explains the long run economic growth of an
Growth theory
Simon Xiaobin Zhao
University of Hong Kong, China
Growth theory is an umbrella term for a number
of different theories concerning the economic
development of nations. It is a loose school of
thought that emerged in the post-World War II
era from a number of different economists with
differing theories. The basic aim of these the-
ories was to explain how so-called third world
countries might achieve economic development
and convergence with the First World (devel-
oped countries). Growth theorists first sought to
understand the varying factors that contributed
to economic growth in the developed world;
they then attempted to apply these theories in
order to create a universal model for economic
development. Growth theories were also shaped
by the political climate of the 1940s and 1950s,
particularly the Cold War politics that was
emanating from the United States of America
and Western powers. The political context for
growth theory is most pertinently shown by
Walt Whitman Rostow’s The Stages of Economic
Growth: A Non-Communist Manifesto (1960); a
reaction to economic growth theories emanating
from the Soviet Union (USSR) at the time.
Modern growth theory economics is in part
a reaction to the previously existing neoclassical
models, namely the Harrod–Domar model
(Harrod 1939; Domar 1946) – an example of
post-Keynesianism – which later led to the
development of the Solow–Swan model (Solow
1956; Swan 1956). The Harrod–Domar model,
the earliest example of growth economics,
The International Encyclopedia of Geography.
Edited by Douglas Richardson, Noel Castree, Michael F. Goodchild, Audrey Kobayashi, Weidong Liu, and Richard A. Marston.
© 2017 John Wiley & Sons, Ltd. Published 2017 by John Wiley & Sons, Ltd.
DOI: 10.1002/9781118786352.wbieg0166
economy in terms of the level of national savings
within the economy and the productivity of
the capital available, with an increase in either
resulting in economic growth. The model
does not subscribe to the idea that economics
should experience balanced growth; according
to the Harrod–Domar model there are three
distinct types of growth: warranted growth,
actual growth, and the natural rate of growth.
The Solow–Swan model instead focuses on the
rate of technical progress as the key focus for
economic growth and development and was the
first growth model to distinguish between the
vintages of the capital. The model shows that
growth can be achieved by increasing invest-
ment or reducing taxes that directly relate to
new capital accumulation, thus increasing the
productivity of the economy. The Solow–Swan
model growth is only short term in nature, as
in the long run the natural growth rate of an
economy converges towards a steady state. Both
models are criticized for assuming too much
within their framework: the Harrod–Domar
model assumes that economic growth will result
in full employment; the Solow–Swan model
assumes that too many of the factors of pro-
duction are fixed and that capital is subject to
diminishing returns in a closed economy.
Rostow’s (1960) linear stages of growth model is
a simple stage theory that explains the process
of economic development based on the his-
torical experience of the industrialized powers.
Rostow’s model builds off of Harrod–Domar’s
growth theory, emphasizing the role of savings
(investment) in stimulating economic expansion.
The premise of this structuralist theory was that
economic growth for all countries followed a set
G ROWT H THE O RY
pattern, and therefore economic growth could
be shown to progress through five distinct stages
of varying lengths. The five stages are tradi-
tional, preconditions for takeoff, takeoff into
self-sustaining growth, drive to maturity, and
age of high mass consumption. The traditional
stage is characterized as an almost completely
undeveloped primary sector economy. The pre-
conditions to takeoff involve the development of
excess production of raw materials, mainly cash
crops, in order to utilize the surplus coupled
with an expansion of the technological frontier.
The takeoff into self-sustaining growth involves
the expansion of the secondary sector, mainly
in the form of a few key leading industries. It is
then followed by the drive to maturity in which
the industries of the secondary sector are grown,
diversified, and developed away from capital
goods towards consumer-driven goods (e.g.
apparel, household appliances). The final stage is
the age of high mass consumption, characterized
as an economy that is heavily reliant on the
secondary and tertiary sectors, with the primary
sector greatly diminished, and where the con-
sumption of high-value goods is widespread.
According to Rostow, the onus for an economy
to emerge from being traditional to the takeoff
stage is the mobilization of internal savings in
order to fuel investment endogenously; however,
this can be replaced by the exogenous injection
of foreign aid or capital. Rostow’s model assumes
that the developing countries will follow the
same patterns of growth that had been observed
in the developed countries of the period, which
is the major criticism of this theory.
As a result of the rigid nature of Rostow’s
theory it has been considered less analytical
and less historically sophisticated than other
models. A similar but contrasting model was
developed by Alexander Gerschenkron – the
“backwardness” model. Gerschenkron (1962)
theorizes that some economies, particularly
2
those in Eastern Europe, are more “backward”;
although he never provides a specific definition
for “backwardness,” he relates it to low income
per capita, savings rates, human capital, and
levels of technology. The “backward” nature
of an economy creates a greater chance that
the country will lack economic prerequisites
and therefore the industrialization process will
involve substitutions to achieve these – a focus
on the production of producer goods instead
of consumer goods, the reliance on imported
technology rather than indigenous technology,
and the use of specialist institutions (the state in
the case of Russia) to facilitate the use of human
and physical capital in designated industries.
Gerschenkron’s model, like Rostow’s, is more
of an observation on development rather than a
fully functioning model.
A successor to Rostow’s theory, which came
to the forefront of the discussion in the 1970s,
was Lewis’s (1954) structural change model. Lewis’s
model is an analysis of the internal process of
change that a developing economy will undergo
in order to generate economic growth. The
Lewis model, also Keynesian in inspiration,
theorizes that a developing country’s economy
has two sectors, primary (agriculture) and sec-
ondary (industry). In the model the factors of
production, predominantly labor, are underuti-
lized in the primary sector, which results in a
marginal productivity of effectively zero; this
means labor can be extracted from the primary
sector without reducing its output. In order for
the economy to grow and develop, the factors
of production, normally labor in the case of
agricultural societies, need to be reallocated
towards the secondary, urban, industrial sector
enabling the economy to grow off the back
of cheap, plentiful labor. To encourage labor
to migrate, Lewis assumed that the urban wage
would have to be approximately 30% higher than
the wage, or equivalent, available in the rural

sector. The profits created within the economy
from exploiting cheap labor can be reinvested
towards capital accumulation, which can lead to
self-sustaining economic development. How-
ever, this ignores the potential for capital to
replace the need for labor – as happened during
the Industrial Revolution in England, leading to
the Luddite movement that emerged as a reac-
tion to the resulting unemployment. The model
also assumes a perfect, competitive labor market,
which is unlikely in a developing economy.
Following the focus on Keynesian economics
that the previous growth theories had been
based around, the neoliberal counterrevolution,
which occurred primarily under the Reagan
and Thatcher governments, was a monetarist
approach. The Chicago School of Economics is
credited as being the intellectual source of the
neoliberal movement, with Milton Friedman
developing the laissez-faire economics and
Friedrich Hayek developing the model’s political
roots. Friedman sought to remove as much of
the state’s influence on markets as possible in
order to maximize their efficiency. The change
of policy within key Western governments
towards the neoclassical approach was both a
political and an economic shift, and was heav-
ily influenced by the Cold War geopolitical
situation. The privatization of many national-
ized companies in the United States and the
United Kingdom, for example British Telecom,
resulted from a notable shift in government
policy. Neoliberal policymakers chose to focus
on supply-side macroeconomics, privatization
of public companies, and reducing, or elim-
inating, the controlling role of the state over
economies. The main argument of the neoliberal
counterrevolution is that underdevelopment and
stagnation occur due to poor resource allocation
by the state due to the rational expectations
of the market being usurped, and instead free
markets should be trusted to optimize resource
GROWTH THEORY
allocation. The fundamentals of neoliberal eco-
nomic thought are reliant on a strong legal
grounding to create the ideal environment for
the laissez-faire economics to be effective. This
requires a transparent legal system with strong
property rights enforcement and market-friendly
institutions to support economic policies. On a
global level, neoliberal policies are promoted by
organizations such as the International Monetary
Fund (IMF) and the World Trade Organiza-
tion (WTO), which are heavily influenced by
Western powers. Developing countries’ ability
to receive foreign aid was, in part, based on the
adoption of neoliberal economic policies.
Prior to the 1980s, most growth models
were based on the assumption of exogenously
driven long run growth, the savings rate for the
Harrod–Domar model, and the rate of techno-
logical progress in the Solow–Swan model. In
contrast, most contemporary growth theories are
based on endogenous growth, even though many
of these still exist within a Keynesian framework.
The late 1980s saw the emergence of a neoclas-
sical growth model that allowed for endogenous
growth, called a new growth theory (Romer 2011).
The impetus behind the development of the new
model was the disenchantment with other neo-
classical models’ ability to explain the increasing
disparity between the developed and less devel-
oped economies. The major difference is that the
new growth theory regards knowledge and tech-
nological development as, at least partly, endoge-
nous as the economy will internally develop
technology through research and development.
This also applies to human capital, which can
be improved endogenously through increasing
investment in schools and training. Another
difference between the new growth model and
the older neoclassical models is that in the newer
model the traditional neoclassical assumptions
of diminishing marginal returns on capital and
3
G ROWT H THE O RY
increasing returns to scale in aggregate produc-
tion are negated. However, the theory still utilizes
many of the assumptions of the original neoclas-
sical models that may not apply to the real world,
such as the assumptions of perfect information
for the labor market and the free mobility of cap-
ital. The natural inefficiencies are not accounted
for by the model and may reduce the potential
of the less developed economies to grow.
The evolution of growth theory is clearly a
reflection of the prevailing political and academic
thought paradigms, which are often dictated to
the developing world from the developed world.
One of the difficulties faced by growth theorists
is attempting to develop a nomothetic theory
when faced with an idiographic reality; this is
reflected in the different developmental paths
observed in different parts of the world (see
Dependency theory and World-systems theory).
Growth theory continues to be a key global
political and economic issue driven forward by
both international organizations and countries.
SEE ALSO: Comparative advantage;
Dependency theory; Neoliberalism
References
Domar, E.D. 1946. “Capital Expansion, Rate of
Growth, and Employment.” Econometrica, 14(2):
137–147.
Gerschenkron, A. 1962. Economic Backwardness in His-
torical Perspective: A Book of Essays. Cambridge, MA:
Belknap Press.
Harrod, R.F. 1939. “An Essay in Dynamic Theory.”
The Economic Journal, 49(193): 14–33.
Lewis, W.A. 1954. “Economic Development with
Unlimited Supplies of Labor.” Manchester School of
Economic and Social Studies, 22(2): 139–191.
Romer, D. 2011. “Endogenous Growth.” In Advanced
Macroeconomics, 4th edn, 101–149. New York:
McGraw-Hill.
Rostow, W.W. 1960. The Stages of Economic Growth: A
Non-Communist Manifesto. Cambridge: Cambridge
University Press.
Solow, R.M. 1956. “A Contribution to the Theory of
Economic Growth.” Quarterly Journal of Economics,
70(1): 65–94.
Swan, T.W. 1956. “Economic Growth and Capital
Accumulation.” Economic Record, 32(2): 334–361.
Further reading
Friedman, M., ed. 1956. Studies in the Quantity Theory
of Money. Chicago: University of Chicago Press.
Hayek, F. 1960. The Constitution of Liberty. Chicago:
University of Chicago Press.