3&4 - Classical Theories Of Economic Growth And Development

Question 1

Classic theories of development: 4 approaches, what are they?

Answer 1

• Linear stage of growth model - 1950s & 1960s (Rowstow stages of growth, Harrod-Domar growth model)
• Theories and patterns of structural change - 1970s (Lewis two-sector model)
• International-dependence “revolution” - 1970s (Neoclassical dependence model, false-paradigm model, dualistic development thesis)
• Neoclassical, Free market “counterrevolution” - 1980s & 1990s (Free market approach, public choice approach, market friendly approach)

Question 2

What are the linear stages theories

Answer 2

• Rowstow’s stages of growth
• Harrod-Domar growth model

Question 3

Rowstow’s stages of growth (5 stages)

Answer 3

• Traditional societies
• Preconditions for take-off
• Take-off
• Drive to maturity
• High mass consumption

Question 4

Rowstow’s stages of growth

Traditional societies (first stage)

Answer 4

• Subsistence agriculture, very little mobility or social change, great division of wealth, decentralised political power

Question 5

Rowstow’s stages of growth

Preconditions for take-off (second stage)

Answer 5

Level of investment rises to 10% of national income to ensure self-sustaining growth (transport and other social infrastructure), lend risk capital, entrepreneurship, industry, division of labour, agricultural revolution, political structure - modern government

Question 6

Rowstow’s stages of growth

Take-off (third stage)

Answer 6

Self-sustaining economic growth, investment more than 10% of national income, establishment of leading growth sectors

Question 7

Rowstow’s stages of growth

Drive to maturity (fourth stage)

Answer 7

Application of modern technology to bulk up resources, new leading sectors replace the old (e.g. steel), changes in distribution of workforce, growth in urban population, increase in proportion of white-collar workers, entrepreneur to manager

Question 8

Rowstow’s stages of growth

High mass consumption (5th stage)

Answer 8

Flourishing capitalist system characterised by mass production and consumerism

Question 9

Criticisms and advantages of Rowstow’s stages of growth

Answer 9

Criticisms:
- Can a valid meaningful distinction be made between stages of development (e.g. preconditions for take-off vs take-off)

Advantages:
- Shows the importance of agriculture at the early stage
- Provision of infrastructure and political stability
- How valuable the role of investment is in development
- Industrialisation - rural to industrial society

Question 10

What does Harrod-domar model explain

Answer 10

Economic theory that explains the relationship between savings, investment and economic growth.

Question 11

What’s the main equation

Answer 11

Y = Sg / c minus rate of capital depreciation

Question 12

Suppose a country has a gross savings rate of 20%, a depreciation rate of 3%, and an ICOR of 2.5

Using the Harrod-Domar growth model, find the implied rate of growth of total GDP in the country

Answer 12

0.2 / 2.5 - 0.03 = 0.05

Question 13

Obstacles and constraints of the Harrod-Domar model

Answer 13

• A country must be able to save more to increase GDP growth
• The main obstacle to or constraint on development, according to this theory, is relatively low level of new capital formation in most poor countries
• The “savings gap” can be filled through either foreign aid or private foreign investment
• Growth can also be increased by improving investment efficiency

Question 14

2) Theories of structural-change (Lewis two-sector model)

What are the 3 assumptions of the Lewis two-sector model)

Answer 14

1) There’s 2 sectors
- Traditional, rural, subsistence with zero MPL
- High-productivity modern, urban industrial with labour transfer from traditional sector

2) Capitalists reinvest their profits

3) Level of wages in the modern sector is constant and higher than traditional sector

Question 15

Lewis two sector model

Is there a shortage or surplus of labour in the traditional sector

Answer 15

Surplus of labour in traditional sector, due to underemployment and population growth

Question 16

Lewis model

It assumes the economy is dualistic meaning what

Answer 16

Has two distinct sectors with different levels of productivity, wages and technological advancement

Question 17

Lewis model (check graphs)

Explain the capital accumulation and investment

Answer 17

The surplus labour from agriculture is expected to move to the industrial (modern) sector leading to capital accumulation and increased production

However, industrial sector is seen to be capital intensive therefor requires investment in physical capital (machinery, factories)

Question 18

What’s the Lewisian turning point

Answer 18

Where the surplus labour in the traditional sector become exhausted, and wages in traditional and modern sector start to rise rapidly. Turning point from dualistic economy to a integrated balanced one

Question 19

Criticisms of the Lewis model

Answer 19

• Rate of labour transfer and employment creation may not be proportional to rate of modern-sector capital accumulation
• Questionable assumption of surplus labour in rural areas and full employment in urban
• Questionable assumption of diminishing returns in modern industrial sector, in some cases
• Institutional factors have a small (if any) role in this approach

Question 20

3) The international-dependence model

The 3 theories

Answer 20

• Neo-colonial dependence model
• False paradigm model
• Dualistic-development thesis

Question 21

Describe Neo-colonial dependence model

Answer 21

• Economic imbalances post-colonial era
• Model suggests despite achieving political independence, there’s developing countries still facing economic dependency and exploitation by powerful nations
• Rich ‘core’ nations (USA, UK) at one end, and underdeveloped or ‘peripheral nations’ at the other end. Under colonialism, powerful nations took control
• Attempts by poor nations to be self-reliant where it’s been impossible
• Restructuring of the world capitalist system is to free dependent developing nations from economic control of developed countries

Question 22

Describe the false-paradigm model

Answer 22

• Proposition that developing countries have failed to develop because their development strategies (usually given by western economists) been based on incorrect model of development. For example, over stresses capital accumulation

Question 23

Describe the dualistic development thesis

Answer 23

• Dualism = Existence of substantial divergences between rich and poor nations and people’s on various levels
  Dualism embraces 4 key arguments:
  1) Different sets of conditions, which some are superior and others inferior. For example, highly educated environment compared to illiterate
  2) This coexistence of wealth and poor is chronic and not transitional. Other words, not a temporary phenomenon which time would eliminate
  3) Degree of superiority and inferiority between developed and developing countries fail to show signs of diminishing, but seem to increase. For example, productivity gap between developed and developing countries seem to widen
  4) Superior elements does little or nothing to pull up the inferior elements

Question 24

Conclusions and implications of the international dependence model (revolution)

3 theories = New-colonial dependence, false-paradigm, dualism model

Answer 24

• The 3 theories (neo-colonial dependence, false-paradigm, dualism model) reject the exclusive emphasis on traditional neoclassical economic theories designed to accelerate growth of GDP as principle for development
• They question the validity of the Lewis model of modernisation
• They do not state there are patterns in development poorer countries should follow; instead the 3 theories place emphasis on the fact there’s power imbalances and need economic reform
• These 3 theories give little insight into how to sustain development

Question 25

4) The neoclassical counter-revolution: Market fundamentalism (free market)

Answer 25

- In 1980s, US, Canada, UK, West Germany came with a neoclassical counterrevolution in economic theory and policy - In developed countries, favoured supply-side policies - In developing countries, called for free markets and dismantling of public ownership - Underdevelopment results from poor resource allocation due to incorrect pricing policies and too much intervention by developing nation governments - Economic efficiency and growth will be stimulated if government intervention is minimal - They say what’s needed is free markets and laissez-faire economics with a permissive Government to allow

Question 26

Counterrevolution 2) Public choice theory

Answer 26

- Goes even further from the free market and states the governments can do nothing right - State the governments use their power for their own selfish ends - Minimal Government is best government

Question 27

Counterrevolution 3) Market-friendly approach

Answer 27

- States Government does have a key role to play in facilitating operation of markets through market-friendly interventions such as investing in healthcare facilities, education etc - Market friendly approach differs from ‘free-market’ and ‘public-choice’ as market friendly approach accept market failures

Question 28

3 components of economic growth

Answer 28

- Capital accumulation (including new investments in land, physical equipment, and Human Resources through improvements in health, education and job skills) - Growth In population; therefore growth in labour force - Technological progress - New ways accomplishing tasks

Question 29

Capital accumulation, how does it happen? What’s the result of it?

Answer 29

- Stimulates economic growth - Results when a proportion of income is saved and invested in order to augment future output and income - New factories, machinery, equipment, materials increase physical capital stock of a nation - Capital accumulation makes it possible to increase output levels

Question 30

Populating and labour force growth (graph in textbook)

Answer 30

- Stimulates economic growth - More productive workers, and larger population increases domestic markets - Depends whether the economy can absorb and employ the surplus labour

Question 31

Technological progress

Answer 31

- Stimulates economic growth - New and improved ways of achieving tasks - Neutral, labour saving and capital saving technological progress - Neutral Technological progress = Occurs when higher output levels are achieved with the same quantity of factor inputs (E.g. simple innovations like division of labour) - Labour saving technological progress = Higher output levels are achieved using an unchanged quantity of labour inputs as a result of some invention (E.g. the computer) or assembly line production - Capital saving technological progress (much rarer) = Invention or innovation that achieves higher output levels using same quantity of inputs capital

Question 32

Conclusion of components of economic growth

Answer 32

- Large investments to improve quality of existing physical and Human Resources, increase quantity of these resources, therefore raise productivity of all or specific resources through invention, innovation and technological progress

Question 33

The solow neoclassical model

Answer 33

- Output is a function of capital and labour: Y=(K,L) - The production function relating output to inputs exhibits constant returns to scale, diminishing returns to individual factors of production, and has a unitary elasticity of substitution between factors - The production function is increasing in capital and labour meaning the more people we have the more we will produce and the more capital we have the more we will produce - Perfect competition= Theory assumes competitive markets, where prices are determined by supply and demand. In such markets, resources flow efficiently to their most productive uses, fostering economic growth - Constant positive savings rate - All saving is invested S=I - Constant rate of Depreciation - Labour (population) force grows at a constant exogenous rate

Question 34

The Solow equation (won’t need to calculate)

Answer 34

Change in Workers = Savings per worker - rate of capital depreciation + rate of growth of labour force x workers