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Study Guide in SSE 108 Comparative Economic Planning Module No. 4

STUDY GUIDE FOR MODULE NO. 4

A Comparison of Development Theories

MODULE OVERVIEW

Module IV deals with the economic development theories and focused on growth, stages and
requirements. Due to different views on this matter, it is essential to go over the more popularly accepted ideas
in order to have a fair knowledge of the subject and be able to penetrate the ideas of even the lesser known
economic theorist.

MODULE LEARNING OBJECTIVES

At the end of the semester, the students will be able to:

a. compare and contrast the different theories of development; and

b. identify some strengths as well as weaknesses of each of the different theories.

Definition of Theory

A theory is an attempt to define a relationship of factors which give rise to a particular condition.

It is a statement about the behaviour of dependent variables under a given set of assumed behaviour
or movement of one or several independent variables that can influence the motion of the dependent variables.

It is a concept of interaction that is expected to bring about a predictable outcome.

The Need for Theory

A theory is necessary in the discussion of a situation because it guides the discussant towards a
conclusion.

The behaviour of factors acquires meaning only when they are held against a theoretical framework
otherwise their movement might be considered independent and unrelated to each other (Cairncross, 1965).

The formulation of a theory is essential to the establishment of a law or principle through repeated and
precise relationship of the factors taken into consideration.

Nature of Economic Theory

Economic theory is the application of the logical relationships of dependent and independent variables
in economics that result in some predictable outcomes.

It is the statement of the relationship of economic factors as observed in the real world and which may
be applied under assumed conditions (Kindleberger, 1965).

It is the framework of an analysis of economic conditions that can be said to produce a certain result.

Theory of Development Stages

The theory of economic development has borrowed much from economic history in the formulation of
theory. This is specially so in the case of thinkers who conceptualized the development process as a series of
stages through which an economy passes as it moves towards maturity (Gill, 1965). The most prominent ideas
on the stages of economic development comes from Walt Whitman Rostow who divided the development
stages into five as follows:

1. Traditional Society. This is the situation in a society wherein the people depend upon land as basic

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resources for their livelihood and where the production techniques are more or less the same for many years.
Diminishing returns from farming takes place as the population grows. As a result, production is marginal,
meaning that output values tend to be only equal to inputs so that households could produce only equal to their
basic needs. Very little or no savings is accumulated for investment purposes (Kindleberg, 1965).

2. Precondition Stage. This is an awakening stage when new methods of production are adopted and
society begins to put up its infrastructure for better growth. The spreading out of markets and the improvements
in industry and agriculture make for the transformation of the economy. This stage is the result of a jolting effect
on the economy by education, war or the inflow of foreign technology. This stage is made possible by the
consciousness for capital formation through saving and use of available credit from the growing credit
institutions (Samuelson, 1985).

3. Take-off Stage. This is the stage of acceleration of economic activity in the economy. By this time
the productive activity has expanded through technological change and increased investment. At the same time,
employment is high and the domestic and foreign markets are being fully developed. So rapid is the change
taking place at this stage that education and training must be stepped up to provide the manpower requirement
for the changes and expansion of trade, industry and agriculture. At the same time the total value of goods and
services produced in the economy is sustained at seven (7) per cent per annum. Way above the annual
population growth rate.

4. Drive to Maturity Stage. This stage is the period of rapid technological change, introduction of new
management methods, expansion of international trade and extensive use of credit. The growth of the economy
is rapid with high employment level and high income. Saving is plowed back to investment. By this time the
factors of growth had taken roots. Mass consciousness is directed towards innovation and invention in order to
push production growth up to maturity when the growth is entrenched.

5. High Mass Consumption Stage. The benefits of specialization and automation bring about a high
level of income to the population thus giving them access to an abundance of consumption of goods. Society
begins to look towards enjoyment of leisure rather than hard-nosed economic struggle. At this point, education
for professional training is emphasized to meet the needs of society with its high technology and complex
business organization. The world market becomes the target for domestic production which has already become
very large. Where production used to emphasize consumption goods, the productive capacity is now directed
at durable foods. The concern of society shifts from growth to the correction of policy and strategy lapses in
order to maintain growth (Todaro, 1977).

Adam Smith and the Wealth of Nations

The theory on economic growth which has an encompassing scope even if it lacks the mechanics of
analysis is that of Adam Smith who wrote the Wealth of Nations. He pointed out that a country will grow
economically if the people would accumulate capital via domestic savings and gains from trade (Hierschman,
1958). The increase in productivity can be made more intensive as more units are required to be produced for
a bigger market. When laissez faire or free enterprise prevails, the resources of the country are allocated into
efficient uses by what Adam Smith referred to as an “invisible hand in the economy”. Smith advocated minimal
intervention by the government in production, so that enterprise can guide them in attaining the economies of
scale by producing at optimum level under a given set of fixed and variable production factors. The wealth of a
nation according to Smith is in its enterprise development, labor productivity and capital formation (Kindleberger,
1965).

David Ricardo and the Limits of Growth

According to David Ricardo, the economy will continue to grow for as long as people work the land on
profitable basis so that profit for the entrepreneurs and the wages for labor would result in accumulated saving
which in turn can be used for capital formation. However, Ricardo theorized that as more people worked the
diminishing available land area, the land would produce less through overuse and crowding. Thus Ricardo
concluded that it is not profitable to work land that will only produce the equivalent of whatever has been spent
on production and that returns will later on diminish. Ricardo presented the idea that a point will be reached
when the return to labor will be at a subsistence level so that level shall not be able to contribute to capital
formation. Ricardo was an economist of gloom. (Chenery and Srinivasan, 1988).

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T. R. Malthus and the Population Theory

The Malthusian theory indicates that as population grows, food production can cope less and less with
the food requirement of society so that the quality of life will fall. No saving can be generated by the masses
because they will have subsistence wages (Myrdal, 1957). Malthus assumed that land is of the same quality
and that the ratio of people to land would account for reduced quantity of food. Under this theory, the growth of
the economy would depend on providing an optimal land-labor ratio but this will only be true in the short-run.
Thus, Malthus advocated for the addition of capital and labor to the point at which the marginal product of the
input is zero. Beyond this point, the economic activity is negatively reactive so new land must be secured and
the population level be managed at its lower limit. Malthusian theory finds support among those who believe
that population growth will ultimately lead to the starvation of the human race unless population growth will
ultimately lead to the starvation of the human race unless population growth is checked.

John Maynard Keynes and the General Theory

Keynesian theory was applied with remarkable success in awakening the United States economy in the
early 1930’s after it collapsed in the Depression of 1929 (Dillard, 1965). The theory holds that the economy can
be stabilized and stirred to grow by injecting income into the economy which will in turn spur new productive
efforts among the enterprises. At the same time the public sector can provide new investments to offset the
savings that were not invested. This meant compensatory spending to remedy a deflation. In the case of the
United States, the massive public projects of the Tennessee Valley Authority, was to pump prime the economy.
This was to activate the motionless economic capacity that was at rest. It raised the level of employment and
income, which in turn caused the flow of money and credit into the productive stream.

The Harrod-Domar Model

Working separately, R. F. Harrod and E. D. Domar came up with similar theoretical formulation for
economic growth which was called for in the economic development of a battered Europe after World War II
and in the emergent economies in Africa and Asia. This theory emphasized that growth is determined by the
capital-output ratio and the marginal propensity to save. According to this theory, savings lead to investment
which in turn leads to increase in income, and leads to more savings, and so goes the cycle. The rate of per
capita growth in the economy less the rate population growth would give the rate of growth of income. One
critical assumption of this theory is that savings and investment are equal (Hagen, 1965).

Schumpeter’s Theory of Technological Change

J. A. Schumpeter placed emphasis on the role of the entrepreneur as an innovator in the development
of the business organization and of the economy. However, he viewed the entrepreneur as one who should
give way to a bureaucratic manager who should employ the existing resources through new ways of doing
things. To him, the economy should not only take technological change a central strategy. He specifically
referred to the development of labor-saving and capital-saving innovations. He theorized that the development
of the business organization and the economy is dependent on the chain of innovations that can be produced
(pack, 1986).

Criticisms of Theories and Models

Theories and models have been based upon empirical data taken in the past and many therefore have
little relevance to the present due to the changes in political-economic policy and to technological change.

They sometimes concentrate on the factors favoured by the proponent as influenced by his background,
experience and environment at the time of theoretical formulation.

The economy is too complex so that a theory or model can deal only with a limited number of variables
which might be considered vital but which might exclude a particular variable that is crucial in the case of a
specific economic situation.

Weaknesses of Theories and Models

W. W. Rostow’s theory of economic stages suffers from being a mere historical description which cannot

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be used for development planning purposes.

Adam Smith’s idea that laissez faire would enable the “invisible hand” to allocate the resources
efficiently in the economy precludes the active participation of government in giving direction to the economy.
The economy might grow without regard for the spread of benefits to the lower income groups.

David Ricardo’s theory is that the availability of land defines the limits of development. He assumed
that the economy is basically agricultural so that a country with less land as resource would not be able to
develop. This idea has been proved wrong by the emergence of developed economies despite scarcity of land
area. Ricardo’s idea of comparative advantage by one country over another in production has however clarified
why international trade should be promoted.

The population theory of T. R. Malthus could be right in the ultimate sense when overpopulation could
lead to falling quality of life but it is weak in its contemporary application because it denies the development of
new technologies that have enhanced agricultural productivity. Furthermore, the Malthusian theory did not
consider the flow of food supply in international trade and the inception of policies to manage population levels
in the countries of the world (Myrdal, 1970).

John Maynard Keynes’ theory that stability at less than full employment is feasible through the
application of government spending to supplement the short-fall of investment by the private sector in the event
of a recession is only applicable when the economy has the infrastructure for production and what is needed is
merely to activate the economy by pump priming or by compensatory public spending. This is not however
applicable in the underdeveloped country where the economy lacks the requisites for heightened economic
activity. Publicly funded projects designed to stir the income stream cannot result in capital formation in a poor
country (Dillard, 1965).

The Harrod-Domar model is basically inaccurate in its assumption that capital formation is a function of
saving and the propensity to save is determinant as to how much the growth rate will be. In a real-world situation,
savings are not equal to investments because of hoarding or because of capital flight, which is sending out
savings to other countries for reasons that are very personal to the savers.

J. A. Schumpeter’s theory that economic growth can be maintained by a country through a constant
flow of innovations and changes in technology assumes that the changes are feasible. However, there can be
time lag between innovations and there are countries which cannot afford to keep pace with the need to change
technology because they do not have the capacity to acquire the capital goods. They may, as in the under-
developed countries where there is cheap labor, opt to produce on labor intensive basis.

Other Theories and Concepts on Economic Development

Trickle-Down Theory

It is generally believed by many economic thinkers that the benefits of development will drip down from
the higher income groups to the masses so there is no need to plan for growth with redistribution. The trickling
down of benefits will ensure from the need for labor by the entrepreneurial group who will compete among
themselves for the scarce skilled manpower. This theory does not however hold true because there are
countries where the socio-economic system is biased against maximizing the benefits of the labor group or
where the tax system is not progressive enough to shift economic power to the government which can in turn
provide economic power to the government which can in turn provide services to the masses. (Bauer and
Yamey, 1960).

Theory of the Vicious Circle of Poverty

It is held that a poor country has little capital. Because of this, it can invest little and can therefore have
little production. Due to little production, employment is less and so income is low. Because income is low, there
is little saving and little capital. Thus, the country remains poor. This theory is one that makes economics a
dismal science in the view of the Third World people. Fortunately, the theory is not iron-clad. It can be broken
through the injection of capital from foreign sources.

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The Debt Trap Theory

According to this theory, there is a limit to how much a country can borrow from other countries and the
international lending institutions. Beyond that limit, the burden will be so heavy that the repayment problem will
be pervasive. The piling up of unpaid interest will make the debt awesomely heavy so that the country cannot
ever be out of debt as if in a trap. This theory does not take into consideration that lenders may condone the
debt, restructure it, or that the debtor may unilaterally repudiate its own indebtedness through a change of
government.

Balanced Growth Theory

Many economists believe that a country should balance its development of its agricultural, commercial
and industrial sectors so that it can avoid complications such as the loss of the agricultural base through sudden
shift to industrialization, slow growth through over-emphasis of agricultural production, and failure to find the
markets to match the growth of agriculture and industry (Mowery and Rosenberg, 1989). This theory has been
proven inoperative in the case of countries that developed mainly on the agricultural base like New Zealand; or
only on the industrial base like Singapore and Hong Kong (Wade, 1990).

Import Substitution Theory

This theory emphasizes that a country that wants to develop should manufacture or produce those
items that the economy imports from other countries otherwise it shall remain as an importing country with the
consequent effect of promoting the growth of exporting countries otherwise it shall remain as an importing
country with the consequent effect of promoting the growth of exporting countries while neglecting its own
(Staley, 1963). Furthermore, the theory suggests that import substitution conserves the foreign exchange
reserves of the country for the more important import of capital goods. This theory, however, ignores the reality
that in import substitution, the country may be forcing itself to produce goods for which it has no comparative
advantage and that the more important rationale is to be able to export so that there can be earnings to finance
imports (Staley, 1963).

Manpower Development Theory

Some economists maintain that the development of a country depends upon its manpower skills and in
the general education of the population. They stress that the most fundamental resource is manpower which
can translate its capacity to productivity and economic development of the country as had been demonstrated
by the newly industrialized countries like South Korea and Taiwan. This theory, however, does not take into
consideration the fact that development in those countries were due to investments and job creation. In the
Philippines, high literacy and manpower development did not result in economic development because job
creation was slow (7-E-S, 1972).

Kaldor Model

Nicholas Kaldor contented that there is rigidity in technology. He said that new investments are required
to change technology. He said that new investments, not time determines technological change for higher
production and development. He contented that more investments will lead to more technological change and
consequently to more investment. In Kaldor’s view, the growth rate for capital investments in the economy, the
total output and the productivity of labor are equal. He ignored the fact that when there is a very high level of
investment, the efficiency of capital will be less as seen in a lower capital-output ratio.

Sustainable Development Theory

This is directed at maintaining a balance between preserving the environment on one hand and
enhancing the productivity of agriculture and industry on the other. This developmental theory is supposed to
be applicable to a country and to the whole world. It condemns the pollution brought about by industry,
degradation resulting from agriculture and waste accumulation through consumption. The difficulty to adhere to
this concept is because the poor countries where the masses suffer from environmental degradation cannot
help but aggravate the destruction of the environment because they must survive. Moreover, the economically
advanced countries can go so far as to dump their industrial waste, including radio active waste, including
radioactive waste, in the less developed countries for a price. The increasing cost of providing environment

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friendly technology has placed upon the less developed countries some added burden in their development
efforts so that the quest for sustainable development may be observed in the breach rather that in compliance
among the countries that cannot afford the environment preservation costs.

Economic Development Theory and Policy

Policy-making in the economic development effort of a country has to be based upon a theory. Policy
direction will require a number of enabling legislations. When there is no theory of development being followed,
the direction will be unclear and it will therefore be difficult to obtain the needed legislation. Economic
development is in the realm of political economy so that essential legislations have to be passed. It is the
executive branch that must convince the legislature that the policy proposed is based on a sound theory of
development. Although the theory is not infallible, it must be defensible in the light of the existing economic
situation. Policies affecting investments, credit, taxation, labor, infrastructure, education, land use,
transportation, international trade, technology and international relations have bearing upon economic
development. These are more easily clarified and understood when explained against the theoretical
background that the leadership has adopted (Myinth, 1965)

Policies are needed to establish and fortify the poles of development which are strong points of growth.
The pole of growth in Japan was general innovation. The automotive industry was general innovation. The
automotive industry was the pole of growth in the United States. When theory relates to the pole of development,
the policy becomes clear.

LEARNING ACTIVITY 1

1. How does a theory help in discussing the probable outcome of an economic action?
2. How does the anchorage of policy upon a theory facilitate getting the needed legislation?

SUMMARY

Economic theory is the statement of the relationship of economic factors as observed in the real world
and which may be applied under assumed conditions (Kindleberger, 1965). The most prominent ideas on the
stages of economic development comes from Walt Whitman Rostow who divided the development stages into
five as follows: a) Traditional Society, b) Precondition Stage, c) Take-off Stage, d) Drive to Maturity Stage, and
e) High Mass Consumption Stage.

In addition, there are prominent economists who introduced important economic growth theories like
Adam Smith and his Wealth of Nations, David Ricardo and his Limits of Growth; T. R. Malthus and his Population
Theory; John Maynard Keynes and his General Theory, and Schumpeter’s Theory of Technological Change,
However, these theories and models encountered criticisms and weaknesses.

Furthermore, there are other theories and concepts on economic development such as Trickle-Down
Theory, Theory of the Vicious Circle of Poverty, Debt Trap Theory, Balanced Growth Theory, Import Substitution
Theory, Manpower Development Theory, Kaldor Model and Sustainable Development Theory.

You have to take note that policy-making in the economic development effort of a country has to be based
upon a theory and policy direction will require a number of enabling legislations

REFERENCES

Azanza, Patrick Alain, et.al. 2000. Economics, Society and Development. Philippines. Kayumanggi Press, Inc.

Fajardo, Feliciano. 1990. Economics. Quezon City. Rex Book Store.

Miranda, Gregorio S. 2001. Introductory Economics. L & G Business House.

Sicat, Gerardo P. 2003. Macroeconomics. Manila. Anvil Publishing, Inc.

Todaro, Michael P. 2000. Economic Development. Philippines: Pearson Education Ltd.

Vibar, Teofista et. al. 1998. Economics: Theories and Principles. Quezon City, Vibal Publishing House, Inc.

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