EDPSE-C03: Classic Theories of Economic Growth and Development §

• What is structural transformation mean?
• There are four approaches to classical theories of economic developments in literature

1. Linear-stage theories §

• Economic development happens in a series of steps and stages all countries must pass through

  • Replaced by Structural Change model and International-dependence model

• Rostow’s Stages of Growth: of an economy, similar to Historical Development of Globalization

  • 1. Traditional Society:
    • Subsistent economy dependent on agriculture, for local use, not output
    • Dependent on nature: Barter economy, no money
    • Labor intensive work
    • High investment in non-productive activities like religion and military wars
  • 2. Pre-Conditions:
    • Development of mining industry
    • More capital use like exporting of agriculture products
      • Better yield of agricultural products due to use of better technology
      • Selling of surplus
    • More income, increased savings and investments to new technologies
  • 3. Take Off
    • Increasing industrialization
      • Broaden of industries
      • LIMITED # of industries become successful and competitive globally. Generally TEXTILES and FOOD production.
    • Build new infrastructure and replace old ones to be ready for next step to attract foreign investments
    • Further growth in savings and investment
    • Some regional growth
    • Number employed in agriculture declines
    • Remainder of economy is still TRADITIONAL.
  • 4. Drive to Maturity
    • Rely heavily on access to outside market
      • Rely on foreign investment
    • Growth becomes self-sustaining — wealth generation enables further investment in value adding industry and development
      • RAPID growth
    • Industry more diversified: steel, rubber, intermediary products
      • must build more infrastructure to move to stage 5
    • Increase in levels of technology utilized
      • Technology expand to many other businesses
    • Labor becomes more SKILLED and EDUCATED.
  • 5. High Mass Consumption
    • High output levels
    • Mass consumption of consumer durables
    • High proportion of employment in service sector
    • Economy shifts from heavy industry in STEEL, ENERGY, to consumer goods (CARS, REFRIGERATORS)
      • Move to high skill labor force
    • Service industry dominates the economy: banking, insurance, entertainment, leisure

• Criticisms of Rostow’s Growth Model

  • Too simplistic
  • Necessity of a financial infrastructure to channel any savings that are made into investment
    • How to channel those savings to those who need it?
  • Will such investment yield growth? Not necessarily
  • Need for other infrastructure — human resources (education), roads, rail, communications networks
  • Efficiency of use of investment — in palaces or productive activities?
  • Rostow argued economies would learn from one another and reduce the time taken to develop — this has not happened

• Harrod Domar Growth Model: emphasize on the increase of capital stocks

  $S=sY$ (3.1)

  $I=\Delta K$ (3.2)

  $\Delta K=k\Delta Y$(3.3)

  $S=I$ (3.4)

  $\Downarrow$

  $S=sY=k\Delta Y=\Delta K=I$ (3.5)

  $sY=k\Delta Y$ (3.6)

  $\frac{\Delta Y}{Y}=\frac{s}{k}$ (3.7)

  $sY=c\Delta Y$

  $\frac{\Delta Y}{Y}=\frac{s}{c}$

• Variables

  • S: Net saving
  • Y: National Income
  • I: Net Investment
  • K: Capital Stock
  • c: Capital-output ratio

• Exercise

  The rate of change or growth rate of GDP = s/c = 5/2.5 = 2%

  To bring the economy out of recession GDP growth rates have to be equals or more than capital output ratio: s/c=2.5 => s = 2.5c = 2.52.5 = 6.25% The GDP growth rate would have to be 6.25% or more to move out of recession.

  To bring the GDP growth rate to 5%: x/2.5= 5% => x = 5*2.5 = 10%. Therefore saving rates must be increased by 5 more percent to 10% for GDP growth rate to reach 5%.

$\Delta y=\frac{1}{c}\times \Delta k$

$\Delta y=\frac{1}{c}(I^G-Sk)$

$\Delta y=\frac{1}{c}\times I^G-\frac{1}{c}\times Sk$

$I^G=S^G$

$\Delta y=\frac{1}{c}\times S^G-\frac{1}{c}\times Sk$

$\boxed{\frac{\Delta y}{y}=\frac{S^G}{c}-S}$

2. Structural change model §

• Lewis model
• a set of pattern of structural changes in the country is needed for a country to succeed in generating and sustaining rapid economic growth.
  • Infrastructural changes
  • Cheep unskilled abundance labor → skilled labor

3. International-dependence model §

• radical & political

  • Underdevelopment = international and domestic power relations + institutional and structural economic rigidities + resulting from dual economies and dual societies

• Causes

  • Use of foreign experts
  • Neo-Colonialism

4. Neoclassical counter revolution §

• Blame internal factors

Rostow - stages of growth §

1. Traditional society
   • Characterized by
     • subsistence economy (output not traded or recorded
     • existence of barter
     • high levels of agricultural and labor intensive
     • high investment in non productive activities like military and religion
2. Preconditions: more exposure to knowledge and outside relations with other village
   • development of mining industries
   • increase in capital use in industries
   • necessity of external funding
   • some growth in savings and investment

limited few invest in technology and infrastructure (ex: transportation: pave ways for mobility, water supply, dams)

Trade can happen when an outsider come into the stage 2 economy village, rather than exporting it outside.

For stage 1 economy to develop into another step above, it requires a trigger/motivational point especially from an outside force (ex: flow of interaction with the outsider → knowledge sharing, technology moving)

1. Take off:
   • increasing industrialization: growth of factories (light industry, labor intensive)
   • Further growth in savings and investment
   • some regional growth
   • number employed in agriculture declines
   • limited # of industries become successful and competitive globally. Generally textiles and food production
   • remainder of economy is still traditional

(unequal growth of spread: the developed areas are mostly in a certain place such as the city or urban, therefore people from rural area are not exposed to this new development yet if they do not migrate from rural to the city)

At this stage, there are elites that set up the foundation of the society that no longer solely relies on outsider. However, production capacity is needed which is why FDI is necessary.

In moving from stage 3 onwards, domestic actor like powerful elites are necessary. They need to improve the infrastructure by setting up institutions. If the institution is strong, moving from stage 3 to stage number 4 would be fast.

1. Drive to maturity: economy drive by heavy production like steel, use of capital good like machinery

   • growth becomes self-sustaining, wealth generation enables further investment in value adding industry and development
   • industry more diversifies
   • increase in levels of technology utilized
   • technology expands to many other businesses
   • rapid growth (skilled labor, more market competition, infrastructure development)
   • labor becomes more skilled and educated

2. High mass consumption: high techs industry, well trained workforce (software development),

   • high output levels
   • mass consumption of consumer durables (mobile phones, motorcycles, fridge, air-conditioner)
   • high proportion of employment in service sector 💡 Domestic forces is more important than outsider factor from stage 3 stage 5, especially in driving the development of the economy. (ex: strong institutions) what are some of the features of a strong institution?

The Harrod-Domar Model §

(3.1): National savings (S) **comes from the proportion of the incomes (sY) §

(3.2): economic efficiency or capital output ratio (△k) §

saving = investment: sources of investment comes from domestic saving When national savings decreases, investment—the primary store of national savings—also decreases. Lower investment leads to lower long-term economic growth. Similarly, lower investment is accompanied by higher domestic interest rates, which decreases net exports

Questions and Answers §

• What is meant by the term neoclassical counterrevolution?
  • What are the principal arguments
    • how valid do you think they are?
    • Explain your answer.
  • Liberalism’s capitalism?
    • Economic Liberalism
• Is the neoclassical, free-market theory necessarily incompatible with dependency theory?
  • How might these two approaches work together?
  • Dependency Theory’s criticisms of Capitalism
• In what ways do developing countries depend on rich counteries?
  • In what ways is the opposite true?
  • Dependency Theory or Neo-Marxism’s argument

References §

• C03-EDPSE - Economic Development, 11th Edition (The Pearson Series in Economics, 2011)