Chapter 3

Classic Theories
of Economic
Growth and
Development

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3.1 Classic Theories of Economic
Development: Four Approaches

• Linear stages of growth model

• Theories and Patterns of structural change
• International-dependence revolution
• Neoclassical, free market counterrevolution
3.1 Classic Theories of Economic
Development: Four Approaches

❑ Literature on economic development has been dominated

by four major strands of thought:
✓ Linear stages of growth model -Theorists in 1950s and 1960s
viewed the process of development as a series of successive stages of
economic growth that all countries must pass ( economic theory of
development in which the right quantity and mixture of saving, investment, and
foreign aid were all that was necessary to enable developing nations to
proceed along an economic growth path that developed countries had
followed). Development thus became synonymous with rapid, aggregate
economic growth.
 ✓ Theories and Patterns of structural change -This linear-stages
approach was replaced in the 1970s by two competing schools of
thought. The first, which focused on theories and patterns of
structural change, used 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 it is
to succeed in generating and sustaining rapid economic growth.

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 ✓ International-dependence revolution - more radical and more political. It
viewed 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.
▪ Dependence theories tended to emphasize external and internal institutional
and political constraints on economic development. Emphasis was placed on
the need for major new policies to eradicate poverty, to provide more
diversified employment opportunities, and to reduce income inequalities. These
objectives were to be achieved within the context of a growing economy.

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✓ Neoclassical, free market counterrevolution- Throughout much of the
1980s and 1990s, a fourth approach prevailed. This neoclassical
(sometimes called neoliberal) counterrevolution in economic thought
emphasized the beneficial role of free markets, open economies, and the
privatization of inefficient public enterprises. Failure to develop,
according to this theory, was not due to exploitive external and internal
forces as expounded by dependence theorists. Rather, it was primarily
the result of too much government intervention and regulation of the
economy.

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Class Theories of Economic
Development – Four Approaches
• Structural change model
– Linear stages of growth
– Saving-investment
– Rural-urban migration

• Neocolonial dependence theory

– Dependence: Center vs. Periphery
– False Paradigm

• Neoclassical theory
– Market friendly approach
– Dualistic approach
– Public choice approach

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Rostow’s Linear-Stages Model

1. Traditional society
2. Pre-condition to take-off
3. Take-off
4. Drive to maturity
5. Age of high mass consumption

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Rostow’s Linear-Stages Model

1. Traditional society: slow economic and

population growth

2. Pre-condition to take-off: development of

institutions, organizations, and
infrastructure

3.Take-off: large investment in selected

industry (10 to 15% of GDP)

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 Rostow’s Linear-Stages Model

4. Drive to maturity: sustained growth of the

industry and economy

5. Age of high mass consumption:

production of consumer goods and
services to serve an affluent society

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Rostow’s Linear-Stages Model – countries
can be identified within one of the 5 stages

developed countries are in

GDP Growth the self-sustaining stage
Economic Growth

Post Take-off

Take-off

Pre Take-off

t1 t2 Time

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Harrod-Domar Growth Model

S = sY S=Saving; Y=Real GDP; s=Saving Ratio

I = ΔK I=Investment; ΔK=Capital Accumulation

S=I Saving-Investment identity

Define the Marginal Capital-Output Ratio as k = ΔK/ΔY

Write ΔK = kΔY or I = kΔY

From S = I, write sY = kΔY or ΔY/Y = s/k

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 Harrod-Domar Growth Model
The source of growth is saving and investment in
production of goods and services. Accordingly,

GDP growth rate = s/k

s = national saving ratio; k = marginal capital-output ratio

If s=6% and k=3, then GDP growth rate=2%. Given k=3,

to raise growth rate to 4%, we need to increase the saving
ratio from 6% to 12% with 6% of foreign saving

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Criticism of Investment Models

• Many LDCs have not been able to take-off

or achieve maturity despite massive
foreign investment

• Many nations have neglected the

development of institutions, organizations,
and infrastructure required for
industrialization

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The Lewis Development Model
• Rural agricultural sector
– Low or even zero Marginal Product of Labor so that
labor is a redundant factor and wage rate is at the
subsistence level

• Urban industrial sector

– Rising demand for unskilled labor to be trained for
industrial growth results in greater employment and
more profits and higher wages

• Rural-Urban migration
– To find jobs and earn higher wages
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 Demand for Labor

Wage
R: Rural U: Urban
W: Wage E: Employment
D: Labor Demand S: Labor Supply

Profit
WU SR
WR
Investment in urban areas
Wage
increases the demand and
DU1 DU2 employment for rural labor.

E1 E2 Employment

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 Criticisms of Lewis Model

• Industrial technology is generally capital

intensive/labor-saving. Hence, the demand
for unskilled rural labor would not increase
employment

• Industrialization must be supported by

agricultural development to supply an
ever-increasing supply of food items and
raw materials

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Demand for Labor

Wage No increase in employment when

technology is labor saving

Profit
SR
WU
WR Wage
DU1
DU2
E1 = E2 Employment

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Neocolonial Dependence Model

• MDCs form the “center” of global economic

relations and technological advancement

• LDCs serving as the “periphery” are dominated by:

– unequal trade and finance relations
– domestic politico-economic elite
– multinational corporations

Under these conditions economic development is

impossible

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Neocolonial Dependence Model

African LDCS

Asian LDCS American

MDCs
Latin American LDCS
European Other
MDCs MDCs

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False-Paradigm Model

• Economic development relies heavily on funds

from international donor agencies such as the
World Bank and IMF

• The policy of these agencies is to support urban

industrial growth and impose capitalistic
austerity measures

• They reinforce the pattern of “dependent

development”
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 Dualistic Development Model

• Structural transformation models create a

“dualistic” pattern of development, resulting in an
ever-increasing degree of economic inequality
both nationally and internationally:

– urban vs. rural

– industrial vs. agricultural
– modern vs. traditional
– rich vs. poor

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Approaches to Development

• Free-market approach: rely of the allocation role

of markets and limited government involvement in
economics. But, there are several areas in which
markets fail to achieve efficient outcomes:

– income distribution
– public goods
– externalities
– market power

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 Approaches to Development

• Market-friendly approach: improve market

operation through “nonselective”
interventions such as

– income redistribution system

– investment in social and human capital
– environmental protection policy
– anti-trust laws

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Approaches to Development

• Public-choice approach: public officials and

bureaucrats in the position of authority are
“rent-seeking” citizens acting on self-interest
rather than public-interest

• Need a system of checks and balances to monitor

the behavior of public officials and bureaucrats

• Need a democratic system to let people choose

public officials and bureaucrats for limited duration
of authority

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Appendix 3.1: Components of
Economic Growth
• Capital Formation

– Physical capital formation: investment in tools,

equipment, machinery, buildings

– Social capital formation: investment in roads, dams,

airports, railroads, bridges

– Human capital formation: investment in education,

training, health, nutrition

– Political capital formation: investment is creating a

secular and democratic government and free mass
media
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Determinants of Economic
Growth

• Physical Capital Formation

– Increase in the amount of physical

capital per unit of labor

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Determinants of Economic
Growth

• Technological Advancement

– Increase factor productivity (labor,

land, capital)

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 Production Possibilities Curve

• Maximum quantities of two good and

services the economy can produce,
assuming:

– full employment / efficiency

– fixed resources
– constant technology

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PPC Schedule

Combination A B C E
100 90 50 0
Radios

Rice 0 40 80 100

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PPC Graph

Combinations A, B, C, and E are attainable

Combination D is unattainable given resources
Radios and technology
Combination F is attainable, but inefficient
A
100
B D
90
50 C
F

E
40 80 100 Rice

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Economic Growth

Combination D becomes available with

Radios more resources and better technology
A
100
B D
90
50 C

E
40 80 100 Rice

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 Economic Improvement

Radios Combinations G (or B or C) becomes

efficient with more employment
A and/or improved efficiency
100
B
90
G
50 C
F

E
40 80 100 Rice

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Technological Advancement

Neutral: proportional increase in the supply of Rice and Radios

Radios

Rice
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Technological Advancement

Capital augmenting: greater increase in the supply of Radios

Radios

Rice
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Technological Advancement

Labor augmenting: greater increase in the supply of Rice

Radios

Rice

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Technological Advancement

Advancement only in agricultural production

Radios

Rice

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Technological Advancement

Radios Advancement only in industrial production

Rice

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Factor Accumulation Accounts for
Only a Fraction of Growth

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