ECONOMIC DEVELOPMENT
Prelim Lecture Notes 11
Classical Theories of Economic Development
The four major and often competing theories of economic
development:
a. The linear-stages-of-growth model
b. Theories and patterns of structural change
c. The International-dependence revolution
d. Neo-classical, free market counter-revolution
In 1950’s and 1960’s, theorists viewed the development process
as a series of successive stages of economic growth through which all
countries must pass. It was an economic theory of development
which proposed that the right quantity and mixture of savings,
investment and foreign aid are necessary ingredients to proceed
along the path of economic growth that had been historically applied
by more developed countries.
1. The linear-stages-of-growth model
this theory of economic development says that a country passes
through sequential stages in achieving development.
American economic historian Walt W. Rostow advocated the
linear-stages-of-growth and according to W. W. Rostow, the
transition from underdevelopment to development can be described
in terms of a series of steps or stages through which all countries must
proceed.
W. W. Rostow stages of economic growth:
a. The traditional society
b. The pre-conditions for takeoff into self-sustaining
growth
c. The take-off
d. The drive to maturity
e. the age of high mass consumption
One of the development strategies to effect take-off is the
use of domestic and foreign savings to generate sufficient investment
to accelerate economic growth and the economic mechanism by
which more investment leads to more growth is described in the
Harrod-Domar growth model which is the functional economic
relationship in which the growth rate of gross domestic product (g)
depends directly on the national net savings rate or national net
saving ratio (s) ( savings expressed as a proportion of disposable
income over some period of time) and inversely on the national
capital-output ratio (c) (a ratio that shows the units of capital required
to produce a unit of output over a given period of time).
Change in Y / Y = s / c
Example: capital output ratio is 3, aggregate net saving ratio is 6
percent, then GDP growth rate is 2 percent per year, (.06/3=.02). If
net saving ratio increases to 15 percent then (.15/3= 5) percent GDP
growth rate increases to 5 percent
An increase in the proportion of national income saved will increase
GDP.
Criticism of the theory of linear stages of growth
The theory of linear stages of growth’s development
mechanism does not work always because more savings and
investments are not sufficient condition (a condition that when
present causes or guarantees that an event will or can occur) for
accelerated rates of economic growth though it is necessary condition
(a condition that must be present, although it need not be in itself
sufficient, for an event to occur).
In 1970s, the linear-stages of growth model was replaced by two
competing schools of thought:
a. Theories and Patterns of Structural Change- It used
modern economic theory and statistical analysis to portray
internal process of structural change that a developing
country must undergo if it is to succeed in generating and
sustaining economic growth. 2.a. Theory of Structural
Change (The hypothesis that underdevelopment is due to
underutilization of resources arising from structural and
institutional factors that have their origins in both domestic
and international dualism. Development thus requires more
than just accelerated capital formation, 2.b. Theory of
Pattern-of-Development Analysis of Structural Change (an
attempt to identify characteristics features of the internal
processes of structural transformation that a typical
developing economy undergoes as it generates and sustains
modern economic growth and development).
b. The International Dependence Revolution -It viewed
underdevelopment in terms of international and domestic
power relationships, institutional and structural economic
rigidities, and the resulting proliferation of dual economies
and dual societies both within and among the nations of the
world.
2. Theories and Patterns of Structural Change
2.a. Theory of Structural Change is the structural transformation
(The process of transforming an economy in such a way that the
contribution to national income of manufacturing sector will
surpasses the agricultural sector contribution) of primarily
subsistence economy which was formulated by Nobel Laureate W.
Arthur Lewis known as Lewis two-sector model (A theory of
development in which 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).
In Lewis two-sector model, underdeveloped consist of two
sectors, 1) a traditional, overpopulated rural subsistence sector
characterized by zero marginal labor (surplus labor) productivity 2)
and a high-productivity modern, urban industrial sector into which
surplus labor from subsistence labor is gradually transferred. A
surplus labor means the excess of labor over and above the quantity
demanded at the going free-market wage, however in Lewis two-
sector model, surplus labor means the portion of the rural labor force
whose marginally productivity is zero. The focus of the two-sector
model is both on the surplus labor transfer from subsistence sector
and the growth of output and employment in the modern sector.

Criticisms of the Lewis two-sector Model
a. It assumes that the rate of labor transfer and employment
creation in the modern sector is proportional to the rate of the
modern sector capital accumulation. The faster the rate of
capital accumulation, the higher the growth rate of modern
sector and the faster the rate of new job creation. However,
what if capital accumulated is used in other undertaking beside
using it to create new job.
b. The notion that surplus labor exists in rural areas while there is
full employment in the urban areas. Suppose there is no or little
surplus labor from rural area which is what research indicated.
c. The notion of competitive modern sector labor market that
guarantees the continued existence of constant real urban
wages up to the point where supply of rural surplus labor is
exhausted. However, the tendency of urban wages is to rise
substantially.
d. Its assumption of diminishing return in the modern industrial
sector. Yet there is a much evidence of increasing returns
prevailing in this sector.
2.b. Pattern-of-Development Analysis of Structural Change is an
attempt to identify characteristics features of the internal processes
of structural transformation that a typical developing economy
undergoes as it generates and sustains modern economic growth and
development.
The best-known model on the pattern of development analysis of
structural change is the one based on the empirical of work Hollis C.
Chenery and his colleagues, who examined the patterns of
development for a number of developing countries. Their empirical
studies both cross sectional and time-series of countries at different
levels of per capita income led to identification of different
characteristic features of the development process those are the
1. Shifts from agricultural to industrial production
2. Steady accumulation of physical and human capital
3. Change in consumer demands from emphasis on food
and basic necessities to desires for diverse
manufactured goods and services
4. Growth of cities and urban industries as people
migrates from rural areas
5. Decline in family size and overall population growth
Conclusions and implications:
The model recognizes the differences that arise among
countries in the pace and pattern of development depending on their
circumstances. The limitation on the model approach is on the risk to
draw about causality. The empirical studies on this model led to the
conclusion that the pace and pattern of development can vary
according to the domestic and international factors, which mostly
beyond the control of individual developing countries. It is argued
that there are really certain patterns occurring in almost all countries
during the development process.
3. International-Dependence Revolution
International-Dependence Revolution views developing
countries as beset by institutional, political, and economic rigidities,
bothe domestic and international, and caught up in a dependence and
dominance relationship with rich countries. This has three streams of
thought:
3.a. The neocolonial dependence model- is a model whose main
proposition is that underdevelopment exists in developing countries
because of continuing exploitative economic, political, and cultural
policies of former colonial rulers toward less developed countries.
The coexistence of rich and poor countries in an international system
dominated by an unequal power relationship between the center
(developed countries) and the periphery (developing countries)
makes the attempts of poor nations to be self-reliant and
independent difficult and almost impossible.
3.b. False-paradigm model – the proposition that developing
countries have failed to develop because their development
strategies have been based on an incorrect model of development
(input from western economists), one that, overstresses capital
accumulation of market liberalization without giving due
consideration to needed social and institutional change.
This model attributes underdevelopment to faulty and inappropriate
advice given by well-meaning but often uninformed, biased, and
ethnocentric international experts (advisers) from developed-country
assistance agencies and multinational donor organizations.
3.c. Dualism – The coexistence of two situations or phenomena (one
desirable and other not) that are mutually exclusive to different
groups of society. Example: poverty and affluence, growth and
stagnation, modern and traditional economic sectors, high literacy
and wide low literacy.
Four key arguments of the concept of Dualism
a. Different set of conditions can coexist in a given space
(superior and inferior)
b. The coexistence is chronic and not merely 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. (ex. Workers productivity
gap between rich and poor nations labor force)
d. The interrelationships between the superior and inferior
elements are such that the existence of the superior
elements does little to or nothing to pull up the inferior
element. It may actually serve to push it down (developing
its underdevelopment)
Conclusions and implications:
The dependence, false-paradigm, and dualism theorist place
emphasis on international power imbalances and on needed
fundamental, economic, political, and institutional reform both
domestic and international or global wide. The international
dependence theories weaknesses lie on:
a. They give no insight on 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.
If we take the international dependence theory at face value,
the conclusion is that developing countries should entangle less with
developed countries, instead pursue a policy of Autarky (a closed
economy that attempt to be completely self-reliant), or inwardly
directed development, or trade only with other developing countries.
In 1980s, the political ascendancy of conservative governments
in developed countries (U.S.A., Canada, Britain, Germany) came with
Neo-classical Counterrevolution in Economic Theory and Policy.
1. Neo-Classification Counterrevolution, Free Market
Counterrevolution
The Neo-classical Counterrevolution is the resurgence of neoclassical
free-market orientation toward development problems and policies,
counter to the interventionist dependence revolution of the
immediate previous decade.
Conclusions and Implications:
Dependence theorists saw underdevelopment as an externally
induced phenomenon while neo-classical saw the problems of
underdevelopment as an internally induced phenomenon of
developing countries which is caused by too much government
intervention and bad economic policies. There is little doubt that
market price allocation usually better than state intervention
however, many developing countries 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. Competitive free
markets generally do not exist nor necessarily desirable for a long-
term economic growth and social perspective given the institutional,
cultural, and historical context of many developing countries.
Nevertheless, the reality of institutional and political structure of
many developing countries makes the attainment of appropriate
economic policies based on either market or public intervention a
difficult endeavor. It is then best to assess each individual country’s
situation on a case-to-case basis which means developing nations
should adopt local solutions in response to domestic constraints.

The central argument of the Neo-classical

counterrevolution theorists is that underdevelopment results from
poor resource allocation due to incorrect pricing policies and too
much state intervention of the by active developing-nation
governments. They argue that by permitting a) competitive free
market (the system whereby prices of commodities or services freely
rise or fall when the buyer’s demand for them rises or falls or the
seller’s supply of them decreases or increases) flourish, b) privatization
of state-owned corporations, c) promoting free trade and export
expansion, d) attracting investors from developed countries, and e)
eliminate too may government regulations and price distortions in
factor, product, and financial markets, both economic efficiency and
economic growth will be stimulated.

Neo-classical counterrevolution consists of three approaches

1. Free-market approach – theoretical analysis of the properties of

an economic system operating with free markets, often under
the assumption that an unregulated market performs better
than one with government regulation that means markets alone
are efficient.

2. Public choice or new political economy approach – the theory

that self-interest guides all individual behavior and that
government are inefficient and corrupt because people use
government to pursue their own agendas that means minimal
government is the best government.

3. Market-friendly approach – the notion promulgated by the

World bank that successful development policy requires
governmetns 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. Market-
friendly approach accepts the notion that market failures (a
market’s inability to deliver its theoretical benefits due to the
existencce of market imperfections such as monopoly power, lack
of factor mobility, lack of knowledge, and significant
externalities) are more widespread in developing countries in
areas such as investment coordination and environmental
outcomes.