Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND
DEVELOPMENT
Submitted By:
Mary Grace B. Empig
Jofelyn E. Grasula
April Joy T. Sayon
Classic Theories of Economic Development: Four Approaches
➢ The Linear-stages-of-growth model
➢ Structural Change Model
➢ The International-Dependence Revolution
➢ Neoclassical Counterrevolution
A. The Linear-Stages-of-Growth Model
● right quantity and mixture of saving, investment, and foreign aid was necessary
● oldest and most traditional development plan
Development as Growth and the Linear-Stages Theories
Rostow’s Stages of Growth Model
● formulated by Walt Whitman Rostow (American Economist Historian)
● transition into development occurs in a series of stages
Harrod-Domar Growth Model
● Developed by Roy F. Harrod in 1939
● Often referred as AK Model, based on a linear production function with output given by
the capital stock K times a constant, often labeled A
● 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)
Capital-output ratio - ratio that shows the units of capital required to produce a unit of output
over a given period of time
Necessary versus Sufficient Conditions: Some Criticisms of the Stages Model
● Necessary Condition - A condition that must be present, although it need not be in itself
sufficient, for an event to occur.
● Sufficient condition - A condition that when present causes or guarantees that an event
will or can occur; in economic models, a condition that logically requires that a
statement must be true (or a result must hold) given other assumptions.
B. Structural-change Theory
● Focuses on the mechanism by which underdeveloped economies transform their
domestic economic structures from a heavy emphasis on traditional subsistence
agriculture to a more modern, more urbanized, and more industrially diverse
manufacturing and service economy
The Lewis Theory of Economic Development (Basic Model)
● A theory of development in which surplus labor from the traditional agricultural sector
is transferred to the modern industrial sector, the growth of which absorbs the surplus
labor, promotes industrialization, and stimulates sustained development.
● Formulated by Nobel laureate W. Arthur Lewis in the mid-1950s and later modified,
formalized, and extended by John Fei and Gustav Ranis.
Structural Change and Patterns of Development
Patterns of Development Analysis
● An attempt to identify characteristic features of the internal process of structural
transformation that a “typical” developing economy undergoes as it generates and
sustains modern economic growth and development.
C. The International-Dependence Revolution
The Neocolonial Dependence Model
● A model whose main proposition is that underdevelopment exists in developing
countries because of continuing exploitative economic, political, and cultural policies of
former colonial rulers toward less developed countries.
The False-Paradigm Model
● The proposition that developing countries have failed to develop because their
development strategies (usually given to them by Western economists) have been
based on an incorrect model of development, one that, for example, overstresses
capital accumulation or market liberalization without giving due consideration to
needed social and institutional change.
The Dualistic-Development Thesis
Dualism
● The coexistence of two situations or phenomena (one desirable and the other not) that
are mutually exclusive to different groups of society—for example, extreme poverty and
affluence, modern and traditional economic sectors, growth and stagnation, and higher
education among a few amid large-scale illiteracy.
D. Neoclassical Counterrevolution
● Central Argument: Underdevelopment results from poor resources allocation due to
incorrect pricing policies and too much state intervention by overly active developing-
nation governments
● Cause of Underdevelopment: Corruption, inefficiency and lack of economic incentives
What are not needed?
➢ Reform of the international economic system
➢ Restructuring of dualistic developing economies
➢ Increase in foreign aid
➢ Control population growth
➢ More effective development planning system
What they recommend?
➢ Free Market
➢ Laissez Faire
➢ Invisible Hand
“Free market and Laissez Faire are the same”
● Laissez Faire – French term for “let them do”
● Economic system in which transactions are free from any form of government
intervention such as regulation, privileges, imperialism, tariffs and subsidies.
● Economic competition constitutes a “natural order”
● Taxes are viewed by the economist as penalty for production.
Invisible Hand
● A metaphor for the unseen forces that moves the free market economy
● Constant interplay of individual pressures on the market supply and demand causes the
natural movement of prices and the flow of trade.
Three Component Approaches
➢ Free-market Analysis
➢ Public-choice Theory
➢ Market-friendly Approach
Free-market Analysis
● Markets alone are efficient
● Product markets provide the best signals for investments in new activities
● Labor markets respond to these new industries in appropriate ways
● Producers know best what to produce and how to produce it efficiently
● Product and factor prices reflect accurate scarcity values of goods and resources now
and in the future
Pubic-choice Theory
● Governments can do (virtually) nothing right
● Assumes that politicians, bureaucrats, citizens, and states act solely from a self-
interested perspective, using their power and the authority of government for their own
selfish ends
Market-friendly Approach
● Governments do have a key role to play in facilitating the operation of markets through
“nonselective” (market-friendly) interventions
● This approach recognizes that there are many imperfections in developing-country
product and factor markets
Traditional Neoclassical Growth Theory
● Closed economies (those with no external activities) with lower savings rates (other
things being equal) grow more slowly in the short run than those with high savings rates
and tend to converge to lower per capita income levels.
● Open economies (those with trade, foreign investment, etc.), however, experience
income convergence at higher levels as capital flows from rich countries to poor
countries where capital-labor ratios are lower
