CHAPTER: 4

CLASSIC THEORIES OF ECONOMIC

GROWTH AND DEVELOPMENT

Dr . Shereen Ahmed Abdallah

Main points:
 4.1 Classic Theories of Economic Development:
 4.2 Development as Growth and Linear-Stages Theories:
 4.3 Structural-Change Models
(The Lewis Theory of Economic Development)
 4.4 The International-Dependence Revolution
 4.5 The Solow neoclassical growth model
 4.6 Components of Economic Growth
4.1 Classic Theories of Economic Development:

 Linear stages of growth model.

 Structural-Change Models

 International-dependence revolution.

 The Solow neoclassical growth model

4.2 Development as Growth and Linear-Stages
Theories:

 A) A Classic Statement: Rostow’s Stages

of Growth
 B) Harrod-Domar Growth Model
(sometimes referred to as the AK model)
1- Linear stages of growth model
A) Rostow’s Stages of Growth:
 The most influential and outspoken advocate of the

stages of growth model was the American

ecomomic historian Walt W. Rostow .
 The transition from underdevelopment to

development can be described in terms of a series

steps or stages through which all countries must
proceed.
Rostow’s Stages of Growth:
 The stage of growth model of
development :
 1- the traditional society.
 2- the preconditions for takeoff into self-
sustaining growth .
 3-the take off.
 4- the drive to maturity .
 5- the age of high mass consumption .
Rostow’s Stages of Growth:
 The advanced countries had all
passed the stage of “ take off into
self-sustaining growth “ and the
underdeveloped countries that were
still in either the traditional society
or the preconditions stage had only
to follow a certain set of rules of
development to take off in their turn
into self-sustaining growth .
 One of the principal strategies of
development necessary for any takeoff
was the mobilization of domestic and
foreign saving in order to generate
sufficient investment to accelerate
economic growth.
 The economic mechanism by which
more investment leads to more growth
can be described in terms of the
Harrod-Domar growth model
B)The Harrod-Domar growth Model:

 For all countries to grow, new

investment represent net
additions to the capital stock are
necessary and we assume There
is a direct relationship between
GDP (Y ) & Capital stock (K).
B)The Harrod-Domar growth Model:

 The famous equation in the Harrod-Domar theory of

economic growth, states simply that the rate of growth of
GDP (ΔY>Y) is determined jointly by:
 1- The net national savings ratio, s, and
 2- the national capital-output ratio, c.
 More specifically, it says that in the absence of
government, the growth rate of national income will be
directly or positively related to the savings ratio (i.e., the
more an economy is able to save—and invest—out of a
given GDP, the greater the growth of that GDP will be)
 and inversely or negatively related to the economy’s
capital-output ratio (i.e., the higher c is, the lower the
rate of GDP growth will be).
Criticisms of the Stages
Model
 More savings and investment is a necessary
condition for increasing rate of economic
growth but rather it is not sufficient condition
.
 There must be the necessary structural,
institutional, and attitudinal conditions (e.g.,
well-integrated commodity and money
markets, highly developed transport
facilities, a well-trained and educated
workforce, the motivation to succeed, an
efficient government bureaucracy)
4.3 Structural-Change Models
(The Lewis Theory of Economic Development)

 Structural-change theory focuses on the

mechanism by which underdeveloped
economies transform their domestic economic
structures from a heavy emphasis on
traditional subsistence agriculture to a more
modern, more urbanized, and more industrially
diverse manufacturing and service economy.
 one well-known representative example of the
structural-change approach is the “two-sector
surplus labor” theoretical model of W. Arthur
Lewis
(The Lewis Theory of Economic Development)

 Lewis two-sector model A theory of

development in which surplus labor from
the traditional agricultural sector is
transferred to the modern industrial
sector, the growth of which absorbs the
surplus labor, promotes industrialization,
and stimulates sustained development.
 Surplus labor The excess supply of
labor over and above the quantity
demanded at the going free-market
wage rate. In the Lewis two-sector model
of economic development, surplus labor
refers to the portion of the rural labor
force whose marginal productivity is zero
or negative.
 In the Lewis model, the underdeveloped economy consists
of two sectors: a traditional, overpopulated, rural
subsistence sector characterized by zero marginal labor
productivity—a situation that permits Lewis to classify this
as surplus labor in the sense that it can be withdrawn
from the traditional agricultural sector without any loss of
output—and a high-productivity modern, urban industrial
sector into which labor from the subsistence sector is
gradually transferred.
 The primary focus of the model is on both the process of
labor transfer and the growth of output and employment in
the modern sector. Both labor transfer and modernsector
employment growth are brought about by output
expansion in that sector. The speed with which this
expansion occurs is determined by the rate of industrial
investment and capital accumulation in the modern sector.
 Such investment is made possible by the excess of
modern-sector profits over wages on the assumption that
capitalists reinvest all their profits.
 Finally, Lewis assumed that the level of wages in the
urban industrial sector was constant, determined as a
given premium over a fixed average subsistence level of
wages in the traditional agricultural sector. At the
constant urban wage, the supply curve of rural labor to
the modern sector is considered to be perfectly elastic.
 Lewis makes two assumptions about the traditional
sector. First, there is surplus labor in the sense that MPLA
is zero, and second, all rural workers share equally in the
output so that the rural real wage is determined by the
average and not the marginal product of labor (as will be
the case in the modern sector).
 This process of modern-sector self-sustaining growth
and employment expansion is assumed to continue until
all surplus rural labor is absorbed in the new industrial
sector. Thereafter, additional workers can be withdrawn
from the agricultural sector only at a higher cost of lost
food production because the declining labor-to-land ratio
means that the marginal product of rural labor is no longer
zero.
 This is known as the “Lewis turning point.” Thus, the labor
supply curve becomes positively sloped as modern-sector
wages and employment continue to grow. The structural
transformation of the economy will have taken place, with
the balance of economic activity shifting from traditional
rural agriculture to modern urban industry.
Criticisms of the Lewis
Model
 Although the Lewis two-sector
development model is simple and
roughly reflects the historical experience
of economic growth in the West, four of
its key assumptions do not fit the
institutional and economic realities of
most contemporary developing
countries.
 First, the model implicitly assumes that the rate of labor
transfer and employment creation in the modern sector is
proportional to the rate of modern-sector capital accumulation.
The faster the rate of capital accumulation, the higher the growth
rate of the modern sector and the faster the rate of new job
creation. But what if capitalist profits are reinvested in more
sophisticated laborsaving capital equipment rather than just
duplicating the existing capital, as is implicitly assumed in the
Lewis model?
 In this case a process called “antidevelopmental” economic
growth might happen —where all the extra income and output
growth are distributed to the few owners of capital, while income
and employment levels for the masses of workers remain largely
unchanged.
 Although total GDP would rise, there would be little or no
improvement in aggregate social welfare measured, say, in terms
of more widely distributed gains in income and employment.

The second questionable assumption of the
Lewis model is the notion that surplus labor exists
in rural areas while there is full employment in the
urban areas. Most contemporary research indicates
that there is little surplus labor in rural locations.
True, there are both seasonal and geographic
exceptions to this rule (e.g., at least until recently
in parts of China and the Asian subcontinent, some
Caribbean islands, and isolated regions of Latin
America where land ownership is very unequal),
but by and large, development economists today
agree that Lewis’s assumption of rural surplus
labor is generally not valid.

The third dubious assumption is the notion of a
competitive modern-sector labor market that
guarantees the continued existence of constant real
urban wages up to the point where the supply of rural
surplus labor is exhausted. Prior to the 1980s, a striking
feature of urban labor markets and wage determination
in almost all developing countries was the tendency for
these wages to rise substantially over time, both in
absolute terms and relative to average rural incomes,
even in the presence of rising levels of open modern-
sector unemployment and low or zero marginal
productivity in agriculture.
 Institutional factors such as union bargaining power,
civil service wage scales, andmultinational corporations’
hiring practices tend to negate competitive forces in
 The fourth concern with the Lewis
model is its assumption of diminishing
returns in the modern industrial sector.
Yet there is much evidence that
increasing returns prevail in that sector,
posing special problems for development
policymaking that we will examine in
coming chapters.
 The model is widely considered relevant to recent
experiences in China, where labor has been steadily
absorbed from farming into manufacturing, and to a few
other countries with similar growth patterns. The Lewis
turning point at which wages in manufacturing start to
rise was widely identified with China’s wage increases
starting in 2010
 we must acknowledge that the Lewis two-sector model—
though valuable as an early conceptual portrayal of the
development process of sectoral interaction and
structural change and a description of some historical
experiences, including some recent ones such as China
—requires considerable modification in assumptions and
analysis to fit the reality of most contemporary
developing nations.
4.4 The International-Dependence
Revolution

The International-Dependence models view

developing countries as beset by
institutional ,political and economic rigidities and
caught up in a dependence and dominance
relationships with rich countries .
Dependence :The reliance of developing countries
on developed-country economic policies to
stimulate their own economic growth. Dependence
can also mean that the developing countries adopt
developed-country education systems, technology,
economic and political systems, attitudes,
consumption patterns, dress, and so on.
The International-Dependence
Revolution:

Dominance: a situation in which the developed

countries have much greater power than the less
developed countries in decisions affecting
important international economic issues, such as
the prices of agricultural commodities and raw
materials in world markets.

We have 3 major models :

1- The neocolonial dependence model
2- The false-paradigm model
3- The dualistic-development thesis
1- The neocolonial dependence model:

 It attributes the existence and

continuance of underdevelopment to
 1-the unequal international capitalist
system of rich-poor countries
relationships.
 2- unequal power relationships which
couse attempts by poor nation to be self-
reliant and independent more difficult or
impossible .
 1- The Neocolonial Dependence Model

 Neocolonial view of underdevelopment attributes a large

part of the developing world’s continuing poverty to the
existence and policies of the industrial capitalist
countries of the northern hemisphere and their
extensions in the form of small but powerful elite or
comprador groups in the less developed countries
 Underdevelopment is thus seen as an externally induced
phenomenon, in contrast to the linear-stages and
structural-change theories’ stress on internal
constraints, such as insufficient savings and investment
or lack of education and skills.
 We have to restructure the capitalist system to free
developing nations from direct and indirect economic
control of developed world.
 2-The false-paradigm model
 Underdevelopment attributes due to faulty and
inappropriate advice provided by international
advisers in developed countries.
 These experts provide misleading models of
development that lead to incorrect policies.
 Because of institutional factors such as the central
and remarkably resilient role of traditional social
structures (tribe, caste, class, etc.), the highly
unequal ownership of land and other property rights,
the disproportionate control by local elites over
domestic and international financial assets, and the
very unequal access to credit, these policies, merely
serve the vested interests of existing power groups,
both domestic and international
 2-The false-paradigm model
 In addition, according to this argument,
leading university intellectuals, trade
unionists, high-level government
economists, and other civil servants all get
their training in developed-country
institutions where they are unwittingly
served an unhealthy dose of alien concepts
and elegant but inapplicable theoretical
models.
 As a result, proponents argue that desirable
institutional and structural reforms, are
neglected or given only cursory attention.
3-The dualistic-development thesis

 Dualism :is the existence and increasing

divergences between rich and poor nations and
rich and poor
peoples on various levels.
 The coexistence of two situations or phenomena
(one desirable and the other not) that are
mutually exclusive to different groups of society
—for example, extreme poverty and affluence,
modern and traditional economic sectors,
growth and stagnation, and higher education
among a few amid large-scale illiteracy
3-The Dualistic-
Development Thesis
 The traditional concept of dualism contains 4 key
arguments:
 1- different sets of conditions : some are superior
and other are inferior .as the coexistence of
modern and traditional methods of production ,
the coexistence of wealthy, highly educated
elites with masses of illiterate poor people.
 2- the coexistence is chronic not transitional .It is
not due to temporary phenomenon ,in which
case, time could eliminate the discrepancy
between superior and inferior elements.
3- The Dualistic-
Development Thesis
 3- not only the degree of of superiority or
inferiority fail to show any signs of diminishing
but they even have tendency to increase, for
example the productivity gap between the
workres in developed and developing countries
increased .
 4- The interrelations between the superior and
inferior elements are such that the existence of
the superior elements does little or nothing to
pull up the inferior element, In fact, it may
actually serve to push it down to “develop its
underdevelopment.”
Criticisms of Dependence
theories
 they have two major weaknesses:
 1-although they offer an explanation of why
many poor countries remain underdeveloped,
they give no insight into how countries
initiate and sustain development.
 2- the actual economic experience of
developing countries that have revolutionary
campaigns of industrial nationalization and
state-run production has been mostly
negative.
 If we are to take dependence theory at face value, we
would conclude that the best course for developing
countries is to become entangled as little as possible
with the developed countries and instead pursue a
policy of autarky(A closed economy that attempts to
be completely self-reliant.), or inwardly directed
development, or at most trade only with other
developing countries.
 But large countries that embarked on autarkic
policies, such as China and, to a significant extent,
India, experienced stagnant growth and ultimately
decided to open their economies, China beginning this
process after 1978 and India, after 1990.
4.5 The Solow neoclassical growth model

 This model founded by Robert Solow . It

differed from the Harrod-Domar formulation
by adding a second factor, labor, and
introducing a third independent variable,
technology, to the growth equation.

 where Y is gross domestic product,

 K is the stock of capital (which may include human capital
as well as physical capital),
 L is labor, and
 A represents the productivity of labor, which grows at an
exogenous rate
 According to traditional neoclassical
growth theory, output growth results
from one or more of three factors:
increases in labor quantity and quality
(through population growth and
education), increases in capital (through
saving and investment), and
improvements in technology
4.6 Components of Economic Growth

 Three components of economic growth

are of prime importance:
 1. Capital accumulation, including all new
investments in land, physical equipment,
and human resources through improvements
in health, education, and job skills
 2. Growth in population and hence eventual
growth in the labor force
 3. Technological progress—new ways of
accomplishing tasks
Questions on chapter 4
1. What are the main differences between the
linear stages and international dependency
models
of development?
2. Describe one important criticism of Rostow’s
stages of economic growth theory.
3. Does it follow from the false-paradigm model
that World Bank economists are intentionally
trying
to keep developing countries from realizing
genuine development? Why or why not?
 4. What are the key assumptions of
the Lewis model that give rise to its
conclusions? How would the theory’s
conclusions differ if these assumptions
do not hold?