NS4053

Winter Term 2014Classical Theories

of Growth and Development

Historical Theories: Overview

• For years economists have attempted to identify factors responsible for long term growth, business cycles and development

• Early attempts – British Classicals in 1700s were primarily interested in growth.

• Marx – mid-1800s more interested in stages of development and evolution of economies to higher stages

• Schumpeter – early-to-mid 1900s saw the advantages of capitalism – showed why many of Marx’s forecasts were wrong

• Hansen-- 1930s-1940s largely concerned with the problems of maintaining growth in mature economies

• Each focused on a factor of production – Classicals, land, Marx – capital, Schumpeter entrepreneurship, Hansen technology.

• All very pessimistic about the ability of economies to sustain high rates of growth indefinitely – some sort of diminishing returns/constraints would eventually slow growth

• Each, in own way, can be considered a stagnationist.• All made bad forecasts.

2

Classical Theory of Stagnation I

Overview• Classical theory largely based on work of 19th-century

English economists, David Ricardo, Adam Smith• The group was greatly influenced by Newtonian physics –

activities not random but subject to some grand design.• Believed as in physics some natural order determined

prices, rent, and economic affairs.• For Ricardo – assumption was little continuing

technological progress -- growth limited by land scarcity.• Believed in the labor theory of value – value determined

by labor inputs• Ricardo primarily interested in the distribution of income

between wages, rents and profits – changes in these over time drove the system to eventual equilibrium

• Key assumption the division of labor, limited by size of market – advocated laissez-faire capitalism and free trade to develop larger markets.

3

Classical Theory of Stagnation II

• For Ricardo, the law of diminishing returns – successively lower extra outputs from adding fixed inputs to land was key element

• For him diminishing returns from population growth and a constant amount of land threatened economic growth

• Ricardo believed technological change or improved production techniques could only temporarily check diminishing returns.

• Increasing capital was seen as the only way of offsetting this long run threat. Process as follows:

• In the long run natural wage is at subsistence – cost of perpetuating the labor force.

• The wage may deviate, but eventually returns to a natural rate.

• In years of good harvests food supplies are greater than what is essential for maintaining the population – wage above subsistence level.

4

Classical Theory of Stagnation III

• Ricardian Process (contd)

• Extra food means fewer deaths, more births, and the population increases

• More people need food and the average wage falls. Population growth continues to reduce wages until they research subsistence again

• On the other hand a wage below substance increases deaths and eventually contributes to a labor shortage which raises the wage.

• Population decline increases wages once again to the subsistence level

• In both cases the tendency is for the wage to return to the natural subsistence wage

• Called the iron law of wages – total wages increase in proportion to the labor force

5

Classical Theory of Stagnation IV

• Output increases with population but other things equal, output per worker declines with diminishing returns on fixed land – price of food and thus the wage increase.

• Thus the surplus value (output minus wages) per person declines with increased population

• At same time land rents per acre increase with population growth as land becomes scarcer relative to other factors.

• The only way of offsetting diminishing returns is by increased capital per person.

• However capitalists require minimum profits and interest payments to maintain or increase capital stock.

• Yet because profits and interest per-person decline and rents increase with population growth there is a diminishing surplus (profits interest and rent) available for capital accumulation

• Productivity in manufacturing not sufficient to offset rising wages – profits and investment fall. 6

Classical Theory of Stagnation V

• Classical production function – diminishing returns

7

Classical Theory of Stagnation VII

Capital andLabor

A B C D E A B C D E

0 0 0 0 0 0180 170 160 150 140

1 180 170 160 150 140170 160 150 140

2 350 330 310 290160 150 140

3 510 480 450150 140

4 660 620140

5 800

Price per bushel is $1Price of doses of labor capital is $140Grade A land produce product of $800 with five units for a cost of $700 and rent of $100Similarly Rent on B = 60; C = 30; D = $10 and E = 0.

Total Product From Land Marginal Product From Land

8

Classical Theory of Stagnation VIII

• Argument for free trade – way of postponing diminishing returns

• Increased efficiency allowed higher standard of living.

Number of hours required to produce one unit of wine and cloth in England and Portugal

9

Classical Theory of Stagnation IX

• Critique of Classicals• Paradoxically theory formulated amid numerous

scientific discoveries and technical changes that multiplied output

• Since Ricardo’s time rapid technological progress has contributed to unprecedented economic growth.

• Iron law of wages did not foresee extent to which population growth could be limited

• Later neoclassical economists take the classical stress on savings, free trade and freedom from government restriction and add an emphasis on technological change as an important component of economic growth.

• These ideas are major features of the neoclassical theory of growth – the dominant present day theory of economic growth.

10

Summary: Classical School

11

Modern Malthusians I

• Despite their poor forecasts, many observers still look to the Classical school for insight to current trends.

• Modern Malthusians usually look to something that is linely to be an impediment or barrier – diminishing returns.

• Carliste Ford Runge, “Against the Grain”, Foreign Affairs, 2010

• Notes that in the 1960s, 1970s, and 1980s crop yields continued to increase – “green revolution” greatly increased yields – may have bred over optimism

• Recent increases in food prices complex, but one factor is rising populations and incomes even as food being diverted to other uses – bio-fuels – raises specter of hunger

• A food crisis is intensifying due to three ominous trends:• First, the rate of increase in crop yields appears to be

slowing• Second (and related), agricultural research expenditures

have diminished since the 1980s, especially in Africa• Third, global food supplies have begun to fall relative to

demand and prices – compounded by the use of food in biofuels.

12

Modern Malthusians II

Patterns:• Since World War II gains in agricultural

productivity have been defined by grater output per acre of land

• Gains primarily resulted from substantial use of agrochemicals, fertilizers, large farm equipment water and (mainly in Asia) labor

• All inputs have come at a cost• Over-irrigation and the excessive use of fertilizes

and chemicals have polluted and depleted water supplies and sapped soil’s fertility

• Reality is that in twenty-first century as water and soil quality has fallen, unsustainable techniques have pushed biophysical systems to their limits

• Although yields have continued to increase they have been doing so at diminishing rates. 13

Modern Malthusians III• Problem – appears that yield-increasing technology

began slowing in the 1990s• Due only in part to biological limits• Also due to cutbacks in agricultural research –

complacency that arose from ever-increasing yields• Appears however that improvements brought by

investments in research come with a lag – peak about 25 years and their effects persist for as long as 25 more

• Hence consequence of decisions taken in 1970s and 1980s to limit the growth in funding for agricultural research have only recently become apparent

• Research also changed– public and private researchers increasingly switched.

• Until the late 1970s, public sector, especially U.S. Department of Agriculture had taken lead – much of green revolution came from this effort.

14

Modern Malthusians IV

• With public investment lagging, multinational corporations have taken the lead.

• Problem public research tends to cast benefits more widely including many traditional farmers, whom it allows to make small but significant improvements

• Together, diminished investments in agricultural research, and the shift of research from public sector to private sector have redirected the benefits to large, already successful commercial farmers.

• Not getting the broad-based diffusion of technology as in the past in the past – may account in part for the slowing of productivity

15