CHAPTER THREE

Growth Models and Theories of Development

1
3.1 Facts Of Economic Growth And Why Growth
Rates Differ Across Countries
• Sustained positive growth rate is a fairly recent
phenomenon.
• Growth has been uneven both across time &
countries.
• There was convergence of the cross-country
income distribution during the 2nd half of the
20th century, at least among a large group of
nations.
• There is divergence between the leading
countries as a whole and the very poorest
countries.

2
3
3.1 Facts of Economic Growth

• Continuing divergence does not imply rising income

inequality among the world’s population, mainly
because China and India, which contain about 40% of
that population, are rising rapidly from near the bottom
of the distribution.
• More concern is with the cross-country than the cross-
individual distribution as many of the determinants of
economic growth vary across countries but not across
individuals within countries.
• Growth rates differ across countries and across time
because of differences in factors of economic growth.
4
3.2 Factors of Economic Growth
Capital- Physical Capital
• Physical capital is made up of tools, machines,
buildings, and infrastructure such as roads and ports.
• First, it is produced (via investment), and second that
it is in turn used in producing output.
• Physical capital is rival in its use.
• Differences in physical capital between rich and poor
countries are very large.
• Differences in physical capital among countries can
result from several factors.
– levels of investment in physical capital relative to output
• Saving rates can differ among countries because of differences 5in
3.2 Factors of Economic Growth
Capital- Physical Capital
– the security of property rights,
– the availability of a financial system to bring together
savers and investors,
– government policies like budget deficits or old age
pensions,
– cultural attitudes toward present vs. future
consumption,
• relative price of capital (as high in poor countries
than in rich countries).
– Differences in productivity
– Differences in the accumulation of other factors of
production will produce differences in the level of6
physical capital per worker.
3.2 Factors of Economic growth

Capital: Human capital

• Human capital: qualities such as education and health

that allow a worker to produce more output and which
themselves are the results of past investment.
• Like physical capital, human capital can earn an
economic return for its owner.
• Human capital is “installed” in a person.
• This makes it very difficult for one person to own
human capital that is used by someone else.

7
3.2 Factors of Economic growth
Capital: Human capital
• Human capital investment is a significant expense.
– education differences would explain a difference in
income between the advanced and developing
countries.
• Differences in school quality increase somewhat the
income differences explained by human capital in the
form of schooling.
• Health differences between rich and poor countries
are large, and explain the differences in income growth.

8
3.2 Factors of Economic growth
Capital: Natural capital
• Natural capital is the value of a country’s agricultural
and pasture lands, forests, and subsoil resources.
• Is an input into production of goods and services.
• It is not itself produced.

9
3.2 Factors of Economic growth
Capital: Natural capital
• Natural capital per worker and GDP per worker are
positively correlated, but the link is much weaker than
for the other measures of capital.
– “resource curse” : availability of natural capital undermines
other forms of capital accumulation or reduces productivity.
– resource booms lead countries to raise consumption to
unsustainable levels, thus depressing saving and investment;
• that exploitation of natural resources suppresses the development of
a local manufacturing sector, which holds back growth because
manufacturing is inherently more technologically dynamic than other
parts of the economy (this is the so called Dutch disease); and
• that economic inefficiencies are associated with political
competition or even civil war to appropriate the rents generated by
natural resources. 10
3.2 Factors of Economic growth

Population
• Population affects the accumulation of all three forms
of capital, and through them the level of output per
worker.
• Rapid population growth dilutes the quantities of
physical and human capital per worker, raising the rates
of investment and school expenditure required to
maintain output per worker.
• For a fixed stock of natural capital, higher population
lowers output per capita.
• In addition population also matters for economic growth
because demographic change produces important
changes in the age structure of the population.
• A reduction in fertility, will produce a long period of
11
reduced dependency, (increase in working age adults)
3.3 Models and Theories Of Economic Growth
and Development
•
Literature on economic development is dominated by the following four
strands of thought:
–
Linear-stages-of-growth model: 1950s and 1960s
–
Theories and patterns of structural change: 1970s
–
International-dependence revolution: 1970s
–
Neo-classical, free-market counterrevolution: 1980s and 1990s

Linear-stages theory
• Viewed the process of development as a series of
successive stages of economic growth
• Mixture of saving, investment, and foreign aid was
necessary for economic development
• Emphasized the role of capital accumulation in economic
development

12
 3.3.1 Linear-stages theory
1. Rostow's Stages of Economic Growth
• Rostow described dev’t in terms of a series of stages.
• These stages of economic growth are:
– (1) Traditional society, (2) Pre-conditions to take-off, (3) Take-
off, (4) Drive to maturity, (5) High mass consumption.
(1) Traditional Society:
• Characterised by
• Subsistence economy – output not traded or recorded
• High levels of agriculture and labor intensive agriculture
• Wealth allocated to nonproductive activities (religious,
military…)
• Unchanging technology places a ceiling on productivity.

13
 Rostow's Stages of Economic Growth
• Man is valued on family basis, not on the basis
capabilities.
• Long Fatalism prevails in society.
• The range of possibilities for a grand children are the
same what they were for grand father.
• The society is ruled by those who owned or controlled
land.
• Landlords used to have long chain of servants and
soldiers.
(2) Pre Conditions to Take Off:
In pre-conditions to take off:
An elite group initiates development 14

Investments in technology and infrastructure

 Rostow's Stages of Economic Growth
• Is a period of transition where the conditions
for take-off are developed.
– due to invasion of advanced societies which
destroyed the culture of traditional society.
– emergence of new ideas
– start of thinking about economic progress
– the new entrepreneurs come forward to take risks.
• Due to establishment of financial institutions savings
and investment are mobilized in Social Overhead
Capital(SOC).
• But still the society is characterized by low productivity.
15
 Rostow's Stages of Economic Growth
• Still there is a need to build an effective national state
against the traditional land lordism.
– the transition is a multi-dimensional phenomenon.
• A country will have to shift to industry, trade and
commerce.
• View of more children will have to be replaced by less
children.
• The income will have to be shifted from the feudals to
those who will spend it on productive items.
• The man will be valued on the basis of his competence.
• Moreover, during this transitional period, the following
major changes will occur:

16
 Rostow's Stages of Economic Growth
(i) Crucial Role By Agriculture:
• The self-sufficiency in agri. is required.
• Such self-sufficiency is justified on the following grounds:
– To meet the increased needs of growing population.
– With agri. surplus foreign exchange can be earned to meet
the import bill of capital goods.
– The overall increase in the productivity due to agri.
development will provide stimulus to other sectors of the
economy.
– In short, agri. sector must supply expanded food, expanded
markets and expanded funds to the modern sector.
(ii) Growing Outlays on SOC:
• The resources are diverted to SOC. The SOC has three
distinctive characteristics:
• (a) The gestation period is long, (b) It is lumpy, (c) It is
beneficial for the community. 17
 Rostow's Stages of Economic Growth
• Due to these reasons it is the duty of state to provide SOC
(3) Take Off Stage:
• The take-off stage is a break-through in the history of the
society.
• The take-off stage remains for more than two or three
decades.
• In this stage three conditions must be satisfied:
– (i) The rate of investment must rise from 5 to 10%
of GNP.
– (ii) The development of one or more substantial
manufactured sector with the high growth rate.
– (iii) The existence of social, political and institutional
framework which could give impulses to modern sector
expansion.
18
 Rostow's Stages of Economic Growth
Further:
(i) Increase in rate of investment: It is attached with
changes in income distribution, i.e., the income begins
to flow into the hands of capitalists who would re-invest
to increase the rate of capital formation.
• This process of capital formation will further be
promoted by fiscal measures of govt., banking
institutions and capital markets.
(ii) Emergence of leading sectors: The entrepreneurs of
one or two leading sectors re-plough their profits.
• Moreover, the expansion of leading sectors helps to pay
for imports and debt charges.
Loanable funds play an important role in the emergence of
leading sectors, particularly in financing large overhead
capital.

19
 Rostow's Stages of Economic Growth
Rostow grouped the sectors of the economy as:
(a) Primary growth sectors:
– Where possibilities for innovations in unexplored resources
yield a higher growth rate.
(b) The Supplementary growth sectors:
– Where these sectors supplement. For instance coal, iron,
and engineering industry in relation to rail road.
(c) The Derived growth sectors:
– Advances in these sectors occurs in relation to growth of
total real income, population and industrial production.
Historically, these sectors range from cotton textile, heavy
industrial complex and dairy products.

20
 Rostow's Stages of Economic Growth
(4) Drive to Maturity Stage:
• 40 years after the take-off stage there is a long interval.
• Economy experiences a regular growth and modern
technology extends over to a bulk of resources.
• On the basis of entrepreneurial and technological
development everything is produced which is desired.
• A shift in emphasis from coal, iron and heavy
engineering to machine tools, chemicals and electrical
equipments.
• 10% to 20% of GNP is ploughed in investment and
output grows more than increase in population.
• The goods which were earlier imported now they are
produced at home.
• The economy becomes a part of international economy.

21
 Rostow's Stages of Economic Growth
(5) Age of High Mass Consumption Stage:
• Real incomes rise and the people became aware of as
well anxious to have a command over the
consumption of the fruits of mature economy.
• The leading sectors of the economy produce
consumer durables like TV, fridges and automobiles
etc.
• Society pays more attention on social welfare and
social security than on economic growth.

22
 Rostow's Stages of Economic Growth
Practical Importance of Rostow's Stages:
• Advanced countries had passed the stage of take off
into self-sustaining growth.
• UDCs are still passing through traditional society or the
pre-conditions to take-off.
• The UDCs should mobilize domestic and foreign
savings in order to generate sufficient investment to
accelerate economic growth.

23
 Rostow's Stages of Economic Growth
Criticism:
• Despite these merits of Rostow's theory, following
criticism has been leveled against it.
• (i) Stage Making Idea is Misleading: it is incorrect to
say that all the nations have to follow this route when
they are having different environment and resources etc.
• (ii) Leading Sectors: Rostow did not identify the
chronology of leading sectors.
• (iii) Data is Unconfirmed: statistical data presented by
Rostow regarding doubling of productivity in the period
of take-off stage is not reliable and confirmed.
• (iv) No Distinction Between Pre-Conditions and Take-Off:
it is not possible to assess when take-off starts after
pre-conditions.
24
 Rostow's Stages of Economic Growth
• (v) Self-Sustained Growth: increase in per capita
income, increase in savings, and investment may even
take place before take-off.
• (vi) Pre-Conditions is Not a Chronological Concept: In
some countries agri. expanded during industrialization,
and SOC was mostly required during the
industrialization.
• (vii) Idea of Increase in Investment is Not New:
Rostow presented the idea that increase in investment
from 5% to 10% will take the economy into take-off
stage. But it is not a new idea. It is also available in
Lewis thinking. When the saving habits will change,
whether in pre-conditions or in take-off stage? 25
Rostow's Stages of Economic Growth

26
2. The Harrod-Domar Growth Model
• HD Growth model is a particular model with basic
feature of fixed coefficient production function.
• It assumes no substitution between labor and capital:
Q = F(L, K): the production Isoquant is L shaped
• It also shows constant returns to scale (CRS) i.e.
doubling inputs will double output
• The production function Y= (1/v).K or Y=K/v, where
v= constant or v=K/Y
• v= capital output ratio or measure of the productivity
of capital or investment(indication of K intensity)
• For example if v=4, then 20 million investment will be
needed produce 5 million output or 20/4 =5 based on
Y=K/v
27
The Harrod-Domar Growth Model
• ΔY=ΔK/v and g= ΔY/Y=ΔK/Yv ... growth rate of output
• since ΔK =sY-dK : g= (s/v)-d ... thus:
• K created by I is the main determinant of growth in
output
• S makes I possible
• The Basic HD Model Point: Save(S) more and make
productive investment(I) and the economy will grow.
• Example: if s=0.24, v=3, and d=0.05, then the economy
will grow at 3% (why? s/v-d = 0.24/3-0.05= 0.03=3%)
• Obstacles and Constraints
• Low rate of savings in developing countries gives rise to
savings gap and capital constraint
• Savings and investment is a necessary condition for
accelerated economic growth but not a sufficient
condition

28
 Production function

29 29
 3. The Solow neoclassical growth model
• Implies that economies will conditionally converge to the
same level of income if they have the same rates of savings,
depreciation, labor force growth, and productivity growth.
• Model allows for substitution between capital and labor.
• It assumes diminishing returns to the use of these inputs.
• The aggregate production function, Y = F(K, L) is assumed
characterized by constant returns to scale.
• In the special case known as the Cobb-Douglas production
function, at any time t we have
• Y=AKαL1-α …………………………………… (1)
• 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 over time at an
exogenous rate.

30
 The Solow neoclassical growth model
• Because of CRS, if all inputs are increased by the same
amount, then output will increase by the same.
• More generally, => γY=F(γK, γL)
– where γ is some positive amount.
• Because γ can be any positive real number, a mathematical
trick useful in analysing the implications of the model is to
set γ= 1/L so that
– Y/L = ƒ(K/L, 1) or y = ƒ(k)……………………………(2)
• Lowercase variables are expressed in per-worker terms in
these equations.
• The concave shape of ƒ(k)—that is, increasing at a
decreasing rate—reflects diminishing returns to capital per
worker, as can be seen in Figure below.
• This simplification allows us to deal with just one argument
in the production function. In the Cobb-Douglas case
introduced in Equation 1,
– y = Akα ……………………………………... (3)
31
 The Solow neoclassical growth model
• This represents an alternative way to think about a
production function, in which everything is measured in
quantities per worker.
• The more capital with which each worker has to work,
the more output that worker can produce.
• The labor force grows at rate n per year, and labor
productivity growth, the rate at which the value of A in
the production function increases, occurs at rate λ.
• The total capital stock grows when savings are greater
than depreciation,
• But capital per worker grows when savings are also
greater than what is needed to equip new workers with
the same amount of capital as existing workers have.

32
FIGURE: Equilibrium in the Solow Growth Model

33
Example: suppose a production output Y equals a square root of K and if the
investment is 30% of output and capital depreciation is 2 percent

34
• Simple Solow Model - Wolfram
Demonstrations Project

35
 The Solow neoclassical growth model
• That is, Δk= sf(k) –(n+δ)k ………………………………(4)
• The Solow equation (Equation 4) gives the growth of the
capital-labor ratio, k (known as capital deepening), and
shows that the growth of k depends on savings (sf(k)),
after allowing for the amount of capital required to
service depreciation, dk, and after capital widening, that
is, providing the existing amount of capital per worker to
net new workers joining the labor force, nk.
• Assuming that A remains constant, there will be a state
in which output and capital per worker are no longer
changing, known as the steady state.
• To find this steady state, set Δk = 0:
• sƒ(k*) = (δ + n)k* ………………………………(5)

36
 The Solow neoclassical growth model
• The notation k* means the level of capital per worker
when the economy is in its steady state.
• That this equilibrium is stable can be seen from Figure
above.
• The capital per worker k* represents the steady state.
• If k is higher or lower than k*, the economy will return
to it; thus k* is a stable equilibrium.
• This stability is seen in the diagram by noting that to
the left of k*, k < k*.
• Looking at the diagram, we see that in this case,
(n + δ)k < sf(k).
37
 The Solow neoclassical growth model
• But now looking at the Solow equation (Equation 4),
we see that when (n + δ)k < sf(k), Δk > 0.
• As a result, k in the economy is growing toward the
equilibrium point k*.
• By similar reasoning to the right of k*, (n + δ)k > sf(k),
and as a result, Δk < 0 (again refer to Equation 4), and
capital per worker is actually shrinking toward the
equilibrium k*.
• It is instructive to consider what happens in the Solow
neoclassical growth model if we increase the rate of
savings, s.
• A temporary increase in the rate of output growth is38
realized as we increase k by raising the rate of savings.
 The Solow neoclassical growth model
• We return to the original steady-state growth rate later,
though at a higher level of output per worker in each
later year.
• The key implication is, in the Solow model an increase
in s will not increase growth in the long run; it will only
increase the equilibrium k*.
• That is, after the economy has time to adjust, the
capital-labor ratio increases, and so does the output-
labor ratio, but not the rate of growth.
• The effect is shown in Figure below, in which savings
is raised to s .

39
 The Solow neoclassical growth model
• In the Solow model, an increase in s does raise
equilibrium output per person—which is certainly a
valuable contribution to development—just not the
equilibrium rate of growth.
• And the growth rate does increase temporarily as the
economy kicks up toward the higher equilibrium
capital per worker.
• Finally, 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 A
depends on s.
• Provides good insights about the relationship between
role of technology and innovation on growth 40

• Limitations: Assumes saving rate, population growth ,

FIGURE: The Long-Run Effect of Changing the Savings
Rate in the Solow Model

41
3.3.2 Structural change models: Lewis theory of
Development
• Lewis offers a model of growth based on existence of
disguised unemployment in less developed countries.
• It is propounded in his work, “Economic development
with Unlimited Supply of Labour”.
• Also known as the two-sector surplus labor model
The main assumptions of the model:
• In LDCs, many people are disguisedly unemployed and
marginal productivity of these people is zero.
• The supply of labour is perfectly elastic at the
subsistence rate of wages.
• Less developed economies are dual economies:
coexistence of capitalist sector and subsistence sector.
• Wage rate is higher in the capitalist sector compared to
subsistence sector, wage rate stagnates at the
subsistence level

42
 Lewis Theory of Development

Features of the basic model:

• Economy consists of two sectors- traditional and
modern
• Traditional sector has surplus of labor (MPL=0)

• Model focuses on the process of transfer of surplus

labor and the growth of output in the modern sector
• 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

43
44
 Lewis Theory of Development: Criticisms
• Four of the key assumptions do not fit the realities of
contemporary developing countries
• Reality is that:
– Capitalist profits are invested in labor saving technology
– Existence of capital flight
– Little surplus labor in rural areas
– Growing prevalence of urban surplus labor
– Tendency for industrial sector wages to rise in the face of
open unemployment

45
 3.3.3 Dualistic Theories
• There are different theories which are of the view that the
poverty and underdevelopment of poor countries is
attributed to their dualistic character.
(1) Social Dualism, (2) Technological Dualism and (3) Financial
Dualism.
Theory of social dualism: Definition and Explanation
• J.H. Boeke is a Dutch Economist who studied Indonesian
Economy and presented his theory of social dualism.
• He maintains that there are three characteristics of a
society in the economic sense.
• They are as: (i) Social Spirit (ii) Organizational Form (iii)
Techniques Dominating Them.
• Their inter-relationship and interdependence is called the
social system or social style.
• A society is homogeneous if there is only one social
system in the society.
• But the society which has two or more social systems is
known as dual or plural society. 46
 3.3.3 Dualistic Theories
• The dual society is a society which has two full grown
social styles which represent pre-capitalism and post-
capitalism.
• Such a dual society is furnished with the existence of an
advanced imported western system on the one side and
endogenous pre capitalistic agricultural system on other
side.
• Western system is under the western influence which
uses the advance techniques and where standard of
living is high.
• Pre capitalistic agricultural system is native and it is
furnished with the outdated techniques and low social
and economic life.
• This is called social or sociological dualism and these
two systems are clashing.
• The imported social system is highly capitalistic and it
may be socialistic as well as communistic system. 47
 3.3.3 Dualistic Theories

• Characteristics of Dualistic Society:

• On economic basis the dualistic society is
classified as by giving the names:
• (i) Eastern Sector and (ii) Western Sector.
• There are certain characteristics of eastern
sector of a dualistic economy which
distinguishes it from western sector. They are as:
• (i) The needs of eastern sector are limited.
• People pass a contented life.
• (ii) People work for social needs rather for
economic needs. For example, if a three acres
are enough to supply the needs of a household
he will not cultivate six acres.
48
 3.3.3 Dualistic Theories

• (iii) Goods are cultivated according to their prestige

value rather on their use value.
• (iv) As a result of all above, the eastern economies are
characterized with backward bending supply curves of
effort and the risk taking.
• (v) The native industries have neither organization nor
capital-Intensive and they are ignorant of modern
technology and market conditions.
• (vi) People are indulged in speculative activities rather in
business enterprises.
• (vii) They do not take risk by making productive
investment.

49
 3.3.3 Dualistic Theories
• (viii) They lack the initiative and organizational skill which is
a feature of western sector of dual economy.
• (ix) Labor is unorganized, passive and unskilled.
• They are reluctant to leave their village and community. They
are fatalist.
• (x) The urban development takes place at the cost of rural.
• (xi) Exportation is the main objective of foreign trade in the
eastern sector while the western sector believes in imports.
• Due to these features of eastern society the western
economic theory is not applicable as far as UDCs are
concerned.
• The western economic theory is meant to explain capitalistic
society whereas eastern sector is pre capitalistic.
• The western sector or society is based upon unlimited wants
and money economy etc.
50
 3.3.3 Dualistic Theories
• The MP theory cannot be applied in UDCs for resource allocation
and distribution of income because of immobility of resources.
• Thus Boeke says:
• We should not try to transplant the delicate houseplant of
western theory to tropical soils where an early death awaits for it.
• If the pre-capitalistic agricultural sector of eastern sector is
attempted to develop along western lines it will create
deterioration.
• The modern agricultural techniques can not be applied how-long
the mental attitudes of the farmers are not changed, otherwise
the increase in wealth following modern technology will result in
further growth of population.
• Moreover, in case of failure of modern technology, the
indebtedness of the country will increase.
• Therefore it is better that these existing agricultural systems
should not be disturbed.
51
 3.3.3 Dualistic Theories
• As far as industrial field is concerned the eastern
producers cannot follow the western technology on the
basis of economic and social reasons.
• Further, the adoption of western technology to
industrialize Indonesian economy has moved the goal of
self sufficiency farther and ruined its small industry.
• Boeke refers to five kinds of unemployment in UDCs:
• (i) Seasonal,
• (ii) Casual,
• (iii) Unemployment of regular workers,
• (iv) Unemployment of white collard class,
• (v) Unemployment of Eurasians.

52
 3.3.3 Dualistic Theories
• The govt. is unable to remove such unemployment because of the
reason that it will require the funds which the govt. cannot avail.
• Booke says that limited wants and limited purchasing power in eastern
sector hamper economic development.
• If the food supply is increased or industrial goods are increased, it will
bring a excess of commodities in the market.
• The prices will fall and economy will face depression.
• But this does not mean that Boeke is against industrialization, and
agricultural improvement.
• Rather he is in favor of slow process of industrialization and
agricultural development on small scale which could have an
adaptability with the dualistic structure of eastern society.
• The urge for development should come from the people themselves.
• New leaders must emerge who should work for the goal of
development with faith, charity and patience.

53
 3.3.3 Dualistic Theories
Criticism:
• Professor Bengmin Higgins has criticized the social
dualistic theory on the following grounds:
• (i) Wants are not Limited: If we analyze "Indonesia's life"
we do not find that the desires of the people are limited.
This is the reason that the govt. has to impose import
restrictions. Moreover, whenever the harvest is good the
farmers become prosperous and the demand for
luxurious goods rises.
• (ii) Casual Labor are not Unorganized: Boeke presented
the version that casual workers are unorganized and
passive. But this may be true as far as agricultural
sector is concerned but they are not unorganized in
coffee, tea, rubber and plantation etc.
54
 3.3.3 Dualistic Theories

• (iii) Eastern Labor is not Immobile: Boeke thought that

eastern labor is immobile. It is not so because of
attraction of modern facilities of life in the urban areas.
Moreover the high income incentives force the labor to
move from rural areas to urban areas.
• (iv) Dualistic Theory is not Particular To UDCs Only:
The eastern society, according to Boeke, only exists in
UDCs. It is not true. It does exist in Canada, Italy and
even in the United States.

55
 3.3.3 Dualistic Theories
• (v) Applicability to Western Society: According to
Professor Higgins most of the characteristics of eastern
society given by Boeke are present even in the western
societies.
• For example, during hyper inflation, speculation is
preferred to investment.
• This means, the people in the western countries also
have a strong desire to keep their capital safe and in
liquid form.
• The western society also believes in conspicuous
consumption as discussed by Veblin and Snob effects.
• The backward bending supply curve of efforts has been
experienced by Australia during post war period and by
US in the fifties.

56
 3.3.3 Dualistic Theories

• (vi) Not a Theory But a Description: It is objected that

the Boeke's dualistic theory is merely a description
rather than a theory. His findings are based upon neo-
classical theory which has the limited applicability in
the western world.
• (vii) Does not Provide Solution to the Problem of
Unemployment: Boeke's dualism centers more on
socio-cultural aspects rather on economic. He only
says that govt. is not in a position to remove
unemployment. Moreover, he does not mention the
situation of under employment.
57
 3.3.3 Dualistic Theories
Technological Dualism: Definition and Explanation
• Professor Higgins has developed the theory of
Technological Dualism. By this we mean:
• "The use of different production functions in the
advance sector and in the traditional sectors of UDCs".
• The existence of such dualism has increased the
problem of structural or technological unemployment in
the industrial sector and disguised unemployment in the
rural sector.
• Technological dualism incorporates the factor
proportion problem, which is related to limited
productive employment opportunities found in the two
sectors of a UDCs because of market imperfections,
different factor endowments and different production
functions. 58
 3.3.3 Dualistic Theories
• The UDCs are characterized with structural disequilibrium
at the factor level.
• This arises, because a single factor gets different returns in
different uses or because price relationship among factors
are out of line with factor availabilities.
• Such disequilibrium leads to unemployment or
underemployment in two ways. It is as:
(i) Imperfection of price system.
(ii) Structure of demand which results in surplus labor in
overpopulated backward country.
• Thus the technological unemployment in UDCs is because
of surplus labor which results from misallocation of
resources and structure of demand.

59
 Technological Dualism
• The theory assumes two goods; two factors and two
sectors and their factor endowments and production
functions.
• Of these two sectors the industrial sector is engaged in
plantation, mines, oil field and large scale industry.
• It is capital intensive and characterized by fixed
technical coefficients .
• While the rural sector is engaged in producing food
stuffs, handicrafts and very small industries.
• It has changeable technical coefficients of production.
• Hence it has different alternative combinations of labor
and capital.
• The production functions in the industrial sector are
represented as in figure: 60
Technological Dualism

61
 Technological Dualism
• Here the IQ1, represents the combination of OL1, of labor
(L) and OK1, of capital (K) which produces a certain level
of output.
• While IQ2, IQ3 and IQ4 represent higher level of output
which are only possible if K and L are increased in the
same proportion.
• Thus the points; A, B, C and D show fixed combinations of
capital and labor which are used to produce different
levels of output.
• The line OE represents expansion path in the industrial
sector and its slope represents constant factor
proportions.
• The line K2L2 shows that the production process is capital
intensive.
• To produce Q1, output OK1, of K and OL1 of L are used.
• If the actual factor endowment is at S rather A. It means
that more labor are available to produce same amount of
output. While here units of K are OK1. 62
 Technological Dualism
• Since there are fixed technical coefficients, the excess
labor supply will not affect the production techniques
at all.
• The L1L2 units of labor will remain unemployed.
• It is only when capital stock increases to SF, then it will
be possible to absorb this excess labor supply in this
sector.
• Otherwise it has to seek employment in rural sector.
• The production functions for rural sector are shown in
the figure below:

63
Technological Dualism

64
 Technological Dualism
• The isoquants, Q1, Q2, Q3 and Q4 show variable
coefficients of production.
• To produce more output more labor is employed as
compared with the capital.
• As a result the good land (capital) becomes scarce and
all available land is cultivated by high labor intensive
techniques.
• At point E where maximum output level is reached as
shown by Qn.
• Thus, according to Higgins, because of different
production functions the unemployment and
underemployment comes into being in UDCs.
• The industrial sector uses capital intensive techniques
and fixed technical coefficients and it is not in a position
to create employment opportunities at the same rate at
which population grows.
65
 Technological Dualism
• Rather, the industrialization reduces the employment in
this sector.
• Therefore, the rural sector is an alternative for the surplus
labor.
• In the beginning it is possible to absorb the additional labor
by bringing more lands under cultivation.
• This leads to optimal combination of labor and capital.
• Eventually good lands become scarce.
• The ratio of labor to capital in that sector rises and the
techniques become increasingly variable in this sector.
• Ultimately all available lands is cultivated by high labor
intensive techniques and MP of labor becomes zero and
negative.
• Thus with the growth of population disguised
unemployment begins to appear. 66
 Technological Dualism
• Under these circumstances farmers have no incentives
either to invest more capital or to introduce labor saving
techniques.
• As a result the techniques of production, the productivity
of labor and socio-economic life is remained at low level in
the rural sector.
• In the long run the technological progress does not help in
removing the disguised unemployment. Rather it tends to
increase the number of disguised unemployed.
• The situation is further aggravated by keeping wage rates
artificially high by trade unions or by govt. policies.
• For high industrial wages relative to the productivity
provide an incentive to the producers for introducing labor
saving techniques and thereby it diminishes the further
capacity of the industrial sector to absorb surplus labor.
• Accordingly these factors increase the technological
dualism in UDCs.
67
 Technological Dualism
• Criticism:
• Professor Higgins has attempted to present how
disguised unemployment gradually rises in the rural
sector of dualistic society. But the theory has following
defects:
• (i) Assumption of Fixed Technical Coefficient: Higgins
wrongly assumes fixed technical coefficient in the
industrial sector without any empirical verification.
• (ii) Factor Prices do not Entirely Depend Upon Factor
Endowment: This theory indicates how the factor
endowment and different production functions result in
disguised unemployment. So disguised unemployment
is connected with the factor prices. But it has been
found out that the factor endowments do not entirely
determine the factor prices. 68
 Technological Dualism
• (iii) Ignoring The Institutional Factors: There are many
institutional and psychological factors which have been
ignored by Higgins in connection with their effect on
factor proportion.
• (iv) Ignoring the Use of Labor Absorbing Techniques:
According to Higgins that industrial sector employs
highly capital intensive techniques which are imported.
But practically we find that all imported techniques are
not labor saving. For example, Japan's agricultural
development is not due to capital intensive techniques.
• (v) Size and Nature of Disguised Unemployment is not
Assessed: Higgins does not clarify the nature of
disguised unemployment in the rural sector and excess
labor supply in the industrial sector. Moreover, he does
not tell about the extent of disguised unemployed due to
technological dualism.
69
 3.3.3 Dualistic Theories
Financial Dualism: Definition and Explanation
• Professor Hala Myint has developed the theory of financial
dualism.
• Such dualism rises because of division of money markets in
unorganized and organized money markets in LDCs.
• The rate of interest in unorganized market is higher than the rate
of interest in organized money market which is concerned with
modern sector.
• The unorganized money market consists of village money lenders,
landlords, arties.
• They charge the high interest because of the following reasons.
(i) The lenders have monopoly and position of the borrowers is very weak.
(ii) There is a shortage of savings in the traditional sector
because most of the savings are made in terms of land or
gold.
(iii) Due to natural calamities etc. the risk attached with such
70
lending are very high.
 Financial Dualism
• Thus farmers have to pay not only formal interest
charges but also the concealed charges obtained
through under pricing the grains purchased from the
farmers.
• On the other hand, in the organized markets of LDCs the
interest rates are low and credit facilities are abundant.
• The loans are advanced to manufactured sector, export
industry and modern commerce sector.
• Professor Myint says that there was an old financial
dualism which used to exist in the open economy of
colonial period and the financial dualism which now
exists.
• Under colonial system there was perfect convertibility at
fixed exchange rate.
• Consequently there was no shortage of foreign
exchange and there were no BOP problems.
71
 Financial Dualism
• But now a days the LDC's have to face internal as well
as external balance.
• Thus the poor traders and small peasants face both
high interest rates, and shortage of foreign exchange.
• Then they are not in a position to get advanced
machinery etc.
• Under colonial system organized money market of
LDCs is consisted of the branches of western
commercial banks which were linked with international
financial market.
• In colonial system the modern sector consisting of
mines, plantation and foreign trade borrowed at low72
interest rates both from western banks and the world
 Financial Dualism
• But the present LDCs have attained monetary
independence by establishing their own central banks.
• They have introduced the exchange control.
• As a result, the organized money market of the LDCs
have been separated from the world capital market.
• Hence, their central banks are following the cheap
monetary policy even when they are having shortage of
funds.
• They are maintaining over-valued exchange rate on the
ground that devaluation will create inflation.
• On the other hand there is chronic excess demand for
foreign exchange in these poor countries.
• To meet this situation, these countries depend upon
exchange controls, direct controls, monetary and fiscal
policies.
73
 Financial Dualism
• This has led to enhance the economic dualism
between the traditional sector and modern industrial
sector.
• The cheap monetary policy by maintaining artificial
low interest rates has become helpful for the large
industrial sector.
• The low interest rates have discouraged the flow of
funds from abroad and savings from within the country.
• But it has created an excess demand for loans.
• Thus the major part of domestic savings are flowing
towards industrial sector.
• This has reduced the capital to traditional and 74

agriculture sector which have to get at higher interest

 Financial Dualism
• The foreign exchange control to correct deficit in BOP
has also benefited the modern industrial sector against
the traditional sector.
• It is because that the major share of available foreign
exchange is allocated to the industrial sector to import
capital intensive goods.
• On the other hand, the agricultural and small scale
sector fail to get foreign exchange and import permits
because of red-tapism/excessive paper work and
corruption in the LDCs.
• Most of the UDC's have established agricultural banks
and cooperative societies.
• But these institutions have been found providing loans
to the influential people and to the model villages.
75
 Financial Dualism
• All this has led to misallocation of resources between the
modern and traditional sector.
• So money markets in the LDCs remain backward.
• Domestic inflation along with over-valued exchange rate
have encouraged flight of capital.
• The countries where this is checked, the capital moved in
the purchase of gold, jewellery, real estates and other
speculative activities.
• This is because of low rate of interest against investment.
• Hence the money market remains ineffective.
• Govt. controls over the scarce supply of capital have also
retarded the growth of financial intermediaries in the LDCs.
• These controls favor the large manufacturing units and the
banks.
76
 Financial Dualism
• They discriminate against the small borrowers and the
money lenders who provide credit to the small borrowers.
• In the LDCs govts. believe that capital funds invested in
durable capital goods are productive while those invested
in financing agriculture and trading activities are
unproductive.
• The cheap and easy credit to the traditional sector is not
provided because of following:
– (i) The high over head costs and salaries of officials of
commercial banks in the rural areas.
– (ii) The red-tapism in dealing with small borrowers according
to the rigid rules.
– (iii) The lack of coordination between the head office and the
branches.
– (iv) Lack of subsidized loans supplied by the agricultural
banks etc.

77
 Financial Dualism
• Professor Myint suggest two types of policies to
reduce financial dualism in LDCs:
• (i) The official interest rate in the organized capital
market be increased.
– This will attract the savings both from the country and out of
the country.
– It will also create an equilibrium between the demand for
loan able funds and supply of loan able funds.
• (ii) There should be free access on equal terms to
capital funds by modern and traditional sector. This
will reduce misallocation of resources between the
two sectors.
78
3.3.4 The process of Cumulative Causation
• Gunnar Myrdal argue that because of economic
growth such a cumulative causation comes into being
that the developed countries attain more development
while the under—developed countries remain
backward.
• It happens because in case of developing countries
the pro—growth effects are not capable enough to
face the unfavourable effects existing in these
countries.
• Accordingly, the inequalities at world level are
increasing and the regional disparities in the
developing countries are emerging.
79
 The process of Cumulative Causation…cont
• Traditional economic theories are not capable enough to
analyse the problems of development of UDCs.
– unrealistic assumption that there always exists a stable
equilibrium in the economy.
– in the presence of such stable equilibrium we cannot
construct any economic theory which could justify social
change.
– the social and economic forces which remain operative in
UDCs become responsible for instability in their
economies.
– such instability will never convert itself into stable
equilibrium.
• Accordingly, Myrdal stipulates the assumption of
‘Cumulative Causation’, instead of stable equilibrium, which
helps in explaining the development gap at global level and
regional development gap at domestic level. 80
 The process of Cumulative Causation…cont
Regional Inequalities/Geographical Dualism”
• Occurs because of (1) migration of labor, (2) mobility
of capital and (3) difference in trade facilities.
• Labor Migration
• Migration from backward regions to developed regions.
– The educated, intelligent and skilled people have the
tendency to move to the developed regions of the country.
– As a result, there occur the pro—growth effects on the
growth of developed regions.
– Whereas the backward regions suffer from anti—growth
effects.

81
The process of Cumulative Causation…cont
• Capital Movement
• In UDCs the capital becomes mobile in those regions
where it could earn more profits.
• Banking system becomes responsible for shifting the
savings of villages and small cities to those areas
where capital is more safe and more yielding.
– result of such capital mobility, the cities go on
growing and the Villages remain backward.
• Difference in Trade Facilities
• In a poor country in certain regions the trade facilities
are more as compared with other parts.
• Because of such trade and business opportunities the
82

industrialization takes place.

The process of Cumulative Causation…cont
• On the other hand, because of lack of opportunities in
backward areas even the existing handicrafts and
traditional businesses get failed.
• Because of growth process some expansionary effects
will rise as the growth in the advanced regions will lead to
create some ‘Backwash Effects’ on the poor regions.
• As the demand for the products of the poor regions will
increase, or the labor working in the developed regions will
send money to their dependants living in the backward
areas (Spread Effect).
– But such all will not compensate for the loss which occurred
due to difference in the facilities of trade, labor and mobility of
capital.
• Thus Myrdal says that poverty rises because of poverty.

83
 The process of Cumulative Causation…cont
• Backwash effect: economic growth in one area
adversely affects the prosperity of another.
– Wealth and labour move from poorer, peripheral areas to
more central regions of economic growth and the industrial
production of wealthy regions may well undercut the
industrial output of the poorer regions.
– This draining of wealth and labour together with industrial
decline is the backwash, or polarization effect
• Spread effect: the filtering through of wealth from
central, prosperous areas, to peripheral, less wealthy
areas.
• Thus, increased economic activity at the core may
stimulate a demand for more raw materials from the
84

periphery, and technological advance in the core

The process of Cumulative Causation…cont
• A belief in the spread effect lies behind the planning
of growth poles; in a sense, the spread effect is the
spatial equivalent of trickle-down economics.
• Criticism
• Does not consider measures taken by certain
governments to alleviate economic disparity between
regions

85
 3.3.5 A Model of Low Level Equilibrium Trap
• Nelson has presented the theory of low level
equilibrium trap for the UDCs.
• Is based upon 'Malthus' view that when per capita
income of a country raises above the 'Minimum
Subsistence Wage', the population will tend to
increase.
• Initially population grows rapidly with increase in per
capita.
• But when the growth rate of population reaches an
upper physical level, it starts declining with further
increase in per capita.
– in the beginning the increase in per capita income leads to
increase the population. 86

– Afterwards, the increase in the per capita income leads to

 A Model of Low Level Equilibrium Trap
• UDCs have a stable equilibrium of per capita income
which is close to subsistence requirements.
– Hence, the savings and investment remain at very low level.
• Thus whenever, the efforts are made to raise the level
of NI, savings and investment they also resulted in
increase of the population.
• Accordingly, the per capita income remained at its
stable equilibrium level.
• All this means that UDCs are caught in low level
equilibrium trap.
• Factors responsible for such trap are :
– high correlation between the level of per capita income and
87
rate of population growth.
 A Model of Low Level Equilibrium Trap
– little propensity to direct additional per capita
income to increase investment.
– shortage and scarcity of uncultivated area of
land.
– the economy is having inefficient techniques
of production.
– the economy is furnished with social and
economic inertia.

88
 A Model of Low Level Equilibrium Trap
• Nelson presents three sets of relationships to show the
trapping of an economy at a low level of income:
• Y = f (K, L, Tech.).
• The new investment consists of capital which is created
out of savings in the form of additions to the stocks of
machine tools etc. in the industrial sector plus the
additions of new lands to the amount of land under
cultivation.
• With low per capita incomes, short run changes in the
rate of population growth are caused by changes in
death rate; and the changes in death rate are caused by
changes in the level of per capita income.
• Whenever, the per capita income reaches a level above
the subsistence level, further increase in per capita
income will have a negligible effect on death rate. 89
A Model of Low Level Equilibrium Trap

90
 A Model of Low Level Equilibrium Trap

• In the (1) part of Fig. the dP/P curve represents

percentage rate of growth of population, while the Y/
P curve represents per capita income.
• The point J is minimum subsistence per capita income
where dP/P = dY/P.
• Here, the population is stationary. But to left of J, the
population is decreasing while to the right of J, the
growth rate of population increases to the upper
physical limit, shown by 'U'.
• This happened due to increase in per capita income
above subsistence level as shown by the arrow
movement on the horizontal axis in the (1) part of Fig.
91
 A Model of Low Level Equilibrium Trap
• For some time the population will grow at this level with
rise in per capita income and then it will start falling at
point M.
• In (2) part of Fig.1, dK/P is per capita rate of investment
out of savings.
• The curve dK/P is the growth, curve of investment which
relates the per capita of investment to different levels of
per capita income.
• At point 'X', there are zero savings. While to its left, there
are negative savings.
• If we move above point 'X' along the growth curve of
investment, the per capita rate of investment will rise
beyond the upper physical limit of the growth rate of
population as denoted by 'U' in (1) part of Fig. 1. 92
 A Model of Low Level Equilibrium Trap

• In (3) part of Fig.1, Y/P is again per capita income.

While dY/Y is rate of growth of total income, and dP/P,
is growth curve of population at various levels of per
capita. The point 'S' is so drawn that it equals the zero
savings level of income (point X in (2) part) and
minimum subsistence level of per capita income 'J'. So
the situation where J = X = S the low level equilibrium
trap exists in the economy.
• Here: dY/Y = dP/P. For any increase in per capita
income beyond point S, the growth rate of population is
higher than the growth rate of income, (dP/P > dY/Y).
• This will push the economy back to point S, the point of
93
stable equilibrium.
 A Model of Low Level Equilibrium Trap
• This low level of trap will be stronger the more quickly the
rate of population growth responds to a given rise in per
capita income, and more slowly the rate of growth in total
income responds an increase in investment.
• Methods to Escape from Trap:
• a favorable socio-economic political environment in the
country.
• Social structure be changed by greater emphasis on
entrepreneurship.
• The size of the family by reduced.
• Measures be taken to change the distribution of income.
• The proportion of public investment be increased.
• In order to enhance capital and investment the loans be
obtained from foreign countries.
• Improved techniques of production be used to utilize the
existing resources. 94
 3.3.6 The Big-Push Theory

• Growth strategy deals with the coordinated application

of capital to a wide range of different industries.
• Three Versions of growth strategy:
1. A critical minimum effort is required to overcome
indivisibilities in the productive processes on both
the demand and supply side of the market=> Big
Push
2. The path of development and the pattern of
investment must be balanced between the sectors
of the economy to ensure its smooth functioning
=>balanced growth
3. The path of development and the pattern of
investment must unbalanced between the sectors
of the economy to ensure its smooth
functioning=>unbalanced growth
95
 Big Push: Rosenstein-Rodan

• Argue for an intensive, economy wide and typically

public policy–led effort to initiate or accelerate
economic development across a broad spectrum of
new industries and skills.
• This theory is an investment theory which stresses the
conditions of take-off.
• The investments should be of a relatively high
minimum in order to reap the benefits of external
economies.
• Only investments in big complexes will result in social
benefits exceeding social costs.
• High priority is given to infrastructural development96
and industry, and this emphasis will lead to
 Big Push…continued
• Industrialisation is the only way to alleviate
underdevelopment in which investment will not occur
without coordination.
• Coordination failure: A state of affairs in which the
inability of agents to coordinate their behaviour (choices)
leads to an outcome (equilibrium) that leaves all agents
worse off than in an alternative situation that is also an
equilibrium.
• There are some reasons for coordination failure:
A. Complementarity of Industries
• Complementarity: An action taken by one firm, worker,
or organization that increases the incentives for other
agents to take similar actions.
• Often involve investments whose return depends on
other investments being made by other agents. 97
 Big Push…continued

• The implication is that:

– 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
– But Say’s Law suggests every supply creates its own
demand
– 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.
– This requires coordination between industries

98
 Big Push…continued
B. 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
– A coordinating body, with more information, would be
more able to assess risk than individual entrepreneurs
C. Indivisibilities and economies of scale(two cases)
• 1. Indivisibilities in Production Function:
– When so many industries are established the
economies regarding factors of production, goods,
and techniques of production are accrued.
– More importance to economies which arise due to the
establishment of social overhead capital(SOC).
99
 Big Push…continued
• SOC consists of means of transportation, communication
and energy resources.
– They all contribute to development indirectly.
– They last for a longer period of time.
– The SOC cannot be imported.
– To construct it a big amount of capital is required.
– For some time, the excess capacity may grow in SOC, but they
are very much must.
• Accordingly, UDCs have to spend 30%-40% of investment
on SOC.
• The SOC is attached with the following indivisibilities:
– The SOC must be provided before Directly Productive
Activities (DPA).
– It is lumpy (uneven) and it has a minimum durability.
– It lasts for a longer period of time and it is irreversible.
100
 Big Push…continued

• These indivisibilities serve as big obstacle in the way of

economic development of a UDCs.
• (2) Indivisibilities of Demand:
• The complementarily with respect to demand requires that
UDCs should establish such industries which could support
each other.
– To make investment in one project may be risky because
in UDCs the demand for goods and services is limited due
to lower incomes.
– In other words, the indivisibilities of demand require that at
least a certain amount of investment be made in so many
industries which could mutually support each other.
– As a result, the size of market will be extended in UDCs; or
the problem of limited market will come to an end in UDCs.
– Consider the following figure:
101
 Big Push…continued
Single Firm profit
=p1cab(loss)

4Firms
profit
=P4RST(gai
n)

It means that the greater investment in so many

102

industries may convert the losses into profits.

 Criticism of Big Push
• Negligible Economies in Export, and Import Substitute Sectors:
– the export sector and, import-substitute sectors are so
backward in UDCs that they hardly give rise to economies.
• Negligible Economies from Cost Reducing Investment:
– The goods which are concerned with public welfare hardly
yield external economies.
– Investment which is aimed at reducing costs does not yield
economies.
• Neglecting Investment in Agriculture Sector:
– It neglects the investment to be made in agriculture, and its
allied sectors.
• Inflationary Pressure:
– From where the funds will come in UDCs to spend them on
SOC.
– If the funds are raised through foreign loans and by printing
new notes they will create inflation in the economy. 103
 Criticism of Big Push…continued
• Administrative and Institutional Difficulties:
– This theory stresses upon state investment to remove
deficiency of capital.
– But in case of UDCs the machinery is corrupt.
– There exist a lot of problems in state machinery.
– The private and public sectors compete with each other,
rather supporting each other.
– Consequently, there will not be the balanced growth in
the economy.
• It is Not a Historical Fact:
– The Big Push theory is a formula for the UDCs, but it has
not been derived on the basis of historical experience.
– "The Big Push theory lacks the historical evidences and
facts".
104
 3.3.7 Balanced Growth (Nurkse)

• 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 emphasize the importance of
achieving balance between different sectors of the
economy
• Nurkse was concerned with the path of development
and the pattern of investment.
• He argued that these should be of such a nature that
growth is balanced between different sectors such that
no bottlenecks or excess capacity arise.
• Integral to this proposition is the notion that the
agricultural and industrial sectors must be balanced105
 Balanced Growth…continued
• The government of any underdeveloped country needs
to make large investments in a number of industries
simultaneously.
• This will enlarge the market size, increase productivity,
and provide an incentive for the private sector to
invest.
• He recognised that the expansion and inter-sectoral
balance between agriculture and manufacturing is
necessary so that each of these sectors provides a
market for the products of the other and in turn,
supplies the necessary raw materials for the
development and growth of the other. 106
 Balanced Growth…continued

The process of development as Balanced growth

Econo
Large Scale
Complemen my
Investment in Size of
tarity of grows
many Sectors market
Demand b/n and
Simultaneousl expands
sectors develo
y
ps

107
 3.3.8 Unbalanced Growth (by Hirschman)
• Hirschman challenged the theory of balanced growth
• He embraced the theory of ‘unbalanced growth’
• He argued that there are insufficient resources available
in developing countries to allow for a ‘big push’
– Big Push is not feasible
– Should concentrate on certain sectors
– These sectors should be chosen based on their
linkages to other sectors in the economy i.e the more
linkages the more likely that a sector should be
focused upon.
– Firms with more linkages, through their growth and
increase in output, encourage other firms to increase
output due to increased demand for inputs and an
increase in outputs.
– Banks and the government choose and provide the
funds for investment 108
 Criticisms of Balanced growth
• The strategy is beyond the resources of most poor
countries
• Balanced growth within a closed economy rather than
specialisation and trade contradicts comparative
advantage
• Government planning results in government failure i.e
government intervention in the market fails to bring
about an efficient allocation of resources eg planning
process creates a bureaucracy.
• LDC development policies focusing on import
substitution, agricultural self-sufficiency and state
control of production yield poor growth.
109
 Criticism of Unbalanced Growth
• The model leaves a lot to chance;
• Have the correct sectors been focused upon?
• What criteria has the government uses to identify the
sector to focus upon?
• Bottlenecks may occur where there is a shortage in
supply to the growth sector
• There may not be a sufficient demand for the output
from the growth sector

110
 3.3.9 The International Dependence Model
• International-dependence models gained increasing
support, especially among developing-country
intellectuals, as a result of growing disappointment
with both the stages and structural-change models.
• IDMs view developing countries as plagued by
institutional, political, and economic rigidities, both
domestic and international, and caught up in a
dependence and dominance relationship with rich
countries.
• Within this general approach are three major
streams of thought:
– the neo-colonial dependence model,
– the false-paradigm model, and
– the dualistic-development thesis. 111
 The Neo-colonial Dependence Model
• Underdevelopment exists in LDCs because of
continuing exploitative economic, political, and
cultural policies of former colonial rulers toward less
developed countries.
• It attributes the existence and continuance of
underdevelopment primarily to the historical
evolution of a highly unequal international capitalist
system of rich country–poor country relationships.
• The coexistence of rich and poor nations in an
international system dominated by such unequal
power relationships between the center and the
periphery renders(reduces) attempts by poor nations
to be self-reliant and independent difficult and 112

sometimes even impossible.

 Neo-colonial Dependence…continued
• Certain groups in the LDCs who enjoy high incomes,
social status, and political power constitute a small
elite ruling class whose principal interest is in the
perpetuation of the international capitalist system of
inequality and conformity in which they are rewarded.
• They serve (dominated by) and are rewarded by
(dependent on) international special interest power
groups, including MNCs, National Bilateral Agencies
(NBAs), and Multilateral Aid Organizations (MAOs)
like the WB or (IMF), which are tied by funding to the
wealthy countries.
• The elites’ activities and viewpoints often serve to
inhibit any genuine reform efforts that might benefit 113

the wider population and in some cases actually lead

 Neo-colonial Dependence…continued

• In short, the neo-colonial view of underdevelopment

attributes a large part of the developing world’s continuing
poverty to the existence and policies of the industrial
capitalist countries of the northern hemisphere and their
extensions in the form of small but powerful elite or
comprador groups in the less developed countries.
• Underdevelopment is thus seen as an externally induced
phenomenon, in contrast to the linear stages and
structural-change theories’ stress on internal constraints
such as insufficient savings and investment or lack of
education and skills.
• Revolutionary struggles or at least major restructuring of
the world capitalist system is therefore required to free
dependent developing nations from the direct and indirect
economic control of their developed-world and domestic
oppressors. 114
 The False-Paradigm Model

• LDCs have failed to develop because their

development strategies have been based on an
incorrect model of development
– for example, overstressed capital accumulation or market
liberalization without giving due consideration to needed
social and institutional change.
• Attributes underdevelopment to:
– faulty and inappropriate advice provided by well-meaning
but often uninformed(ignorant), biased, and ethnocentric
international “expert”(conviction of own culture superiority)
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.

115
 False-Paradigm…continued
• Because of institutional factors such as
– the central and remarkably resilient role of traditional
social structures (tribe, caste, class, etc.),
– the highly unequal ownership of land and other
property rights,
– the disproportionate control by local elites over
domestic and international financial assets, and
– the very unequal access to credit, these policies,
based on neoclassical models, in many cases merely
serve the vested interests of existing power groups,
both domestic and international.
• LDCs 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 (unintentionally)
served an unhealthy dose of alien concepts and
elegant but inapplicable theoretical models. 116
 The Dualistic-Development Thesis
• Dualism: coexistence of one desirable and the other not
• Dualism: the existence and persistence of substantial and
even increasing divergences between rich and poor
nations and rich and poor peoples on various levels.
• Dualism holds four key arguments:
– 1. Different sets of conditions, of which some are “superior”
and others “inferior,” can coexist in a given space.
– 2. This coexistence is chronic and not merely transitional.
– 3. Not only do the degrees of superiority or inferiority fail to
show any signs of diminishing, but they even have an inherent
tendency to increase.
– 4. The interrelations between the superior and inferior
elements are such that the existence of the superior elements
does little or nothing to pull up the inferior element, let alone
“trickle down” to it. In fact, it may actually serve to push it
down—to “develop its underdevelopment.”
117
 Criticisms of IDM
• Give no insight into how countries initiate and sustain
development.
• The actual economic experience of developing
countries that have pursued revolutionary campaigns
of industrial nationalization and state-run production
has been mostly negative.

118
 3.3.10 Neo-Classical Counter Revolution Theory:
Approach to Privatization and Free Market:
• Underdevelopment results from poor resource allocation
due to incorrect pricing policies and too much state
intervention on the part of UDCs in their economic
activities.
• State intervention in the economic life slowed down the
pace of economic growth in the UDCs.
• Emphasizes free markets, privatization, free trade, FDI
etc.
• Thus the neo classical counter-revolution theory says
that:
– "It is heavy hand of state and corruption, inefficiency
and lack of economic incentives that permeate the
economies of UDCs.

119
 (i) Free Market Analysis:
• Markets alone are efficient, as the goods markets
provide reasonable signals for investment in new
activities.
• Labor markets show the reaction properly
automatically in new industries.
• Entrepreneurs know better that what to be produced
and how they are to be produced, as the factor and
goods prices reflect the true scarcity of their present
and future prices.
• In such like any govt. intervention will not only be
unproductive but it will also lead to create distortions.
• Thus supporters of free markets are of the view that if
we implement the free market economic system all
over the world it will result in more efficient situation,
and the market imperfections will be of least
importance. 120
 (ii) Public Choice Theory/Modern Political
Economy
• Governments fail to do anything good.
• The politicians, bureaucrats, citizens and the state
function just on the ground of their interests.
• They use the government authority and power for their
personal interests.
• Such all leads to misallocation of resources as well as
losing of personal freedoms.
• Thus, this theory advocates the limited-or minimal size
of the govt.

121
 (iii) Market Friendly Approach

• Government has to play an important role in this

regard so that the markets could function well.
• But, the government will have to play this role
through market friendly approach.
• Have to create a suitable and favourable environment
for private enterprises by providing them physical
infrastructure, health-care and educational facilities.
• The market friendly approach is different from free
market approach and the public market approach, as
this theory admits that there is a greater role of market
imperfections in in the LDCs.
122
 Criticism of NCCR

• The UDCs lack competitive markets.

• Consumers are not sovereign.
• Market imperfections.
• The people are highly illiterate.
• Non -monetized economy.
• The poor societies face both consumption and
production externalities.
• There exist discontinuities in production and
indivisibilities (i.e., economies of scale) in
technology etc.

123
 3.3.10 The new growth theories (Romer,
Lucas)
• Endogenous growth theory holds that economic
growth is primarily the result of endogenous and not
external forces.
• EGT holds that investment in human capital,
innovation, and knowledge are significant contributors
to economic growth.
• The theory also focuses on positive
externalities and spill over effects of a knowledge-
based economy which will lead to economic
development.
– Problems of Solow, Convergence, MPK eventually declines
– Technological advances may eliminate convergence, but
they are Exogenous in the model- 124

– The growth model itself doesn’t explain TA, and technical

Endogenous Growth & new Explanatory Variable

• Human Capital with Knowledge;

– it is separate physical capital with technical innovation;
– we can have an accumulation/evolution function for human
capital
– Other variables measuring quality of human factors may be
tried.
• No convergence – MPK does not have to decline if
there is an increase in Human Capital
• The contribution of this model is that it emphasizes
the link between
– Technical innovation, Human Capital, and
Institutions including Government. 125
 Endogenous Growth & Technological
change
• Technological change is the result of the intentional
actions of people, such as Invention, and R&D
• Some institutions promote innovation and R&D, and
others inhibit R & D.
– Supports Government-funding for Educational
Institution and R & D.
– At an early stage of economic development, the level
of education plays important role in technological
catch-up
– Productivity growth is more rapid where countries
have higher levels of average schooling
• Human capital has largest effects when specific to
– sub-categories important for technological diffusion
– science, math, engineering 126
 Human capital, Labor, knowledge

• Human capital – “our knowledge, skills learning,

talents and abilities.”
• Labor:-
– quantity of workforce
– physical
– individual
• Human Capital
– Quality of workforce
– Intellectual
– Between Humans, Institutional 127
 Human capital, Labor, knowledge…

• Unlike physical labor (and the other factors of

production), knowledge is:
• Expandable and self-generating with use: as doctors
get more experience, their knowledge base will
increase, as will their endowment of human capital.
The economics of scarcity is replaced by the
economics of self-generation.
• Transportable and shareable: knowledge can be
moved and shared. This transfer does not prevent its
use by the original holder. It is public goods.
• Quantification of Human Capital:
– Years of Schooling. 128

– Literacy rate
 Math of the Formal Model:

• Instead of Y= A Ka L1-a of conventional Neo-

Classical Model
• proposes Y = A Ka Hb L1-a-b
• Because of H, there is no convergence; an
increase in H can cancels the decreasing MP.
• Human capital becomes the engine of growth

129
 Limitations and Extension

• A Lot of Remaining Ambiguity of Human Capital

• Not fully captured by a single, individual measure of
education
– e.g. military services, and non-school training and services
are not formally included in education, but should be
included in case of nation-wide compulsory military services.
• Not only quantity of education but also quality of
education
• Some authors suggest that education system should
be included

130