THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

1. THEORIES OF RESOURCES CONSTRAINTS

A. MALTHUSIAN POPULATION TRAP

The Malthusian population trap is a concept that describes how population growth can
outstrip the availability of resources, leading to poverty, famine, and disease.

● population growth is potentially exponential, meaning that it can double or triple in

a short period of time

● the growth of food production and other resources is linear, meaning that it
increases by a fixed amount each year.

⇒ This creates a gap between the demand and supply of resources, which eventually
reduces the living standards of the population

⇒ eventually, population will stop growing due to shortage of food supply

Observation:

● The population of a country, unless checked by dwindling food supplies, grows at a

geometric rate, doubling every 30 - 40 years (tăng theo cấp số mũ)

● Because of diminishing returns to the fixed factor, land & food supplies could
expand only at a roughly arithmetic rate

→ As each member of the population has less land to work, their marginal contribution to
food production starts to decline

⇒ Per capita incomes would have a tendency to fall so low as to lead to existence barely at
subsistence level

- Malthusian population trap (low-level equilibrium population trap):

 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

Income growth rate: g = (RGDPt - RGDPt-1)/RGDPt-1 = ΔY/Y

Population growth rate: p = ΔP/P g > p: Y/P increases

(population growth rate = change in population/ initial population) g < p: Y/P decreases
Income per capita: Y/P (total income/ population)

RGDP: Real gross domestic product

(1) When income is very low, nutrition is so poor that people become susceptible to fatal
infectious diseases, pregnancy and nursing become problematic and outright starvation
may occur → population growth rate is negative

(2) Eventually, the curves cross at the minimum level of income S (subsistence: mức đủ
sống, ngưỡng sinh tồn), which is a stable equilibrium. If Y/P falls below this equilibrium, g
would be greater than p, causing income per capita to continue rising until it reaches S

(3) If Y/P becomes larger than S, population size will begin to increase because higher
income improves nutrition and reduces death rates. However, population gradually grows
faster than income, causing income per capita to decrease and eventually move back to S →
Population trap

→ Poor nations will never be able to rise much above subsistence levels of per capita
income unless:

● They initiate preventive checks (birth control)

● Malthusian positive checks take place (starvation, diseases, wars) and provide
inevitable restraining force → increasing death rate by nature
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

(4) If somehow Y/P can reach a threshold level T (threshold), from that point, population
growth (population growth will begin to fall until a fairly stable growth rate close to zero is
reached after reaching its peak) is less than total income growth, and thus Y/P grows
continually afterwards → Escape population trap

Solution to escape Malthusian population trap:

● Achieve technological progress → shift g curve upward

● Achieve changes in economic institutions & culture (social progress) → shift p curve
downward

- Criticism:

● Ignorance of technological progress impact: economic growth is closely associated

with technological progress, which augments the availability of factors of production
by raising its productivity, making g > p at all levels of per capita income
the Malthusian population trap assumes that the production function is fixed and
constant, meaning that the output per unit of input does not change over time. This
implies that the only way to increase output is to increase the amount of inputs,
which are limited by nature and population growth. Therefore, the Malthusian
population trap predicts that economic growth will eventually stagnate or decline as
population growth outstrips resource availability. However, in reality, economic
growth can be sustained or accelerated even with a fixed or declining amount of
inputs, as long as there is innovation and adaptation in the methods and tools of
production.
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

● Inappropriate foundation: empirical testing of modern period has proven no clear

correlation between population growth and levels of per capita income
sử dụng biến income per capita không phù hợp để biểu thị sự phát triển kt

● Focus on per capita income as the principal determinant of population growth

rates: individual, rather than aggregate variables, levels of living (microeconomic of
family size) become the principal determinant of a family’s decision to have
more/fewer children
trong giai đoạn đầu của industrialization thì đúng nhưng càng phát triển thì việc sinh
nhiều có tác hại nhiều hơn ích lợi đối với người dân, nếu xét đến mức sống → không
có việc bùng nổ dân số nữa → ngược lại với lý thuyết Malthusian

China case (p200), answer question 12 (p210)

Consider the most recent economic performance in China. To what extent do you think it
confirms, and to what extent calls for adjustments in, the analysis in the China case study?

B. HOUSEHOLD UTILITY MAXIMIZATION

*Application of fertility analysis: children are considered a special kind of consumption so

that fertility becomes a rational economic response to the consumer’s demand for children
relative to other goods (this is considered The microeconomic household theory of fertility:
household make rational decisions about family size based on cost and benefits of having
children)

(in easier word said) Assumption: The demand for children in developing countries is
determined by family preferences for a certain number of surviving children by
- The price (“opportunity cost”) of rearing these children,
- Levels of family income
- Children are considered as “consumer goods” or "investment goods”?

Cd = f(Y, Pc, Px, tx), x = 1, … , n

● Cd: demand for surviving children (the number of children that the household wants
to have alive at a certain age)

● Y: level of household income

● Pc: net price of children (the difference between the total cost and the total benefit
of having a child.)

● PX: price of other goods relative to children (the average price of all the goods and
services that the household consumes or desires other than children)

● tx: the tastes for goods relative to children (a measure of how much the household
prefers or values other goods over children)
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

- Analysis:

● ⇒ The higher the household income, the greater the demand for children

● ⇒ The higher the net price of children, the lower the quantity demanded

● ⇒ The higher the prices of all other goods relative to children, the greater
the quantity demanded

● ⇒ The greater the strength of tastes for goods relative to children, the
fewer children demanded
∂: đạo hàm (của Cd(y))

The theory of constraints can help households identify and eliminate the constraints that
limit their utility or happiness from having children, and optimize their allocation of
resources among children and other goods.

- Theory of constraints:

● An increase in household income will shift the curve combination outward

● An increase in price/opportunity cost of children relative to other goods will rotate

the curve combination downward, with the fixed point located on the y-axis
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

- The demographic transition

Stage 1: High birth rates and death rates

Stage 2: Continued high birth rates, declincing death rates

Stage 3: Falling birth rates and death rates, eventually stablizing

- Demand for children in the developing world: due to the intrinsic psychological and
cultural determinant of family size, the first 2 - 3 children are viewed as consumer goods
which are not very responsive to relative price changes. Additional children are considered
investment decision which parents make by weighing private economic benefits against
private costs

BENEFITS COSTS

- Opportunity cost of the mother’s time (the income she

- Income from child labour could earn if she were not at home caring for children)

- Eventual financial support - Cost of educating children - the tradeoff between

for elderly parents high-cost children with high-income-earning potential
and low-cost children with lower earning prospects

→ Elements that might reduce demand for additional birth:

● Increased educational & employment opportunities for women, which leads to:

○ Increased opportunity cost of the mother’s time

 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

○ Increased bargaining power of women in household decisions (husbands

generally want more children)

○ Increased income share for children and increased knowledge for

child-rearing, which increases the chances of survival among children,
reducing the necessity of more birth to achieve the same quantity demanded
for surviving children

● Increased price of raising children: rising school fees, minimum-age child labour
policies

● Improved public health & child nutrition programs

- Implications for development & fertility: birth rates among the poor are likely to fall in
the face of these socioeconomic changes:

● Increase in the education of women and improvement of their role & status

● Increase in female nonagricultural wage & employment opportunities, which

raises the price/cost of their traditional child-rearing activities

● Rise in family income levels through the redistribution of income & assets

● Reduction in infant mortality through improvement in public health programs,

better nutritional status for mother and child and better medical care

● Development of social security systems to lessen economic dependence on

offspring

● Expansion of schooling opportunities

C. DUTCH DISEASE

Definition

causal relationship between the increase in the economic development of a specific sector
(Ex: natural resources) and a decline in other sectors (Ex: manufacturing/ agriculture)

→ Dutch disease: any development that results in a large inflow of foreign currency,
including a sharp surge in natural resource prices, foreign assistance and FDI

(explain: Windfall revenues from natural resources give rise to real exchange rate
appreciation, which in turn reduces the competitiveness of the manufacturing sector)
*resource endowments: A nation’s supply of usable factors of production including mineral
deposits, raw materials, and labor.

Model

- 1 non-tradeable sector (service)

- 2 tradeable sectors
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

● the booming sector (natural resource extraction, production of crops)

● the lagging sector (manufacturing, agriculture).

A resource boom affect the economy in 2 ways:

● Resource movement effect: resource boom increases demand for labor, shifting
labor toward the booming sector, away from the lagging sector →
direct-deindustrialization

● Spending effect: resource boom increases revenue, which increases demand for
labor in the non-tradable sector at the expense of the lagging sector →
indirect-deindustrialization

→ Increased demand for non-traded goods increases their price, while prices in
traded good sector are set internationally

⇒ Increase in real exchange rate

giải thích:

- currency appreciation + declining manufacturing: xuất khẩu resources nhiều, thu về lượng
ngoại tệ lớn làm cho đồng tiền trong nước có tỉ giá cao (real exchange rate appreciation) ⇒
các mặt hàng dịch vụ và công nghiệp khác trở nên đắt đỏ hơn so với sản phẩm tương ứng
nhập từ nước ngoài

- rising service sector: xuất khẩu nhiều, làm cho thu nhập tăng, nhu cầu sử dụng dịch vụ
tăng → ngành dịch vụ phát triển, nhân lực cũng đổ về ngành nhiều, lương ngành cao nhưng
có độ trễ nhất định

Effects:

● Stagnant economy: technological growth is smaller in the booming sector and

non-tradable sector than in the lagging sector, while booming sector is prone to
depletion and comparative advantage usually lies in the lagging sector

● Volatility: natural resources can be prone to depletion, and commodity exports such
as raw materials drive up the value of currency, creating volatility in real exchange
rate → limit investment by private firms

● Job creation: extraction of natural resources is capital intensive, resulting in few

new jobs being created

● Currency appreciation

● Rising service sector

Minimization (solution):

● Slowing the appreciation of the real exchange rate

○ Sterilize (reduce) the boom revenues by saving some abroad in special funds
and bringing them in slowly
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

○ Increase saving by reducing income and profit taxes

● Boosting the competitiveness of the lagging sector

○ Invest in education and infrastructure

○ Increased protectionism (subsidies, tariffs, etc.) + regulat profits and financial

policies

Case study: Oil price shocks and Netherlands

● After WWII: The traditional export sector (agricultural and electronics) is very
competitive → Low inflation, low unemployment, good GNP

● Early 19702: Significant reserves of natural gas were found

● 1973-1975: Gas exports → 10% export growth, GNP + 4% increase

● Guilder (Netherlands currency) increased → Lost 30% traditional customer & costs
increased → P increased rapidly from 2% (1970) to 10% (1975) → GNP fell to 1%

2. TRADITIONAL THEORIES OF INTERNATIONAL TRADE

- Factor endowment trade theory: countries will tend to specialize in the production of the
commodities that make use of their abundant factors of production (land, labor, capital, etc.)

- Specialization: concentration of resources in the production of relatively few commodities

(countries can benefit from trade by specializing in the production of goods that they have a
comparative advantage in, meaning that they can produce them at a lower opportunity cost
than other countries.)

- Invisible hand (Adam Smith): a man, when pursuing his benefits, will be led by an
invisible hand to maximize the social benefits, which was not part of his intention

- Absolute advantage (Adam Smith): production of a commodity with the same amount of
real resources as another producer but at a lower absolute unit cost

- Comparative advantage (David Ricardo): production of a commodity at a lower

opportunity cost than any of the alternative commodities that could be produced

3. LINEAR-STAGE-OF-GROWTH MODEL
The Harrod-Domar Model and Rostow model have mutual effects. These models
emphasize the central role of accelerated capital accumulation in economic growth, thus it
is often dubbed “capital fundamentalism”.

(economic growth can only be achieved by industrialization and that the main obstacle to
development is the lack of capital.)
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

A. HARROD-DOMAR MODEL

Origin: a classical Keynesian model of economic growth developed independently by Roy F.

Harrod and Evsey Domar

Observation:

Least Developing Countries (LDCs) have much less capital (machinery & equipment) per
worker than rich countries
→ lower productivity of labor → lower wages/incomes
⇒ LICs are poor because they lack capital

- Assumption: there is a direct economic relationship between the size of the total capital
stock K and total GDP Y → net additions to the capital stock in the form of new investment
will bring about corresponding increases in the flow of national output

Construction of the model:

VARIABLE MEANING FORMULAE

Net saving ratio: a fixed proportion of national

s
output that is put to saving

S = sY
Net saving: a fixed amount of national output that is
S put to saving and that determines total new (Y: total GDP)
investment

I Net investment: the change in the capital stock

I = ΔK
I = ΔK = kΔY
K Capital = K

Capital-output ratio → 1/k measures the efficiency

k k = K/Y = ΔK/ΔY
of capital utilization

I Closed Economy S=I

Because net national savings must equal net investment: S = I ⇔ sY = kΔY ⇔ ΔY/Y = s/k
It can also be expressed in terms of gross savings: ΔY/Y = sG/k - δ (δ: the rate of capital
depreciation)
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

→ Meaning: Growth rate of GDP = Savings rate/ Capital output ratio

⇒ to grow, economies must save & re-invest a certain proportion of their GDP (increase s or
Foreign S) → the more they can save and invest, the faster they grow

Criticism:

● Saving & investment can be a necessary condition to facilitate economic growth,

but this can also be done by foreign investment or foreign aid (world bank loans,
etc.)

● Saving & investment are not a sufficient condition, but rather institutional, social
and attitudinal changes necessary to use the saving & investment (because not all
governments use a well-functioning financial system or government plan) → not fit
in current context

⇒ Harrod-Domar model was the precursor (tiền thân) to the exogenous growth model
(Solow, Solow-Swan model)

EXERCISES

(Q) If the current saving rate of the country is 10% → what is the “financing gap” they
should overcome?

financing gap = expected saving 25% - current 10% = 15%

B. ROSTOW MODEL

- Principal: the transition from underdevelopment to development can be described in

terms of a series of stages through which all countries must proceed

⇒ Advanced countries have passed all the stages and take off into self-sustaining
growth. Underdeveloped countries are still in either the traditional society or the
precondition stage

The model asserted that all countries exist somewhere on this linear spectrum, and climb
upward through each stage in the development process
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

Xác định trình độ phát triển của mỗi quốc gia trong mỗi giai đoạn. Lý thuyết này gợi ý về sự
thúc đẩy hoàn thành những tiền đề cần thiết nào đó cho sự phát triển của mỗi nước trong
từng giai đoạn.

(1) Xã hội truyền thống: Giai đoạn này dựa trên khoa học và công nghệ thời kỳ tiền
Newton, thường có khu vực nông nghiệp lớn và cơ cấu xã hội đẳng cấp
(2) Tạo ra các tiền đề để cất cánh: Các điều kiện này liên quan đến việc áp dụng khoa
học hiện đại vào nông nghiệp. Châu Âu vào cuối thế kỷ XVII được coi là ví dụ. Xã hội
này phải có các doanh nghiệp mạo hiểm và các nhà đầu tư sẵn sàng cung cấp tài
chính cho các ý tưởng mới
(3) Cất cánh (cho cách mạng công nghiệp): tăng trưởng ổn định, bình thường, không
phải là bùng nổ ngắn hạn. Tỉ lệ tiết kiệm và đầu tư đối với thu nhập quốc dân sẽ tăng
ít nhất 10% trong giai đoạn này.
- có ít nhất 1 khu vực chế tạo với tốc độ tăng trưởng cao
- có 1 khuôn khổ, hoặc chính trị hay xã hội ủng hộ sự mở rộng khu vực hiện đại
(4) Tiến tới trưởng thành: Giai đoạn tiến bộ liên tục và lâu dài với mức đầu tư tăng cao,
lên tới 20% thu nhập quốc dân, kéo dài khoảng 60 năm
(5) Giai đoạn tiêu dùng hàng loạt ở mức cao: giai đoạn dài nhất (Rostow cho rằng nước
Mỹ cần khoảng 100 năm để chuyển từ 4 sang 5). Đặc điểm là dân cư giàu có và sản
xuất hàng loạt tiêu dùng và dịch vụ phức tạp

4. EXOGENOUS GROWTH MODEL

Origin: A neoclassical model of economic growth developed by Robert Solow
(a mathematical model of long-run economic growth that analyzes how the level of output
in an economy changes over time as a result of changes in the population growth rate, the
savings rate, and the rate of technological progress

The model shows how output, capital, and labor grow over time, depending on the values
of three exogenous variables: the population growth rate, the savings rate, and the rate of
technological progress.

● The population growth rate determines how fast labor grows over time.
● The savings rate determines how much of output is invested in new capital.
● The rate of technological progress determines how fast the productivity of capital
and labor improves over time.

A. SOLOW MODEL

Model construction:

(1) The supply of goods & production function: Y = F(K,L) → Production function has
constant returns to scale: zY = F(zK, zL)
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

z = 1/L ⇒ Y/L = F(K/L, 1)

● Y/L: output per worker

● K/L: capital per worker

⇒ Production function for individual worker: y = f(k)

(*We designate quantities/ worker with lowercase letters)

The model assumes that output depends on 2 factors: capital and labor.

● Capital is the stock of physical assets, such as machines and buildings, that are used
to produce goods and services.
● Labor is the number of workers in the economy.

⇒ There is a production function that describes how capital and labor are combined to
produce output. The production function exhibits constant returns to scale, meaning that if
both capital and labor are increased by the same proportion, output will also increase by
the same proportion.

(2) Capital steady state:

this is the state when

- depreciation and investment intersect

- capital stock unchanged → output unchanged → capital per labor & output per labor
unchanged ⇒ total output unchanged

- if capital continues to rise, output still increases but gets slower by time → income for
saving still increases but gets slower by time

- Only a fraction of output is consumed, leaving the saved share to investment ⇒

Investment: I = s.f(k) (I: investment; s: saving rate; k: capital per worker)
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

- Depreciation: a fraction of the capital that is depreciated when time goes by → δk (ẟ:
depreciation rate)

● At the beginning of capital input, the rate of returns on capital is high, and
depreciation is insignificant (as there is little capital that goes depreciated) →
Investment exceeds depreciation → Capital stock increases

● However, subject to diminishing return law, the investment on capital diminishes.

Depreciation increases in positive correlation to the increase in capital. The 2 curves
meets at the steady state → Every investment on capital is being used to
compensate for depreciation to maintain capital at its current state

● When investments exceed the steady state, investment on capital continues to

diminish while depreciation steadily increases → Depreciation exceeds investment
→ Capital stock decreases
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

k*: the steady state

- How saving affects growth: s increases → I = s.f(k) increases → Investment curve shifts
upward, creating a new steady state → k* increases

Saving rate s1 → The steady state k1*

If s increase → i = sf(k) increase → k2* increase

This model predicts that countries with high saving rate and investment will have higher
capital stock and income per capita in the long run.

However when saving increases → income for consumption decreases → lower outputs
being sold in short run ⇒ short run output declines

golden rule: optimal steady state is when consumption per capita is the highest
c* = (1-s)f(k*)
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

- Implications:

● Poorer countries will grow faster than richer countries → catching-up growth

● Conditional convergence: given the same institutions, poorer countries will

eventually converge to the same state as richer countries, where growth in output
and investment eventually equal zero

(3) Introduction of technology into the equation

Y = K(t)α(E(t).L(t))1-α

● E: the rate of technological progress

● α: elasticity of output with respect to capital (0<α<1)

● E(t).L(t): effective labor input
○ actual labor input L(t)
○ Level of technology E(t)
the model assume that both labor and technology grow at constant rate n and g, respectively

⇒ The growth rate of labor is n: L(t) = L(0).ent

The growth rate of technological advancement is g: E(t) = E(0).egt

● L(0) and E(0): initial levels of labor and technology

At the steady-state:

● k,y unchange, but Y = (y x L x E) grows at rate (n+g)

● Y/L = yxE ⇒ output per worker (productivity) grows at rate g

⇒ A high rate of saving leads to a high rate of growth only until the steady state is reached

⇒ Technological progress can help y grows at rate g when the economy is in the steady
state

VARIABLE SYMBOL GROWTH RATE

Capital per effective worker k = K/(E x L) 0

Output per effective worker y = Y/(E x L) = f(K) 0

Output per worker Y/L = y x E g

Total output Y=yxExL n+g

- Implications: Technological progress can help output and investment grow even when
they have reached their steady state by shifting the 2 curve upward, creating a new steady
state with higher capital stock → cutting-edge growth
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

higher technological process → improve labor-augmenting technological process →

enhance capital augmenting technological process ⇒ produce more output with the same
capital and labor ⇒ increase TFP - total factor productivity of capital and labor

(4) Growth of capital: the growth of capital depends on savings s.f(k) after allowing for:

● Capital required for service depreciation

● Capital widening, which provides the existing amount of capital per worker to new
workers joining the labor force

● Capital widening, which provides for the new technological advancement

⇒ Δk = sf(k) - (δ + n + g).k

⇒ (δ + n + g).k: break-even investment - the amount of investment necessary to keep

capital stock from falling

Solow model explains the constant growth of income per capita of some countries is due to
technological progress (g) while the growth in total output is due to combination of labor
growth and technological process

→ Solow model highlights technology but did not explain what makes technology change
→ act like a bridge between old development theories (only focus on capital, neglect
technology,...) with the new ones
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

5. ENDOGENOUS GROWTH MODEL

a theory of economic growth that emphasizes the role of internal factors, such as
innovation, knowledge, and human capital, in driving long-term growth. The theory
challenges the neoclassical view that growth is determined by exogenous factors, such as
population growth and technological change

ROMER MODEL

Insufficiency of Solow’s model: the source of growth and technological progress are left
unexplained

→ Romer model: Long-run growth is driven by technological progress from the search for
new ideas by researchers motivated by profits.

Implications:

● Larger market size (population/growth) would mean companies have more

incentives for R&D activities

● Institutions drive the generation of ideas

○ Improved IPR (intellectual property right) → incentive: monopoly power

○ Favorable commercial environment to connect innovators & venture

capitalists → incentive: ideas can be easily translated into commercial
products

- Dimensions of economic goods (goods that can be traded in the market):

 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

● Rivalry: when one uses it, everyone else cannot use it

eg. oil, gasoline, a piece of pizza has rivalry attribute

● Non-rivalry: when one uses it, other can use it (no one can occupy it)
eg. air

● Excludability: restriction of access to usage, set by legal system → come from legal
system → need excludability if want to sell (rivalry is closely related to
excludability)
eg. anti-virus software is non-rivalry and excludable
eg. design of coke can be intimated by the other so they need legal system (IPR) to
protect company’s design

→ Technology is a non-rival + potentially excludable goods in monopolistically

competitive market

NON-RIVAL POTENTIALLY EXCLUDABLE

Spillover effects: an economic event in one

context that appears because of something else in
- Patent
a seemingly unrelated context
- Trade secret
→ Ex: Basic ideas stemming from science have
multiple applications

- Attributes of economic goods:

RIVALRY EXCLUDABILITY

Market goods Yes Yes

Public goods No No

Yes (partially)
2 characteristics of knowledge: for
Knowledge No
free (online article) + have to pay
eg. company and R&D (yes)

KNOWLEDGE/DESIGN HUMAN CAPITAL

Rivalry
Non-rivalry ability, skill, education, training → it depends
because everyone has the right to on whether people can have it, and human
Rivalry
access knowledge or design as capital brings about profits for company
they are shared ⇒ if you hire that labor to work for 8 hire, the
other cannot hire them anymore
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

Dependent
Independent
→ lose when physical body is lost
Physical → growth without bound
non-rivalry
body Rivalry
→ when you lose the physical body, you lose
→ can be transfer
human capital

As much as the previous unit

Cost of have to cover the cost (money, time) for
None
replication training, education, coaching for a person to
achieve skills, ability, human capital

Model constructions:

(1) Assumptions:

- Inputs: K, L, H (rivalrous) + A: technological component (non-rivalrous)

● Fixed H: H = HA + HY

○ HA: human capital in the design section

○ HY: human capital in the final goods section

● L & H is different

- Final goods & capital goods use the same technology

- 3 sections:

● Research sector: HA + Existing stock of knowledge = new knowledge (designs)

● Intermediate-goods sector: designs + forgone output = durable goods for final

goods production

● Final goods sector: L + HY + durable goods = final output

(2) Model:

A: Non-rivalrous input

X: Rivalrous input

⇒ F(A,2X) = 2F(A,X)

F(2A,2X) > 2F(A,X)

 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

- First column: constant RTS (return to scale) Y = f(A1, A2) → zY = f(xA1, xA2)

● z=x: constant RTS

● z>x: increasing RTS
● z<x: diminishing RTS

- second column: double all rivalrous

- third column: double all non-rivalrous → develop the new knowledge, the same but new
capacity → the output increase

- fourth column: increasing RTS

● F(A,2X) = 2F(A,X)
● F(2A,2X) > 2F(A,X)
⇒ z>x: increasing RTS (the more economic activity one undertakes, the more
profitable one’s reamining economic activity will be

⇒ The stock of human capital determines the rate of growth

(3) Conclusions: The stock of human capital determines the rate of growth

→ Suggested government policies:

● Encourage allocation of human capital to research

● Subsidize production of human capital (education)

 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

6. CONTEMPORARY MODELS
a model that reflects the characteristics, trends, or issues of present time. This is based on
current research, incorporating new findings → is relevant and applicable to current context

A. THE BIG PUSH THEORY

a concept in development economics that suggests that a large-scale and coordinated

investment in various sectors of an underdeveloped economy can help it overcome the
obstacles and bottlenecks that prevent it from achieving sustained growth.

(Q) Who will buy goods produced by the 1st firm to industrialize?

The 1st factory can sell its goods to its own workers, but no one spends all of one’s income
on a single food → profitability of one factory depends on whether another one opens

⇒ a pattern of coordination failure problem → need a Big push (eg. from the government)
to initiate the development process

Origin: Pioneered by Paul Rosenstein-Rodan who first raised some of the basic coordination
issues → Become the classic model of the new development theories of coordination failure
of 1990s

- Question: Who will buy the goods produced by the 1st firm to industrialize?
The 1st factory can sell its goods to its own workers, but no one spends all of one’s income
on a single good

→ Profitability of 1 factory depends on whether another one opens → Depends on its own
potential profitability → A pattern of a coordination failure problem

⇒ Need a Big push (eg. from the government) to initiate the development process

- Assumptions:

● Factors: only 1 factor of production - labor → fixed total supply, L

● Factor payments: The labor market has 2 sectors

○ Traditional sector: w = 1 (workers receive a wage of 1)

○ Modern sector: w > 1 (workers receive a wage W>1 that is, some wage is
greater than 1)

● Technology:

○ N types of products (N: large number)

○ Traditional sector: 1 worker produces 1 unit of output → constant

return-to-scale production

○ Modern sector, there are increasing returns to scale: no product can be

produced unless a minimum of F workers are employed → do not put capital
in the model, the only way to introduce a fixed cost is to require a minimum
 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

number of workers
→ L = F + cQ (c < 1: the marginal labor required for an extra unit of output)
→ increasing return-to-scale

● Domestic demand: each good receives a constant and equal share of consumption +
there is no saving → consumers spend an equal amount on each products: Y/N

● Closed economy

● Perfect competition in traditional sector

The model:

● Traditional sector:

○ Each worker produces one unit of output → the slope of production line = 1

○ Wage bill line coincides with the production line

○ Traditional sector: workers receive a wage of 1 (or normalized to 1, treating

the wage as the numeraire; that is, if the wage is 19 pesos per day, we
simply call this amount of money “1” to facilitate analysis using the
geometry in Figure 4.2).

● Modern sector:

○ Firm requires F workers before it can produce anything, but after that, it has a
linear technique with slope 1/c < 1

○ The wage bill line has the slope W > 1

○ Price = 1 ⇒ PQ can be read off the Q axis

 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

- Analysis:

(1) W1 is the modern sector’s wage (below point A)

- Revenues (Q1) > Cost (W1)

- Modern firm will pay fixed cost F and enter the market

- Production function is the same for every goods → once modern firm finds it profitable to
produce one goods, the same incentives will be present for other goods

⇒ Industrialization will happen through market forces alone

- Demand is now high enough that we end up at point B for each product
⇒ Coordination failure does not always happen, it depends on the technology & prices
(including wages) prevailing in the economy

(2) W2 is the modern sector’s wage (between A and B): wages = W2

→ 2 possible outcomes

- If only 1 modern firm enter the market: Revenue < Cost → No modern firm enters, no
industrialization, wages & output remain low

- If modern firms enter in all market

 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

● Wages increase to W2 in all market → Income increases

● Modern firm can now sell all of its expanded output (at point B) produced by using
all of its available labor allocation (L/N) because it has sufficient demand from
workers and entrepreneurs in the other industrializing product sectors

● Workers are well off than in traditional sector (higher wage, purchase higher
quantity of goods) → they have changed sectors voluntarily from traditional to
modern

⇒ Industrialization will gain benefit, but cannot happen by itself

(3) W3 is the modern sector’s wage (above point B)

- Revenue < Cost

- Even if modern producers enter in all sectors, they still lose money

⇒ Industrialization makes no sense, the traditional technique would continue to be used

- Conclusion:

● Wage line < A: market pushes the economy to industrialization → the steeper (more
efficient) modern sector production or the lower the fixed costs is, the more likely it
is that wage < point A

● A < Wage line < B: there would be 2 scenarios

○ with industrialization (point B)

○ without industrialization (point A)

⇒ it is efficient to industrialize, but the market will not achieve this on its own because of
coordination failure ⇒ the role for policy in starting economic development

● Wage line > B: no sense to industrialize

type of push

● government investment
● infrastructure
● open trade (to gain a larger size of market)

- Criticism:

● Neglect agriculture while it is a big part of a lot developing countries

● government planning does not always work well, usually in the interest of planners,
not citizens

● corruption: large projects with significant revenue streams

● most growth is gradual → not a big leap as expected

 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

● Semi–industrialization: three or more equilibria can exist

● Did not assume the existence of technological externality: the presence of one
advanced, through “learning by watching” other firms’ production method
⇒ Generate spillovers to other firms that can raise their productivity as well as
lower their costs → another type of market failure

B. MICHAEL KREMER’S O-RING THEORY

O-ring theory explains not only the existence of poverty traps but also the reasons that
countries caught in such traps may have exceptionally low incomes compared with
high-income countries

- Assumptions:

● Production is broken down into n tasks

● To complete these tasks, level of skills q is needed, where 0 ≤ q ≤ 1 (higher q

implies higher possibility of successfully completing a task)

● Firms are risk-neutral, labor markets are competitive and workers supply labor
inelastically (i.e. they work regardless of wages)

● Capital markets are competitive

● Closed economy

- Production function:

● A production function with strong complementarities among inputs, based on the

products (i.e., multiplying) of the input qualities

● Output is given by multiplying the q values of each of the n tasks together, in turn
multiplied by a term B that depends on the characteristics of the firm and is
generally larger with a larger number of tasks

→ Suppose each firm hires only 2 workers and B = 1: BF(qiqj) = qiqj

- Positive assortative matching: One’s effort is multiplied with that of someone else (as in
the production function equation), so one will be more productive when working with a
more productive person → Implications:

● Workers with high skills work together and workers with low skills work together

● High-value products will be concentrated in countries with high-value skills

Ex: A company with 4 employees, 2 highly-skilled qH workers and 2 low-skilled qL workers,

which can be arranged into either skills-matching pairs or unmatched pairs

→ qh2 + qL2 > 2qHqL ⇒ workers sort out by skill level

 THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

⇒ Total output will always be higher under a matching scheme, workers sort out by skill
level

- Implications: this positive assortative matching process make some workers/ firms/
economies fall into a trap of low skills and productivity (“poverty trap”) while others
escape into higher productivity.

→ Explain:

● Countries caught in such traps may have exceptionally low incomes compared with
high-income countries.

● Why rich countries produce more complicated products, have larger firms and
higher worker productivity than poor countries

○ production depends on completing a series of tass

○ failure of any tasks reduces the value of entire product, maybe to 0 ⇒ one
week link in a chain destroys the entire value of the chain

○ can’t substitute quantity for quality (eg. microchips, cake)\

positive assortative matching: people like to work with more productive workers because
if their efforts are multiplied by those of someone else (as in production function equation),
they will be more productive when working with a more productive person

→ workers with high skills will work together and workers with low skills will work
together

→ high-value products will become concentrated in countries with high-value skills