Lecture Chapter 3 Notes for presentation Oct 28 PDF

CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT 1. LINEAR-STAGES-OF-GROWTH MODEL (1950s and 1960s) LINEAR-STAGES-OF-GROWTH MODEL Definition of Series of successive stages of economic growth through which all countries must Development...

CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT 1. LINEAR-STAGES-OF-GROWTH MODEL (1950s and 1960s) LINEAR-STAGES-OF-GROWTH MODEL Definition of Series of successive stages of economic growth through which all countries must Development pass to achieve development Right quantity and mix of saving, investment, and foreign aid based on the experience of more developed countries Underdevelopment is internally-induced and due to internal constraints within the country. Models 1. Rostow’s Stages of Growth Model by Walt Rostow Five Stages: (a) traditional society; (b) pre-conditions for take-off; (c) take-off; (d) drive to maturity; and (e) age of high mass consumption Developed countries had passed “take-off” stage. Underdeveloped countries which are either under “traditional society” or the “pre- conditions for take-off” need to follow set of rules of development to take-off such as mobilization of savings to generate investments. 2. Harrod-Domar Growth Model by Roy Harrod and Evsey Domar The more a country can save and invest, the faster it grows. More investment leads to more growth Also called the AK Model (output depends on capital stock (K) times a constant (A) Increased investment leads to higher capital stock then higher economic growth then increased savings Limitations/ Emphasizes the crucial role of savings and investment in promoting sustainable long- Implications term growth. The Rostow’s Model historical approach is based on the experience of Western countries towards development. It may not be applicable to all countries. It has bias towards Western model as the only path towards development. The Rostow’s Model assumes all countries have a desire to develop in the same way, with the end goal of high mass consumption, disregarding the diversity of priorities of countries and different measures of development. The Rostow’s Model assumes all countries have equal chance to develop without regard to population size, natural resources, or location. The Harrod-Domar Model assumes a constant capital-output ratio. However, economic growth can be also increased by improving investment efficiency. The Harrod-Domar Model does not take into account labor force growth and technological change. There is a relatively low level of new capital formation in most poor countries.  LINEAR-STAGES-OF-GROWTH MODEL More savings and investments are necessary conditions but not sufficient conditions toward development Marshall Plan worked for Europe because European countries receiving aid from US already possessed the necessary structural, institutional, and attitudinal conditions to convert new capital effectively into higher levels of outputs. The Rostow and Harrod-Domar Models assume the existence of these same attitudes and arrangements in poor countries. Yet, in many cases, they are lacking. 2. THEORIES AND PATTERNS OF STRUCTURAL CHANGE (1970s) Theories and Patterns of Structural Change Definition of Economies of poor countries transform their domestic economic structures from Development traditional subsistence agriculture to a more modern, more urbanized, more industrially diverse manufacturing and service economy. Development requires more than just accelerated capital formation. Underdevelopment is due to underutilization of resources from structural or institutional factors in both domestic and international dualism. Underdevelopment is internally-induced and due to internal constraints within the country. Models 1. Lewis Two-Sector Model by W. Arthur Lewis and later modified by John Fei and Gustav Ranis The underdeveloped economy consists of two sectors: (a) traditional, overpopulated, rural subsistence sector (surplus labor); and (b) high-productivity, modern industrial sector. Surplus labor from the traditional agricultural sector is transferred to the modern industrial sector, the growth of which absorbs the surplus labor, promotes industrialization, and stimulates sustained development. The primary focus of this model is on the process of labor transfer and the growth of output and employment in the modern sector. Growth depends on the rate of industrial investment and capital accumulation in the modern sector. It emphasizes the importance of transfer of resources from low-productivity to high- productivity activities in the process of economic development. 2. Patterns-of-Development Analysis (Chenery Model) To identify characteristic features of the internal process of structural transformation that a “typical” developing economy undergoes as it generates and sustains modern economic growth and development  Theories and Patterns of Structural Change Increased savings and investments are necessary but not sufficient conditions for economic growth (in contrast with the Lewis Model and linear-stages-of-growth model) Accumulation of capital (both physical and human) are required. Emphasize both domestic and international constraints on development including differences in development level among developing countries (in contrast with the linear-stages-of-growth model) Developing countries are part of an integrated international system that can promote or hinder their development. Chenery Model (by Hollis Chenery and colleagues) ✓ It documented precisely how economies undergo structural change while identifying the numerical values of key economic parameters involved in that process. ✓ This model examined patterns of development for numerous developing countries during the postwar period. It led to the identification of characteristic features of development or stylized facts: shift from agricultural to industrial production, the steady accumulation of physical and human capital, the change in consumer demands from emphasis on food and basic necessities to desires or diverse manufactured goods and services, the growth of cities and urban industries as people migrate from farms and small towns, and the decline in family size and overall population growth in the long- term Limitations/ The Lewis Two Sector Model key assumptions do not fit the realities of contemporary Implications developing countries. We should take into account the following: a. Labor-saving bias of most modern technological transfer b. Existence of substantial capital flight c. Wide-spread non-existence of rural surplus labor d. Growing prevalence of urban surplus labor e. Tendency for modern-sector wages to rise rapidly Structural-Change Model assumes that development is an identifiable process of growth and change, and whose main features are similar in all countries. It assumes that there are well-defined empirical patterns of development that should be pursued by most poor countries. Structural-Change Model does not recognize the differences that can arise among countries in the pace and pattern of development. Structural-Change Model emphasizes patterns rather than theory which runs the risk to draw wrong conclusions about causality. We can learn that development varies according to domestic and international factors, many of which lie beyond the control of a developing country. Patterns of development may be affected by the choice of development policies, trade policies, and foreign aid policies pursued by both the developed and developing countries. 3. INTERNATIONAL-DEPENDENCE REVOLUTION (1970s) International-Dependence Revolution Definition of Developing countries are affected by institutional, political, and economic rigidities, Development both domestic and international. Developing countries are caught up in a dependence and dominance relationship with rich countries. Underdevelopment is externally-induced and due to constraints outside of the country. International Dependence Revolution places emphasis on international power imbalances and on needed fundamental economic, political, and institutional reforms, both domestic and worldwide. International Dependence Revolution argues that the pace of economic growth could be accelerated through domestic and international reforms, accompanied by public and private activities. International Dependence Revolution emphasizes the importance of the structure and workings of the world economy and the many ways in which decisions made in the developed world can affect the lives of millions of people in the developing world. International Dependence Revolution recognizes the dualistic structures and the role of ruling elites in the domestic economies of the developing world. Models/ 1. The Neocolonial Dependence Model Streams of Thought Underdevelopment exists in developing countries because of continuing exploitative economic, political, and cultural policies of former colonial rulers toward less- developed countries. Underdevelopment exists because of historical evolution of highly unequal international capitalist system of rich country-poor country relationships. Coexistence of rich and poor nations in an international system dominated by unequal power relationships between the center (developed countries) and the periphery (developing countries) Underdevelopment and poverty exist because of the existence and policies of the industrial capitalist countries of the northern hemisphere and their extensions in the form of comprador groups or local elites in the less-developed countries. Restructuring of the world capitalist system is required to free dependent developing nations from the direct and indirect economic control of their developed-world and domestic oppressors. 2. The False-Paradigm Model Developing countries have failed to develop because their development strategies (usually given to them by Western economists) have been based on an incorrect model of development. Underdevelopment happens due to faulty and inappropriate advice provided by well- meaning but often uninformed and biased international “expert” advisers from developed-country assistance agencies and multinational donor organizations without giving due consideration to needed social and institutional change.  International-Dependence Revolution 3. The Dualistic-Development Thesis Notion of a world of dual societies, of rich nations and poor nations and, in the developing countries, pockets of wealth within broad areas of poverty Dualism is the coexistence of two situations (one desirable and the other not) that are mutually exclusive to different groups of society—for example, extreme poverty and affluence, modern and traditional economic sectors, growth and stagnation, and higher education for a few amid large-scale illiteracy. Four key arguments: a. Coexistence of superior and inferior conditions b. This coexistence is chronic and not transitional. c. Not only do the degrees of superiority or inferiority fail to show any signs of diminishing, but they even have an inherent tendency to increase. d. The existence of the superior elements does little or nothing to pull up the inferior element. Limitations/ International-Dependence Revolution rejects the Chenery Model that there are well- Implications defined empirical patterns of development that should be pursued by most poor countries. Two weaknesses of International-Dependence Revolution Theories: a. Give little insight into how countries initiate and sustain development b. The actual economic experience of developing countries that have pursued revolutionary campaigns of industrial nationalization and state-run production has been mostly negative. International-Dependence Revolution somewhat argues that the best course for developing countries is to become entangled as little as possible with the developed countries and instead pursue a policy of autarky, or inwardly directed development, or at most trade only with other developing countries. What is needed is a reform of the international economic system, a restructuring of dualistic developing economies, an increase in foreign aid, attempts to control population growth, or a more effective development planning system. 4. NEOCLASSICAL COUNTER-REVOLUTION (1980s and 1990s) Neoclassical Counter-Revolution Definition of The resurgence of neoclassical free-market orientation toward development problems Development and policies, counter to the dependence revolution, particularly from USA, Canada, Britain and West Germany. Underdevelopment results from poor resource allocation due to incorrect pricing policies and too much government intervention of developing countries. In developed countries, it called for supply-side macroeconomic policies, rational expectations theories, and the privatization of public corporations. In developing countries, it called for freer markets and the dismantling of public ownership, statist planning, and government regulation of economic activities.  Neoclassical Counter-Revolution It argues that government intervention in economic activity slows the pace of economic growth. Underdevelopment exists not because of the predatory activities of the developed world and the international agencies, but rather because of the heavy hand of the government and the corruption, inefficiency, and lack of economic incentives that permeate the economies of developing nations. What is needed is promoting free markets and laissez-faire economics within the context of permissive governments that allow the “magic of the marketplace” and the “invisible hand” of market prices to guide resource allocation and stimulate economic development. They point to the successes of Asian tigers such as South Korea, Taiwan, and Singapore, and to the failures of Africa and Latin America. It challenges the statist model. The statist model or statism refers to an economy where there is a high degree of government intervention, regulation, and influence over markets. We learned that promoting efficient production and distribution through a proper, functioning price system is an integral part of any successful development process. It recognizes the inefficiency of state-owned enterprises and the failures of development planning, and the harmful effects of government-induced domestic and international price distortions. Models/ 1. The Free-Market Approach or Free-Market Analysis Approaches Markets alone are efficient and any government intervention in the economy is distortionary and counterproductive. It assumes that markets of developing countries are efficient. 2. The Public-Choice or New Political Economy Approach The theory that self-interest guides all individual behavior and that governments are inefficient and corrupt because people use government to pursue their own agendas. It assumes that politicians, bureaucrats, citizens, and states act solely from a self- interested perspective, using their power and the authority of government for their own selfish ends. It argues that minimal government is the best government. 3. The Market-Friendly Approach The notion historically promulgated by the World Bank that successful development policy requires governments to create an environment in which markets can operate efficiently and to intervene only selectively in the economy in areas where the market is inefficient. It recognizes that there are many imperfections in developing-country product and factor markets and that governments do have a key role to play in facilitating the operation of markets through “non selective” (market-friendly) interventions such as  Neoclassical Counter-Revolution investing in physical and social infrastructure, healthcare facilities, and educational institutions. It accepts the notion that market failures are more widespread in developing countries in areas such as investment coordination and environmental outcomes. Missing and incomplete information, externalities in skill creation and learning, and economies of scale in production are also endemic to markets in developing countries. 4. Traditional Neoclassical Growth Theory Liberalization (opening up) of national markets draws additional domestic and foreign investment and thus increases the rate of capital accumulation. Output growth results from one or more of three factors: increases in labor quantity and quality (through population growth and education), increases in capital (through saving and investment), and improvements in technology. Solow Neoclassical Growth Model or Exogenous Growth Model ✓ Growth model in which there are diminishing returns to each factor of pro duction but constant returns to scale. Exogenous technological change generates long- term economic growth. ✓ It differed from the Harrod-Domar Model by adding a second factor, labor, and introducing a third independent variable, technology, to the growth equation. ✓ Formula is (where Y is GDP, K is capital stock, L is labor, and A is productivity of labor, which grows at an exogenous rate). The ∝ represents the elasticity of output with respect to capital (the percentage increase in GDP resulting from a 1% increase in human and physical capital). Limitations/ It argues that underdevelopment is internally induced phenomenon of developing Implications countries, caused by too much government intervention and bad economic policies. Many developing economies are so different in structure and organization from their Western counterparts that the behavioral assumptions and policy precepts of traditional neoclassical theory are sometimes questionable and often incorrect. However, enlightened governments can also make effective use of prices as signals and incentives for influencing socially optimal resource allocations. The reality of the institutional and political structure of many developing countries — not to mention their differing value systems and ideologies—often makes the attainment of appropriate economic policies based either on markets or on enlightened public intervention an exceedingly difficult endeavor. Lesson: It is a matter of assessing each individual country’s situation on a case-by- case basis. Developing nations need to adopt local solutions in response to local constraints. References: Economic Development Thirteenth Edition (Michael P. Todaro and Stephen C. Smith) https://www.e-education.psu.edu/ geog128/node/719  SUMMARY AND INSIGHTS ON CLASSIC THEORIES OF GROWTH AND DEVELOPMENT 1. Each approach has its strength and weaknesses. 2. Development economics has no universally accepted doctrine or paradigm. 3. We have a continually evolving pattern of insights and understandings, reflecting in part improved data and emergence of new technologies and new institutions, that together provide the basis for examining the possibilities of contemporary development of the diverse nations of Africa, Asia, and Latin America. 4. Development requires a skillful and judicious balancing of market pricing and promotion where markets can exist and operate efficiently, along with intelligent and equity-oriented government intervention in areas where unregulated market forces would lead to undesirable economic and social outcomes. 5. Well-formulated government policy can facilitate the development of markets and shared growth. Reference: Economic Development Thirteenth Edition (Michael P. Todaro and Stephen C. Smith)  CASE STUDY: SOUTH KOREA VERSUS ARGENTINA Approach South Korea Argentina Stages of Confirms some linear-stages of growth Poses a serious challenge to linear- Growth stages-of-growth Huge investment share in national income Takeoff has been completed and pre- conditions were there for some time Entered the “age of high mass before take off to excessive import of consumption” foreign capital over too long a period without increasing domestic savings. Met the “maturity” criterion of becoming integrated with the world economy Met criterion of developing through new types of exports and imports manufacturing sectors at a rapid rate Investment is lower than that of South Korea Development progress is not irreversible and that sustained growth can come to an end. Structural Confirms some patterns-of-development It confirms some structural patterns of Patterns such as increasing agricultural development such as agricultural productivity, shifts of labor from productivity rose, industrial employment agriculture to industry, the steady growth grew though slowly, urbanization took of the capital stock and of education and place, and fertility fell. Many structural skills, and the demographic transition regularities of development were from high to low fertility observed. However, living standards stagnated. After about 1970, productivity growth in agriculture also increased rapidly, owing in part to a successful integrated rural development program. Dependence Poses a serious challenge to Confirms Dependence Theories Revolution Dependence Revolution Relied to a large extent on exporting Strongly dependent in international primary goods, and the real prices of relations (USA and Japan) these goods fell compared to imports. Development is largely due to export Multinational corporations played a opportunities to developed countries. large role, and it was unable to create its own viable manufacturing export Achieved a developed-country status industries. Magnitude of aid it received and the self- Fell victim to developed-country interests of the advanced countries in economic interests, especially those of seeing its full successful development British and American corporations because of its role against communism Pursued some particular policies including carrying out an extremely active industrial upgrading policy, sharply limiting the role of multinational corporations and deliberately establishing indigenous industries as an alternative,  Approach South Korea Argentina and using debt rather than direct foreign equity investment Implemented land reform programs and emphasized primary education rather than university education Neoclassical Poses a serious challenge to Confirms Neoclassical Counter- Neoclassical Counterrevolution Counterrevolution revolution (Neoliberal) Highly interventionist at home and in Illustrates how the government can international trade, with the government become part of a bad equilibrium making extensive use of development planning and its powers Faulty interventionist restrictions, inefficient state enterprise, bias against Highlights the important role of production for exports, and government in overcoming coordination unnecessary red tape ended up hurting failures industry and entrepreneurship. Government policy consistently seemed to support privileged interests rather than broad goals of development, and government failure was usually worse than market failure in the country. Rising internal fiscal and external trade deficits, caused in part by the linking of the peso to a strong US dollar Economic recovery remained erratic. Largest IMF loan given due to 2018 crisis Reference: Economic Development Thirteenth Edition (Michael P. Todaro and Stephen C. Smith)