MODULE 4

Development Economics
ADAM SMITH’S IDEAS FOR DEVELOPMENT
 Classical theory
 Division of labour
 Pin factory example - without and with – division of labour
 Saving of time
 Increase in dexterity – learning by doing , specialisation
 Invention

 Power of trade
 Free trade
 Extend trade by extending market( larger market)
 Trust among people, justice – peace, rule of law
 International division of labour
 Capital accumulation – will increase
productivity of labour
 Natural law is superior to manmade laws

 Agents of growth – producers, indudtrialist

businessmen : sequence of growth
 Stationary state – due to scarcity of natural
capital
 Limitations
 Unrealistic assumptions
 Based on perfect competition
 Static model
KARL MARX- CONCEPTS
 Assumptions
 Dialectical materialism
 Class of people
 Bourgeoisies- capitalists, owners of FoP
 Proletariat - workers
 Subsistence wages
 Labour is the source of value
 Materialistic interpretation of history – class struggle
 Primitive communism
 Slavery
 Feudalism
 Capitalism
 Socialism
 Value of a commodity – labour embodied
 Surplus value

 Capital accumulation
 Increasing in working hours
 Increase in productivity
 Reduction of wages

 Total value of product (w) = constant capital (c) +

variable capital (v) + surplus value (s )
 Organic composition of capital = c/v

 Rate of exploitation = s/v

 Industrial reserve army – surplus labour

supply compared to demand
 Downfall of capitalism

 Limitations
ROSTOW’S STAGES OF GROWTH
 W.W Rostow 5 stages
 Underdevelopment to development

 Propensities
 To develop and apply science
 To consume
 To seek progress
 To have children
 Stage 1-Traditional society
 Agrarian economy, subsistence , low per capita income and
capital formation, pre Newtonian science
 Stage 2- Pre conditions to take off
 Social capital. Modernisation in agriculture, establishment
of industry , Renaissance – scientific advancement, changes
in institution
 Increase in productivity, Slow increase in savings and
investment
 Stage 3- Take off
 Growth of manufacturing sector, institutions (social,
political and economic) transformation , S&I growth (5-10%)
 Leading sector
 Stage 4- Drive to maturity
 Technological changes, sustained increase in income,
growing urbanisation
 Stage 5-Age of high mass consumption
 Urbanisation ,Mass production, consumerism , developed
 Idea of welfare state-
CASE STUDY – SINGAPORE
 Criticism
 Non linearity
 Overlapping of stages
 Does not talk about unemployment
PAUL ROSENSTEIN RODAN
BIG PUSH THEORY
 By Rosenstein Rodan - developed in the 1940s
 A certain amount of investment required
“bit by bit investment won’t help” – to overcome underdevelopment
 Analogy of aircraft

 Initial heavy investment as a thrust to overcome inertia

 A certain minimum amount of resources is necessary to set

economy in motion
 Indivisibilities – obstacles to development process
 Types
 Indivisibility of production –that make goods
unaffordable or unavailable at smaller levels
 output
 input
 Production methods
 (example- electricity generation- needs large investment )
lumpiness of capital : solution – public investment on basic
utilities
 Indivisibility of Demand – small sized markets (low
income-> low purchasing power-> low demand) as a
constraint to inducement of investment (example of shoe
factory), solution - can be extended with market –
complementarity of demand ( increase employment
more income  more demand)
 Indivisibility in supply of Savings –for UDCs, Low
Income-Low savings : solution: increase income
 A big-push investment through a centralised planning can keep
the developing countries on a self-generating development process.
 Thus he emphasized on government initiated
industrialization and investment in various sector
Criticisms-
 Quantum of minimum investment is not specified
 Neglected agriculture sector
 Role of technology was ignored
 Over emphasise on indivisibility
 Government's of developing countries have its limitations
CASE STUDY
 Role of foreign Aid
RAGNER NURKSE
Balanced growth model
 Underdeveloped country – common features
 Causes of backwardness –
 vicious circle of poverty - “poverty breeds poverty”
 Supply side , demand side, market imperfections
 Low savings – due to poor ability to save
 Nurkse, List , Rodan
 Analogy of balanced diet
 W.A. Lewis “in development programmes, all sectors of economy
should grow simultaneously so as to keep a proper balance
between industry and agriculture and between production for
home consumption and production for exports.”
 Balanced growth
 Balanced investment in various sectors is necessary
– agriculture and industry, domestic trade and foreign
trade
 Balanced investment in various industry
 Balanced growth in various regions
 Massive investment in various sectors
 To extend markets – use advertising , remove
trade restrictions
 Thus it calls for positive intervention from
government , close coordination between sectors
Advantages of balanced Limitations
growth  Simultaneous growth of all sectors
 INCLUSIVE growth not possible
 promotes balanced regional  Contradiction to theory of
development comparative advantage
 Better utilisation of resources  Shortage of funds
 Economic self reliance
 Wide extent of markets
UNBALANCED GROWTH MODEL
 Hirschman advocated this model for UDCs with scarce resources
 According to Hirschman, “development is a chain of disequilibrium
which must be kept alive rather than eliminate the disequilibrium”
 Concentration of investment to selected sectors- key sectors/
strategic sector, instead of all sectors
 External economies and complementarities (stimulation of
demand in other industries)
 Investment by state
 Classification of investment – SOC, DPA
 SOC – Social Overhead Capital- basic facilities-
economic and social infrastructure like education,
electricity generation but can create external
economies – usually done by govts / autonomous
investment ( this may have time lags). Thus called as
divergent series
 DPA- Directly Productive Activity – will lead to
increase in supply of goods (immediate results) – by
private sector with a profit motive- induced
investment. Thus called as convergent series
  Growth by Unbalancing
 Unbalancing the economy through SOC
 Unbalancing the economy with DPA

DPA=SOC

In the Figure
X axis
Y axis
AA, BB, CC – isoquants
Via investment in SOC
- DEGHK route of
development
Via investment in DPA
– route of development
DFGJK
 Convergent vs divergent investment
 Identification of key industries based on Forward and backward
linkages in industries
 Excessive SOC is a better strategy for UDCs

 H.W.Singer, “Unbalanced growth is a better development strategy

to concentrate available resources on types of investment, which
help to make the economic system more elastic, more capable of
expansion under the stimulus of expanded market and expanding
demand”.
Merits Demerits
 Realistic theory  Problem in Selection of key

 Importance to key sectors industries

 Requires less time and  Lack of clarity about

investments investment needed

 Self reliance  Can lead to inflationary
pressure
LEIBENSTEIN’S CRITICAL MINIMUM EFFORT
 UDCs vicious level of poverty causes backwardness
 Development strategy should break the vicious circle of poverty

 The need for Critical minimum effort for sustained growth

 Shocks- income depressing factors and

 Stimulants- income rising factors

 in poor countries shocks>stimulants

 Leibenstein identified population growth as an income-
depressing factor
 Whereas investment is an income-generating factor.

 Other income depressing factors (shocks) – resistance to

change, conservative ideas, unproductive use of resources,
excessive consumption expenditure – demonstration effect
 Other income generating factors (stimulants) –
entrepreneurial activities with innovation (growth agents) ,
creation of opportunities, expansion of various sectors of the
economy
 Zero sum
incentives-
redistribution
Incentives
Positive sum
incentives –
results in growth
 Growth agents – entrepreneurs investors etc.
expansion of growth agents
 The critical minimum effort needed to overcome
diseconomies
 Critical minimum effort should also encourage
positive sum incentive

XXt- shock
ZZt – stimulus
Om- level of investment
path fabcd
Ok- level of investment –
sustained growth
Limitations
 It does not talk about role of government

 Population growth need not be a depressive factors always

 Quantum of critical minimum investment is not specified

 Based on closed economy model

HARROD- DOMAR MODEL
 2 Economists – Harrod (1939), Domar
 Based on Keynesian framework
 Savings , Investment
 Y =C+S
 Dual role of investment – supply side effect, demand side effect
 Harrod’s model
 Assumptions
 Full employment
 Laissez faire
 Closed economy
 No adjustment lags
 We use net value variables
 MPS = APS
 S=I
 Change in investment leads to changes in capital stock
 Y =f(L,K)
 General price level remains same
 Constancy of Capital Output ratio (K/Y) (cr or v)

 Rate of growth of GDP = Savings / capital output ratio (g=s/cr)

DERIVATION

1. S=I
2. I=∆K
3. Capital output ratio (cr) = ∆K/∆Y
4. ∆Y x cr= ∆K
5. ∆Y x cr =I substitute (2) in (5)
6. ∆Y = I/cr
7. ∆Y = S/cr substitute (1) in (7)
PROBLEMS
 If the savings rate is 10% and the capital output ratio is 2, then a
country would grow rate would be ___________.
 If the savings rate is 8% and the capital output ratio is 4, then the
country would grow at ____ per year.
 Economy's rate of growth depends on:
 The level of national saving (S)
 The productivity of capital investment (this is known as
the capital-output ratio)

 Actual growth rate(Ga)

 Natural growth rate (Gn)= ∆ L/L necessary to maintain full
employment – Gn ( Gn=N where N is GR of population)
 Warranted growth rate (Gw) - to make sure economy does not go
into recession
 Domar’s contribution- Gn
 Equilibrium Ga=Gn=Gw (knife edge , golden edge , razor-edge
equilibrium)
 Disequilibrium Ga>Gw, Ga<Gw
APPLICATION
The H-D model contributes not only to the economic analysis but also
to design economic policy actions
eg. if a country sets a target growth-rate at the 5% and if the capital
output ratio is 3, the level of saving and investment, needed to
insure that growth rate is 15% of GDP
LIMITATIONS

 Domestic savings gap

 Financial system not developed in UDCs

 Capital may be used inefficiently

MYRDAL THESIS (SELF STUDY)
 Authored “Asian Drama”
 Differences in growth of countries between rich and poor
nations
 Explanation of backwardness
 In difference between different countries
 In differences in regions within a same country

 Disequilibrium in economy
 Cumulative Causation - Needed for economy to move from
underdevelopment towards development
 Suppose there are two countries A&B
 Suppose region A develops more
 When Wa>Wb is higher
 There will be labour migration to Region A
 Capital movement to A
 International trade
 Backwash effect -movement of skilled people and
investments, trade - away from backward region – unfavorable
effect due to migration of labour and movement of capital to
developed regions (causes divergence)
 Spread effect – opposite of above, development of suburban and
rural region – new businesses can start – favourable (causes
convergence)
 Backwash effect may be > spread effect

 Dualism in growth is promoted

 Need for state intervention to reduce differences – balanced

regional development
GANDHIAN MODEL (SELF STUDY)
 Social change to be brought by non-violence
 Self-sufficiency - village as a self-sufficient unit
 Salvation of the Indian economy depends on “Rural development”.
Rural development depends on agricultural development, which is the
integration of both, the farm and nonfarm activities of the village
economy. Village “sarvodaya”
 Opposed labour-replacing technology- advocated production by the
masses ( labour intensive technology)
 Balanced growth
 Doctrine of Trusteeship - hold the surplus wealth in trust for society
 Towards a sustainable lifestyle- Sustainable agriculture, Khadi and
village industries are eco friendly, Appropriate technologies, Renewable
energy sources, tree plantation