Economic Development Theory

"The real differences are not quantitative, but qualitative.  Egypt's inability to raise its standard of living has more to do with its social, political, and economic institutions and with its perceptions of past, present, and future than with any lack of effort or personal talents"  Fred Gottheil, Principles of Macroeconomics 3e, p. 426.

the stages of economic growth

The Stages of Growth: A Non-Communist Manifesto, Walt Whitman Rostow, 1960.

The theory is intended as a direct counter to the Marxist stage theory of capitalist development.  The basic proposition is that all countries are located in one of a hierarchy of developmental stages:

  1. traditional society
  2. transitional stage: the preconditions for take-off
  3. take-off
  4. drive to maturity
  5. high mass consumption
In stages four and five nations achieve stable conditions for self-sustaining growth and wealth creation.  This notion presents a direct challenge to the Marxist argument of a violent end to the capitalist system.

The launching platform for development is in the preconditions stage.

The critical stage is the take-off stage.  At this time the rate of investment increases sharply.  Leading economic sectors emerge and create investment opportunities in other parts of the economy.  This ensures the self-sustained growth of the drive to maturity and high mass consumption stages.
 
Study Questions:
Profile less developed countries (LDCs) using as many of the 10 criteria given in the lecture as you feel are necessary to provide an adequate picture of life in a LDC.

Harrod-Domar Growth model

Harrod, R. F. (1939), "An Essay in Dynamic Theory," Economic Journal, Vol. 49, No. 1.

Domar, D. (1946), "Capital Expansion, Rate of Growth and Employment," Econometrica, Vol. 14.

Neither of the articles was concerned with developing countries.  Each dealt with conditions for stable growth in more developed countries.  Nevertheless the articles have had a great impact on economic development theory.

Assume:

  1. Aggregate demand and supply would be in balance when investment (It) in any period equaled the change in national income (Yt -Yt-1) times the capital to output ratio (k).  The capital to output ratio indicates the value of capital required to produce one unit of output in a single time period.
  2. At equilibrium in a closed economy intended investment would equal intended savings (St), which gives the initial equilibrium condition.

The rate of growth is determined jointly by the national savings ratio and national capital to output ratio.  The more a nation can save and invest the quicker it can grow!

    e.g. assume k = 3, s = 6%

    but, if one can increase national savings from 6% to 15%

This helped Rostow to define the "take-off" stage.  If a country could just save 15% to 20% it could develop and grow at a much faster rate than those who saved less.  This growth would be self-sustaining.

The primary policy implication is that the needed investment resources could be met through foreign aid.
 
Study Question:
Describe the Harrod-Domar Growth Model including equations and policy implications.

two-gap model

The two-gap model is an extension of the Harrod-Domar growth model.  The second "gap" (in addition to the savings gap)  is found by introducing foreign trade and rephrasing the model such that:

savings gap -- domestic savings are inadequate to support the level of growth which could be permitted given the import purchasing power of the economy and the level of other resources

foreign exchange gap -- import purchasing power conferred by the value of exports plus capital transfers may be inadequate to support the level of growth permitted by the level of domestic saving

The two-gap theory purports that investment and development are restricted by level of either domestic saving or import purchase capacity.

the vicious circle of poverty

The vicious circle of poverty is perpetuated by the lack of capital.

The way to break the cycle is to increase savings and therefore increase capital stock which will lead to increased productivity and higher income.  With higher income the vicious cycle is broken.
 
Study Question:
Describe W. W. Rostow's Stages of Growth model for LDC development.

the big push/balanced growth

Rosenstien-Rodan, Paul N., "Problems of Industrialization of Eastern and Southeastern Europe," Economic Journal (June - Sept. 1943), p. 202-211.

unbalanced growth

The Strategy of Economic Development, A. O. Hirschman, Yale University Press, 1958.

Unbalanced growth recognized both backward (inputs create demand for other products) and forward (inputs to other industries).

State support was seen as needed to initiate large-scale investment in a leading sector.  This would create the necessary external economies to induce supplying and client industries which would in turn stimulate a secondary wave of investment and entreprenuership.