Ragnar Nurkses balanced growth theory

The balanced growth theory is an economic theory pi-oneered by the economist Ragnar Nurkse (19071959).The theory hypothesises that the government of any un-derdeveloped country needs to make large investments ina number of industries simultaneously.[1][2] This will en-large the market size, increase productivity, and providean incentive for the private sector to invest.Nurkse was in favour of attaining balanced growth in boththe industrial and agricultural sectors of the economy.[3]He recognised that the expansion and inter-sectoral bal-ance between agriculture and manufacturing is necessaryso that each of these sectors provides a market for theproducts of the other and in turn, supplies the neces-sary raw materials for the development and growth of theother.Nurkse and Paul Rosenstein-Rodan were the pioneers ofbalanced growth theory and much of how it is understoodtoday dates back to their work.[4]

Nurkses theory discusses how the poor size of the marketin underdeveloped countries perpetuates its underdevel-oped state.[5][6] Nurkse has also claried the various de-terminants of the market size and puts primary focus onproductivity.[3][7] According to him, if the productivitylevels rise in a less developed country, its market size willexpand and thus it can eventually become a developedeconomy. Apart from this, Nurkse has been nicknamedan export pessimist, as he feels that the nances to makeinvestments in underdeveloped countries must arise fromtheir own domestic territory.[1] No importance should begiven to promoting exports.[8]

1 Size ofmarket and inducement toinvest

The size of a market assumes primary importance in thestudy of what induces investment in a country. RagnarNurkse referenced the work of Allyn A. Young to as-sert that inducement to invest is limited by the size ofthe market.[9] The original idea behind this was put for-ward by Adam Smith, who stated that division of labour(as against inducement to invest) is limited by the extentof the market.[7]

According to Nurkse, underdeveloped countries lackadequate purchasing power.[7] Low purchasing powermeans that the real income of the people is low, althoughin monetary terms it may be high. If the money income

were low, the problem could easily be overcome by ex-panding the money supply; however, since the meaningin this context is real income, expanding the supply ofmoney will only generate inationary pressure. Neitherreal output nor real investment will rise. It is to be notedthat a low purchasing power means that domestic demandfor commodities is low. Apart from encompassing con-sumer goods and services, this includes the demand forcapital as well.The size of the market determines the incentive to investirrespective of the nature of the economy.[6] This is be-cause entrepreneurs invariably take their production deci-sions by taking into consideration the demand for the con-cerned product. For example, if an automobile manufac-turer is trying to decide which countries to set up plants in,he will naturally only invest in those countries where thedemand is high.[7] He would prefer to invest in a devel-oped country, where though the population is lesser thanin underdeveloped countries, the people are prosperousand there is a denite demand.Private entrepreneurs sometimes resort to heavyadvertising as a means of attracting buyers for theirproducts. Although this may lead to a rise in demand forthat entrepreneurs good or service, it does not actuallyraise the aggregate demand in the economy. The demandmerely shifts from one provider to another.[5] Clearly,this is not a long-term solution.Ragnar Nurkse concluded,

The limited size of the domestic market ina low income country can thus constitute an ob-stacle to the application of capital by any indi-vidual rm or industry working for the market.In this sense the small domestic market is an ob-stacle to development generally. [3]

Large scaleinvestment inmany sectorssimultaneously

Complementarity ofdemand betweensectors

Size of market expands Economy grows anddevelops

The process of economic development as per Ragnar Nurke's Balanced Growth Theory

The process of economic development as per Ragnar NurksesBalanced Growth Theory

1

2 2 DETERMINANTS OF SIZE OF MARKET

2 Determinants of size of marketAccording to Nurkse, expanding the size of the market iscrucial to increasing the inducement to invest. Only thencan the vicious circle of poverty be broken. Hementionedthe following pertinent points about how the size of themarket is determined:

Money Supply

Population

Geographical Area

Transport Cost andTrade Barriers

Sales Promotion

Productivity

Determinants ofSize of Market

in Ragnar Nurkse'sBalanced Growth Theory

Determinants of size of market

2.1 Money supplyMain article: Money supply

Nurkse emphasised that Keynesian theory shouldn't beapplied to underdeveloped countries because they don'tface a lack of eective demand in the way that developedcountries do.[7] Their problem is to do with a lack of realpurchasing power due to low productivity levels. Thus,merely increasing the supply of money will not expandthe market but will in fact cause inationary pressure.

2.2 PopulationNurkse argued against the notion that a large populationimplies a large market.[5] Though underdeveloped coun-tries have a large population, their levels of productivityare low. This results in low levels of per capita real in-come. Thus, consumption expenditure is low, and savingsare either very low or completely absent. On the otherhand, developed countries have smaller populations thanunderdeveloped countries but by virtue of high levels ofproductivity, their per capita real incomes are higher andthus they create a large market for goods and services.

2.3 Geographical areaNurkse also refuted the claim that if a countrys geo-graphical area is large, the size of its market also ought tobe large.[1] A country may be extremely small in area butstill have a large eective demand. For example, Japan.

In contrast, a country may cover a huge geographical areabut its market may still be small. This may occur if alarge part of the country is uninhabitable, or if the coun-try suers from low productivity levels and thus has a lowNational Income.

2.4 Transport cost and trade barriersThe notion that transport costs and trade barriers hinderthe expansion of the market is age-old. Nurkse empha-sised that tari duties, exchange controls, import quo-tas and other non-tari barriers to trade are major ob-stacles to promoting international cooperation in export-ing and importing.[7] More specically, due to high trans-port costs between nations, producers do not have an in-centive to export their commodities. As a result, theamount of capital accumulation remains small. To ad-dress this problem, the United Nations produced a re-port in 1951[10] with solutions for underdeveloped coun-tries. They suggested that they can expand their marketsby forming customs unions with neighbouring countries.Also, they can adopt the system of preferential taxationor even abolish customs duties altogether. The logic wasthat once customs duties are removed, transport costs willfall. Consequently, prices will fall and thus the demandwill rise. However, Nurkse, as an export pessimist, didnot agree with this view.[8] Export pessimism is a tradetheory which is governed by the idea of inward lookinggrowth as opposed to outward looking growth. (SeeImport substitution industrialization)

2.5 Sales promotionOften, it is true that a companys private endeavour to in-crease the demand for its products succeeds due to theextensive use of advertisement and other sales promotiontechnique. However, Nurkse argues that such activitiescannot succeed at the macro level to increase a countrysaggregate demand level.[7] He calls this the macroeco-nomic paradox.[7]

2.6 ProductivityMain article: Productivity

Nurkse stressed productivity as the primary determinantof the size of the market. An increase in productivity (de-ned as the output per unit input) increases the ow ofgoods and services in the economy. As a response, con-sumption also rises. Hence, underdeveloped economiesshould aim to raise their productivity levels in all sectorsof the economy, in particular agriculture and industry.[3]

For example, in most underdeveloped economies, thetechnology used to carry out agricultural activities is back-ward. There is a low degree of mechanisation coupled

3Increase in Productivity

Increase in flow of goodsand services in economy

Consumption rises

Size of market increases

Inducement to invest for firms

Economic growth and development

The process of how increased productivity leads to economic de-velopment and growth

with rain dependence. So while a large proportion ofthe population (70-80%) may be actively employed in theagriculture sector, the contribution to the Gross Domes-tic Product may be as low as 40%.[7] This points to theneed to increase output per unit input and output per head.This can be done if the government provides irrigation fa-cilities, high-yielding variety seeds, pesticides, fertilisers,tractors etc. The positive outcome of this is that farmersearn more income and have a higher purchasing power(real income). Their demand for other products in theeconomy will rise and this will provide industrialists anincentive to invest in that country. Thus, the size of themarket expands and improves the condition of the under-developed country.Nurkse is of the opinion that Says Law of markets oper-ates in underdeveloped countries. Thus, if the money in-comes of the people rise while the price level in the econ-omy stays the same, the size of the market will still notexpand till the real income and productivity levels rise.To quote Nurkse,

In underdeveloped areas there is generallyno 'deationary gap' through excessive savings.Production creates its own demand, and the sizeof the market depends on the volume of pro-duction. In the last analysis, the market canbe enlarged only through all-round increase inproductivity. Capacity to buy means capacity to

produce. [3]

3 Export pessimism

Citing the limited size of the market as the main im-pediment in economic growth, Nurkse reasons that anincrease in productivity can create a virtuous circle ofgrowth.[7] Thus, a large scale investment programme ina wide array of industries simultaneously is the answer.The increase in demand for one industry will lead to anincrease in demand for another industry due to comple-mentarity of demands. As Says Law states, supply createsits own demand.[11]

However, Nurkse claried that the nance for this devel-opment must arise to as large an extent as possible fromthe underdeveloped country itself i.e. domestically.[12]He stated that nancing through increased trade orforeign investments was a strategy used in the past - the19th century - and its success was limited to the case ofthe United States of America. In reality, the so-callednew countries of the United States of America (whichseparated from the British empire) were high incomecountries to begin with.[8] They were already endowedwith ecient producers, eective markets and a highpurchasing power. The point Nurkse was trying to makewas that USA was rich in resource endowment as wellas labour force. The labour force had merely migratedfrom Britain to USA, and thus their level of skills wereadvanced to begin with. This situation of outward ledgrowth was therefore unique and not replicable by under-developed countries.In fact, if such a strategy of nancing development fromoutside the home country is undertaken, it creates anumber of problems.[12] For example, the foreign in-vestors may carelessly misuse the resources of the under-developed country. This would in turn limit that econ-omys ability to diversify, especially if natural resourceswere plundered. This may also create a distorted socialstructure.[8] Apart from this, there is also a risk that theforeign investments may be used to nance private lux-ury consumption. People would try to imitate Westernconsumption habits and thus a balance of payments crisismay develop, along with economic inequality within thepopulation.Another reason exports cannot be promoted is becausein all likelihood, an underdeveloped country may only beskilled enough to promote the export of primary goods,say agricultural goods.[7] However, since such commodi-ties face inelastic demand, the extent to which they willsell in the market is limited.[7] Although when populationis at a rise, additional demand for exports may be created,Nurkse implicitly assumed that developed countries areoperating at the replacement rate of population growth.For Nurkse, then, exports as a means of economic devel-opment are completely ruled out.[1]

4 5 REACTIONS

Thus, for a large-scale development to be feasible, therequisite capital must be generated from within the coun-try itself, and not through export surplus or foreigninvestment.[6][12] Only then can productivity increase andlead to increasing returns to scale and eventually createvirtuous circles of growth.[8][12]

4 Role of stateAfter World War II, a debate about whether a coun-try should introduce nancial planning to develop itselfor rely on private entrepreneurs emerged. Nurkse be-lieved that the subject of who should promote devel-opment does not concern economists. It is an admin-istrative problem.[7] The crucial idea was that a largeamount of well dispersed investment should be made inthe economy, so that the market size expands and leads tohigher productivity levels, increasing returns to scale andeventually the development of the country in question.[7]However, it should be noted that most economists whofavoured the balanced growth hypothesis believed thatonly the state has the capacity to take on the kind of heavyinvestments the theory propagates. Further, the gestationperiod of such lumpy investments is usually long and pri-vate sector entrepreneurs do not normally undertake suchhigh risks.[5]

5 ReactionsRagnar Nurkses balanced growth theory too has beencriticised on a number of grounds. His main critic wasAlbert O. Hirschman, the pioneer of the strategy of un-balanced growth. Hans W. Singer also criticised certainaspects of the theory.Hirschman stressed the fact that underdevelopedeconomies are called underdeveloped because theyface a lack of resources, maybe not natural resources,but resources such as skilled labour and technology.[7]Thus, to hypothesise that an underdeveloped nation canundertake large scale investment in many industries of itseconomy simultaneously is unrealistic due to the paucityof resources.[13] To quote Hirschman,

If a country were ready to apply the doc-trine of balanced growth, then it would not beunderdeveloped in the rst place. [13]

Hans Singer asserted that the balanced growth theory ismore applicable to cure an economy facing a cyclicaldownswing.[7] Cyclical downswing is a feature of anadvanced stage of sustained growth rather than of thevicious cycle of poverty. Hirschman also stated that dur-ing conditions of slack activity in developed countries,the stock of resources, machines and entrepreneurs aremerely unemployed, and are present as idle capacity. So

in this situation, simultaneous investment in a large num-ber of sectors is a well-suited policy. The various eco-nomic agents are temporarily unemployed and once theinducement to invest starts operating, the slump will beovercome. However, for an underdeveloped economy,where such resources are absent, this principle doesn'tt.[7]

Another contention was Nurkses approval of Says Law,which theorises that there is no overproduction or glut inthe economy.[11] Supply (production of goods and ser-vices) creates a matching demand for the output and thisresults in the entire output being sold and consumed.However, Keynes stated that Says Law is not operationalin any country because people do not spend their entire in-come - a fraction of it is saved for future consumption.[11]Thus, according to Nurkses critics, his assumption ofSays Law being operational in underdeveloped countriesneeds greater justication.[7] Even if the section of saversis few, the tenet of putting emphasis on supply rather thandemand has been widely discredited.[11][14]

Nurkse states that if demand for the output of one sectorrises, due to the complementary nature of demand, thedemand for the output of other industries will also ex-perience a rise.[7] Paul Rosenstein-Rodan to spoke of asimilar concept called indivisibility of demand whichhypothesises that if large investments are made in a largenumber of industries simultaneously, an underdevelopedeconomy can become developed due to the phenomenonof complementary demand.[7] However, both Nurkse andRosenstein-Rodan only took into consideration the situa-tion of industries that produce complementary goods.[7]There are substitute goods too, which are in competitionwith each other. Thus if the state pumps in large invest-ments into the car industry, for example, it will naturallylead to a rise in the demand for petrol. But if the statemakes large scale investments in the coee sector of acountry, the tea sector will suer.Hans Singer suggested that Nurkses theory makes dubi-ous assumptions about the underdeveloped economy.[7]For example, Nurkse assumes that the economy startswith nothing at hand.[5] However, an economy usuallystarts at a position which reects the previous invest-ment decisions undertaken in the country,[7] and at anygiven moment, an imbalance already exists. So the logi-cal step would be to take on those investment programmeswhich compliment the existing imbalance in the econ-omy. Clearly, such an investment cannot be a balancedone. If an economy makes the mistake of setting out tomake a balanced investment, a new imbalance is likely toappear which will require still another balancing invest-ment to bring equilibrium, and so on and so forth.[7]

Hirschman believed that Nurkses balanced growth the-ory wasn't in fact a theory of growth.[1] Growth impliesthe gradual transformation of an economy from one stageto the chronologically next stage. It entails the series ofactions which leads the economy from a stage of infancy

5to that of maturity.[7] However, the balanced growth the-ory involves the creation of a brand new, self-sucientmodern industrial economy being laid over a stagnant,self-sucient traditional economy. Thus, there is notransformation.[13] In reality, a dual economy will comeinto existence, where two separate economic sectors willbegin to coexist in one country. They will dier on levelsof development, technology and demand patterns. Thismay create inequality in the country.[13]

6 See also Big push model Rostows stages of growth Critical minimum eort theory Strategy of unbalanced growth Low level equilibrium trap

7 References[1] James M. Cypher; James L. Dietz (17 July 2008). The

Process of Economic Development (3rd Revised ed.).Routledge. p. 640. ISBN 0-415-77104-8.

[2] Yjir Hayami, Yoshihisa Gdo (2005). Developmenteconomics: from the poverty to the wealth of nations (3,illustrated ed.). Oxford University Press. p. 430. ISBN0-19-927271-9.

[3] Nurkse, Ragnar (1961). Problems of Capital Formation inUnderdeveloped Countries. New York: Oxford UniversityPress. p. 163.

[4] Hollis Chenery, T.N. Srinivasan, ed. (15 October 1988).Handbook of Development Economics, Vol. 1. North Hol-land. p. 882. ISBN 0-444-70337-3.

[5] Gaur, K.D. (1995). Development and Planning. Univer-sity of Michigan: Sarap & Sons. p. 820. ISBN 81-85431-54-X.

[6] Ray, Debraj (2009). Development Economics. OxfordUniversity Press. p. 847. ISBN 0-19-564900-1.

[7] S. K. Misra; V. K. Puri (2010). Economics Of Develop-ment And PlanningTheory And Practice (12th ed.). Hi-malaya Publishing House. ISBN 81-8488-829-5.

[8] Rainer Kattel, Jan A. Kregel, Eric S. Reinert (March2009). The Relevance of Ragnar Nurkse and ClassicalDevelopment Economics. Working Papers in TechnologyGovernance and Economic Dynamics no. 21.

[9] Money and Growth: Selected Papers of Allyn AbbottYoung. London and New York: Routledge. 1999. p. 464.ISBN 0-415-19155-6. |rst1= missing |last1= in Authorslist (help)

[10] Measures for the Economic Development of Underde-veloped Countries, Report by a Group of Experts ap-pointed by the Secretary-General of the United Nations.May 1951.

[11] Gulati, Ambika (2006). Introductory MacroeconomicTheory - A Textbook For Class XII. New Delhi: Cam-bridge University Press India. p. 304. ISBN 81-7596-335-2.

[12] Ragnar Nurkses Biography. Published by so-cial.jrank.org.

[13] Hirschman, Albert O. (1969). Strategy of Economic De-velopment. Yale University Press (NewHaven, London).pp. 534.

[14] Says Law: Were (Are) The Critics Right?. Ludwig VonMises Institute. p. 27. |rst1= missing |last1= in Authorslist (help)

8 External links Some reections on Nurkses Patterns of Trade andDevelopment byDeardor and Stern. University ofMichigan, 27 August 2007.

TDESA Working Paper No. 53-Industrial Policyand Growth by Helen Shapiro. Economic and So-cial Aairs.

The Doctrine of Market Failure and Early Devel-opment Theory by Jeannette C. Mitchell. Historyof Economics Review.

Positional Goods, Conspicuous Consumption andthe International Demonstration Eect Reconsid-ered by Jeerey James. World Development, Vol.15, No. 4, pp. 49462,1987.

Ragnar Nurkses Rule-Based Approach to Interna-tional Monetary Relations: Complementarities withChicago. University of Auckland and the Aus-tralian National University.

The life and time of Ragnar Nurkse. Conferenceon Ragnar Nurkse (19072007): Classical Devel-opment Economics and Its Relevance for Today,Tallinn, 31 August 1 September 2007.

Ragnar Nurkses Development Theory. BremenUniversity of Applied Sciences.

Dr.Robert E. Looneys Homepage. Dr.Robert E.Looney.

Development Economics: Previous Studies.

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Size of market and inducement to invest Determinants of size of market Money supply Population Geographical area Transport cost and trade barriers Sales promotion Productivity

Export pessimism Role of state Reactions See alsoReferences External links Text and image sources, contributors, and licensesTextImagesContent license