CHAPTER 4 THEORIES OF ECONOMIC DEVELOPMENT

The Linear-Stages of growth model

Development Theories in Geography

Geographers often seek to categorize places using a scale

of development, frequently dividing nations into the
"developed" and "developing," "first world" and "third
world," or "core" and "periphery." All of these labels are
based on judging a country's development, but this raises
the question: what exactly does it mean to be
"developed," and why have some countries developed
while others have not? Since the beginning of the
twentieth century, geographers and those involved with
the vast field of Development Studies have sought to
answer this question, and in the process, have come up
with many different models to explain this phenomenon.

W.W. Rostow and the Stages of Economic Growth

One of the key thinkers in twentieth-century
Development Studies was W.W. Rostow, an American
economist, and government official. Prior to Rostow,
approaches to development had been based on the
assumption that "modernization" was characterized by
the Western world (wealthier, more powerful countries
at the time), which were able to advance from the initial
stages of underdevelopment. Accordingly, other
countries should model themselves after the West,
aspiring to a "modern" state of capitalism and a liberal
democracy. Using these ideas, Rostow penned his classic
Stages of Economic Growth in 1960, which presented five
steps through which all countries must pass to become
developed: 1) traditional society, 2) preconditions to
take-off, 3) take-off, 4) drive to maturity and 5) age of
high mass consumption. The model asserted that all
countries exist somewhere on this linear spectrum, and
climb upward through each stage in the development
process:

Traditional Society: This stage is characterized by a

subsistent, agricultural based economy, with intensive
labor and low levels of trading, and a population that
does not have a scientific perspective on the world and
technology.
Preconditions to Take-off: Here, a society begins to
develop manufacturing, and a more
national/international, as opposed to regional, outlook.
Take-off: Rostow describes this stage as a short period of
intensive growth, in which industrialization begins to
occur, and workers and institutions become
concentrated around a new industry.
Drive to Maturity: This stage takes place over a long
period of time, as standards of living rise, use of
technology increases, and the national economy grows
and diversifies.
Age of High Mass Consumption: At the time of writing,
Rostow believed that Western countries, most notably
the United States, occupied this last "developed" stage.
Here, a country's economy flourishes in a capitalist
system, characterized by mass production and
consumerism.
Rostow's Model in Context
Rostow's Stages of Growth model is one of the most
influential development theories of the twentieth
century. It was, however, also grounded in the historical
and political context in which he wrote. Stages of
Economic Growth was published in 1960, at the height of
the Cold War, and with the subtitle "A Non-Communist
Manifesto," it was overtly political. Rostow was fiercely
anti-communist and right-wing; he modeled his theory
after western capitalist countries, which had
industrialized and urbanized. As a staff member in
President John F. Kennedy's administration, Rostow
promoted his development model as part of U.S. foreign
policy. Rostow's model illustrates a desire not only to
assist lower income countries in the development
process but also to assert the United States' influence
over that of communist Russia.
Rostow's principal argument is that some places have
progressed further than others in terms of economic
development (as represented by the map of GNP).
Rostow believes that poorer places are in an initial or
beginning stage of development, while countries with
higher levels of GNP are in a later stage of higher
development. All places, therefore, are at some stage in
a development sequence.
The sequence of development that Rostow outlines
include the following five stages:

traditional society
preconditions for change
take-off
drive to maturity
mass consumption
These stages suggest that a society moves from a
traditional phase which is characterized by a lack of
exposure to Western society, a lack of science or
technology, a dependence on agriculture, and a high
level of poverty to a modernized, industrialized, and
developed economy. Rostow argues that through
increased investment, increased exposure to
modernized, Western society, and changes in traditional
culture and values, societies will become more highly
developed.

What is presumed goal and model?

The goal is industrialized, capitalist liberal democracy;
the U.S. is the model. Modernization theory is basically a
diffusionist theory: the premise is that development in
the U.S. and Europe can be copied elsewhere. It purports
that what developing countries need is at least an initial
stimulus from an outside source, a developed country
perhaps, to jumpstart the process. It, therefore, posits
that internal development is unlikely.

Stages of Economic Growth in Practice: Singapore

Industrialization, urbanization, and trade in the vein of

Rostow's model are still seen by many as a roadmap for a
country's development. Singapore(link is external) is one
of the best examples of a country that grew in this way
and is now a notable player in the global economy.
Singapore is a southeast Asian country with a population
of over five million, and when it became independent in
1965, it did not seem to have any exceptional prospects
for growth. However, it industrialized early, developing
profitable manufacturing and high-tech industries.
Singapore is now highly urbanized, with 100% of the
population considered "urban." It is one of the most
sought-after trade partners in the international market,
with a higher per-capita income than many European
countries.

Criticisms of Rostow's Model

As the Singapore case shows, Rostow's model still sheds

light on a successful path to economic development for
some countries. However, there are many criticisms of
his model. While Rostow illustrates faith in a capitalist
system, scholars have criticized his bias towards a
western model as the only path towards development.
Rostow lays out five succinct steps towards development
and critics have cited that all countries do not develop in
such a linear fashion; some skip steps or take different
paths. Rostow's theory can be classified as "top-down,"
or one that emphasizes a trickle-down modernization
effect from urban industry and western influence to
develop a country as a whole. Later theorists have
challenged this approach, emphasizing a "bottom-up"
development paradigm, in which countries become self-
sufficient through local efforts, and urban industry is not
necessary. Rostow also assumes that all countries have a
desire to develop in the same way, with the end goal of
high mass consumption, disregarding the diversity of
priorities that each society holds and different measures
of development. For example, while Singapore is one of
the most economically prosperous countries, it also has
one of the highest income disparities in the world.
Finally, Rostow disregards one of the most fundamental
geographical principals: site and situation. Rostow
assumes that all countries have an equal chance to
develop, without regard to population size, natural
resources, or location. Singapore, for instance, has one of
the world's busiest trading ports, but this would not be
possible without its advantageous geography as an island
nation between Indonesia and Malaysia.

In spite of the many critiques of Rostow's model, it is still

one of the most widely cited development theories and
is a primary example of the intersection of geography,
economics, and politics.
Critiques of Rostow’s Modernization theory:
The goal is industrialized, capitalist liberal democracy;
the U.S. is the model.
The model assumes development in the U.S. and Europe
can be copied elsewhere. One size fits all.
It ignores a lot of geography and history, such as the
impact of colonization on economic development.
It does not address the obstacles to development that
previously colonized regions face: exploitation of
resources, genocide, political domination during long
periods of time, civil unrest, extreme poverty, artificial
boundaries (Africa).
Countries that do not develop like the U.S. or Europe are
seen as “problems”.
There are ecological limits to high mass consumption
(the final goal).
Dependency Theory: The Development of
Underdevelopment (Frank)
Scale of analysis: Regional / Global
Through historic (colonial) and contemporary (neo-
colonial) interaction, developing countries have seen
change, but for the worse.
Source of cheap labor and raw materials for the
developed countries, through which these poor countries
were then further depleted & impoverished.
Unequal exchange and declining terms of trade.
Lack of institutions and infrastructure not necessarily the
problem.
i.e., infrastructure in Africa, MNCs, IMF & WB
The question of who they serve is integral.
Critiques of Dependency Theory:
Since the problem is the international capitalist system,
the solution is a revolution of the capitalist system.
Views core countries as the obstacle to peripheral
countries' well-being.
Heavy weight on the role of the government - to serve
the people.
Import Substitution
Import substitution industrialization (ISI) is a trade and
economic policy that advocates replacing foreign imports
with domestic production. ISI is based on the premise
that a country should attempt to reduce its foreign
dependency through the local production of
industrialized products. Early European merchants and
manufacturers as far back as the 1400s became adept at
import substitution (copying and making goods
previously only available by trading). This process
facilitated the rise of Western Europe as a core region of
the world (Knox & Marston, 2013).

As a contemporary economic development strategy,

import substitution industrialization is much more
challenging. The goal here is to develop a diversified
economy, rather than specialize in a primary commodity.

Export-Led Trade Based on Comparative Advantage

The export-led growth paradigm rose to prominence in
the late 1970s when it replaced the import-substitution
paradigm that had dominated development policy
thinking (especially in Latin America) in the thirty years
after World War II. Export-led growth is a development
strategy aimed at growing productive capacity by
focusing on foreign markets.

Mainstream examples would probably include coffee in

Peru and parts of sub-Sarahan Africa; low-wage labor
forces for manufacturing in Vietnam, Thailand, Mexico;
software from Silicon Valley and Seattle; etc.
Comparative Advantage: The advantage in the
production of a product enjoyed by one country over
another.

This is the model favored by most mainstream

economists and by major international institutions such
as the World Bank and IMF.

Late Developers’ Model: Learn from Predecessors

This is Gerschenkron's concept of the late developers. His
idea was that there were countries in Europe that
wanted to follow in the industrial footsteps of Britain.
The problem was, how could they compensate for the
huge lead that Britain had already developed? If you
wanted to get into the game, you had to come in
incredibly big. You had to have leading-edge technology,
and you had to raise or save huge amounts of capital to
compensate for the lead that Britain had, and come on
board producing with the very latest technology and
competing aggressively for market share. There are
advantages to late development, though: you can learn
from your predecessors' mistakes, borrow their best and
latest approaches, and plan the timing of your market
entry.

An example of this at the firm level would be the car

manufacturer, Kia. This South Korean company has had
tremendous growth in US sales over the past six years,
basically by replicating Honda’s earlier strategy of
producing basic, reliable cars for the very low end of the
market. Kia did exactly what Honda did starting in the
1970s, but with even cheaper cars, more efficient
production methods, and a lot of help from the South
Korean government.

State Intervention
Compatible w/ any of above, coordinated by the state to
reduce inefficiencies.

Common concerns include raising national savings rates;

balancing growth in different sectors of the economy;
managing the demographic and economic shifts that go
along with transitions from a rural, agrarian society to an
urban, industrial one; managing monetary policy so that
foreign investors will invest in the country and trust the
national currency, and so on.
Very often, the state has to raise huge amounts of capital
by borrowing on the international lending markets. The
government itself may intervene in shaping
industrialization.
For example, the South Korean government has acted as
an entrepreneur, a banker, and a shaper of industrial
structure. The Korean state has deliberately adjusted
economy through subsidies, protection, price controls
(food, etc.), and restrictions on foreign direct investment.
There is no one formula that works equally well for all
countries. Each of the models or strategies above will or
won’t work (in the form mentioned or in some hybrid or
modified form) depending upon historical contingencies,
government structure, geopolitical positioning,
environmental resource endowments, and so forth. And,
of course, the international organization of the global
economy—how the rules are made, regulated and evolve
over time will work to determine how any one strategy
will fare in the global market.
Nonetheless, though each country has its own set of
circumstances that facilitate its economic development
path, all countries and their economies are linked to the
global economy. One way to learn more about this is to
investigate global commodity chains (also known as the
“global assembly line”) that produce our everyday
products.

Economic Growth - Harrod-Domar Model

What is the Harrod-Domar Model?

The Harrod-Domar economic growth model stresses the

importance of savings and investment as key
determinants of growth
The Harrod Domar Growth model is a growth model and
not a growth strategy!

A model helps to explain how growth has occurred and

how it may occur again in the future. Growth strategies
are the things a government might introduce to replicate
the outcome suggested by the model.
Basically, the model suggests that the economy's rate of
growth depends on:

The level of national saving (S)

The productivity of capital investment (this is known as
the capital-output ratio)
The Capital-Output Ratio (COR)

For example, if £100 worth of capital equipment

produces each £10 of annual output, a capital-output
ratio of 10 to 1 exists. A 3 to 1 capital-output ratio
indicates that only £30 of capital is required to produce
each £10 of output annually.
If the capital-output ratio is low, an economy can
produce a lot of output from a little capital. If the capital-
output ratio is high then it needs a lot of capital for
production, and it will not get as much value of output
for the same amount of capital.
Key point: When the quality capital resources is high,
then the capital output ratio will be lower
Basic Harrod-Domar model says:

Rate of growth of GDP = Savings ratio / capital output

ratio

Numerical examples:

If the savings rate is 10% and the capital output ratio is 2,

then a country would grow at 5% per year.
If the savings rate is 20% and the capital output ratio is
1.5, then a country would grow at 13.3% per year.
If the savings rate is 8% and the capital output ratio is 4,
then the country would grow at 2% per year.
Based on the model therefore the rate of growth in an
economy can be increased in one of two ways:

Increased level of savings in the economy (i.e. gross

national savings as a % of GDP)
Reducing the capital output ratio (i.e. increasing the
quality / productivity of capital inputs)
LDCs often have an abundant supply of labour it is a lack
of physical capital that holds back economic growth and
development. Boosting investment generates economic
growth which leads to a higher level of national income.
Higher incomes allow more people to save.
What are some of the key limitations / problems of the
Harrod-Domar Growth Model?
Increasing the savings ratio in lower-income countries is
not easy. Many developing countries have low marginal
propensities to save. Extra income gained is often spent
on increased consumption rather than saved. Many
countries suffer from a persistent domestic savings gap.
Many developing countries lack a sound financial system.
Increased saving by households does not necessarily
mean there will be greater funds available for firms to
borrow to invest.
Efficiency gains that reduce the capital/output ratio are
difficult to achieve in developing countries due to
weaknesses in human capital, causing capital to be used
inefficiently
Research and development (R&D) needed to improve the
capital/output ratio is often under-funded - this is a
cause of market failure
Borrowing from overseas to fill the savings gap causes
external debt repayment problems later.
The accumulation of capital will increase if the economy
starts growing dynamically – a rise in capital spending is
not necessarily a pre-condition for economic growth and
development – as a country gets richer, incomes rise, so
too does saving, and the higher income fuels rising
demand which itself prompts a rise in capital investment
spending.

What is Neoclassical Growth Theory?

In economics, the neoclassical growth theory is an
economic model that maintains that the stability of
economic growth rests on three major factors:

the availability of capital,

the availability of labor, and
State of technology.
These factors influence the growth of the economy
significantly. Robert Solow and Trevor Swan developed
the neoclassical growth theory, this theory is sometimes
referred to as the Solow-Swan model. Right from 1956,
the neoclassical growth theory has been the model for
long-run economic growth.

Back to: ECONOMIC ANALYSIS & MONETARY POLICY

How is Neoclassical Growth Theory Used?
The neoclassical growth theory is one that maintains that
a well-adjusted capital, labor and technology is important
for a stable economic growth. For this to happen, a
temporary equilibrium is required, that is, for an
economy to function adequately, a proportional capital
size and appropriate labor coupled with technology must
be in place. This is however, different from a long-term
equilibrium that features none of the three factors. The
theory also places much importance on the role of
technology in the growth of an economy. Here are the
key points you should know about the neoclassical
growth theory;

The theory was introduced in 1956 and has since then

been used as a long-run economic growth.
The theory was introduced by Robert Solow and Trevor
Swan.
Steady economic growth is derived from three factors
which are; labor, capital and technology.
The role of technology in economic advancement is
crucial according to the neoclassical growth theory.
The Production Function of the Neoclassical Growth
Theory
The economic growth that a country enjoys and the
equilibrium of the economy is determined using the
neoclassical growth theory. The formula for estimating
neoclassical growth theory is; Y = AF (K, L). Y symbolises
the GDP of a country. K stands for share of capital L is the
level unskilled labor in an economy A symbolises the
level of technology. According to this theory, despite the
fact that the capital accrued by a country is important to
economic growth, the integration of technology as well
as labor productivity are also crucial to achieving a stable
economic growth.

Technology's Influence on the Growth Theory

The influence of technology on the economic growth of a
nation is crucial, so also the other two driving forces of
the economy; labor and capital. It is important to know
that these three factors have diverging influence on the
economy. While technology has a limitless impact on the
stable growth of the economy, the influence of unskilled
labor and capital can diminish due to certain factors.
Real Word Example
The neoclassical growth theory is not only in theory, it is
also in practise. Technological innovations however play
an immeasurable role in the growth of an economy. The
role of technology in the neoclassical growth theory
examined in a study carried out by Dragoslava Sredojevi,
Slobodan Cvetanovi, and Gorica Bokovi in 2016. These
authors in their study considered technology as a major
contributor to the economic growth.