### Chapter 3

```Chapter 3
Classic Theories
of Economic
Growth and
Development
Class Theories of Economic
Development – Four Approaches
• Structural change model
– Linear stages of growth
– Saving-investment
– Rural-urban migration
• Neocolonial dependence theory
– Dependence: Center vs. Periphery
• Neoclassical theory
– Market friendly approach
– Dualistic approach
– Public choice approach
3-2
Rostow’s Linear-Stages Model
2. Pre-condition to take-off
3. Take-off
4. Drive to maturity
5. Age of high mass consumption
3-3
Rostow’s Linear-Stages Model
1. Traditional society: slow economic and
population growth
2. Pre-condition to take-off: development of
institutions, organizations, and
infrastructure
3. Take-off: large investment in selected
industry (10 to 15% of GDP)
3-4
Rostow’s Linear-Stages Model
4. Drive to maturity: sustained growth of the
industry and economy
5. Age of high mass consumption:
production of consumer goods and
services to serve an affluent society
3-5
Rostow’s Linear-Stages Model
GDP Growth
Economic Growth
Post Take-off
Take-off
Pre Take-off
t1
t2
Time
3-6
Harrod-Domar Growth Model
S = sY
S=Saving; Y=Real GDP; s=Saving Ratio
I = ΔK
I=Investment; ΔK=Capital Accumulation
S=I
Saving-Investment identity
Define the Marginal Capital-Output Ratio as k = ΔK/ΔY
Write ΔK = kΔY or I = kΔY
From S = I, write sY = kΔY or
ΔY/Y = s/k
3-7
Harrod-Domar Growth Model
The source of growth is saving and investment in
production of goods and services. Accordingly,
GDP growth rate = s/k
s = national saving ratio; k = marginal capital-output ratio
If s=6% and k=3, then GDP growth rate=2%. Given k=3,
to raise growth rate to 4%, we need to increase the saving
ratio from 6% to 12% with 6% of foreign saving
3-8
Criticism of Investment Models
• Many LDCs have not been able to take-off
or achieve maturity despite massive
foreign investment
• Many nations have neglected the
development of institutions, organizations,
and infrastructure required for
industrialization
3-9
The Lewis Development Model
• Rural agricultural sector
– Low or even zero Marginal Product of Labor so that
labor is a redundant factor and wage rate is at the
subsistence level
• Urban industrial sector
– Rising demand for unskilled labor to be trained for
industrial growth results in greater employment and
more profits and higher wages
• Rural-Urban migration
– To find jobs and earn higher wages
3-10
Demand for Labor
Wage
R: Rural
W: Wage
D: Labor Demand
U: Urban
E: Employment
S: Labor Supply
Profit
WU
SR
WR
Wage
DU1 DU2
E1
E2
Investment in urban areas
increases the demand and
employment for rural labor.
Employment
3-11
Criticisms of Lewis Model
• Industrial technology is generally capital
intensive/labor-saving. Hence, the demand
for unskilled rural labor would not increase
employment
• Industrialization must be supported by
agricultural development to supply an
ever-increasing supply of food items and
raw materials
3-12
Demand for Labor
Wage
No increase in employment when
technology is labor saving
Profit
SR
WU
WR
Wage
DU2
DU1
E1 = E2
Employment
3-13
Neocolonial Dependence Model
• MDCs form the “center” of global economic
• LDCs serving as the “periphery” are dominated by:
– unequal trade and finance relations
– domestic politico-economic elite
– multinational corporations
Under these conditions economic development is
impossible
3-14
Neocolonial Dependence Model
African LDCS
Asian LDCS
American
MDCs
Latin American LDCS
European Other
MDCs MDCs
3-15
• Economic development relies heavily on funds
from international donor agencies such as the
World Bank and IMF
• The policy of these agencies is to support urban
industrial growth and impose capitalistic
austerity measures
• They reinforce the pattern of “dependent
development”
3-16
Dualistic Development Model
• Structural transformation models create a
“dualistic” pattern of development, resulting in an
ever-increasing degree of economic inequality
both nationally and internationally:
– urban vs. rural
– industrial vs. agricultural
– rich vs. poor
3-17
Approaches to Development
• Free-market approach: rely of the allocation role
of markets and limited government involvement in
economics. But, there are several areas in which
markets fail to achieve efficient outcomes:
– income distribution
– public goods
– externalities
– market power
3-18
Approaches to Development
• Market-friendly approach: improve market
operation through “nonselective”
interventions such as
–
–
–
–
income redistribution system
investment in social and human capital
environmental protection policy
anti-trust laws
3-19
Approaches to Development
• Public-choice approach: public officials and
bureaucrats in the position of authority are
“rent-seeking” citizens acting on self-interest
rather than public-interest
• Need a system of checks and balances to monitor
the behavior of public officials and bureaucrats
• Need a democratic system to let people choose
public officials and bureaucrats for limited duration
of authority
3-20
Appendix 3.1: Components of
Economic Growth
• Capital Formation
– Physical capital formation: investment in tools,
equipment, machinery, buildings
– Social capital formation: investment in roads, dams,
– Human capital formation: investment in education,
training, health, nutrition
– Political capital formation: investment is creating a
secular and democratic government and free mass
media
3-21
Determinants of Economic
Growth
• Physical Capital Formation
– Increase in the amount of physical
capital per unit of labor
3-22
Determinants of Economic
Growth
– Increase factor productivity (labor,
land, capital)
3-23
Production Possibilities Curve
•
Maximum quantities of two good and
services the economy can produce,
assuming:
– full employment / efficiency
– fixed resources
– constant technology
3-24
PPC Schedule
Combination
Rice
A
B
C
E
100
90
50
0
0
40
80
100
3-25
PPC Graph
Combinations A, B, C, and E are attainable
Combination D is unattainable given resources
and technology
Combination F is attainable, but inefficient
100 A
90
50
B
F
40
D
C
E
80 100
Rice
3-26
Economic Growth
Combination D becomes available with
more resources and better technology
100 A
90
B
D
C
50
40
E
80 100
Rice
3-27
Economic Improvement
Combinations G (or B or C) becomes
efficient with more employment
and/or improved efficiency
100 A
90
50
B
G
F
40
C
E
80 100
Rice
3-28
Neutral: proportional increase in the supply of Rice and Radios
Rice
3-29
Capital augmenting: greater increase in the supply of Radios
Rice
3-30
Labor augmenting: greater increase in the supply of Rice
Rice
3-31
Rice
3-32