This ppt talks about various theories of economic growth.

1. Theories Of Economic Development
• Dang and Pheng 2015 , Infrastructure Investments in Developing
Economies Chapter 2

2. Classical theories of
Economic Development
1. The linear stages of Growth Models
2. Structural Change Model
3. International dependence models
4. Neoclassical counter-Revolution Models

3. Evolution of Economic Development
Thoughts
• Early Views About the Nature of the Economic Society and Prosperity.
Adam smith(1776)
He believed in the doctrine of natural law in economic affairs.
He regarded that every individual is best judge of itself and should be left to pursue its own
interest
Each individual was led by an Invisible hand which guides market mechanism
Laissez-faire Policy
Smith was naturally opposed to any government intervention in industry and in commerce and was
in favour of free trade
He promoted division of labour and specialisation which would increase the productivity of
workers
Only capitalists and landlords were capable of saving
Capitalism is often criticized for bringing wealth only to rich, whereas the poorer gets poorer

4. Karl Marx
• “Das Capital”
• Feasible system should be based on social and public ownership.
• Wealth of capitalists comes from the exploitation of the surplus value
created by the workers
• Hence private property and free market was seen as causes of
poverty for many workers.
• A nation economy shoul be managed by state to serve the interest of
many

5. The linear Stages of Growth Models
• Formulated in the early years after World War II
• These focused on the utility of massive injections of capital to achieve
rapid GDP growth rates.
• Walt Whitman Rostow’s Stages growth model and the Harrod Domer
model the 2 famous models during this time.
• Theorists of the 1950s and early 1960s viewed the process of
development as a sequence of historical stages.

6. Rostow’s Stages Of Economic Growth
It was published in 1960’s and viewed the process of development as a sequence of Historical stages
Building on the historical pattern of the then developed countries Rostow’s claimed that the transition from
underdevelopment to development would pass through 5 stages.

7. Stage 1:Traditional Economy
• Dominated by subsistence farming.
• Agricultural based Economy
• Intensive labour and low levels of trading.
• Having a population that has no scientific perspective on the world and the technology
Stage 2 : Preconditions to take off
• Society begins to develop manufacturing
• Country advances to a more complex economy, beginning of economic development
• Levels of technology develop.
• Development of transport system- Trade
• Rostow's believed this could only be reached by a great achievement of a surplus of wealth.
Stage:3 Take- off
• Short period of extensive growth.
• Industrialisation begins Manufacturing more important part of the economy.
• Introduction to technical innovations.
• Agriculture progressed to commercial rather than subsistence.

8. Stage-4: The Drive to Maturity
• Takes place over a long period of time standards of living rise
• Use of technology increases.
• National economy grows and diversifies.
• Increase percentage of nation's wealth invested in to developing its economy.
Stage-5: High Mass Consumption
• Individual incomes are greater than necessary for buying essential
• Growing demand for additional consumer goods and services
• Improve healthcare systems and education.
• Economy flourishes.

9. Harrod- Domar Model
Roy Harrod gave his model in 1939 and Evsey Domar in 1946-47
These models are based on the experiences of advanced economies.
As a classic model of economic growth, it tries to explain economic growth through
savings and productivity of capital . Output is assumed to be a function solely of
capital. Y=AK
Its Implication is clear: Boosting savings rate(Hence investment) and making capital
more productive will increase Economic growth.
According to these models increasing rate of Investments is considered to be
necessary to induce per capita growth.
Every country therefore needs capital to generate investments.

10. Criticism
The key weakness lies in the underlying assumptions:
1. A single production function was used for all countries.
2. Every economy is assumed to have the same necessary conditions and would pass through
the same phasing, stage by stage.
3. But that economic growth path Which historically had been followed by more developed
countries, is not the only one pathway.
4. The development process is actually highly nonlinear. Countries may pursue distinct
development paths. Economies may miss stages. Become locked in one particular stage or
even regress depending on many other factors.

11. Structural Change Models
In this economists Generally describe the development process as a structural change. By which the reallocation of
labour from the agricultural sector to the industrial sector is considered the key source for economic growth.
Well known models of this is Two-Sector Lewis Model (1954) and the structural change and patterns of
development Chenery, (1960)

12. Lewis Model
This theory was given by Arthur Lewis in 1954. Also known as the “Model of Unlimited Supply of
Labour”.
The theory assumes a dual economy, that is coexistence of Agriculture/Subsistence/Traditional sector
and Industrial/ manufacturing/modern sector.
 This theory provides solution to the excess labour supply in the developing nations.
 Theory states that with the movement of labour from rural to urban sector, the traditional society
transforms into the modern society.
 Due to Unlimited supply of labour these labourers still earned subsistence wages.
 The excess of Modern sector Profits over wages and hence investments In the modern sector
continued to expand generate further economic growth.
 This process of modern sector self sustaining growth and employment expansion facilitated the
structural transformation from a traditional subsistence economy to a more modern developed
economy.

13. Like Harrod- Domar Model Lewis also considered savings and investments to be the driving forces of the
the economic development but in the less developed world.
The analysis Identified that the steady accumulation of physical and human capital is among conditions
necessary for economic growth, apart from savings and investment.
However, the structural changes occurred not only in the 2 sectors but in overall economy like change in
consumer demand from basic necessities to more diverse manufactured good and services, international
trade and resource use, as well as changes its socio economic factors such as Urbanization and the
growth and distribution of countries population.
The structural change models focused on the pattern of development and hypothesised that the pattern
was similar in all countries and was identifiable. However., works, such as ( Chenery 1960), Chenery and
Taylor(1968), on the process of structural change does recognise that pattern of development can be
different among countries, which is dependent on the country’s particular set of factors, including a
country’s resource endowment and size, its government policies and objectives, the availability of
external capital and technology, the international trade environment.

14. International Dependence Models.
The dependence theorists argued that underdevelopment exists because of the dominance of
developed countries and multinational corporation over developing countries.
 The poor countries are said to be dependent on the developed countries for market and capital, but the
benefits received by developing countries are in very small proportion as compared to the developed countries.
 Developed countries can exploit national resources of developing countries through getting cheap supplier
food and raw materials.
 As a result, the poorer countries could not expect sustained growth from that dependence. So according to
Dependence theory, developing countries should end the dependence by breaking their relationship with the
developed countries.
 The model gained increasing support from developing countries.

15. Limitations
 Developing countries which followed Autarky policy often experienced stagnant
growth and finally decided to open their economies once again such as China, India.
 Also the experience of the newly industrialised economies of East Asia. Namely,
Hong Kong, Singapore, Taiwan and South Korea during the 1970s and 1980s showed
that their success had been the result of trade with the advanced industrial
countries.

16. Neoclassical Counter- Revolution Models
• This model argued that Under development is not the result of the predatory
activities of the developed countries and the international agencies, but was
rather caused by the domestic issues arising from heavy state intervention, such
as poor resource allocation, government induced price distortions and corruption.
• They focused on promoting free markets eliminating government impose
distortions associated with protectionism, subsidies, and public ownership.

17. ROBERT SOLOW MODEL(1956)
Expanding the Harrod Domar formulation Solow neoclassical growth model stresses
the importance of 3 factors of output growth. The most glaring omission in the
harrod-Domar model is the missing labour input in the production function. After
all, Labour claims about two-third of the total output produced, about twice as
much as what is claimed by capital in the United States.
Y (t) = F[K(t), L(t)] = K(t)α L(t) 1−α
• Increases in labour quantity and quality (through population growth and
education)
• Increases in capital (Through savings and investment)
• Improvements in technology (Technology as Exogenous factor)

18. Contemporary Theories of Economic
development
 Endogenous growth, or the new growth theory, emerged in the 1990s to explain the poor
performance of many less developed countries.
 Under this model, the technological change has not been equal nor it has been exogenously
transmitted in most developing countries as developed by Solow model.
 New Growth Theorists( Romer 1986, Lucas 1988) linked to the technological change to the
production of knowledge. The new growth theory emphasises that economic growth results from
increasing returns to the use of knowledge rather than labour and capital.
 They emphasised the importance of investment in human capital education, infrastructure, and
research and development. They believe that investment in knowledge creation can bring about
sustained growth. Also the knowledge can create a spill over benefit to other firms once they
obtained the knowledge.

19.  Romer stated long-run growth results from the contribution of entrepreneurs and researchers in the form of
innovation and technological advancement.
 His idea is treat Technology at a more abstract level:- It is the ideas or knowledge to produce goods and services,
different from the tools and machines that embody the ideas.
 The New growth models therefore promote the role of government and public policies in complimentary
investments in human capital formation and the encouragement of foreign private investments in knowledge
Intensive industries such as computer software and telecommunications.
 These ideas can be produced with capital and labour inputs, much like ordinary goods, but they have some crucial
properties that make them unique.
Ideas are non-rival
• Once person use of idea does not make the
idea non usable by others
Ideas are Partially excludable
• Ideas can be owned and owner can sell the
rights to use the ideas at a market price. Eg
patent
Romer Model

20. The technological production function given by Romer is as follows:
∆A = F (KA, HA, A)
Here,
∆A is the increasing technology.
F is the production function for technology.
KA denotes the capital investment in developing the new technology.
HA is the human capital used for research and the development of new ideas.
A is the current technology.

21. Limitations
 Although the new growth theory helps to explain the divergence in growth rates across economies, it
was criticized for overlooking the importance of social and institutional structures (Skott and Auerbach
1995).
 Its limited applicability lies in its assumptions. For example, it treats the economy as a single firm that
does not
permit the crucial growth-generating reallocation of labour and capital within the economy during the
process of structural change.
 Moreover, there are many other factors which provide the incentives for economic growth that
developing countries lack such as poor infrastructure, inadequate institutional structures and imperfect
capital and goods markets (Cornwall and Cornwall 1994).
 Policy-makers will therefore need to pay careful attention to all of the factors that determine the
changes and their impacts on the aggregate growth rate.

22. Theory of Coordination Failure
 The foundation of the theory of coordination failure is the idea that the market may fail to achieve
coordination among complementary activities.
 These theories talk about complementarities , that is investment in one firm are dependent upon the
investments of other firms.
 Coordination failure therefore leads the market to an (equilibrium) outcome inferior to a potential situation in
which resources would be optimally allocated and all agents would be better off. As a result,
underdevelopment equilibrium is possible.
 The theory of coordination failure became influential in the 1990s.
 Coordination issues among complementary industries were first raised by Rosenstein-Rodan (1943). Like
Rosenstein-
 Rodan (1943), early coordination failures economists Nurkse (1953) and Hirschman (1957) emphasized the
role of the government to solve the problem. In order to reach an optimal level of coordination, the policy
they recommended was a “big push”—a public-led massive investment program—which can cause
complementarities to take place in the rest of the economy

23. Big- Push Theory
The theory suggests that for developing countries to break out of poverty trap a big push of basic investment
between now and 2015 in public administration, human capital and key infrastructure is necessary.
The theory of big push was given by Rodenstein Rodan in 1943. In his work “Problems of industrialization of East
and South East Europe”
 A firm will be influenced by what other forms are doing.
 Coordination amongst firm is important.
 The theory talks about indivisibilities. External economies, which will result from wide scale production, enhance
cheap raw materials and wide extent of markets.
 The theory also talks about complementarities, that is, interdependence. It implies that investment in one firm
are dependent upon investment on other firms. The theory of big push give importance to government’s role.

24. Limitations
 Critics have asserted that the government is, ineffective and could choose a bad policy (Killick 1976; Hoff and
Stiglitz 2000).
 If a bad policy is implemented, it can push an economy into a bad equilibrium form years to come and even
into a worse equilibrium than the one with which the country began (Hoff and Stiglitz 2000).
 Moreover, the policies recommended by coordination failure models lacked details of how the government
can coordinate the economy. Policy-makers therefore need to be more cautious of these strategies to address
coordination failure issues.