Classic Theories of Economic Growth and … Theories of Economic Growth and ... 3-2 Classic Theories of Economic Development – Four Approaches 1. ... Michael P. Todaro

Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

Chapter 3

Classic Theories

of Economic

Growth and

Development

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-2

Classic Theories of Economic

Development – Four Approaches

1. Capital accumulation (Harrod-

Domar)

2. Theories and Patterns of structural

change (Lewis)

3. International-dependence revolution

4. Neoclassical, free market

counterrevolution

Observation:

• LDCs have much less capital per worker

than rich countries.

• “Capital” = machinery and equipment

• Result: Lower productivity of labor

• And thus Lower wages/incomes.

• LDCs are poor because they

lack capital


sYS

KI

(3.1) Savings rate s

(3.2) Invest = ΔCapital

YkK (3.3) Capital/Output = k

IS (3.4) Closed Economy

The Harrod-Domar Model


The Harrod-Domar Model

IKYksYS (3.5)

YksY (3.6)

k

s

Y

Y

(3.7)

Growth rate of GDP = savings rate/capital-output ratio

=> To increase GDP growth, increase s (or foreign S)


Criticisms of the Harrod-Domar

Model

• Necessary versus sufficient conditions

• Is Saving necessary for growth?

– Not if foreign investment or foreign aid (World

Bank Loans, etc.)

• Is Saving (Investment) sufficient for growth?

– Are there institutions to channel savings to

productive uses: a well-functioning financial

system or government plan?

Observation:

LDCs often have two quite different sectors:

1. Traditional (subsistence) agriculture

Low K/L, low Land/L, “old” technology

(NOT: tractors or combines, hybrid seeds,

chemical fertilizer, pesticides, herbicides)

Result: VERY low productivity and

incomes

“Modern” Industrial Sector

• Higher K/L, more modern technology than

traditional sector (tho often low by rich

country standards)

• Result: Higher productivity and incomes

• Also: Large Urban-Rural gaps in income

result in migration to the cities

Urban-Rural Income Ratio:

China

1.8

2.0

2.2

2.4

2.6

2.8

3.0

1978 1983 1988 1993 1998Chen (2002)

Rural vs. Urban Consumption

405

559

779

1,052

0

200

400

600

800

1,000

1,200

1972-73 2004-05

Co

ns

tan

t (2

00

4-0

5)

Ru

pe

es

pe

r P

ers

on

pe

r M

on

th Rural Urban

NSSO


Figure 3.1 The Lewis Model of Modern-

Sector Growth in a Two-Sector

Surplus-Labor Economy


Criticisms - Lewis Model • Rate of labor transfer and employment

creation may not be proportional to rate of modern-sector capital accumulation

• Surplus labor in rural areas (no) and full employment in urban (no)?

• Institutional factors (unions, min wage)?

• Assumption of diminishing returns in modern sector (agglomeration economies)

• BUT: Captures some elements of urban-rural divide. Chapter 7: Todaro Model


The International-Dependence

Revolution • The neoclassical dependence model

– Unequal power, core-periphery (exploitation)

• The false-paradigm model

– Using “expert” advisors who give wrong advice (true!)

• The dualistic-development thesis

– Superior and inferior elements can coexist (true)

• Implications

– Autarky (end exploitation by “neocolonialists”)

– State led development: SOEs, central planning,

regulation


The Neoclassical

Counterrevolution • Challenging the statist model of government led

development

– Central planning, SOEs, etc, not usually successful

– Free market approach

– Public choice approach (not: government is “bad;”

rather, what incentives for politicians/bureaucrats)

• Criticism of Neoclassical Counterrevolution:

– Institutional and political realities in developing world

differ from Western world

• assume property rights and functioning court systems

• ignore power relationships of traditional social systems based

on caste, gender, elites


Theories of Development:

Reconciling the Differences • Development economics has no

universally accepted paradigm

• Insights and understandings are

continually evolving

• Each theory has some strengths and

some weaknesses


Case Study: South Korea and

Argentina


Concepts for Review

• Autarky

• Average product

• Capital-labor ratio

• Capital-output ratio

• Center

• Closed economy

• Comprador groups

• Dependence

• Dominance

• Dualism

• False-paradigm

model

• Free market

• Free-market analysis

• Harrod-Domar growth

model


Concepts for Review (cont’d)

• Lewis two-sector

model

• Marginal product

• Market-friendly

approach

• Necessary condition

• Neoclassical

counterrevolution

• Neocolonial

dependence model

• New institutionalism

• New political

economy approach

• Open economy

• Patterns-of

Development analysis



• Periphery

• Production function

• Public choice theory

• Savings ratio

• Self-sustaining growth

• Solow neoclassical

growth model

• Stages-of-growth

model of development

• Structural-change

theory

• Structural

transformation

• Sufficient condition

• Surplus labor



• Traditional neoclassical growth theory

• Underdevelopment

• You are NOT responsible for the

appendices

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Classic Theories of Economic Growth and … Theories of Economic Growth and ... 3-2 Classic Theories of Economic Development – Four Approaches 1. ... Michael P. Todaro