IIUI/IIIE/FALL2007/PZJ/DE1

Classical Development Theories

The literature on economic development after the II World War can be divided into four strands of thoughts, namely:

Linear stages of growth

Structural change

International dependency

Free marker counterrevolution

1. Linear stages of growth:

Theorists of the 1950s and 1960s viewed the process of development as a series of successive stages of economic growth through which all countries must pass. It is primarily an economic theory of development in which the right quantity and mixture of saving, investment and foreign aid were necessary to enable developing countries to proceed along an economic growth path that historically had been followed by developed countries. Development thus became synonymous with rapid, aggregate economic growth.

In fact, after the II World War the economists in developed countries had no readily available conceptual apparatus with which to analyze the process of economic development in largely agrarian societies characterized by the virtual absence of modern economic structures. However, they did have the experience of so called Marshall Plan, under which massive amount of U.S. financial and technical assistance enabled the war-torn countries of Europe to rebuild and modernize their economies in a matter of few years. Moreover, as the modern industrial nations were once underdeveloped agrarian societies, their historical experience in transforming their economies from poor agricultural subsistence societies to modern industrial countries had important lessons for the “backward” countries of Asia, Africa and Latin America. Due to emphasis on accelerated capital accumulation this approach is often called as “capital fundamentalism”.

Rostow’s Stages of Growth:

The “stages of growth model” emerged during the “cold war politics (1950-70)” and resulting competition for the allegiance of newly independent states.

According to Rostow’s doctrine, the transition from underdevelopment to development can be described in terms of a series of stages through which all countries must proceed. It is possible to identify all societies, in their economic dimensions, as lying within one of five categories: the traditional society, the

precondition for take-off into self-sustaining growth, the take-off, the drive to maturity, and the age of high massive consumption. (Rostow:1960:1f.)

It was argued that 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 societies”, or the “preconditions stage”, had only to follow a certain set of rules of development to take off in their turn into self-sustaining economic 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.

Harrod-Domar Growth Model:

Every economy must save a certain portion of its national income in order to replace worn-out capital goods (buildings, equipments, materials). However, in order to grow, new investments representing net additions to the capital stock are necessary, which will bring about corresponding increases in the national output (GNP). This relationship is known as the capital-output ratio.

If we define capital-output ratio as “k” and assume national saving ratio “s” is a fixed proportion of national output and that total new investment is determined by the level of total saving, we can construct simple model of economic growth:

1. Saving (S) is some proportion, s, of national income (Y)Thus, we have simple equation S = sY (1)

2. Net investment (I) is defined as the change in the capital stock, K, and can be represented by ∆K

In this way I = ∆K (2)

Total capital stock, K, has direct relationship to national income or output, Y, as expressed by the capital-output ratio, k.

It follows that K/Y = k, or ∆K/∆Y = k, or ∆K = k ∆Y (3)

3. Net national saving (S) must equal net investment (I).We can write this equality as S = I (4)

But from equation (1) we know that S = sYand from equations (2) and (3) we know that I = ∆K = k ∆YTherefore, we can write the identity of saving as sY = k ∆Y (5)

Dividing both sides of equation (5) first by Y and then by k,we obtain ∆Y/Y = s/k (6)

Note that left side of equation (6) represents the rate of growth of GNP.

Equation (6) is a simplified version of Harrod-Domar Economic Growth Model.

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The model simply states that the rate of growth of GNP (∆Y/Y) is determined jointly by the national saving ratio (s), and the national capital-output ratio (k). In other words it says that in the absence of government, the growth rate of national income (output) will be directly or positively related to the savings ratio and inversely or negatively related to the economy’s capital-output ratio.

In order to grow economies must save and invest a certain proportion of their GNP. The more they can save and invest, the faster they can grow. But the actual rate at which they can grow for any level of saving and investment – how much additional output can be had from an additional unit of investment – can be measured by the inverse of the capital-output ratio (1/k), because this inverse is simply the output-capital or output-investment ratio. It follows that multiplying the rate of new investments (s = I/Y) by its productivity (1/k) will give the growth rate of GNP.

Obstacles and constraints:

What we learn from Harrod-Domar growth model is simply to increase saving rate (s) of the economy. If we raise this rate in equation (6) we can increase growth rate (∆Y/Y) of GNP.

For example, if we assume that the national capital-output ratio is 3 and aggregate saving ratio is 6% (0.06) of GNP, the economy can grow at a rate of 2% per year, because

∆Y/Y = s/k = 0.06/3 = 0.02 = 2% (7)

Now if the national saving rate can be increased from 6% to 15% – through increased taxes, foreign aid, and/or general consumption sacrifices – the GNP growth rate can be increased from 2% to 5%, because

∆Y/Y = s/k = 0.15/3 = 0.05 = 5% (8)

In fact, Rostow and others defined the takeoff stage in this way. Countries that were able to save 15% to 20% of GNP could grow at a much faster rate than those that saved less. Moreover, this growth would then be self-sustained. The mechanism of economic growth and development in this theory, therefore, are simply a matter of increasing national saving and investment.

The main obstacle or constraint on development, according to this theory, was the relatively low level of new capital formation in poor countries. But if a country wanted to grow, say, at a rate of 7% per year and if it could not generate savings and investment at a rate of 21% of national income (assuming that capital-output ratio is 3) but could only manage to save 15%, it could seek to fill this “saving gap” of 6% through either foreign aid or private foreign investment.

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Thus “capital constraint” to growth became a rationale and (in terms of cold war politics) an opportunistic tool for justifying massive transfer of capital and foreign assistance from the developed to the less developed countries. It was also a kind of Marshall Plan for the underdeveloped countries.

Critique on growth model:

More saving and investment are although necessary, yet not sufficient condition for a rapid economic growth.

The Marshall Plan worked for Europe, because the European countries receiving aid possessed the necessary structural, institutional, and attitudinal conditions (i.e. well-integrated commodity and money markets, highly developed transport facilities, a well-trained and educated work force, the motivation to succeed, an efficient government bureaucracy) to convert new capital effectively into higher levels of output. The growth models implicitly assume the existence of these attitudes and arrangements in underdeveloped countries. These models also failed to take into account the external forces, which are beyond the control of underdeveloped countries.

evelopment models - lewisLewis Model - An Overview

The Lewis model is structural change model that explains how labour transfers in a dual economy. For Lewis growth of the industrial sector drives economic growth. The Lewis Model argues economic growth requires structural change in the economy whereby surplus labour in traditional agricultural sector with low or zero marginal product, migrate to the modern industrial sector where high rising marginal product.

Transferring surplus labour from rural to urban areas has no effect on agricultural productivity as MP of rural workers = 0.

Firm’s profits are reinvested. Growth means jobs for surplus rural labour. Additional workers in urban areas increase output hence incomes and profits. Extra incomes increase demand for domestic products while increased profits fund increased investment. Hence rural urban migration offers self-generating growth.

The ability of the modern sector to absorb surplus works depends on the speed of investment and accumulation of capital. Where firms invest in new labour saving capital equipment, surplus workers are not taken on by the formal sector. Recently arrived rural migrants join the informal economy and live in shantytowns

Given urban growth drives economic growth it can lead to the neglect of agriculture by government

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Neglect of Agriculture – yet most people live in rural areas where incomes are relatively low

Increased profits may be invested in labour saving capital rather than taking on newly arrived workers

For many LDC's, rural urban migration levels have been far greater than the formal industrial sector’s ability to provide jobs. Urban poverty has replaced rural poverty.

http://tutor2u.net/economics/content/topics/development/development_models_lewis.htm

Dual Sector modelFrom Wikipedia, the free encyclopediaJump to: navigation, searchThis article is about the economic model. For the diagram representing atomic bonding, see Lewis structure.

The Dual Sector model, or the Lewis model, is a model in Developmental economics that explains the growth of a developing economy in terms of a labour transition between two sectors, a traditional agricultural sector and a modern industrial sector.

Contents[hide]

1 History 2 Theory 3 Criticism

4 Practical Application

[edit] History

Initially enumerated in an article entitled "Economic Development with Unlimited Supplies of Labor" written in 1954 by Sir Arthur Lewis, the model itself was named in Lewis's honor. First published in The Manchester School in May 1954, the article and the subsequent model were instrumental in laying the foundation for the field of Developmental economics. The article itself has been characterized by some as the most influential contribution to the establishment of the discipline.

[edit] Theory

The "Dual Sector Model" is a theory of development in which surplus labor from traditional agricultural sector is transferred to the modern industrial sector whose growth over time absorbs the surplus labor, promotes industrialization and stimulates sustained development.

In the model, the traditional agricultural sector is typically characterized by low wages, an abundance of labour, and low productivity through a labour intensive production process. In contrast, the modern manufacturing sector is defined by higher wage rates than the

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agricultural sector, higher marginal productivity, and a demand for more workers initially. Also, the manufacturing sector is assumed to use a production process that is capital intensive, so investment and capital formation in the manufacturing sector are possible over time as capitalists' profits are reinvested in the capital stock. Improvement in the marginal productivity of labour in the agricultural sector is assumed to be a low priority as the hypothetical developing nation's investment is going towards the physical capital stock in the manufacturing sector.

Since the agricultural sector has a limited amount of land to cultivate, the marginal product of an additional farmer is assumed to be zero as the law of diminishing marginal returns has run its course due to the fixed input, land. As a result, the agricultural sector has a quantity of farm workers that are not contributing to agricultural output since their marginal productivities are zero. This group of farmers that is not producing any output is termed surplus labour since this cohort could be moved to another sector with no effect on agricultural output. The term surplus labour here is not being used in a Marxist context and only refers to the unproductive workers in the agricultural sector. Therefore, due to the wage differential between the agricultural and manufacturing sectors, workers will tend to transition from the agricultural to the manufacturing sector over time to reap the reward of higher wages.

If a quantity of workers moves from the agricultural to the manufacturing sector equal to the quantity of surplus labour in the agricultural sector, regardless of who actually transfers, general welfare and productivity will improve. Total agricultural product will remain unchanged while total industrial product increases due to the addition of labour, but the additional labour also drives down marginal productivity and wages in the manufacturing sector. Over time as this transition continues to take place and investment results in increases in the capital stock, the marginal productivity of workers in the manufacturing will be driven up by capital formation and driven down by additional workers entering the manufacturing sector. Eventually, the wage rates of the agricultural and manufacturing sectors will equalise as workers leave the agriculture for the manufacturing, increasing marginal productivity and wages in agriculture whilst driving down productivity and wages in manufacturing.

The end result of this transition process is that the agricultural wage equals the manufacturing wage, the agricultural marginal product of labour equals the manufacturing marginal product of labour, and no further manufacturing sector enlargement takes place as workers no longer have a monetary incentive to transition.

[edit] Criticism

The theory is complicated in reality by the fact that surplus labour is both generated by the introduction of new productivity enhancing technologies in the agricultural sector and the intensification of work. Also, the migration of workers from the countryside to the cities is an incentive towards those two phenomena as the relative bargaining power of workers and bosses varies and thus with it the cost of labour.

The wage differential between industry and agriculture needs to be sufficient to incentivise movement between the sectors and, whereas the model assumes any differential will result in a transfer.

The model assumes rationality, perfect information and unlimited capital formation in industry. These do not exist in practical situations and so the full extent of the model is rarely

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realised. However, the model does provide a good general theory on labour transitioning in developing economies.

[edit] Practical Application

This model has been employed quite successfully in Singapore. Ironically however it has not been employed in Sir Arthur Lewis' home country of St. Lucia.

http://en.wikipedia.org/wiki/Dual_Sector_model

Theories

Lewis's Dual Sector Model of Development: The theory of trickle down

Next theory - Rostow's Model >>

Lewis proposed his dual sector development model in 1954. It was based on the assumption that many LDCs had dual economies with both a traditional agricultural sector and a modern industrial sector. The traditional agricultural sector was assumed to be of a subsistence nature characterised by low productivity, low incomes, low savings and considerable underemployment. The industrial sector was assumed to be technologically advanced with high levels of investment operating in an urban environment.

Lewis suggested that the modern industrial sector would attract workers from the rural areas. Industrial firms, whether private or publicly owned could offer wages that would guarantee a higher quality of life than remaining in the rural areas could provide. Furthermore, as the level of labour productivity was so low in traditional agricultural areas people leaving the rural areas would have virtually no impact on output. Indeed, the amount of food available to the remaining villagers would increase as the same amount of food could be shared amongst fewer people. This might generate a surplus which could them be sold generating income.

Those people that moved away from the villages to the towns would earn increased incomes and this crucially according to Lewis generates more savings. The lack of development was due to a lack of savings and investment. The key to development was to increase savings and investment. Lewis saw the existence of the modern industrial sector as essential if this was to happen. Urban migration from the poor rural areas to the relatively richer industrial urban areas gave workers the opportunities to earn higher incomes and crucially save more providing funds for entrepreneurs to investment.

A growing industrial sector requiring labour provided the incomes that could be spent and saved. This would in itself generate demand and also provide funds for investment. Income generated by the industrial sector was trickling down throughout the economy.

Problems of the Lewis Model

The idea that the productivity of labour in rural areas is almost zero may be true for certain times of the year however during planting and harvesting the need for labour is critical to the needs of the village.

The assumption of a constant demand for labour from the industrial sector is questionable. Increasing technology may be labour saving reducing the need for

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labour. In addition if the industry concerned declines again the demand for labour will fall. http://kegsnet.org.uk/mod/resource/view.php?id=4032

The idea of trickle down has been criticised. Will higher incomes earned in the industrial sector be saved? If the entrepreneurs and labour spend their new found gains rather than save it, funds for investment and growth will not be made available.

The rural urban migration has for many LDCs been far larger that the industrial sector can provide jobs for. Urban poverty has replaced rural poverty.

http://www.bized.co.uk/virtual/dc/copper/theory/th8.htm

http://www.associatedcontent.com/article/234339/william_arthur_lewiss_twosector_economic.html

Home Field Trips Copper Tour The Dependency Ratio

Theories

Dependency Theory

Next theory - Economic Efficiency >>

Underdevelopment is seen as the result of unequal relationships between rich developed capitalist countries and poor developing ones. In the past colonialism embodied the inequality between the colonial powers and their colonies. As the colonies became independent the inequalities did not disappear. Powerful developed countries such as the US, Europe and Japan dominate dependent powerless LDCs via the capitalist system that continues to perpetuate power and resources inequalities.

Dominant MDCs have such a technological and industrial advantage that they can ensure the global economic system works in their own self-interest. Organisations such as the World Bank, the IMF and the WTO have agendas that benefits the firms, and consumers of primarily the MDCs. Freeing up world trade, one of the main aims of the WTO, benefits the wealthy nations that are most involved in world trade. Creating a level playing field for all countries assumes that all countries have the necessary equipment to be able to play. For the world's poor this is often not the case.

In this model the responsibility for lack of development within LDCs rests with the MDCs. Advocates of the dependency theory argue that only substantial reform of the world capitalist system and a redistribution of assets will 'free' LDCs from poverty cycles and enable development to occur. Measures that the MDCs could take would include the elimination of world debt and the introduction of global taxes such as the Tobin Tax. This tax on foreign exchange transactions, named after its proponent, the American Economist, James Tobin, would generate large revenues that could be used to pay off debt or fund development projects.

Problems

Power is not easily redistributed as countries that possess it are unlikely to surrender it

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It may be that it is not the governments of the MDCs that hold the power but large multinational enterprises that are reluctant to see the worlds resources being reallocated in favour of the LDCs

The redistribution of assets globally will result in slower rates of growth in the MDCs and this might be politically unpopular

http://www.bized.co.uk/virtual/dc/copper/theory/th3.htm

Theories

Lewis's Dual Sector Model of Development: The theory of trickle down

Next theory - Rostow's Model >>

Lewis proposed his dual sector development model in 1954. It was based on the assumption that many LDCs had dual economies with both a traditional agricultural sector and a modern industrial sector. The traditional agricultural sector was assumed to be of a subsistence nature characterised by low productivity, low incomes, low savings and considerable underemployment. The industrial sector was assumed to be technologically advanced with high levels of investment operating in an urban environment.

Lewis suggested that the modern industrial sector would attract workers from the rural areas. Industrial firms, whether private or publicly owned could offer wages that would guarantee a higher quality of life than remaining in the rural areas could provide. Furthermore, as the level of labour productivity was so low in traditional agricultural areas people leaving the rural areas would have virtually no impact on output. Indeed, the amount of food available to the remaining villagers would increase as the same amount of food could be shared amongst fewer people. This might generate a surplus which could them be sold generating income.

Those people that moved away from the villages to the towns would earn increased incomes and this crucially according to Lewis generates more savings. The lack of development was due to a lack of savings and investment. The key to development was to increase savings and investment. Lewis saw the existence of the modern industrial sector as essential if this was to happen. Urban migration from the poor rural areas to the relatively richer industrial urban areas gave workers the opportunities to earn higher incomes and crucially save more providing funds for entrepreneurs to investment.

A growing industrial sector requiring labour provided the incomes that could be spent and saved. This would in itself generate demand and also provide funds for investment. Income generated by the industrial sector was trickling down throughout the economy.

Problems of the Lewis Model

The idea that the productivity of labour in rural areas is almost zero may be true for certain times of the year however during planting and harvesting the need for labour is critical to the needs of the village.

The assumption of a constant demand for labour from the industrial sector is questionable. Increasing technology may be labour saving reducing the need for labour. In addition if the industry concerned declines again the demand for labour will fall.

9

The idea of trickle down has been criticised. Will higher incomes earned in the industrial sector be saved? If the entrepreneurs and labour spend their new found gains rather than save it, funds for investment and growth will not be made available.

The rural urban migration has for many LDCs been far larger that the industrial sector can provide jobs for. Urban poverty has replaced rural poverty.

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