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Chapter 3

Classic Theories of Economic Growth and Development

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Classic Theories of Economic Development – Four Approaches

1. Linear stages of growth models

2. Theories and Patterns of structural change

3. International-dependence revolution

4. Neoclassical, free market counterrevolution

Observation:

• LDCs have much less capital per worker than rich countries.

• “Capital” = machinery and equipment

• Result: Lower productivity of labor

• And thus Lower wages/incomes.

• LDCs are poor because they lack capital

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sYS

KI

(3.1) Savings rate s

(3.2) Invest = ΔCapital

YkK (3.3) Capital/Output = k

IS (3.4) Closed Economy

The Harrod-Domar Model

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The Harrod-Domar Model

IKYksYS (3.5)

YksY (3.6)

k

s

Y

Y

(3.7)

Growth rate of GDP = savings rate/capital-output ratio=> To increase GDP growth, increase s (or foreign S)

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Criticisms of the Harrod-Domar Model

• Necessary versus sufficient conditions

• Is Saving necessary for growth? – Not if foreign investment or foreign aid (World

Bank Loans, etc.)

• Is Saving (Investment) sufficient for growth?– Are there institutions to channel savings to

productive uses: a well-functioning financial system or government plan?

Observation:

LDCs often have two quite different sectors:

1. Traditional (subsistence) agricultureLow K/L, low Land/L, “old” technology

(NOT: tractors or combines, hybrid seeds, chemical fertilizer, pesticides, herbicides)

Result: VERY low productivity and incomes

“Modern” Industrial Sector

• Higher K/L, more modern technology than traditional sector (tho often low by rich country standards)

• Result: Higher productivity and incomes

• Also: Large Urban-Rural gaps in income result in migration to the cities

Urban-Rural Income Ratio: China

1.8

2.0

2.2

2.4

2.6

2.8

3.0

1978 1983 1988 1993 1998Chen (2002)

Rural vs. Urban Consumption

405

559

779

1,052

0

200

400

600

800

1,000

1,200

1972-73 2004-05

Cons

tant

(200

4-05

) Rup

ees

per P

erso

n pe

r Mon

th

Rural Urban

NSSO

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Figure 3.1 The Lewis Model of Modern-Sector Growth in a Two-Sector

Surplus-Labor Economy

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Criticisms - Lewis Model• Rate of labor transfer and employment

creation may not be proportional to rate of modern-sector capital accumulation

• Surplus labor in rural areas (no) and full employment in urban (no)?

• Institutional factors (unions, min wage)?• Assumption of diminishing returns in

modern sector (agglomeration economies)• BUT: Captures some elements of urban-

rural divide. Chapter 7: Todaro Model

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The International-Dependence Revolution

• The neoclassical dependence model– Unequal power, core-periphery (exploitation)

• The false-paradigm model– Using “expert” advisors who give wrong advice (true!)

• The dualistic-development thesis– Superior and inferior elements can coexist (true)

• Implications– Autarky (end exploitation by “neocolonialists”)– State led development: SOEs, central planning,

regulation

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The Neoclassical Counterrevolution

• Challenging the statist model of government led development– Central planning, SOEs, etc, not usually successful– Free market approach– Public choice approach (not: government is “bad;”

rather, what incentives for politicians/bureaucrats)

• Criticism of Neoclassical Counterrevolution:– Institutional and political realities in developing world

differ from Western world• assume property rights and functioning court systems• ignore power relationships of traditional social systems

based on caste, gender, elites

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Theories of Development: Reconciling the Differences

• Development economics has no universally accepted paradigm

• Insights and understandings are continually evolving

• Each theory has some strengths and some weaknesses

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Case Study: South Korea and Argentina

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Concepts for Review

• Autarky• Average product• Capital-labor ratio• Capital-output ratio• Center• Closed economy• Comprador groups• Dependence

• Dominance• Dualism• False-paradigm

model• Free market• Free-market analysis• Harrod-Domar growth

model

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Concepts for Review (cont’d)

• Lewis two-sector model

• Marginal product• Market-friendly

approach• Necessary condition• Neoclassical

counterrevolution

• Neocolonial dependence model

• New institutionalism• New political

economy approach• Open economy• Patterns-of

Development analysis

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Concepts for Review (cont’d)

• Periphery• Production function• Public choice theory• Savings ratio• Self-sustaining growth• Solow neoclassical

growth model

• Stages-of-growth model of development

• Structural-change theory

• Structural transformation

• Sufficient condition• Surplus labor

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Concepts for Review (cont’d)

• Traditional neoclassical growth theory• Underdevelopment• You are NOT responsible for the appendices