Chapter 3

Driving Factors of Development:

Theory and Practice

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3.1Classic Theories of Economic Development
1. Linear stages of growth models (Rostow model
and Harrod-Domar model, Solow)
2. Theories and Patterns of structural change (The
Lewis two-sector model and Chenery Model)
3. Development strategy theories(Balanced and
unbalanced)
4. International-dependence revolution
(Neoclassical dependence model, The False
Paradigm model, Dualistic development thesis)
5. Pattern of Development Theory
6. Neoclassical, free market counterrevolution
7. Endogenous Development Theory

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 1) Rostow’s Stages of Growth
• All countries must pass series of successive stages of
economic growth
1. Traditional society
•simple, traditional, labor intensive techniques,
traditional social norms, land owner holds the power,
high share of agriculture, low agricultural productivity
2. Precondition for take-off stage(Transitional society)
•Development of institutions, organizations, and
infrastructure
•Perquisites for “take off” are installed, traditional
boundaries and norms collapse; modern form of
production and innovations are accepted, consciousness
for development and national spirit

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3. Take off Stage:
•Large investment in selected industry (10 to 15% of GDP)
•Economic growth and technical innovation become a
national phenomena in industry, agriculture and other sectors
•The emergence of new institutions or cultural framework
that exploits expansion.
•Social and political structures become more susceptible to
change Steady growth, use of technical progress
•Broad acceptance of technical progress, wide production
base

4. Drive to maturity stage:

••sustained growthofof the
Diversification the industry
industrialandbase;
economy
multiple industries
expand & new ones take root quickly manufacturing shifts
from investment-driven (capital goods) towards consumer
durables & domestic consumption rapid development of
transportation infrastructure large-scale investment in social
infrastructure 07/10/23 4
•The character of labor force changes, be skilled; the
character of entrepreneurship changes; and the society feels
industrialization
5. Age of High mass consumption
• High per-capita-income above the minimum for existence; social
security systems (welfare state), services
• Steady growth, structural changes. And Old industries disappear,
new industries arise
• High technology and social welfare
•The industrial base dominates the economy;
• The primary sector is of greatly diminished weight in economy &
society widespread and normative consumption of high-value
consumer goods consumers typically (if not universally),
•Society with high disposable income, beyond all basic needs, for
additional goods

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Figure 3.1 : Rostow’s model

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 2) Harrod-Dommar Model
• During the 1940s by Roy Harrod and Evsey
Domar developed the model.
• But the H-D model has been used extensively in
LDCs as a simple way to look at the relationship
between growth and capital requirements.
• Every economy must save a certain proportion of
its national income to replace worn-out or
impaired capital goods & to invest for further
growth.
• Assuming a closed economy (no international
trade), total income (Output) -Y is defined as total
consumption plus saving of the society. i.e,
Yt = Ct +St ….. (1)

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Cont…
• The other side of the coin is that the value of produced
output (Y) must be matched to goods produced for
consumption (C) plus those needed by investors (I); that is,
Yt = Ct +It ….. (2)
• From equation (1) & (2) we get the balanced Equation
St = It ….. (3)
• “Savings equals investment”, . We can use this equation
to complete our basic argument.
• Investment augments (increases) the national capital Stock
K and replaces that part of it, which is wearing out. Suppose
that a fraction (sigma) of the capital stock depreciates.

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 Cont…
Mathematically, Kt + 1 = Kt - δkt + It
Where, δ = rate of depreciation of capital stock
Kt = Capital stock at time t
Kt +1 = Capital stock next Year
It = Investment at time t
Then Kt +1 =(1- δ) kt + It ………….. (4)
• Equation (4) Tell us how the capital stock must
change overtime. Now we introduce two important
Concepts.
•The saving rate-is just savings divided by
income: S in

our model. Call that s is,
or St= sYt
t
Y
t

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• The second concept is also a ratio.
• The capital output ratio, which we call  (Teta). It is the
amount of capital required to produce a single unit of
output in the economy, and it is represented by the
ratio:
K
  ort Kt = Yt
Yt

Combining (3) and (4), we get,

Kt +1 =(1-  ) kt + St
Now if savings is a constant fraction of income, then S t
= sYt for all dates t, where as if the capital output ration
is , then Kt = Yt for all dates t, using these
calculations in the proceeding expression, we see that
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 Kt+1 = (1-)kt + St ------------------ (5)
Kt+1 = (1-)kt + sYt ------------- (6)
Yt+1 = (1- s) Yt + sYt ----------- (7)
Yt+1-Yt= sYt - Yt

Dividing the whole by Yt

Yt 1  Yt sYt  Yt
=
Yt Yt
y t 1  y t s

yt 
 The left hand side of this equation is just the rate of growth
g. That is

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 Cont…
s s
g   or  g   .........8
 
Equation 8 is called Harrod-Domar growth equation. It
isn’t difficult to see why the Harrod-Domar equation was
influential. It firmly links the growth rate of the economy
(g) to two fundamental variables: the ability of the
economy to save (s) and the capital -out put ratio ().
 You can easily grasp from equation (8) that, by pushing up
the rate of savings, it would be possible to accelerate the
rate of growth.
 Likewise, by increasing the rate at which capital produced
output (i.e. a lower ), growth would be enhanced.

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 3. Solow Growth Model
• Solow model differs from the Harrod-Domar
formulation by adding a second factor, labor, and
introducing a third independent variable,
technology, to the growth equation.
• Technological progress become the residual factor
explaining long-run growth, and its level was
assumed by Solow and other growth theorists to be
exogenously determined.
• 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.

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Technology and Solow model:

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Cont…

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Cont…
 Saving, depreciation, population and technology are
crucial factors that determine economic growth
 It is possible that the rate of savings (and hence
investment) is positively related to the rate of
technological progress itself, so that the growth of
technology depends on saving.
 The higher level of saving or investment implies higher
percapta income
 Higher population growth slows economic growth or
percapita income
 Income difference among countries contributes to the
differences in saving/investment and population growth
 The higher level of depreciation reduces the economic
growth
 The long-run growth in percapita income and economic
growth is exogenously determined by level of technology

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 4. Structural-Change Model: The Lewis two-
sector model
• Set of changes in the composition of demand, trade, production,
and factor use that takes place as per capita income increases
(consists 6 elements):
1. structural change: shift of resources from low to high
productivity activities (agriculture, industry, services -
associated with goods, welfare state, and informal sector)
2. changes in demand patterns: e.g., changes in income elasticity
of demand for food (0.6%), agricultural raw materials (0.5%),
oil and fuel (2.4%) and other manufactured goods (1.9%)
3. changes in composition of trade (from exports of
primary agricultural goods to low wage manufacturing
goods)

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3. Changes in composition of production factors
(changes in capital labor ratio, and development of
knowledge capital & physical capital)

4. changes in social institutions and attitudes

5. The Need for new structural policies (industrial

policies, technology policies, education policies and
social policies)

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 Cont…
The model tends to emphasize the transformation
of domestic economic structures from traditional
subsistence agriculture economies to more modern,
urbanized and industrially diverse manufacturing
and service economies.
It is the theory of development in which surplus
labor (the portion of the rural labor force whose
marginal productivity is zero or negative) from the
traditional agricultural sector is transferred to the
modern industrial sector, the growth of which
absorbs the surplus labor, promotes
industrialization, and stimulates sustained
development
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 Cont…
• It is a dualism model and provides more emphasis on
industry-agriculture interdependency and said that the
robust connectivity between the two would encourage
and speed up development.
• The three fundamental ideas used this model are:
1. Agricultural growth and industrial growth are both
equally important
2. Agricultural growth and industrial growth are
balanced
3. Only if the rate at which labour is shifted from
agriculture to industry is greater than the rate of
growth of population will the economy be able to lift
itself up from the Malthusian population trap.

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Figure 3.2 The Lewis Model of Modern-Sector Growth in a
Two-Sector Surplus-Labor Economy

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 5. Pattern of Development Theory (Chenery
Model)
The patterns of development approach, which is
the empirical analysis of the “sequential process
through which the economic, industrial and
institutional structure of an underdeveloped
economy is transformed over time to permit new
industries to replace traditional agriculture as the
engine of economic growth
• Also necessary are changes in the economic
structure which face constraints in LDCs
• Difference in constraints (domestic and
international) accounts for difference in
development levels among countries

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 Cont…
 International constraints most importance since
transition can occur faster with access to international
sources of capital, technology, manufactured imports
etc.
 He identified five characteristic features (not
necessarily stages) of the development process for
countries that have developed:
 Shift from agricultural to industrial production
 Steady accumulation of physical and human K
 Change in composition of consumer demand
 Growth of cities and urban areas
 Decline in family size and overall population growth

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6. The International-Dependence Model
a) The neocolonial dependence model
◦ Legacy of colonialism, Unequal power, Core-
periphery
LDCs serving as the “periphery” are dominated
by:
unequal trade and finance relations
domestic politico-economic elite
multinational corporations

 Under these conditions economic development is

impossible

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Cont…
b) The false-paradigm model
◦ Pitfalls of using “expert” foreign advisors who misapply
developed-country models
◦ Economic development relies heavily on funds from
international donor agencies such as the World Bank and
IMF
◦ Wrong and incorrect advises that may not work for
developing economies contexts
◦ They reinforce the pattern of “dependent development”
c)The dualistic-development thesis
◦ Superior and inferior elements can coexist; Prebisch-
Singer Hypothesis( the superior elements does little or
nothing to pull up the inferior)

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7. Balanced growth model (Nurske)
 Developed by Nurske
 Pursuit on many fronts “pattern of mutually supporting
investments over a range of industries”
 The advocates of balanced growth argued that countries
have to develop a wide range of industries
simultaneously if they have to succeed in achieving
sustained growth.
 It requires balance between different consumer goods
industries, and between consumer goods and capital
goods industries.
 It also implies balance between the domestic and export
sector.
 Further, it entails balance between social and economic
overheads and directly productive investment, and
between vertical and horizontal external economies.

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 Cont…
It states that there should be simultaneous and
harmonious development of different sectors of the
economy so that all sectors grow in unison.
For this, balance is required between the demand
and supply sides.
The supply side lays emphasis on the simultaneous
development of all inter-related sectors, which
help in increasing the supply of goods.
However, it may be beyond the capabilities of
underdeveloped countries-the initial resources for
simultaneous developments on many fronts are
generally lacking

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 8. Unbalanced Growth Model (Hirschman)
 Developed by Hirschman
 The theory of unbalanced growth is the opposite of the
doctrine of balanced growth. According to this
concept, investment should be made in selected sectors
rather than simultaneously in all sectors of the
economy.
 No underdeveloped country possesses capital and
other resources in such quantities as to invest
simultaneously in all sectors.
 Therefore, investment should be made in a few
selected sectors or industries for their rapid
development, and the economies accruing from them
can be utilized for the development of other sectors.
 Thus the economy gradually moves from the path of
unbalanced growth to that of balanced growth.

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Cont…
 Don’t focus on all at the same time
 Provide a boost to leading sectors which will create
the linkages to bring others into existence
 ‘Backward linkage’: proportion of inputs purchased
from other industries
 ‘Forward linkage’: proportion of outputs sold to other
industries how?
 Import substitution; i.E. Developing domestic
industries replaces imports and so improves the
balance of payments,
 By setting up industries, create shortage of key input,
to create incentives for other firms to set up to produce
them (backward linkage)
 or create excess capacity, creating incentives for others
to set up production requiring this output as an input
(forward linkage)
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 9. Big Push theory
o In order to economic transformation via industrialization,
we need a big push – a massive investment o why?
industrial development is characterized by:
 complementarities and externalities: mutual dependence
on
 suppliers and customers, with benefits from mobility of
workers across firms
 indivisibilities: high fixed costs and long gestation
periods
 market imperfections: just focusing on the slow
correction of market failures will not achieve much
 large infrastructure development with positive
externalities
 massive savings requirements

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10. Neoclassical Counterrevolutions: The Market
Fundamentalism models
•The 1980s resurgence of neoclassical free-market
orientation toward development problems and
policies, counter to the interventionist dependence
revolution of the 1970s.
•In developing countries, it called for freer markets
and the dismantling of public ownership, statist
planning, and government regulation of economic
activities.
a)Free-market approach: rely of the allocation role
of markets and limited government involvement in
economics.

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 Cont…
But, there are several areas in which markets fail
to achieve efficient outcomes:
income distribution
public goods
externalities
market power
b)Market-friendly approach: improve market operation
through “nonselective” interventions such as;
income redistribution system
investment in social and human capital
environmental protection policy
anti-trust laws

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 Cont…
c) Public-choice approach: public officials and
bureaucrats in the position of authority are
“rent-seeking” citizens acting on self-interest
rather than public-interest
Need a system of checks and balances to monitor
the behavior of public officials and bureaucrats
Need a democratic system to let people choose
public officials and bureaucrats for limited
duration of authority

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 11. Endogenous Development Theory
Knowing the failures the externally induced and
imposed standardized development approaches
prescribed by big international organizations (like
WB and IMF), radical writers presented a new
and potential theory/approach known in various
names as “endogenous development”, “self-
reliant development", and “new growth theory”.
The new growth theory, however, seems to be a
little broader than the endogenous and/or self-
reliant development" as it further encompasses
such other local and inward-oriented theories.

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Cont…
Endogenous development model is relatively a self-
sustaining model capable of transforming the
local economic system based on local
characteristics with the ability to control certain
fundamental variables.
This includes:
o The use of local resources (capital,
entrepreneurship, specific knowledge of the
production process of professional tasks, material
resources),
o The ability to check the accumulation process,
o The ability to innovate,
o The existence of productive interdependence,

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