D-3. Theories of DVT & Their Evolution Chap 3-Students

Theories of Economic
Development and their

Evolution
Chapter 3,
Department of Economics, College of Business
and Economics, Addis Ababa University (AAU),
Ethiopia
Assignment II.
• Summarize, Synthesize your understanding of

the chap 2, the philosophical &
Methodological issues and establish their
implications to Development Economics.
• What do you learn from the evolution of the
different theories of Development. This is
quite relevant for your final exam open exam
question.
Tsegabirhan Weldegiorgis Abay, DoE, CBE,

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Classic Theories of Economic
Development: Five Approaches
1.We explore the historical and intellectual evolution in
scholarly thinking about how and why development does
or does not take place. (Todaro & Smith, 2011)
2.Literature on economic development is dominated by
the following five strands of thought:
a. Linear-stages-of-growth model: 1950s and 1960s
b. Theories and patterns of structural change: 1970s
c. International-dependence revolution: 1970s
d. Neo-classical, free-market counterrevolution: 1980s
and 1990s
e. Back to the State: Politics and Institutions in the
21st century,
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Early Post-War Consensus: 1950s-1960s
• Replication of the historical experience of the
now developed countries, after Marshal plan
• Massive injections of capital: Because of its emphasis on
the central role of accelerated capital accumulation, this
approach is often dubbed “capital fundamentalism.”
• “Right quantity and mixture of saving, investment, and
foreign aid (hence capital accumulation as the
explanatory factor) were all that was necessary to
enable developing nations to proceed along an
economic growth path that had historically been
followed by the more developed countries. (Todaro &
Smith, 2011)
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1950s & 1960s
• Development viewed the process of
development as a series of successive stages
of economic growth through which all
countries must pass.
• Development thus became synonymous with
rapid, aggregate economic growth. (Todaro &
Smith, 2011)

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Marxian Development Theory:
Marxian Historical Materialism:
Evolution of Modes of Production:
Stages of Development
Marxism
• Historical materialism – examines where
society was, is going, and its change
process.
• Reserve army of unemployed.
• Can socialism be introduced through
parliamentary democracy?
CHAPTER 5 ©E.Wayne Nafziger

7
Development Economics
Five Modes of Production
1. Five Stages of Development (Five Modes of production), including:
a. Primitive society, a class less society
b. Slavery mode of production, class society, slave-owners and slaves,
c. Feudalism, class society, landowners & landless(tenants)
d. Capitalism (latter stage imperialism), a class society, bourgeoisie and
proletariat. Inherent irreconcilable conflict that eventually leads to
socialist revolution that serves as a transition period to communism.
e. Communism, a class less, harmonious, ultimate destination of human
kind, as a class less society, fraternal society, it is the only sustainable
society as there are no inherent class contradictions and conflicts.
2. Inequality is not Sustainable: Class struggle: Changes in the class
society, takes place through class struggle, based on changes in
ruling & oppressed classes & their relationship to each other.
• Every society lays the seeds of change within itself. The incremental change,
which exist always, give place to radical, revolutionary changes.
Lessons from Marxian Theory
1. Historical & Evolutionary approach to development, if history
matters, it means the unique history of a given society, which
implies the need to tailor development theories and policies
to the particular situation. In fact, it suggests for developing
development theory and policy for each country on the basis
of the history of that country.
2. Recognition of friction (Conflict) in a society, instead of taking
a friction-less, homogenous society, it is a system that has
recognized at least dichotomy within the society;
3. Recognition of Inequality as social, economic and political
problem, if not addressed leading to revolutions, unrest,
instability. Inequality is not sustainable. No society can attain
sustainable peace with genuine fraternal relationships among
its diverse social units and actors.
Critique of Marxism
1. Discussion of socialism not well developed.
2. The class struggle, worker revolt is weakest link. So far
human kind did not experience or witness the transition
from capitalism/imperialism/ to communism. It only led to
what is referred to ‘state capitalism’, which adopted central
command system of managing an economy. The Soviet block
failed with the collapse and disintegration of the Germany
Wall in 1989 and the Soviet Union in 1990-1991 period.
3. Overlooked possibility that workers’ & capitalists’ interests
can and do converge and hence don’t conflict.
 Welfare states have evolved within the capitalist system, that
enhances the wellbeing of the workforce in a society, Instead we
have very large middle class, and few business community, though
large income gap, the well-being of the workforce has improved
quite substantially.
10
Critique of Marxism
4. Dichotomized view, progressive against reactionary, bourgeoisie against
proletariat, leaving no room for accommodation, peaceful coexistence
among heterogeneous societies, leaving such political mindset for
irresponsible politicians.
5. The state capitalism, instead of empowering the oppressed, it rather
suppressed individual freedom which caused to stifle individual initiatives,
creativity and innovativeness, while the Capitalist system despite its major
limitations proved better in encouraging, supporting, individual freedom,
initiative taking, business new start-ups, creativity and innovativeness,
which played an instrumental role in ensuring sustainability of capitalism
against the Marxian historical analysis and prediction that Imperialism is a
dying system and Socialism is a triumphing system.
6. Stage approach to Development: This is a linear, ladder type of
development path where one mode of production giving place to another
higher mode of production. It does not anticipate nonlinear development
path where by economies may not necessarily pursue the same rigid
development path. China is managing which does not follow the Marxian
evolution of modes of production.
11
Rostow-
The Stages of Economic Growth-
A Non-Communist Manifesto
Rostow’s Stages of Economic Growth, 1960
• Much of the US’s early economic development program
was based on Walt Rostow’s 1960 book;
• It was intended as a direct counter to the Marxist Stage
Theory of Capitalist Development
• The most influential and outspoken, economic historian,
an advocate of the stages-of-growth model of
development.
• Viewed the process of development as a series of
successive stages of economic growth. A country
passes through sequential stages in achieving
development. So all countries are located in one of a
hierarchy of development stages.
Rostow’s Stages of Economic Growth , 1960
• Mixture of saving, investment, and

foreign aid was necessary for economic
development
• Emphasized the role of accelerated
capital accumulation in economic
development

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Rostow’s Five Stages-1
1. Traditional Society: pre-Newtonian (!); limited to ad hoc (i.e.,
non-systematic) technical innovations; largely agricultural;
“long-run fatalism”(no hope for improvement)
a)Pre-Newtonian or 18th century.
b)Lumps past economies, DCs 19th century, & LDCs today together.
c) Neglects dualism of many low-income countries today.
2. Preconditions for take-off: spread of idea that economic
progress is possible and good; mobilization and use of
savings in pursuit of profit or modernization; but still not
very productive as a society; political change and shift to
nation-state (from traditional family/tribal regional interests)
seen as crucial

Increased transport investment – enlarge market & specialization.

Agricultural revolution to feed urban population.

Expansion of imports (especially capital), perhaps financed by exporting natural resources.
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3. Take-off: ethos of economic progress dominates society; tradition

marginalized; compound interest; technology is central; growth becomes
centerpiece of politics; investment and savings rates increase from less than
5% to 10% or more of national income; rapid industrialization and plowing
profits into modernization; agriculture commercialized and productivity of
farms increases; urbanization
Decisive expansion 2-3 decades.
Radically transforms economy & society.
Barriers to steady growth overcome.
Late 18th-century Britain, pre-civil war US, late-19th-century Germany, post-Meiji
(1868) Japan, pre-1917 Russia, post-independence India & post-1949 China.
Growth of per capita increases sharply, say 5 to 10%.
Leading manufacturing sector stimulates growth through linkages.
 Political, social, & institutional framework to exploit modern expansion:
entrepreneurship, retained earnings, banks & capital markets, foreign
investment

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4. The Drive to Maturity: savings and investment increases to 10-20% of national
income; new industries emerge and old ones die off; change becomes the only
constant; joins global economy;
• Science-Based Industries emerge and prosper
• Growth regular, expected & self-sustained.
• Urban, skilled, less individualistic, more bureaucratic labor force.
• State provides more economic security.
• So the system is inherently dynamic and hence stable no reason for violent change.
5. Age of High Mass-Consumption: Leading sectors shift to consumer’s goods and
services; real income rises; most people can afford to consume; “consumer
sovereignty”; end-goal shift to social welfare and security
• Alternative: welfare state, military power.
• US 1920s, Western Europe 1950s.
• Autos, suburbs, innumerable durable consumer goods & gadgets.
• Stable condition for sustaining growth and wealth, challenging the Marxist argument of a violent class
struggle leading to an end of capitalism
Note therefore stages 4 & 5 are stages where there is stable and self-sustaining
growth and wealth, showing the capitalist system is inherently dynamic and
stable with no drive for revolution or transformation to a communist system.
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• These stages are not merely descriptive. They have
an inner logic and continuity. . . . They constitute, in
the end, both a theory about economic growth and
a more general, if still highly partial, theory about
modern history as a whole.
• The advanced countries, had all passed through the
stage of “takeoff into self-sustaining growth,”
• The underdeveloped countries that were still in
either the traditional society or the “preconditions”
stage had only to follow a certain set of rules of
development to take off in their turn into self-
sustaining economic growth.
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Major Lesson from Rostow
• Development as an evolutionary process, from one state to
another, history matters (Unlike neoclassical economics),
• The essential message of the book is that capitalism won’t
give way to communism, as it is claimed in the Marxian
literature. Rather capitalism, or the free-market system will
strive within itself, graduating from lower level to higher
level, ultimately reaching the mass-consumer society, a
society of abundance and high level of human welfare.
• Process depends crucially on increasing rates of
savings and investment; still S-I gap as a major
constraint, remains relevant.

Rostow’s Limitations-1
• Irrespective of the claim of history, his development process involves replication of Economic
theories and rules from the developed world which cannot be applied to places with different
histories, cultures and starting conditions. If history of DCs matters, then history of LDCs
should have mattered!
• How does an economy move to next stage? Does self-sustained growth imply effortlessness?
It does not explain as to why the DCs managed to develop and the LDCs failed to do so?
• It implicitly assumes a friction-less society, the antithesis of the Marxian class-based-conflict
analysis
• Developing countries are still in the traditional society or the pre-conditions stage. If
development were about following certain rules and then linearly develop, why then
many LDCs remained least developed since the 1960s up to now? Why not they
follow these “natural paths of growth”?
• Note that due attention is not given to the role of government as a collective entity to
facilitate, regulate and directly involve in the development process.
• One major critics is that it pursued a linear, stage by stage development path ruling
out non-linear development path.
• It assigns saving and investment as the critical, drivers of wealth creation that
defines the momentum of development and transition of societies from one stage to
another stage, which stands against theories that attach much attention to human
capital, creativity and innovation.

Harrod-Domar Growth Model
• One of the principal strategies of development necessary for
any takeoff was the mobilization of domestic and foreign
saving in order to generate sufficient investment to
accelerate economic growth.
• The economic mechanism by which more investment leads
to more growth can be described in terms of the Harrod-
Domar growth model, today often referred to as the AK
model because it is based on a linear production function
with output given by the capital stock K times a constant,
often labeled A.
• A functional economic relationship in which the growth rate
of gross domestic product (g) depends directly on the
national net savings rate (s) and inversely on the national
capital-output ratio (c). (Todaro & Smith, 2011)
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• The principal strategy for development is
mobilization of saving and generation of
investment to accelerate economic growth
• Importance of H-D growth model (AK
model): It explains the mechanism by which
investment leads to growth
• Rate of economic growth (GNP growth rate)
is determined jointly by the ability of the
economy to save (savings ratio) and the
capital-output ratio.
change in Y/Y=s/k
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• The model assumes that there is some direct economic
relationship between the size of the total capital stock, K, and
total GDP, Y—for example, if $3 of capital is always necessary to
produce an annual $1 stream of GDP—it follows that any net
additions to the capital stock in the form of new investment
will bring about corresponding increases in the flow of national
output, GDP.
• Capital-output ratio: A ratio that shows the units of capital
required to produce a unit of output over a given period of
time.
• National net savings ratio, s, is a fixed proportion of national
output (Y) (e.g., s=6%); Savings expressed as a proportion of
disposable income over some period of time. S = sY
• Total new investment is determined by the level of total
savings, we can construct the following simple model of
economic growth: Tsegabirhan Weldegiorgis Abay, DoE, CBE,
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1. Net saving (S) is some proportion , s, of national income, (Y);
2. Net investment (I ) is defined as the change in the capital stock, K, and can be
represented by K such that
I=∆K
C=K/Y
Or c= ∆K/ ∆Y
Given s = I
S= sY =c ∆Y= ∆K=I
sY =c ∆Y
Dividing first by Y and then by c,
∆Y/Y =s/c
∆Y/Y =sG/c – δ, where δ is the rate of capital depreciation, SG stands for gross saving
 Growth depends on directly on s and inversely on c. So economies
must save & invest a certain proportion of their GNP/GDP. The more
they can save and invest the more they can grow.
 The equilibrium growth rate of output is equal to the ratio of the marginal
propensity to save andTsegabirhan
the Incremental
Weldegiorgis Capital-Output
Abay, DoE, CBE, Ratio (ICOR).
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Harrod-Domar Model:
Including explicit treatment of depreciation
1
Y  K
c
And,


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So,

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Examples:
Suppose sG = .125, =.04, c =2.5
Then,
But if sG = .175,  =.04, c =2.5
Then, .175
gTOT   .04  .03
2.5

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Harrod-Domar Model
• How much additional output can be generated
from an additional unit of investment?
• This can be measured by the inverse of the
capital-output ratio (c=k/y). So the inverse will
be 1/c=y/k, which is output-investment ratio, the
volume of output generated per unit investment.
• So multiplying the rate of new investment s=1/Y,
by its productivity, 1/c, will give the rate by
which national income or GNP will increase.

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Limitations of the Harrod-Domar Growth Model
1. Savings and investment is a necessary condition for
accelerated economic growth but not a sufficient
condition
2. The Marshall Plan worked for Europe because the European
countries receiving aid possessed the necessary structural,
institutional, and attitudinal conditions.
3. The role of international trade and the impact of globalization is missing
4. Critics against basic assumptions of neoclassical economic theory,
remain valid critics:
 Equilibrium analysis;
 Production function approach of the firm
 Technological change
 Institutional and political neutrality
 Homogenous, friction-less society,
 Ahistorical approach

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Solow Growth Model-An
Exogenous Model
Solow Growth Model-1
1. Developed in the mid-1950s by Robert Solow of MIT, it is the basis for
the Nobel Prize he received in 1987.
2. A Building block & basis for most growth theories/models. It is a starting
point and a springboard for richer models.
3. Solow neoclassical growth model represented the seminal contribution
to the neoclassical theory of growth.
4. Solow growth model is a simplified version of the dynamic general
equilibrium model
5. It depends on two functional relationships
a. At the centre of the Solow growth model, distinguishing it from the
Harrod-Domar model is the neoclassical aggregate production
function. This function not only enables the Solow model to make
contact with microeconomics, but it also serves as a bridge
between the model and the data.
b. The Solow Growth Model is a model of capital accumulation. It
captures the pure impact savings = investment has on the long run
standard of living, per capita income.
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Diaparity in Per Capita Income Across the World
40000
35620
35000 34100 34100
us-dollar ppp
30000
27080
24430
25000 23550
US Dollars
20000 18530
15000 12990
9340
10000
7300
5000 3020 3600 3580 2360

1370 1910 1470
193 340 1120 510 370 980 990
0
Japan Nepal Sauth Ghana Albania UK Haiti USA NewZeland Benin Brazil Bolivia
Africa
Source: Hull University Network.

Start/Applications/Economics/ World
01/06/2023 Development
AAU, Ethiopia Indicators 2002 33
Growth Rate of Per Capita Income Growth Miracle Countries
Growth Miracles, Average Annual Growth Rate 1960-2000
7.00%
5.72% 5.89%
6.00%
5.40%
5.21%
4.99%
5.00%
4.49%
4.06% 4.19%
3.86%
4.00%
3.00%
2.00%
1.00%
0.00%
na na nd p. an ta al re nd
i hi l a e p al u g o li a
Ch ,C Ire ,R Ja M o rt gap a
g re
a P n Th
n Si
Ko Ko
o ng Source: Hull University Network.
H
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Growth ate of Per Capita Income In Growth Disaster
Countries
Growth Disasters, Average Annual Growth Rate 1960-2000
Venezuela, RB
Sierra Leone
Madagascar
Nicaragua
Senegal
CAFRP
Zambia
Ghana
Chad
Niger
Haiti
0.00%
-0.20%
-0.21% -0.24%
-0.40% -0.30%
-0.60%
-0.80% -0.75%-0.71%
-0.79%
-1.00%
-1.00% -1.04%
-1.20% -1.11%
-1.40% -1.26%
-1.60%
-1.61%
-1.80%
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Simplified Growth Model
1. it is a simple and abstract representation of a complex
economy
2. Simplifying assumptions include:
 Single good produced with a constant technology.
 No government or international trade.
 All factors of production are fully employed.
 Labor force grows at constant rate
 Neoclassical (Cobb-Douglas) aggregate production function with constant
returns to scale
 Representative agent: representative household & firm
 Households are assumed to save a constant exogenous fraction s ∈ (0,
1) of their disposable income.
 Technology is free: it is publicly available as a non-excludable, non-rival
good. So, A(t) is freely available to all potential firms in the economy
and firms do not have to pay for making use of this technology.

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The Solow Model
• A major assumption of the Solow growth model (and
of the neoclassical growth model) is that technology
is free: it is publicly available as a non-excludable,
non-rival good. So technology is freely available to all
potential users in the economy.
• Positive marginal products;

• Diminishing marginal products;

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The Solow Model
• Where Y is gross domestic product, K is the stock of capital (which may include human
capital as well as physical capital), L is labor, and ‘A’ represents the productivity of labor,
which grows at an exogenous rate. For developed countries, this rate has been
estimated at about 2% per year. It may be smaller or larger for developing countries,
depending on whether they are stagnating or catching up with the developed countries.
• Because the rate of technological progress is given exogenously (at 2% per year, say), the
solow neoclassical model is sometimes called an “exogenous” growth model, to be
contrasted with the endogenous growth approach.
• α, Represents the elasticity of output with respect to capital (the percentage increase
in GDP resulting from a 1% increase in human and physical capital). Since α is assumed
to be less than 1 and private capital is assumed to be paid its marginal product so that
there are no external economies, this formulation of neoclassical growth theory yields
diminishing returns both to capital and to labor.
• Closed economies (those with no external activities) with lower savings rates (other
things being equal) grow more slowly in the short run than those with high savings rates
and tend to converge to lower per capita income levels. Open economies (those with
trade, foreign investment, etc.), however, experience income convergence at higher levels
as capital flows from rich countries to poor countries where capital-labor ratios are lower
and thus returns on investments are higher.

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Contribution Over H-D Model
• It differed from the Harrod-Domar formulation by adding a second factor, labor,
and introducing a third independent variable, technology, to the growth
equation.
• Thus Solow model allows for technical substitution between labor and
capital in the production function.
• Unlike the fixed-coefficient, constant-returns-to-scale assumption of the Harrod-
Domar model, Solow’s neoclassical growth model exhibited diminishing returns
to labor and capital separately and constant returns to both factors jointly.
• Owing to the assumption of diminishing returns to both factors of
production (L & K) hypothesizes convergence of the growth of LDCs to
that of DCs.
• Technological progress, became the residual factor explaining long-term growth,
and its level was assumed by Solow and other neoclassical growth theorists to
be determined exogenously, that is, independently of all other factors in the
model.
• Solow model uses both the production function and the capital accumulation,
involving two markets of an economic system

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The Solow Model-Simplified
• we are interested in explaining output per worker or per capita
output. With more capital per worker, firms produce more output
per worker. However, there are diminishing returns to capital per
worker: each additional unit of capital we give to a single worker
increases the output of that worker by less and less. We can
rewrite the production function in equation [1] in terms of output
per worker, y ≡ Y/L, and capital per worker, k ≡ K/L - i.e. setting z =
1/L. Thus, k=K/L is the capital labor ratio.
• We can rewrite the above as follows:

so everything is measured in quantities per worker.
• or alternatively with A>0 , output per worker is a function that
depends on the amount of capital per worker.
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• This shows that the per capita production
depends only on the capital/labor ratio. With
more capital per worker, firms produce more
output per worker. However, there are
diminishing returns to capital per worker:
each additional unit of capital we give to a
single worker increases the output of that
worker by less and less

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• The per capita production depends only on the
capital/labor ratio.
• The consumer : consumption and savings. The

consumer saves the fraction s of income: The amount of
investment in the economy is equal to a constant
investment rate, s, times total output, Y.
• Capital accumulation: the capital stock next year equals

the sum of the capital started with this year plus the
amount of investment undertaken this year minus
depreciation.
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• Use the above production function and
savings = investment identity to deduce per
capita capital accumulation evolves

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Solow Growth Model-Mechanism
• Capital accumulation: The capital stock next
year equals the sum of the capital started with
this year plus the amount of investment
undertaken this year minus depreciation
• When investment is greater than depreciation,
the capital stock increases. The capital stock
rises until investment equals depreciation.
• Foreign capital inflow can strongly supplement
domestic capital in raising capital/labor ratio.

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The Solow Model
• Output per worker rises with capital per
worker. i.e. More machines for each worker
lead to greater output.
• Higher savings rates lead to higher output per
worker-- a higher standard of living
• Poorer countries grow faster than rich
countries. If savings is the same in all countries
and technology is shared, we should see
convergence in standards of living over time.

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Solow Model: Why Growth Rates Differences?
1. Differences in Capital Stock: differences in saving and
investment rates
2. Differences in Technology adoption (knowledge on how to
combine inputs in production; formula, design, software and
management)
3. Labour input (Health and education of working populations,
their productive skills, knowledge)
4. Economic Policy
 Realistic Trade and exchange rate policies.
 Control of population growth rate
 close co-operation between the public and the private sector
 Managing interest rate, keeping it positive to attract saving
 Encourage exports so that no trade deficit
 Low population growth rate
5. Natural resources

Solow Growth Model- Lessons:
• Still capital accumulation is one of the

requirements (necessary condition) for
development, so high saving and investment rates
are basic requirements. All factors that
discourage saving and investment remain valid
lessons
• Appreciation of technological change, though
exogenously given.
• The Solow growth model is the starting point to
determine why growth differs across similar
countries.
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Solow Growth Model-Critics
1. Highly simplifying assumptions
2. Recognizes technological change yet, it is based on constant rate of return.
The purpose of technology is increasing rate of return.
3. Saving is exogenous
4. The role of government is assumed away
5. It has much regard to trade liberalization policy since inflow of foreign
capital can strongly supplement the domestic capital accumulation,
improving the capital/labor ratio. The other side of the coin is that there is
capital outflow > capital inflow.
6. Critics against basic assumptions of neoclassical economic theory, remain
valid critics:
 Equilibrium analysis;
 Production function approach of the firm, as the blackbox,
 Technological change, as exogenous variable,
 Institutional and political neutrality
 Homogenous, friction-less society,
 Ahistorical approach

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Structural Change Models
1970s-Structural Change
• This linear-stages approach was largely replaced in
the 1970s by two competing schools of thought.
• The first set of theories of the 1970s is the
structural change theories, which focused on
theories and patterns of structural change, used
modern economic theory and statistical analysis
in an attempt to portray the internal process of
structural change that a “typical” developing
country must undergo if it is to succeed in
generating and sustaining rapid economic growth.

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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.
• Structural change models focus on the different productivity
levels of economies
• Process of structural change determines the rate of
development
• It employs the tools of neoclassical price and resource allocation

theory and modern econometrics to describe how this
transformation process takes place.

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Structural Change
• Less developed nations – tend to be
dominated by primary industries – low
value added, difficult to generate wealth
and thus sources of investment.
• Developed nations – diversified
economies, high value added, high
levels of investment.
• Structural change can be encouraged by
incentives.
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Structural-Change Models
Two well-known representative examples of
the structural-change approach are:
a. The “two-sector surplus labor” theoretical
model of W. Arthur Lewis and
b. The “patterns of development” empirical
analysis of Hollis B. Chenery and his coauthors.

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Lewis Model-
“Economic development with
Unlimited Supply of Labor”
The Lewis Model-Introduction-1
• The Lewis model, presented in 1954/55, remained
dominate in the 1960s & 1970s.
• It is also known as the two sector surplus labor
model.
• Less developed economies are dual
economies, with two sectors; a rural,
subsistence agricultural sector and an
urban modern industrial sector.
• It focused on the need for countries to transform
their structures, away from agriculture, with
low productivity of labor, towards industrial
activity, with a high productivity of labor.
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Lewis Model Assumptions-2
1. Less developed economies have dual economies. There is
coexistence of industrial sector and subsistence sector.
2. Surplus labor agricultural sector:
a. High density of population, & high disguised unemployment. (>80% of
population)
b. Marginal productivity of rural labor is zero. So labor can withdraw
without reducing total output from agriculture.
c. Fixed capital: no capital accumulation in this sector. Only labor is a
variable input.
d. Supply of rural labor is perfectly elastic at the subsistence rate of
wages.
3. Modern industrial sector:
a. Labor shortage in urban centers,
b. Wage rate is higher, and assumed to remain constant, horizontal line.
c. High productivity, MPL > 0; and MPk >0.
d. Capital accumulation through reinvestment of profit, so both labor &
capital are variable inputs.
5. Output can increase through labor transfer from agriculture to
the modern, urban sectors
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The Lewis Model-Introduction-3
• The process of self-sustaining growth and
employment expansion continues in the
modern sector until all of the surplus labor is
absorbed.
• Structural transformation of the economy has
taken place with the growth of the modern
industry.
• Therefore, transferring workers out of
agriculture does not reduce productivity in the
whole economy.
• Labor is then released for work in the more
productive, urban, industrial sector.
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The Lewis Model-4
• Start with the left side of the figures, an increase

in use of labor beyond LA would reduce
agricultural supply. Capital is fixed for the
agricultural sector. So no possibility for investing
and hence increasing agricultural output.
• Right hand side of the figures show the modern
sector, given a constant, horizontal wage, an
increase in labor supply is generating additional
production, shifting the production function
upwards,
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Lewis Model-Basic Assumptions-2
• Agriculture generally under-employs
workers: Large disguisedly unemployed
agricultural labor. So need to use this labor
for capital accumulation in the industrial
sector.
• Marginal productivity of agricultural labor
is virtually zero, (MPL=0).
• The supply of labor is perfectly elastic at the
subsistence rate of wages.
• Wage rate is higher in the Industrial sector
compared to subsistence sector, wage rate
stagnates at the subsistence level.
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The Lewis Model-5
• Industrialization is now possible, given the
increase in the supply of workers who have
moved from the land.
• Industrial firms start to make profits, which
can be re-invested into even more
industrialization, and capital starts to
accumulate. As soon a capital accumulates,
further economic development can sustain
itself.

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Lewis Model-Lessons-6
• Labor as the source of dynamism and change in
productivity;
• The significance of creating employment
opportunities in the economy.
• Development process as engaging all the factors of
productions in an efficient way to quicken the
process of development within a country.
• Need for structural transformation of the economy,
• Capital accumulation remains a necessary condition
for development.

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Lewis Model-Critics-7
1. It is closed economy: ex. Capital flight from urban economy may
discourage capital accumulation.
2. Labor market assumptions:
a. Capital accumulation, expansion of capital intensive industries may reduce
the need for labor in the urban industrial sector; So labor transfer
discouraged, or urban unemployment.
b. The assumption that the rate of labor transfer and employment creation in
the modern sector is proportional to the rate of modern-sector capital
accumulation may not hold true
c. Urbanization may create problems, such as poverty, squalor
and shanty-towns, with unemployment replacing
underemployment.
3. Agricultural sector needs transformation for its own sake: Food
supply shortage, eradicating rural poverty and climate change are
some of the justifications for agricultural developments.

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Lewis Model-Critics-8
4. Perception of technology: Diminishing
returns in the modern industrial sector may
not hold true, rather increasing returns may
prevail.
5. The people are not the target of the model.
Rather, income (production) approach!
6. It does not explicitly recognize the role of the
government and institutions. They are just
there assumed to exist or to be neutral.

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Structural Change &
Patterns of
Development: Chenery’s
Model
Introduction
• Hollis B. Chenery, from Harvard University, based on empirical study
on many LDCs. His studies (both cross section & time series) led him
to establish certain patterns in establishing several characteristic
features of the development process.
• Focus on the sequential process through which the economic and
institutional structure of LDCs is transformed over time, giving place
to new industries, as the engines of growth.
• Based on empirical observation of the characteristic features of set of
economies. Thus, though it recognizes possible differences, the
structures of the economies of LDCs are average patterns of
development.
• Increased saving and investment as necessary but not sufficient
condition for development.
• In addition to capital (both human & Physical) a set of interrelated
changes in the economic structure are required.
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Transformation involves:
• Transformation of production system, shift from
agriculture to industrial production,
• Steady accumulation of physical & human capital
• Changes in the composition of consumer demand from
food to diverse industrial products & services
• Changes in international trade,
• Changes in resource use
• Rapid urbanization, cities, urban industries, high urban
employment,
• Changes in the growth and distribution of a country’s
population, decline in the family size, decline in
population growth rate, decline in birth rates,
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Development constraints
1. Differences in development among the countries are ascribed
to:
 Domestic constraints
 International constraints
2. Domestic constraints include:
a. Endowments of resources,
b. Physical size
c. Population size
d. Institutional constraints, such as government policies & objectives
3. International constraints include:
a. Access to external capital
b. Access to technology
c. International trade
d. It is the international constraints that make the transition of LDCs differ from
that of the now DCs. LDCs can make the transition faster through the use of
international resources (capital, technology, markets).

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Lessons & Critics
• The major hypothesis of this model is that development is an
identifiable process of growth and change whose main
features are similar in all countries. Yet it recognizes the
possible differences in pace and pattern of development,
depending on their particular circumstances.
• Structural-change analysts believe that the
“correct mix” of economic policies will
generate beneficial patterns of self-sustaining
growth
• One lesson is the recognition of the international factor,
understanding LDCs as operating in such an international
system.
• Major limitation is the heavy reliance on the international
factor as the engine of growth, which may not hold true.
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International Dependence
Model (IDM)/Revolution
(IDR)
Dependency Theory
1. Started around the 1950s
2. Took hold in the 1960s and 1970s partly
because of the revolutionary atmosphere of
the period
3. Alternative theory to the Modernization
school, neoclassical theory
4. Versions:
a. Classical Dependence (1950s)
b. New Dependency Studies (1970s)

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Background-1970s-International Dependency Theory
• The second theory of the 1970s was the international-
dependence revolution, which was more radical and
more political.
• Latin America’s centre-periphery paradigm theory,
• Mainly developed by staff working in the United Nations
Economic Commission for Latin America (ECLA) during
the 1950s and 1960s under the inspired leadership of Raúl
Prebisch.
• The theory evolved within ECLA and its sister institution
ILPES (Instituto Latinoamericano de Planificación
Económicay Social), while some of the key neo-Marxist
thinkers were at one time working in the Centre for Socio-
Economic Studies (CESO) of the University of Chile.
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International Dependency Theory
• Prebisch and his colleagues were troubled by the
fact that economic growth in the advanced
industrialized countries did not necessarily lead to
growth in the poorer countries. Rather, economic
activity in the richer countries often led to serious
economic problems in the poorer countries.
• Such a possibility was not predicted by neoclassical
theory, which had assumed that economic growth
was beneficial to all (Pareto optimal) even if the
benefits were not always equally shared.

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1970s-International Dependency Theory
1. International-dependence models view
developing countries as beset by institutional,
political, and economic rigidities, both domestic
and international, and caught up in a
dependence and dominance relationship with
rich countries.
2. It viewed underdevelopment in terms of
international and domestic power relationships,
institutional and structural economic rigidities,
and the resulting proliferation of dual
economies and dual societies both within and
among the nations of the world.
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International Dependence Model (IDM)
1. The IDM models argue that developing countries
are up in a dependence and dominance
relationship with rich countries
a. Inherited structure of the economy from colonialism,
highly import-dependent economy, no/small/ domestic
industrial sector, agricultural predominance
b. Unequal & Unfair relationships: LDCs are
disadvantaged from the existing international order.
c. International trade among unequal traders
d. This unequal, unfair international order is self-
sustaining dependency relationship
e. Economic Outcomes: Balance of payment crisis,
persistent current account deficit, international
indebtedness, Severe shortage of foreign exchange
f. A condition of cultural, psychological, social and
political dependency. Only nominal political
independence!
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http://www.uni-giessen.de/geographie/presse/images/Slums.jpg
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Low value-added products High value-added goods
(primaries: raw materials Center (industrial products)
and food)
Periphery

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The International Dependence Model (IDM)
1. Focus on
a. The international front:
Emphasis on international power
balances and on fundamental
reforms world-wide.
b. The IDR models reject the
exclusive emphasis on GNP growth
rate as the principal index of
development
c. Rather claim to be and argue for
the need for a new, LDCs-
tailored development paradigm.
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The International-Dependence Model
• Emphasis was placed on the need for major

new policies to eradicate poverty, to provide
more diversified employment opportunities,
and to reduce income inequalities.
• These and other egalitarian objectives were to
be achieved within the context of a growing
economy, but economic growth per se was
not given the exalted status accorded to it by
the linear stages and structural-change
models.
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1970s-International Dependency Theory
1. Different versions of this theory:
a. The neocolonial dependence model: Legacy of
colonialism, Unequal power, Core-periphery
b. The false-paradigm model: Pitfalls of using
“expert” foreign advisors who misapply
developed-country models
c. The dualistic-development thesis: Superior and
inferior elements can coexist; Chronic, not
transitional

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Neocolonial Dependence Model
a. “Dependence is a conditioning situation in which
the economies of one group of countries are
conditioned by the development and expansion of
others.”
b. “Dependence, then, is based upon an international

division of labor which allows industrial
development to take place in some countries, while
restricting it in others, whose growth is conditioned
by and subjected to the power centers of the world.”
Theotonio Dos Santos

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The False-Paradigm Model
• The false-paradigm model, attributes underdevelopment to
faulty and inappropriate advice provided by well-meaning
but often uninformed, biased, and ethnocentric
international “expert” advisers from developed- country
assistance agencies and multinational donor organizations.
These experts are said to offer complex but ultimately
misleading models of development that often lead to
inappropriate or incorrect policies.
• Leading university intellectuals, trade unionists, high-level government
economists, and other civil servants all get their training in developed-
country institutions where they are unwittingly served an unhealthy dose
of alien concepts and elegant but inapplicable theoretical models.
• The policy prescriptions serve the vested interests of
existing power groups, both domestic and international
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The False-Paradigm Model
• Too much emphasis is placed on attempts to
measure capital-output ratios, increase
savings and investment ratios, privatize and
deregulate the economy, or maximize GDP
growth rates at the expense of more relevant
& desirable institutional and structural
reforms.

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Policy Implications
• On the domestic front, inward-directed
development policy largely through import-
substituting industrialization (ISI),
• On the international arena, creating a new
international economic order,
• a transition to socialism as a way out of
underdevelopment
• Develop own development paradigm instead
of neo-liberalism and hence neoclassical
economics based development agenda
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Lessons from International Dependency
Models
• Politics and Institutions, especially international
politics, came into the analysis which in contrast to
neoclassical economics in general and in view of the
previous theories learned in class is very important
contribution.
• Need for home-tailored development ideology,
paradigm instead of importing one or instead of being
a victim of ideological and philosophical hegemony.
• Need for a new, fair International order
• Equity, fairness, poverty eradication as the center of
development

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Criticisms and limitations of IDR
• Offers Causes but No Solutions: Do little to show how

to achieve development in a positive sense;
accumulating counterexamples (China, India, etc.). Do
not offer any policy prescription for how poor countries
can initiate and sustain economic development
• Actual experience of developing countries that have
pursued policy of autarky/closed economy has been
negative
• Narrow focus on exchange relations as basis for
domination
• Doesn’t look at local processes of exploitation and
exclusion
• Socialism did not prove itself successful to date.
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Balanced Growth Models
Balanced Growth
“The synchronised
application of capital to a
wide range of different
industries”
- Nafziger (1990, p. 85)

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Vicious Circle of Poverty (VCP) as a Critical Problem
Existence & Interconnectedness of different parts &
sectors of a society & an economy, recognition of
duality in the economy.
"It is the vicious circle of poverty (VCP) which is responsible

for backwardness of UDCs"(Prof. Nurkse).
Vicious circle of poverty:
"Implies a circular constellation of forces tending to act and

react in such a way as to keep a country in the state of
poverty".
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Elements of the Vicious circle theory
• Supply side - Because incomes are

low, there is low propensity to save
for capital formation, low
investment, capital deficiency and
low productivity leading to low
income.
• Demand side – Because incomes
are low, market size is too small to
spur investment. Narrow home
market leads to low investment
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89
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Strategic Direction
• Simultaneous, coordinated expansion of several parts &
sectors. All (several) sectors need to grow to support
each other.
• A clear role of government in supporting those sectors
that might not ‘naturally’ grow, or might lack
investment from the private sector
• Strategy theories intend to break up the vicious cycle at a
certain point which they consider critical and which
varies according to the different theories. Their main
emphasis is on capital formation and investment
(investment theories) and, by and large, they prescribe
action for overcoming underdevelopment.
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Two Versions of Balanced Growth
1. Big push theories are an extension of the balanced
growth approach. A big push might be needed by a
government to help the economy grow in a balanced way.
Big push needed because of indivisibilities on both
supply and demand side of the market –infrastructure
& demand -(Rosenstein- Rodan).
or
2. The path of development and the pattern of
investment must be balanced between the sectors of
the economy to ensure its smooth functioning (Nurkse
and Lewis). Synchronized application of capital to
wide range of different industries – (Nurkse).

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Version 1. Big Push: Rosenstein-Rodan
 Rosenstein-Rodan was initially
concerned with the post war
development of Eastern and South
Eastern Europe
 He argued that industrialisation was the
only way to alleviate the 25%
unemployment rate due to excess
agricultural workers
 However, he believed that such
investment would not occur without co-
ordination
Paul Rosenstein-Rodan
1902 - 1985 Tsegabirhan Weldegiorgis Abay, DoE, CBE,
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The demand side - Complimentarity of Industries
 The inducement to invest is limited by the size of the
market
 In a non-surplus producing agricultural economy
there is no initial demand for manufactured goods
 Whilst Say’s Law suggests that once workers are
transferred to an individual industry (say shoe
production) they will generate their own demand by
consuming shoes, Rosenstein-Rodan noted that they
will not spend their entire wages on shoes alone.

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The demand side - Complimentarity Of Industries
 If the workers are transferred into a
range of industries producing the bulk of
goods on which workers would spend
their wages then these industries will act
as compliments to each other and will
thus be mutually supporting.(Note it
builds on Lewis model)
 This requires coordination between
industries, hence the government as
coordinator, planner
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95
Supply Side-Inexperienced Entrepreneurs
 The driving force behind investment
is profit expectations, which are based
on experience.
 In developing countries there is little
experience to guide entrepreneurs
 Thus subjective risk is considerably
higher than objective risk and
investment is hence impeded.
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Coordinated ‘Big Push’
 A coordinating body, with more information, would be more
able to assess risk than individual entrepreneurs
Government intervention in the form of a
coordinated investment body alleviates these
problems by: coordinating complementary industries;
viewing externalities as profits; and gathering
sufficient information to correctly calculate risk
 Once a threshold level of industrialisation has been
achieved, normal private incentives may operate
successfully and investment can be left to the market.
 Thus, a big push breaks an economy out of a vicious
circle and leads toTsegabirhan
a virtuous circle of growth
Weldegiorgis Abay, DoE, CBE,
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Version 2. Balanced Growth: Nurkse
 Pioneered by Ragnar Nurkse (1907–
1959)
Nurkse followed up on Rosenstein-
Rodan’s thesis
He embraced ‘Big Push’ theory, but
argued that coordination could also be
achieved by private agents, i.e. banks.
 His contribution was to assert the
importance of achieving balance
between different segments & sectors
Ragnar Nurkse of the society & economy
1907 - 1959
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Breaking VCP: A Balanced Economy-Nurkse
1. According to Nurkse, a break through on
demand side can be brought about by dashing
initiatives on the part of entrepreneurs.
2. On the supply side the disguised unemployment
ranging between 20% to 30% of total agri. labor
force can be mobilized for financing capital
formation. And the parents of such disguised
unemployed will go on feeding them.
3. It means that in Nurkse's model the hidden
food surplus will finance the process of
economic growth.
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Breaking VCP: A Balanced Economy-Nurkse
 Nurkse was concerned with the

path of development and the
pattern of investment
 Growth should be balanced
between different sectors such that
no bottlenecks or excess capacity
arise

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A Balanced Economy-Nurkse
Nurkse was in favor of attaining balanced growth in both the
industrial and agricultural sectors of the economy . Integral to
this proposition is the notion that the agricultural and
industrial sectors must be balanced;
a. Each of these sectors provides a market for the products of
the other and in turn,
b. Supplies the necessary raw materials for the development
and growth of the other.
=
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Being Critical one, What are the Determinants
of Market Size?

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Balanced Growth-Nurkse
• The increase in demand for one industry will
lead to an increase in demand for another
industry due to complementarity of demands. In
line to the logic of the Say's Law, supply creates
its own demand.
• According to Nurkse, expanding the size of the
market is crucial to increasing the inducement
to invest.
• Improving productivity is one strategic
intervention area to expand the market size and
break the vicious circle of poverty.
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Productivity leading to Economic Development & Growth:
An increase in productivity can create a virtuous circle of growth !!!

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Balanced Growth
• Nurkse clarified that the finance for this
development must essentially arise from the
underdeveloped country itself i.e. domestically.
• Nurkse’s theory hypothesizes that the
government of any underdeveloped country
needs to make large investments in a number of
industries simultaneously.
• Nurkse believed that the subject of who should
promote development does not concern
economists. It is an administrative problem.

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Lessons from Balanced Growth
1. Agricultural investment needed: relevant today in
the face of global food shortage, climate problem,
rural poverty alleviation
2. Recognition of the importance of demand side,
the market as an economic resource, as a
competitive advantage, which transcends to the
present era.
 Mind you, one of the competitive advantages of the DCs is
their high income: destination of nearly 70% of global trade.
 Mind you, China is the largest destination of FDI merely
because of the fact that it has eliminated poverty for nearly
300 million of its citizens

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Lessons from Balanced Growth
1. Recognition of the need to eradicate poverty as
prime development agenda not only moral
agenda!!
2. Recognition of domestic financing, which has
transcended to present. There has been an
aggressive move and pressure for domestic
resource mobilization.
 Note that there is always cost to be paid for external
sources of finance: Narrow policy space, sovereignty
challenged, policy conditionalities, mechanism for
huge capital flight, high debt servicing cost.
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Critique of Balanced Growth
1. Infrastructure not so indivisible.
2. Economy that can undertake balanced growth is not
underdeveloped - capital, skills, materials needed are
immense.
3. Nurkse was criticized for being export- pessimist, ruled out
external sources of financing investment. So investments in
underdeveloped countries must arise from their own
domestic territory.
4. Pessimism on external sources of financing including FDI
5. Nurkse believed that the subject of who should promote
development does not concern economists. It is an
administrative problem.
 But recall the dilemma of both market failures vs. government
failure
 The role and responsibility of the state is largely ideological,
political not administrative!!!
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Unbalanced Growth
Unbalanced Growth
• Hirschman
challenged the
theory of balanced
growth
• He embraced the
theory of
‘unbalanced
Alfred Hirschman growth’
1915 -
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Unbalanced Growth
1. Pioneer is a German political economist, Albert
Hirschman
2. Major shortage is investment by entrepreneurs &
risk takers.
3. So need for development strategy to spur
investment decisions.
4. Overall growth is faster when it is unbalanced. So
unbalanced growth as a strategy of development
of LDCs.
5. Development should concentrate on certain
sectors. He argued that there are insufficient
resources available in developing countries to
allow for a ‘big push’
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Unbalanced Growth
1. Creating imbalances in the system is the best strategy
for growth.
a. Premise: the little that is available must be used
efficiently.
b. Owing to the lack of availability of resources in the
LDCs, it is not possible to invest in all, so selective
investment is a must.
c. Need to consider how investment affects
profitability of other sectors. Select areas of
intervention on the basis of linkages of investment
areas to other sectors in the economy.
 Consider both backward to sales of inputs &
forward linkages effects

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Unbalanced Growth
• This theory stresses on the need of investment in
strategic sectors of the economy instead of all the
sectors simultaneously. So strategic sectors in the
economy should get priority or precedence over
others. Concentrate on certain sectors; The other
sectors would automatically develop themselves
through what is known as “linkages effect”.
• Growth of output of industry A may generate the
demand for the products of B and C and also may
reduce the marginal cost of production in these
industries. There are technical complementarities
which stimulate the growth of related industries,
following the strategy
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Unbalanced Growth
• So Big Push is not feasible.
• Banks and the government choose and provide the
funds for investment
• If growth is unbalanced, resource prices will rise
in those areas where output growth is relatively
slow, and this will act as a signal for investors to
allocate funds to opening up these bottlenecks.
So market can taker of the resource allocation.
• The role of government should be to help support
those industries with the strongest linkages to the
growth industries

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Unbalanced Growth-Lessons
• Underlying concern is efficient allocation of
resources in face of severe scarcity of
resources.
• Strategic intervention in the economy,
which extends to the current debate on
selective industrialization policy vs.
creating conducive investment climate
• Complementary role of the market and the
government in investment allocation

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Critique of Unbalanced Growth
• The assumption of Imbalances

leading to ultimate balance may
not be warranted.
• Too little emphasis on agriculture –
contributes to industry through
food, foreign exchange, labor,
capital & larger markets.

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Criticisms of Both Balanced & Unbalanced Growth
1. Balanced growth 1. Unbalanced

• The strategy is beyond the resources of
most poor countries
Growth
• The model leaves a lot to
• Balanced growth within a closed chance;
economy rather than specialization and o Have the correct sectors been
trade contradicts comparative advantage focused upon?
• Government planning results in o What criteria has the

government failure i.e. government government used to identify
intervention in the market fails to bring the sector to focus upon?
about an efficient allocation of resources
e.g. planning process creates a
bureaucracy. o Bottlenecks may occur where
there is a shortage in supply to
• LDC development policies focusing on the growth sector
import substitution, agricultural self-
sufficiency and state control of o There may not be a sufficient
production yield poor growth. demand for the output from
the growth sector
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Critics of Both Balanced & Unbalanced Models
• These theories contributed less towards

explaining the root causes of
underdevelopment, vicious circle.

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Dualistic Theories
Recall or Note
• Representative economic agent: the firm, the consumer,
• The market, the industry, the economy imply one
homogenous market, industry, economy
• All the statistical tools and econometrics models are
meant to capture the general behavior of an industry, sector
or an economy.
• So in a way economics is all about aggregation, because we
want to infer and understand the macro behavior of the
economy, stability, growth, employment/unemployment/,
etc.
• But there is a cost to be paid to this aggregation.
• Duality comes to qualify the fact that there are
multiple/dual/ behaviors in the economy instead of one!
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Dualist Models
• The dominant one-sector macro models, from Keynesian to
Harrod-Domar to Solow, seemed to have limited relevance for
societies not primarily concerned with business cycle or steady
state (growth comparison of two equilibrium positions)
properties.
• The dominant assumptions of neoclassical micro theory –full
employment, market clearing and perfect competition-seemed to
have little relevance for the segmented commodity, labor, and
credit markets of poor countries.
• Early post-war consensus focused on capital scarcity and
savings-pushed growth, with relatively minor emphasis on
technology change in either sector.
• High pessimism of the elasticity of agricultural production,
and the non-responsiveness to price signals of various actors
and with respect to the open economy, i.e. export
opportunities Tsegabirhan Weldegiorgis Abay, DoE, CBE,
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Dualist Models
• Implicit in structural-change theories and explicit
in international-dependence theories is the notion
of a world of dual societies, of rich nations and
poor nations and, in the developing countries,
pockets of wealth within broad areas of poverty.
• Dualism represents the existence and persistence
of substantial and even increasing divergences
between rich and poor nations and rich and poor
peoples on various levels. So it assumes a split of
economic and social structures of different sectors
so that they differ in organization, level of
development, and goal structures.
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Dualist Theories
• The first modern theorists to build on classical dualism
were undoubtedly Rosenstein-Rodan 1943,
Mandelbaum 1945 and Nurkse 1953, all of whom, in
their own way, pointed to the existence of surplus labor
as a potential resource which, once reallocated from
agriculture to higher productivity pursuits in non-
agriculture, would constitute a major fuel for
development. (Ranis, Gustav; 2004)
• Arthur Lewis 1954; built on some of the main ingredients
of the classical tradition, focusing more precisely on
dualism in labor markets (i.e., a competitive wage in
non-agriculture tied to a bargaining or institutional wage
in agriculture) (Ranis, Gustav; 2004)
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The Dualistic- Development Thesis
1. Dualism represents the existence and
persistence of increasing divergences between
rich and poor nations and rich and poor
peoples at all levels.
2. The concept embraces four key arguments:
a. Superior and inferior conditions can coexist
in a given space at given time
b. Chronic and non-transitional coexistence
c. The degrees of the conditions have an
inherent tendency to increase
d. Superior conditions serve to develop under
development/marginalization/
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Versions of the Dualist Theories
a. Social Dualism
b. Technological Dualism
c. Financial Dualism
d. Labor Market Dualism
e. Another strand of dualism Classical Dualism:
Physiocrats who emphasized the importance
of an agricultural (considered productive)
surplus supporting non-productive activities
elsewhere (artisanal goods),

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Sociological Dualism
1. Sociological dualism associated with Julius Herman
Boeke 1953 emphasized differences between Western
and non-Western objectives and cultures;
2. Social dualism characterizes a society in the economic
sense by the social spirit, the organizational forms and
the technique dominating it. According to Boeke, "These
three aspects are interdependent and in this connection
typify a society, in this way that a prevailing social spirit
and the prevailing forms of organization and of technique
give the society its style, its appearance, so that in their
interrelation they may be called the social system, the
social style or the social atmosphere of that society

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Sociological Dualism
Societies "showing a distinct cleavage of two
synchronic and full grown social styles which in
the normal, historical evolution of
homogeneous societies are separated from each
other by transitional forms, as for instance, pre-
capitalism and high capitalism by early
capitalism.
 Differences in culture, values, practices, outlook to
life,
 Attitude towards once job, industry discipline
 Attitude towards social responsibility,
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Technological Dualism
1. Technological dualism pointed to by Benjamin Higgins 1956 and
Eckaus 1955 focused on the difference between variable factor
proportions in traditional and fixed coefficients in modern
sectors;
2. Higgin’s theory explains the causes of unemployment in the
underdeveloped economies, which are characterized by dualistic
Economy- modern sector & traditional Sector.
3. Two fundamental basis of technological dualism:
a. Both sectors use different production functions
b. Both sectors have different resource endowments; difference in
availability of labor and capital
 Differences in factor proportion: Fixed technical coefficients in the modern sector
and variable technical coefficients
 Advanced technology vs. traditional technology
 Capital intensive vs. labor intensive;
 Differences in knowledge intensity.
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Technological Dualism-1
Traditional sector
1. Main occupations: Agriculture, cottage
industries and small industries.
2. Variable technical coefficients of production:
different techniques and combinations are
used. Products are produced with a wide
range of techniques and combinations of
labor and capital.
3. Labor intensive technique is dominating.

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Technological Dualism-2
Modern sector:
1. Large scale industries, plantation, transport,
oil fields are the main occupation in this
sector.
2. Capital-intensive production dominant.
3. Fixed technical coefficients: Homogenous
techniques used. Different techniques and
combination are not used. There is a limited
degree of technical substitutability of
factors.
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Fixed Technical Coefficients of Modern Sector

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Fixed Technical Coefficients of Modern Sector
• The curve which is an isoquant shows the
combination of labor and capital at the same
level of output.
• The higher the curve the higher the levels of
output i.e. O1 level of output is least and as
you go to O2,O3,O4 the output level
increases.
• The dotted line Ti shows the expansion path
of the modern sector.

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Technological Dualism-Conclusion
• Technological dualism in underdeveloped
countries is the cause of unemployment and
disguised unemployment.
• Development in the modern sector can take
place if foreign capital is present in the
economy.
• Industrialization in these economies does not
contribute to capital formation.
• Increasing population.

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Technological Dualism-Critics
• It fails to offer an explanation of nature and growth of

unemployment in the traditional sector in the dual
society
• The theory gives importance to only technical factors
affecting labor and capital whereas social and
psychological factors are completely ignored.
• This theory is based on the assumption that the
technical coefficients are fixed in the modern sector a
little degree of elasticity cannot be ruled out
completely. This makes this assumption questionable.
• The theory explains the under employment in the
traditional sector but it never give any solution.
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Low-level Equilibrium
Trap
Background
• The theory developed by Richard R. Nelson in his article
A Theory of the Low-Level Equilibrium Trap published in
1956.
• A theory of underdevelopment for the Underdeveloped
countries.
• It is based upon 'Malthus' view that when per capita
income of a country rises above the 'Minimum
Subsistence Wage', the population will tend to increase.
In the beginning the increase in per capita income leads
to increase the population. Afterwards, the increase in
the per capita income leads to decrease population.

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THE MALTHUSIAN TRAP
1. In 1798 Thomas Malthus published his Essay on the

Principles of Population.
2. Malthus drew attention to three facts.
a. Human beings are very strongly motivated by a desire for
sexual intercourse, or, as he wrote, 'the passion between
the sexes is constant' and very strong.
b. High fertility of humans and other animals
c. Economic resources, and in particular food, cannot keep
pace with this population growth within a basically
agrarian economy largely dependent on human labor.
A powerful tendency for population to outstrip
resources.
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The Theory
• Underdevelopment can be diagnosed as a stable

equilibrium level of per capita income at or
close to subsistence requirements.
• At this low stable equilibrium level, both the rate
of investment and saving are low. If per capita
income is increased above the minimum
subsistence level, it encourages growth in
population.
• The population growth, in turn pushes down per
capita income again to subsistence level. Thus
the economy is caught in low level equilibrium
trap.
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139
The Model
1. Attempts to integrate population and development theory by

recognizing the interdependence between population growth, per
capita income, and national income growth.
2. Nelson uses a model with three equations.
a. First, there is an income determination equation. Income depends on the
stock of capital, the size of the population, and the level of technique.
b. Second, net investment consists of saving-created capital plus additions
to the amount of land under cultivation.
c. Third, there is the population growth equation according to which in
areas with low per-capita incomes short-run changes in the rate of
population growth are caused by changes in the death rate, and changes
in the death are caused by changes in the level of per-capita income. Yet
once per capita income reaches a level well above subsistence
requirements, further increases in per-capita income have a negligible
effect on death rate.
3. With these three sets of relationships, it is easy to see that an
underdeveloped economy is caught in a low level trap.
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Factors of Nelson's Trap:
According to Nelson following factors are responsible

for such trap:
1. There is a high correlation between the level of per
capita income and rate of population growth.
2. There is a little propensity to direct additional per
capita income to increase investment.
3. There exists a shortage and scarcity of uncultivable
area of land.
4. The economy is having inefficient techniques of
production.
5. The economy is furnished with social and economic
inertia.
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Conclusion
• This model has demonstrated the difficulties that
developing countries may face in achieving a self-
sustaining rise in living standards.
• Starting from this low level equilibrium trap, any small
increase in per capita income will not be able to
sustain itself or lead to further increase in per capita
income because the rate of growth in population is
higher than the rate of growth in total income.
• A critical minimum effort is required! Nelson's thesis
advocates that if the country is to break the shackles
of low level equilibrium trap, its rate of growth of
total income must be higher than 3% per year.
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Methods to Escape from Trap:
1. There should be a favorable socio-economic

political environment in the country.
2. Social structure be changed by greater emphasis
on entrepreneurship.
3. The size of the family by reduced.
4. Measures be taken to change the distribution of
income.
5. The proportion of public investment be increased.
6. Foreign loans to enhance capital and investment.
7. Improved techniques of production be used to
utilize the existing resources.
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Lessons: Way out from the Trap
• Getting out of the trap requires increasing the rate
of growth of income to the levels higher than the
rate of increase in population, >3%.
• Brought population and its growth rate into the
picture.
• Recognize the interdependence between
population growth, per capita income and income
growth.
• Still keeps up with recognizing the importance of
capital accumulation, like preceding development
theories.
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Critics
• Low-equilibrium trap, an extension to the ‘vicious circle of
poverty’ leads to pessimism.
• Capital formation is only a necessary condition for
development, definitely not sufficient condition for
development.
• it is not always possible to draw a rigid functional
relation between the level of per capita and the rate of
growth of population and rate of growth in total income.
• The relation between the level of per capita income and
the rate of saving and investment is modified by number
of factors such as pattern of distribution of income and
effectiveness of financial institution in mobilizing savings
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Neoclassical Counterrevolution:
Market
Fundamentalism/Washington
Consensus/
Recall: Traditional Neoclassical Growth Theory
According to the traditional neoclassical growth theory:

Output growth results from one or more of three factors-
increases in Labor, increases in capital, and technological
changes.

Closed economies with low savings rates grow slowly in the
Short-Run and converge to lower per capita income levels.

In the long run, open economies converge at higher levels of
per capita income levels.

It is argued that capital flows from rich to poor countries as
K/L ratios are lower and investment returns are higher in the
latter.

By impeding the flow of foreign investment, poor countries
choose a low growth path.

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Definition
• Neoclassical counterrevolution: The
1980s resurgence of neoclassical
free-market orientation toward
development problems and policies,
counter to the interventionist
dependence revolution of the 1970s
and before.

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Background to Neoclassical Counterrevolution
1. The 1980s & early 1990s were the period where the failure and weakness of the
Soviet model were clearly recognized
The success of the Soviet Union in transforming itself from an agrarian nation at
the time of the communist revolution to an industrial power in the 1930s, 40s,
50s, 60s and early 70s did not sustain in the 1970s and 1980s. The period 1930s-
early 1970s, particularly since WWII the period was the peak of the inward-
oriented, state-oriented development paradigm driven by an acceptance of the
pervasiveness of market failures or non-existence of many markets in LDCs. Note:
 The success of the soviet model (after Lenin & his Bolsheviks party took power in
1917 and Soviet union came out as successful after WWII, becoming one of the
superpowers.
 The came out of the Dependency theory from L. America and its dominance
throughout the LDCs, easier in introducing I-S, protection of infant industries.
However, the success story did not sustain even in the Soviet Union and Eastern
European communist countries were lagging behind their Western counter parts .
 This was increasingly observed and echoed from within and from outside. Literature was
coming out that show the failure of central planning, & the limitations of I-S, the relative
success of the West against the East.
 Berlin wall fell down in 1989
 The Soviet union collapsed and disintegrated in 1991, the Cold War was over.
 The Washington ConsensusTsegabirhan
01/06/2023 was initiated in 1989
Weldegiorgis Abay, DoE, CBE,
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AAU, Ethiopia
1. Remember of the debt crisis of LDCs of the early
1982, which started in Latin America, in Mexico and
then many Latin American countries in 1983, one of
the root cause of this problem is policy problem, I-S
strategy at the expense of exports, state control and
planning failure, showing the failure of governments.
2. In the 1970s & early 1980s, the macro level policies of
trade protection and heavy state intervention in
industry was criticized from the “left” for not giving
distribution sufficient attention, and from the “right”
for giving insufficient attention to trade and to the
private sector.
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1. In the 1980s, the political ascendancy of conservative governments in
the United States, Canada, Britain, and West Germany (Reagan-
Thatcher-Kohl era) came with a neoclassical counterrevolution in
economic theory and policy.
2. Neoclassicists obtained controlling votes on the boards of the world’s
two most powerful international financial agencies—the World Bank
and the International Monetary Fund.
3. Simultaneous erosion of influence of organizations such as the
International Labor Organization (ILO), the United Nations
Development Program (UNDP), and the United Nations Conference on
Trade and Development (UNCTAD), which more fully represent the
views of delegates from developing countries.
 Remember the existence of Russia with Veto power in the UN, so the
USA does not have complete control over the UN compared to that
of the World Bank & IMF
4. So recognize the origin of this theory is in an economics-cum-
ideological perspectives and interests.
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Leading writers of the counterrevolution
school, include:
Lord Peter Bauer,
Deepak Lal,
Ian Little,
Harry Johnson,
Bela Balassa,
Jagdish Bhagwati, and
Anne Krueger.
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Market Fundamentalism -Arguments & Policies
• Underdevelopment results from poor resource allocation due
to incorrect pricing policies and too much state intervention
by overly active developing-nation governments.
• Unlike ‘Dependency Theories’, the problem is internal,
domestic rather than the international, the DCs. The
developing world is underdeveloped not because of the
predatory activities of the developed world and the
international agencies that it controls but rather because of
the heavy hand of the state and the corruption, inefficiency,
and lack of economic incentives that permeate the
economies of developing nations.
• The problem is rather on the government not on the market
or the private sector

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Promoted Policies
1. In DCs, favored policies and theories:
 Supply-side macroeconomic policies,
 Rational expectations theories, and
 The privatization of public corporations
2. In LDCs, the favored and imposed policies (conditions for getting aid, grants)
were:
 Free Market, laissez-faire economics , “magic of the marketplace” “invisible hand”
of market prices to guide resource allocation and stimulate economic development.
 Privatization: Dismantling of public ownership,
 Less regulation, so letting the market to freely operate.
 Trade liberalization, trade, financial liberalization for goods, factors including capital
flow, no protection of domestic industries, exposing local market to foreign
competition.
 The driving force of growth is the private, government playing no or minimal role.
Less government, “the best government is one that governs least” , avoid state
planning.
 An increase in foreign aid,
 Attempts to control population growth,

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Neoclassical Counterrevolution: Market Fundamentalism
• The neoclassical counterrevolution can be divided
into four component approaches:
a. Free-market approach- markets alone are
efficient
b. The public-choice (or “new political economy”)
approach - governments can do nothing right
c. Market- friendly approach- governments have
a key role to play in facilitating operations of
markets through nonselective interventions
d. New institutionalism- success or failure of
developmental efforts depend upon the
nature, existence, and functioning of a
country’s fundamental institutions.

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Free-market Approach: Washington Consensus
• “Washington Consensus” (1989 by
Williamson), was coined to capture the
wisdom of the Washington-based Institutions
(the IMF, the World Bank and the US
Treasury) aimed to promote development in
Latin America and later throughout the
world.

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Premises & Assumptions of Washingto Consensus:-1
1. That developing-world markets exist and

are efficient and that whatever
imperfections exist are of little
consequence
2. Government Failure: Any government
intervention in the economy is
distortionary and counterproductive.
3. Hence, “Competitive equilibrium
theorem can be applied for raising
efficiency of the markets”.

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Premises & Assumptions of Washingto Consensus:-2
1. Markets alone are efficient—
 Product markets provide the best signals for investments
in new activities; producers know best what to produce
and how to produce it efficiently; Labor markets respond
to these new industries in appropriate ways; and product
and factor prices reflect accurate scarcity values of goods
and resources now and in the future.
2. Competition is effective, if not perfect;
3. Technology is freely available and nearly costless to
absorb;
4. Information is also perfect and nearly costless to
obtain.
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Policies of the Washington Consensus
• The policy slogans of the period were,
“Stabilize, privatize, and liberalize”. The ten
Washington Consensus Policies can be
grouped into two:
a. Structural Reforms;
b. Macroeconomic Policies.

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Structural Reforms
1. Tax reform
 Lower marginal tax rates assuming tax payers would be
motivated to pay their taxes, and investors will respond to
lower taxes, investment, leading to broadern tax bases
 Broaden the tax base: introduction or extension of VAT
(Value-Added Tax)
 Aims were to stimulate investment by lowering taxes, & to
replace the revenue lost by trade reforms, specifically
avoiding tarrifs.
2. Deregulation
 Easing barriers to entry and exit,
 In principle, not on abolishing regulations designed for safety
or environmental reasons, or to govern prices in a non-
competitive industry. In reality, this did not get due attention.

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Structural Reforms
3.Financial sector and Interest Rates liberalization.
 Efficient banking system able to intermediate internal capital flows
efficiently
 Liberalisation of credit flows, interest rates
 Liberalize foreign exchange rates
 Liberalize and open up international capital flow
4. Trade liberalization
 Gget rid of quantitative restrictions and to reduce/avoid/ tariffs progressively
 Reluctant with I-S and encourage to Exports-Promotion policies
5.Privatization of State owned enterprises
6. Secure property rights
• providing the informal sector with the ability to gain property rights at
acceptable cost. This allows to obtain credit from the formal sector.
• The goal is to mobilize assets and to reduce the cost of defending
property.

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Macroeconomic Policies
7. Fiscal discipline: Reduce budget deficits through a selective reduction of expenditures.

 This was in the context of a region where almost all countries had run large deficits that
led to balance of payments crises and high inflation that hit mainly the poor because
the rich could park their money abroad.
8. Reordering public expenditure priorities
 Priority should be given to expenditures with high economic returns and aimed to
improving income distribution in a pro-poor direction such as primary health care,
primary education and pro-growth expenditures (infrastructures).
9. Competitive exchange rate: A devaluation of the exchange rate is
considered an instrument to fostering exports growth.
10. Liberalization of FDI’s inflows
 According to the 2 gaps model: 1) in a first period trade deficit is
binding (imports are higher than exports), in a second period saving
gap is binding (saving is higher than investment).
 In the first period a foreign inflow of capital is needed to accelerating
growth.

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Performance of Washington Consensus
1. In the second half of 90’ Washington Consensus has
been identified as a “neoliberal manifesto”
2. The Washington Consensus was a failure
a. Some improvements in economic policy management, like
lower inflation, low budget deficits, reduced external debt
b. However this policy packages were insufficient for
achieving long term growth or even macroeconomic
stability. Latin America & Sub-Saharan Africa have stagnated
in terms of growth per capita.
c. Rather poverty and unemployment increased
3. Calls were made for the implementation of a different
set of policies called
 “post- Washington Consensus” or “Augmented
Washington Consensus”.
 Different development paradigm

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Public-Choice (or “New Political Economy”) Approach
1. Self-interest guides all individual behavior and that
governments are inefficient and corrupt because
people use government to pursue their own
agendas.
 Recall agency theory
2. Politicians, bureaucrats, citizens, and states act
solely from a self-interested perspective, using their
power and the authority of government for their
own selfish ends
3. Politicians use government resources to consolidate
and maintain positions of power and authority
4. Governments can do (virtually) nothing right.
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The “Market-Friendly” approach
• Championed by the World Bank by people who

graduated their views and outlooks from the
preceding approaches of ‘market
fundamentalism’. This approach represents the
1990s writings of the World Bank and its
economists,
• successful development policy requires
governments to create an environment in which
markets can operate efficiently and to intervene
only selectively in the economy in areas where
the market is inefficient.
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The “market-friendly” approach
• This approach recognizes that there are many imperfections in

developing-country product and factor markets and that
• Governments do have a key role to play in facilitating the operation of
markets through “nonselective” (market-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 enterprise.
• Unlike the previous approaches, this accepts & recognizes the
widespread market failures in LDCs in areas such as investment
coordination and environmental outcomes.
• Phenomena such as missing and incomplete information, externalities
in skill creation and learning, and economies of scale in production
are also endemic to markets in developing countries. In fact, the
recognition of these last three phenomena gives rise to newer schools
of development theory, the endogenous growth approach, and the
coordination failure approach.

New institutionalism-Augmented Washington
Consensus
• Success or failure of developmental efforts
depend upon the nature, existence, and
functioning of a country’s fundamental
institutions.
• The Augmented Washington Consensus interpreted
the negative outcomes of the original Consensus as
the result of the inadequate application of the
policies recommended, concluding that the original
policies were based on sound principles.
• More on institutions to come in chapter 4.

Lessons
• No matter of the role of the international community and the
significance of its impact, the focus should be on the domestic
front. After all development is inherently internal rather than
external. Though for different reasoning, the focus should be
inward, instead of outward.
• Recognize the fact that governments fail too, is a message that
should not be ignored at all.
• The efficiency concept is a big notion and free, competitive
market is definitely efficient, if it exists and prevails in an
economy.
• Irrespective of the existence of competitive markets, the concept
of promoting competitive environment and competitiveness
remains valid.
• The private sector remains a major driving force in development
that cannot be dispensed with by governments.
Critics
1. Neglect of the critical importance of the role of government to bring about
long term growth, development, generation of employment, eradication of
poverty, addressing equity issues.
2. Both fail: Not governments only, but markets too fail. So the real question is
how to complement both and mobilize every driving force of development.
 Competitive free markets generally do not exist, Information is limited, markets are
fragmented, and large nonmonetized economy.
 LDCs operate in a different institutional, cultural, and historical context
3. It fails to recognize that development is contextual, which needs to take into
account the history and current realities of the country and society.
4. Still like its preceding theories in the neoclassical theoretical paradigm, it
ignored equity.
5. Through its policy conditioanlities, this view led to the erosion of sovereignty
and policy space of LDCs, leading to lack of ownership of development policies.
6. Failure to recognize the unfair international order and leaving all the blames to
domestic factors is not fair and unrealistic.

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Theories of Economic

Development and their

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Tsegabirhan Weldegiorgis Abay, DoE, CBE,

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But if sG = .175,  =.04, c =2.5

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

5000 3020 3600 3580 2360

Source: Hull University Network.

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

• Positive marginal products;

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

• We can rewrite the above as follows:

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

• The consumer : consumption and savings. The

• Capital accumulation: the capital stock next year equals

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

01/06/2023 Tsegabirhan Weldegiorgis Abay, DoE, CBE, AAU, Ethiopia 46

• Still capital accumulation is one of the

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

• It employs the tools of neoclassical price and resource allocation

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

• Start with the left side of the figures, an increase

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

• Emphasis was placed on the need for major

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

b. “Dependence, then, is based upon an international

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

• Offers Causes but No Solutions: Do little to show how

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

"It is the vicious circle of poverty (VCP) which is responsible

Vicious circle of poverty:

"Implies a circular constellation of forces tending to act and

• Supply side - Because incomes are

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

Tsegabirhan Weldegiorgis Abay, DoE, CBE,

 Nurkse was concerned with the

Tsegabirhan Weldegiorgis Abay, DoE, CBE,