ECONOMIC DEVELOPMENT 2.

Preconditions to Take off

- Here, a society begins to develop manufacturing,
Chapter 2: Theories of Economic Development and a more national/international, as opposed to
regional, outlook.
A. Linear- Stages Theory
In the 1950s and the early 1960s, the process of 3. Take-off
development was viewed as a series of successive stages - Rostow describes this stage as a short period of
through which all countries must pass. intensive growth, in which industrialization begins
to occur, and workers and institutions become
With the right mix of savings, investment and foreign concentrated around a new industry.
aid — these countries could be put on the path to
development, thereby making development synonymous 4. Drive to Maturity
with aggregate economic growth. - This stage takes place over a long period of time,
as standards of living rise, use of technology
Walt W. Rostow increases, and the national economy grows and
Became the most influential advocate of the stages of diversifies.
growth model of development- he argued that the
advanced countries had all passed through a series of 5. Age of High Mass Consumption
steps leading to development and growth. - At the time of writing, Rostow believed that
western countries, most notably the United States,
One of the key thinkers in twentieth century occupied this last "developed" stage. Here, a
Development Studies was W.W. Rostow, an American country's economy
economist and government official. Prior to Rostow, flourishes in a capitalist system, characterized by
approaches to development had been based on the mass production and consumerism.
assumption that "modernization" was characterized
by the Western world (wealthier, more powerful The developing countries were still in either the
countries at the time), which were able to advance traditional society or the preconditions stage and
from the initial stages of underdevelopment. had to follow a set of rules to take-off into self-
sustaining economic growth.
Accordingly, other countries should model themselves
after the West, aspiring to a "modern" state of The principal strategy to help this takeoff was the
capitalism and a liberal democracy. Using these ideas, mobilization of domestic and foreign savings in order to
Rostow penned his classic Stages of Economic Growth generate sufficient investment to accelerate economic
in 1960, which presented five steps through which all growth.
countries must pass to become developed:
1) traditional society, 2) preconditions to take-off, 3) B. Harrod- Domar Model
take-off, 4) drive to maturity, and 5) age of high mass The economic mechanism through which more
consumption. The model asserted that all countries investment leads to more growth can be described by
exist somewhere on this linear spectrum, and climb the Harrod- Domar Model.
upward Sirotg) each stage in the development
process: The Harrod-Domar model is an early post-Keynesian
model of economic growth. It is used in development
1. Traditional Society economics to explain an economy's growth rate in
- This stage is characterized by a subsistent, terms of the level of saving and productivity of capital.
agricultural based economy, with intensive labor It suggests that there is no natural reason for an
and low levels of trading, and a population that economy to have balanced growth.
does not have a scientific perspective on the world
and technology.

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The model was developed independently by Roy F. Two important example of such models are:
Harrod in 1939, and Evsey Domar in 1946, 1. Lewis's Model
although a similar model had been proposed by 2. The pattern of development empirical analysis by
Gustav Cassel in 1924. The Harrod-Domar model Chenery
was the precursor to the exogenous growth model.
Lewis's Structural Change Model
In simple words the HD theory of economic growth Nobel laureate Sir William Arthur Lewis said that
states that the rate of growth of GNP is determined underdeveloped economy consists of two sectors.
jointly by the national savings ratio and the national A traditional, over populated rural subsistence
capital-output ratio. sector with surplus labour and a high productivity
modern sector to which this surplus labour is
Thus, the most fundamental strategies to grow for transferred.
economies is to save and invest a certain proportion
of their GNP — but the actual rate at which they can Lewis’ Structural Change Model of Growth:
grow for any level of saving and investment, depends
on how much additional output can be had from an
additional unit of investment.

According to this theory, the major obstacle to growth

is the capital constraint, which became the reason for
transfer of capital and technical assistance to the
developing countries.

C. Structural Change Models

Structural change model focuses on the mechanism by
which underdeveloped economies transform their
domestic economic structures from a heavy emphasis
on traditional subsistence agriculture to a more The focus of the model is on the process of surplus
modern, more urbanized and more industrially diverse labour transfer from the traditional sector which
manufacturing and service economy. leads to the growth of output and employment in
the modern sector. Lewis calculated that with an
The term “structural change” refers to changes in the increase of 30% or more in the urban wages,
sector-structure of an economy, where “sectors” are workers will migrate from the rural areas to the
some theoretical “groups” of goods and services (e.g. urban areas- which would lead to growth in output
agricultural sector, manufacturing sector, services and employment through the modern sector.
sector).
Structural Change and Patterns of
In fact, structural change is one of the most striking Development: Hollis B. Chenery
empirical facts of the development process; most
prominent examples of structural change are In Structural Change and Pattern of Development,
“industrialization” and “transition to a services in addition to the accumulation of capital, both
economy”. Even more importantly, it is well known physical and human, a set of interrelated changes
that structural change has some key impacts on in the economic structure of the country are
economy and society, especially on (aggregate) required for the transition from a traditional
economic growth. economic system to a modern one.

These structural changes involve all economic

functions — including the transformation of

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 production and changes in the composition of The poorer countries would still sell their primary
consumer demand, international trade and products on the world market, but their foreign
resource use as well as changes in socioeconomic exchange reserves would not be used to purchase
factors such as urbanization and the growth and their manufactures from abroad.
distribution of a country’s population.

Development shows certain patterns — for Three issues made this policy difficult to follow.
instance, a shift away from agriculture to industrial The first is that the internal markets of the poorer
production, the steady accumulation of physical countries were not large enough to support the
and human capital, the change in consumer economies of scale used by the richer countries to
demands from emphasis on food and basic keep their prices low.
necessities to manufactured goods and services.
This leads to the growth of cities and urban The second issue concerned the political will of the
industries as people migrate from the rural to the poorer countries as to whether a transformation from
urban regions with a decline in overall family size being primary products producers was possible or
and rate of population growth. desirable.

D. International Dependence Revolution The final issue revolved around: the extent to which
Dependency Theory developed in the late 1950s the poorer countries actually had control of their
under the guidance of the Director of the United primary products, particularly in the area of selling
Nations Economic Commission for Latin America, those products abroad. These obstacles to the import
Raul Prebisch. Prebisch and his colleagues were substitution policy led others to think a little more
troubled _by the fact that economic growth in the creatively and historically at the relationship between
advanced industrialized countries did not necessarily rich and poor countries.
lead to growth in the poorer countries. Indeed, their
studies suggested that economic activity in the richer 1. Neo-Colonial Dependence Model
countries often led to serious economic problems in - It is an indirect outgrowth of Marxist thinking. It
the poorer countries. Such a possibility was not refers to the existence and continuance of
predicted by neoclassical theory, which had assumed underdevelopment in a highly unequal
that economic growth was beneficial to all (Pareto international capitalist system.
optimal) even if the benefits were not always equally
shared. The international system is dominated by unequal
power relationships between the centre (the
Prebisch's initial explanation for the phenomenon was developed nations) and the periphery (the less
very straightforward: poor countries exported developed countries). The poor nations attempt to
primary commodities to the rich countries who then become self-reliant and independent but this
manufactured products out of those commodities and system makes it difficult and sometimes even
sold them back to the poorer countries. The "Value impossible.
Added" by manufacturing a usable product always
cost more than the primary products used to create According to this theory, certain groups in the
those products. Therefore, poorer countries would developing countries (including landlords,
never be earning enough from their export earnings to entrepreneurs, military rulers, merchants, salaried
pay for their imports. public officials, and trade union leaders) who enjoy
high incomes, social status, and political power
Prebisch's solution was similarly straightforward: constitute a small elite ruling class whose principal
poorer countries should embark on programs of interests are in perpetuation of the international
import substitution so that they need not purchase capitalist system of inequality.
the manufactured products from the richer countries.

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 Directly and indirectly, they serve (are dominated unequal ownership of land and other property
by) and are rewarded by (are dependent on) rights, the disproportionate control by local elites
international special-interest power groups over domestic and international financial assets,
including multinational corporations, national and the very unequal access to credit, these
bilateral-aid agencies, and multilateral assistance policies, based as they often are on mainstream,
organizations like the World Bank or the Lewis-type surplus labour or Chenery-type
International Monetary Fund (IMF). structural-change models, in many cases merely
serve the vested interests of existing power
Therefore, a major restructuring of the world groups, both domestic and international.
capitalist system is required to free dependent
developing nations from the direct and indirect 3. Dualistic Development Thesis
economic control of their developed-world and Dualism is a concept widely discussed in
domestic oppressors. development
economics. It represents the existence and
Curiously, a very similar but obviously non-Marxist persistence of increasing divergences between rich
perspective statement was expounded by Pope and poor nations and rich and poor peoples on
John Paul Il in his widely quoted 1988 encyclical various levels. One of the elements of dualism is
letter: that there is a coexistence of wealthy, highly
educated elites with masses of illiterate poor
“One must denounce the existence of economic, people within the same country or city. According
financial, and social mechanisms which, although to this theory, there is a coexistence of powerful
they are manipulated by people, often function and wealthy industrialized nations with weak,
almost automatically, thus accentuating the impoverished peasant societies in the international
situation of wealth for some and poverty for the rest. economy.
These mechanisms, which are manoeuvred directly
or indirectly by the more developed countries, by This coexistence is chronic and not merely
their very functioning, favour the interests of the transitional. It is not due to a temporary
people manipulating them. But in the end they phenomenon, in which with the capacity of time,
suffocate or condition the economies of the less the discrepancy between superior and inferior
developed countries.” elements would be eliminated.

2. False-Paradigm Model E. Neo- Classical Counter

- The second and less radical international- In the 1980s, the political ascendancy of conservative
dependence approach to development, the false- governments in the United States, Canada, Britain, and
paradigm model, attributes underdevelopment to West Germany brought a neoclassical
faulty and inappropriate advice provided by well- counterrevolution in economic theory and policy. In
meaning but often uninformed, biased, and developed nations, this counterrevolution favored
ethnocentric international ‘expert’ advisers from supply-side macroeconomic policies, rational
developed-country assistance agencies and expectations theories, and the privatization of public
multinational donor organizations. These experts corporations. In developing countries, it called for
offer sophisticated concepts, elegant theoretical freer markets and the dismantling of public
structures, and complex econometric models of ownership, statist planning, and government
development that often lead to inappropriate or regulation of economic activities.
incorrect policies.
The central argument of the neoclassical
Because of institutional factors such as the central counterrevolution is that underdevelopment results
and remarkably resilient role of traditional social from poor resource allocation due to incorrect pricing
structures (i.e., tribe, caste, class, etc.), the highly policies and too much state intervention by overly

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active developing-nation governments. Rather, the signals for investments in new activities; labor
leading writers of the counterrevolution school, markets respond to these new industries in
including Lord Peter Bauer, Deepak Lal, lan Little, appropriate ways; producers know best what to
Harry Johnson, Bela Balassa, Jagdish Bhagwati, and produce and how to produce it efficiently; and
Anne Krueger, argue that it is this very state product and factor prices reflect accurate scarcity
intervention in economic activity that slows the pace values of goods and resources now and in the
of economic growth. future. Competition is effective, if not perfect;
technology is freely available and nearly costless to
The neoliberals argue that by permitting competitive absorb; information is also perfect and nearly
free markets to flourish, privatizing state-owned costless to obtain. Under these circumstances, any
enterprises, promoting free trade and export government intervention in the economy is by
expansion, welcoming investors from developed definition distortionary and counterproductive.
countries, and eliminating the plethora of government Free-market development economists have tended
regulations and price distortions in factor, product, to assume that developing-world markets are
and financial markets, both economic efficiency and efficient and that whatever imperfections exist are
economic growth will be stimulated. of little consequence.

Contrary to the claims of the dependence theorists, 2. Public-choice theory, also known as the new
the neoclassical counterrevolutionaries argue that the political economy approach, goes even further to
Third World is under-developed not because of the argue that governments can do nothing right. This
predatory activities of the First World and the is because public-choice theory assumes that
international agencies that it controls but rather politicians, bureaucrats, citizens, and states act
because of the heavy hand of the state and the solely from a self-interested perspective, using
corruption, inefficiency, and lack of economic their power and the authority of government for
incentives that permeate the economies of developing their own selfish ends. Citizens use political
nations. What is needed, therefore, is not a reform of influence to obtain special benefits (called “rents”)
the international economic system, a restructuring of from government policies (e.g., import licenses or
dualistic developing economies, an increase in foreign rationed foreign exchange) that restrict access to
aid, attempts to control population growth, or a more important resources. Politicians use government
effective development planning system. resources to consolidate and maintain positions of
power and authority. Bureaucrats and public
Rather, it is simply a matter of promoting free officials use their positions to extract bribes from
markets and laissez-faire economics within the rent-seeking citizens and to operate protected
context of permissive governments that allow the businesses on the side. Finally, states use their
“magic of the marketplace” and the “invisible hand” of power to confiscate private property from
market prices to guide resource allocation and individuals. The net result is not only a
stimulate economic development. They point both to misallocation of resources but also a general
the success of countries like South Korea, Taiwan, and reduction in individual freedoms. The conclusion,
Singapore as “free market” examples. therefore, is that minimal government is the
best government.
The neoclassical challenge to the prevailing
development orthodoxy can be divided into three 3. The market-friendly approach is the most recent
component approaches: the free-market approach, the variant on the neoclassical counterrevolution. It is
public choice (or “new political economy”) approach, associated principally with the writings of the
and the “market-friendly” approach. World Bank and its economists, many of whom
were more in the free-market and public choice
1. Free-market analysis argues that markets alone camps during the 1980s.
are efficient—product markets provide the best

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 This approach recognizes that there are many coefficient, constant-returns-to-scale assumption of
imperfections in LDC product and factor markets the Harrod-Domar model, Solow’s neoclassical growth
and that governments do have a key role to play in model exhibited diminishing returns to labor and
facilitating the operation of markets through capital separately and constant returns to both factors
“nonselective” (market friendly) interventions— jointly. Technological progress became the residual
for example, by investing in physical and social factor explaining long-term growth, and its level was
infrastructure, health care facilities, and assumed by Solow and other growth theorists to be
educational institutions and by providing a suitable determined exogenously, that is, independently of all
climate for private enterprise. The market-friendly other factors.
approach also differs from the free-market and
public-choice schools of thought by accepting the
notion that market failures are more widespread in References: Economic Development Twelfth Edition
developing countries in areas such as investment Michael P. Todaro (New York University) &
coordination and environmental outcomes. Stephen C. Smith (The George Washington University)
Moreover, phenomena such as missing and Economic Development
incomplete information, externalities in skill
creation and learning, and economies of scale in
production are also endemic to LDC markets.

In fact it is the recognition of these last three

phenomena that gives rise to the newest schools of
development theory, the new or endogenous
growth school of thought, and the coordination
failure approach.

F. New Growth Theory

Another cornerstone of the neoclassical free-market
argument is the assertion that liberalization (opening
up) of national markets draws additional domestic
and foreign investment and thus increases the rate of
capital accumulation.

In terms of GNP growth, this is equivalent to raising

domestic savings rates, which enhances capital-labor
ratios and per capita incomes in capital-poor
developing countries. Traditional neoclassical models
of growth are a direct outgrowth of the Harrod Domar
and Solow models, which both stress the importance
of savings.

The Solow neoclassical growth model in particular

represented the seminal contribution to the
neoclassical theory of growth and later earned Solow
the Nobel Prize in economics. It expanded on the
Harrod-Domar formulation by adding a second factor,
labor, and introducing a third independent variable,
technology, to the growth equation. Unlike the fixed-

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