Chapter 3

Classic Theories
of Economic
Growth and
Development

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Class Theories of Economic

Development Four Approaches
Structural change model
Linear stages of growth
Saving-investment
Rural-urban migration

Neocolonial dependence theory

Dependence: Center vs. Periphery
False Paradigm

Neoclassical theory
Market friendly approach
Dualistic approach
Public choice approach

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Rostows Linear-Stages Model

1. Traditional society
2. Pre-condition to take-off
3. Take-off
4. Drive to maturity
5. Age of high mass consumption
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Rostows Linear-Stages Model

1. Traditional society: slow economic and
population growth
2. Pre-condition to take-off: development of
institutions, organizations, and
infrastructure
3. Take-off: large investment in selected
industry (10 to 15% of GDP)
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Rostows Linear-Stages Model

4. Drive to maturity: sustained growth of the
industry and economy
5. Age of high mass consumption:
production of consumer goods and
services to serve an affluent society

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Rostows Linear-Stages Model

GDP Growth
Economic Growth

Post Take-off
Take-off
Pre Take-off

t1
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t2

Time

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Harrod-Domar Growth Model

S = sY

S=Saving; Y=Real GDP; s=Saving Ratio

I = K

I=Investment; K=Capital Accumulation

S=I

Saving-Investment identity

Define the Marginal Capital-Output Ratio as k = K/Y

Write K = kY or I = kY
From S = I, write sY = kY or
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Y/Y = s/k
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Harrod-Domar Growth Model

The source of growth is saving and investment in
production of goods and services. Accordingly,

GDP growth rate = s/k

s = national saving ratio; k = marginal capital-output ratio
If s=6% and k=3, then GDP growth rate=2%. Given k=3,
to raise growth rate to 4%, we need to increase the saving
ratio from 6% to 12% with 6% of foreign saving
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3-8

Criticism of Investment Models

Many LDCs have not been able to take-off
or achieve maturity despite massive
foreign investment
Many nations have neglected the
development of institutions, organizations,
and infrastructure required for
industrialization
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The Lewis Development Model

Rural agricultural sector
Low or even zero Marginal Product of Labor so that
labor is a redundant factor and wage rate is at the
subsistence level

Urban industrial sector

Rising demand for unskilled labor to be trained for
industrial growth results in greater employment and
more profits and higher wages

Rural-Urban migration
To find
jobs and
earnAddisonhigher wages
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2009
Pearson
Wesley. All rights reserved.

3-10

Demand for Labor

Wage
R: Rural
W: Wage
D: Labor Demand

WU

Profit

U: Urban
E: Employment
S: Labor Supply

SR

WR
Wage

DU1 DU2
E1

E2

Investment in urban areas

increases the demand and
employment for rural labor.

Employment

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Criticisms of Lewis Model

Industrial technology is generally capital
intensive/labor-saving. Hence, the demand
for unskilled rural labor would not increase
employment
Industrialization must be supported by
agricultural development to supply an
ever-increasing supply of food items and
raw materials
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Demand for Labor

Wage

No increase in employment when

technology is labor saving
Profit

SR

WU
WR

Wage

DU2
E1 = E2

DU1
Employment

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3-13

Neocolonial Dependence Model

MDCs form the center of global economic
relations and technological advancement
LDCs serving as the periphery are dominated by:
unequal trade and finance relations
domestic politico-economic elite
multinational corporations

Under these conditions economic development is

impossible
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Neocolonial Dependence Model

African LDCS

Asian LDCS

American
MDCs

Latin American LDCS

European Other
MDCs MDCs

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False-Paradigm Model
Economic development relies heavily on funds
from international donor agencies such as the
World Bank and IMF
The policy of these agencies is to support urban
industrial growth and impose capitalistic
austerity measures
They reinforce the pattern of dependent
development
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Dualistic Development Model

Structural transformation models create a
dualistic pattern of development, resulting in an
ever-increasing degree of economic inequality
both nationally and internationally:
urban vs. rural
industrial vs. agricultural
modern vs. traditional
rich vs. poor
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Approaches to Development
Free-market approach: rely of the allocation role
of markets and limited government involvement in
economics. But, there are several areas in which
markets fail to achieve efficient outcomes:
income distribution
public goods
externalities
market power
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Approaches to Development
Market-friendly approach: improve market
operation through nonselective
interventions such as

income redistribution system

investment in social and human capital
environmental protection policy
anti-trust laws

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Approaches to Development
Public-choice approach: public officials and
bureaucrats in the position of authority are
rent-seeking citizens acting on self-interest
rather than public-interest
Need a system of checks and balances to monitor
the behavior of public officials and bureaucrats
Need a democratic system to let people choose
public officials and bureaucrats for limited duration
of authority
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Appendix 3.1: Components of

Economic Growth
Capital Formation
Physical capital formation: investment in tools,
equipment, machinery, buildings
Social capital formation: investment in roads, dams,
airports, railroads, bridges
Human capital formation: investment in education,
training, health, nutrition
Political capital formation: investment is creating a
secular and democratic government and free mass
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media 2009 Pearson Addison-

Wesley. All rights reserved.

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Determinants of Economic
Growth
Physical Capital Formation
Increase in the amount of physical
capital per unit of labor

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Determinants of Economic
Growth
Technological Advancement
Increase factor productivity (labor,
land, capital)

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3-23

Production Possibilities Curve

Maximum quantities of two good and

services the economy can produce,
assuming:
full employment / efficiency
fixed resources
constant technology

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3-24

PPC Schedule

Combination
Radios
Rice

100

90

50

40

80

100

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PPC Graph
Combinations A, B, C, and E are attainable
Combination D is unattainable given resources
and technology
Combination F is attainable, but inefficient

Radios
100
90
50

A
B
F

D
C

E
40 80 100
Rice
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Economic Growth

Combination D becomes available with

more resources and better technology

Radios
100
90
50

D
C

E
40 80 100
Rice
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Economic Improvement

Radios
100
90
50

Combinations G (or B or C) becomes

efficient with more employment
and/or improved efficiency

A
B

G
F

E
40 80 100
Rice
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Technological Advancement

Neutral: proportional increase in the supply of Rice and Radios

Radios

Rice
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Technological Advancement

Capital augmenting: greater increase in the supply of Radios

Radios

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Wesley. All rights reserved.

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Technological Advancement

Radios

Labor augmenting: greater increase in the supply of Rice

Rice
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Technological Advancement

Radios

Advancement only in agricultural production

Rice
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Technological Advancement

Radios

Advancement only in industrial production

Rice
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3-33

Factor Accumulation Accounts for

Only a Fraction of Growth

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