The Harrod-Domar modelThe Harrod-Domar model

Economic growth depends on Economic growth depends on three factors:three factors: A.A. the saving rate the saving rate B.B. the capital/output ratio the capital/output ratio C.C. the depreciation rate the depreciation rate

Economic growth depends on Economic growth depends on three factors:three factors: A.A. the saving rate the saving rate B.B. the capital/output ratio the capital/output ratio C.C. the depreciation rate the depreciation rate

Essentially all among classical economist, Essentially all among classical economist, from Adam Smith onwards, in a single, from Adam Smith onwards, in a single, simple equation: Growth depends on saving simple equation: Growth depends on saving and efficiency, including depreciationand efficiency, including depreciation

Essentially all among classical economist, Essentially all among classical economist, from Adam Smith onwards, in a single, from Adam Smith onwards, in a single, simple equation: Growth depends on saving simple equation: Growth depends on saving and efficiency, including depreciationand efficiency, including depreciation

The Harrod-Domar modelThe Harrod-Domar model Shortcomings:Shortcomings:

Neither theory nor empirical evidence Neither theory nor empirical evidence seemed to provide much support for the seemed to provide much support for the capital/output ratio as an capital/output ratio as an exogenous exogenous behavioural parameterbehavioural parameter in the model in the model

a more elaborate formulation of the link a more elaborate formulation of the link between capital and output was called forbetween capital and output was called for

The model did not leave much room for the The model did not leave much room for the other crucial factor of production, other crucial factor of production, labourlabour

population or labour-force growth is absent population or labour-force growth is absent from the formula, which explains output from the formula, which explains output growth solely by growth solely by savingsaving and and efficiencyefficiency

Shortcomings:Shortcomings: Neither theory nor empirical evidence Neither theory nor empirical evidence

seemed to provide much support for the seemed to provide much support for the capital/output ratio as an capital/output ratio as an exogenous exogenous behavioural parameterbehavioural parameter in the model in the model

a more elaborate formulation of the link a more elaborate formulation of the link between capital and output was called forbetween capital and output was called for

The model did not leave much room for the The model did not leave much room for the other crucial factor of production, other crucial factor of production, labourlabour

population or labour-force growth is absent population or labour-force growth is absent from the formula, which explains output from the formula, which explains output growth solely by growth solely by savingsaving and and efficiencyefficiency

Since population growth is basically a demographic phenomenon and, hence, exogenous from an economic point of view, it must follow that economic growth is also exogenous

According to Solow, saving behaviour was no longer relevant for long-run growth, nor was efficiency in a broad sense, except insofar as it mattered for technology

Economic growth was considered immune to economic policy, good or bad

Even so, saving and efficiency play an important role for growth over long periods, that is, the medium term

The second revolution:The second revolution:The neoclassical model - SolowThe neoclassical model - Solow

Solow showed how the capital/output ratio, rather than being exogenously fixed as in the Harrod-Domar model, is better viewed as an endogenous variable, which moves over time and ultimately reaches long-run equilibrium

Once attained, the long-run equilibrium is consistent with not only a constant capital/output ratio

… but also with a constant rate of growth of output per capita, a constant rate of interest, and a constant distribution of national income between labour and capital, all of which seemed to apply to the real world

The second revolution:The second revolution:The neoclassical model - SolowThe neoclassical model - Solow

If capital/output ratio is exogenous it is … possible to view growth as an endogenous variable: growth adjusts to the exogenously given capital/output ratio

• Solow reversed the roles of the rate of growth and the capital/output ratio

He treated the capital/output ratio as an endogenous variable that adjusts over time to the exogenously given growth rate of output

• Growth is exogenous because its two main Growth is exogenous because its two main determinants, determinants, population growthpopulation growth and and technological progresstechnological progress, are exogenous, are exogenous

The second revolution:The second revolution:The neoclassical model - SolowThe neoclassical model - Solow

Modern TheoriesModern Theories of Economıc Developmentof Economıc Development

BASIC CHARACTERISTICS:BASIC CHARACTERISTICS: Post-WWII Pioneers of Development EconomicsPost-WWII Pioneers of Development Economics Loose school of thought; Loose school of thought; less theoreticalless theoretical;; more historical more historical

and and practical approachpractical approach to the question of how to develop to the question of how to develop OptimisticOptimistic,, believe in the inevitability of development as a believe in the inevitability of development as a

linear process that all nations go throughlinear process that all nations go through Emphasize large-scale industrializationEmphasize large-scale industrialization as the key to as the key to

the development processthe development process Profound respect for market forcesProfound respect for market forces yet yet support support

large-scale government interventionlarge-scale government intervention to force economic to force economic growthgrowth

Similar to Keynesians in regard tSimilar to Keynesians in regard to o advocacy for advocacy for government intervention and also that government intervention and also that poor economic poor economic performance reflects a lack of aggregate demandperformance reflects a lack of aggregate demand

LEADINGLEADING THEORETICIANS: THEORETICIANS: Theory of the Big Push: Rosenstein-RodanTheory of the Big Push: Rosenstein-Rodan

Theory of balanced growth: Ragnar NurkseTheory of balanced growth: Ragnar Nurkse

Unbalanced Growth: HirschmanUnbalanced Growth: Hirschman

Growth with Unlimited Supply of Labor: Growth with Unlimited Supply of Labor: LewisLewis

Stages of Growth Theory: RostowStages of Growth Theory: Rostow

Modern TheoriesModern Theories of Economıc Developmentof Economıc Development

Theory of the Big PushTheory of the Big PushPaul Paul Rosenstein-Rodan (1948)Rosenstein-Rodan (1948)

hhidden potential in developing economiesidden potential in developing economies

llarge-scale industrialization and arge-scale industrialization and infrastructural developmentinfrastructural development is key is key

mmore investment is needed in many places ore investment is needed in many places at one timeat one time

but this cannot be left to the market due to but this cannot be left to the market due to information and appropriation failuresinformation and appropriation failures (“externalities”)(“externalities”)

tthe big pushhe big push needs to come from the state needs to come from the state to escape the low-level equilibrium trapto escape the low-level equilibrium trap

Theory of balanced growthTheory of balanced growthRagnar Nurkse (1953)Ragnar Nurkse (1953)

eexport pessimismxport pessimism: exports cannot be : exports cannot be depended upon as the source of growthdepended upon as the source of growth

mmassive injection of new technology, assive injection of new technology, machines, production processes is the key to machines, production processes is the key to developmentdevelopment

hhence need for domestic industrializationence need for domestic industrialization

llarge scale industrial investments (i.e. arge scale industrial investments (i.e. expandedexpanded supply) would also generate large supply) would also generate large scale demand, hence leading to:scale demand, hence leading to:BALANCED BALANCED GROWTHGROWTH

Industrial Linkages & Industrial Linkages & Unbalanced Growth Unbalanced Growth Alfred Alfred Hirschman (1958)Hirschman (1958)

RResource constraints in developing countries esource constraints in developing countries necessitate prioritization as to where to invest firstnecessitate prioritization as to where to invest first;;

the big push should be only for a limited no of the big push should be only for a limited no of industriesindustries, hence initially , hence initially unbalanced growthunbalanced growth;;

this will initially result in unbalanced growth such this will initially result in unbalanced growth such that inducing development in key sectors first will that inducing development in key sectors first will create overcapacity here; cheapening their output create overcapacity here; cheapening their output due to economies of scale;due to economies of scale;

this will stimulate upstream investmentsthis will stimulate upstream investments::eg. oversupply electric power; as electricity becomes cheaper this will eg. oversupply electric power; as electricity becomes cheaper this will stimulate investments in those sectors that use electric power in big amounts.stimulate investments in those sectors that use electric power in big amounts.

TThehe key sectors for initialkey sectors for initial investment shouldinvestment should be be determined ondetermined on the basisthe basis of industrialof industrial backward backward and forward linkagesand forward linkages..

Growth with unlimited supply of laborGrowth with unlimited supply of laborArthur Arthur LewisLewis

main difference between North and South: main difference between North and South: the relative weight of agricultural versus the relative weight of agricultural versus industrial production and employment. industrial production and employment.

Hidden poHidden pottential of developing countries for ential of developing countries for grgroowth lies in wth lies in unlimited supplies of unlimited supplies of rural rural laborlabor inherent in their la inherent in their larrge agricultural ge agricultural sector ready to be pulled into the modern sector ready to be pulled into the modern urban sector.urban sector.

in the South, coexistence of the two sectors is in the South, coexistence of the two sectors is dualistic dualistic such that:such that:

agricultural sector provides labor to industry; and agricultural sector provides labor to industry; and industry buys food from them; but there is little industry buys food from them; but there is little connection bconnection betweenetween them them

productivity in agricultural sector is so low that productivity in agricultural sector is so low that there is disguised unemployment; i.e. surplus there is disguised unemployment; i.e. surplus laborlabor

trantranssformation dynamic lies in the attraction of this formation dynamic lies in the attraction of this rural surplus labor into the industry such that while rural surplus labor into the industry such that while industrial production increases, there is no change industrial production increases, there is no change in agricin agricuultural production.ltural production.

Growth with unlimited supply of laborGrowth with unlimited supply of laborAArthur rthur LewisLewis

Growth with unlimited supply of laborGrowth with unlimited supply of labor Arthur Arthur LewisLewis

Distribution of Income:Distribution of Income: Higher level of savings and investment in the Higher level of savings and investment in the

industrial sector is key to development; butindustrial sector is key to development; but

only capitalist class is capable of savings and only capitalist class is capable of savings and investment.investment.

A limit will be imposed on this growth process as A limit will be imposed on this growth process as L surplus is depleted and wages increase L surplus is depleted and wages increase → → undesirable from Lewis’ perspective.undesirable from Lewis’ perspective.

Hence Hence Lewis Lewis advocates income distribution in advocates income distribution in favor of the capitalist class and against labor.favor of the capitalist class and against labor.

Stages of Growth TheoryStages of Growth TheoryWalt Whitman RostowWalt Whitman Rostow

The The RostoRostowwian take-off modelian take-off model claims to be a universal claims to be a universal historical modelhistorical model of economic growthof economic growth which was developed on the which was developed on the basis of the economic history of Britainbasis of the economic history of Britain. .

The model claims that economic modernization The model claims that economic modernization occurs in five basic stages, in changeable time period.occurs in five basic stages, in changeable time period.– Traditional society Traditional society – Preconditions for take-off Preconditions for take-off – Take-off Take-off – Drive to maturity Drive to maturity – Age of Age of hhigh mass consumption igh mass consumption

Rostow argues this is a universal historical Rostow argues this is a universal historical categorization of stages of growth that all societies categorization of stages of growth that all societies necessarily go through with similar experiences.necessarily go through with similar experiences.

Traditional SocietyTraditional Society output consumed by producers rather than output consumed by producers rather than

traded traded trade carried out by bartertrade carried out by barter; ; goods exchanged for goods exchanged for

other goods other goods aagriculture griculture →→ dominating sector; dominating sector; labor-intensive labor-intensive rresource allocation determined by traditional esource allocation determined by traditional

methods of productionmethods of production than than scientific knowledge scientific knowledge ““pre-Newtonian” pre-Newtonian” or “pre-scientific” or “pre-scientific” society society

dominated with a perspective of long-term dominated with a perspective of long-term fatalismfatalism

llandholders plays a dominant and important role andholders plays a dominant and important role in the determination of political and economic in the determination of political and economic powerpower

Pre-conditions for Take-offPre-conditions for Take-off destruction of traditional society destruction of traditional society through through outside forces such asoutside forces such as colonialism colonialism

emergence of emergence of entrepreneurentrepreneurial andial and manager managerial classial class

development of a financial sector and increase in development of a financial sector and increase in investmentinvestment

infrastructural developmentinfrastructural development

modern business usmodern business usinging new and sophisticated new and sophisticated methods of productionmethods of production

emergence of emergence of “reactive nationalism”“reactive nationalism”

Take-off into sustained growthTake-off into sustained growth

increasing increasing industrialization, industrialization, productionproduction and employment and employment switchswitcheses from agriculture to from agriculture to

manufacturingmanufacturing

grgrowth concentrated in a few regions of the country owth concentrated in a few regions of the country and in one or two manufacturing industries and in one or two manufacturing industries

investment reaches over 10% of GNPinvestment reaches over 10% of GNP

evolution of new political and social institutions evolution of new political and social institutions supportsupportinging the industrialization the industrialization

growth growth becomebecomes self-sustaining as investment s self-sustaining as investment leads to increasing incomes in turn generating leads to increasing incomes in turn generating more savings to finance further investment.more savings to finance further investment.

Drive to MaturityDrive to Maturity

tthe economy he economy startsstarts spreading into new areas spreading into new areas

ttechnological innovation providechnological innovation provides expandedes expanded range of investment opportunities. range of investment opportunities.

tthe economy he economy starts starts producing a wide range of producing a wide range of goods and services and there is less reliance goods and services and there is less reliance on imports on imports

tthis diversity leads to greatly reduced rates of his diversity leads to greatly reduced rates of poverty and rising standards of living, as the poverty and rising standards of living, as the society no longer needs to sacrifice its comfort society no longer needs to sacrifice its comfort in order to make certain sectors more in order to make certain sectors more productive.productive.

Age of High Mass ConsumptionAge of High Mass Consumption

tthe economy is oriented towards mass he economy is oriented towards mass consumption consumption

service sector becomes increasingly service sector becomes increasingly dominant dominant

ssociety is now devoted to the ociety is now devoted to the pleasures of consumer choice, the pleasures of consumer choice, the pursuit of security, and the pursuit of security, and the enjoyments of the arts and leisureenjoyments of the arts and leisure

Critics of Critics of the Stages of Growth the Stages of Growth TheoryTheory by Rostowby Rostow

attempts to universalize the experience of a attempts to universalize the experience of a particular country (Britain) in a specific period of particular country (Britain) in a specific period of time (16th to 20th century)time (16th to 20th century)

External factors such as colonization / imperialism External factors such as colonization / imperialism can hinder the process of development in the can hinder the process of development in the colonized nationscolonized nations

descriptive; no analysis of how the pre-conditions descriptive; no analysis of how the pre-conditions for take-off for take-off are to emerge are to emerge

empirically not validatedempirically not validated