Keynesian theory in the developing world

Balanced and unbalanced growth

• There was a need for a broad attack to get an economy out of its vicious cycle of poverty
• wave of new investments in different branches of production can economically succeed, enlarge
the total market and so break the bonds of the stationary equilibrium of underdevelopment
• This was also known as “balanced growth,” in the sense that a whole set of complementary
investments would be made.
• Theory of unbalanced growth, formulated by Albert Hirschman.
• Development was a “chain of disequilibria”.
• the task of development policy was to maintain tensions, disproportions, and disequilibria
• Problems of industrialization did not require a simultaneous solution, as claimed by Rosenstein-
Rodan, Nurkse, and others
• Solutions that were essentially different from those undertaken by the older industrial countries
• Instead of emphasizing obstacles to economic progress, like land tenure systems, family structure,
administrative instability, lack of savings, and so on, Hirschman stressed the need for inducement
mechanisms.
• Fundamental problem of development consisted in generating and channeling human energies in
a desired direction
• big-push theory to be unrealistic
• the greatest shortage in poor counties was entrepreneurship, or the ability to perceive
opportunities and make investment decisions.
• The notion of unbalanced growth was based on creating situations where people were forced
to make investment decisions by deliberately unbalancing different sectors of the economy.
• If certain parts of the economy are made to grow (by state investment, for instance),
shortages in other sectors will force investments for their growth.
• In Hirschman’s The Strategy of Economic Development (1958), he proposes an unbalanced
growth theory, emphasising specific industries which have particularly strong linkages with
the rest of the economy.
• He argues that a developing country can grow from prioritizing strategic sectors even with a
relatively small set of resources to utilize.
• Hirschman uses the concepts of complementarity and external economies to support his
views on unbalanced growth.
• Complementarity is an interdependence among industries in the production process and the
external economy is the subsequent growth of other industries originating from growth of a
given industry.
Albert Hirschman – importance of certain industry- unbalanced growth-
promote industries those have forward and backward linkages
• 4 types of linkages
- Forward: one investment encourages investment in subsequent production
- Backward: projects encourage investment in infrastructure, services, inputs
etc. for the project to succeed.
- Consumption: rising income stimulates the production of consumer goods
- Fiscal: surplus from one sector are taxed by the government to promote
industrial development

- Promote and protect infant industries

• The relationship among domestic industries is known as ‘a domestic
linkage’ (sometimes just referred to as linkage). Broadly speaking, there are
two kinds of linkages: backward and forward.
• On the one hand, a backward (input-provision) linkage of a given industry
is strong when its growth stimulates the production/use of other
upstream industries.
• An increase in these inputs is thus required to sustain the production
process. For example, a rising demand in cars leads to an increase in the
demand for automotive parts (e.g., wheels, seats, and thermal).
Consequently, when backward linkages are strong, growth fuels the rest of
the economy.
• On the other hand, forward linkage effects occur when the output of an
industry becomes the input for other industries. For example, an increased
amount of rubber can lead to an increase in the production of goods that
use rubber as inputs, such as tyres and gloves.
• However, growth driven by linkages also hinge upon several factors such as institutions (think of
rules that encourage supply management among firms without burdensome red tape) and
services (think of infrastructure needed to support several stages of production).
• Backward and forward linkages are used to identify ‘key sectors’ to focus on and invest in
(Rasmussen, 1956; Hazari, 1970). The key sectors are considered more capable of contributing to
growth through their spread effects, compared to low-linkage industries (Yotopoulos and Nugent,
1973).
• The concept of key sectors was widely used in identifying sector priority in the import-substitution
industrialization (ISI) era of the 1950s and 1960s. The objective of ISI was to achieve economic
growth through developing domestic capabilities of an economy to produce manufactured goods
that used to be imported, so trade barriers had to be erected for that purpose.
• The existence of strong linkages was for example used as a criterion to target certain industrial
sectors in South Korea.
• South Korea pursued the Heavy Chemical and Industry (HCI) Drive enacted in the 1970s. During
that time, six target industries were selected: (a) iron and steel, (b) non-ferrous metal; (c)
machinery; (d) shipbuilding; (e) electrical appliances and electronics; and (f) petrochemicals. Even
though this big push in South Korea was temporary, Nathan Lane (2017) finds that its effects are
lasting long in targeted industries relative to other manufacturing sectors.
• The initial unbalancing should be done in an activity that has strong backward and
forward linkages (Ilchman and Bhargava 1966).
• In Hirschman’s conception, backward linkages corresponded to the stimuli going to
sectors that supplied the inputs required by a particular activity, whereas forward
linkages were the inducement to set up new activities utilizing the output of the
proposed activity.
• The main source of development would be activities with high-potential linkage
effects, mainly backward ones.
• The idea that industrial development should (and in fact would) proceed largely
through backward linkages was quite revolutionary at the time: instead of doing
things in the conventional way, industrial development would work its way from
the “last touches” to intermediate and basic industry.
• Industrialization of certain leading sectors would pull along the rest of the
economy.
• In this sense, it was not feasible or desirable to suppress the tensions and
disequilibria created by the development process, since there was a “creative
virtue” in them.
Criticism
• Promoting specific industries which have strong domestic linkages can be difficult in several ways under
the era of global production sharing. On the forward linkage side, a country can produce a tiny piece of
part of hard disk drive and export it to be assembled in another country.
• This practice naturally sets a limit on domestic forward linkages because this production does not lead to
an establishment of further industries in the same country.
• On the backward linkage side, a final assembly activity in a given country can rely entirely on imported
intermediate inputs. This process does not require any domestically produced inputs resulting in low
domestic backward linkages. Still, both forms of GPS can create jobs.
• Support for sizable domestic linkages can pose another limitation when a country starts to produce more
capital-intensive goods due to a rising proportion of capital-intensive intermediates.
• An example is when the use of synthetic fiber, that is more capital-intensive, was substituted for natural
fiber, which requires more labor in its production process. This resulted in a rising capital-labor ratio in
many industries, for example, textile, footwear, and electrical equipment. Accordingly, an increased use of
domestically produced capital-intensive intermediates in labor-intensive industries can harm
employment despite its linkages. It has been considered a curse of developing countries (Little, 1981).
• Industrialization-led development has long been a key strategy for developing countries.
• Yet, an emphasis on domestic linkages, an interconnectedness among domestic industries, may no longer
be relevant. A focus on linkages, which is used as a powerful argument to support active industrial policy,
appears to be increasingly difficult in contemporary times, when countries are encouraged to integrate
into a highly globalized and fragmented trading system
• Rosenstein Rodan’s- Problems of Industrialization of eastern and South-
eastern Europe’, Emigration and industrialization
• Big push theory
• Ragnar Nurkse- 1953- Problem of capital formation in underdeveloped
countries.: vicious circle of poverty to be unlocked through big push.
• Unbalanced growth theory formulated by Albert Hirschman. Prioritizing
strategic sectors - complementarity and external economies - domestic
linkage: backward, forward, Consumption, Fiscal; Promote and protect infant
industries; Criticism : global production forward- backward linkage, assembly
activity in a given country can rely entirely on imported intermediate inputs,
interconnectedness among domestic industries, may no longer be relevant.
• Gunnar Myrdal
• Francois Perroux
Gunnar Myrdal
- great and growing economic inequalities
- dynamic processes of under-development and development.
- assumption of stable equilibrium.
- not be restricted to interactions among purely “economic” variables,
ignoring “noneconomic” factors.
• “circular and cumulative causation” Because of such circular causation a
social process tends to become cumulative and often to gather speed at an
accelerated rate” (Myrdal 1963: 13).
• market forces widen interregional differences
• This divergence stems from two sources:
- “backwash effects”
- “spread effects”
• “lucky” rich regions, and “unlucky” poor regions
• In underdeveloped countries- the backwash effects.
• International trade becomes the medium through which market forces
tend to result in increased inequalities.
• In neoclassical economics- assumption of diminishing marginal returns,
capital would have relatively high returns in a poor region, migrating
from rich regions to poor.
- capital is attracted to rich regions, where external economies produce
increasing returns
Francois Perroux (1955): growth
poles theory
- growth is not uniform in different places but growth has different degrees of intensity in different
point, or poles
- He was concerned with the phenomenon of economic development and with the process of
structural change.
- propulsive industries on the propelled/ pushed/ driven.
- propulsive pole is a business unit (a company, industry) or a set of these units and these units are
the main force of the economic development as they generate growth through the impact of
strong input-output linkages
- innovations and large-scale firms.
• Peripheries and this theory identifies 4 basic types of polarization:
- technological and technical - based on the concentration of new technology in the growth pole,
- income - the growth pole contributes to the concentration and the growth of income due to
expansion of services and dependence on demand and profit,
- psychological based on the optimistic anticipation of future demand in the propelled region,
- geographical based on the concentration of economic activity in a geographically determined space.
-The growth-pole strategy typically focused investment at a limited number of
locations (usually as part of a deliberate effort to modify a regional spatial
structure)
- Economic geography also had an interest in cumulative causation as a process
that caused uneven development in space.
• Here the leading work by Allan Pred asked: Why do some cities grow more
rapidly than, and at the expense of, other cities?
• Of several causes, Pred thought, initial advantage was probably most important.
• Innovations made in cities have a neighborhood effect due to “distance decay”
(that is, they affect nearby areas more), and so some places are more innovative
than others. The more important the innovative center, the more rapid the
economic growth.
• As the process evolved, a hierarchical structure emerged among the various
urban places, essentially linked by the constant interchange of information
• the “new economic geography” and the “new trade theory” of the 1990s - Paul
Krugman, Michael Porter, and Anthony Venables.
• For Krugman, economic geography, or uneven regional development, is central to the
process by which national economic prosperity and trade are created and maintained.
• Krugman’s theory differs from the Ricardian theory of comparative advantage
• specialization and trade driven by increasing returns and economies of scale rather
than by comparative advantage
• gains from trade arise because production costs fall as the scale of output increases.
• economic specialization is, to some extent, a historical accident -once a pattern of
specialization is established, it gets “locked in” by the cumulative gains from trade.
• “path dependence”
• Because of forward and backward linkages, once an initial regional advantage is
established, it may cumulate over time
• Krugman thinks that the original cause of growth in a place is relatively unimportant,
emphasizing path dependence instead