Development Economics-I

LECTURE NOTES
 1.1 The Nature of Development Economics
1. Traditional economics is concerned primarily with the efficient, least-cost allocation

of scarce productive resources and with the optimal growth of these resources

over time so as to produce an ever-expanding range of goods and services.

• Traditional neoclassical economics deals with an advanced capitalist world of

perfect markets; consumer sovereignty; automatic price adjustments; decisions

made on the basis of marginal, private-profit, and utility calculations; and

equilibrium outcomes in all product and resource markets.

• It assumes economic “rationality” and a purely materialistic, individualistic, self-

interested orientation toward economic decision making .

2. Political economy :the social and institutional processes through
which certain groups of economic and political elites influence the
allocation of scarce productive resources now and in the future,
either for their own benefit exclusively or for that of the larger
population as well.
• Political economy is therefore concerned with the relationship
between politics and economics, with a special emphasis on the role
of power in economic decision making.
3. Development economics: The study of how economies are
transformed from stagnation to growth and from low income
to high-income status, and overcome problems of absolute
poverty.

4. More developed countries (MDCs) The now economically

advanced capitalist countries of Western Europe, North
America, Australia, New Zealand, and Japan.

5. Less developed countries: A synonym for developing

countries
 1.2 Three Core Values of Development

• The three basic components or core values serve as a conceptual

basis and practical guideline for understanding the inner meaning of
development. These core values— sustenance, self-esteem, and
freedom—represent common goals sought by all individuals and
societies.

• They relate to fundamental human needs that find their expression in

almost all societies and cultures at all times. Let us therefore examine

each in turn.
 1. Sustenance: The Ability to Meet Basic Needs

• All people have certain basic needs without which life would be impossible.

• These life-sustaining basic human needs include food, shelter, health, and
protection.
• Without sustained and continuous economic progress at the individual as
well as the societal level, the realization of the human potential would not be
possible.

• One clearly has to “have enough in order to be more.” Rising per capita
incomes, the elimination of absolute poverty, greater employment
opportunities, and lessening income inequalities therefore constitute the

necessary but not the sufficient conditions for development .

 2. Self-Esteem: To Be a Person

• A second universal component of the good life is self-esteem—a

sense of worth and self-respect, of not being used as a tool by others
for their own ends.
3. Freedom from Servitude: To Be Able to Choose
• A third and final universal value which is , Freedom here is to be
understood in the sense of emancipation from alienating material
conditions of life and from social servitude to nature, other people,
misery, oppressive institutions, and dogmatic beliefs, especially that
poverty is predestination.
 1.3 Three Objectives of Development

• We may conclude that development is both a physical reality and a

state of mind in which society has, through some combination of

social, economic, and institutional processes, secured the means for

obtaining a better life. Whatever the specific components of this better

life, development in all societies must have at least the following

three objectives:

1. To increase the availability and widen the distribution of basic life-sustaining

goods such as food, shelter, health, and protection
2. To raise levels of living, including, in addition to higher incomes,
the provision of more jobs, better education, and greater attention to
cultural and human values, all of which will serve not only to
enhance material wellbeing but also to generate greater individual
and national self-esteem

3. To expand the range of economic and social choices available to

individuals and nations by freeing them from servitude and
dependence not only in relation to other people and nation-states but
also to the forces of ignorance and human misery
End of the chapter
 Unit Two: Economic Growth and
Development
2.1 Economic Development vs. Economic Growth

• Friedman defines growth as an expansion of the system in one or more dimensions

without a change in its leading to the structural transformation of social system.

• Economic growth is related to a quantitative sustained increase in the country's per

capita output or income accompanied by expansion in its labor force consumption,

capital and volume of trade.

• The concept of development should embrace the major economic and social

objectives and values that society strives/ achieves for three basic values of

development.
• These are ability to meet basic needs, self respect and freedom
from the evils of want.
• Economic development is wider concepts than economic
growth. It is taken to mean growth plus change in the technical
and institutional arrangement by which it is produced and
distributed.
• It is related to qualitative change in economic wants,
institutions or the upward movement of the entire social system.
• It describes the underlining determinants of growth such as
technological and structural changes.
.
 The Key Differences Between Economic Growth and
Economic Development
• The primary differences between economic growth and development are explained in the points

given below:

1. Economic growth is the positive change in the real output of the country in a particular span of

time economy. Economic Development involves the rise in the level of production in an

economy along with the advancement of technology, improvement in living standards and so

on.

2. Economic growth is one of the features of economic development.

3. Economic growth is an automatic process. Unlike economic development, which is the outcome of

planned and result-oriented activities?

 The Key Differences Between Economic Growth and
Economic Development

4. Economic growth enables an increase in the indicators like GDP, per capita income,
etc. On the other hand, economic development enables improvement in the life
expectancy rate, infant mortality rate, literacy rate and poverty rates.

5. Economic growth can be measured when there is a positive change in the national
income, whereas economic development can be seen when there is an increase in
real national income.

6. Economic growth is a short-term process which takes into account yearly growth of
the economy. But if we talk about economic development it is a long term process
 The Key Differences Between Economic Growth and
Economic Development

7. Economic Growth applies to developed economies to gauge to the quality of life,

but as it is an essential condition for the development, it applies to developing
countries also. In contrast to, economic development applies to developing
countries to measure progress.

8. Economic Growth results in quantitative changes but economic development bring

both quantitative and qualitative changes.

9. Economic growth can be measured in a particular period. As opposed to economic

development is a continuous process so that it can be seen in the long run.
 2.2 Measurements of Economic Development

1.GNP- Gross National Product: refers to the country's total output of

final goods and services over a long period of time.

 This term of over a long period of time implies a sustained

increase in real national income.

But this definition is not satisfactory due to following reasons.

i. GNP does not reveal the changes in growth of population.

ii. It does not reveal -the costs to society of environmental

pollution.
 Cont`d……
iii. It tells us nothing about the distribution of income in the economy.

iv. Another difficulty in calculating GNP is of double counting

which arises from the failure to distinguish properly between

final and intermediate products.

v. It failed to account costs to the societies. The sustained

increase GNP may be attained by environmental pollution,

inefficient uses of resource etc..

 Cont`d….
2. GNP per capita-it is the GNP divided by the total
population of the country.
• The real GNP per capita fails to take problems associated
with basic needs like nutrition, health, sanitation,
housing, water and education
• The improvement in living standards by providing basic
needs cannot be measured by increase in GNP per capita
 Cont’d……

• The distribution of income does not become more unequal

and the growth rate of real national income should be higher

than population growth rate. But difficulties still remain:

i. An increase in per capital income may not raise the

real standard living of masses.
 It possible that while per capita income increasing,
per capita consumption may be failing.
 Cont`d…
ii. There is another possibility of the mass remaining poor despite
an increasing in the real GNP per capita if the increase income
goes to a few rich instead of going to the country.

iii. International comparisons of the real GNP per capita are

inaccurate due to exchange rate conversion of different
currencies in to a common currency
 Cont’d…..
• 3.Welfare- economic development IS regarded as a process
whereby there is an increase in the consumption of goods and
services of individual. But difficulties still remain:
i. The weights of output to be attached consumption of
individuals.
 This consumption depends on the taste performance of
individuals.
 Therefore, it is not a correct to have the weights in preparing the
welfare of index of individual.
 Cont`d……
ii. It does not consider how to produce goods and services

and what is produced output.

• The expansion of real output may have raised the costs

(pension and Sacrifices) and social costs in the economy.

• Example, increase output may have resulted from long

hours work and deterioration of the working conditions

of the lobar forces.

 Cont`d…….

4. Social Indicators- are inputs such as nutritional standards or

number of hospital based or doctors per head of

population ,improvements in health in terms of infant

"mortality rates, sickness rates etc, social indicators are often

referred to as the basic needs for development.

 The social indicators include health, food, water, sanitation,

housing and the like.
 Cont`d……
But difficulties still remain:

i. The number and types of items included in such index.

 Therefore, different items include in different countries and
some of items left in different countries. These items are
mortality rates, sickness rates, food, water, sanitation etc…
• So it has no a full agreement in all countries.

ii. Social indicators are concerned the current welfare but not
related to the future.
 2.3 Human Development Index (HDI)

-The HDI value of a country is measured by taking three indicators:-

- Longevity: as measured by life expectancy at birth the range is 25 to

85 years.

- Education attainment as measured by a combination of adult literacy

(2/3 weight) and combined primary, secondary and tertiary

enrollment ratios (1/3 weight), the range for both is 0% to 100%.

- Standard of living as measured by real GDP per capita based on

Purchasing Power Parity (PPP), the range is between $100 to $40,000.
 Cont’d
- For any component of the HDI, the individual indices can be computed according to the general

formula:

Index = Actual value-Minimum value

Maximum Value- Minimum value

Example: life expectancy at birth for country X is given to be 58 years. The combined primary secondary

and tertiary education attainment is given to be 50%, for the same country the real per capita GDP is

$900.The adult literacy is given to be 30%.Calculate,

a) Life expectancy index

b) Education index

c) GDP index

d) HDI
 Cont’d
Solution:
A) Life Expectancy Index= 58-25 = 0.55
85-25

B) Education index = 2/3 (30-0/100-0) + 1/3 (50-0)

(100-0)
= 0.37

C) GDP index = log 900- log 100 = 0.52

log 40, 000-log100

D) HDI = 1/3(0.55) + 1/3(0.37) + 1/3(0.52)

= 0.48
 Cont’d
• HDI takes the range from 0 to 1.

• Countries with an HDI value below 0.5 are considered to have

a low level of human development.

• The range between 0.5 to 0.8 a medium level and those above
0.8 a high level.
 2.4 Economic Growth and Income Distribution
The kuznet's Hypothesis
 There has been much controversy among economists
over the issue whether economic growth increases or
decreases income distribution

 Prof. Kuznet’s is the first economist to study this problem

empirically.

 He observes that in the early stages of economic growth

relative income inequality increases, stabilizes for a time
and then decline in the later stages.
 Cont’d
• This is known as the inverted U- shaped
hypothesis of income distribution.

• Lorenz curve is a common way of analyzing

personal income statistics.

• The more the Lorenz curve is a way from the

diagonal, the greater the degree of inequality
represented
 Cont’d
• The extreme case of perfect inequality is a situation in which one person
receives all of the national income while everybody else receives
nothing.

• This would be represented by the congruence of the Lorenz curve with

the bottom horizontal and right hand vertical axis.

• Because no country exhibits either perfect equality or perfect inequality

in its distribution of income, the Lorenz curve for different countries will
lie somewhere to the right of the diagonal.
 Cont`d……..
• Gini coefficient (also Gini concentration ratio) is named after the
Italian statistician who first formulated it in 1912.

• It is obtained by calculating the ratio of the area between the diagonal

and the Lorenz curve divided by the total area of the half square in
which the curve lies.

• Gini coefficients are aggregate inequality measures and vary from o

(perfect equality) to 1(perfect inequality).
 Cont`d….
• Gini coefficients for countries with highly unequal income
distribution typically lie between 0.5 and 0.7, while for countries
with relatively equal distribution; it is on the order of 0.2 to 0.5.

• But the Gini coefficient of distribution is a better measure of the

degree of income inequality.

• It varies from 0 to 1. The Gini coefficient is measured as the ratio of

area A/OCD.
 It is possible to measure how equally or unequally a price system rations by
looking at the distribution of income

Eg. Percent Distribution of Aggregate Household Income in 1978, by Fifths of Households

Households Percent of Income

Lowest Fifth (under $6391) 4.3

Second Fifth ($6392 - $11955) 10.3

Third Fifth ($11956 - $18122) 16.9

Fourth Fifth ($18122 - $26334) 24.7

Top Fifth ($26335 and over) 43.9

Source: U.S. Bureau of Census, Current Population Reports, P-60, No. 121, "Money Income in 1978 of Households in the United States," Washington, D.C.: U.S.
Government Printing Office, 1980. Data taken from cover. (Data are before taxes.)
 Cont`d…..
• The information in the above table can be made in to a Lorenz
curve such as that shown below.

• The further the Lorenz curve lies below the line of equality,
the more unequal is the distribution of income.
Cont’d
• Income distribution is intended to tell us about the rich and the
poor, or about how much discrimination exists in a system of price
rationing.

• In a system of price rationing, however, differences in the ability

to use income wisely also determine how much discrimination
there is.

• If those who receive the most income and also tend to be the most
capable at using that income, then the picture that the Lorenz
curve shows will understate the actual amount of inequality.
 2.5 Sustainable Development

• The concept of sustainable development is of recent origin.

• The term sustainable development was presented by the International

Union for the Conservation of Nature and Natural Resources in 1980.

• Sustainable development is defined as "meeting the needs of the

present generation without compromising the needs of future
generations".
 Cont’d
• It means that the development should keep going. Thus, sustainable
development is closely linked to economic development.

• Sustainable development is development that is everlasting and

contributes to the quality of life through improvements in natural
environments. Through the process of development environmental
degradation may occur.

• There are various causes for the environmental degradation.

 Cont’d
1.Population growth-it is a major cause for rapid use of resource leading to
increased pressure on the use of country's resources.

2. Poverty- encourages un sustainability because the poor use and deplete

more natural resources than others because they have easy access to
them.

3.Agricultural Development-Intensive farming and excessive use of fertilizers

and pesticides has led to over exploitation of land and water resources.
 Cont’d
4.Industrialization- to industrialize rapidly, under developed countries are

causing environmental degradation.

• The establishment of such industries as fertilizers, iron and steel,

chemicals, refineries, etc has led to land, air and water pollution.

5. Transport development- under developed countries are developing

transport facilities for the expansion of trade and commerce.

• But they are also bringing about environmental degradation in the

form of air pollution, noise pollution and sea pollution.

 Cont’d
6. Urbanization- rapid and unplanned urbanization has led to degradation of
urban environment. Slums and shanty towns pollute air and water and
generation of solid and hazardous wastes have contributed to environmental
degradation in a vast scale.

7. Foreign Indebtedness- in order to repay their debt, underdeveloped countries

produce commercial crops for export that displace subsistence crops which are
subsequently grown on marginal lands. They also export minerals by
exploiting them recklessly, there by depleting them at a great cost to future
generations.
 Unit Three: Characteristics of an Underdeveloped Country

3.1 The meaning of the term Underdeveloped

• The term “Underdeveloped” has been used in a variety of ways.

• The two terms “Underdeveloped” and “undeveloped” countries

are often used as synonyms. These two terms are easily
distinguishable.

• An undeveloped country is one which has no prospects of

development while `underdeveloped` country is one which not
 Cont`d…….

• The Arctic, the Antarctica and the some parts of Sahara may be termed as

undeveloped.

• India, Pakistan, Uganda etc…may be called underdeveloped.

• A “poor” and “backward” are also used as synonyms for “underdeveloped”. A poor

country does not mean young country.

• Poverty refers to the low level of per capita income of a country.

• Backward countries is static term like the term “underdeveloped”. So the term

“poor” and “underdeveloped” are interchangeable.

 3.2 Some classification of Developing Countries

• There are different attempts to classify countries by different

organization. Some of classification system outlined below.

1. United Nation Classification

• United Nation Classification System refers to distinguish

among three major groups within the third world nations.
These are:
 Con`t……
i. Least Developed Countries these are poorest nations.
ii. Developing nations these are non-exporting Third
World Nation.
iii. OPEC ( Organization of Petroleum Exporting Countries)
member nation : these are petroleum rich countries
which are members of OPEC whose national income
increased dramatically during the 1970`s
 2. World Bank Classification

• The World Bank Classification both developing and developed

countries in to four categories according to their per capita income

level.

• The first three groups are developing countries while the last group

(4) comprises developed countries. These are:

i. Low- Income countries

ii. Middle - Income countries

iii. Upper-Middle income countries

iv. High- Income Countries

 3. United Nation Development Program (UNDP) Classification

• It focuses socio-economic variables beyond income level.

• Based on these criteria all countries are ranked in to three Hunan
Development Indices.
• First, below 0.5 are considered to have a low level of human
development income.
• Then, between 0.51-0.79 are middle level and those between
0.8-1 are a high level of human development
 4.Organization for Economic Cooperation and Development (OECD) Classification

• This classification the third world countries into three categories

based on per capital income depends on the base year
considered.
i. Low- Income Countries (LICs)
ii. Middle- Income Countries (MICs)
iii. New –Industrialization Countries (NICs)
 3.3 Criteria of underdevelopment

2.3.1 Different criteria of underdevelopment

1. Ratio of industrial output to total output

- Countries with a low ratio of industrial output to total output are

considered underdeveloped.

2. Low ratio of capital to per head of population

- Underdeveloped countries compared with the advanced countries are
under equipped with capital in relation to their population and natural
resources
 Cont’d
3. Poverty as the main cause of underdevelopment
- underdeveloped country as one characterized by mass poverty which is

chronic and not the result of some temporary misfortune and by obsolete

methods of production and social organization, which means that poverty is

not entirely due to poor natural resources.

4. Low per capita income as compared with the advanced countries

- According to the United Nations, we use the term underdeveloped country to mean

countries in which per capita real income is low as compared to the real per capita

income of the United States of America, Canada, Australia and Western Europe.
 3.3.2 Common Characteristics of Underdeveloped Country

1.General poverty

- It is not relative poverty but absolute poverty that is more important in

assessing underdeveloped countries.

- Absolute -poverty is measured not only by low income but also by

malnutrition, poor health, clothing, shelter, and lack of education.

- Thus, absolute poverty is reflected in low living standards of the people.

- The vast majority of the people in LDCs are ill fed, ill-clothed, ill-housed

and ill educated.

 Cont’d
2. Agriculture, the main occupation

- Heavy concentration in agriculture is a symptom of

poverty.
- Agriculture, as the main occupation, is mostly
unproductive.
- It is carried on in an old fashion with obsolete and
outdated methods of production.
 Cont’d…….
3. A dualistic economy

• One is the market economy which is modern and the other

subsistence economy which is backward and mainly agriculture-
oriented.
• Advanced industrial system and an indigenous backward agricultural
system
• unorganized money market charging very high interest rates on
loans and the organized money market with low interest and
abundant credit facilities.
 Cont’d
4. Underdeveloped natural resources
- The natural resources of an underdeveloped country are underdeveloped in the sense that they are
either unutilized or underutilized.

5. Demographic features

- possess high population growth potential characterized by high birth rate

and high but declining death rate.

- A large percentage of children in the population entail a heavy burden on

the economy which implies a large number of dependents who do not

produce at all but do consume.

 Cont’d
6. unemployment and Disguised Unemployment
- unemployment is spreading with urbanization and the spread of
education.
- A person is said to be disguised unemployed if his contribution to output
is less than what he can produce by working for normal hours per day

7. Economic Backwardness
• Economic backwardness are low labor efficiency, factor immobility, and
limited specialization in occupation and in trade, economic ignorance,
values and social structure that minimize the incentive for economic
change
 Cont`d
8. Lack of enterprise and initiative
- The force of custom, the rigidity of status and the distrust of new
ideas and of the exercise of intellectual curiosity.

- The small size of the market, lack of capital, absence of private

property, absence of freedom of contract and of law and order
hamper enterprise and initiative
 Cont’d
9. Insufficient capital equipment

- Underdeveloped countries are characterized as capital poor or low saving and

low-investing economies. The current rate of capital formation is also very low.

10. Technological Backwardness

• It is reflected in the high average cost of production and the predominance of

unskilled and untrained workers

11. Foreign Trade Orientation

-This orientation is reflected in exports of primary products and imports of

consumer goods and machinery.

 3.4 Obstacles to Economic Development

3.4.1 Obstacles to Economic Development in underdeveloped countries

Some of the obstacles are:

a. Vicious Circles of Poverty

1. The vicious circle of supply side which tend to perpetuate the low level of
development in LDCs

• Low Income→ Low Saving→ Low Investment → Low capital formation →Low
capital per worker → Low Productivity→ Low Income which leads to
underdevelopment economic
 Cont’d…….
2. The vicious circle of demand side.

• Lack of industrialization → over population in agriculture → low productivity →

low agricultural surplus → low demand of industrial product → Lack of
industrialization which leads to underdevelopment.

b. Low rate of capital formation

- They are mostly illiterate and unskilled, use out molded capital
equipment and methods of production. Low productivity leads to low
real income, low saving, low investment and to a low rate of capital
formation.
 Cont`d
c. Foreign exchange constraint
• Certain unequalizing forces have been operating
in the world economy as a result of which the
gains from trade have gone mainly to the
developed countries leading to foreign
exchange constraint.
 3.4.2 Factors of Economic Growth

1.Economic factors of economic growth

a. Natural Resources

• A country which is deficient in natural resources will not be in a

position to develop rapidly.

• In LDCs natural resources are unutilized, underutilized or mis utilized.

This is one of the reasons for their backwardness.

• The presence of abundant resources is not sufficient for economic

growth, because without proper exploitation of the resource.
 Cont`d
• This is due to economic backwardness and lack of technological factors.

• To the contrary, economic growth is possible even when an

economy is deficient in natural resources.

• E.g Japan is one such country which is deficient in natural resources

but it is one of the advanced countries of the world because it has

been able to discover new uses for limited resources.

 Cont’d
b. Capital Accumulation
 Capital means the stock of physical reproducible factors of production.

• When the capital stock increases with the passage of time, this is called
capital accumulation (or capital formation).
• The process of capital formation is cumulative and self-feeding and
includes three interrelated stages:

i. The existence of real savings and rise in them

ii. The existence of credit and financial institutions to mobilize savings
and to divert them in desired channels and
 Cont`d
iii. To use these savings for investment in capital goods
 There are various possibilities of increasing the rate of

capital accumulation.
 Since the propensity to save is low in an LDC, voluntary

savings will not be forthcoming in sufficient quantities.

e.g borrowing, taxation, loans, grants and larger exports
 Cont’d
c. Structural changes
 It imply the transition from a traditional agricultural society to a
modem industrial economy involving a radical transformation of
existing institutions, social attitudes, and motivations.

 Such structural changes lead to increasing employment

opportunities, higher labor productivity and the stock of capital,
exploitation of new resources and improvements in technology.
 Cont’d
2. Non- Economic Factors of Economic Growth

i. Social factors

-In LDCs there are such social attitudes, values and institutions
which are not conducive to economic development.

-Religion gives less inducement to the virtues of thrift and hard

work.

-They are influenced more by traditional customs and place high

values on festivities and ceremonies indicating when money is
wasted on non-economic ventures.
 Cont’d
ii. Human factor
• Economic growth is attributed to the development of the
human factor which is reflected in the increased efficiency or
productivity of labor forces.
• This is called human capital formation. This is the process of
increasing knowledge, the skills and the capacities of all people
of the country.
• It includes expenditure on health, education and generally on
social services.
 Cont’d
iii. Political and Administrative Factors
• -A strong, efficient and non-corrupt administration is essential for economic
development.

• -weak administrative and political structure is a big hindrance to the economic

development of LDCs.

• A strong, efficient and non-corrupt administration is therefore essential for

economic development.

• Professor Lewis said that the behavior of government plays an important role in
stimulating or discouraging economic activity.
 3.5 Poverty Reduction Strategies

• Poverty means low level of income and

consumption, and low level of human
development in terms of education, health care.
• Not only here, but also feeling of powerlessness,
vulnerability and fears, because the poor people
are not free and are exposed to greater risk living
on the margin of subsistence.
 Cont’d…..
 The World Bank proposes a three- pronged strategies for poverty
reduction. These are:
1) Promoting opportunity,
2) Facilitating empowerment and
3) Enhancing security.

1. Promoting opportunity:
• It is partly about expanding economic opportunity for
peoples through a process of economic growth and partly
expanding asset base of poor people and increased return
on asset.
 Cont`d……

• The major cause of individual poverty can be

linked to lack of asset and/or return on asset.
• Importance asset to enable people to grow out
of poverty include:
1. Natural asset like land,
2. Human asset like education and health
3. Financial asset like, access of credit
4. social asset like network of contacts
 Cont`d……

• The state of major roles to playing in expanding of poor people`s

assets because markets do not work well for poor people owning to
lack of access, power and collateral. The state can help in three ways:

1. using its power redistribution resource

2. through institutional reforms to deliver service more effectively like

health and education

3. Facilitating the engagements of poor people in programmes which

helps them to acquire assets such as land and credit.
 2. Facilitating empowerment

• Empowerment Poor people means the strengthen the

participation of poor people in decision making: eliminating
various from discrimination. The state has a role to playing in
help to empower people by:

1. Curbing corruption and harassment, using the power of the

state to redistribute resource for action of benefits the poor.
 Cont`d….
2. Ensuring that legal system is fair and accessible the poor people
3. Making sure that the delivery of local service is not captured by
legal elites
4. Encourage the participation of the poor people in the political
process
5. Galvanized the political support for public action against poverty
 3. Enhancing security

• It is reducing of the poor people’s vulnerability

to the various forms of insecurity that affect the
poor person’s living such as economic shocking:
natural disaster: crop failing and so on.
 Unit Four: The Classical Theories of Economic
Development

 Four approaches to the Classic Theories of Development.

• Literature on economic development is dominated by the

following four strands of thought:
1. Linear-stages-of-growth model: 1950s and 1960s
2. Theories and patterns of structural change: 1970s
3. International-dependence revolution: 1970s
4. Neo-classical, free-market counterrevolution: 1980s and 1990s
 Linear-stages theory

• Viewed the process of development as a series of successive stages

of economic growth.
• Mixture of saving, investment, and foreign aid was necessary for
economic development .
• Emphasized the role of accelerated capital accumulation in
economic development .
 1.Adam Smith and Ricardo Theories.

1.1 Adam Smith's Theory

• Adam Smith was an important Scottish political philosopher and
economist whose famous work Wealth of Nation (1776) set the
tone for work on politics and economics for many people even
through today.

• He was primarily concerned the problems of economic

development.
 Cont’d
• His fundamental argument was regarded every individuals should be

allowed to pursue their own private economic interests as much as possible.

• Every individual will seek to maximize his own wealth and all individual

will maximize aggregate wealth

• Smith called this the “invisible hand” of the market – although everyone is

acting in their own self-interest, they are led to achieve the goal of all as if

by an invisible hand of economic forces.

 Cont’d..
• This “invisible hands” the automatic equilibrating mechanizing
of the perfect competitive market tends to maximizing national
wealth.

• He opposed to government intervention in industry, commerce and

advocated the policy of laissez faire in economic affaires

• Therefore, outside interference will inevitably lead to disaster.

This became known as laissez faire economic policy.
 Cont’d…
• Smith also emphasized the capital accumulation, which must
precede the introduction of division of labor (the degree of labor
specialization).

• This capital accumulation as a necessary condition for economic

development.

• So the problem of economic development was largely the ability

people to saving more and more invest in the country.
 Cont’d….
• Because the rate of investment was determining by the rate of saving and the rate of

capital accumulation was determining by the rate of investment.

Capital
i.e,
saving investment accumulation

 Agents of Economic Growth in Smith

• According to Smith, farmers, producers and businessmen are the agents of economic
progress.

• The capital accumulation and economic development take place due to the
emergence of agents of economic progress. These agents are farmer, the producer
and the business men.
 Cont’d
• According to Smith, the process of growth is cumulative when there
is prosperity as a result of progress in agriculture, manufacturing,
industries and commerce.

• It leads to capital accumulation, technical progress, increase in

population, and expansion of markets, division of labor and rise in
profits continuously.

• All this happens in Smith’s progressive state.

 Cont’d
• But this progressive state of Smith is not an endless. which is
leads to a stationary state.

• Because the scarcity of natural resources that finally stops

growth.

• In such a state the competition for employment would reduce

wages to the subsistence level and competition among business
men would bring profits as low as possible.
 Cont’d
• Once profits fall, they continue to fall. Investment also starts
declining and in this way the end result of capitalism is the
stationary state.

• All these happen , capital accumulation stops: population

become stationary; profits are minimum ; wages are subsistence
level ; there is no change in per capital income and production
and the economy reaches the state of stagnation.
 1.2 The Ricardian Theory

• David Ricardo was another of the great classical pessimists.

• He was a self made millionaire land owner who argued vehemently/ forceful

against the interests of landowners.

• In 1817, he published his principles of political economy and taxation, in

which he predicted that capitalist’s economies, would end up in a stationary

state, with no growth, also owing to diminishing returns in agriculture.

• He recognized by putting forth(forward) economic theories that contradicted

the interest of landowners.

 1.2.1 Assumption of the Ricardo theory

• The Ricardian theory is based on the following assumptions:

1. That all land is used for the production of corn and the working forces in
agriculture help in determine distribution in industry.
2. The law of diminishing returns operates on land.
3. The supply of land is fixed.
4. The demand of corn is perfectly inelastic.
5. That labour and capital are variable inputs.
6. The state of technical knowledge is given.
7. That all workers are paid a subsistence wages.
8. The supply price of labour is given and constant.
 Cont’d….
9. The demand for labour depends upon the accumulation of capital and that both
demand and supply price are independent of the marginal productivity of
labour.

10. There is perfect competition.

11. That capital accumulation results from profit.

 Given these assumptions, the Ricardian theory is based on the interrelations of

three groups in the economy. They are landlords, capitalists, and labourers,

among who the entire produce of land is distributed, as, rent, profits and

wages respectively.
• Ricardo was noisy critic of laws which favored landowners, most
notably the so called “Corn Laws” and international borders.

• Ricardo thought of the economy as one big farm in which food

(corn) and manufactures are consumed in fixed proportions, so
that corn can be used as the unit of account.

• Ricardo never propounded ( forward ) any theory of

development. But, he simply discussed the theory of distribution.
 Cont`d..
• In Ricardo's model, like Smith's, growth and development is a function of capital

accumulation, and capital accumulation depends on reinvested profits.

Process of capital accumulation:

• According to Ricardo, capital accumulation is the outcome of profit because profit

leads to saving of wealth which is used for capital formation.

• Capital accumulation depends on two factors: First, the capacity to save, and

second the will to save the capacity to save is more important in capital

accumulation.

• This depends upon the surplus out of total output after meeting the cost of workers

subsistence.
 Cont’d…..
• These larger of the output surplus, the capacity to save will be larger.

• In reality, profit depends on wages, wages on the price of corn and the price of

corn depends on the fertility of the marginal land. In this way, there is an

inverse relation between profits and wages, and wages rise or fall in keeping

with the price of corn.

• When there are improvements in agriculture, the productive power of land

increases this results in the fall in the price of corn.

• As a result, the subsistence wage also falls, but profits increase and there is

more capital accumulation.

 Cont’d….
• This will increase the demand for labour and the wage rate will
rise.

• This, in turn, will increase population and the demand for corn
and its price. Thus wages will rise and profits decline.

• However, profits are squeezed between subsistence wages and

the payment of rent to land lords.

• which increases as the price of food rises owing to diminishing

returns to land and rising marginal costs.
 Increase in wages:

• In the Ricardian system wages play an active role in determining

income between capital and labour.
• The wage rate increases when the prices of commodities forming
the subsistence of the workers increase. The commodities
consumed by workers are primarily agricultural products.
• As the demand for population and food increases, less fertile land
is brought under cultivation.
• For this purpose, to produce a unit of the product more labourers
are required.
 Cont’d…
• At that time the demand for labour starts rising, which, raises wages.

• Moreover, to match the increasing cost of subsistence, money-wages will

also continue to rise.

• Thus wages would rise with the increase in the price of corn and then
profits would decline.

• In such a situation, rent also increases which absorbs the rise in the price
of corn. Since wages also increases, the ratio of capitalist’s profits
declines.
 Free trade:

• Ricardo is in favour of free trade, free trade is an important factor

for economic development of the country.
• The profit rate can be saved from declining by importing corn.
• The capital accumulation will, therefore, continue to be high. In
this way, the resources of the world can be used more efficiently
through foreign trade.
• But the import of corn leads to fall in the demand for labour
which deteriorates the economic condition of labourers.
 Cont’d….

• On the other hand, land-lords and capitalists do not think it fit to

import cheap corn from foreign countries, as a result their profits
decline.

• This is but natural, because with the application of the law of

diminishing returns on land and increase in population, the price
of corn and wages increase the profit rate declines.
 1.2.2 The Ricardo’s Critical Appraisal

• Ricardo was the forerunner of modern economists and his ideas on economic growth
have been adopted. They are as follows:

1. Ricardo emphasized the agricultural development in economic growth, because

industrial development depends on it.

2. Ricardo advocated the increase in the profit rate in economic development for
capital accumulation depends on it.

3. Like modern economists, His theory underlines the importance of saving for higher
capital accumulation.

4. Foreign trade in improving the economic condition of the economy because it

leads to the maximum utilization of resources and increase in income.
 1.2.3 Weaknesses Of Ricardo theory.

1. Neglects the impact of technology:

• Ricardo under-estimated the potentialities of technological progress in
counteracting diminishing returns of land.
2. Wrong notion of the stationary state:
• The Ricardian view that the economy reaches the stationary state automatically
is baseless because no economy attains the stationary state in which profits are
increasing, production and capital accumulation is taking place.
3. Impracticable Laissez-faire policy:
• In reality, there is no economy which is free from governmental interference
and in which perfect competition prevails
 Cont’d…
4. Neglects institutional factors:
• He was neglects the role of institutional factors, But they are
crucial in economic development and cannot be overlooked.

5. Distribution rather than growth theory:

• According to Ricardian theory is not a growth theory but it is the theory of
distribution which determines the share of workers, landlords and capitalists.

• Ricardo failed to present a functional theory of distribution because he did not

determine the share of each factor separately.
 Cont’d….
6. Land also produces goods other than corn:
• Ricardo believed that only one product corn is produced on land. But this is an
outdated notion because land produces a variety of products other than corn.
7. Capital and labour not fixed co-efficient:
• The Ricardian assumption that capital and labour are fixed co-efficients of
production is not correct.
• This assumption is invalid because labour and capital are independent
variables.
 2.The Rostow’s, Lewis’ and Limits to growth Theory

• Rostow is a very strong advocate of the doctrine of unbalanced growth.

• This Rostow’s growth theory is linear stage of growth model.

• He wants growth through leading sectors, big project, and big industries.

• These are growth poles which are of course locational in nature but more
than that functional in nature.

• When this growth poles develop there will be supplementary,

complimentary, imitative and supportive investment.
 Cont’d…
• Growth will spread from these leading sectors (big project, and big
industries).

• Because, such projects and great industries will earn profit and from
the reserve funds they can invest further.

• Growth need not be financed with the help of deficit financing. But,
growth will follow certain stage and the economy will reach
maturity.
 2.1 The Five Stages of Economic Growth

• Prof. W.W. Rostow has thought a historical approach to the process of

economic development.

• Walt W. Rostow, according to which a country passes through sequential

stages in achieving development.

• Which is the transition from underdevelopment to development can be

described in terms of a series of steps or stages through which all countries
must proceed.

• He distinguishes five stages of economic growth. These are :

 A. The traditional society

• A traditional society is one whose structure is developed within limited

production functions. i.e The economy operating largely at a subsistence
level.

• It does not mean that there is little economic change in that such
societies.

• The central fact about the traditional society, the systematic uses of
modern science and technology`s a ceiling existed on the level of
attainable output per head
 Cont’d
• This ceiling resulted from the fact that the potentialities which
flow from modern science and technology.

• But, these science and technology were either not available or

not regularly and systematically applied.

• It did not lack innovations, it lacks the tools and outlooks.

 Cont’d
• To summarize, traditional society means a society as one whose
social structure of such societies was hierarchical in which family
and clan connections played a dominant role.

• Political power was concentrated in the regions, in the hands of

the landed aristocracy supported by a large soldiers and civil
servants.
 Cont’d
• More than 75 percent of working population was engaged in agriculture. Because

the economy operating largely at a subsistence level.

• There is very fragmentation of political authority. There is relatively little

economic growth with savings rate being very low.

• Naturally, agriculture happened to be the main- source of income of the state and

nobles, which was dissipated on the construction of temples and other

monuments, on expensive funerals and weddings and on the prosecution of wars.

 B. The pre-conditions for Take-off

• The second stage of growth embraces societies in the process of transition.

 That means : introducing a modern economy.
• The preconditions for take-off were initially developed, as the insights of
modern science began to be translated into new production functions in both
agriculture and industry by setting:
 the given lateral expansion of world markets
 the international competition for them.
 the establishment of central political authority
 the elimination of trade barriers
 the creation of appropriate transport and etc..
 Cont’d…
• To summarize this stage: the pre-conditions for sustained growth were created
slowly in Britain and Western Europe, from the end of the 15 th and the beginning of
the 16th centuries, when the medieval age ended and the modern age began.

• The pre -conditions for takeoff were encourages or initiated by four forces.

• These forces are The new learning or Renaissance, the new Monarchy, the new
World, and the new Religion or the Reformation.

• Eg. Britain, was first to develop fully the preconditions for take-off.
 Cont’d…
• The spirit of adventure which led to new discoveries and inventions and

consequently the rise of the elite in the new mercantile cities were realized .

• Thus, these forces were instrumental in bringing about changes in social

attitudes, expectations, structure and values.

• Investment increased, the scope of commerce widens, modern manufacturing

appears, banks appear and others.

• The idea spreads that economic progress is possible.

 C. The take-off (self-sustained stage)

•It is the great watershed in the life societies “ the growth

becomes its normal condition forces of modernization.
• During the take-off, the rate of effective investment and savings
may rise from, say, 5 % of the national income to 10% or more.

• In a nut shell, Rostow defines the take-off as an industrial

revolution, which is directly to radical changes in the methods of
production, having their decisive (deciding) consequence over a
relatively short period of time lasting for about two decades.
 Cont’d..

• The requirements of takeoff are the following three related but

necessary condition.
1.A rise in the rate of productive investment from 5% or less to over
10% of national income.
2.The development of one or more substantial manufacturing sectors
with a high rate of growth.
3.The existence of quick emergence of a political, social and
institutional frame work which exploits the impulses to expand
the modern sector and gives to growth an outgoing character.
 D. The Drive to Maturity

• This stage is a situation in which traditional methods of production are almost

completely eliminated while modem technology is applied to almost all aspects of

production.

• Generally, Rostow defines this stage as the period when a society has effectively

applied the range of modern technology to the bulk of its resources.

• It is a period of long sustained economic growth extends well over four decades.
 Cont’d..
• Rate of net investment is well high over 10% of national income.

• When a country is the stage of technological maturity three

significant changes take place.

• First the characteristics of working force changes. this work

force becomes skilled. People prefer to live in urban areas rather
than in rural areas. The people’s real wages rise.
 Cont’d
• Second, the character of entrepreneur ship changes .
Hardworking masters give way to polite efficient managers.

• Third , the society feels bored of the miracles (achievement) of

industrialization and wants something new leading to a further
change.
 E. The Age of High Mass-consumption

• It is associated with relatively large amount of leisure for working masse.

• In short, this stage has been characterized by the migration to suburban,

the extensive use of the automobile, the durable consumers' goods and
household gadgets.

• In this stage, the balance of attention of the society is shifted from:

 supply to demand,

 problems of production to problems of consumption and

of welfare in the widest sense.

 2.2 The Lewis' Theory of Unlimited Supplies of Labor

 Professor W. Arthur Lewis has developed a very systematic theory of economic

development with unlimited supplies of labor.

 He focused on the structural transformation of a subsistence economy because Which

is structural –change theory approach.

 Like other classical economists he believes in the existence of an unlimited supply of

labor at a subsistence wage.

 Economic development takes place when capital accumulates as a result of the

withdrawal of surplus labor from the subsistence sector to the capitalist sector.
 Cont’d…
• The capitalist sector is that part of the economy which uses reproducible
capital and pays capitalists for the use there of.

• It employs labor for wages in mines, factories, and plantations for earning
profits.

• However, the subsistence sector is that part of the economy which does not
use reproducible capital.

• In this sector, output per head is lower than in the capitalist sector
 Together with Adam Smith and other classical economists, Lewis sees the basic

problem as low savings.

 The key to development is to be found in mechanisms which dramatically

increase the savings rate.

 Increased savings, in a capitalist economy, come mainly if not entirely from

savings out of the profits of the capitalists.

 The reason why savings are low in an underdeveloped economy that capitalists’

profits are low relative to national income.

 As the capitalist sector expands, profits grow relatively, and an increasing

proportion of national income is reinvested

 2.2.1 Lewis’s basic model

• Lewis’s basic model may be set out as follows. First, let us assume two sectors in the
economy.

• One, a capitalist or modern sector, uses physical capital owned by the capitalists and
employs wage-labor for profit.

• The other sector is an overpopulated traditional or subsistence sector.

• Here the second sector the organization of production is small scale, with family
activity being the norm.
 Cont’d
• Some of the labor in the traditional sector may be
characterized as “surplus labor,” in the sense that it can be
withdrawn from the sector without any noticeable loss of
output.

• This is because, in this sector, productivity at the margin is

very low and may even be zero or negative.

 Cont’d…
• The primary focus of the model is on both the process of labor
transfer and the growth of output and employment in the modern
sector.

• (The modern sector could include modern agriculture, but we will

call the sector “industrial” as a shorthand).

• Both labor transfer and modern-sector employment growth are

brought about by output expansion in that sector.
 Cont’d
• Capitalists will not have to continually raise wages to attract
increasing amounts of labor into the modern sector.

• One reason for this will be the existence of disguised

unemployment in the traditional sector where the marginal
product is “negligible, zero or even negative”
 2.2.2 Criticisms of the model

• First, the model implicitly assumes that the rate of labor

transfer and employment creation in the modern sector is

proportional to the rate of modern sector capital accumulation

• Second, implicit in the model is the notion that there is surplus
labor in rural areas and full employment in urban areas.
• Third, nominal and real urban wages in the capitalist sector of
many Third World countries appear to be able to rise rapidly,
even when there is substantial unemployment
 Cont’d
• Fourth, the model presumes the existence of entrepreneurs who
will act in the way specified.

• Fifth, marginal productivity of labor in the rural sector is not

zero or negligible in LDCs as argued by the theory. if it was so,
the subsistent wage would also be zero.

• Sixth, higher capitalist wage will not necessarily lead to the

movement of surplus labor from the subsistent sector to the
capitalist sector.
 2.3 The limits to growth theory

• The model owners presented a large and new type of model

designed to predict the future development of five global
inter-related variables-populations, food production,
industrial production, non renewable resources and pollution.

• The model is based on the thesis that "the continued growth

leads to infinite quantities that just do not fit into a finite
world".
 2.4 Balanced vs Unbalanced Growth Theories

1. Balanced growth

• Balanced growth requires a balance between different consumer durable

goods industries and capital goods industries.

• It also implies a balance between industry and agriculture, and between

the domestic and export sector.

• Further it refers to the balance between social and economic overheads

and directly productive investments and also between the vertical and
horizontal external economies.
 Cont’d…
• In short, the theory states that there should be a simultaneous and
harmonious development of different sectors of the economy so
that all sectors grow together.
• This doctrine requires a balance between different sectors of the
economy during the process of economic growth.
• There should be a proper balance between investment in
agriculture and industry, which are complementary sectors.
 Cont’d…
• An increase in the industrial sector’s output requires an expansion
of agricultural output if employment increases in the industrial
sector, it will lead to an increase in the demand for food.
• This necessitates the rise in food supplies.
• Similarly supplies of raw materials should also rise with the
expansion of the industrial sector.

• In short, the agricultural sector must also develop along with the

industrial sector’s development.

 Cont’d…
• There must also be a balance between the domestic and foreign
sector.
• Export revenue is an important source for financing development.

• As production and employment increase, the domestic sector

requires increasing imports of necessary materials (raw materials
and machineries).
• To pay for these rising imports and to allow exports to finance
development, the country must expand its foreign sector along with
the expansion in the domestic sector.
 Criticism of the balanced growth doctrine

1. Rise in costs
• Simultaneous establishment of a number of industries is likely to
raise money and real cost of production.

2.demand side problems

• When the new industries are established, the demand for the
products of existing firms will decrease.
• The demand for factors of production, on the other hand, rises
causing a rise in price of inputs (factors).
• This makes the industries unprofitable.
 Cont’d…
3. doesn’t consider the capacities of poor nations( shortage of
resources)
• The doctrine doesn’t consider the capacities of poor nations. The
resources (human and physical) those are required for
simultaneous development of multiple sectors is lacking in
developing countries.
• When investments are undertaken in all sectors simultaneously,
the demand for factors would be competitive but the supply of
factors would be inelastic in poor nations.
 Cont’d…
4. scarcities and shortages encourage growth
• Scarcities and bottle necks provide the stimulus to inventions and
inventions in turn created new scarcities and bottlenecks.
• Some economists argue that had the world depended on balanced
development, it would have reduced or eliminated the incentives
for discoveries.
5. the concept of balanced growth is only applicable to developed or
rich nations
 Cont’d…
• According to Keynes, simultaneous and multiple development
during increasing to the activities of the trade cycle can lead to
balanced recovery of economic activity as the industries , machines,
managers, workers and consumption habits are all there.

• In LDCs, however, there is no temporary suspension (confidential)

of economic activities.
• Many of the economic activities are static or permanently missing in
the LDCs..
 2. Unbalanced growth

• This theory is the direct opposite of the doctrine of the balanced growth.

• It argues investment should be made in selected sectors rather than

simultaneous investment in all sectors.

• No poor country owns capital and other resources in such quantities as to

enable it invest simultaneously in all sectors.

• Hence, investment should be made in a few selected sectors or industries for

their rapid development, and the economies arising from them can be
utilized for the development of other sectors.
 Cont’d…
• Thus the economy moves gradually from the path of unbalanced
growth to balanced growth.
• The process of unbalancing the economy to bring about
development can be undertaken through investing in social
overhead capital or in directly productive activities.

Unbalancing the economy with social overhead capital

• It comprises those basic services without which primary,

secondary and tertiary productive activities cannot function .
 Cont’d….
• It includes investment on education, public health, communication,

transportation and conventional public utilities like light, water, power,

irrigation, drainage schemes etc.

• Large investments in social overhead capital will latter encourage investment

in directly productive activities. E.g. cheaper supply of electric power may

encourage establishment of industries.

• The objective is to unbalance the economy so that subsequent (the following

time) investments are stimulated.

 Unbalancing the economy with directly productive activities

• The government may invest in directly productive activities instead of investing in

social overheads.
• If direct productive investment is undertaken first, the shortage of social overhead
facilities is likely to raise production costs.
• In course of time, political pressures might stimulate investment in social
overheads.
• Investment sequences are generated by profit expectations and political pressures.

• Profit expectations generate the sequence from social overheads to directly

productive activities and political pressures from directly productive activities to
social overhead capital.
 Limitations (criticisms) of the unbalanced growth doctrine

1.too much emphasis on investment decisions

• Poor countries not only need investment decisions but also
administrative, managerial and policy decisions. The theory lays too
much emphasis on investment decisions as compared to other
important decisions required for development

2. lack of basic facilities

• There may be difficulties in having technical personnel, raw materials,
and basic facilities like power, transport, markets for products etc.

3.lack of factor mobility

• In LDCs it is difficult to shift resources from one sector to another.
 2.5 The Dualistic-Development Thesis:

• It is the explicit in International Dependence Revolution (IDR growth

theory).

• Dualism is a concept widely discussed in development economics, which

represents the existence and persistence of increasing divergences between
rich and poor nations and rich and poor peoples at all levels.

• Specifically, although research continues, the traditional concept of dualism

embraces four key arguments. These are:
 Cont’d….
1. Different sets of conditions, of which some are “superior” and
others “inferior,” can coexist in a given space.
 Examples of this element of dualism include Lewis’s notion of
the:
coexistence of modern and traditional methods of production
in urban and rural sectors respectively.
the coexistence of wealthy, highly educated elites with masses
of illiterate poor people.
 Cont’d…..
2. This coexistence is chronic and not merely transitional.
 It is not due to a temporary phenomenon, in which case time could eliminate the

discrepancy between superior and inferior elements.

3. Not only do the degrees of superiority or inferiority fail to show any signs of

diminishing, but they even have an inherent tendency to increase.

 For example, the productivity gap between workers in developed countries and

their counterparts in most developing countries seems to widen with each passing

year.
 Cont’d….
4. The interrelations between the superior and inferior elements are
such that the existence of the superior elements does little or
nothing to pull up the inferior element, let alone “trickle down”
to it.

• In fact, it may actually serve to push it down—to “develop its

underdevelopment.”
 Unit five:

Economic GROWTH MODELS

 5.1 Harrod-Domar Growth Model

• It is the linear-stage theory of economic growth.

• Every economy must save a certain proportion of its national income, if only
to replace worn-out or damaged or impaired capital goods (buildings,
equipment, and materials).
• Both Harrod and Dammar assign a key role of to new investment representing
net addition to the capital stick in the process of economic growth.
• However, in order to grow, new investments representing net additions to the
capital stock are necessary. Because , Investment creates output or income.
• If we assume that there is some direct economic relationship between the size
of the total capital stock, K, and total GDP, Y
 Cont’d…..
• If we define the capital-output ratio as k and assume further that the
national net savings ratio, s, is a fixed proportion of national
output.
• Total new investment is determined by the level of total savings.

• We can construct the following simple model of economic growth:

1.We assume that the total new investment is determined by total

saving (S) and national saving ratio (s) is a fixed proportion of
national output (Y) , then,

S= sY
 Cont’d…

2. Net investment (I) is the change in capital stock (K) and

represented by such that I= ∆K
3. Further assume that the total capital stock has a fixed and direct
relationship with the total national income such that K= kY or
∆K=k* ∆Y or k= ∆K/ ∆Y
 Where k is the capital output ratio (K/Y) or the rate of net
investment (∆K/ ∆Y) need to produce one unit of the national
income.
 Cont’d…

4. Finally let as collect all the equations by assuming that the new
investment equal to total national saving .
S=I
sY=I , From assumptions 1
sY= ∆K , from assumptions 2
sY = k ∆Y from assumptions 3
s = k∆Y/Y multiplied by both sides 1/Y
s/k= ∆Y/Y multiplied by both sides 1/k
 Cont’d…..
• Where , ∆Y/Y represents the rate of percentage change of Y or the
rate of growth of the national income Y or GNP.

• From the state of equations the growth of GNP (Y) is determined

jointly by the saving ratio , s and the national capital –output ratio , k.

• The higher the rate of saving and the more productive the capital is
positively to the rate of saving(s) and output- capital ratio, k.
 5.2 Solow model of Economic Development.

• The Solow model is a model that original form of capital

accumulation.
• Which concerned the accumulation of capital in this model is
easily extended to incorporate any accumulative factor of
production.
• This, however, does not change the key insights of the model.
 Cont’d….

• The production takes place by combining inputs (factor of

productions) in a special way.

• By using land, water, seeds, fertilizer, pesticides, labor, tractors,

etc. to produce output (eg. Vegetables)

• Each farmer might use a different technology and combine inputs

in a different way, leading to different levels of production.
 Cont’d..

• We usually focus on a few factors of production and make them

explicit in the production function and keep other factors implicit in
the form of a productivity parameter or residual.
 For example, a production function for vegetable farming could be
as follows: yi = fi (ki, li)

where yi is the quantity of produce by farmer

i, ki is the capital (machinery) used,

and li is labour employed in the

production process.
 Cont’d…

• Economic growth is concerned about aggregate (total) production in a given

country.
• Therefore we need to sum up the monetary value of all production to arrive
at aggregate output.

• Similar to the farming production function, we can use an aggregate

production function to show the link between aggregate output and
aggregate levels of input use (factors).

• For example: Y = F(K, L) shows the relationship between aggregate output

Y and total capital, K, and total labour, L as two factors of production.
 Cont’d…..

• We will naturally assume that expansion of inputs leads to expansion of

output.

• There are many other factors of production that are not explicitly listed
but influence aggregate output by changing the shape of the production
function F ( eg. political factors).

• One country might have a more efficient judiciary and hence higher
security of investment leading to more production given similar capital
and labour in another country.
 Cont’d…
• Economic growth is the expansion of output over time.

• This could happen through the expansion of factors of production (factor

accumulation) or through enhancement of the production function (e.g.
technical progress).

• The Solow model focuses on the process of capital accumulation and its
contribution to economic growth.

• In each period a constant fraction of aggregate income is saved and the

rest is consumed
 Unit Six: Population growth, History, Expectations and Development

Introduction
• One way to get constant returns is to incorporate externalities in the
production function.
• When someone’s choice affects the payoff of another
person, we say that the decision has created an externality.
• If the payoff is increased, we refer to it as a positive externality and if it is
decreased ,it is a negative externality.
• For example, when an entrepreneur introduces a new production technique
to an industry, the other firms active in the sector will become aware of the
technique and receive an information benefit from an entrepreneur’s action.
 Cont’d…..
• Having more information, they can better plan
for adoption of new technologies and hence receive a positive externality.
• It is called an externality because the entrepreneur\himself would not care
about potential benefits to others and therefore the benefits are external
to him.

• In the other part, the populations were increases either as a result of an

increase in the birth rates (fertility) or a decline in the death rate (mortality),
or as a result of an excess of immigration over emigration which influencing
the economic growth.
 6.1 Policy on the context of Development.

 Economic policy is a statement of objectives and the method of achieving these

objectives (policy instruments ) by government, business entities etc..

 Examples of government economic objectives could be maintaining full

employment: achieving high rate of economic growth: reducing income
inequality.

 The purpose of government economic policy is to stimulate, direct and in some

cases even economic activities to ensure a harmonious relation ship between the
desires of the private business operators and social objective of the government.
 Cont’d…
 The methods or policy instruments of achieving economic objectives
could be, for example taxation, industrial licensing, the setting of tariff,
wage, price ,interest rate, etc….

 In the world, be it in developed or developing countries economic

policy has been a crucial variable determining economic development.

 Any policy formulation is expected to include the following four

elements.
 Cont’d…
1. Goals, desired ultimate results.

2. Means, resources used to attained the goals.

3. Implementing agencies, agents or agencies that activate and control the means and
4. Constraints, things or conditions considered in the plan.
 Policy making as the following process
1. Understand the current state of desire that needs changes
2. Develop pubic awareness
3. Develop alternative policies
4. Allow the pubic to participate and accept the proposed policy for possible actions to
adopt the policy and
5. Evaluate and analysis the adopted policy.
 6.2 Population Growth and Economic Development

• An increment population is problem of welfare and development not only for

the current generation but also for the future generation.

• Population growth today is the result of rapid transition from high birth rate and
death rate to one which death rates are fallen sharply and birth rates only
recently begin to decline especially in developing countries.

• Populations increase either as a result of an increase in the birth rates (fertility)

or a decline in the death rate (mortality), or as a result of an excess of
immigration over emigration.
 Cont’d
• The rapid increase in population in the low income countries has
come about broadly as the result of a marked fall in the death
rate without a corresponding fall in the birth rate.

• The case against rapider population growth in poor countries is

that it absorbs large amounts of food and other resources, which
may otherwise be used either for increased consumption or for
development.
 Cont’d
• World population is very youthful, particularly in the developing world.
Children under the age of 15 constitute almost 40% of the total population of
developing countries but less than 20% of the total population of developed
countries. For example, 46% of Nigeria’s population and 48% of Ethiopia’s
was under 15 in 2000.
• The more rapid the population growth rate, the greater the proportion of
dependents (children) in the total population and the more difficult it is for
people who are working to support those who are not.
• These high youth dependence ratio will affect the development process in
two ways.
i. Little is left for economically active peoples which lower their productivity.
ii. Little is left for saving for further investment and economic growth.
 Cont’d
• Generally, the higher dependency ratio in the total population the
more difficult the economic growth.
• This phenomenon of youth dependency also leads to an important
concept, hidden Momentum of Population Growth.
• That means the least understood aspect of population growth is its
tendency to continue even after birth rates have declined
substantially for decades. The momentum persists for decades after
birth rates drop). As a speeding car tend to keep going for some
time after the brakes are applied.
 6.2.1 Demographic Transition.

• The process by which fertility rates eventually decline to replacement levels

has been portrayed by a famous concepts of economic demography is called
demographic Transition.
• All the contemporary developed nations have passed through the same three
stage s of modern population growth history. These are the following.

• Stage –I Before economic growth , they had stable or very slow growing
population as a result of high birth rate and almost equally high death rate.
• Stage-II When modernization associated with better public health methods
and other improvement led to a marked reduction in death rate. but this
reduction in death rate was not immediately accompanied by a decline in birth
 Cont’d…
• Hence, stage –II marked the beginning of demographic transition from a
stable to rapid increasing population number.

• Stage –III Due to the force of modernization and development eventually

birth rate decline and converged to lower death rate brought little or no
population growth.
• However, birth rate in many developing countries today is considering higher
than they were in pre-industrial western Europe countries.
 6.3 Complementarities

• The positive externality from capital accumulation in the model is

in fact a complementarily.
• The capital accumulation decision of each firm affects the
accumulation decision of others.
• From this if one firm decides to invest, everyone will enjoy a
higher marginal product of capital and increase their investments.
• In other words, capital accumulation by one firm increases the
gains from accumulating more capital for others.
 Cont’d….

• This is a complementarily because not only is the level of

utility (profit) affected but the relative value of alternative
options (investment) has also changed.

• When a firm invests more it increases the value of the

investment for other firms and therefore they are inclined to
choose this option (relative to the no investment option).
 Cont’d…

• Complementarities have a ubiquitous presence.

 Example : the adoption of high yield variety (HYV) seeds.
Farmers need to use the right amount of fertilizer and other
inputs to get the most benefit of HYVs.
• Therefore, adopting HYVs involves costly experimentation with
inputs. Once farmers learn the right amount of inputs, HYV are
much better than traditional seeds.
 Cont’d….
• If most of the farmers in an area have already adopted HYVs, neighboring
farmers can see the results of their experimentation and learn from their
mistakes. On the other hand, if no one has chosen HYVs, farmers need to
carry out several rounds of experimentation to learn the right amount of
inputs.

• Now think about the cost of adopting the traditional crops. Since everyone
is familiar with these crops, farmers know which seeds are suitable for
which plots and they have learned the right level of inputs too.
 Poverty traps

• Poverty traps are an undesirable equilibrium situation, which are traps

because they are difficult to escape from.
• Individuals without any assets or skills could be in a poverty
trap because they earn low incomes and this income is insufficient to
be invested in the acquisition of productivity enhancing skills.

• Countries with poor institutions might be in a poverty

trap because they cannot produce enough output to fix their institutions.

• Institutions are, however, a critical determinant of aggregate productivity.

• Maintaining poor institutions keeps the country’s income down.

 6.4 Coordination Failure

 Coordination failure could result in poverty traps.

 Example: the two firms using an old technology to produce two
goods.
• These firms can choose a new technology by paying an upfront
cost of F (e.g. training workers to operate the new machines).
• Furthermore, investment in new technology creates a positive
externality on the other firm (as in the learning model you saw
earlier).
 Cont’d……
• In the table 6.1 showing the payoff structure for these firms under the two
scenarios of investing or not investing in the new technology.

• When both continue with the old technology and do not invest, they both
get zero profits (this is a normalization).

• When firm 1 invests, it pays the upfront cost of F. If firm 2 does not adopt
the technology, firm 1’s payoff is σ – F but if firm 2 also invests in new
technology, the externality results in an additional gain and increases firm
1’s payoff to π – F.
 On the other hand, if firm 1 decides not to invest in new technology,
but firm 2 does, firm 1 receives a payoff of 1. We assume σ – F < 0 and
π – F > 1, so investment is an inferior decision if the business partner
does not invest and it is superior if the partner decides to invest.

Table: 6.1 Payoffs under the two scenarios of investing or Firms- 2

not investing.

Investmnet Do not investment

Investment (π – F, π – F) (σ – F, 1)
Firm -1
Do not investment (1, σ – F) (0,0)
 Cont’d……..
• This simple game has two pure strategy Nash equilibria. There is a good
equilibrium where both firms invest in the new technology.

• Conditional on firm 2 investing in the new technology, firm 1 prefers to invest

as well, because π – F > 1. Symmetrically, conditional on firm 1 investing in
the new technology, firm 2 prefers to invest too because π – F > 1.

• The other equilibrium is where no one invests in the new technology.

• When firm 2 does not invest then firm 1 prefers to withdraw from investment
because σ – F < 0 and vice versa.
 Cont’d………
• Therefore either both firms invest or both withdraw from investment.

• This shows the classic big push argument, although industrialization by one
firm is not viable (σ – F < 0); when both firms industrialize they can get a
higher profit and generate more income (see next subsection).

• Expectations play a key role in this classic example of coordination failure.

• If each firm expects the other to invest in adopting the new technology it will
invest itself.
• But if expectations are for some reason set at non take-up of new technology
the economy remains at the low equilibrium.
 6.5 History and Economic Development.

• History could influence current economic outcomes through various

channels.
• In the presence of multiple equilibria, historical events could shift the
path of development from one equilibrium to the other, resulting in a
long-lasting impact on economic outcomes.
• Alternatively, historical events could change fundamental factors
influencing economic growth.
 For example, historical events could shape local institutions.
Institutions, however, are persistent and therefore link historical events
to current outcomes.
 Cont’d…..
• History could shape social norms and expectations.
 For example, Nunn and Wantchekon (2011) use the Afrobarometer survey
of 2005 and link today’s trust levels to historical slave trade in Africa.
• The level of trust affects the extent of cooperation and teamwork in society and
hence could influence development.

• Historical levels of knowledge and technology could affect current economic

outcomes.
 For example, if higher levels of technology reduce the cost of adopting new
technology, then countries with historically higher levels of technology would be
able to grow at a faster rate.
 6.6 Increasing returns

• Increasing returns to scale (IRS) is a situation where scaling up all production

outputs results in a more than proportionate increase in input.

• The presence of IRS results in decreasing marginal and average costs of

production. Therefore, firms with higher levels of production have a cost
advantage over new entrants and smaller firms.

• Further expansion of output and stealing the market from competitors is profitable
because it leads to greater utilization of IRS and reduction of average costs.

• This characterizes the case of a natural monopoly. Other entrants are deterred
because they cannot undercut the monopoly’s price and still survive.
 6.7 International trade and Economic development

• International trade has often played a crucial role in the historical

development of the third world. Unlike the few oil – producing states
and a few newly industrializing countries like south Korea because they
were export primary products.

• Most of developing countries must depend on non mineral primary –

product exports for the majority of their foreign exchange earnings.
Because the market and prices for these exports are often unstable,
primary product export dependence carries with it a degree of risk and
uncertainty that few nation desire.
 Cont’d…
• Besides many developing countries rely on the importation demands have
increasingly of capital goods to fuel their industrial expansion and satisfy the rising
consumption in aspirations of their people than the sale of exports.

• This has led to deficit on the current account ( an excess of import payments over
export receipts for goods and services) were often compensated by a surplus on the
capital account of their balance of payment in excess of repayment of principal and
interest on former loans and investments).

• But debt burden has become increasingly acute. This is related to LDCs vulnerability
to global economic disturbances and significantly retards development efforts.
 Cont’d…
• Countries by opening their economies and societies to global trade and
commerce and by looking outward to the rest of the world, developing countries
can get the international transfer of goods, services and finical resource.
• There fore, what sort of trade policy developing countries should follow that
contributes significantly to the process of economic development.

• Generally speaking it is important to see the broader categories of trade namely

the out ward looking and inward looking with in which we can have many
different aspects of trade policy for each commodity.
• Finally, we will spend some time in the analysis of the welfare effect of tariff.
 Cont’d…..
• Trade strategies for development can be out ward or inward looking.

1. Outward looking development policies encourage not only free trade but also involve
free movement of capital, workers, enterprises, and an open system of
communications.

2. Inward looking development policies stress the need for LDCs to evolve their own
style of development and to control their own destiny. This means policies to
encourage indigenous “Learning by Doing” in manufacturing and the development
of indigenous technologies appropriate to a country’s resources endowment.
 Cont’d…
• According to proponents of inward- looking trade policies. Greater self reliance
is accomplished only if you restrict trade, the movement of people and
communications.

• And also keep out the Multi national Enterprise, with its wrong products and
wrong want – stimulation and hence it’s wrong technology.

• In this new style of development closing the door is the important thing and it
is the indigenous people that will have a major role instead of copying the

foreign experience.
 Cont’d….
• In the import substitution strategy (inward –looking strategies), the
supporters classify it in to three stages:

1) Light industrial establishment like consumer goods producing industries.

2) the establishment of manufactured goods industries

3) Diversified industries in the domestic industries.

• In the export promotion strategy: (outward looking policies ) which

encouragement of primary agricultural products and raw material exports and
secondary outward looking polices in which promotion of manufactured
export.
 Unit Seven: Agricultural Transformation and Rural
Development
7.1 The Role of Agriculture in Economic Development
 The historical record shows that agriculture always declines in relative
importance in growing economies.
 It is the home of traditional people, ways, and living standards.

 But today’s development economists have come to realize that the agricultural
sector and the rural economy in general, far from passive and supporting role
they must be the leading element in any overall strategy.
 There need to have integrated rural development strategy.

 A more positive emphasis was placed on role rather than the more forced
concept of contribution of agriculture.
 Cont’d….
There are five roles of agriculture in economic development.
Increase the supply of food for domestic consumption
Release labor for industrial employment
Enlarge the size of the market for industrial output
Increase the supply of domestic savings, and
Earn foreign exchange
• Agriculture in the process of development is to provide increased food supplies and
higher rural incomes to enlarge markets for urban output, as well as to provide
resources to expand that urban output.
• Agricultural sector must be viewed as part of the overall economy and that the
emphasis be placed on the sector’s interdependence with the industrial and service
sectors rather than on its forced contribution to them.
 7.2 The elements of Agriculture and employment based on
Economic Development

• Any economic policy related to the development of the agriculture in

general will have the following points.
1. Raising productivity of small farmers ( accelerate output growth)
through technological institution (like access of credit) and price
incentive on both output and inputs.
2. Raising domestic demand for agricultural output through employment
oriented development strategy.
3. Diversified non-agriculture , labor incentive rural development
activities that directly and indirectly support.
 Cont’d…

• To understand how the agricultural systems of developing country tends to

evolve overtime from predominantly subsistence level to more diversified.
• We can identify the following three broad stage in the evolution of agricultural
production system.

i. The subsistence farming

 Most output produced for family consumption.
 Some may be sold in local markets
 Simplest traditional methods and tools are used.
 The operation is law of diminishing return.
 Highly and uncertain is high and etc…
 ii. The transition to mixed and diversified farming

• Which represents a logical intermediate steps in the transition from subsistence

to specialization of production.
• In this stage the stable crops no longer dominated farm output new cash crops
such as fruits, vegetables, coffee are established together with simple animal
husbandry.
• New activities can take up normal slacks in form of work loads when disguised
unemployment is relevant.
• To use better seeds.

• To ensure an adequate supply of the stable foods.

 iii. Modern commercial farming

• It is prevalent types of farming in advanced industrial nations.

• All specialized farms are their emphasizes on the cultivation of one

particular crops.
• It uses the capital incentive and labor saving technical production.

• It provided the expansion to national and international markets

• It has enough share to the economy.

• All production for markets.

• It is a scientific and research development.

• It is pure commercial profits.

 7.3 Toward a Strategy of Agricultural and Rural Development

• If the major objective of agricultural and rural development in developing

nations is the progressive improvement in rural levels of living achieved
primarily through increases in small farm incomes, output and productivity.
• Which is important to identify the principal sources of agricultural progress and
the basic conditions essential to its achievement.
• Sources of small scale agricultural progress include:

i. Technological change and innovation

ii. Appropriate government economic policies

iii. Supportive social institutions

 i. Technological change and innovation

• Two major sources of technological innovation can increase farm yields.

Unfortunately, both have somewhat problematic implications for LDC
agricultural development.

a) The first is the introduction of mechanized agriculture to replace human labor.

• The introduction of labor saving machinery can have a dramatic effect on the
volume of output per worker, especially where land is extensively cultivated and
labor is scarce.

b) The biological seeds, water control irrigation, and chemical (fertilizer, pesticides,
insecticides, etc) innovations – the second major source are not without their
own problems
 ii. Providing the necessary economic incentives and social institutions

• Economists argue that if LDC governments economic policies are to promote

increases in agricultural production through new green revolution technologies.
• they must make the appropriate institutional and credit market adjustments.
• and also provide incentives for small and medium sized farmers by
implementing pricing policies that truly reflect internal market conditions.

iii. Supportive social institutions

• Supportive social institutions are banks, moneylenders, and government

supportive services (technical , educational extension service, public credit
agency, storage and marketing facilitating and also rural transport
facilities and etc…..)