioned by and subjected to the
power centers of the world.
Theotonio Dos Santos
22
The False-Paradigm Model
Attributes under development to the
faulty and inappropriate advice

provided by well-meaning but biased
and ethnocentric international expert
advisers
The policy prescriptions serve the vested

interests of existing power groups, both
domestic and international
23
The Dualistic- Development Thesis
Dualism represents the existence and
persistence of increasing divergences between

rich and poor nations and rich and poor
peoples at all levels.
The concept embraces four key arguments:
1. Superior and inferior conditions can coexist
in a given space at given time
2. The coexistence is chronic and not
transitional
3. The degrees of the conditions have an
inherent tendency to increase
4. Superior conditions serve to develop under
development
24
Weaknesses of IDR Models

Do not offer any policy prescription for
how poor countries can initiate and
sustain economic development
Actual experience of developing
countries that have pursued policy of

autarky/closed economy has been
negative
25
The Neoclassical Counterrevolution:

Market Fundamentalism
Neoclassical counterrevolution in the 1980s called for

freer markets, and the dismantling of public
ownership, and government regulations
Four component approaches :

Free-market analysis- markets alone are efficient
Public-choice theory- governments can do nothing
right
Market- friendly approach- governments have a
key role to play in facilitating operations of markets
through nonselective interventions
New institutionalism- success or failure of
developmental efforts depend upon the nature,
existence, and functioning of a countrys
fundamental institutions
26
Traditional Neoclassical Growth Theory
According to the traditional neoclassical

growth theory:
Output growth results from one or more of three

factors- increases in Labor, increases in capital, and
technological changes
Closed economies with low savings rates grow
slowly in the SR and converge to lower per capita
income levels
Open economies converge at higher levels of per
capita income levels
27
Traditional Neoclassical Growth Theory
Traditional neoclassical theory argues that
capital flows from rich to poor countries as KL ratios are lower and investment returns are
higher in the latter
By impeding the flow of foreign investment,
poor countries choose a low growth path.
28
Solow's Neoclassical Model or

Exogenous Growth Model
Solows model of economic growth implies
that economies will conditionally converge to

the same level of income, given that they have
the same rates of savings, depreciation, labor
force growth, and productivity growth
Solows model differs from Harrod-Domar
model in the following respects:
Allows for substitution between labor and capital
Assumes that there exist diminishing returns to
these inputs
Introduces technology in the growth equation
29

30

Impact of increase in savings rate:

Temporary increase in per capital K/L and per
capita output. However, both would return to a
steady- state of growth at higher level of per capita
output
Savings has no impact on long-run per capita
output growth rate but has an impact on long-run
level of per capita output
Total output and total capital stock grow at the
same rate as the population growth rate
31

Impact of increase in population growth rate:

Population growth rate has a positive effect on the
growth of total output
Results in a lower steady -state growth rate with
lower levels of per capita capital, output, and
consumption
32

Impact of increase in productivity:

Shifts the per-worker production function to the
right
Raises steady state per capita output through
increase in per capita capital.
In the long-run increase in per capita income takes
place at the same rate as productivity/ technical
progress
33
Application: Do Economies Converge?
Unconditional convergence occurs when poor

countries will eventually catch up with the
rich countries (LR) resulting in similar living
standards
Conditional convergence occurs when
countries with similar characteristics will
converge (savings rate, investment rate,
population growth)
No convergence occurs when poor countries
do not catch up over time and living
standards may diverge
34

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Classic theories of

The Quest for Growth

The financing gap

Four approaches to the Classic Theories of

Classic Theories of Economic

Literature on economic development is

dominated by the following four strands of

Theories and patterns of structural change:

Viewed the process of development as a

series of successive stages of economic

Rostows Stages of Growth

The traditional society

All advanced economies have passed the

stage of take-off into self sustaining growth

Rostows Stages of Growth

Lack of adequate investment. The

The Harrod-Domar Growth Model

mobilization of saving and generation of

The Harrod-Domar Growth Model

The Harrod-Domar Growth Model

for a labour surplus economy.

Obstacles and Constraints

Problem with the argument that GDP

growth is proportional to the share of

Endogeneity of population growth

Endogeneity of capital-output ratio

mechanism by which underdeveloped

Lewis Theory of Development

Also known as the two-sector

Economy consists of two sectorstraditional and modern

Lewis Theory of Development

The process of self-sustaining

growth and employment expansion

Structural transformation of the

economy has taken place with the

Lewis Theory of Development:

Structural Changes and Patterns of

Patterns of development theorists view

increased savings and investment as

Structural Changes and Patterns of

The empirical studies identified several

Shift from agriculture to industrial production

Structural Changes and Patterns of

Differences in development among the

To summarize, structural-change analysts

believe that the correct mix of economic

The International Dependence

on GNP growth rate as the principal index of

The International Dependence

Neoclassical Dependence Model

the economies of one group of countries are

Dependence, then, is based upon an

international division of labor which allows

The False-Paradigm Model

Attributes under development to the

faulty and inappropriate advice

The policy prescriptions serve the vested

The Dualistic- Development Thesis