Economic Growth Factors

Sources of Growth

• Economic growth is measured by increases in GDP per capita
• Economies and societies become more prosperous due to discovery of riches, natural resources, effort, saving, capital accumulation, and education
• Other factors of growth include theft, efficiency, and technological change

The Growth Function Formula

• Output (O) = F(K,L,R)e + A + P
• "F" means "function of"
• K is capital
• L is labor
• R is natural resources
• E is an exponent for the efficiency of using K, L, & R to transform intermediate inputs into final goods and services
• "A" refers to net income from capital investments and labor abroad
• "P" refers to colonial plunder, expropriation (-), transfers, and development aid (+)

Intermediate and Ultimate Sources of Growth

• Intermediate sources include trends in domestic and international demand, economic and social policies, and the distance to the world technological frontier
• Ultimate sources include long-run trends in scientific and technological knowledge, demographic trends, institutions/institutional change, historical developments, basic social attitudes/capabilities, and changes in class structures etc.

Classical Thinking

• Classical economists and sociologists since the 1700s tried to determine why the capitalistic West succeeded in economic growth and advancement
• Their main focus has been on the ultimate origins of growth and development

Adam Smith's Theories

• Adam Smith was interested in differences between countries in terms of income and wealth
• Smith sought causes of prosperity
• He firmly believed in the free market, invisible hand, and price mechanism
• Smith believed that the free market would promote and improve the collective welfare
• There should be limited government intervention
• Free trade and free competition would improve net gains from world trade
• Specialization and division of labor dramatically increase productivity

Ricardo, Malthus, and Mill

• Ricardo (1792 – 1823), Malthus & Mill (1806-73) shared Adam Smith's preference for free markets
• Ricardo's law of Comparative Advantage states that countries entering international trade benefit by specializing in products they are most efficient at

Ricardo and Population Growth

• Ricardo feared economic development stagnation in the long run due to population growth
• Increased population growth will require using less fertile soils, resulting in diminishing marginal returns and less productivity
• Food scarcity would cause prices and wage rates to increase

Ricardo and Tariffs

• Rising wages cut profits, which cuts future investment and lowers economic growth
• Ricardo advocated abolishing tariffs on imported food to postpone the slowdown of growth

Thomas Malthus' Theories

• Thomas Malthus (1766 – 1834) believed food production grew arithmetically, while population grew geometrically
• Food production would not keep up with population growth, resulting in starvation and famine
• German infant industries were to be tariff protected

Friedrich List's Theories

• Friedrich List (1789 – 1846) was a firm believer of protection and government intervention, unlike Ricardo, Malthus, and Mill
• The dominant nations primarily benefited from free trade
• Active government intervention was vital for structural transformation of agrarian societies into industrial ones
• Active government intervention was necessary to build industrial sector in later–developing economies

Classical Sociologists

• Similar to classical economists, classical sociologists focused on development trends linked to the rise of modern capitalist societies

Herbert Spencer's Theories

• Herbert Spencer (1820-1903) favored free markets
• Societies evolve, adapting to changing environmental conditions
• Social evolution happens through increasing size, differentiation, and complexity
• Militant hierarchical societies represent earlier stages of social evolution
• Industrial societies represent later stages of social evolution
• Market competition promotes survival of more efficient firms, contributing to social change and increasing welfare

Ferdinand Tonnies

• Ferdinand Tonnies (1855-1936) highlighted the change from communal social patterns (Gemeinschaft) to individualistic, specialized relationships (Gesellschaft)
• Many sociologists focused on changes that accompanied economic growth

Rostow's Stages of Development

• In 1960 economist W. W. Rostow suggested countries pass through five stages of economic development

Stage 1: Traditional Society

• Subsistence activity dominates where output is consumed by producers rather than traded
• Trade is carried out by barter
• Agriculture is the most important industry
• Production is labor intensive, using limited capital
• Resource allocation is determined by traditional methods

Stage 2: Transitional Stage (Preconditions for Takeoff)

• Increased specialization generates surpluses for trading
• Transport infrastructure emerges to support trade
• Incomes, savings, and investment grow, and entrepreneurs emerge
• External trade occurs, concentrating on primary products

Stage 3: Take Off

• Industrialization increases, with workers switching from agricultural to manufacturing sectors
• Growth is concentrated in a few regions and one or two manufacturing industries
• Investment reaches over 10% of GNP
• Economic transitions accompany evolution of new political/social institutions supporting industrialization
• Growth is self-sustaining as investment leads to increasing incomes, generating more savings to finance further investment

Rostow's Stage 4: Drive to Maturity

• The economy is diversifying into new areas of innovation for a diverse range of opportunities for investment that leads to production of wide range of goods and services and there is less reliance on imports

Rostow's Stage 5: High Mass Consumption

• The economy is geared towards mass consumption
• Consumer durable industries flourish and the service sector becomes increasingly dominant
• Development requires substantial investment in capital
• For LDCs to grow, the right investment conditions must be created
• If aid/FDI occurs at stage 3, the economy must have reached stage 2 for possible rapid growth with investment injections

Rostow's Model: Limitations

• Many economists argue that Rostow's model was developed with Western cultures in mind and not applicable to LDCs
• Its generalized nature makes it somewhat limited
• It doesn't detail the preconditions for growth
• Policymakers can't clearly identify stages as they merge together, making it not very helpful as a predictive model
• Its main use is to highlight the need for investment
• It's essentially a growth model, not addressing the wider development context

Advantages of Backwardness

• Late-developing economies experience industrialization in rapid spurts
• Financial institutions (e.g., banks) play a more important role
• International technology transfer

Neoclassical Theories of Growth

• Economic growth is caused by increasing labor quantity (population growth), improvements in labor quality (training/education), and increasing capital (higher savings/investment)
• Improvements in technology

Neo-Classical Growth Theories and Underdevelopment

• Underdevelopment comes from inefficient government utilization of resources and state intervention in markets via price regulation
• Government control inhibits growth, encouraging corruption, inefficiency, and no profit motive for entrepreneurship
• The root cause of underdevelopment lies with governments of LDCs themselves

Neo-Classical Strategies

• Competitive free markets, privatization of state-owned industries, a move from closed to open economies, and encouraging free trade/foreign direct investment
• These policies stimulate investment, higher output/income, and higher savings

Neo-Classical Model: Problems

• Unrealistic assumptions are made and crucial issues are ignored
• The assumption that a free market and private enterprise culture can be created is made
• Market failure such as externalities are associated with economic growth and are ignored
• Uneven income distribution is ignored

Theories of Unequal Exchange

• Involvement of developing countries in the international division of labor is detrimental to their chances of economic development