CEC/XEA 301: DEVELOPMENT

ECONOMICS

Lecture Four

Dr. Bethuel Kinyanjui Kinuthia

Department of Economics & Development Studies
GW 310
TOPIC IV: Theories of balanced growth and unbalanced
growth

• The big-push theory (Paul Rosenstein-Rodan,1943)

• “Vicious circle of poverty” (Ragnar Nurkse 1953)

• Theories of unbalanced Growth-Alfred O Hirschman

(1958).

• Cumulative causation theory (Gunnar Myrdal- 1956)

The big push theory
• Idea that there is need for a big push or a big and
comprehensive investment package that can help in
bring economic development.

• “Coordinated Investment”: There is a certain minimum

amount of resources that need to be devoted for
development program, if the success of programs is
required.
• ‘Bit by bit’ allocation on economy can result on the
path of economic development

• So mutual supporting industries which depend upon

each are started the economies of scale will be reaped.

• External economics is due to a specific amount of

investment which results in economic development
• Balanced growth involves the simultaneous expansion of
large number of industries in all sectors and regions of the
economy.

• Balanced growth theory argues that as a large number of

industries develop simultaneously, each generates a market
for one another.

• The manufacturing sector, firms create market result in

additional output affecting the sectors, regions e.t.c
(Technically interdependent industries)
• The indivisibilities and external economics flowing from
this big push (coordinated investment) are a
prerequisite for launching economic development
successfully.
• Three aspects:
indivisibilities in the production function, especially
the indivisibility of the supply of social overhead capital;
indivisibility of demand
indivisibility in the supply of savings.
Indivisibilities in the production
function
• According to Rosenstein-Rodan, indivisibilities of inputs, outputs or
processes lead to increasing returns.

• He regards social overhead capital as the most important instance

of indivisibility and hence of external economies on the supply side.
The principal obstacles to development in underdeveloped countries

• The services of social overhead capital comprising basic industries

like power, transport, and communications are indirectly productive
and have a long gestation period. They cannot be imported. Their
installations require a “size able initial lump” of investment.
 Indivisibility of demand

• The indivisibility or complementarity of demand

requires simultaneous setting up of interdependent
industries in underdeveloped countries.
• This is because individual investment projects have
high risks because low incomes limit the demand for
their products.
• In other words, it is the indivisibility of demand which
necessitates a high minimum quantum of investment in
inter dependent industries to enlarge the size of the
market.
Indivisibility in the supply of
savings
• A high income elasticity of saving is the third
indivisibility in Rosenstein’s theory.
• A high minimum size of investment requires a high
volume of savings. This is not easy to achieve in
underdeveloped countries because of low incomes.
• To overcome this, it is essential that when incomes
increase due to an increase in investment, the marginal
rate of saving should be very much higher than the
average rate of saving.
Virtuous circle effect
• An expanding manufacturing sector that raises
productivity then stimulates income growth
• In turn, it leads to increasing demand for the products
of the expanding manufacturing sector
• Increasing growth is the manufacturing sector could
lead to increasing demand for inputs
• Result: Lower the cost of production for the
manufacturing sector which could lead to increasing
demand for the product and growth
Challenges
• Negligible economies from investment in export and
import substitutes
• Negligible economies even from cost-reducing
investments
• Neglects investment in the agricultural sector
• Generates inflationary pressures
• Low investment leads to large increase in output
• Administrative and institutional difficulties.
• Not an historical fact
Vicious circle of poverty
• Nurkse holds that the major obstacle to the development of
the underdeveloped countries is the vicious circle of poverty.

• This vicious circle of poverty shows that income in

underdeveloped countries is low.

• Low income leads to low savings.

• Low savings will naturally result in low investment, which

will result in less production.
• Low production will generate low income. Low income
will create low demand for goods.

• In other words, it will result in smaller markets (limited

extent of markets). Thus, there will be no inducement
to invest.

• So, in order to break the vicious circle of poverty in the

under-developed countries, it is essential to have a
balance between demand and supply.
(a) Demand Side:
• Vicious circle of poverty affects the demand side of
capital formation.
• The underdeveloped countries are poor because their
level of income is low. Due to low level of income, their
demand for low-income goods is low.
• The size of the market is limited. As a result, private
investors do not get opportunities for more investment.
This reduces investment and capita. Hence productivity
of capital would fall→ Low Size of Market → Low Investment → Low
Low Income
Productivity → Low Income.
(b) Supply Side:
• Vicious circle of poverty affects the supply side of capital
formation.
• In the underdeveloped countries, poverty exists because
the per capita income of the people is low.
• Due to low per capita income, the level of saving is low.
Since investment depends on savings, so investment
would be low due to which capital formation would be
low.
• Low capital formation would lead to low productivity
which would result
Low-Income inSavings
→ Low poverty. This is
→ Low Investment how
→ Low vicious circle
Capital
→Formation → Low Productivity → Low Income
from supply side completes.
How to Break Vicious Circle of
Poverty
• Complementary Demand
This vicious circle of poverty cannot be broken only by
making investment in one industry or one sector. Rather,
there should be overall investment in all the sectors. This is
the only way to enlarge the size of the market.
• Government Intervention
Nurkse is of the view that the government must intervene in
productive activities through economic planning.
He is of the view that when government participates in
productive activities, it will help in breaking the vicious circle
of poverty.
Nurkse opines that if entrepreneurs are available in underdeveloped
countries, then they can be induced to make investment.
But in underdeveloped countries, private entrepreneurs cannot
come forward with so much heavy investment. This can easily be
carried by the government only. Thus, vicious circle of poverty can
be broken only by the intervention of the government.
• External Economies
Balanced growth also leads to external economies. External
economies are those which accrue because of the setting up of new
industries and expansion of the existing industries.
• Export pessimist: weak patterns of prices for traditional price
exports vs need for domestic industrialization
Theories of unbalanced Growth
• Alfred O Hirschman (1958).

• This theory suggests to select priority sectors or

strategic sectors and invest heavily on them and other
sectors would automatically develop through “linkages
effect”.

• The underdevelopment countries lack resources and

many other factors.
• The best strategy od development is the creation of
imbalances in the economy, since it is observed that the
efforts to correct disequilibrium constitutes a major step
for the progress of the economy.
• Unbalanced growth according to Prof. Hirschman
generates externalities.
• Further explaining, we could say that the growth of
industry A leads to or stimulates the growth of industry
B and C and so on, similarly the growth of industry B and
C will lead to the subsequent growth of industries E and
F.
• Thus, the growth of a strategic industries apart from
providing the benefits belonging to itself also
stimulates the growth of other set of industries. The
existing externalities are explored, and fresh ones
generated.
• Complementary: Growth of output of industry A may
generate the demand for the products of B and C and
also may reduce the marginal cost of production in
these industries.
• There are technical complimentary which stimulate the
growth of related industries, following a strategy of
unbalanced growth
Classification of Investment by
Hirschman
• Social Overhead Capital or SOC: Social overhead capital
comprises of those basic devices without which primary,
secondary and tertiary activities cannot function: Government
• Direct Productive Activities or DPA: These are those activities
which are a consequence of some investment, add to the flow of
final goods and services: Private entrepreneurs.
• Therefore both SOC and DPA cannot be taken up simultaneously
in less developed countries, owing to the general lack of
resources.
• Initially, we should concentrate on either of the two, the other
one would be automatically stimulated.
• Either way it would result in growth
Forward and Backward linkages
• Creating unbalances are a pre-requisite of economic
growth, according to Hirschman.
• Backward linkages- growth of a set of industries
stimulates the growth of those which supply raw
materials.
• Setting up a steel plant for example, would stimulate
the demand for steel scrap, coal and other related
goods.
• Production of these goods will accordingly increase.
• Forward linkages refer to the growth of certain industries
owing to the initial growth of those which supply raw
materials.
• Expansion of steel industry, for example, will encourage
industries making machine, tools, etc. using steel as their
basic input..
• Study of these linkages facilitates the choice of activities
through which growth with imbalances should be
generated in the system.
• Industries with maximum linkages ought to be developed
first.
• Inflation
• Wastage of resources
• Non mention of obstacles
• Increase of uncertainty
• Unbalance is not necessary
• Linkages effect are not based on empirical data
• Neglect of the degree of unbalance
• Lack of basic facilities
Cumulative causation theory
(Gunnar Myrdal- 1956)
• International trade cannot encourage growth specially
in underdeveloped countries.

• Argues that economic development results in a circular

causation process leading to rapid development of
developed countries while weaker countries tend to
remain behind and poor.
• Circular cumulative causation is a multi-causal
approach where the core variables and their linkages
are delineated.

• Change of institutions results in successive changes in

other institutions.

• They changes are circular and it occur in cycles, mainly

negative way, in cases of no end results in cumulative
in that they persist in each period.
Main theories based on Myrdal
The theory of backward effect of international trade

The cumulative causation theory of economic

development

• These two causes the vicious circle of backwardness

The institutional reforms theory of development

The theory of backward effect of
international trade
• International and inter-regional economic relations in
practice involve unequal exchanges in the sense of the
weak is always exploited by the strong.
• Backward effect: the negative impacts of the growth of
the core region on the peripheral regions, which tend
to be poorer.
• Mainly migration, capital movement and trade
• Main cause of underdevelopment strong backward
effects and weak spread effect
• Inequality emerge because of BWE>SPE
• Developed region is developing at a faster rate at the
cost of backward region.
• Income earned by developed region is not reinvested in
backward regions but is repatriated to the developed
sectors/regions leading to more development in these
areas.

• Spread effect continues to become stronger in

developed countries while backward effect continued
to become even more spread in backward countries.
The cumulative causation theory of
economic development
• The cumulative causation action has been built upon
spread effect and backwash effects.
• The theory emphasizes that “poverty is further
perpetuated by poverty” (BWE > SPE) and “affluence is
further promoted by affluence” (SPE>BWE).
• In backward regions problem creates more problems.
In developed regions auto solutions solve all problems.
• Under such situations cause becomes its own effect
• A region is backward because it is backward.
• Myrdal contention is that the free play of market forces and
operation of profit motive in the capitalist system normally tends
to increase inequalities between regions rather than decrease.
• When backwash effect dominates divergence will develop;
periphery will remain weak, only center will develop and dualism
in growth is promoted.
• When spread effect dominates convergence will develop;
periphery will develop, there will be economic integration
between center and periphery.
• The theory is center periphery model because the
favorable effects flow from center to periphery.

• Periphery supplies raw material and human power to

center.

• Centre supplies finished output for consumption and

input.