Objectives today

Discuss how potential sources of growth are used in theories of economic development

Economic Growth and Development Theories Classical model Growth stage theories Dual economy models Dependency theories Exogenous growth theories Endogenous growth theories Transactions costs/collective action

Classical Model (late 1700’s & early 1800’s)(Malthus)

Wages are at subsistence level Favorable event leads to capital accumulation Increased demand for labor Wages in short run Population growth Demand for food Land fixed so food prices , real wages population

This (Classical) Model failed to consider the following factors and therefore did not predict correctly:

Factors which lower birth rates Technological progress

Therefore, in Classical model, law of diminishing returns constrains growth in the long run

Growth stage theories

Fred List (mid 1800’s) – stages based on shifts in occupational distributionSavagePastoralismAgricultureAgriculture and manufacturingAgr., manufacturing, and commerce

He called for import substitution

Growth stage theories (continued)

Karl Marx (late 1800’s) – stages based on changes in technology, property rights, and ideology Primitive communism Ancient slavery Medieval feudalism Industrial capitalism Socialism and communism

He felt class struggles drive classes through these stages.One class has land and capital. Other class has labor.

Growth stage theories (continued)

W. W. Rostow (1950’s) Traditional society Precondition for takeoff Takeoff Drive to technological maturity Age of high mass consumption*Sectors decline due to declining income and

price elasticities of demand*Capital accumulation and technological change

will lead to emergence of leading sectors

Growth stage theories (continued)

Colin Clark (1930’s)AgricultureManufacturingTertiary or services

Growth results from: Increased output per worker in any sectorWorkers moving from sectors with low

output per worker to high output per worker

Technological change important

Harrod-Domar model (1950)

Savings leads to economic growth Output per unit of capital up leads to

economic growth

Led policymakers to focus on capital-led industrial growthThe H-D model: g=s/k where:

g = rate of growth in national income

s = savings rate

k = ratio of capital to output

Main features of labor-surplus dual-economy model 2 sectors – agriculture & industry Marginal product of labor in agriculture Wage rate in agriculture equals average

product of labor in agriculture Land fixed Wage rate higher in industrial sector Marginal product of labor in industry equals

the wage rate

(features continued)

Labor moves from agriculture to industry Profits reinvested in capital items resulting in

greater M P & demand for labor Shifts in M P of labor creates more profits, etc. This happens as long as marginal cost of labor

is constant If marginal cost of labor (wage rate) goes up,

profits stop increasing as fast and eventually the process stops.

Q

P

Profit

Wages

Agricultural Marginal Product

Modern (Ind.) SectorTraditional (Ag.) Sector

Industrial Marginal Product

Redundant labor

Industrial Total Product

Agricultural TotalProduct

Marginal product curve

W

N3 N2 N1 N0 Labor

Labor Labor

P2

P1

P0

LaborL4L2L1L00

0

0

0

P3

Why might the marginal cost(supply) curve of labor turn up?

Surplus labor used up so industry must offer higher wages

Supply of food does not keep up with the demand for food so wages must rise

What does this say about the need for technological progress in agriculture?

Weaknesses in the model

Says nothing about the cost of moving people and food

May not have excess labor in some countries Says nothing about cost of and how to

develop the agricultural sector Assumes profits reinvested in labor-intensive

industries (what if not invested or invested in capital-intensive industries due to subsidies)?

Ignores international trade

Can extend model to open economy If natural resources are poor: can export

labor-intensive industrial goods (examples: Taiwan & Korea) and import food

If natural resources rich: can export agricultural products and use foreign exchange to develop industry (examples: Thailand & Malaysia)

Dependency theories (1950’s, 60’s, 70’s

Center – developed countries and elites within developing countries

Periphery – poor in developing countries

Center develops at the expense of the periphery

Why dependency?

Center has monopoly power Low price and income elasticities for goods

produced by the periphery High price elasticity of demand for goods

imported by the periphery from the center

Result: periphery receives less and less for exports and pays more and more for imports

Dependency theory suggests that countries become self-sufficient

What do you think?

Lessons from each theory

Classical theory – savings & capital investment important Diminishing returns to labor

Growth stage theories – structural change with development Class struggles over distribution

Dual economy theories – food is important wage good Surplus labor may facilitate capital formation Technological change in agriculture important

Dependency theories – interdependent world History important Political and social power important

More Recent Development Thinking Role of Human capital Importance of Institutional differences

Rule of lawEnforceable property rightsNeed to minimize policy distortions

Importance of freely flowing information

Transactions costs, Collective Action, and Institutions Costs of transacting are key obstacles

holding countries back from developing. Transactions costs include the costs of

adjustment, information, measuring attributes, and negotiating, monitoring, and enforcing contracts

Because of these costs, people take advantage of others

Transactions costs, Collective Action, and Institutions (continued) People often act collectively to influence

public decisions in ways that help them but hurt society at large

Therefore with transactions costs and collective action, institutions and asset distribution matter

Need institutions to control behavior through property rights, laws, and policies

Conclusions Agriculture can provide labor, food, and capital

for overall economic development Rising food prices relative to industrial prices is a

symptom of the need to invest in new technologies for agriculture

In light of transactions costs and collective action, and societies that become less personal as development occurs, institutions are needed that establish and enforce the “rules of the game”