Agricultural Economics

Development Economics (Ag.Ec. 442)

Chapter 5
THEORIES OF ECONOMIC
DEVELOPMENT

Instructor: Kassa Ejigu Afrie

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5.1. Introduction to Theories of Economic Development
5.2. Classical Theories of Development
5.2.1. Linear-stages-of-growth model: 1950s and 1960s
Rostow’s Stages of Economic Growth
5.2.2. Theories and patterns of structural change: 1970s
5.2.2.1. Adam Smith’s Theory of Development
5.2.2.2. Unlimited Supply of Labor Theory by Lewis
5.2.3. International-dependence revolution: 1970s
5.2.4. Neo-classical, free-market counter revolution: 1980s &
1990s
5.3. Dualistic Theories
5.4. Balanced Vs Unbalanced Growth Theory
5.5. The Marxian Theory
5.6. The Keynesian Theory
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5.1 Introduction Theories of Economic Development
▪ The growth models and development theories the available
tools useful in explaining development problems and
formulating relevant development policies and strategies.
▪ There are different theories explaining the diverse
development problems of countries at different social,
economic, political, and institutional circumstances.
▪ Theory: systematic explanation of interrelationships among
economic variables.
▪ The purpose is to explain causal relationships among these
variables, to understand world better and provide basis for
policy.
▪ Modelling is a systematic description of a system,
phenomenon that accounts for its known or inferred properties
and may be used for further study of its characteristics. 3
5.2. Classical Theories of Development
▪ Literature on economic development is dominated by the
following four strands of thought:
1. Linear-stages-of-growth model: 1950s and 1960s

2. Theories and patterns of structural change: 1970s

3. International-dependence revolution: 1970s

4. Neo-classical, free-market counter revolution: 1980s and

1990s

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5.2.1. The linear stage growth model (1950-1960):
▪ Theorists view the process of development as a series of
successive stage of economic growth through which all
countries must pass
▪ This theory is based on the experience of developed countries
historically achieved their growth because of their emphasis on
saving, investment and foreign aid.
▪ Economic Growth Stages of Rowstow (1960): All countries
have to pass through the following steps or stages before they
reach the modern society.
i. The traditional society
ii. The preconditions for take-off
iii. The take-off
iv. The drive maturity
v. The age of high mass consumption
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i) Traditional society
✓ Economy is dominated by subsistence production
✓ Limited scope for trade. If there is trade it takes in the form
of barter (exchange of goods by goods)
✓ Limited specialization
✓ Agriculture is the dominant sector
ii) Transitional stage (the preconditions for take-off)
✓ Increase in specialization
✓ Emergency of modernizing entrepreneurs and experts
(know how techniques)
✓ From this we can conclude increases in agricultural
productivity and mining
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iii) Take off
✓ Change in structure of the economy, instead of agricultural
dominating, industry becomes important.
✓ Industrialization process is confined to few regions of a
country.
✓ Investment level increase from about 5% to 10% of GDP.
✓ Change in economic institution is also followed
(accompanied) by evolution of new political and social
institutions.
✓ This change support industrialization. This will result self
industrialization process.

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▪ According to Rowstow three sectors of the economy have to
develop at this stage:-
1. Primary growth sectors: - possibilities of innovation or of
exploiting new or unexplored resources tend to be a higher
growth rate that in the rest of the economy.
2. Supplementary growth sectors: - due to development in
primary growth sectors, rapid growth takes place with the
development of railways, other supplementary growth
sectors grow as well e.g. iron, coal and steel industry
3. Derived growth sector: - production of food, houses and
other sectors grow to meet the demand of growing
population.

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iv) Drive to maturity
✓ Spread of new production technologies to the rest of the
economies
✓ The economy is diversifying (enlarge or vary its range of
products or field of operation) in to new areas
✓ Industrialization takes place in all most all regions.
✓ Technological innovation in providing a diverse range of
opportunities.
✓ The economy then produces diverse goods and services.

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▪ When a country reaches the stage of technology maturity two
changes are visible:-
a) Working forces have change in character: - they are
skilled, city dwellers with rising real wages and organize
themselves to gain more economic and social security
b) Enterprisership changes: - refined and polite managers in
place of rugged and hardworking masters.

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v) High mass consumption
✓ A progressively greater consumption of goods is
economically beneficial
✓ Final stage of modernization
✓ The whole economy is geared towards mass consumption
✓ Affluence (wealthy) of life, the final output of
modernization.
✓ The service sector becomes more important

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▪ There are three forces that lead to welfare increase:-
a) The pursuit of national interest to increase power and
influence beyond the national frontiers.
b) A more equitable distribution of national income through
progressive taxation, increased social security and leisure to
working class.
c) Decisions to create new commercial centre and leading
sectors like cheap automobiles, houses and innumerable
electric operated household articles.

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Mass Consumption Means:
1. The movement seeking to protect and inform consumers by
requiring such practices as honest packaging and advertising,
product guarantees, and improved safety standards.
2. The theory that a progressively greater consumption of goods is
economically beneficial.
3. Attachment to materialistic values or possessions: deplored (feel
or express strong disapproval of) the rampant (flourishing or
spreading unchecked or unrestrained in action or performance)
consumerism of contemporary society.
▪ In the take off stage high requirement of large scale investment
in industry. This can come from foreign aid, loans and foreign
investment.
▪ Rostow does not explain why some countries are doing well and
others do not. 13
Criticism of Rowstow’s Theory
▪ Economists have expressed doubts of Rowsto’s stages of
growth.
i. Traditional society not essential for development
ii. Preconditions may not come before take-off. There is no
reason to trust that an agricultural revolution and collection of
social overhead capital in transport must come before take-off.
iii. Overlapping of stages: for example agricultural development
could be observed in the take-off stage as well.
iv. Criticism of the take-off analysis: the take-off neglects the
effect of historical heritage, time of entry into the process of
modern economic growth, degree of backwardness and other
relevant factors on the characteristics of the early phases of
modern economic development in other countries.

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5.2.2. The structural change (1970s):
▪ It is a change agriculture to manufacture to service
5.2.2.1. Adam Smith’s Theory of Development
▪ Adam Smith’s ideas on economic development are
expounded on his publication of 1776 titled ‘An inquiry into
the Nature and Causes of the Wealth of Nations’
▪ Salient Features
✓ Natural Law
✓ Division of labor
✓ Process of capital accumulation
✓ Why Capitalists make Investments
✓ Interest
✓ Agents of growth
✓ Process of growth 15
▪ Limitations
✓ Rigid division of society
✓ One-sided saving base
✓ Unrealistic Assumption of Perfect Competition
✓ Neglect of Enterprise
✓ Unrealistic assumption of stationery state

▪ Applicability of Smith’s Theory to Underdevelopment

Nations
✓ It has limited application in developing countries because the
markets are small, there is little savings and income is low.
✓ Political, social and institutional assumptions do not apply as
conditions do not allow them.
✓ The government has to play a big role in bringing about
development.
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5.2.2.2. Lewis Dual economy model (Unlimited Supply of
Labor Theory by Lewis )
▪ Lewis assumes there are two dominant sectors in the economy
of developing countries, traditional (agricultural) and modern
(industrial) sectors
➢ The traditional sector
▪ The agricultural productivity is low
▪ Population growth is fast. This leads to;
✓ Surplus/excess labor.
✓ Unemployment
▪ Consequences of this
✓ Opportunity cost of labor is close to zero
✓ This puts down the industrial wage rate. This is because of
the opportunity cost in the traditional sector is close to zero.
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➢ The modern (industrial) sector
✓ Productivity is high
✓ One of the problem is shortage of labor
✓ Due to the surplus labor in the traditional sector, industry can
hire labor at a rate below the market wage rate
✓ MR = MC → condition for hiring factors of production
✓ This does not true in the developing countries
✓ We can hire labor at a lower wage rate (market wage rate)
✓ Therefore, by exploiting the surplus labor from the
traditional sector one could promote industrialization.

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▪ Criticism of Lewis theory
i. Not all underdeveloped countries have an unlimited supply of
labor
ii. Limited enterprise/capitalist initiative
iii. In underdeveloped countries multiplier process does not
operate
iv. Neglects total demand
v. Mobility of labor is not easy
vi. Marginal productivity of labor is not zero

Merits
✓ Despite the demerits, Lewis theory explains a very clear cut
process of development.
✓ The two sector theory has a good analytical value.
✓ The theory touches on some key real life problems such as
credit, inflation, population growth, technological progress and
international trade.
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5.2.3. International dependence revolution (1970s)
▪ Proposed that every nation must get first education and must
have international relation.
▪ Less Developed Countries are highly depended on
developed countries.
▪ The Less Developed Countries harmed in two cases during
international relation:
✓ Exploit (make use of unfairly; benefit unjustly from the
work or actions)
✓ Neglection (fail to give proper care or attention)
▪ The dependence school (1970): The cause of
underdevelopment is the dependence of developing countries
on industrialized countries.
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▪ The coexistence (exist at the same time) of rich and poor
nations in an international system makes poor nations self
reliant and independent difficult and some times impossible.
▪ A center versus periphery relationship
✓ Center - industrialized countries
✓ Periphery - developing countries (a marginal or secondary
position)
▪ Periphery, they produce primary or raw materials to the
industrialized countries
✓ primary products are income inelastic whereas manufacture
goods are income elastic (our willingness to pay increases)
✓ the main reason may be that for most agricultural products
the price elasticity of demand and income elasticity of
demand are below one, that is it is price and income inelastic
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 ✓ price of primary goods decline over time but the
manufactured goods increase over time. As a result of this
developing countries have negative terms of trade
▪ Major economic decision are made at the center power
relationship, the leaders in the periphery stand for the interest
of the center
▪ They suggest cut off this dependence (a kind of economic
liberation) domestic industrialization and import substitution
policies must be promoted state has to play a lot of policy
influence in the developing world;
✓ restricted trade
✓ import restriction

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5.2.4. Market fundamentalism (1980)
▪ The market must be free market, no government
intervention, market should be competitive
▪ Market liberalization (1980s): This theory argue that by
permitting competitive free trade privatization of state owned
enterprises promoting free trade and export expansion
eliminating government regulation and price distortions
✓ both economic efficiency and economic growth will be
stimulated

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5.3. Dualistic Theories
▪ Dualism indicates a situation where types of parallel
phenomena co-exist.
▪ Specifically, the concept of dualism embraces four key
elements.
✓ Different sets of conditions of which some superior and others
inferior can co-exist in a given space
✓ This co-existence is chronic and not merely transitional
✓ Not only do the degrees of superiority or inferiority fail to show
any sign of diminishing, but they even have an inherent
tendency to increase
✓ The interrelations between the superior and inferior elements
are such that the existence of the superior elements does little or
nothing to pull up the inferior elements 24
▪ Dualism has been perceived in different ways such as: Social,
Technological, Financial, and Geographic dualism.
A. Social dualism
▪ The theory of social dualism was developed by a Dutch
economist J.H. Bocke.
▪ The theory of social dualism is a general theory of economic
and social development of UDCs. It is based on his studies of
the Indonesian economy.
▪ Dr. Bocke maintains that there are three characteristics of a
society in the economic sense.
▪ They are the social spirit, the organizational forms and the
techniques dominating it. The interdependence of these
characteristics is called the social system or social style.
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▪ If there is only one social style in a society it is a
homogeneous society.
▪ When a society possesses two or more social systems
simultaneously it is a dual or plural society.
▪ A dual society according to Bocke is characterized by the
existence of an advanced imported Western system and an
indigenous pre-capitalist agricultural system.
▪ Bocke defines social dualism as the clashing of an imported
social system with an indigenous social system of another
style.
▪ Most frequently the imported social system is high capitalism.

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B. Technological Dualism
▪ As an alternative to Boeke’s social dualism, Benjamin Higgins
has developed the theory of technological dualism.
▪ Technological dualism implies the use of different production
functions in the advanced sector and the traditional sector of
the economies of underdeveloped countries.
▪ The existence of such dualism has accentuated the problem of
structural or technological unemployment in the industrial
sector and disguised unemployment in the rural areas.
▪ UDCs are characterized by structural disequilibrium at the
factor level.
▪ Disequilibrium at the factor level may arise either because the
same factor receives different returns in different uses or
because price relationships among factor are out of line with
factor availabilities. 27
▪ Disequilibrium leads to unemployment or underemployment in
UDCs.
C. Financial Dualism
▪ Prof. Myint has developed the theory of financial dualism.
▪ Financial dualism refers to the co-existence of different
interest rates in the organized and unorganized money markets
in the LDCs.
▪ The rate of interest in the unorganized money market is higher
than that in the organized money market in the modern sectors.
▪ The unorganized money market consists of the non-
institutional lenders such as village money lenders, land lords,
shopkeepers, traders, etc.
▪ They charge very high interest rates on loans. It is so because
there is a real shortage of savings in the traditional sector.
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▪ These money lenders occupy strategic positions in the village
economy and create monopoly power over the peasants.
▪ In the organized money market of LDCs the interest rates are
low and credit facilities are abundant.
▪ The organized money market consists of the commercial
banks and other financial institutions which lend short term
credit at low interest rate in the modern business sector.
▪ This has created economic dualism between the traditional
and modern sector.
▪ The fiscal and monetary measures followed in LDCs favored
the interests of the modern sector as against the traditional
sector.
▪ More investment is made in the modern sector. The
agricultural and small scale sector suffers due to these
reforms.
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5.4. Balanced and unbalanced growth theory
5.4.1. Balanced growth theory
▪ Many writers viewed balanced growth differently
▪ To some writers, balanced growth means investing in a
lagging sector (backward sector: having made less progress
than is normal or expected)
▪ The other viewed that investment should take place
simultaneously in all sectors. i.e.
✓ Balance between consumer and capital good industries
✓ Balance between domestic and export sector
✓ Balance between supply and demand
▪ To sum up all the sectors of the economy should grow
simultaneously
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▪ Nurkse (1953), the main obstacle to economic growth is the
limited market opportunities.
▪ Vicious circle in both demand and supply

▪ A strategy is required to go out of this trap. This is the

concept of Balanced growth.
▪ The real bottleneck in breaking the narrow market is the
shortage of capital.
▪ If capital is available, investment will be made.
▪ If investment is to be made there is a need for investment
planning by governments.

Criticisms of Balanced growth theory

✓ Disproportionalties in factors of production. This theory is
applicable in a developed country.
✓ There is scarce resources in LDCs

✓ Increasing returns is wrong

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5.4.2. Unbalanced Growth Theory
▪ This theory starts by criticizing the balanced growth.
▪ Balanced growth requires high state involvement and high
amount of capital.
▪ Real bottleneck for growth is lack of entrepreneur abilities.
▪ Investment should not be spread evenly but concentrate in
projects in which they cause additional investments.
▪ Complementarities of investment: forward and backward
linkages.
▪ Increase the rate of productive investment in two or more
sectors
▪ Since the LDCs do not possess sufficient capital and other
resources to invest simultaneously, investment should be
made on selected sector
➢ Backward and Forward linkages
▪ The theory of linkages stress that when certain industries are
developed first, their interconnections (linkages) with other
sectors will induce the development of new industries.
▪ Backward linkages raise demand for an activity, while
forward linkages lower the cost of using an industry's
output.
Example: cotton and textile factory 34
❑ Criticism of Unbalanced Growth Theory
✓ The optimal degree of imbalance is not identified

✓ Neglected the influences of growth retarding forces

✓ Lack of facilities, personnel, power markets for products

❑ Similarity of Balanced and Unbalanced Growth Theories

✓ Nurkse argued that private investment is incapable of
breaking the vicious circle of poverty and government
investment is indispensable.
✓ Hirschman also called for investment in social overhead
capital (SOC) which is based on state plans.
✓ However, the unbalanced growth theory is far more
applicable than the balanced growth theory.
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