Development Economics I Lecture Note

Chapter Three: Growth Models and Theories of development

3.1. Components of Economic Growth
Three factors or components of economic growth are of prime importance:
1. Capital accumulation, including all new investments in land, physical equipment, and human
resources through improvements in health, education, and job skills
2. Growth in population and hence eventual growth in the labor force
3. Technological progress—new ways of accomplishing tasks.
1. Capital Accumulation
Capital accumulation results when some proportion of present income is saved and invested in order
to augment future output and income. New factories, machinery, equipment, and materials increase the
physical capital stock of a nation (the total net real value of all physically productive capital goods) and
make it possible for expanded output levels to be achieved. These directly productive investments are
supplemented by investments in what is known as social and economic infrastructure roads,
electricity, water and sanitation, communications, and the like which facilitates and integrates economic
activities. For example, investment by a farmer in a new tractor may increase the total output of the
crops he can produce, but without adequate transport facilities to get this extra product to local
commercial markets, his investment may not add anything to national food production. There are less
direct ways to invest in a nation’s resources. The installation of irrigation systems may improve the
quality of a nation’s agricultural land by raising productivity per hectare.
Similarly, investment in human resources can improve its quality and thereby have the same or even a
more powerful effect on production as an increase in human numbers.The concept of investment in
human resources and the creation of human capital is therefore analogous to that of improving the
quality and thus the productivity of existing land resources through strategic investments.
All of these phenomena and many others are forms of investment that lead to capital accumulation.
Capital accumulation may add new resources (e.g., the clearing of unused land) or upgrade the quality of
existing resources (e.g., irrigation), but its essential feature is that it involves a trade-off between present
and future consumption giving up a little now so that more can be had later, such as giving up current
income to stay in school.
2. Population and Labor Force Growth
Population growth, and the associated eventual increase in the labor force, has traditionally been
considered a positive factor in stimulating economic growth. A larger labor force means more productive
workers, and a large overall population increases the potential size of domestic markets. However, it is
questionable whether rapidly growing supplies of workers in developing countries with a surplus of labor
exert a positive or a negative influence on economic progress. Obviously, it will depend on the ability of
the economic system to absorb and productively employ these added workers an ability largely
associated with the rate and kind of capital accumulation and the availability of related factors, such as
managerial and administrative skills.
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3. Technological Progress
It is now time to consider the third, and to many economists the most important, source of economic
growth, technological progress. In its simplest form, technological progress results from new and
improved ways of accomplishing traditional tasks such as growing crops, making clothing, or building a
house. There are three basic classifications of technological progress:
 Neutral,  Capital-saving.
 Labour-saving and
Neutral technological progress occurs when higher output levels are achieved with the same quantity
and combinations of factor inputs. Simple innovations like those that arise from the division of labor can
result in higher total output levels and greater consumption for all individuals. In terms of production
possibility analysis, a neutral technological change that, say, doubles total output is conceptually
equivalent to a doubling of all productive inputs.
Labour-saving technological progress: By contrast, technological progress may result in savings of
either labor. Computers, the Internet, automated looms, high speed electric drills, tractors, mechanical
ploughs—these and many other kinds of modern machinery and equipment can be classified as products
of laborsaving technological progress. Technological progress since the late nineteenth century has
consisted largely of rapid advances in laborsaving technologies for producing everything from beans to
bicycles to bridges.
Capital-saving technological progress: In the labor-abundant (capital-scarce) developing countries,
however, capital-saving technological progress is what is needed most. Such progress results in more
efficient (lower-cost) labor-intensive methods of production for example, hand- or rotary-powered
weeders and threshers, foot-operated bellows pumps, and back-mounted mechanical sprayers for small-
scale agriculture. The indigenous development of low-cost, efficient, labor-intensive (capital-saving)
techniques of production is one of the essential ingredients in any long-run employment-oriented
development strategy.
Technological progress may also be labor-augmenting or capital-augmenting.
Labor-augmenting technological progress: Technological progress that raises the productivity of an
existing quantity of labor by general education, on-the-job training programs, etc.
Capital-augmenting technological progress: Technological progress that raises the productivity of
capital by innovation and inventions.
3.2. Models and theories of economic growth and development
3.2.1 Linear stages of growth models: Linear stages of growth models includes:
a. Rostow’s stage of growth c. Solow growth model
b. Harod Domar growth model
a. Rostow’s stage of growth
The most influential and outspoken advocate was the American economic historian Walt W. Rostow.
According to the Rostow doctrine, the transition from underdevelopment to development can be

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described in terms of a series of steps or stages through which all countries must proceed. Restow
identified the following stages of economic growth that societies have to pass through.
According to him, there are five stages of economic growth; namely,
i. Traditional society iv. drive to maturity, and
ii. Pre-conditions for the take-off v. Age of high mass consumption.
iii. Take-off
I. The Traditional Society
The traditional society is defined as one whose structure is developed within a limited production and
backward technology. That means production function is based on pre-Newtonian science and
technology. The social structure is hierarchical in which family and class connections play a dominant
role. Political power is concentrated in the hands of the landed aristocracy. More than 75% of the
population is engaged in agriculture, which is the main source of income for the state and the peasants.
II. The “Pre-condition for Take-off”
Rostow calls the stage between feudalism and take-off the transition stage. During the transition period
all the pre-conditions for sustained economic development are created. It started in Western Europe and
Britain at the end of the 15th century and the beginning of the 16th century, when the medieval age
ended and modern age began. During this age reasoning and scepticism replaced feudalism and led to
the rise of nation states. Such pre-conditions require a number of radical changes, which include:-
i) the main economic requirement in the transition period is that
1. the level of investment should be raised to at least 10% of the national income so as to ensure
self-sustaining growth.
2. the main direction of investment must be in building of social overhead capita, especially
transportation and telecommunication to enlarge the market size.
3. a technological revolution in the agricultural sector and a transfer of surplus from agriculture to
industry.
4. an expansion of imports especially capital goods
ii) on the social front
1. a new elite (middle class) must emerge to fabricate the industrial society, and it must supersede
in authority the land-based elite of the traditional society
2. Surplus must be channeled by the new elite from agriculture to industry.
iii) Politically, the establishment of an effective modern government is vital.
III. Take-off
Take-off is defined by Rostow as “an industrial revolution tied directly to radical changes in the methods
of production having their impact over a short period of time which lasts for two decades.” The take-off is
the most important stage in the life of the society. Economic growth is a normal condition of the society.
Forces of modernization operate against the habits, institutions, the values and interest of the traditional
society and make a decisive break through.

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The following are three necessary conditions for take-off:
i) a rise in the rate of productive investments to a level in excess of 10% of the national
income in order for per capita income to rise sufficiently to guarantee adequate future levels of
saving and investment
ii) the development of one or more substantial manufacturing sector with a high growth rate
and
iii) the existence of political, social and institutional framework which can foster economic
development.
Historically, domestic finance for take-off seems to have come from two main sources.
 From diversion of part of the product of agriculture. Example in Japan, USSR
 From enterprising landlords voluntarily ploughing back rents into commerce and industrial.
There are two approaches for take-off:
Aggregate approach - this is based on Harrod model of growth
/
= for growth either s/y must be high or v must be low

Leading-sector approach: Rostow emphasized on the importance of leading growth sector for the
take-off. This approach is based on the principle of unbalanced growth theory. It assumes that
simultaneous growth in all the sectors is not possible because of limitation of resources. Some sectors of
the economy will play a leading role. Example, railway transports industry, iron and steel etc. Different
industries played leading role in different countries example, textile in UK; iron and steel, shipbuilding,
and textile in Japan etc.
Rastow argues that an industry can play the role of leading sector in the take-off stage provided that four
conditions are met:
 That the market for the product is expanding rapidly to provide a firm basis for the growth of
output
 That the leading sector generates secondary expansion
 That the sector has an adequate and continual supply of capital from ploughed back profits.
 The new production functions can be continually introduced into the sector, meaning scope for
increased productivity
The take-off period is different for different countries. The take-off stages for some of the developed
countries are
UK 1783-1802 Germany 1850-73
France 1840-60 Japan 1878-90
USA 1843-60 Russia 1890-1914
IV. Drive to maturity stage
This stage is defined by Rostow as a period when a society has effectively applied the range of modern
technology to develop the bulk of its resources. This calls for a period of sustained economic growth
extending over four decades. This period is required for new production techniques to take the place of
old ones and the economy being able to absorb unexpected internal and external shocks. Rostow sees

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the development of the steel industry as one of the symbols of maturity. In this stage, three significant
changes take place:
a) The character of the working forces changes. They become skilled and organized. Their real
wages start increasing. People prefer to live in urban areas than in rural areas.
b) The character of entrepreneurship changes. They become polished, polite and efficient
c) The society becomes more industrialized and it leads to more and more changes.
V. Age of High Mass Consumptions
During this stage, the balance of attention of society is shifted from supply to demand for goods and
services and from problems of production to consumption and welfare. There is a greater tendency
towards mass consumption of durable consumer goods, maintaining full employment and an increasing
sense of security which leads to high rates of population growth.
It should be pointed out, however, that Rostow’s last two stages – “Drive to Maturity” and “Age of Mass
consumption” describes a developed industrial economy and are the result of successful take-off. The
characteristic elements of the second and third stages- 'pre-conditions for take-off' and 'Take-off' are also
more or less similar. To summarize

All
advanced economies have passed the stage of take-off into self sustaining growth
Developing countries are still in the traditional society or the pre-conditions stage. Why
The financing gap exists
Lack of adequate investment are the
According to Rostow development requires:
Substantial investment in capital. For the economies of LDCs to grow the right conditions for
such investment would have to be created.
If aid is given or foreign direct investment occurs at stage 1 the economy needs to have reached stage 2.
If the stage 2 has been reached then injections of investment may lead to rapid growth to stage 2.

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Criticisms of Rostow's Model
Rostow’s model has been severely criticized and rejected in several grounds.
 First, it is too rigid, mechanical and deterministic with each stage rigidly leading to the next.
There is no possibility of skipping or merging stages.
 Rostow didn‘t identify what exactly the factors are responsible for take –off.
 Following Rostow’s model, it is very difficult to identify countries at which sage they are. But
Restow’s theory has an advantage of drawing attention on long term determinants of growth. i.e.
investment.
b. The Harrod-Domar Growth Model
Developed during the early days of the post-World War II Keynesian Revolution in the 1940s: Harrod
(1939) and Domar (1946). The model suggests that the economy’s rate of growth depends on:
the level of saving
the productivity of investment i.e. the capital output ratio

The Hrrod- Domar construct the following simple model of economic growth
Solving for the Hrrod- Domar model
1. Investments and savings: We assume a closed economy (no trade). Then savings S must be used
for investments I, and investments can only come from savings. Hence they must be equal:
S = I…………………………………(1)
We assume further that a constant fraction of income is saved. Call this fraction s; this is the savings
rate/ net savings ratio.
S = sY………………………………(2)
Net savings ratio: Savings expressed as a proportion of disposable income over some period of time

= , where s saving rate……………..(3)

2. Capital stock, investment and depreciation

In year t, the stock of capital is Kt. The year after, year t + 1, the capital stock is Kt+1.
Changes in the capital stock come from investments and the depreciation (wearing out) of the capital
stock. Depreciation occurs at a constant rate , so an amount Kt of capital disappears every year. Hence
the change in capital stock is:
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∆ = − …………………………………(4)
Where ∆ annual change in capital stock is, is depreciation occurs at constant rate. So an amount of
of capital disappear every year. Now, we substitute in = because = = .Then:
∆ = −
The capital output ratio given by:

= , where is capital output ratio…………….(5)

Capital-output ratio: A ratio that shows the units of capital required to produce a unit of output over a
given period of time.
Lets suppose a fraction of K depreciates. Then it must be true that:
Kt+1 = (1- )Kt + It ………………………(6)
Capital in period (2) is capital in period (1); minus depreciated capital ( K); plus the amount of new
investments in capital.
As we are mostly interested in the rate of growth of GDP.
Solving for a growth rate =
Now we can use (1); (3); (5); and (6) we can solve for g
1st S(t) = I(t)
Kt+1 = (1- )Kt + It
Kt+1 = (1- )Kt + St ……………………..(7)
2nd Rearrange s and v from (3) and (6) as a function of Y (t)
= = = ………………………(8)
= = = ……………………..(9)
rd
3 Substitute equation 8 and 9 in equation 7 in terms of K
Kt+1 = (1- )Kt + St
=(1- ) +
4th Divide both sides by
( )
= +
= (1 − )+
th
5 Subtract 1 from both sides
− 1 = (1 − )+ −1
= −
=
th
6 Since g is the overall growth rate
= − is Harrode-Domer model
According to this identity, the fundamentals to economic growth are;
The ability of the economy to save and invest ( captured by s )
The ability of the economy to convert capital into output (v) – capital efficiency or
productivity
The rate at which capital depreciates ( )
Growth in GDP is given by g
The equation is simplified by the assumption that depreciation is near to zero. The Harod-Domar
equation is: The actual growth rate (g) is defined as:
=
Where:
s = the ratio of saving to incomes (S/Y) or MPS
v = the actual incremental capital output ratio, that is the ratio of extra capital
accumulation or investment to the growth of output

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Numerical illustration: Suppose the economy is currently operating at a capacity production level of
1000 per year and the capital stock is 3000. Assume again the marginal propensity to consume out of
GDP is 0.7. This includes business and public saving as well as household saving. Then find the
equilibrium growth rate using Harode- Domer growth model.
Solutions: = first compute = = = 3 and
= 1− = 1 − 0.7 = 0.3. Then,
.
= = =0.1 or 10%
Interpretation: The Harrod-Domar growth model tells that the equilibrium growth rate is g = 0.3/3 =
0.1; i.e., the economy can grow at 10 percent per year.
The Harrod- Domar model with population growth A small amendment to the Harrod- Domar
model allows us to incorporate the effects of population growth on economic growth.
Let Pt = population at time t.

Pt+1 = Pt + nPt =

Where n= rate of growth of population. Then after solving the above relationship by including population
the Harrod-Domar growth model becomes
g* = s/v –n-d
According to this identity, the fundamentals to economic growth are;
Population growth has a negative effect on the rate of growth of per capita income. As n
increases g will be decreases .So the rate of population growth (n) is other determinants of
economic growth.
The assumptions/ intuition behind the Harrod-Domar model:
A larger saving rate (a higher s) will lead to a larger growth rate (g) because a higher saving rate
leads to greater investment (thus, greater capital formation) and output (Y) grows faster – for
example, the rate of growth will be twice as much if 20% of output is saved instead of 10%
(assuming the capital output ratio is the same)
The capital output ratio (v) is a measure of the efficiency of the use of capital, a smaller capital
output ratio means less capital is needed to create a certain amount of output (or that a given
amount of capital will create more output)
As a matter of policy, to increase the growth rate either the saving rate or capital output ratio
could be targeted. This means to increase growth either:
Raise the saving rate Do both of them
Use capital more efficiently
Drawbacks Harrod-Domar growth model:
 One of the drawbacks of this model is that an increase in savings ratio is difficult in developing
countries because developing countries have very low marginal propensities to save as mainly
the citizens spend most of their income on daily supplies or necessary goods which they need.
 Another drawback is that making capital use more efficient is not very easy in developing
countries. There is often a shortage of skilled and educated labour and a lack of managing skills.

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 Investment and saving are the necessary condition not sufficient condition for economic growth,
i.e. in addition we need managerial capacity and skill to transform the potentials of capital
investment into practice, skilled labour, the ability to plan and administer.
 The effect of technological progress has not been incorporated in the models.
c. Solow growth model
It is the extension of the Harode-Domar model. Solow extended the Harrod-Domar model by
Adding labor as a factor of production
Requiring diminishing returns to labor and capital separately, and constant returns to scale for
both factors combined
Introduces technology in the growth equation
The capital-output and capital-labor ratios are not fixed as they are in the Harrod-Domar model.
We will develop a neoclassical model of economic growth called the Solow growth model. The Solow
growth model is named after economist Robert Solow and was developed in the 1950s and 1960s. In
1987 Solow won the Nobel Prize in economics for his work on economic growth. The model was
introduced in Robert M. Solow, “A Contribution to the Theory of economic Growth.
The Solow growth model is a dynamic model that shows:
How growth in the capital stock and saving,
Growth in the population/labour force, and
Technological progresses interact in an economy as well as how they affect a nation’s total output
of goods and services.
The model states:
The difference in income must come from differences in capital, labor, and technology.
The model also identifies some of the reasons that countries vary so widely in their standards of
living.
We will then examine how economic policy can influence the level and growth of the standard of
living.
We will build this model in a series of steps. Our first step is to examine how the supply and demand for
goods determines the accumulation of capital. To do this, we hold the labor force and technology
fixed. We then relax these assumptions by introducing changes in the labor force later by introducing
changes in technology in the next.
The neoclassical growth models are based on four propositions:
1. Growth rate is independent of saving-income ratio and investment-income ratio. According to
neoclassical economists higher saving-income ratio and investment-income ratio can be offset by
high capital-output ratio (COR) and a low productivity of capital because they assume diminishing
returns to capital.

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2. Growth of output in the long run is determined by technological progress and the rate of growth of
labour force indicated by efficiency units. The latter is the rate of growth of labour force plus the rate
of growth of productivity of labour.
3. The level of per capita income, however, depends on savings and investment ratios to GDP (or
income). The level of PCI varies positively with savings and investment ratios to income and
negatively to population growth. Poor countries with smaller capital per head must grow faster than
developed countries with higher capital per head leading to convergence in per capita income.
4. Neoclassical models are based on flexibility where as H-D models are based on rigidity. In H-D model,
there is no substitutability of factors, but neoclassical model allows substitutability of factors based on
price of factors.
Note: For the detail refer your materials Macroeconomics II
3.2.2. Structural change models:
Structural-change theory focuses on the mechanism by which underdeveloped economies transform
their domestic economic structures from a heavy emphasis on traditional subsistence agriculture to a
more modern, more urbanized, and more industrially diverse manufacturing and service economy. It
employs the tools of neoclassical price and resource allocation theory and modern econometrics to
describe how this transformation process takes place. Two well-known representative examples of the
structural-change approach are the “two-sector surplus labor” theoretical model of W. Arthur Lewis and
the “patterns of development” empirical analysis of Hollis B. Chenery and his coauthors.
a. Lewis theory of Development
One of the best-known early theoretical models of development that focused on the structural
transformation of a primarily subsistence economy was that formulated by Nobel laureate W. Arthur
Lewis in the mid- 1950s.
In the Lewis model, Many LDCs/ underdeveloped economy consist of two sectors/ dual economies: have
dual economies:
I. A traditional, overpopulated rural subsistence sector characterized by
 zero marginal labor productivity a situation that permits Lewis to classify this as surplus labor,
in the sense that it can be withdrawn from the traditional agricultural sector without any loss of
output
 low incomes,
 Low savings and considerable underemployment.
II. A high-productivity modern urban industrial sector into which labor from the subsistence sector is
gradually transferred.
 It is technologically advanced with high levels of investment operating in an urban
environment.

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 Development Economics I Lecture Note
Surplus labour means the existence of such a large population in the rural sector so that the marginal
productivity of labour has fallen to zero. This condition is also called disguised unemployment.

The situation of subsistence wage and surplus labour is illustrated below. Fig. 3.1 shows the marginal
product of successive units of labour added to the land. OW is the subsistence wage. At this wage, there
is unlimited supply of labour. The productivity of labour increases at the beginning but after X units of
labour, marginal product of labour declines. Owing to diminishing returns, after X1 units of labour,
marginal contribution of labour to output falls below the subsistence wage. And after X2 units of labour,
the contribution of labour to output becomes negative and total product will decline with successive
additions of labour beyond X1. All the labour beyond X1 is considered as surplus labour and is in a
completely elastic supply to the industrial sector at whatever the industrial wage
Fig. 3.1: Subsistence wage and surplus labour
Managerial Product of
labor

The Subsistence Wages

W
X Units of Labour added to Land
X1 X2 MPL

To attract labour from agriculture to industrial sector they must be offered wages which is higher than
the wages they get in the agricultural sector. That is, industrial wage (WI) should be greater than
agricultural wage (WA). Lewis assumes that urban wages will have to be at least 30% higher than
average rural income to induce workers. Employments in the industrial sector would hire labourers to the
point where it is profitable to do so. It means that they will employ workers up to that point where the
marginal productively of workers equals wage rate.

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Those people that moved away from the rural /Agricultural sectors to industrial/towns would earn
increased incomes:
 Higher incomes generate more savings.
 Increased savings meant more fund available for investment.
 Increased investment meant more capital and increased productivity in the industrial sector,
higher wages, more incentive to move from low productivity agriculture to high productivity
industry, the circle continue.
 Lewis suggested that the modern industrial sector would attract workers from the rural areas.
Both labor transfer and modern-sector employment growth result in output expansion in the
sector
A part of the profit is reinvested by the capitalist in the industrial sector. By investing more capital, he can
introduce new capital equipments, more raw materials, etc. The expansion of the industrial sector makes
it possible to employ new employees. For Lewis, this is the essence of the development process.
According to Lewis Economic development takes place:
When capital accumulates as a result of transfer of labour resources from the agricultural sector
where they add nothing to production to the more in modern industrial sector.
Switch from agriculture to industry (and services)
Criticisms of Surplus Labor Theory
Although the Lewis two-sector development model is simple and roughly reflects the historical
experience of economic growth in the west, some of its key assumptions do not fit the institutional and
economic realities of most contemporary developing countries.
1. Lewis assumes that due to competitive labour market, the wage rate remains constant in the urban
sector for a long time. It is an unrealistic assumption.
2. If the method of production in the industrial sector is capital intensive and labour saving, this
theory will not work
3. It considers lack of skilled labourers as a temporary bottleneck in the development process of
underdeveloped countries. But it is a serious problem.
4. Lack of entrepreneurial initiative is another problem that affects the industrial expansion of
developing economies
5. It is unrealistic to assume that there is high unemployment in rural areas and full employment in
urban areas. In most developing countries the reverse is true. Schultz argued that MP of labour in
the over-crowded agricultural sector is not zero. So, when there is shift the workers from
agricultural to industry, the agricultural production decreases
6. Mobility of labour from agriculture to industrial sector is not easy. Differences in language and
customs, problem of housing, high cost of living in urban sector and the attachment of the people
to their family land are some factors that affect the labour mobility.

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7. It is a one sided theory because the theory does not consider the possibilities of progress in the
agricultural sector.
3.2.3. Dualistic Theories
Dualism indicates a situation where types of parallel phenomena co-exist. It represents the existence and
persistence of increasing divergences between rich and poor nations and rich and poor people on various
levels. Specifically, the concept of dualism embraces four key elements.
1. Different sets of conditions, of which some are “superior” and others “inferior,” can coexist in a
given space. Examples of this element of dualism include Lewis’s notion of the coexistence of
modern and traditional methods of production in urban and rural sectors; the coexistence of
wealthy, highly educated elites with masses of illiterate poor people; & the dependence notion of
the coexistence of powerful & wealthy industrialized nations with weak, impoverished peasant
societies in the international economy.
2. This co-existence is chronic and not merely transitional (coexistence continues forever). It is not
due to a temporary phenomenon.
3. Dualism has an inherent tendency to increase (not diminishing).
4. The interrelations between the superior and inferior elements are such that the existence of the
superior elements does little or nothing to pull up the inferior element, let alone “trickle down” to
it. In fact, it may actually serve to push it down—to “develop its underdevelopment.”
Dualism has been perceived in different ways such as: social, technological, financial, and
geographic dualism.
a. Social Dualism
The theory of social dualism was developed by a Dutch economist J.H. Bocke. The theory of social
dualism is a general theory of economic and social development of UDCs. It is based on his studies of
the Indonesian economy.
Such a dual society is furnished with the existence of an advanced imported western system on the one
side and endogenous pre capitalistic agricultural system on the other side.
Western system: is under the western influence which uses the advance techniques and where
standard of living is high.
Pre capitalistic: agricultural system is native and it is furnished with the outdated techniques and low
social and economic life.
On economic basis the dualistic society is classified as by giving the names:
Eastern Sector and
Western Sector.
There are certain characteristics of eastern sector of a dualistic economy which distinguishes it from
western sector. They are:
The needs of eastern sector are limited. People pass a contented life.

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People work for social needs rather for economic needs. For example, if a three acres are enough
to supply the needs of a household he will not cultivate six acres.
Goods are cultivated according to their prestige value rather on their use value.
As a result of all above, the eastern economies are characterized with backward bending supply
curves of effort and the risk taking.
They do not take risk by making productive investment.
Labor is unorganized, passive and unskilled. They are reluctant to leave their village and
community. They are fatalist.
The urban development takes place at the cost of rural life.
Criticisms of Social Dualism
Prof. Benjamin Higgins put forward the following arguments against this theory.
It is argued that Bocke’s contention that people in UDCs have limited wants is unrealistic
It is argued social dualism is not peculiar to UDCs alone. It exists in developed nations too.
Higgins said that Bocke fails to provide a distinctive economic and social theory for UDCs. His
dualistic theory is merely a description of the eastern society.
Bocke’s theory centers more on socio-cultural aspects rather than economics. So it fails to
provide solutions to economic problems of UDCs.
b. Technological Dualism
As an alternative to Bocke’s social dualism, Benjamin Higgins has developed the theory of technological
dualism. Technological dualism implies the use of different production functions in the advanced sector
and the traditional sector of the economies of underdeveloped countries. The existence of such dualism
has accentuated the problem of structural or technological unemployment in the industrial sector and
disguised unemployment in the rural areas.
Higgins builds his theory around two goods, two factors of production and two sectors with their own
factor endowments and production functions. Of the two sectors,
The industrial sector is engaged in plantations, miners, refineries, large scale industries etc. It is
capital intensive and there is no technical substitutability of factors which are combined in
different proportions (fixed technological co-efficient).
The rural sector is engaged in producing food stuffs, handicrafts and it consists of very small
industries. It has variable technical co-efficients of production so that it can produce the same
output with a wide range of techniques and alternative combinations of labour and capital.
c. Financial Dualism
Prof. Myint has developed the theory of financial dualism. Financial dualism refers to the co-existence of
different interest rates in the organized and unorganized money markets in the LDCs. The rate of interest
in the unorganized money market is higher than that in the organized money market in the modern
sectors.

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 Development Economics I Lecture Note
The unorganized money market consists of the non-institutional lenders such as village money
lenders, land lords, shopkeepers, traders, etc. They charge very high interest rates on loans.
The organized money market consists of the commercial banks and other financial institutions
which lend short term credit at low interest rate in the modern business sector.
This has created economic dualism between the traditional and modern sector. The fiscal and monetary
measures followed in LDCs favoured the interests of the modern sector as against the traditional sector.
More investment is made in the modern sector. The agricultural and small scale sector suffers due to
these reforms. Criticisms of Technological Dualism
Technical co-efficient are not fixed in industrial sector.
Factor prices do not depend on factor endowments alone
Higgins theory neglects institutional and psychological factors
Higgins neglects the possibilities to use labour absorbing techniques in urban sector
He failed to explain the nature and size of disguised unemployment
3.2.4. A Model of Low Level of Equilibrium trap
There are two major interrelated reasons why rapid population growth may be regarded as a
retarding influence on development.
I. Rapid population growth may not permit a rise in per capita incomes sufficient to provide
savings necessary for the required amount of capital formation for growth.
II. If population growth outstrips the capacity of industry to absorb new labour, either urban
unemployment will develop or rural underemployment will be exacerbated, depressing
productivity in the agricultural sector.
It is not inconceivable, moreover, that rises in per capita income in the early stages of development
may be accompanied by, or even induce, population growth in excess of income growth, holding down
per capita incomes to a subsistence level.
Models of the low level equilibrium trap attempt to integrate population and development theory. Its
focus is on the interdependence between population growth, per capital income and national income
growth. One such model is given by Nelson which contains the basic equation that deals with the
determination of net capital formation, population growth and income growth.
3.2.5. The Big-Push Theory
The theory of big push is associated with the name of Paul N. Rosentern Rodan. The theory says that a
big push or a large comprehensive program is needed in the form of a high minimum amount of
investment to overcome the obstacles for development in UDCs. The theory states that proceeding bit-
by-bit investment program will not lead the economy successfully through the development path. A poor
country can be caught in a low-equilibrium “poverty trap”, government intervention can potentially solve
the coordination problem, and “push” the economic into the better equilibrium allowing a “take-off” into
sustained growth. For sustained development, a minimum amount of investment is necessary. Rodom
distinguished three types of indivisibilities and external economies.

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1. Indivisibilities in the Production Function
Rosentein Rodan stated that indivisibility of inputs, outputs or processes of production lead to increasing
returns. Increasing returns play a significant role in lowering the capital output ratio. The services of
social overhead capital (SOC) or indirectly productive activity play a significant role in this regard. SOC
has a long gestation period, a minimum durability, they are lumpy, and it is irreversible in time.
Therefore, it must precede the directly productive activity (DPA).
2. Indivisibilities of Demand
The indivisibility or complementarity of demand requires a simultaneous setting up of interdependent
industries in UDCs. Rosenstein Rodan used his famous example of shoe factory to explain his view point.
If the entire investment is made only in one industry, lack of demand may result in overproduction. If
instead the investment is made in different industries at the same time, complementarity of demand
reduces the risk of finding a market and increases the incentive to invest. In short, a minimum quantum
of investment in interdependent industries is essential to overcome the market imperfections.
c. Indivisibilities in the Supply of Saving
A high income elasticity of saving is the third indivisibility in Rodan’s theory. A high minimum size of
investment requires a high volume of savings. It is difficult to achieve it in a poor country because of low
income. To overcome this, when income increases due to an increase in investment, the marginal rate of
savings should be much higher than the average rate of savings. According to this theory, high
investment leads to high level of employment, increased income, and increased saving which again leads
to increased investment. Thus an initial investment is a precondition for saving.
Applicability to Less Developed Countries (LDCs)
The development of complementary industries and basic industries are important in LDCs. But the
problem is that there is no sufficient capital and skilled manpower to develop them.
Limitation of the theory
It neglects investment in agricultural sector. In fact developing economies are agrarian
economies. Thus a large amount of investment is needed in agriculture in such projects as
irrigation.
It generates inflation since the high investments in the basic industries do not directly increase
goods and services.
In a poor country there are so many administrative and institutional difficulties.
Rosenstain Rodan’s theory is not a historical explanation of how development takes peace.
3.2.6. The Balanced Growth Theory
This theory was advocated mainly by Rosenstein-Rodan (1943), Ragnar NurKse (1953) and Arthur Lewis
(1954). Many writers view balanced growth differently.
To some writers, balanced growth means investing in a lagging sector of the national economy or
industry so as to ensure that it catches up with others.

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To others, balanced growth implies that investment takes place simultaneously in all sectors of
the national economy.
Still to others, it implies the balanced development of agricultural and industrial sectors of the
economy.
To this extent, balanced growth helps for maintaining the balance between:
The different consumer and capital goods industries.
It also calls for ensuring balance between agriculture and industry and between the domestic and
export sectors of the national economy.
Additionally, it requires balance between social and economic overheads and directly productive
investment.
Moreover, the economists in favour of the balanced growth postulated the balance between supply side
and demand side.
The supply side consists of simultaneous development of all interrelated sectors, i.e.,
intermediate goods, raw materials, power, agriculture, transport, and consumer goods industries.
The demand side comprises provision of employment opportunities which increase income and
thus demand of the consumers.
Rodan was the first to develop the theory of balanced growth without using these words. His main
contention was that often social marginal product (SMP) of an investment is different from its private
marginal product (PMP). When industries are planned in accordance with their SMPs, the rate of growth
of the economy is greater than it would have been otherwise. It is complimentarity of different industries
which leads to the most profitable investment from the stand point of the society.
He gives the famous example of a shoe factory. Suppose a large shoe factory is started in a region where
20,000 unemployed workers earn their wages on shoes, a market for shoes would be created. But the
trouble is that the workers will not spend their entire wage on shoes. If instead a whole series of
industries were started which produce the consumption goods on which the workers would spend their
income, all industries would expand via the multiplier process.
This idea has been developed and elaborated by Nurkse in his thesis. According to Nurkse, Vicious circles
of poverty are at work in UDCs. To attain development, these vicious circles must be broken. Individual
decisions related to investment cannot save the problem. According to him, “More or less synchronized
application of capital to a wide range of different industries” will help to break the vicious circles.
To sum up in the words of Lewis, “in development programme all sectors of the economy should grow
simultaneously so as to keep a proper balance between industry and agriculture and between production
for home consumption and production for exports”.
Criticisms of Balanced Growth
It is argued that a simultaneous establishment of a number of industries is likely to raise money
and real cost of production. Nurkse’s model does not consider the possibility of cost reduction in
the existing industries.

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Balanced growth strategies are beyond the capability of UDCs. In these nations, the availability of
resources for simultaneous development on many fronts are generally lacking
The doctrine of balanced growth presupposes increasing returns. But this is a wrong assumption.
Dis-proportionalities in factors of production and shortage of resources make the theory
unrealistic in LDCs. This theory is applicable in a developed country.
3.2.7. Unbalance Growth
The theory of unbalanced growth is the opposite of the doctrine of balanced growth. The dissatisfaction
with the theoretical underpinnings of the balanced growth theory gave rise to a new school of thought
that of unbalanced growth which has an intellectual as well as a practical appeal. Mainly Walt Rostow and
more particularly Albert Hirschman were who propounded the theory in a systematic manner.
To Rostow, as noted earlier, for an economy to cross the stage of traditional society and achieve take-off,
it is essential for it to increase the rate of productive investment from 5% to 10% or more. This is
possible only if investment is undertaken in two or more sectors of the national economy. This will lead to
the development of related industries and as a result of increased production, profits will increase and
which can in turn be reinvested.
According to this theory investment should be made in selected sectors rather than simultaneously in all
sectors of the economy. UDC does not possess sufficient capital and other resources to invest
simultaneously in all sectors. Hirschman regards economic development as a “chain of disequilibria” that
must be kept alive rather than eliminated.
Hirschman said unbalancing the economy can be made either by selecting social overhead capital
investment (SOC) or by selecting directly productive activities (DPA. In an UDC, unbalancing the economy
by giving importance first to the investment on SOC is more advisable. But this theory is also criticized on
several grounds:
Criticisms of Unbalanced Growth
according to Paul Streeton, Hirschman’s theory failed to say what is the optimum degree of
imbalance, where to imbalance and how much in order to accelerate economic growth
Streeton argued that Hirschman expected a simultaneous expansion of the economy through
balancing it. He neglected the influence of the growth retarding forces
Lack of basic facilities. There may be lots of difficulties in procuring technical personnel, raw
materials and basic facilities like transport, power and even markets for the products produced.
Technical flexibility (factor mobility) of resources is limited in the underdeveloped countries. It
adversely affects growth process.
Hirschman’s development strategy is largely related to maximizing investment decisions. In an
UDC, not only investment decisions but also administrative, managerial and policy decisions are
important.
The investment on SOC which does not directly increase the amount of goods and services is also
inflationary.

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2.3.8. The International- Dependence Revolution
International dependence models gained increasing support among third world intellectuals in 1970s. The
international dependence models view developing counties as beset (threatened) by institutional, political
and economic rigidities and caught up in dependence and dominance relationships with the rich countries.
They argue that the main reason for lack of development in LDCs is the dominance and dependence
relationship among rich and poor countries. Within this approach there are three streams:
 Neoclassical Dependence Model
 The False- Parading Models and
 The Dualistic Development Thesis.
1. The Neoclassical Dependence Model.
The main proposition of the model is that underdevelopment exists in LDCs because of continuing
exploitative economic, political and cultural powers of former colonial rulers towards less developed
countries. It argued that the rich and the poor country’s relationship in an international system are
dominated by unequal power relationships between the rich and the poor. This model suggests that major
restructuring of the world capitalist systems are required to free dependent LDCs from the direct and
indirect economic control of the developed world and domestic oppressors.
2. The False - Paradigm Model
This model argues that developing countries have failed to develop because their development strategies
(usually given to them by western economies) have been based on an incorrect model of development, one
that, for example, overstressed capital accumulation without due consideration to needed social and
institutional changes. In addition to this argument leading University intellectuals, trade unionists, high level
government economists and others get training in developed country institution where they gain unhealthy
dose of alien concepts and inapplicable theoretical models.
3. The Dualistic Development Thesis
Dualism is a concept widely discussed in development economics. It represents the existence and
persistence of increasing divergence between the rich and the poor nations and rich and poor peoples on
various levels. The concept of dualism contains four arguments:
1. Different sets of conditions of which some are superior and others inferior coexist in a given space.
Examples.
Coexistence of modern and traditional methods of production in urban and rural sectors
Coexistence of wealthy, highly educated elites with masses of illiterate poor people.
Coexistence of developed and industrialized nations with weak impoverished peasant
society.
2. This coexistence is chronic and not merely transitional. It is not due to a temporary phenomenon,
in which case time could eliminate the discrepancy between superior and inferior elements.
3. The degree of inferiority or superiority not only fails to show any sign of diminishing, even they
have a tendency to increase.
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4. The interrelations between the superior and inferior elements are such that the existence of the
superior elements does little of nothing to pull up the interior element, let alone trickle downs to it.
Conclusions and Implications
Whatever their ideological differences, the advocates of neoclassical-dependence, false -paradigm and
dualistic models reject the exclusive emphasis on traditional western economic theories designed to
accelerate economic growth as a principal index of development. Therefore the dependent theories have
the following weaknesses:
1. Although they offer an appealing explanation of why LDCs remain underdeveloped, they offer a
little formal or informal explanation of how countries initiate and sustain development.
2. The importance and role of government and private market system in the process of economic
development is not discussed. Government can fail as well as markets; the key to successful
performance is achieving a careful balance among what government can do successfully and what
private market system can do and what both can best do together.
2.3.9. The Neoclassical Counterrevolution
Free markets, Public Choice and Market Friendly Approaches
The central argument of the neoclassical counterrevolution is that under development results from poor
resource allocation due to incorrect pricing policies and to much government intervention. The
neoconservatives argue that in order to stimulate both economic efficiency and growth the following
should be permitted;
Competitive free market to flourish Eliminating excessive government
Privatizing state owned enterprises regulation and price distortions in
Promoting free trade and exports different markets.
Welcoming foreign investment
The neoclassical challenge to development can be divided into three approaches:
1. The Free Market Approach
2. The Public Choice (or new political economy) Approach
3. Market Friendly Approach
1. Free Market Analysis
This approach argues that markets alone are efficient. That is product market provide the best signals for
investment in new activities; and labor markets respond to these new investments in appropriate way;
producers know best what to produce and how to produce it efficiently; and product and factor prices
reflect accurate scarcity values of goods and resources now and in the future. Even if competition is not
perfect it is effective. Technology is freely available and costless to absorb; information is also free and
costless to obtain. Therefore, it is argued that under these circumstances any government intervention in
the economy is by definition distortionary and counterproductive. Free market development ecumenists
assume that LDCs markets are efficient; whatever imperfections exist are of little importance.
2. Public Choice Theory:
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This theory is also known as new political economy approach. The approach goes even further to argue
that governments can do nothing right. This is because public choice theory assumes that politicians,
bureaucrats, citizens and states act solely from a self-interested perspective, using the authority and
power of government for their own selfish ends.
Citizens use political influence to obtain special benefits from government policies that restrict
access to important resources,
Politicians use government resources to consolidate and maintain positions of power and
authority.
Bureaucrats and public officials use their positions, to extract bribes from rent seeking citizens
and to operate protected businesses on the side.
Finally, states use their power to take away private property from individuals.
Therefore, the net result of all these is not only misallocation of resources but also general reduction in
individual freedoms. The conclusion therefore, is minimal government is the best government.
3. The Market Friendly Approach
This is the most recent variant on the neoclassical counterrevolution. It is associated principally with the
writings of the World Bank and its economists.
This approach recognizes that there are many imperfections in Third World product and factor markets
and those governments do have a key role to play in facilitating the operations of markets through
friendly interventions; for example by investing in physical and social infrastructure, health care facilities,
and educational institutions and by providing a suitable climate for private enterprises.
2.3.10. The New Growth Theory
The new growth theory is a modification of the traditional growth theory. It explains why some countries
develop rapidly while others stagnate and why government still have an important role to play in the
development process.
According to traditional neoclassical growth theory, output growth results from one or more of three
factors:
 Increase in labor quantity and quality (through population growth and education)
 Increase in capital (through saving and investment) and
 Improvement in technology
Motivation for the New Growth Theory
New growth theory emerge from the inabilities of the traditional growth theories (neo classical ) to
explain the long-run term economic growth. Solow model says that:
1. GDP grows at the rate of population growth rate in the long –run in the absence of technological
progress.
2. Per capita income do not grow in the long run, but it grows at the rate of technological progress.
3. Technology is exogenous (Black –box).

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4. Because of diminishing return to capital, the growth rate of countries with high and low saving rate will
converge.
5. With free international trade or capital mobility, differences in per capita income should disappear and
convergence in standards of living will occur. So, different approaches have been developed to address
the above problems. These approaches are collectively called New growth theories (Endogenous growth
theories). Models of endogenous growth differ from neoclassical growth models in their underlying
assumption and implications. The most significant theoretical differences stem from the following factors.
 Models of endogenous growth discard the neoclassical assumption of diminishing marginal
returns to capital investments, and permit increasing returns to scale in aggregate production,
by assuming that public and private investment in human capital generate external economies
and productively improvements that offset the natural tendency for diminishing returns,
endogenous growth theory seeks to explain the existence of increasing return to scale and the
divergent long term growth pattern among countries.
 Even though the new growth theory reemphasizes the importance of saving and human capital
investment for achieving rapid growth in LDCs, it also leads to several implications for growth
that are in direct conflict with traditional theory.
 The other interesting aspect of new growth model is that they help explain international flow of
capital exacerbate wealth disparities between the First world and Third word. The potentially high
rates of return on investment offered by developing countries are greatly eroded by lower levels
of complementary investments in human capital (education), infrastructure or research and
development. In turn poor countries benefit less from social gains associated with this capital
expenditure.
Where complementary investments produce social as well as private benefits, governments may improve
the efficiency of resource allocation. They can do this by providing public goods or encouraging private
investment in knowledge-intensive industries where human capital can be accumulated and subsequent
increasing return to scale generated. Unlike the Solow model, endogenous growth model explains
technological change as an endogenous outcome of public and private investments in human capital and
knowledge intensive industries. Thus in contrast to neoclassical growth theories, endogenous theories
suggest an active role for public policy in promoting economic development though direct and indirect
investment in human capital formation and the encouragement of foreign investment is essential.

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