GROWTH AND MODELS

THE HARROD – DOMAR GROWTH MODEL

Introduction

The Harrod – Domar growth model evolved from the works of J. M.

Keynes that focused on the short run aspect of investment. Roy
Harrod and Evsey Domar both working separately and independently
formulated what has become the most widely applied growth model in
economic history. However, inspite of close to a half century of its
application the model having been meant for short term investment
analysis, based on unsustainable assumptions and drawing from a
differing environment, has been rendered in effectual in developing
economies as attested.

The importance of studying economic growth and investigating its

causes seems to be obvious though it is by no means certain that
growth will be accompanied by development or increasing equality, it
offers unrivaled potential to reduce poverty in developing nations.

Explanations of economic growth date as far back as the classical

economists, Smith, Hume and Malthus. Smith (1976) saw growth as
a product of specialization and the division of labour resulting from
the scale of markets and trade. It’s in the period 1940s to 1960s that
interest in economic growth went through a period of a usually rapid
development. The term “modern growth theory” is usually applied to
the large body of theory, which began to appear a few years after
publication of Keynes general theory of 1936.

Harrod – Damar Model

Despite the obvious interest in economic growth from the outset, the
first widely applied model of growth was the Harrod – Domar Model,
named after the separate writings of Roy Harrod (1948) and Evsey
Domar (1946). Keynes biographer, the Cambridge economist Roy –
Harrod asked whether an economist Evsey Domar a professor at
Brandels University independently investigated the circumstances
under which a growing economy could sustain full employment. The
resulting Harrod – Domar Model focused on “dynamic theory on the
relations between savings, investment and output”. Essentially, the
model argued that the national savings rate (the fraction of income
saved) had to be equal to the product of the capital – output ratio and
the rate of growth of the effective labour force if the economy was to
keep its stock of plant and equipment in balance with its supply of
labour so that the steady growth could occur.

Harrod and Domar tried to put together two of the key features of the
keynessian economics i.e. the multiplier and the accelerator in one
model that explained the courses of long run economic growth. The
model rose out of necessity of ensuring long term full employment
equilibrium in developed economies. Both of them mere interested in
discovering the rate of income growth necessary for a smooth and
uninterrupted working of the economy. In their analysis they
assigned a key role of investments in the process of economic
growth. They did consider capital accumulation a dual role to play in
investments. First investments creates incomes and secondly it
arguments the existing productive capacity by increasing its capital
stock i.e demand and supply effects.

However for enhancing a full employment equilibrium level of income

from year to year, it is necessary that both real income and output
should expand at the same rate, at which the productive capacity of
the capital stock is expanding. The required rate of income growth is
what they call the warranted rate of growth rate.

A necessary condition of economic growth is that the new demand or

spending must be adequate enough to absorb the output generated
by increase in capital stocks or else there will be idle production in
capacity. The conditions should be fulfilled year in year out in order
to enhance full employment and to achieve steady economic growth
in the long run (Central theme of the Model).

To illustrate the Harrod – Domar model let’s assume that there are
two factors of production i.e. labour and capital combined in fixed
proportions to produce a single good (L & K). The fixed proportion
assumption (which is an equivalent to L-shaped isoquants) means
that the ratio of capital to labour used in production is given and
invariable. Also it is assumed that the economy is a closed one so
that any output that is not consumed is given over purely for capital
investments introducing as the proportion of output saved in each
period and as δ as the rate of depreciation of capital (0≤ δ ≤ 1)
allows us to state the evolution of capital stock.
Ќ = I – δK

Ќ = SY – δK (1)

A dot above variable indicates differentiation with respect to time and

so dividing both sides equation (I) K gives the growth rate of capital
stock.

Ќ = SY – δK (2)
K K K

Taking V as the capital – output ratio and assuming no depreciation

(ie – δ=0) allows slight modification of equation 2 to give the well
known Harrod Domar Equation for the so called warranted growth
rate gw

Ќ =S
K V

Gw = S
V

Because of the assumption of fixed coefficients in production, the

warranted rate of growth is an upper bound for the rate of output
growth. Likewise the growth of the labour force, known as the natural
growth rate (gn) also limits the growth rate of output. Most early
development economists shared Domar’s view that unskilled labour
was in abundant supply and so it was the warranted rate that would
act as the brake to growth. The shortfall of investment (savings)
below that required to satisfy the Harrod Domar consistency condition
(gw = gn) became known as the ‘financing gap’. Before the advent of
significant international capital flows, or attract foreign aid to fill any
existing gap. Today governments are perhaps more likely to look
towards portfolio and direct foreign investment.

The major stumbling block of the Harrod Domar model is that long
run equilibrium growth can only be attained if the warranted and
natural rates are equal. If this is not the case of economy will be
subject to prolonged periods of escalating unemployment (gn < gw).
However, S, v, n and & are all exogenous to the model and there is
little reason to believe that they will just happen to all take the
necessary values so that gw and gn will equate!
Several methods of extending the Harrod Domar model were
proposed so that the achievement of steady state growth might
become the norm instead of the exception Nicholas Kaldor (1962)
suggested that the saving rate was in fact an endogenous variable,
whose value would fluctuate until the Harrod Domar consistency
condition for steady state growth (gw = gn) was achieved. To outline
the mechanism through which this may occur consider the saving
rate, s, to be a weighed average of the saving rate of (poor)wage
earners and (richer) profit earners. If the natural growth rate is
initially greater than the warranted rate, the economy will experience
growing unemployment with the consequence that wage fall relative
to profit. This is equivalent to a proportional shift in the distribution of
income in favour of profit earners, which itself will lead to an increase
in this manner until the warranted growth rate equals the natural rate.
The classical economists would surely have been inclined to suggest
a different solution, one in which the natural rate of growth is
endogenous. Malthus (1978) argued that population growth has a
natural tendency to outstrip the food supply leading to ‘misery and
vice’. This will result in population reduction through two
mechanisms, (1) a falling fertility rate as per capita income falls (i.e.
rising fertility rate with prosperity), and (2) extreme population –
reducing disasters (such as famine and pandemics). The reason that
growth have seemed reluctant to incorporate Maltus’ideas is probably
because of empirical evidence that shows that the fertility rate is in
fact negatively related to income (except at very low income levels)
and also because the processes of industrialization and technical
progress have to date, allowed many countries to escape Malthus’
pessimistic predictions. However, his theory still seems to have
some relevance today for less developed countries (LDCs) as
regretfully evidenced by recent famines in Africa. To incorporate
Malthus’ ‘iron Law of Wages’ into the Harrod Domar model, again
assume that the natural rate initially exceeds the warranted rate.
Above, we saw how an endogenous saving rate may fluctuate in
order to obtain the consistency condition. In this case, however,
excess population growth reduces the wage rate, which leads to
falling fertility and increasing mortality until the natural and warranted
rates are once again equal.

Solow (1970 suggests another mechanism through which the natural

rate may fluctuate to satisfy the consistency condition in LDCs. In
this case a large pool of agricultural sector allows the consistency
condition to be met when the warranted rate initially exceeds the
natural rate. However, it was Solow’s (1956) favoured solution to this
problem that led to the development of the so-called neoclassical
growth model. He argued that the endogenous factor in the Harrod
Domar model was actually the capital output ratio, u. This is
achieved by allowing the factor proportions used in production to vary
(which also means that the capital labour output ratios are no longer
fixed ) therefore, in the case where the natural rate initially exceeds
the warranted rate, increasing unemployment will lower the wage rate
and firms find it more cost efficient to increase the proportion of
labour employed in the production process. The capital output ratio,
u, will necessarily fall and will continue to do so until the warranted
rate (s/v) rises sufficiently to equal the natural rate. So, whatever the
initial conditions faced by the economy, the capital output ratio will
adjust so that warranted and natural rates equate and steady state
growth is achieved. We have shown how the attainment of steady
state growth under the Harrod Domar is highly unlikely unless by
chance the consistency condition that the warranted and natural rates
are equal is met. Rather, economies are likely to suffer fluctuating
unemployment or excess (capital) capacity. In the rare case where a
steady state is attained, the growth rate of the economy will be
governed by saving behaviour of both households and firms. What is
more, the well known knife-edge problem of the Harrod Domar model
suggests that the steady state, is achieved is unstable and the
economy may spontaneously diverge from the steady-state growth
path. Solow offered a solution to these problems by allowing the
capital-labour ratio to be endogenously determined. The neoclassical
model predicts that economies will converge towards their steady
state levels regardless of initial conditions.

The limitations of the “Harrod – Domar model”

Economic growth and development usually has economic plans

relating to it and these plans are always established in accordance
with some particular mathematical or statistical models. These
models try to take into account the structural conditions existing
within a given economy during a proposed planning period.

Consequently we define model as an organized set of relationships

that attempts to describe the functioning of an economic entity,
whether household or firm, national economy, under a set of
simplified assumption.
The Harrod Domar models of economic growth are based on the
experiences of advance economies and are primarily addressed to an
advanced capitalist economy in an attempt to analyze the
requirements of steady growth in such economy.

Basically both Harrod and Domar are interested in discovering the

rate of incomve growth necessary for a smooth and uninterrupted
working of the economy. Here investment is treated as a significant
factor in the process of economic growth.

However due to certain crucial assumptions made by Harrod, these

models have been made weak and unrealistic in a number of ways.
The propensity to save (< or s) and the capital output ratio (0) are
assumed to be constant which is not so actual sence. In the long run
these are likely to change, thus modifying the requirements for steady
growth which can, however, be maintained without the assumption.

Harrod and Domar also make the untenable assumption that labour
and capital are used in fixed proportions. Generally labour can be
substituted for capital and the economy can move more smoothly
towards a path of steady growth. In fact, unlike Harrod’s mode, this
path is not so unstable that the economy should experience chronic
inflation or unemployment if the rate of growth of output in given
period of time does not coincide with the warrant rate of growth of
output does not coincide with the ‘warrant rate of growth’ or the full
capacity rate of growth of income.

No consideration is made by this model of the changes in the general

price level, price changes always occur overtime and may stabilize
otherwise unstable situations. This assumption that there are no
changes in interest rates is irrelevant to the analysis rates change
and affect investment. A reduction in interest rates during periods of
overproduction can make capital intensive processes more profitable
by increasing the demand for capital and thereby reducing excess
supplies of goods.

Harrod Domar models ignores the effect of government programs on

economic growth. In case of the government undertaking a program
of development, no casual or functional relationship is provided by
this analysis, which is quite unrealistic.
The entrepreneurial behaviour actually determines the warrant growth
rate in the economy and this is conspicuous reflected by the model.
This further makes the concept of the warrant growth rate unrealistic.
In addition, the Harrod Domar model clearly fails to make a distinction
between capital goods and consumer goods, earning them very
sharp criticisms from various quarters. Professor Rose, states that
the primary source of instability is Harrods system lies in the effect of
excess demand or supply on production decisions and not in the
effect of growing capital shortage or redundancy on investment
decisions.

Harrod Domar analysis was evolved under different set of conditions.

It was meant to prevent and advanced economy from the possible
effect of secular stagnation. It was never intended to guide
industrialization programmes in underdeveloped economies. This
limits the application of these models in the latter.

Another limitation with these growth model is that they are

characterized by a high saving ratio and a high capital output ratio,
while it is crystal clear that decisions to save and invest are generally
undertaken by the same group of persons in underdeveloped
economies. The vast majority of the people live on the margin of
subsistence and thus very few are in a position to save.

According to Professor Kurihara, this model fails to solve the problem

of structural unemployment found in underdeveloped countries. It
can tackle the problem of keyesian unemployment arising out of
deficiency of effective demand or under utilization of capital. But
when population grows faster than accumulation of capital in
underdeveloped country, structural unemployment will arise due to
lack of capital equipment.

The Harrod Domar models are based on the assumption that there is
no government intervention in economic activities which is not
applicable to underdeveloped countries, which can not develop
without government help. In such countries, the state plays the role
of “pioneer entrepreneur in starting large industries and regulating
and directing private enterprise.

Whereas the Harrod Domar models are based on the assumption of

a closed economy, underdeveloped countries are open rather than
closed economies. Foreign trade and aid play very crucial roles in
their economic development and hence are the bases of their
economic progress.

Institutional factors have been assumed to be given in these models.

But the reality is that economic development is not possible without
institutional changes in such countries. Consequently, these models
fail to apply in underdeveloped countries.

It is therefore, prudent to categorically conclude that the Harrod

Domar models based as they are on unrealistic assumptions have
little practical application in underdeveloped countries. But despite all
these limitations, these models are purely laissez – faire, based on
the assumption of fiscal neutrality and designed to indicate conditions
of progressive equilibrium for an advanced economy. The universal
character of saving income ratio and capital output ratio as
measurable strategic variables, systems, albeit with due modification.

THE SOLOW GROWTH MODEL

Solow growth model was developed by a Harvard economist, Robert

Solow in 1956 in response to one shortcoming of the Harrod Domar
model, which explains growth mainly in terms of investments and
assumes a fixed capital coefficient and constant marginal propensity
to save. Solow set out to develop a long run growth model which was
more flexible than the Harrod Domar model, a starting point for
thinking about cross-country differences and led to the development
of neoclassical growth model.

This paper first presents the model (Solow’s Growth model) then
gives a detailed assessment of it and outlines the assumptions on
which it is based.

In Solow’s growth model, there is a single commodity in the economy

and its annual rate of production is given by Y(t) which also
represents the real income of the economy. Part of the income is
consumed and the rest saved and invested. That which is saved is a
constant s and the rate of savings is given as sY, while K is the stock
of capital. What is saved is equivalent to what is invested, thus
current savings determine the rate of growth of society’s capital i.e.

K = sY (1)
Where K stands for dK/dt
Output is produced by capital and labour. The production function is
hence given as:

Y = F(K,L) (2)

That displays constant returns to scale. This function also represents

the technological possibility. Substituting equation (2) into (1) give
the following equation;

K = sF(K,L) (3)

The model takes into account the fact that population grows
exogenously and that labour force increases exponentially at a
constant rate n. The available supply of labour at time t (L9t) ) is
dependent on the compound rate of growth of labour force from one
period to another.

Loent Thus

L(t) = Loent (4)

Equation (4) above can be regarded as the supply curve of labour.

Capital accumulation thus determined by the equation.

K = sF(K, Loent) (5)

The above equation gives the time path that capital accumulation K
must follow if labour is to remain fully employed. Once the time path
of the capital stock and of the labour force are known, the
corresponding time path of real output can be computed from the
production function.

Professor Solow sums up the growth process thus;

“at any moment of the time available labour supply is given by

equation (4) and the available stock of capital is also a datum. Since
the real return to factors will adjust to bring about full employment of
labour and capital we can use the production function of equation (2)
to find the current rate of output. Then the propensity to save tells us
how much of net income will be saved and invested. Hence we know
the net accumulation of capital during the current period. Added to
the already accumulated stock this gives the capital available for the
next period, and the whole process can be repeated”.

Capital accumulation path consistent with any rate of growth of labour

force is given in the equation;

R = sF(r,1)-nr

Where r is the ratio of the capital to labour (K/L);

N is the relative ate of change of labour force (L/L)

The function sF(r,1) represents output per worker as a function of

capital per worker;

From the above equation, the rate of change of capital labour ratio ®
is the difference of two terms, one representing the increment of
capital (sF(r,1) and the other increment in labour (nr). The economy’s
behaviour when capital labour ratio is changing can be illustrated
diagrammatically as ;

The below graph show diminishing marginal productivity of capital as

more capital is employed with one unit of labour.

See Todaro page 263 Figures 30.2 and 30.3

Note: The side of the sF(r,1) curve is infinite at the origin

The line nr which has a slope of n shows how fast the capital output
ratio would be declining for a given rate of growth of the labour force
if savings were zero. While the line sF(r-1), which has a slope s
shows how fast the capital output ratios would be growing as a result
of capital accumulation if the labour force were not growing. If both s
and n are non zero, the actual value of r is the difference between nr
and sF(r-1), represented by the vertical distance between the two
lines.

When the capital labour ratio (r) = 0 (constant), the capital stock
expands at the same rate as the labour force (n). Assuming constant
returns to scale, real output would also grow at the same relative rate
(n). Once an equilibrium capital – labour ratio r1 is established, it will
be maintained. The equilibrium r1 is stable and any divergence from
r1 would lead to movements towards r1, if r < r1 it would mean that nr
> sF(r, 1), which imply that capital accumulation outweighs population
growth and r will be positive, leading to an increase in r towards r1. If
on the other hand r > r1 would mean that nr>sF(r, 1), which imply that
population growth outweighs capital accumulation and r will be
negative, leading to a decrease in r towards r1. Hence at r1 there will
be balanced growth equilibrium also referred to as the balanced
growth path where each variable (capital and labour) grows at a
constant rate. This equilibrium exists if the production function ins
Cobb-Douglas because the slope of sF(r, 1) is infinite at the origin
and falls steadily as r increases.

The shape of the productivity curve is important in determining the

stable equilibrium r1. If the total productivity curve sF(r, 1) intersects
the labour increment curve, nr, from above. Then stable equilibrium
is achieved. If it intersects from below then unstable equilibrium is
achieved. If is interacts from below then unstable equilibrium is
realized. Where productivity curve is above the labour increment, it
depicts an unproductive system in which the full employment path
leads to ever diminishing per capita income. However, aggregate
income increases due to positive net investment and increasing
labour supply. It should be noted that after developing his simple
model as illustrated above, slow (1970) take a critical look at his
theory and attempts to explain the relevance in the real world. He
further introduces the impact of government monetary policies on
capital accumulation and growth.

Assessment of the Model

In developing his model, Solow was driven by questions as to

whether or not a growing economy could develop full employment of
all factors; whether there was full employment natural-rate growth;
and whether a growing economy would converge to this path,
oscillate around it or diverge continuously farther from it. Prior to the
development of this model, there had been concern with the secular
unemployment problem, and that a rapidly growing capitalist
economy might either display unstable cyclical behaviour, or suffer
serious permanent unemployment of some factors of production
(especially labour) if settled down into a stable growth path.

Solow’s model could not address all the above concerns within its
simplified form and assumptions. Solow (1970) recognizes the
limitation of his simplified model in addressing all aspects of
economic life. Nevertheless, his model is an improvement of the
Harrod Domar’s model as he develops a continued production
function in which capital and labour can be varied to allow for steady
stage growth and steady state growth paths.

Solow recognizes that may inputs i.e capital (investment) labour and
technological innovations can create output. Hence the model
provided a basis for measuring what factors were contributing to
growth. He further recognizes the importance of technological
progress and increasing returns to scale. When capital/output ratio is
constant, the capital/labour ratio must be constant, however, with
introduction of technological progress, capital and output could both
rise through time faster than employment. Hence, continues
innovation staves off the effect of diminishing returns and allows
economy to experience rise in capital and output per man. The
model further shows that with variable technical coefficient, there
would be a tendency for capital – labour ratio to adjust in the direction
of equilibrium ratio. If initial ratio of capital to labour is more, capital
and output would grow more slowly than labour force and vice versa.

Solow (1970) notes the information available between 1950 to 1962,

which shows that the constancy of the capital/output ratio was to
some extent realized by some of the developed nations such as
United States and Belgium where the difference between the rates of
growth of output and capital was slight i.e. 3.3% and 3.7% a year in
the U.S and #,2% and 2.9% in Belgium. He also note that some
countries, there is scope for increasing returns to scale which could
lead to capital flowing from the developed to poor countries.

The model indicate that the long run rate of growth is determined by
an expanding labour force and technical progress, thus, differences in
income levels between rich and poor countries are due primarily to
differences in rates of investment in physical and human capital over
long periods of time and that if all economies have similar parameters
and access to common pool of technology, all countries would
eventually converge with rich countries. This applicable in the case
of some poor countries, which grew fast to be on the level with the
developed countries in the 20th century. It is however worth noting
that some poor countries have however remained poor despite world
wide technological progress mainly due to other factors such as civil
plagues etc.
Solow points out that may possibilities of growth exist. He shows
more possibilities; one where the economy is highly productive and
increment in capital is realized faster than the growth of labour force,
thus resulting in full employment; and the other where the economy is
highly unproductive thus resulting in full employment path that leads
to diminishing per capita income.

Solow’s model is seen to explain cross country differences in income

and growth in the politically stable market economies where total
factor productivity has been the major contributor to economic
growth. However, it is not been able to explain short-term economic
behaviour in countries experiencing plagues, civil unrest, military
coups, and economy transition from centrally planned to market
economy. In such countries, major changes in the level of national
income can not be explained by minor changes in factor
accumulation. The model also seems not to address capital
accumulation resulting from grants and donations. Most developing
countries have experienced capital accumulation through the
intervention of the developed nations.

David Griffins (2002) in his paper ‘Economic Growth: new recipes

from old books’ considers the model’s predictions and relevance to
less developed countries. Griffins points out the studies by various
economists (Barro and Sala-I-Martin) who found evidence that
economies with identical saving, population and depreciation rates
are predicted to converge towards a common steady state. This was
so in various US states, Canadian provinces and European countries.
Further studies give empirical evidence of ‘convergence clubs’ with
rich countries converging towards higher state than less developed
countries.

Some major deficiencies in the model are that; it does not include any
fixed natural resources such as land and the problem of growing
population pressing against a fixed supply of land and other
resources; it has no investment function and does not take into
account the role of future entrepreneurial expectations; the model has
no monetary sector and ignores impact of interest rates thus the
problems of possible instabilities caused by the behaviour of demand
and supply of money is not handled; the assumption of homogeneous
capital is unrealistic as capital goods are highly heterogeneous and
thus pose problem of aggregation and determination of steady growth
path; lastly, the model ignore the problems of inducing technical
progress through the process of learning, investment research and
capital accumulation.

Lastly, Solow’s model provides limited contribution on policies that

can lead to growth. This made economists move beyond the ne-
classical models to understand the determinants of long-run
economic success and effects of such policy actions as tax subsidies
for private research, activities for multinational firms, effects of
government procurement etc thus leading to the emergence of
Empirical Growth models.

Assumption of Slow Growth Model

Solow’s growth model is built on the assumptions that:

1. There is one production function for the entire economy i.e.

‘aggregate’ production function. Homogeneous capital and
labour are the inputs transformed into a singly homogeneous
output.
2. The production function is homogeneous of the first degree
hence assumes constant returns to scale in capital and
labour. The constant returns to scale is consistent with a
balanced growth path along which output, capital and
effective labour grow at the same rate.
3. The two factors of production, labour and capital, are paid
according to their marginal physical productiveness, and that
prices and wages are flexible.
4. The economy is closed and one composite commodity is
produced hence relative prices are not considered.
5. Domestic investment is financed by domestic private
savings. Households will save a constant fraction of their
income every year i.e. constant savings ratio.
6. There is perpetual full employment of labour and available
stock of capital.
7. Labour and capital are substitutable for each other. This
assumption gives the growth process adjustability and
provides a touch of realism in the growth model.
8. Output is regarded as net output after making allowances for
the depreciation of capital, a fixed percentage of capital
stock is assumed to depreciate every year.
9. There is neutral technical progress.
APPROACHES TOWARDS THE STUDY OF DEVELOPMENT

The study of development began in an era of optimism and giving

prosperity for advanced countries, and that climate is reflected in the
subjects early concern for evolution and stability (Leymann 1979).
The study of development can be traced to the concerns of
eighteenth centrury’s philosopy and the fledging sciences and
political economy. After the World War II, the rate of social and
economic change within the countries reaching a struggling for
independence propelled development to the forefront of public
debate. The consequence has been a challenging discussion among
and within disciplines about development’s origins, nature and
implications. Targets of development are untilmately to eradicate
poverty.

However, it is important to observe that development economics is

one of the most unsettled fields of economics. It is a wash with a
profusion of competing theories of the causes of underdevelopment
and swarming with even more approaches to development policy.
Nevertheless the major theories of underdevelopment fall into three
broad categories; stage (linear) theories, neoclassical structural
change models and international dependence paradigms though,
there is need to mention also the neoclassical counter-revolution
model of 1980s. Stage theories stresses the similarities between the
underdeveloped economies today and how developed economies
during earlier phases of their industrial revolutions enhanced
development. It was primarily an economic theory of development of
which the right quantity and mixture of savings, investment and
foreign aid were all that was necessary to enable third world nations
to proceed along an economic growth path, that historically had been
followed by the more developed countries (Todaro 1985 pg 62).

The neoclassical structural change models stress the differences

between conditions faced by under-developed countries today and
the conditions under which the now developed countries began their
industrial revolutions. These models use modern economic theory
and statistical analysis in an attempt to portray the internal process of
structural change that a “typical” developing country must undergo if if
is to succeed in generating and sustaining a process of rapid
economic growth (Todaro 1958).
The international dependence paradigms which can also be termed
as neoclassical counter-revolutions emphasizes corruption,
inefficiency and lack of economic incentives within developing
countries as being responsible for sluggish development. As Todaro
puts it, news underdevelopment in terms of international and
domestic power relationships, institutional and structural economic
rigidities and the resulting proliferation of dual economies and dual
societies both within and among the nations of the world.

International dependence models view developing countries as being

rigid politically, institutionally and economically both domestically and
internationally. Furthermore these countries tend to be dependent
and dominated by rich countries. In contrast to stage and structural
change models, international dependence models claim that
underdevelopment is externally induced. Within this general school
of thought are three major streams. The neoclassical dependence
model, the false paradigm model and the dualistic development
model.

Neocolonial Dependence Model

This model attributes the existence of continuance of

underdevelopment primarily to the fact that the mere co-existence of
rich and poor nations in an international system makes it difficult and
sometimes even impossible for poor countries to be self-reliant and
independent. Rich countries are either intentionally exploitative or
unintentionally neglectful. Wealthy capitalistic-thinking dominates.
The system stresses inequality and conformity. Developed
capitalistic countries drive the development process that resting on
military superiority, shape developing countries to suit their needs for
raw materials and labour power. Profits tend to leave the developing
countries or are used to create a dependent business/Elite class
within the developing countries, which is treated favourably. Those
Elite groups also serve and are rewarded by international special
interest power groups, including multilateral assistance organizations
like the World Bank or multinational corporations, which are tied by
allegiance or funding to the wealthy capitalist countries. The Elite
opinion and activities often serve to inhabit any reform efforts that
may benefit the wider population and, thus often leads to a
perpetuation of underdevelopment in a country.
In order to free development countries from their direct and indirect
economic control by their developed world and domestic opperssors,
it is necessary that these countries break out of the prevailing world
system thus breaking their economic link with the western world.

False Paradigm Model

This model is less radical than the Neocolonial Dependence Model

and attributes underdevelopment in developing countries to
inappropriate advice provided by well meaning but often uninformed,
biased international “expert” advisers from developed country
assistance agencies. Those experts offer “solutions” (often based on
complex econometric development models) that often lead to
inappropriate or incorrect policies. Also, within the developing
country, many experts such as university intellectuals, high-level
government economists, etc get their training in developed country
institutions where they often learn theoretical concepts of the western
world that are inapplicable to developing countries issues.

Dualistic Development Model

This model claims that there exist two societies in the world – rich
and poor. There are also existing and persisting divergence on
several levels between rich and poor countries, as well as rich and
poor people (e.g slums next to luxurious mansions) on several levels.
Those two different kinds of society are not independence from each
other but integrated. NO “trickle down effect” of progress from rich to
poor can be observed.

THE NEOCLASSICAL COUNTERREVOLUTION

Starting around the 1980s, this theory claims that, underdevelopment

results from poor resource allocation due to incorrect pricing policies
and to much state intervention by developing country governments.

Contrary to the claim of the dependency model, neoclassical models

argue that the third world is underdeveloped not because of the
activities of the developed world and the international agencies that is
controls, but rather of corruption, inefficiency and lack of economic
incentives, in order to become developed, the following would need to
be created: high levels of domestic savings, free markets, privatized
enterprises, free trade, attractive opportunities for foreign investors.
One of the best-known representatives of the Neo-classical counter-
revolution is Robert Solow. By expanding on Harrod-Domars stage
model, slow reaches the following conclusions: Economies will
converge to the same level of GNI, provided that they have the same
savings ratios, capital depreciation, labour force growth and
productivity growth.

For developing countries, there exist lower standards of limiving, less

capital and lower capital-labour ratio than for developed countries
(because of lower capital-labour ratios, returns on investment are
higher. Therefore it would be beneficial if foreign countries could
invest in developing countries. However, for this to happen,
regulations would have to be changed e.g. free markets, etc). It
follows that developing countries need to devote less of their total
savings to the replacement of depreciated capital, leaving a possible
surplus for the purchase of additional capital. This will in turn add to
the growth of GNI. Subsequently, the capital-labour ratio will
increase along with labour productivity. Eventually, the pace of
growth will slow down until it reaches the steady-state growth rate.
The reason for this development is that for a given savings ratio,
positive net investment increases the capital stock over time. As it
grows, so does the total level of capital depreciation. As total
depreciation increases, so does proportion of savings needed to
offset the depreciation, leaving less surplus saving for net investment.
Hence, the country will invest just enough to replace the capital stock
that has depreciated each year.

GROWTH AND STRUCTURAL CHANGE

The importance of studying economic growth and investigating its

causes seems to be obvious. Growth as process needs to be
accompanied with structural and qualitative changes with the
potential to reduce poverty. Explanations regarding economic growth
dates back to the classical economists Adam Smith, Hume and
Malthus, who saw growth as a product of specialization and the
division of labour resulting from the scale of markets and trade.
Despite the obvious interest in economic growth from the outset, the
first widely applied model of growth was Harrod – Domar model
named after the separate writings of Roy – Harrod (1948) and Evsey
Dorma (1946).
There is a popularly held view that the main problem of exonomic
growth and development is to initiate the process itself . Once started
the rise to becoming a modern developed society proceeds moreover
less automatically. The analogy is to an airplane that requires great
energy and a skilled pilot to get off the gound, but once it has taken
off soars easily through the air to its final destination. “Walt Rostor”.

Attempts to determine the basic sources and patterns of growth have

followed two very different approaches – one empirical and the other
theoretical. One group of economists betst represented by Simon
Kuznets of Havard and the World Bank’s Hollis chancery has
attempted to discern patterns of development through the analysis of
data on gross national product.

The second approach has been to construct theories of how the

structure of a nation’s economy could be expected to change given
various assumptions about the conditions facing that nation. This
was advocated by David Ricardo, Adam Smith and more recently by
growth models of Roy Harrod, Evsye Domar, Robert Solow, Arthur
Lewis and Gustav.

In essence, the analysis of growth requires one to understand the

Country’s Gross National Product (GNP). This is the sum of the
value of finished goods and services produced in a society during a
stipulated period of time in one financial year. Gross domestic
product (GDP) is similar to GNP except it excludes incomes earned
by citizens of a country who are residents abroad. The great
advantage of GNP concepts is that it encompasses all of a nations
economic activity in a few summary statistics that are mutually
consistent. It normally requires the calculation of the goods and
services produced in a country and sold at either market prices or
factor costs. There are various types of growth here:

(i) Growth that is involved in moving the economy from the

position of slack demand and high unemployment to full
employment i.e. short-term growth. This kind of growth
according to Thriwall can not be continuous process; once
utilizing its resources fully. It can only grow at the pace of
resource’s expansion i.e growth of capital stock, labour
force, and technological progress.
(ii) Growth with full employment towards a long-run equilibrium
growth path. In this case, while maintaining full employment,
 the economy increases its ratios of capital and output to
effective labour input moving towards long-run equilibrium i.e
medium – Run growth.
(iii) Balanced growth (long-run) of the neoclassical growth
models.

There are several ways in which growth of income or ouput of an

economy can be expressed; but frequently they consist of identities
which can tell one very little about the causes of growth. For
example, growth can be expressed as the product of a country’s ratio
of investment to output (I/O) and the productivity of investment ∆O/I
i.e.

Growth = ∆O = I x ∆O
O O I

By the above explanation, slow growth can be as a result of either:

(i) a slow investment ratio

(ii) a slow productivity of capital or both

Alternatively, income or output can be expressed as the product of

the total labour force (L) and output per unit of labour (O/L) so that
the rate of output growth can be expressed as the sum of the rate of
growth of the work force (∆L/L) and the rate of growth of output per
unit of labour or labour productivity in other words.

Growth = ∆O = ∆L + ∆(O/L)
O L (O/L)

In the above definition, slow growth is attributed to either:

(i) a slow rate of growth of labour force or

(ii) the lagging rate of growth of labour productivity or both

Logically, economic growth should be seen as a necessary but not

sufficient condition for improving the living standards of the majority of
people in respective societies. It is necessary because if there is no
growth, people can be made better off only by taking income and
assets from others. Economic growth by contrast makes it possible
for some or even all people to become better without making any
worse off. Economic growth is not sufficient conditions for improving
mass living standards however because it can lead to increased
wealth only to the few. This can be explained that one can not
assume that higher per-capita GNP necessary means higher incomes
for all simply because:

(i) Governments promote economic growth not just to improve

the welfare of their citizens but also and sometimes primarily
to argument the power and glory of the state and its rulers.
For example it is argued that much of the wealth of ancient
Egypt was invested in Pyramids. Modern LDCs may for
example buy ballistic missile systems and develop nuclear
weapons. When the gains from growth are channeled to
such expensive projects they provide little immediate benefit
to its citizens.
(ii) Resources may be heavily invested in further growth with
significant consumption gains deferred to alter date case of
former Soviet Union, which heavily invested in space
technology.
(iii) Income and consumption may increase but those who are
richer gets richer and the poor gets poorer. Indeed the best
approach here is to evaluate the effect of growth and
development on economic well being through the study of
income distribution and the size of distribution, namely
functional distribution. The crudest and most familiar
indicator of growth is GNP. The limitation of GNP as a
measure of growth is GNP. The limitation of GNP as a
measure of growth can be identified as.

(a) GNP measures ‘productive’ activity in a very narrow

way, excluding for example, the productive activities
of the household because many of these
undertaken by wives and children.
(b) GNP is a very blunt investment for measuring
economic development without considerable
attention being given to demographic profiles per
capita figures for economic growth, for example,
disguise the number of developments within
families, the number of single parents and elderly
people without dependants within families.
(c) Economic growth measured through GNP is also an
inadequate measure of how production activity is
considered the same, whether it is channeled
 towards arms expenditure and the army or the
maintenance of primarily health care system. This
makes it impossible to distinguish between
countries, which spend a high proportion of their
income on defending themselves i.e. Israel and
those, which have no army like Costa Rica.
(d) GNP figures also fail to distinguish between groups
of people, especially social classes within a country.
Some countries share their income more equally
than others. While others have unequal distribution
of income.
(e) GNP statistics record the productive utilization of
resources, whether or not these resources are
renewable moreover, if productive activity is
associated with the costs of economic growth,
through pollution control for example this is also
entered under GNP. GNP therefore does not tell as
about the cost in the society in producing the
various goods and services i.e it figures the cost of
economic growth pollution, degradation,
deforestation, soild erosion, it treats sustainable and
unsustainable production alike.

Note: with the above shortcomings the use of other social and
economic indicators represent an advance on the crude
measurement of GNP.

Structural change in the course of economic development involves

rise in productivity along side with increases in capital stock relative
to other inputs such as labour. Structural change also involves major
shifts between the sectors that make up the output side of production
function equation.

One clear pattern of changing economic structure in the course of

economic structure in the course of economic development is that as
per capita income rises, the share of industry in Gross National
Product rises also. While is possible to conceive of situation in which
a nation moves from a condition of poverty to one of wealth while
concentrating on agriculture, this kind of growth has yet to occur.
Every country that has achieved a high per-capita income also
experienced a population shift – where the majority moves from rual
areas and farming to cities and industrial jobs. All have also
experienced an increase in industrial value added in gross national
product.

There are two principal reasons for this. The first Engel’s law. In the
19th century Evrst Engel discovered that as incomes of family’s nose,
the proportion of their budget spent on food declined. Since the main
function of the agricultural output would not grow as rapidly as
demand for industrial goods. The relationship holds for all countries
that have experienced sustained development.

A second reason has the impact of the first, productivity in the

agricultural sector has risen has growth has progressed. People
require food to survive and if a household had to devote all its
energies to producing enough of its own food, it would have no
surplus time to make industrial products or to grow surplus food that
could be traded for industrial goods.