Economic Development succeed in generating and sustaining rapid economic

growth

International-dependence revolution
Chapter 3: Classic Theories of Economic Growth and
Development - more radical and more political
- viewed underdevelopment in terms of international
1.1 Classic Theories of Economic Development: Four and domestic power relationships, institutional and
Approaches structural economic rigidities, and the resulting
1.2 Development as Growth and the Linear-Stages Theories increase of dual economies and dual societies both
• Rostow’s Stages of Growth within and among the nations of the world
• The Harrod-Domar Growth Model - emphasize external and internal institutional and
• Obstacles and Constraints political constraints
• Necessary versus Sufficient Conditions: Some - emphasized on the need for major new policies to
Criticisms of the Stages Model eradicate poverty, provide more diversified
1.3 Structural-Change Models employment opportunities, and reduce income
• The Lewis Theory of Economic Development inequalities
• Structural Change and Patterns of Development
• Conclusions and Implications Neoclassical (or neoliberal) Counterrevolution
1.4 The International-Dependence Revolution
• The Neocolonial Dependence Model - emphasized the beneficial role of free markets, open
• The False-Paradigm Model economies, and the privatization of inefficient public
• The Dualistic-Development Thesis enterprises
• Conclusions and Implications - failure to develop was primarily the result of too much
1.5 The Neoclassical Counterrevolution: Market government intervention and regulation of the
Fundamentalism economy rather than the exploitive external and
• Challenging the Statist Model: Free Markets, internal forces
Public Choice, and Market-Friendly Approaches
• Traditional Neoclassical Growth Theory
Development as Growth and the Linear-Stages Theories
• Conclusions and Implications
1.6 Classic Theories of Development: Reconciling the Capital Fundamentalism - emphasis on the central role of
Differences accelerated capital accumulation

Classic Theories of Economic Development: Four  Rostow’s Stages of Growt

Approaches (Classic Post–World War II Literature) - transition from underdevelopment to development
can be described in terms of a series of steps or stages
1. Linear-stages-of-growth model
through which all countries must proceed
2. Theories and patterns of structural change - The Stages of Economic Growth:
3. International-dependence revolution 1. Traditional Society – dependent on rural
4. Neoclassical, freemarket counterrevolution economy (subsistence, barter, agriculture)
2. Pre-conditions for Takeoff into Self-
Linear-stages-of-growth model
sustaining Growth (Transitional Stage) –
- development is a series of successive stages of dependent on social appreciation of
economic growth through which all countries must educational and skill development
pass (specialization, surpluses, infrastructure)
- right quantity and mixture of saving, investment, and 3. Take-off - dependent on sub-urban economy
foreign aid were all that was necessary to enable (industrialization, growing investment,
developing nations to proceed along an economic regional growth, political change)
growth path 4. Drive to maturity – dependent on growth and
developed economies (diversification,
Theories and patterns of structural change innovation, less reliance on imports,
investment)
- used modern economic theory and statistical analysis 5. Age of high mass consumption – dependent
- portray the internal process of structural change that a on global economy or market managing
“typical” developing country must undergo if it is to
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 economies (consumer oriented, durable  Necessary versus Sufficient Conditions: Some Criticisms
goods flourish, services sector become of the Stages Model
dominant)
Necessary condition - condition for an event to occur, but it
Marshall Plan - massive amounts of U.S. financial and is not sufficient in and of itself.
technical assistance enabled the war-torn countries of
Europe to rebuild and modernize their economies in a matter Example: capital formation may be a necessary condition for
of years sustained economic growth, but social, institutional, and
attitudinal changes may have to occur for this growth to
 The Harrod-Domar Growth Model (AK Model) continue.
- more investment leads to more growth
- growth rate of gross domestic product (g) depends Sufficient condition - causes or assures the occurrence of an
directly on the national net savings rate (s) and event
inversely on the national capital-output ratio (c)
Theory of Stages of Growth Criticism:

 more saving and investment isn’t a necessary

AK Model
condition for accelerated rates of economic growth
- based on a linear production function with output because it is not a sufficient condition
given by the capital stock K times a constant, often
The Rostow and HarrodDomar Models Criticism:
labeled A
- net additions to the capital stock (K) – new investment  assume the existence of these same attitudes and
– bring about corresponding increases in the flow of arrangements (well-integrated commodity and
national output, GDP (Y) = there is a direct relationship money markets, highly developed transport
between the K and Y facilities, a well-trained and educated workforce, the
motivation to succeed, an efficient government
bureaucracy) in underdeveloped nations, but they
Capital-output ratio - ratio that shows the units of capital
lack complementary factors (managerial
required to produce a unit of output over a given period of
competence, skilled labor, and the ability to plan
time
and administer a wide assortment of development
Net savings ratio - savings expressed as a proportion of projects)
disposable income over some period of time  insufficient focus on another strategy for raising
growth

Explains 3 Types of Growth Structural-Change Models

1. Warranted growth (gw): all resources & savings are - mechanism by which underdeveloped economies
used in capital transform their domestic economic structures from a
2. Actual growth rate of GDP(g): to find whether there's heavy emphasis on traditional subsistence agriculture
growth or not to a more modern, more urbanized, and more
3. Natural growth rate (gn): growth an economy requires industrially diverse manufacturing and service
to maintain full employment economy
- underdevelopment is due to underutilization of
 Obstacles and Constraints resources

The main obstacle to or constraint on development = low

 The Lewis Theory of Economic Development
level of new capital formation in most poor countries
Structural transformation
“capital constraint” stages approach to growth and
development = became a rationale an opportunistic tool - transforming an economy in such a way that the
(Cold War Politics) for justifying massive transfers of capital contribution to national income by the manufacturing
and technical assistance from the developed to the less sector eventually surpasses the contribution by the
developed nations agricultural sector
- major alteration in the industrial composition of any
economy

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Lewis two-sector model Rising GDP but little to no improvement in social welfare
(“Antidevelopmental” Economic Growth – all extra
- general theory of the development process in surplus- income & output growth are distributed to the few
labor developing nations owners of capital = All of the extra output accrues to
- surplus labor from the traditional agricultural sector is capitalists in the form of profits)
transferred to the modern industrial sector
2. Model assumes that surplus labor exists in rural areas
Underdeveloped economy consists of two sectors:
while there’s full employment in urban areas -> not valid
1. a traditional, overpopulated, rural subsistence = contemporary research indicates that there is little
sector characterized by zero marginal labor surplus labor in rural locations
productivity - surplus labor can be withdrawn
from the traditional agricultural sector without 3. competitive modern-sector labor market will ensure the
any loss of output continuation of steady real urban wages until the supply
2. a high-productivity modern, urban industrial of rural surplus labor is depleted -> institutional factors
sector into which labor from the subsistence (union bargaining power, civil service wage scales, and
sector is gradually transferred multinational corporations’ hiring practices) tend to
negate competitive forces in modern-sector labor
markets in developing countries
Surplus labor
4. assumption of diminishing returns in the modern
- excess supply of labor over and above the quantity
industrial sector -> there is much evidence that
demanded at the going free-market wage rate.
increasing returns prevail in industrial sector posing
- Lewis two-sector model: portion of the rural labor
special problems for development policymaking
force whose marginal productivity is zero or negative

 Structural Change and Patterns of Development

Production function – technological or engineering
Patterns-of-development analysis
relationship between the quantity of a good produced and
the quantity of inputs required to produce it - focuses on the sequential process through which the
economic, industrial, and institutional structure of an
Average product = total output or product divided by total
underdeveloped economy is transformed over time to
factor input
permit new industries to replace traditional agriculture
Marginal product = increase in total output resulting from as the engine of economic growth
the use of one additional unit of a variable factor of - increased savings and investment are perceived as
production (such as labor or capital) necessary but not sufficient conditions for economic
growth
Self-sustaining growth – economic growth that continues
over the long run based on saving, investment, and Domestic and International constraints on development:
complementary private and public activities
Domestic: economic constraints (country’s resource
Process of modern-sector self-sustaining growth and endowment, physical and population size) and institutional
employment expansion = continue until all surplus rural labor constraints (government policies and objectives)
is absorbed in the new industrial sector
International: access to external capital, technology, and
Lewis turning point - declining labor-to-land ratio means that international trade
the marginal product of rural labor is no longer zero
Structural-change model recognizes the fact that developing
countries are part of an integrated international system that
can promote (as well as hinder) their development.
Criticisms of the Lewis Model:

1. Model assumes that rate of labor transfer &

employment creation is proportional to rate of modern- The International-Dependence Revolution
sector capital accumulation (the faster the rate of capital
- view developing countries as beset by institutional,
accumulation, the higher the growth rate of modern
political, and economic rigidities, both domestic and
sector & faster rate of job creation) ->
international

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 - developing countries caught up in a dependence and  The False-Paradigm Model
dominance relationship with rich countries - attributes underdevelopment to faulty and
- Three major streams of thought: inappropriate advice provided by well-meaning but
 neocolonial dependence model often uninformed, biased, and ethnocentric
 false-paradigm model international “expert” advisers from developed-
 dualistic-development thesis country
- Development strategies were based on incorrect
models of development (e.g. overstresses capital
accumulation or market liberalization without
Dependence
considering needed social and institutional change)
- reliance of developing countries on developed-country
economic policies to stimulate their own economic  The Dualistic-Development Thesis
growth
Dualism - existence and persistence of substantial and even
- can also mean that the developing countries adopt
increasing divergences between rich and poor nations and
developed-country education systems, technology,
rich and poor peoples on various levels.
economic and political systems, attitudes, dress, etc.
- In the developing countries, pockets of wealth within
Dominance
broad areas of poverty
- developed countries have much greater power than
the less developed countries in decisions affecting
important international economic issues (prices of 4 Key Arguments:
agricultural commodities and raw materials in world
markets) 1. Coexistence of “superiority” and “inferiority”: e.g.
modern & traditional methods of production, highly
 The Neocolonial Dependence Model educated elites & illiterate poor, and wealthy
- attributes the existence and continuance of industrialized nations & weak peasant societies
underdevelopment due to highly unequal international 2. This coexistence is chronic and not transitional. The
capitalist system of rich country–poor country difference between superior and inferior elements
relationship ((economic exploitation, unequal could NOT be eliminated over time.
exchange, limited development, and continued 3. The degrees of superiority or inferiority fail to show
control) any signs of diminishing – it has a tendency to
- the coexistence of rich and poor nations in an increase
international system dominated by such unequal 4. The superior elements does little or nothing to pull
power relationships between the center (the up the inferior element
developed countries) and the periphery (the
developing countries) renders attempts by poor
nations to be self-reliant and independent (sometimes Dependence theories have two major weaknesses:
even impossible)
- underdevelopment attributes a large part of the 1. Although they offer an appealing explanation of why
developing world’s continuing poverty to the existence many poor countries remain underdeveloped, they
and policies of the industrial capitalist countries of the give no insight into how countries initiate and
northern hemisphere and their extensions in the form sustain development
of small but powerful elite or comprador groups in the 2. The actual economic experience of developing
less developed countries countries that have pursued revolutionary
campaigns of industrial nationalization and state-run
Comprador group - In dependence theory, local elites who production has been mostly negative
act as fronts for foreign investors
It conclude that the best course for developing countries is to
Underdevelopment - a consequence and a particular form of become entangled as little as possible with the developed
capitalist development known as dependent capitalism countries and instead pursue a policy of autarky, or inwardly
directed development, or at most trade only with other
Some countries can expand through self-impulsion while
developing countries
others, being in a dependent position, can only expand as a
reflection of the expansion of the dominant countries Autarky – closed economy that attempts to be completely
self-reliant.

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The Neoclassical Counterrevolution: Market Neoclassical counterrevolution can be divided into three
Fundamentalism component approaches:

 Challenging the Statist Model: Free Markets, Public 1. free-market approach

Choice, and Market-Friendly Approaches 2. public-choice (new political economy) approach
3. “market-friendly” approach.
Neoclassical counterrevolution
Free-market analysis
- the 1980s resurgence of neoclassical free-market
orientation toward development problems & policies - theoretical analysis of the properties of an economic
- In developed nations: counterrevolution favored system operating with free markets (assumption:
supply-side macroeconomic policies, rational unregulated market performs better than government
expectations theories, and the privatization of public regulated)
corporations - any government intervention in the economy is by
- In developing countries: it called for freer markets and definition distortionary and counterproductive
the dismantling of public ownership, statist planning,
and government regulation of economic activities
Public-choice theory (new political economy approach)
Developing world is underdeveloped, not because of the
predatory activities of the developed world and the - argue that governments can do (virtually) nothing right
international agencies that it controls, but rather because of - politicians, bureaucrats, citizens, and states act solely
the heavy hand of the state and the corruption, inefficiency, from a self-interested perspective, using their power
and lack of economic incentives that permeate the and the authority of government for their own selfish
economies of developing nations ends:
 Politicians: use government resources to
Underdevelopment results from poor resource allocation due consolidate and maintain positions of power
to incorrect pricing policies and too much state intervention and authority.
by overly active developing-nation governments.  Bureaucrats and public officials: use their
positions to extract bribes from rent-seeking
- state intervention in economic activity slows the pace
citizens and to operate protected businesses
of economic growth on the side
The neoliberals argue that by permitting competitive free  Citizens: use political influence to obtain
markets to flourish, privatizing state-owned enterprises, special benefits (called “rents”) from
promoting free trade and export expansion, welcoming government policies (e.g., import licenses or
investors from developed countries, and eliminating the rationed foreign exchange)
plethora of government regulations and price distortions  States: use their power to confiscate private
property from individuals
Free markets

- prices of commodities or services freely rise or fall Market-friendly approach – notion that successful
base on its supply and demand development policy requires governments to create an
- where the laws of supply and demand provide the sole environment where markets can operate efficiently and to
basis for the economic system, without government intervene only selectively where market is inefficient
intervention
Market failure – market’s inability to deliver benefits due to
market imperfections (e.g. monopoly power, lack of
Promote free markets and laissez-faire economics within the knowledge, significant externalities)
context of permissive governments that allow the “magic of
the marketplace” and the “invisible hand” of market prices to
guide resource allocation and stimulate economic
 Traditional Neoclassical Growth Theory
development.
Solow neoclassical growth model
Laissez-faire – policy of minimum governmental interference
in the economic affairs of individuals and society - exhibited diminishing returns to labor and capital
separately and constant returns to both factors jointly
- technological change generates long-term economic
growth

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 - implies that economies will converge to the same level  Invisible hand often acts not to promote the general
of income per worker “conditionally”—that is, other welfare but rather to lift up those who are already
things equal, particularly savings rates, depreciation, well-off while failing to offer opportunities for
labor force growth, and productivity upward mobility for the vast majority
 Enlightened governments can also make effective
According to traditional neoclassical growth theory output
use of prices as signals and incentives for influencing
growth results from one or more of three factors:
socially optimal resource allocations
1. increases in labor quantity and quality (through
population growth and education)
2. increases in capital (through saving and investment) Conclusion for All Theories
3. improvements in technology
Linear-stages-of-growth model - underdevelopment is seen
Closed economy as an externally induced phenomenon

- economy in which there are no foreign trade Structural-change theories – stress on internal constraints,
transactions or other economic contacts with the rest such as insufficient savings and investment or lack of
of the world education and skills.
- those with no external activities with lower savings
rates grow more slowly in the short run than those International-dependence revolution – underdevelopment is
with high savings rates and tend to converge to lower an externally induced phenomenon
per capita income levels
Neoclassical, freemarket counterrevolution. – saw the
Open economy problem as an internally induced phenomenon of developing
countries, caused by too much government intervention and
- economy that practices foreign trade and has bad economic policies
extensive financial and nonfinancial contacts with the
rest of the world
- experience income convergence at higher levels as
capital flows from rich countries to poor countries
where capital-labor ratios are lower and thus returns
on investments are higher

 Conclusions and Implications

Neoclassical counterrevolution’s contention that free

markets and less government = market price allocation
usually does a better job than state intervention

Criticisms of Neoclassical Counterrevolution:

 Competitive free markets generally do not exist

 Consumers as a whole are rarely sovereign about
what goods and services are to be produced
 Information is limited, markets are fragmented, and
much of the economy in low-income countries is still
non-monetized
 There are widespread externalities of both
production and consumption as well as
discontinuities in production and indivisibilities (i.e.,
economies of scale) in technology
 Producers, private or public, have great power in
determining market prices and quantities sold
 The ideal of competition is typically just that—an
ideal with little substance in reality