▪ Classical economics

▪ Adam Smith - Capitalism

▪ Karl Marx & Friedrich Engels – Socialist Revolution
▪ John Maynard Keynes – Middle Way/ Great Depression
▪ The Linear Stages of Growth Models
▪ Structural Change Models
▪ International Dependence Models
▪ Neoclassical Counter-Revolution Models

▪ Contemporary Theories of Economic Development

▪ New Growth Theory
▪ Theory of Coordination Failure
THE LINEAR STAGES OF GROWTH MODELS
▪ The first generation of economic development models was formulated in the early
years after the World War II.
▪ These early models focused on the utility of massive injections of capital to achieve
rapid GDP growth rates.
▪ The two famous models are:
▪ Rostow’s stages growth model
▪ The Harrod–Domar model
▪ The transition from underdevelopment to development would pass through five
stages:
▪ the traditional society
▪ the preconditions for take-off
▪ the take-off
▪ the drive to maturity
▪ the age of high mass consumption.

▪ The decisive stage is the take-off, through which developing countries are
expected to transit from an underdeveloped to a developed state. Increasing rate
of investments is considered to be necessary to induce per-capita growth.
▪ emphasized that the prime mover of the economy is investment.
▪ Every country therefore needs capital to generate investments. The principal
strategies of development from the stage approach were commonly used by
developing countries in the early post-war years. With a target growth rate, the
required saving rate can then be known. If domestic savings were not sufficient,
foreign savings would be mobilized.
STRUCTURAL CHANGE MODELS
▪ During most of the 1960s and early 1970s, economists generally described the
development process as structural change by which the reallocation of labor from
the agricultural sector to the industrial sector is considered the key source for
economic growth.
▪ Two well-known representatives of this approach are:
▪ the two-sector model (Lewis 1954)
▪ the structural change and patterns of development
▪ Labor increasingly moves away from the agricultural sector to the industrial sector.
However, with unlimited supply of labor from the traditional sector, these
transferred workers continually received only subsistence wages. The excess of
modern sector profits over wages and hence investments in the modern sector
continued to expand and generate further economic growth on the assumption that
all profits would be reinvested. Both labor transfer and modern sector employment
growth were in turn brought about by output expansion in that sector. This process
of modern sector self-sustaining growth and employment expansion facilitated the
structural transformation from a traditional subsistence economy to a more modern
developed economy to take place.
▪ The Lewis model considered savings and investments to be the driving forces of
economic development but in the context of the less developed countries.
However, several Lewis’ assumptions are not valid such as those relating to rural
surplus labor, and the proportional rate of expansion in capital accumulation in the
modern sector
▪ The analysis identified that the steady accumulation of physical and human capital
is among conditions necessary for economic growth, apart from savings and
investments.
▪ Moreover, the structural changes occurred not only in the two sectors but also in all
economic functions, including the change in consumer demand from an emphasis
on food and basic necessities to desires for diverse manufactured goods and
services, international trade and resource use as well as changes in socioeconomic
factors such as urbanization and the growth and distribution of a country’s
population.
INTERNATIONAL DEPENDENCE MODELS
▪ The international dependence theory was very popular in the 1970s and early
1980s.
▪ The dependence theorists argued that underdevelopment exists because of the
dominance of developed countries and multinational corporations over developing
countries. The theory is considered an extension of Marxist theory.
▪ The poor countries are said to be dependent on the developed countries for
market and capital. However, developing countries received a very small portion of
the benefits that the dependent relationship brought about. The unequal exchange,
in terms of trade against poor countries, made free trade a convenient vehicle of
“exploitation” for the developed countries.
▪ Developed countries can exploit national resources of developing countries
through getting cheap supply of food and raw materials. Meanwhile, poor countries
are unable to control the distribution of the value added to the products traded
between themselves and the developed countries.
▪ The growth of international capitalism and multinational corporations caused poor
countries to be further exploited and more dependent on the developed countries.
Poor countries therefore could not expect sustained growth from that dependence.
Following the international dependence theory, developing countries should
therefore end the dependence by breaking up their relationships with the
developed world, as well as by closing their doors on the developed countries
NEOCLASSICAL COUNTER-REVOLUTION
MODELS
▪ In the 1980s, neoclassical counter-revolution economists used three approaches,
namely the free market approach, the new political economy approach and the
market-friendly approach, to counter the international dependence model. In
contrast with the international dependence model, these approaches mainly
argued that underdevelopment is not the result of the predatory activities of the
developed countries and the international agencies but was rather caused by the
domestic issues arising from heavy state intervention such as poor resource
allocation, government-induced price distortions and corruption.
▪ As a response to public sector inefficiency, economists of the counter-revolution
thinking, for example Bauer (1984), Lal (1983), Johnson (1971), and Little (1982),
focused on promoting free markets, eliminating government-imposed distortions
associated with protectionism, subsidies and public ownership
▪ Neoclassical economists focused on the market to find a way out for the developing
countries. Policies of liberalization, stabilization and privatization therefore become
the central elements of the national development agenda. Foreign trade, private
international investments and foreign aid flowing into the developing countries are
expected to accelerate economic efficiency and economic growth of these
countries. Empirically, the models, however, did not bring about the expected
results
CONTEMPORARY THEORIES
OF ECONOMIC DEVELOPMENT
NEW GROWTH THEORY
▪ the new growth theory emerged in the 1990s to explain the poor performance of
many less developed countries, which have implemented policies as prescribed in
neoclassical theories.
▪ New growth theorists (Romer 1986; Lucas 1988; Aghion and Howitt 1992) linked the
technological change to the production of knowledge. The new growth theory
emphasizes that economic growth results from increasing returns to the use of
knowledge rather than labor and capital. The theory argues that the higher rate of
returns as expected in the Solow model is greatly eroded by lower levels of
complementary investments in human capital (education), infrastructure, or
research and development (R&D).
▪ Meanwhile, knowledge is different from other economic goods because of its
possibility to grow boundlessly. Knowledge or innovation can be reused at zero
additional cost. Investments in knowledge creation therefore can bring about
sustained growth. Moreover, the knowledge could create the spill over benefits to
other firms once they obtained the knowledge. However, markets failed to produce
enough knowledge because individuals cannot capture all of the gains associated
with creating new knowledge by their own investments. Policy intervention is thus
considered necessary to influence growth in the long term. The new growth models
therefore promote the role of government and public policies in complementary
investments in human capital formation and the encouragement of foreign private
investments in knowledge-intensive industries such as computer software and
telecommunications
THEORY OF COORDINATION FAILURE
▪ The foundation of the theory of coordination failure is the idea that the market may
fail to achieve coordination among complementary activities.
▪ When complementaries exist, that is when returns of one investment depend on
the presence or extent of other investments, there exist two scenarios. On the one
hand, optimally, all investors as a whole are better off with all investments to be
achieved at the same time. On the other hand, it would not make sense for an
investor to take similar actions when he believes that others may not do the same
as well. The market is said to have failed to coordinate investors’ actions in this way.
Coordination failure therefore leads the market to an (equilibrium) outcome
inferior to a potential situation in which resources would be optimally allocated
and all agents would be better off. As a result, underdevelopment equilibrium is
possible
▪ In order to reach an optimal level of coordination, the policy they recommended
was a “big push”—a public-led massive investment program— which can cause
complementarities to take place in the rest of the economy. Like other early
development models, “big push” strategies ran out of favor when the world
witnessed the collapse of centrally planned economies and the slow growth,
stagnation or worst results of state-led industrialization in the underdeveloped
countries
▪ The coordination failure among many different individuals lead the economy to
multiple equilibrium, but not all of them are good for every member of the
economy, and some in fact are very undesirable. As a result, the market fails to
coordinate everyone to achieve the optimal equilibrium.
▪ In a market mechanism, there are uncertainties that a good equilibrium can be
obtained. A bad equilibrium can exist when firms have pessimistic expectations
and thus show their reluctance to invest, and consequently fail to coordinate their
businesses.
▪ The existence of coordination failure cannot therefore be disputed and has become
important. When the market mechanism does not work, the active roles of the
government need to be highlighted. According to coordination failure economists,
in the multiple equilibrium circumstances described above, the government can
coordinate firms to move them into the domain of good equilibrium.
▪ The review of the literature shows that there is increasingly a consensus that
economic development is a multidimensional process that involves interactions
among different goals of development and therefore would require systematically
designed policies and strategies. Development issues are complex and
multifaceted. There is no one single pathway for economic development that all
countries can pursue. In the long term, the economic development process
requires changes in policies to account for new emerging factors and trends.
Designing these economic development policies also need to take into
consideration the social, cultural, political systems and institutions as well as their
changing interaction over time in a country