PASIG CATHOLIC COLLEGE

Economic Development
Chap. 3. Classic Theories of
Economic Growth and Development

Professor: Dr. Ronaldo A. Poblete, CFMP

 Classic Theories of
Economic Development:
Four Approaches
 Literature on economic development is
dominated by the following four
strands of thought:
 Linear-stages-of-growth model: 1950s and
1960s
 Theories and patterns of structural
change: 1970s
 International-dependence revolution:
1970s
 Neo-classical, free-market
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counterrevolution: 1980s and 1990s
Linear - Stages Theory
 Viewed the process of development
as a series of successive stages of
economic growth
 Mixture of saving, investment, and
foreign aid was necessary for
economic development
 Emphasized the role of accelerated
capital accumulation in economic
development 3
 Rostow’s Stages of
Growth
 Walt W. Rostow
 Rostow identified 5 stages of growth:
1. The traditional society
2. The pre-conditions for take-off
3. The take-off
4. The drive to maturity
5. The age of high mass consumption
 All advanced economies have passed
the stage of take-off into self sustaining
growth 4
 Rostow’s Stages of
Growth

Developing countries are still

in the traditional society or
the pre-conditions stage.
Why?

Lack of adequate
investment. The financing 5
 The Harrod - Domar
Growth Model
 The principal strategy for development is
mobilization of saving and generation of
investment to accelerate economic growth
 Importance of H-D growth model (AK
model): It explains the mechanism by
which investment leads to growth
 Investment comes from savings
 Rate of economic growth (GNP growth
rate) is determined jointly by the ability of
the economy to save (savings ratio) and
the capital-output ratio. 6
 Simple Model of Economic
Growth


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

8
 Obstacles and
Constraints
 Problem with the argument that
GDP growth is proportional to the
share of investment expenditure
in GDP
 Low rate of savings in developing
countries gives rise to savings
gap and capital constraint
 Savings and investment is a
necessary condition for9
Structural-Change Models
 Structural-change theory focuses
on the mechanism by which
underdeveloped economies
transform their domestic
economic structures from
traditional to an industrial
economy
 Representative examples of this
strand of thought are
 The Lewis theory of development 10
 Lewis Theory of
Development

 Also known as the two-sector

surplus
labor model
 Features of the basic model:
 Economy consists of two sectors-
traditional and modern
 Traditional sector has surplus of
labor (MPL=0)
 Model focuses on the process of
transfer of surplus labor and the
growth of output in the modern 11
 Lewis Theory of
Development
 The process of self-sustaining
growth and employment
expansion continues in the
modern sector until all of the
surplus labor is absorbed
 Structural transformation of
the economy has taken place
with the growth of the
modern industry
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13
Lewis Theory of Development:
Criticisms

 Four of the key assumptions do not

fit the realities of contemporary
developing countries
 Reality is that:
 Capitalist profits are invested in
labor saving technology
 Existence of capital flight
 Little surplus labor in rural areas
 Growing prevalence of urban
surplus labor
 Tendency for industrial sector
wages to rise in the face of open
unemployment. 14
 Structural Changes and
Patterns of Development :
Chenery’s Model
 Patterns of development theorists
view increased savings and
investment as necessary but not
sufficient for economic development
 In addition to capital accumulation,
transformation of production,
composition of demand, and changes
in socio-economic factors are all
important
 Chenery and colleagues examined
patterns of development for
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 Structural Changes and
Patterns of Development :
Chenery’s Model
 The empirical studies identified
several characteristic features of
economic development:
 Shift from agriculture to industrial
production
 Steady accumulation of physical and
human capital
 Change in consumer demands
 Increased urbanization
 Decline in family size
 Demographic transition 16
 Structural Changes and
Patterns of Development :
Chenery’s Model
 Differences in development
among the countries are
ascribed to:
 Domestic constraints
 International constraints
 To summarize, structural-
change analysts believe that
the “correct mix” of economic
policies will generate beneficial
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 The International
Dependence Revolution
(IDR)
 The IDR models reject the exclusive
emphasis on GNP growth rate as the
principal index of development
 Instead they place emphasis on
international power balances and on
fundamental reforms world-wide.
 IDR models view developing countries
as beset by institutional, political, and
economic rigidities in both domestic
and international setup
 The IDR models argue that developing
countries are up in a dependence and
dominance relationship with rich 18
The International Dependence
Revolution (IDR)

 Three streams of thought:

 Neoclassical dependence
model
 False-paradigm model
 Dualistic-development
thesis
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Neoclassical Dependence
Model

 “Dependence is a conditioning
situation in which the economies of
one group of countries are
conditioned by the development and
expansion of others.”
 “Dependence, then, is based upon an
international division of labor which
allows industrial development to take
place in some countries, while
restricting it in others, whose growth
is conditioned by and subjected 20to
The False-Paradigm Model

 Attributes under development to

the faulty and inappropriate
advice provided by well-meaning
but biased and ethnocentric
international “expert advisers”
 The policy prescriptions serve the
vested interests of existing power
groups, both domestic and
international.
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The Dualistic- Development
Thesis
 Dualism represents the existence and
persistence of increasing divergences
between rich and poor nations and rich
and poor peoples at all levels.
 The concept embraces four key
arguments:
1. Superior and inferior conditions can
coexist in a given space at given time
2. The coexistence is chronic and not
transitional
3. The degrees of the conditions have an
inherent tendency to increase
4. Superior conditions serve to “develop 22
 The Neoclassical
Counterrevolution: Market
Fundamentalism
 Neoclassical counterrevolution in the 1980s called
for freer markets, and the dismantling of public
ownership, and government regulations
 Four component approaches :
 Free-market analysis- markets alone are
efficient
 Public-choice theory- governments can do
nothing right
 Market- friendly approach- governments
have a key role to play in facilitating
operations of markets through nonselective
interventions
 New institutionalism- success or failure of
developmental efforts depend upon the
nature, existence, and functioning of a 23
country’s fundamental institutions.
Traditional Neoclassical
Growth Theory
 Traditional neoclassical theory
argues that capital flows from
rich to poor countries as K-L
ratios are lower and investment
returns are higher in the latter
 By impeding the flow of foreign
investment, poor countries
choose a low growth path.

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Solow's Neoclassical Model or
Exogenous Growth Model
 Solow’s model of economic
growth implies that economies will
conditionally converge to the same
level of income, given that they have
the same rates of savings,
depreciation, labor force growth, and
productivity growth
 Solow’s model differs from Harrod-
Domar model in the following
respects: Allows for substitution between
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Solow's Neoclassical Model or
Exogenous Growth Model

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 Solow's Neoclassical Model or
Exogenous Growth Model
 Impact of increase in savings rate:
 Temporary increase in per capital K/L
and per capita output. However, both
would return to a steady- state of
growth at higher level of per capita
output
 Savings has no impact on long-run per
capita output growth rate but has an
impact on long-run level of per capita
output
 Total output and total capital stock grow
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 Solow's Neoclassical
Model or Exogenous
Growth Model
 Impact of increase in population
growth rate:
 Population growth rate has a
positive effect on the growth of
total output
 Results in a lower steady -state
growth rate with lower levels of
per capita capital, output, and
consumption 28
Solow's Neoclassical Model or
Exogenous Growth Model
 Impact of increase in
productivity:
 Shifts the per-worker production
function to the right
 Raises steady state per capita
output through increase in per
capita capital.
 In the long-run increase in per
capita income takes place at the
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 Application: Do
Economies Converge?
 Unconditional convergence occurs
when poor countries will eventually catch
up with the rich countries (LR) resulting in
similar living standards
 Conditional convergence occurs when
countries with similar characteristics will
converge (savings rate, investment rate,
population growth)
 No convergence occurs when poor
countries do not catch up over time and
living standards may diverge 30
Traditional Neoclassical
Growth Theory
 According to the traditional
neoclassical growth theory:
 Output growth results from one or
more of three factors- increases in
Labor, increases in capital, and
technological changes
 Closed economies with low savings
rates grow slowly in the SR and
converge to lower per capita
income levels
 Open economies converge at
higher levels of per capita income
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