Ecomomics evelopment 10th y p todaro and smith chapter 03

Chapter 3
Classic Theories
of Economic
Growth and
Development

Class Theories of Economic
Development – Four Approaches
• Structural change model
– Linear stages of growth
– Saving-investment
– Rural-urban migration

• Neocolonial dependence theory
– Dependence: Center vs. Periphery

• Neoclassical theory

– Market friendly approach
– Dualistic approach
– Public choice approach

3-2

Rostow’s Linear-Stages Model
2. Pre-condition to take-off
3. Take-off
4. Drive to maturity
5. Age of high mass consumption

3-3

Rostow’s Linear-Stages Model
1. Traditional society: slow economic and
population growth
2. Pre-condition to take-off: development of
institutions, organizations, and
infrastructure
3. Take-off: large investment in selected
industry (10 to 15% of GDP)

3-4

Rostow’s Linear-Stages Model
4. Drive to maturity: sustained growth of the
industry and economy
5. Age of high mass consumption:
production of consumer goods and
services to serve an affluent society

3-5

Rostow’s Linear-Stages Model
GDP Growth
Economic Growth

Post Take-off
Take-off
Pre Take-off

t1

t2

Time

3-6

Harrod-Domar Growth Model
S = sY

S=Saving; Y=Real GDP; s=Saving Ratio

I = ΔK

I=Investment; ΔK=Capital Accumulation

S=I

Saving-Investment identity

Define the Marginal Capital-Output Ratio as k = ΔK/ΔY
Write ΔK = kΔY or I = kΔY
From S = I, write sY = kΔY or

ΔY/Y = s/k
3-7

Harrod-Domar Growth Model
The source of growth is saving and investment in
production of goods and services. Accordingly,

GDP growth rate = s/k
s = national saving ratio; k = marginal capital-output
ratio
If s=6% and k=3, then GDP growth rate=2%. Given k=3,
to raise growth rate to 4%, we need to increase the
saving
3-8

Criticism of Investment Models
• Many LDCs have not been able to takeoff or achieve maturity despite massive
foreign investment
• Many nations have neglected the
development of institutions,
organizations, and infrastructure
required for industrialization

3-9

The Lewis Development Model
• Rural agricultural sector
– Low or even zero Marginal Product of Labor so that
labor is a redundant factor and wage rate is at the
subsistence level

• Urban industrial sector
– Rising demand for unskilled labor to be trained for
industrial growth results in greater employment and
more profits and higher wages

• Rural-Urban migration
– To find
jobsPearson
and earn
higher wages

3-10

Demand for Labor
Wage
R: Rural
W: Wage
D: Labor Demand

WU

Profit

U: Urban
E: Employment
S: Labor Supply

SR

WR
Wage

DU1 DU2
E1

E2

Investment in urban areas
increases the demand and
employment for rural labor.

Employment

3-11

Criticisms of Lewis Model
• Industrial technology is generally capital
intensive/labor-saving. Hence, the
demand for unskilled rural labor would
not increase employment
• Industrialization must be supported by
agricultural development to supply an
ever-increasing supply of food items and
raw materials

3-12

Demand for Labor

Wage

No increase in employment when
technology is labor saving
Profit

SR

WU
WR

Wage

DU2
E1 = E2

DU1
Employment

3-13

Neocolonial Dependence Model
• MDCs form the “center” of global economic
• LDCs serving as the “periphery” are dominated
by:
– unequal trade and finance relations
– domestic politico-economic elite
– multinational corporations

Under these conditions economic development is
impossible

3-14

Neocolonial Dependence Model

African LDCS

Asian LDCS

American
MDCs

Latin American LDCS

European Other
MDCs MDCs

3-15

• Economic development relies heavily on
funds from international donor agencies
such as the World Bank and IMF
• The policy of these agencies is to support
urban industrial growth and impose
capitalistic austerity measures
• They reinforce the pattern of “dependent
development”

3-16

Dualistic Development Model
• Structural transformation models create a
“dualistic” pattern of development, resulting in
an ever-increasing degree of economic
inequality both nationally and internationally:
– urban vs. rural
– industrial vs. agricultural
– rich vs. poor

3-17

Approaches to Development
• Free-market approach: rely of the allocation
role of markets and limited government
involvement in economics. But, there are
several areas in which markets fail to achieve
efficient outcomes:
– income distribution
– public goods
– externalities
– market power

3-18

Approaches to Development
• Market-friendly approach: improve market
operation through “nonselective”
interventions such as
– income redistribution system
– investment in social and human capital
– environmental protection policy
– anti-trust laws

3-19

Approaches to Development
• Public-choice approach: public officials and
bureaucrats in the position of authority are
“rent-seeking” citizens acting on self-interest
rather than public-interest
• Need a system of checks and balances to monitor
the behavior of public officials and bureaucrats
• Need a democratic system to let people choose
public officials and bureaucrats for limited
duration of authority

3-20

Appendix 3.1: Components of
Economic Growth
• Capital Formation
– Physical capital formation: investment in tools,
equipment, machinery, buildings
– Social capital formation: investment in roads, dams,
– Human capital formation: investment in education,
training, health, nutrition
– Political capital formation: investment is creating a
secular and democratic government and free mass
3-21

Determinants of Economic
Growth
• Physical Capital Formation
– Increase in the amount of physical
capital per unit of labor

3-22

Determinants of Economic
Growth
– Increase factor productivity (labor,
land, capital)

3-23

Production Possibilities Curve

Maximum quantities of two good and
services the economy can produce,
assuming:
– full employment / efficiency
– fixed resources
– constant technology

3-24

PPC Schedule

Combination
Rice

A

B

C

E

100

90

50

0

0

40

80

100