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Introduction to Classic Theories

Multidimensional Development Process

 Development encompasses more than just economic progress; it involves reorganization


of economic and social systems.

 It includes radical changes in institutions, social structures, and attitudes.

 Development at a national level may require modifications in the international economic


and social system.

 Scholars have evolved in their thinking about the development process over time.

 Newer models draw from classic theories to offer valuable insights.

Four Major Classic Theories

 Linear-stages-of-growth model

 Theories and patterns of structural change

 The international-dependence revolution

 The neoclassical, free-market counterrevolution

 An eclectic approach that integrates aspects of all these theories has emerged.

Classic Theories of Economic Development


Linear-Stages-of-Growth Model

 Viewed development as a series of successive stages of economic growth.

 Emphasized the importance of saving, investment, and foreign aid for economic growth.

 Replaced in the 1970s by theories focusing on structural change and international


dependence.

 Development was synonymous with rapid economic growth in this model.

 Historical context: Developed countries' experiences were seen as a blueprint for


developing nations.
Theorists and Models of Structural Change

 Used economic theory and statistical analysis to depict the internal process of structural
change in developing countries.

 Aimed to generate and sustain rapid economic growth through structural transformations.

 Contrasted with the linear-stages model by focusing on the dynamics of change.

 Highlighted the necessity of major new policies to address poverty and income
inequalities.

 Emphasized the role of institutional and political constraints on development.

International-Dependence Revolution

 Viewed underdevelopment in terms of power relationships and economic rigidities.

 Emphasized external and internal constraints on development.

 Advocated for policies to eradicate poverty and reduce income inequalities.

 Considered economic growth as important but not the sole focus.

 Addressed the need for structural changes within and among nations.

Neoclassical Counterrevolution

 Emphasized free markets, open economies, and privatization of public enterprises.

 Criticized excessive government intervention in the economy.

 Contrasted with dependence theories by attributing underdevelopment to government


regulations.

 Prevailed in the 1980s and 1990s as a dominant economic thought.

 Neoliberal approach that prioritized market mechanisms for development.

Eclectic Approach

 Draws on perspectives from all classic theories.

 Considers the strengths and weaknesses of each approach.

 Aims to integrate diverse viewpoints for a comprehensive understanding of development.


 Acknowledges the complexity of development processes.

 Encourages a nuanced approach to policy-making and economic strategies.

Development as Growth and the Linear-


Stages Theories
Capital Fundamentalism and Historical Context

 Post-World War II interest in economic growth in agrarian societies.

 Influence of the Marshall Plan on rebuilding European economies.

 Historical experiences of developed countries seen as lessons for developing nations.

 Emphasis on accelerated capital accumulation in the development process.

 Criticized as 'capital fundamentalism' due to its focus on capital injections.

Rostow's Stages of Growth

 Walt W. Rostow's influential stages-of-growth model.

 Describes development as a series of sequential stages that all countries must pass
through.

 Categories include traditional society, preconditions for growth, take-off, drive to


maturity, and high mass consumption.

 Not just descriptive but a way to generalize the development sequence of societies.

 Known for its simplicity and historical perspective on economic growth.

Harrod-Domar Growth Model


Economic Relationship in the Harrod-Domar Model

 The Harrod-Domar growth model is a functional economic relationship where the growth
rate of GDP (g) is directly influenced by the national net savings rate (s) and inversely by
the national capital-output ratio (c).

 Developed countries had already achieved self-sustaining growth, while underdeveloped


countries needed to follow specific development rules to achieve economic growth.
 Mobilization of domestic and foreign savings is crucial for generating enough investment
to accelerate economic growth.

 The model is based on a linear production function with output determined by the capital
stock (K) multiplied by a constant (A), often referred to as the AK model.

 It has been applied to policy issues in developing countries, such as the two-gap model.

Simple Model of Economic Growth in the Harrod-Domar Model

 Every economy must save a portion of its national income to replace capital goods and
achieve growth through new investments.

 Net savings (S) is a proportion (s) of national income (Y), represented by the equation S
= sY.

 Net investment (I) is the change in the capital stock (K), denoted as ΔK, leading to I =
ΔK.

 The capital-output ratio (c) shows the units of capital required to produce a unit of output
over time.

 The relationship between total capital stock (K) and national output (Y) is expressed by
the equation K/Y = c.

Relationship between Savings, Investment, and GDP Growth

 Net national savings (S) must equal net investment (I), leading to the equation S = I.

 The growth rate of GDP (∆Y/Y) is determined by the net national savings ratio (s) and
the national capital-output ratio (c).

 Gross savings (sG) can be factored in to account for capital depreciation (δ) in the growth
rate equation.

 Economies need to save and invest a portion of their GDP to grow, with the rate of
growth influenced by the capital-output ratio.

 Labor force growth and technological progress are also essential components of
economic growth.
Classic Theories of Economic Growth and
Development
Strategies for Economic Growth

 Increasing the proportion of national income saved is fundamental for economic growth.

 Raising the net savings rate can lead to a higher GDP growth rate.

 Countries with higher savings rates can experience faster growth and achieve self-
sustaining development.

 The mechanisms of economic growth primarily involve increasing national savings and
investment.

Obstacles and Constraints in Economic Growth

 The stages-of-growth theories emphasize the importance of increasing the national


savings rate to boost GDP growth.

 Higher savings rates can significantly impact the rate of GDP growth.

 Examples illustrate how increasing the net savings rate can lead to higher GDP growth
rates.

 Rostow and others defined the takeoff stage based on the ability to save a certain
percentage of GDP for faster growth.

Theories of Economic Growth and


Development
Capital Constraint and Stages Approach

 Economic growth and development rely on increasing national savings and investment.

 The main obstacle to development is the low level of new capital formation in poor
countries.

 Countries may seek to fill the 'savings gap' through foreign aid or private foreign
investment.

 The stages approach justifies capital transfers from developed to less developed nations.
 Necessary conditions must be present for an event to occur, but they may not be
sufficient on their own.

 The Marshall Plan in Europe succeeded due to existing structural, institutional, and
attitudinal conditions.

Structural-Change Models

 Underdevelopment stems from structural or institutional factors, requiring more than just
capital formation.

 Focuses on transforming economies from traditional agriculture to modern, diverse


sectors.

 Utilizes neoclassical price theory and econometrics to describe the transformation


process.

 Examples include W. Arthur Lewis' two-sector surplus labor model and Hollis B.
Chenery's patterns of development analysis.

 Structural transformation involves shifting the economy towards manufacturing


surpassing agriculture in national income contribution.

Lewis Theory of Economic Development

 Surplus labor model where labor shifts from traditional agriculture to modern industrial
sector.

 The modern sector's growth absorbs surplus labor, promoting industrialization and
sustained development.

 Production function defines the relationship between quantity produced and input
quantity.

 Lewis model focuses on labor transfer, output growth, and employment in the modern
sector.

 Illustrates the model with the assumption of reinvested profits and constant urban wages.
Overview of Lewis Model
Total Output Determination

 Total output of food (TPA) determined by changes in labor (LA), capital (KA), and
technology (tA).

 Total product of manufactures (TPM) influenced by labor (LM), capital (KM), and
technology (tM).

 Illustration of the Lewis Model in a two-sector surplus-labor economy.

Average and Marginal Products

 Average product: Total output divided by total factor input.

 Marginal product: Increase in total output from one additional unit of a variable factor.

 Surplus labor concept in the Lewis model where workers have zero marginal product.

Sector Specifics

 Traditional sector: Surplus labor assumption, equal sharing of output among rural
workers.

 Modern sector: Capital stock growth, reinvestment of profits, and demand for labor.

 Self-sustaining growth: Continuation of economic growth based on saving, investment,


and activities.

Detailed Concepts and Examples


Total Product Curves

 Total product curves for the traditional agricultural and modern industrial sectors.

 Shifts in total product curves due to changes in capital stock and technology.

 Derivation of average and marginal product curves from total product curves.

Labor Market Dynamics

 Assumptions of perfectly competitive labor markets in the modern sector.


 Determination of labor demand based on declining marginal product.

 Equilibrium levels of employment and output in the modern sector.

Self-Sustaining Growth Process

 Reinvestment of profits leading to capital stock growth.

 Shifts in labor demand curves and levels of employment.

 Absorption of surplus rural labor until the Lewis turning point.

Criticisms of the Lewis Model

 Simplistic nature and historical reflection of Western economic growth.

 Incompatibility with the realities of contemporary developing countries.

 Discussion on four key assumptions that do not align with current economic contexts.

Lewis Model of Economic Growth


Criticisms of the Lewis Model

 The Lewis model assumes that the rate of labor transfer and employment creation in the
modern sector is directly proportional to the rate of modern-sector capital accumulation.

 It questions what happens if capitalist profits are reinvested in laborsaving capital


equipment rather than duplicating existing capital, leading to a scenario where labor
demand curves do not uniformly shift outward.

 The model assumes surplus labor in rural areas and full employment in urban areas,
which contradicts contemporary research indicating little surplus labor in rural locations.

 It assumes a competitive modern-sector labor market with constant real urban wages,
which is negated by factors like union bargaining power and multinational corporations'
practices in developing countries.

 The model assumes diminishing returns in the modern industrial sector, whereas evidence
suggests increasing returns, posing challenges for development policymaking.

Modified Lewis Model and Employment Implications

 Total output increases substantially, but total wages and employment remain unchanged,
leading to a scenario where extra output accrues to capitalists as profits.
 Illustrates a scenario of unequal income distribution where extra income and output
growth benefit a few capital owners while the majority of workers see little improvement
in income and employment levels.

 The model highlights the concept of 'antidevelopmental' economic growth.

 The Lewis turning point, where wages in manufacturing start to rise, was identified with
China's wage increases in 2010.

 Acknowledges the need for significant modifications in assumptions and analysis to align
with the reality of contemporary developing nations.

Patterns of Development Analysis


Structural Change and Patterns of Development

 Patterns-of-development analysis aims to identify characteristic features of the internal


process of structural transformation in developing economies as they transition to modern
economic growth.

 Focuses on the sequential process of transforming the economic, industrial, and


institutional structure to replace traditional agriculture with new industries as the driver of
economic growth.

 Requires changes in economic functions, production transformation, shifts in consumer


demand, international trade, resource use, urbanization, and population growth.

 Emphasizes domestic and international constraints on development, including resource


endowment, government policies, access to external capital and technology, and
international trade.

 Recognizes developing countries as part of an integrated international system that can


promote or hinder their development.

Hollis B. Chenery's Structural Change Model

 Based on the empirical work of economist Hollis B. Chenery and colleagues, examining
patterns of development in developing countries postwar.

 Identifies characteristic features of development process such as shift from agriculture to


industrial production, accumulation of physical and human capital, and changes in
consumer demands.
 Acknowledges the role of international constraints in shaping the transition of developing
countries, offering opportunities for faster development through access to capital,
technology, and markets.

 Contrasts with the earlier stages model by recognizing developing countries as integral
parts of the global economic system.

 Chenery's model builds on the research of Nobel laureate Simon Kuznets on modern
economic growth in developed countries.

Discussion questions

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1. Discuss the four major classic theories of economic development and growth as outlined
in the note. How do these theories differ in their approaches to development?

The note discusses four major classic theories of economic development and growth: the linear-
stages-of-growth model, theories and patterns of structural change, the international-dependence
revolution, and the neoclassical, free-market counterrevolution. The linear-stages model views
development as a series of successive stages of economic growth, focusing on saving,
investment, and foreign aid. The structural change theories emphasize the transformation of
economic structures from traditional agriculture to modern industries. The international-
dependence revolution views underdevelopment in terms of power relationships and institutional
rigidities. The neoclassical counterrevolution emphasizes free markets and privatization. Each
theory offers a unique perspective on development, focusing on different aspects and strategies.

2. Explain the Harrod-Domar growth model and its implications for economic growth. How
does this model relate to the concept of capital-output ratio?

The Harrod-Domar growth model describes the relationship between the growth rate of GDP and
the national net savings ratio and the national capital-output ratio. It states that the growth rate of
GDP is determined by the savings ratio and inversely related to the capital-output ratio. The
model shows that economies must save and invest a proportion of their GDP to grow. The
capital-output ratio represents the units of capital required to produce a unit of output over time.
The model highlights the importance of investment and saving in driving economic growth and
the efficiency of capital utilization in generating output.

3. Critically analyze the Lewis two-sector model of economic development. What are the
key assumptions of the model, and how do they impact its applicability to contemporary
developing nations?

The Lewis two-sector model focuses on the transfer of surplus labor from traditional agriculture
to modern industry to drive economic growth. It assumes surplus labor in rural areas, competitive
urban labor markets, and diminishing returns in the industrial sector. However, these
assumptions may not hold in contemporary developing nations. Surplus labor is rare, urban
wages tend to rise, and modern technology may lead to capital-intensive growth. The model's
assumptions limit its applicability to current contexts, requiring modifications to reflect the
realities of modern economies.

4. Discuss the concept of structural change in economic development. How does the
structural-change theory differ from the Lewis two-sector model?

Structural change theory focuses on transforming economic structures from traditional to modern
sectors. It emphasizes changes in production, consumer demands, and resource use. Unlike the
Lewis model, it considers capital accumulation as necessary but not sufficient for growth.
Structural change theory recognizes domestic and international constraints on development and
the importance of access to external resources. It differs from the Lewis model by highlighting
broader economic transformations beyond labor transfer and capital accumulation.

5. Explain the concept of self-sustaining growth in the context of economic development.


How does it relate to the Lewis model and the Harrod-Domar growth model?

Self-sustaining growth refers to economic growth based on saving, investment, and


complementary activities that promote long-term development. It relates to the Lewis model by
depicting the transition from traditional to modern sectors as a self-sustaining process driven by
capital accumulation and labor transfer. In contrast, the Harrod-Domar model emphasizes the
relationship between savings, investment, and GDP growth, highlighting the importance of
capital-output ratio and savings rate in driving economic expansion.

6. Evaluate the criticisms of the Lewis two-sector model and its implications for economic
development. How do the assumptions of the model impact its effectiveness in explaining
contemporary economic realities?

The Lewis two-sector model has been criticized for assumptions like surplus labor in rural areas,
competitive urban labor markets, and diminishing returns in the industrial sector. These assumptions
may not align with modern economic contexts where surplus labor is scarce, urban wages rise, and
technology leads to capital-intensive growth. The model's limitations in reflecting current economic
conditions affect its effectiveness in explaining contemporary realities, requiring adjustments to better
capture the complexities of modern economies.

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