CHAPTER THREE

3. GROWTH MODELS AND THEORIES OF

DEVELOPMENT
3.1 Models and Theories of Economic Growth and
Development
 The post-World War II literature on Economic
development has been dominated by four major and
sometimes competing strands of thoughts:
1) the linear stages-of-growth models,
2) theories and patterns of structural change,
3) the international-dependence model,
4) the neo-classical, free-market counter-revolution.
In addition, as a recent approach: new theory of economic
growth.
The Linear Stages of Growth Model
The liner stages of growth models were derived largely,

from the experience of how the present developed

countries were transferred from agrarian economy to
modern economy.

Theorists of the 1950s and early 1960s viewed the process

of development as a series of successive stages of economic
growth through which all countries must pass in their
history.
It was primarily an economic theory of development in
which the right quantity and mixture of saving,
investment and foreign aid

 were all that was necessary to enable developing

countries to proceed along an economic growth path,

 that historically had been followed by the more developed

countries.

Development thus became synonymous with rapid and

aggregate economic growth.
The linear stages of growth is divided in to
three main models of growth:
 Rostow'sstages of growth,
 The Harrod-Domar growth model, and

 The Solow growth model.

 Rostow's Stages Of Growth
 This model is highly influenced by American Economist called
Walt W. Rostow.
 According to the Rostow doctrine,
 the transition from underdevelopment to development can be
described in terms of a series of steps or stages through which all
countries must proceed.
 Rostow identified stages of economic growth that societies have to
pass through as follows.
1. The traditional society,
2. Pre-condition for the take-off into self-sustaining growth,
3. Take-off stage,
4. Drive to maturity, and
5. The age of high mass consumption: stages of self-sustained
growth.
Traditional society or Pre-Industrial stage.
1. Traditional Society is
Characterised where
 The economy is
dominated by
subsistence activity.
 existence of barter.
 Agriculture is the most
important industry.
 Output is consumed by
producers; it is not traded
nor recorded.
 Production is labor intensive
using only limited quantities
of capital.
Technology is limited, and resource allocation is
determined very much by traditional methods of
production.
People stick to age old customs and traditions.
Output per worker is very low and doesn't
change from time to time.
In this stage, there may be craft industries with
strong social stratification.
The World was in this stage before 19th century
"Industrial Revolution"
Transitional Stage (Preconditions for
Take-off)
 Development of
mining industries.
 Increase in capital
usage in
agriculture.
 Some growth in
savings and
investment.
 Necessity of
external funding.
Increased specialization generates surpluses for
trading.
There is an emergence of transport
infrastructure to support trade.
Entrepreneurs emerge as incomes, savings and
investment grow.
External trade also occurs concentrating on
primary products.
A strong central government encourages private
enterprise.
In this stage the economy is more open to
modern technology and preparing itself for take-
off.

There is a start of construction of roads and

railways, growing export, new political and
economic elites, and high external influence.

Investment ranged around 5% of the GNP in this

stage.
 The take-off stage
Increasing
industrialisation
Further growth in
savings and investment
Some regional growth
Labor employed in
agriculture declines

At this stage, industrial growth may be

linked to primary industries. The level of
technology required will be low.
Industrialization increases with workers
switching from the agricultural sector to the
manufacturing sector.
Growth is concentrated in a few regions of the
country and within one or two manufacturing
industries.
The level of investment reaches over 10% of GNP.
People save money.
Any remaining barriers to growth are overcome
and
growth becomes a normal condition at least in
one sector of the economy (the leading sector).
In this stage; political, social and institutional setups
favor dynamic growth.

The growth is self-sustaining as investment leads to

increasing incomes in turn generating more savings to
finance further investment.

A country may be in the take-off period for two to three

decades.
 Conditions that should be fulfilled for take-off
1. A rise in the rate of productive investment say, from
5% or less to over 10% of national income.

2. The development of one or more substantial

manufacturing sectors with a high rate of growth i.e
development of leading sectors.

3. The quick emergence of political, social and

institutional framework that exploits expansion.
 Drive to Maturity
Growth becomes self-sustaining –
wealth generation enables further
investment in value adding industry and
development.
Industry becomes more diversified.
Increase in levels of technology
utilization.
The economy is diversifying into new
areas.
Technological innovation is providing a
As the economy diverse range of inv't opportunities.
The economy is producing a wide range of
matures, technology
g/s & there is less reliance on imports.
plays an increasing role Urbanization increases and technology is
in developing high value used more widely.
added products.
 High Mass Consumption

High output levels

Mass consumption
of consumer durables.
High proportion of
employment in the
service sector.

Service sector dominates the economy –

i.e. marketing, banking, insurance,
finance, entertainment, leisure and so on.
In this last stage, the per capita income becomes so high
that,

consumption transcends beyond food, clothes and

shelter to goods of comforts and luxuries; or

a mass scale industrialization and urbanization change

the values of the society and development.

In this stage, people do not feel any pinch of shortages

i.e, very high levels of consumption and physical quality
of life are achieved.
The economy is geared towards mass
consumption, and
the level of economic activity is very high.
Technology is extensively used but its expansion
slows down.
The service sector becomes increasingly
dominant.
Urbanization is complete.
Now, multinational companies emerge.
Increased interest in social welfare exist.
 The Harrod-Domar Growth model

The model takes two economists, Sir Roy Harrod and

Evsey Domar, who independently developed the model
in 1939 and 1946.

It is based on the experience of advanced economies

Economic growth can be thought of a result of

abstention from current consumption i.e saving matters.

The Harrod-Domar model is an economic growth model

that uses saving and investment as growth sources.
Harrod Domar’s model helps explain why an economy
grows and how to grow it.
This model shows you that the national savings rate and
capital productivity are the two main variables driving
economic growth.
Importances of the Harrod-Domar model
First, the model explains, the savings rate and the
capital-output ratio affect the growth rate.
Low levels of economic growth can be associated with
low savings rates.
This situation usually occurs in developing countries.
 A low level of domestic savings causes a low level of investment in
the economy.

 It results in a low supply of loanable funds for investment.

 As a result, the capital stock is low, as well as economic growth.

Second, a low savings rate can create a vicious cycle.

 This results in low investment resulting in low economic growth.

 Low economic growth indicates slow economic prosperity.

 That leads to a low level of national income.

 Low income causes a few people to save.

When growth is low, the economy creates relatively
limited new jobs.
As a result, household income and aggregate demand are
also low.
Likewise, facing limited demand conditions,

it is also difficult for businesses to increase output and

gain significantly more profits.
This all ultimately results in a low savings rate.
Therefore, an option to boost the rate of economic
growth is to increase savings.
A higher saving rate creates a cycle of self-sustaining
economic growth.
The economy is less dependent on the supply of funds
from the external sector (foreign investment).
However, indeed, increasing the saving rate is not an
easy matter.
Most people in developing countries use additional
income for consumption instead of saving.
They have to struggle to meet their basic needs, so they
find it difficult to set aside more money to save.
 Limitations of the Model
The model oversimplifies the sources of economic
growth.

It only uses capital and savings as determinants.

 It ignores other factors such as labor productivity and

technological advances as factors spurring economic
growth.

Saving rate and investment are the necessary

conditions not sufficient conditions for economic
growth.
Some managerial capacity and skill are also required to
change saving into inv’t (to transform the potentials of
capital inv’t into practice).

Saving, population & capital-output ratios are not

exogenous but actually they are endogenous i.e. these
parameters themselves are affected by economic growth.

Harrod-Domar is a neutral theory. It doesn't explain

why growth rates at different levels of per capita income
differ.
 Capital-output ratio () is assumed fixed in the H-D
model. But from microeconomics, if we apply more and
more labor in to a fixed capital, diminishing returns to
scale operate.

 If there are diminishing returns to scale, the efficiency of

capital to produce output may diminish.

 Generally, the main obstacle to or constraint on

development, according to this model, is the relatively low
level of new capital formation in most LDCs.
 The Solow Growth Model
The Solow growth model is named after Robert
Solow, who published a seminal paper
 “ A Contribution to the Theory of Economic Growth
” in 1956; for which, he was awarded the Nobel prize
in economics.
Solow’s model was a response to the Harrod-Domar
model and some of its obvious weaknesses, especially
its assumption of a constant capital-output ratio.
The Solow growth model now is the basic reference
point for almost all analyses of modern growth.
The basic Solow growth model takes technological
progress as given and

investigates the effects of the division of output

between consumption and investment on capital
accumulation and growth.

In Solow’s model, the long run rate of growth is

determined by an expanding labour force and
technical progress.
The Solow growth model is an economic model that
analyzes a country's output compared to a country's
input,
which includes its population growth, savings,
investments, capital, depreciation and technological
advancements.
The Solow model focuses on the long-term
growth of an economy and
 shows how depreciation and investment
eventually reach a steady state as technology
advances,
meaning it determines a country's ratio of capital
to its labor.
The Solow growth model is a model that
measures a nation's economic growth rate over a
period of time to indicate the direction of its
economy.
This economic growth model considers the input
of a nation's population, savings and advances in
technology,
compared to the production of output identifying
the cost of each unit produced.
The Solow model uses these principles, showing that
over time,
the gross domestic product (GDP) increases through
economic fluctuations due to technological progress.
The reason technological progress is an important part
of the nation's input is that these
advancements increase production and the efficiency of
the labor force.
Structural-Change Models(Lewis theory of dev’t)
Lewis theory of dev’t(two-sector surplus model) was
formulated by Nobel laureate W. Arthur Lewis in the mid
1950’s & later modified by John Fei & Gustav Ranis.

The focuses these theory is on the mechanism by w/c

underdeveloped economies transform their domestic
economic structures from a heavy emphasis on traditional
subsistence agriculture:

 to a more modern, more urbanized, &

more industrially diverse manufacturing & service

 The Lewis Theory of Development
Under this theory surplus labor from the traditional
agricultural sector is transferred to the modern
industrial sector,
the growth of w/c absorbs the surplus labor, promotes
industrialization, & stimulates sustained dev’t.
Surplus labor -The excess supply of labor over & above
the quantity demanded at the going free-market wage
rate.
In these theory, surplus labor refers to the portion of the
rural labor force whose marginal productivity is zero or
negative.
In this model, the underdeveloped economy consists of
two sectors:

 Traditional (overpopulated rural subsistence

sector ) with zero marginal productivity of labor &

 Modern urban industrial sector-High-productivity

of labor

The speed with w/c output expansion occurs is

determined by the rate of industrial inv’t & capital
accumulation in the modern sector.
Lewis assumed that the level of wages in the
urban industrial sector was constant, determined
as a given premium over a fixed average
subsistence level of wages in the traditional
agricultural sector.

 At the constant urban wage, the supply curve of

rural labor to the modern sector is considered to
be perfectly elastic.

Under the assumption of perfectly competitive labor
markets in the modern sector, these marginal product of
labor curves are in fact the actual demand curves for
labor.
Self-sustaining growth-Economic growth that continues
over the long run based on saving, inv’t, &
complementary private & public activities.
Modern-sector self-sustaining growth & employment
expansion is assumed to continue until all surplus rural
labor is absorbed in the new industrial sector.
 Balanced versus unbalanced growth theories

The Balanced Growth Theory

This theory was advocated mainly by Rosenstein-Rodan

(1943), Ragnar Nurkse (1953) and Arthur Lewis (1954).

Many writers view balanced growth differently.

Balanced growth means investing in a lagging sector of

the national economy or industry so as to ensure that it
catches up with others.

To others, balanced growth- implies that inv’t takes place

Still to others, it implies the balanced dev’t of agricultural
& industrial sectors of the economy.

Balanced growth calls for:

 maintaining the balance b/n the d/t consumer & capital

good industries.

 ensuring balance b/n agriculture & industry & b/n the

domestic & export sectors of the national economy.

it requiring balance b/n social & economic overheads &

directly productive inv’t.
The economists in favour of the balanced growth
postulated the balance b/n supply side & demand side.

The supply side consists of simultaneous dev’t of all

interrelated sectors, i.e.,

 intermediate goods,

raw materials, power, agriculture, transport, &

consumer good industries.

The demand side comprises :- provision of emply’t

opportunities w/c increase income & thus demand of the
 Criticism of Theory of Balanced Growth
1. Model does not consider the possibility of cost
reduction in the existing industries.

2. Balanced growth strategies are beyond the capability

of UDCs.

3. The doctrine of balanced growth presupposes

increasing returns. But this is a wrong assumption.

4. Dis-proportionalities in factors of production &

shortage of resources make the theory unrealistic in
 Unbalance Growth
Hirschman, Rostow, Fleming, Singer have propounded
the concept of unbalanced growth as a strategy of dev’t
for the underdeveloped nations.
The theory stresses the need for inv’t in strategic sectors
of the economy, rather than in the all sectors
simultaneously.
Unbalanced growth is a situation in w/c the various
sectors of a given economy are not growing at a rate
similar to one another.
To Rostow, as noted earlier, for an economy to
cross the stage of traditional society & achieve
take-off, it is essential for it to increase the rate of
productive inv’t from 5% to 10% or more.

This will lead to the dev’t of related industries &

as a result of increased production, profits will
increase & w/c can in turn be reinvested.
To Hirschman, the deliberate unbalancing of the
economy in accordance with a pre-designed strategy is
the best way to achieve rapid economic dev’t in the less
developed countries.

Inv’ts in strategically selected industries or sectors of the

economy, will lead to

 new investment opportunities and

 so pave the way for further economic dev’t

 Criticism of the Theory of Unbalanced Growth
1. According to Paul Streeten, Hirschman’s theory failed
to say what is the optimum degree of imbalance, where
to imbalance & how much in order to accelerate
economic growth.
2. He neglected the influence of the growth retarding
forces.
3. Lack of basic facilities
4. Technical flexibility (factor mobility) of resources is
limited in the underdeveloped countries.
5. Hirschman’s dev’t strategy is largely related to
maximizing inv’t decisions.
 Balanced Growth Theory Vs.
Unbalanced Growth Theory

Dissimilarities
Balanced Unbalaced Growth
GrowthTheory: Theory:
1. Simultaneous growth of 1. Focuses is on the
all sectors of the growth of certain key
economy. sectors of the economy
2. Seeks to accelerate the 2. The process of growth
process of growth through Imbalances in
through simultaneous the system.
investment across all
sectors of the economy
 Balanced Growth Theory Vs.
Unbalanced Growth Theory

Dissimilarities
Balanced Unbalaced Growth
GrowthTheory: Theory:
1. Simultaneous growth of 1. Focuses is on the
all sectors of the growth of certain key
economy. sectors of the economy
2. Seeks to accelerate the 2. The process of growth
process of growth through Imbalances in
through simultaneous the system.
investment across all
sectors of the economy
 Cont’d…

3. Requires lot of 3. Requires relatively

capital inv’t right much less
from the beginning investment.
of growth process. 4. A Short period
4. A long period of strategy of growth.
strategy of growth 5. It is decision
5. Size of the market is making and
the principal limiting entrepreneurial skill
factor.
 Similarity

• Both focus on the gov’t investment or SOC

(social overhead capital investment ) to
breaking the vicious circle of poverty and
economic growth, respectively.
 The International-Dependence
Model

During the 1970s, this models gained increasing

support, among LDC intellectuals, as a result of
growing disenchantment(false belief) with both
the stages & structural-change models.
Essentially, this models view developing
countries as beset (occupied) by institutional,
political, & economic rigidities, both domestic &
international, & caught up in a dependence &
dominance r/nship with rich countries.
Cont’d…

There are three streams of thoughts in

international-dependence model.
-The neocolonial dependence model
- The false-paradigm model
-The dualistic-development thesis
Neocolonial Dependence Model

Neocolonial dependence model:- A model whose main

proposition is that underdev’t exists in developing
countries b/c of continuing exploitative economic,
political, & cultural policies of former colonial rulers
toward LDCs.
DCs form the “center” of global economic relations &
technological advancement
LDCs serving as the “periphery” are dominated by:
– unequal trade and finance relations
– domestic politico-economic elite
– multinational corporations
Cont’d…

Under these conditions economic dev’t is

impossible
The neo-marxist, neocolonial view of underdev’t
attributes a large part of the developing world’s
continuing poverty
 to the existence & policies of the industrial
capitalist countries of the northern hemisphere &
their extensions in the form of small but powerful
elite or comprador groups in the LDCs.
Cont’d...
Underdev’t is thus seen as an externally induced
phenomenon, in contrast to the linear stages &
structural-change theories’ stress on internal
constraints such as insufficient savings & inv’t 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 &
indirect economic control of their developed-world &
domestic oppressors.
 False-Paradigm Model

False-paradigm model:- The proposition that developing

countries have failed to develop b/c their dev’t strategies
(usually given to them by Western economists) have been
based on an incorrect model of dev’t.
It says that underdev’t is due to faulty & inappropriate
advice provided by well-meaning but often uninformed,
biased, & ethnocentric international experts advisers to
developing countries.
E.g., overstressed capital accumulation or market
liberalization without giving due consideration to needed
social & institutional change.
 Dualistic-development thesis

The dualistic-development thesis-this thesis

recognizes the existence & persistence of
increasing divergence b/n rich & poor nations,
& b/n rich & poor people at various level.
Dualism- The coexistence of two situations or
phenomena (one desirable & the other not) that are
mutually exclusive to d/t groups of society;
E.g, extreme poverty & affluence, modern & traditional
economic sectors, growth & stagnation, & higher
education among a few amid large-scale illiteracy.
 Criticisms of International
Dependence Theories
Dependency theories offer little explanation for
economic growth & sustainable dev’t.
The actual economic experience of developing
countries that pursued nationalization &
introduced state-run production had been
mostly negative.
 The Neoclassical Counter-revolution
(Market Fundamentalism )

In the 1980s, the political ascendancy of

conservative gov’ts in the US, Canada,
Britain,& West Germany came with a
neoclassical counterrevolution in economic
theory & policy.
 In developed nations, this counterrevolution
favored supply-side macroeconomic policies,
- rational expectations theories, &
- the privatization of public corporations.
Cont’d…
 In developing countries, it called for:
- freer markets & the dismantling of public ownership,
-statist planning, & gov’t regulation of economic activities.
 The central argument of the neoclassical counterrevolution is
that underdev’t results from poor resource allocation due to:
- incorrect pricing policies &
-too much state intervention by overly active developing-nation
gov’ts.
Cont’d…

The neoclassical counterrevolution can be

divided into three component approaches:
 the free-market approach,
the public-choice (or “new political economy”)
approach, and
the “market-friendly” approach.
The Free-Market Approach

Free-market analysis-Theoretical analysis of the

properties of an economic system operating with free
markets, often under the assumption that an
unregulated market performs better than one with gov’t
regulation.
Under these circumstance, any gov’t intervention in the
economy is by definition distortionary & counter-
productivity.
Free-market dev’t economists have tended to assume
that developing-world markets are efficient & that
whatever imperfections exist have little consequence.
 The public-choice (“new political
economy”) approach

Public-choice theory (new political economy

approach)-The theory that self-interest guides all
individual behavior & that gov’ts are inefficient &
corrupt b/c people use gov’t to pursue their own
agendas.
This theory assumes that politicians, bureaucrats,
citizens, & states act solely from a self-interested
perspective, using their power & the authority of gov’t
for their own selfish ends.
The conclusion of this theory is minimal gov’t is the
best gov’t
 The “Market-Friendly” Approach.

Market-friendly approach-The notion historically

promulgated by the WB that successful dev’t policy
requires gov’ts to create an env’t in w/c markets can
operate efficiently & to intervene only selectively in the
economy in areas where the market is inefficient.
This approach recognizes that there are many
imperfections in developing-country product & factor
markets &
that gov’ts do have a key role to play in facilitating the
operation of markets through “nonselective” (market-
friendly) interventions.
Cont’d…

E.g, by investing in physical & social infrastructure,

health care facilities, & educational institutions & by
providing a suitable climate for private enterprise.
This approach also differs from the free-market &
public-choice schools of thought by accepting the
notion that market failures .
Market failure-A market’s inability to deliver its
theoretical benefits due to the existence of market
imperfections such as monopoly power, lack of factor
mobility, significant externalities, or lack of knowledge.
Thank You!!