DEVELOPMENT ECONOMICS I

MODULE I

Prepared by: Alem Araya

MEKELLE UNIVERSITY
FACULTY OF BUSINESS AND ECONOMICS
DEPARTMENT OF ECONOMICS

December 5, 2005
 Table of Contents
Page
Introduction 2
1. Meaning and Measurement of Economic Development 3
1.1 Growth and Development. 3
1.2 Current interest in development economics. 7
1.2.1 Academic Interest in Development 8
1.2.2 The New International Economic Order 11
1.2.3 The Mutual Interdependence of the World Economy 11
1.3 Measurement and international comparison of growth and development. 13
1.3.1 Conventional Measures of Development and their Limitations 13
1.3.2 Alternative measures of level of development - 18
a. Physical Quality of Life Index, 19
b. Human Development Index 20
c. Human Poverty Index 23
Review Questions on Chapter One 24
2 Dimensions of the problem of development in developing countries 25
2.1 An over view of the diverse structure of developing countries. 25
2.2 Common characteristics of developing countries 36
Review Questions on Chapter Two 54
3. Growth Models and Theories of development 55
3.1 Growth Models 55
3.1.1 The Harrod – Domar Growth Model 55
a. Harrod's Growth Model 56
b. Domar's Growth Model 62
3.1.2 Neoclassical Growth Models 69
a. Solow's Model of Long run Growth 70
b. Meade’s Neo Classical Model of Economic Growth 75
3.2 Theories of development 81
3.2.1 Rostow’s Stages of Economic Growth 81
3.2.2 Surplus Labour Theory 87
3.2.3 Dualistic Theories 91
a. Social Dualism 92
b. Technological Dualism 94
c. Financial Dualism 96
3.2.4 The Process Cumulative Causation 96
3.2.5 A Model of Low Level Equilibrium Trap 99
3.2.6 The Big-Push Theory. 104
3.2.7 The Balanced Growth 106
3.2.8 Unbalanced Growth Theory 108
Review Questions on Chapter III 111

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 Introduction

Generally, the major objectives of the course, development economics (both part I
and II), are to:
• understand the nature and characteristics of the developing countries;
• analyze the economic problems of developing countries, especially
problems related to slow growth, stagnation, high poverty rates, high
income inequality, high unemployment and;
• discuss strategies for accelerating growth, attaining sustainable
development, reducing unemployment and income inequality, eradicating
absolute poverty, and decreasing external imbalances

This module is designed to familiarize the students with the concepts, theories,
development problems and characteristics of developing countries. The module
is divided in to three parts. The first chapter discusses the concept of development
and its measures. The second chapter explores the dimensions of development
problems of developing countries and their characteristics. The last part of this
module assesses the different growth models and theories of development.

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 Chapter I

Meaning and Measurement of Economic Development

Introduction

Distance students, this chapter is an introduction to the course development

economics. Development economics deals with development problems of
developing countries. In other words, it is about the causes and cures of mass
poverty in the less developed nations. At the outset, therefore, we should be aware
of the relevant concepts and measuring methods of development devised by
different institutions and persons. Thus, the discussion of the historical evolution
of the concept development and the methods employed in measuring development
are vital. This chapter has the following major objectives:

To help students understand the meaning of development as distinguished
from economic growth,

To make clear why universities and academicians need to have a separate
subject, i.e. development economics, and why the world is giving an
attention to the development problems of developing countries, and

To identify different methods of measurement of development and discuss
their advantages and disadvantages.

1.1 Growth and Development

Distance students, we will begin our discussion of development economics by
defining the concepts of development and economic growth. The meaning of
economic growth is unambiguous. Almost all economists would accept the
increase in the output of goods and services of a country per unit time as its
definition. Output is measured by the gross national product (GNP) or gross
domestic product (GDP). Growth in GNP/GDP can be calculated either at market
price or factor cost.

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In order to measure the effect of growth on the standard of living of the
population, the GNP/GDP per capital is taken, which is also known as per capital
income. Per capital income can be measured in terms of home currency and for
international comparisons in terms of US dollar. However, the US dollar has
different purchasing power in the market of different countries especially for non-
traded goods. The problem associated with the use of official exchange rate in
converting GNP of a country measured in home currency to US dollar is
discussed in the third section of this chapter.

But development is an elusive term. The concept has been understood differently
in different time periods and by different persons. Its meaning has evolved
progressively to have the present meaning. In the 1950s and 1960s, for example,
development was considered as synonymous to economic growth. Accordingly,
in this period, it has been defined as the capacity of the economy to generate and
sustain fast growth rate of GDP (per capital income).

Others tried to explain development in terms of the process of structural

transformation of the economy. In this regard, development is the planned
alteration of the structure of production and employment so that agriculture’s
share of both declines and that of the manufacturing and service industries
increases.

Later on concerns are accorded to poverty, unemployment, inequalities of

income, and other economic, institutional, social and political factors owing to
the failure of developing countries to improve the standard of living of the poor.
Many developing countries experienced relatively high rates of growth of per
capita income during the 1960s and 1970s. But the countries showed little or no
improvement or even an actual decline in employment, equality, and the real
income of the poorest part of their population. Consequently, in addition to

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economic growth, Dudley Seers argues on the need of looking on what has been
happening to poverty, unemployment, and inequality as a determinant of
development rather than mere growth of per capita income.

Development is further broadened still after Seers. The phenomenon of

development is not merely a question of even the quantitative measurements of
income, employment, and inequality. In addition to these issues, development has
to incorporate other economic and non-economic factors. A concept of
development in general is required which embraces the major economic and
social objectives and values that societies strive for.

Presently, therefore, Todaro succinctly puts the definition of development as

follows: development is “conceived as a multi dimensional process involving
major changes in social structures, popular attitudes, and national institutions,
as well as the acceleration of economic growth, the reduction of inequality (and
unemployment), and the eradication of absolute poverty”.

Denis Goulet distinguishes three basic components or core values in this wider
meaning of development, which he calls life-sustenance, self-esteem and
freedom. All three of these core components are interrelated and are shortly
discussed below.

Life-sustenance: life-sustenance is concerned with the provision of basic needs.

No country can be regarded as fully developed if it cannot provide its entire
people with such basic needs as housing, clothing, food and minimum education.
A major objective of development must be to raise people out of primary poverty
and to provide basic needs simultaneously without which there is absolute under
development. Hence, economic development is a necessary condition (but not
sufficient condition) for the improvement of the quality of life in providing these
life sustenance needs and bringing development.

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Self-Esteem: self-esteem is concerned with the feeling of self-respect and
independence. It means to be a person, a sense of worth and self-respect, of not
being used as a tool by others for their own ends. Every society or individual
strives towards self-esteem. Without development the pride of the peoples of the
developing countries on their cultural identity and dignity are being eroded.

No country can be regarded as fully developed if it is exploited by others and

does not have the power and influence to conduct relations on equal terms. Now
days, economic wealth and technological power have become almost universal
measures of worth. Developing countries seek development for self-esteem; to
eradicate the feeling of dominance and dependence which is associated with
inferior economic status.

Freedom from servitude: Freedom is ability of people to determine their destiny.

It involves an expanded range of choices for societies and their members together
with a minimization of external constraints in the pursuit of devolvement. No man
is free if s/he cannot choose; if s/he is imprisoned by living on the margin of
subsistence with no education and no skills.

Economic prosperity expands the range of choices that people may have. It
enables to gain greater control over nature and physical environment. It gives the
freedom to choose greater leisure, to have more goods and services or deny
material wants.

Therefore, development is hardly possible without growth, but growth is possible

without development. A country may produce more of some types of its goods
and services. However, the benefits of this growth may exclusively be
appropriated by a privileged elite and small middle class. In this case the vast
majority of the country’s people may be completely unaffected or worsened. For
instance, the growth attained in the past in countries such as South Africa, Brazil,
and the oil rich countries was largely without development.

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However, growth without development is not sustainable. In the oil rich countries,
for example, their economies grow when price of oil increases. Nevertheless, this
growth is not sustainable, as prices cannot be increased indefinitely.
Development, on the other hand, is sustainable because it is a change in the
structural and institutional factors, social attitudes and customs accompanied with
a secular rise in real income through a change in output and occupational
structure and improvement in the relative contribution of inputs

1.2 Current Interest in Development Economic

The focus of the world to the development problems of under developed countries
have started recently. Though the study of economic development in general has
attracted the attention of economist’s right from the mercantilist school, classical
school down to Marx and Keynes, its study as a separate subject is a relatively
recent phenomenon. It is also after the end of the II world War that the majority
of the international bodies with the aim of promoting development that exist
today such as the World Bank and its affiliates, and agencies of the UN all have
been established.

Before the war, there was little preoccupation with the economic and social
problems of developing countries with which we are concerned today. One of the
reasons for this little preoccupation may be that the poor countries were colonies.
Moreover, the concern and attention of most people might be focused on
depression and unemployment in the developed countries.

The situation today is different. The development of underdeveloped countries

and primarily the eradication of absolute poverty are now regarded as one of the
greatest social and economic challenges facing humankind. A number of factors
can be pointed out that account for this change in attitude and upsurge of interests
in the economics of development and the economies of poor nations. These

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factors can broadly be classified into three: -
i. Academic interest in development
ii. The awareness of developing countries about their backwardness and their
demand for a new international economic order
iii. The awareness of the world in general and developed countries in
particular about the mutual interdependence of the world economy

1.2.1 Academic Interest in Development

Academic interest in the mechanics of growth and development is a renewed
interest rather than a new preoccupation of economists. The progress and
material well-being of human being and nations have traditionally been at the
center of economic writings and enquiry starting from the classical economists.
Adam Smith, David Ricardo, Thomas Malthus, John Stuart Mill and Karl Marx
all dealt at some length with the causes and consequences of economic advances.

Beyond the classical school, economic development theory traces its antecedents
to the physiocrats who have generally been considered as the first scientific
school of economics. From the 16th to the 18th century European economic
thought and practice had been dominated by the Mercantilists. the Mercantilists
believed that manufacturing and trade rather than agriculture constituted the basis
of a nation’s strength. Physiocratic theory was a reaction against the ideas of the
Mercantilists. According to them, agriculture was the source of all wealth since
they believed that agriculture alone-generated net surplus over the cost of
production while industry merely broke even and trade is considered even as
sterile.

The classical school, in the 18th and 19th countries, focused their attention on the
analysis of long-run economic growth. They studied the causes of economic
growth and its effects on other macro-economic variables as well as the

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constraints on sustainable growth in the long run. They believed that although
both agriculture and manufacturing can bring about growth in both output and
labour productivity, manufacturing has a greater capacity for increase in labour
productivity.

The process of economic growth starts from the extension of market,

specialization and division of labour which leads to increase in labour
productivity, accumulation of capital and its investments by the capitalists, shift
of labour form unproductive to productive activity, and hence enhanced national
income. However, most of the classical economists were pessimist about
sustainable economic development. They assumed that a country will reach at a
stationary state where growth is no longer possible in the system due to
population growth and the law of diminishing return.

Yet, this gloomy assumption would seem to be unfounded. Population growth and
diminishing returns have not been uniformly depressive to the extent that Ricardo
and Malthus supposed. The classical development economists greatly
underestimated the beneficial role of technical progress and international trade in
the process of economic development.

Development also represents a challenge much more complicated than that of

depression and mass unemployment like that of the 1930s. Since the pace of
development is affected by both economic and non-economic factors, most of the
traditional economic theories (micro and macro economics) faced problems in
solving development problems of poor countries. For example, micro-economic
theory which is used to solve problems such as equilibrium price, efficient
production; distribution of income, resources allocation, etc… faces problems in
solving economic development problems. This is because economic development
is influenced by factors like economic forces, political conditions, social and

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institutional factors which many of them are not dealt within micro economic
theory.

Similarly, macroeconomic theories, which are developed on the background of

economies of developed countries, fall short of solving the problems of
development. The non-economic factors, which are essential components of
development problems of the underdeveloped countries are not incorporated.
Moreover, macro-economic theory deals with comparative static economies while
development is a dynamic process which is a continuous process of change.

All these factors have led to a resurgence of academic interest in the growth and
development process of poor nations. Therefore, as the conventional economic
theories could not explain the development problems of these countries,
economists required recently a separate subject that deals with this issue.

1.2.2 The New International Economic Order

There is another major factor accounting for the upsurge of interest in the growth
and development process of the developing countries. This has been the poor
nations’ own increased awareness of their inferior economic and political status in
the World. For this reason, these countries desired strongly for material
improvement and greater political recognition through economic strength.
Countries are becoming more aware of their economic status. International
comparisons are being made by organizations like World Bank and UNDP in
their Annual Reports. Development is, therefore, wanted to provide people with
the basic necessities of life, for their own sake and to provide a degree of self-
esteem which are precluded by poverty.

The developing countries have also called for a fairer deal from the functioning of
the world economy. The developing countries view the present arrangement with

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some justifications, as biased in favor of countries that are already rich. The
official call for the establishment of a new international economic order would be
based on equity, sovereign equality, common interest and cooperation among all
states, irrespective of their economic and social system. It is aimed at correcting
inequalities and to redress existing injustices; make it possible to eliminate the
widening gap between the developed and the developing countries. It is to ensure
steadily accelerating economic and social development, and peace and justice for
present and future generations.

1.2.3 The Mutual Interdependence of the World Economy

The third major factor responsible for the growing interest and concern with the
development of the third world has been the increasing awareness particularly on
the part of developed countries that dependence is not one way. Previously, it
was believed that the relationship between developing and developed countries is
one way i.e. developing countries depend on developed countries. Today the
situation is changing.

The rich countries have been compelled out of economic and political necessity to
rethink their economic relations with the poorer nations of the world. On the
political front, when the world was divided between east and west it forced the
western capitalist and eastern communist countries to compete financially and
technically for getting the favor of larger part of the third world. On the economic
front, the fortunes of all countries, rich and poor are locked together by trade and
balance of payments. There exists interdependence in the world economy such
that the malfunctioning of one set of economies impairs the functioning of the
others.

Therefore, it is not only a moral issue for greater efforts to raise the living
standards of the third world countries. It is also purely practical case to be the

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interest of the developed countries themselves. The ability of poor countries to
sustain their growth and development means a greater demand for the goods and
services of developed countries.

Gradually, the mutual interdependence of the relationship between developed

countries and developing countries has been realized. Developed countries
depend on developing countries in a number of ways. These include: -
• Big market for the products of developed countries which generates output
and employment directly, and also help to maintain the balance of payment
stability of these countries
• Cheep source of labour and raw material
• Source of energy

1.3 Measurement and International Comparison of growth and

development
Distance students, we have discussed in the above two sections the meaning of
development and the reasons for the upsurge of great interest in solving the
problems of poor nations. It is now time to look at the major indicators of
development.

Different methods of measuring development and making international

comparisons have so far been devised. Among these the Income Measures, the
Physical Quality of Life Index, the Human Development Index, and the Human
Poverty Index are the widely employed indicators. In this section we will discuss
each of these measures of development and their limitations.

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 1.3.1 Conventional Measures of Development and their Limitations
Conventional Measures of Development: The dominant conventional measures
of growth and development are the Gross National Product (GNP) or Gross
Domestic Product (GDP) and their corresponding per capital values. GNP is
calculated as the total domestic and foreign value added claimed by a country’s
residents without making deductions for depreciation of the domestic capital
stock. The GDP measures the total value for final use of output produced by an
economy, by both residents and non-residents. Thus GNP comprises GDP plus
the difference between the income residents receive from abroad for factor
services (labour and capital) less payments made to nonresidents who contribute
to the domestic economy.

These national income (GNP/GDP) measures are used for the measurement of
economic development in several ways. For a given country over two or more
years, the absolute value of national income or per capital income is compared for
different years. The difference between the values for various years then reflects
the growth rate over the period. The level of per capita income is taken as a
measure of the average standard of living of the population, while the growth rate
measures improvements in the standard of living.

This income measure of development is also used to compare the economic

performance of different countries. Thus, the level of national income or per
capita income and their growth rates can be compared internationally. The
poverty datum line, as the measure of the critical minimum level of per capita
income below which individuals are deemed to be living in absolute poverty, is
also derived from the income measure of development.

Limitations of conventional income measures: Development is much broader

term than economic performance, although the latter is essentially a part of it. In

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essence, development ultimately refers to the quality of life and of human welfare.
Thus, in essence income indictors are incomplete and limiting measures of
development.

Aside from their defects as indicators of development, the calculations of the

GNP/GDP based measures suffer from a number of shortcomings. These include
the following.
• The GNP/GDP measure excludes non-market activities, transactions and
subsistence production. Since these occur to a significant degree in
developing countries, this means that a sizeable part of economic activities
are left unrecorded. This leads to the distortions of the GNP/GDP figures.
• National income accounting is also subject to a number of statistical
problems. These include the risk of double counting of intermediate
inputs; the underestimation and exclusion of unrecorded transactions,
which are rampant in developing countries, particularly across borders; the
statistical problems arising from the non-quantifiability of important
economic variables and activities. The less developed an economy, the
more serious these problems are likely to be.
• The use of national income data for the purpose of international
comparisons also engenders a number of additional complications.
Generally, the basis for comparison must be identical and up to date. In
spite of all efforts, statistical definitions are not uniformly used, applied or
interpreted by different countries.
• Another difficulty arises as a result of differences in the rate of inflation
among countries such that those with high rates of inflation can post very
high levels of national income. National income deflators can moderate
this problem if appropriately applied.

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 • The other problem in international comparison relates to the problem of
conversion of national incomes measured in national currencies into the
US dollar at the official exchange rate. The concern is the underestimation
of the living standard of developing countries. If the US dollar is used as a
unit of account, the national per capita income of a given country in US
dollar is given by GNP/Population x exchange rate.

However, official exchange rates between currencies of two countries are not
good measures of the purchasing power parity (PPP) between the countries,
especially between countries at different levels of development. The reason is
that exchange rates are largely determined by the supply of and the demand for
currencies based on goods that are traded the prices of which tend to be equalized
internationally.

PPP, however, depends not only on the price of traded goods but also on the
prices of non-traded goods. The prices of traded goods are largely determined by
unit labour cost which tend to be lower the poorer the country. PPP is, therefore,
the number of units of a foreign country’s currency required to purchase the
identical quantity of goods and services in the developing country’s local market
as $1 would buy in the United States. This point is elaborated more widely below.

We can take two commodities, TV set and a service of haircut, which are
respectively one traded and the other is non-traded. Suppose the dollar price of a
particular type of TV set in USA is $500 and the exchange rate of one dollar is
Birr 10. Without taking account of transport cost, tariff, etc, the price of the TV
set in Ethiopia will be equal to Br. 5000.

If we consider the non-traded good, however, there will be a different story.

Suppose in USA, haircut costs $5. At the official exchange rate of Birr 10 to the
dollar, the service in Ethiopia should be $50. But the actual cost of this service in

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Ethiopia may be Birr 10. This would mean that as far as haircut is concerned, the
value of the Birr is underestimated by a value of five times. Hence, the PPP rate
of exchange for this particular service is $1 to Birr 2 while the official exchange
rate is $1 to birr 10.

Clearly, if domestic prices in markets of developing countries are lower, PPP

measures of GNP per capita will be higher than estimates using foreign exchange
rates as the conversion factor. For example, China’s 1997 GNP per capita was
only 2.7% of that of the United States using the exchange-rate conversion. But it
rises to 12.5% when estimated by the PPP method of conversion. In 1997, the
ratio of the highest per capita income of Switzerland ($44,320) and Ethiopia
($110) at foreign exchange rate was 403 to 1. But in PPP, these two countries had
respectively a per capita income of $26,320 and $510 and the ratio is decreased
significantly to 51.6 to 1. Hence, the income gaps between rich and poor nations
thus tend to be less when PPPs are used. An illustration of the significant
difference of using either official exchange or PPP on the level of per capita
income of countries is indicated on table 1.1

Table 1.1 per capita GNP of selected countries at official exchange rate
and PPP
Country At official exchange rate At PPPs exchange rate
Switzerland 44,230 26320
Japan 37850 23400
United States 28740 28740
United kingdom 20710 20520
Canada 19290 21860
Brazil 4720 6240
Mexico 3680 8120
Colombia 2280 6720
Shicipsires 1220 3670
China 860 3570
Pakistan 490 1590
India 390 1650
Bangladesh 270 1050
Nigeria 260 880
Ethiopia 110 510
Source: World Bank, World Development Report, 1998/99 in Todaro, 2000.

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A part from the difficulty of measuring income and the difficulty of making inter-
country comparisons, using a single figure of per capita income as a means of
separating the developed from developing counties is some what arbitrary. This
is because it ignores essential factors that should be incorporated (these will be
discussed on the topic below).

Bearing in mind this arbitrariness of per capita income, it is still convenient to

have a readily available and easily understandable criterion for classifying
countries and perhaps per capita income is the best single index we have. It also
has an advantage in focusing on raison detre of development: raising living
standard and eradicating poverty.

In the last resort, per capita income is not a bad proxy for the social and economic
structure of societies. If developing countries are defined on the basis of per
capita income level, striking similarities are found between the characteristics and
development obstacles of many of the countries. Hence, per capita income may
be used as a starting point for classifying level of development and can certainly
be used to identify the need for development.

1.3.2 Alternative development Indicators

By the beginning of the 1970s a momentum started to gather around the need for
an earnest search of alternative indicators of development. Aside from the
aforementioned deficiencies encountered in measuring income itself, this search
has been prompted by the following considerations:

The failure of the GNP/GDP measures to reflect the impact of growth on
the pattern of income distribution

The inability of the GNP/GDP measures to reflect the welfare impact of
the goods and services produced as well as the likely costs to society of
certain patterns of growth.

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The invalidity of the GNP/GDP indicator as a measure of well being in
situations where growth has actually deepened poverty and income
inequalities, increased unemployment and affected the environment
adversely.

Therefore, the most important factor influencing the search for alternative
indictors has been the marked shift in thinking among development economists,
organizations and practitioners since the beginning of the 1970s about the
meaning of development and the processes leading to it.

Attempts to construct alternative indicators have followed different routes. Some

evolved around the modification of GNP/GDP based measures to incorporate
some of their glaring omissions, e.g. environmental impact, health conditions,
activities in the non-monetized sector, etc. Some others tried to construct an
explicit index of welfare to replace the use of income measures. And others gave
up the idea of a single indicator or index in favor of a set of indictors that show
the different elements of welfare separately.

Among the developed alternative indicators the major are the physical quality of
life index (PQLI) developed by Morris (1979), the Human Development Index
(HDI) developed by UNDP, and the Human Poverty Index. These are to be
discussed one by one below.

a. The physical Quality of Life Index (PQLI)

This composite index is based on three simple indicators: Infant mortality, life
expectancy, and literacy. This measure gives equal weight to each of the three
indictors. For each indicator, the performances of individual countries are rated
on a scale of 1 to 100, where 1 represents the worst performance and 100 the best
performance. For life expectancy the upper limit of 100 was assigned to 77 years

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(achieved by Sweden in 1973) and the lower limit of 1 was assigned to 28 years
(the life expectancy of Guinea Bissau in 1950). Within the limits, each country’s
life expectancy figure is ranked from 0 to 100. Similarly, for infant mortality, the
upper limit was set at 9 per 1,000 (achieved by Sweden in 1973) and the lower
limit at 229 per 1000 (Gabon 1950). Literacy rates measured as percentages from
0 to 100 provide their own direct scale. The PQLI of each country is given by the
following formula.
PQLI = Life expec. index + infant mort. index + literacy index
3

The PQLI indirectly reflects the effects on human development of investment in

health service, water and sewage systems, quality of food and nutrition, education,
housing, and changes in income distribution. One positive aspect of the PQLI is,
therefore, that it helped redirecting attention away from growth, toward a broader
concept of human development.

However, the PQLI has been criticized as an indicator of social development in

relation to both the choice of indicators as well as the weight assigned to the
different indicators.
• It is handicapped by the limited data availability
• It gives disproportionate weight to longevity as two of the three
indicators, infant mortality and life expectancy are related to it.
• It gives equal weight to each indicator arbitrarily without obvious
rationale
• It treats economic and social indictors separately, instead of combining
them in a composite index.

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 b. The Human Development Index (HDI)
HDI is ranking various countries according to the relative success they have had
with the human development of their population. UNDP is offering the HDI as
an alternative to the GNP for measuring the relative socio-economic progress of
nations. HDI has also attempted to take account of some of the limitations of the
PQLI. HDI is based on three variables:
• longevity:- as measured by life expectancy at birth
• educational attainment:- as measured by a condition of adult literacy
(two third weight) and a combined primary, secondary, and tertiary
school enrollment ratios (one third weight)
• Standard of living measured by real per capita income at PPP. The
marginal value of money income above the world average threshold of
$5120 real GDP per capita is assumed to be rapidly diminishing

To construct the index fixed minimum and maximum values are taken for each of
the variables. For life expectancy at birth the range is 25-85 years. For adult
literacy, the range is 0 – 100 percent. For real per capita income the range is $100
– 40,000. For any component of the HDI, the individual indices can be computed
according to the general formula of:

Index = Actual value – Minimum value

Maximum value – Minimum value

• Life Expectancy Index =

• Education Index =

• Adult Literacy Index (ALI) =

• Gross Enrolment Index (GEI) =

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 • GDP Index =

Where: LE: Life expectancy

ALR: Adult literacy rate
CGER: Combined gross enrolment ratio
GDPpc: GDP per capita at PPP in USD

The index thus ranges from 0 to 1. If the actual value is equal to maximum the
index is one. The HDI ranks countries into three groups: low human development
(0.0 to 0.49), medium human development (0.50 to 0.79) and high human
development (0.80 to 1.00). For any given year, HDI measures relative not
absolute level of human development and that its focus is on the ends of
development (longevity, educational achievement and standard of living).

One of the major innovations of HDI over the past few years has occurred
through disaggregating the country’s overall HDI into separate components to
distinguish between Man and Women, different social classes reflecting skewed
income distributions, and different regions and ethnic groups. Hence, the UN HDI
has made a major contribution in improving our understanding of what constitutes
development, which countries are succeeding and the share of different groups
and regions within countries.

By combining social and economic data also, the HDI allows nations to take a
broader measure of their development performance, both relatively and absolutely
and thus to focus their social and economic policies more directly on those areas
in need of improvement. Nevertheless, HDI has been criticized on grounds such
as:

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 • It does not include non-quantitative elements of human development such as human
freedom, the existence of civil liberties and the degree of political participation
• It is biased in the choice of indications
• Its assumption of the rapidly diminishing marginal value of money income above the
world average threshold of $ 5120 real GDP per capita distorts some HDI estimates
and limits its applicability.
• Its statistical methodology may also be compromised by insufficient or inaccurate
data.
With all these criticisms, the fact remains that the HDI when used in conjunction
with the traditional economic measure of development greatly increases our
understanding of which countries are really experiencing development and which
are not. More importantly, by examining each of the three major components of
the HDI and by disaggregating a country’s overall HDI to reflect income
distribution, gender, regional and ethnic differentials, we are now able to identify
not only whether a country is developing but also whether various groups within
that country are participating in that development.

C. Human Poverty Index (HPI)

The United Nations has constructed human poverty indices for developing countries.
The composite measure focuses on dimensions of deprivations. The HPI for
developing countries is based on three main indices:
• The percentage of the population not expected to survive to the age of 40 (P1)
• The adult illiteracy rate (P2)
• A deprivation index based on an average of three variables: the percentage of
the population without access to safe water; the percentage of population
without access to health service; and the percentage of the under weight
children under five years old (P3). The formula is given by:
HPI = [1/3(P13 + P23 + P33)] 1/3

22
Review Questions on Chapter One
1. Shortly show different definitions of development that have so far been used.
2. Explain the advantages of understanding the definition of development in
order to formulate helpful development strategies and policies
3. Why is a strictly economic definition of development inadequate? Use
empirical evidences as examples of countries developing economically but
are underdeveloped.
4. Explain briefly why developing countries are recently pressing on their
development? Why are economists interested in having a separate subject
i.e., development economics?
5. What are the major problems encountered in measuring GNP/GDP? What
are the limitations of the conventional measures of development?
6. Shortly explain the advantages of Human Development Index over the
conventional measures of development.

23
 Chapter II

Dimensions of the Development Problems of Developing Countries

Distance students, we have already seen the concept of development and its

measurements. We will use these concepts and their measurements as

guideline in understanding the depth and width of the problems of countries of

the third world. Thus, this chapter gives a short account of the dimensions of

the development problems of poor nations. These countries have both

similarities and difference among them in economic, geographical, historical,

political, social, cultural and institutional factors. Here, it is attempted to

shortly familiarize the student with the diversities and common characteristic

features of developing countries. The chapter is divided into two parts. We

will start our discussion with the differences among developing countries and

proceed to their common characteristic features.

2.1 An Overview of the Diverse Structure of Developing Countries

This section portrays the structural diversity of developing nations. With this
intention we will make an examination of eight critical components. These are
1. The size of the country (geographic area, size of population, and income
levels)
2 . Its historical and economical background
3 . It endowments of physical and unman resources
4 . Its ethnic and religious composition

24
 5 . The relative importance of its public and private sector
6 . The nature of its industrial structure
7 . Its degree of dependence on external economic and political forces
8 . The distribution of power and the institutional and political structure
within the nation.

Distance students, each of the above components are discussed in detail below. In
doing this we will focus on regional comparisons of the developing countries of
Africa, Asia, and Latin America and their sub regions.

Size and Income Level

Evidently, economic potential of a country is significantly determined by its
physical and population size, and its level of national income per capita. These
are also major factors differentiating one developing country from another. In the
world of developing countries, larger and populated nations such as Brazil, India,
Nigeria and Ethiopia exist side-by-side with small countries like Paraguay, Nepal
and Djibouti.

This size provides both advantages and disadvantages. Large size usually
presents advantages of diverse resource endowment, large potential markets, and
lesser dependence on foreign sources of materials and products. But it also
creates problems of administrative control, national cohesion, and regional
imbalances.

However, it is to be born that there is no necessary relationship among a country’s

size, its level of per capita income, and the degree of equality or inequality in the
distribution of that income. For example, as compared to Ethiopia, the
neighboring country, Kenya is smaller in geographic and population size. But
Kenya has about 3 times the per capita income of Ethiopia at official exchange
rate. But Kenya has also lesser per capita income than Brazil and some other
larger developing countries.

25
Historical Background
The other sources of diversity among the developing countries are their traditional
and colonial heritages. Apparently, countries have their own different cultural
background accumulated in their history making them to have different social and
economic institutions. Moreover, developing nations were at one time or another
colonies of Western European countries. The European colonial powers had a
dramatic and long-lasting impact on the economies, political and institutional
structures of their African and Asian colonies. The economic structures of these
nations, as well as their educational and social institutions have typically been
modeled on those of their former economic rulers.

Hence, the diversity in colonial heritage together with the indigenous cultural
differences have resulted different structural problems in these countries.
Depending on their colonial heritage therefore the countries are required to take
different measures. Countries like those in Africa that only recently gained their
independence are likely to be more concerned with consolidating and evolving
their own national economic and political structures than with simply promoting
rapid economic development. Their policies may consequently, reflect a greater
interest in these immediate political issues.

Latin American countries have a longer history of political independence plus a

more shared colonial heritage. Therefore, in spite of geographic and demographic
diversity the countries possess relatively similar economic, social, and cultural
institutions and face similar problems. In Asia, on the other hand, different
colonial heritages and the diverse cultural traditions of the indigenous peoples
have combined to create different institutional and social patterns.

Physical and Human Resources

Endowments of physical and human resources are other sources of disparities in
economic growth potential of the counties. If we start with the physical resource

26
endowments, on the one hand there are countries which are extremely and
favorably endowed in resources such as minerals, raw materials, and fertile land.
On the other hand, there are also poorly endowed nations where endowments of
raw materials and minerals and even fertile land are relatively minimal.

Moreover, geography and climate can also play an important role in the success
or failure of development efforts. Other things being equal, it is said that island
economies seem to do better than landlocked economies. With respect to climate
also temperate zone countries do better than tropical zone nations.

Developing countries are also distinguished one from the other in their human
resource endowments. The human resource endowments includes not only the
number of people and their skill levels but so also their cultural outlooks, attitudes
toward work, access to information, willingness to innovate, and desire for self-
improvement.

Furthermore, the level of administrative skill will often determine the ability of
the public sector to alter the structure of production and the time it takes for such
structural alteration to occur. This has to do with the whole complex of
interrelationships between culture, tradition, religion, and ethnic and tribal
fragmentation or cohesion. Thus the nature and character of a country’s human
resources are important determinants of its economic structure and these clearly
differ from one region to the next.

Ethnic and Religious Composition

Ethnicity and religion often play a major role in the success or failure of
development efforts. Evidently, the greater the ethnic and religious diversity of a
country the more likely it is that there will be internal strife and political
instability. There is also distinction in ethnic and religious composition among
nations. Presently more than 40% of the world’s nations have more than five
significant ethnic populations.

27
In most cases, one or more of these groups face serious problems of
discrimination. Over half of the world’s less developed countries have recently
experienced some form of interethnic conflict. Just in the first half of the 1990s,
ethnic and religious conflicts leading to wide spread death and distinction took
place in many African countries and some countries of other regions.

But neither overt physical conflict nor widespread violence is necessary to disrupt
an economy or cause political instability. If development is about improving
human lives and providing a widening range of choice to all peoples, racial,
ethnic, or religious discriminations can be equally destructive. For example
through out Latin America, indigenous populations have significantly lagged
behind other groups on almost every measure of economic and social progress. In
these countries, being indigenous makes it much more likely that an individual
will be less educated, in poorer health, and in a lower socio economic structure
than other citizens. This is particularly true for indigenous women.

Ethnic and religious diversity need not, however, necessarily lead to inequality,
turmoil, or instability. There have been numerous instances of successful
economic and social integration of minority or indigenous ethnic populations in
countries as diverse as Malaysia and Mauritius. The point is that the ethnic and
religious composition of a developing nation and whether or not that diversity
leads to conflict or cooperation can be important determinants of the success or
failure of development efforts. Too often economists neglect to recognize this
fundamental fact.

Relative Importance of the Public and Private Sectors

Most developing countries have mixed economic systems, featuring both public
and private ownership and use of resources. The division between the two and
their relative importance are mostly determined by the historical and political

28
circumstances of the countries. Thus, in general, Latin American and South East
Asian nations have larger private sectors than South Asia and African nations.

The degree of foreign ownership on the private sector is another important

variable to consider when differentiating among less developed countries. A large
foreign owned private sector usually creates economic and political opportunities
as well as problems not found in countries where foreign investors are less
prevalent.

Economic policies, such as those designed to promote more employment, will

naturally be different for countries with large public sectors and ones with
sizeable private sectors. Direct government investment projects and large rural
work programs may take precedence in economies dominated by the public
sectors. In the private oriented economies, however, special tax allowances
designed to induce private businesses that can employ more workers might be
more common. Therefore, although the problem to be solved may be similar, the
solution can differ in countries with significant differences in the relative
importance of the public and private sectors.

Economic Structure
Developing countries are predominantly agrarian in economic, social, and cultural
out look. Labour force in most of these countries is overwhelmingly engaged in
agriculture. The agricultural sector contributes significantly also to the GDP of
many of the poor nations. Farming is not merely an occupation but a way of life
for most people in Asia, Africa, and Latin America.

Nevertheless, there are great differences between the structure of agrarian systems
and patterns of land ownership in Latin America and Africa. Asia agrarian
systems are somewhat closer to those of Latin America in terms of patterns of

29
land ownership. But even then the similarities are lessened by substantial by
cultural differences.

It is in the relative importance of both the manufacturing and service sectors that
we find the widest variation among developing nations. Most Latin American
countries possess more advanced industrial sectors. But in the 1970s and 1980s
countries like Taiwan, South Korea, and Singapore are rapidly becoming
industrialized states.

The table below provides information on the distribution of labour force and GDP
between agriculture and industry in some developing and developed countries.
The contrast among the industrial structures of these countries is striking,
especially in terms of the relative importance of agriculture.

Table 2.1: Industrial Structure of some Countries

Percentage of labour force Percentage of GDP
Agriculture Industry Agriculture Industry
Nigeria 54 5 43 25
Tanzania 90 5 48 21
Uganda 86 4 46 16
Bangladesh 64 14 30 18
India 65 13 28 28
South Korea 21 27 6 43
Guatemala 60 12 24 20
Peru 37 19 7 37
Venezuela 16 28 4 47
All Developing
Countries 60 17 20 38
USA 2 25 2 29
UK 1 24 2 37

Source: UNDP, Human Development Report, in Todaro, 2000.

In spite of common problems, therefore, development strategies may vary from

one country to the next, depending on the nature, structure, and degree of
interdependence among its primary, secondary, and tertiary industrial sector.

30
External Dependence: Economic, political, and Cultural
The degree to which a country is dependent on foreign economic, social, and
political forces is related to its size, resources endowment, and political history.
For most developing countries, this dependence is substantial. In some cases, it
touches almost every facet of life.

Most small nations are highly dependent on foreign trade with the developed
world. Almost all small nations are dependent on the importation of foreign and
often inappropriate technologies of production. This fact alone exerts an
extraordinary influence on the character of the growth process in these dependent
nations.

But even beyond the strictly economic manifestations of dependence in the form
of the international transfer of goods and technologies is the international
transmission of institutions and values. Most notably are systems of education and
governance, and attitudes toward life, work, and self. The transmission
phenomenon brings mixed blessings to most less developed countries especially
to those with the greatest potential for self reliance. A country’s ability to chart
its own economic and social destiny is significantly affected by its degree of
dependence on these and other external forces.

Political Structure, Power, and Interest Groups

In the final analysis, it is often not the correctness of economic polices alone that
determines the outcome of national approaches to critical development problems.
The political structure and the vested interests and allegiances of ruling elites (e.g.,
large landowners, urban industrialists, bankers, foreign manufacturers, the
military, trade unionists) will typically determine what strategies are possible and
where the main barriers to effective economic and social change may lie.

31
The concentration of interests and power among different segments of the
populations of most developing countries is itself the result of their economic,
social, and political histories and is likely to differ from one country to the next.
Nevertheless, whatever the specific distribution of power among the military, the
industrialists, and the large landowners of Latin America; the politicians and high
level civil servants in Africa; the oil Sheiks and financial moguls of the Middle
East; or the land lords, money lenders, and wealthy industrialists of Asia – most
developing countries are ruled directly or indirectly by small and powerful elites
to a greater extent than the developed nations are.

Effective social and economic changes thus require either that the support of elite
groups be enlisted or that the power of the elite be offset by more powerful
democratic forces. Either way economic and social development will often be
impossible without corresponding changes in the social, political, and economic
institutions of a nation. Such institutional changes may include: land tenure
systems, forms of governance, educational structures, labour market relationships,
property rights, the distribution and control of physical financial asset, laws of
taxation and inheritance and provision of credit.

2.2 Common Characteristics of Developing Countries

Distance students, the foregoing discussions have demonstrated why it is
sometimes risky to generalize too much about such a diverse set of nations.
Nevertheless common economic features of developing countries permit us to
view them in a broadly similar framework.

This section portrays various dimensions of the development gap between rich
and poor countries and similarities of poor nations. These include level and
growth rate of income, unemployment and underemployment, population growth
rate, economic structure, political and institutional factors, and degree of

32
 dependence. We will attempt to identify these similarities and provide illustrative
data to demonstrate their importance. For convenience, we can classify these
common characteristics into seven broad categories.
I. Low levels of living, characterized by low income inequality, poor health, and
inadequate education
II. Low levels of productivity
III. High rates of population growth and dependency burden
IV. High and rising levels of unemployment and underemployment
V. Substantial dependence on agricultural production and primary product
exports
VI. Prevalence of imperfect markets and limited information
VII. Dominance, dependence, and vulnerability in international relations.

i. Low levels of Living

In developing nations, general levels of living tend to be very low for the vast
majority of people. This is true not only in relation to their counterparts in rich
nations but often also in relation to small elite groups within their own societies.
These low levels of living are manifested quantitatively and qualitatively in the
form of low income (poverty), inadequate housing, poor health, limited or no
education, high infant mortality, low life and work expectancies, and in many
case a general sense of malaise and hopelessness. Let us look at some recent
statistic as comprising certain aspects of life in the underdeveloped countries and
in the more economically advanced nations.

Per Capita National Income: as you have seen it in chapter one, the GNP per
capita is often used as summary index of the relative economic well-being of
people in different nations. One common distinguishing feature of developing
countries as compared to developed nations is the extremely low level of income.
In 1997, the total national product of all the nations of the world was valued at

33
more than $29 trillion, of which more than $22 trillion originated in the
economically developed regions and less than $7 trillion was generated in the less
developed nations.

The difference in income between rich and poor nations will be apparent when
one takes account of the distribution of world population. In this terms, this
means that almost 80% of the world’s income is produced in the economically
developed regions by 20% of the world’s people. Thus the remaining four-fifths
of the world’s population is producing only one-fifth of total world output. In the
year of 1997, the collective per capita incomes of the under developed countries
averaged less than one-twentieth the per capita incomes of rich nations.

Growth Rates of Income: Many developing countries not only have much lower
levels of per capita income but also have experience slower GNP growth than the
developed nations. For example, the average growth rate slowed considerably
during the 1980s. The real per capita GDP even declined by 0.2% in 1990 and in
1991 before rising again for the next five years. Between 1985 and 1995 economic
growth in Latin America and the Caribbean averaged 0.3% and in Africa -1.1 %
per capita, while growth in the developed countries was averaging 1.9% per annum.

Table 2.2: Global Income Disparity between the Richest and Poorest 20 Percent of
the World's Population, 1960-1991

Percentage of Global Income Ratio of Income Shares

Year Poorest 20% Richest 20% Richest to Poorest

1960 2.3 70.2 30 to 1

1970 2.3 73.9 32 to 1
1980 1.7 76.3 45 to 1
1991 1.4 85.0 61 to 1

Sources: United Nations Development Program, Human Development Report, 1992 & 1994 in Todaro
2000.

34
In fact, during the 1980s and early 1990s, the income gap between rich and poor
nations widened at the fastest pace in more than the other three decades. The
impact of this widening gap is striking. If, for example, we take the income levels
of the richest 20% of the world's population in comparison with the poorest 20%,
we find that whereas in 1960 the income ratio was 30 to 1, at the end of 1991 the
rich were receiving 61 times the income of the poor. Table 2.2 gives the details of
the ever-growing income disparity between the richest and poorest 20% of the
world's population.

Distribution of National Income: The growing gap in per capita incomes between
rich and poor nations is not the only manifestation of the widening economic
disparity between the world's rich and poor. To appreciate the breadth and depth of
Third World poverty, it is also necessary to look at the growing gap between rich
and poor within individual LDCs.

All nations of the world show some degree of income inequality. There are large
disparities between the income of the rich and of the poor in both developed and
underdeveloped countries. Nevertheless, the gap between rich and poor is
generally greater in less developed nations than in developed nations.

Comparing the share of national income that accrues to the poorest 40% of a
country's population with that of the richest 20% can be used as an arbitrary
measure of the degree of inequality. In this case, we discover many African and
Latin American countries to be with substantial income inequality. Nevertheless,
most Asian countries have either moderate inequality or lesser inequalities in
overall income distribution.

Moreover, there is no obvious relationship or correlation between levels of per

capita income and degree of income inequality. Kenya, with the same low per
capita income as India, has a much wider income disparity between the top 20%

35
and bottom 40% of the population. Similarly, Kuwait, with almost the same high
per capita income as Belgium, has a much lower percentage of its income
distributed to the bottom 40% of its population.

Extent of Poverty: The magnitude and extent of poverty in any country depend
on two factors: the average level of national income and the degree of inequality
in its distribution. Clearly, for any given level of national per capita income, the
more unequal the distribution, the greater the incidence of poverty. Similarly, for
any given distribution, the lower the average income level, the greater is the
incidence of poverty. But how is one to measure poverty in any meaningful
quantitative sense?

During the 1970s, as interest in problems of poverty increased, development

economists took the first step in measuring its magnitude within and across coun-
tries by attempting to establish a common poverty line. They went even further
and devised the now widely used concept of absolute poverty. It is meant to rep-
resent a specific minimum level of income needed to satisfy the basic physical
needs of food, clothing, and shelter in order to ensure continued survival. One
common methodology has been to establish an international poverty line at, say, a
constant U.S. $370 per year (based, for example, on the value of the 1985 dollar)
and then attempt to estimate the purchasing power equivalent of that sum of
money in terms of a developing country's own currency.

We see that in the last decade of the 20th century, some 1.3 billion people, or 32%
of the developing world population, were living in absolute poverty. Looking at
individual regions we find the highest poverty rate (43%) in South Asia
(Bangladesh, India, Pakistan, etc.) where the largest number of poor people live
(515 million). But sub-Saharan Africa with 219 million absolute poor has by far
the fastest poverty growth rate. It is estimated that during the first decade of the
21st century, African poverty rates will approach 50 percent.

36
Health: In addition to struggling on low income, many people in developing
nations fight a constant battle against malnutrition, disease, and ill health. Life
expectancy in 1998 still averaged only 48 years, compared to 63 years among
other Third World countries and 75 years in developed nations. Infant mortality
rates (the number of children who die before their first birthday out of every
1,000 live births) average about 96 in the least developed countries, compared
with approximately 64 in other less developed countries and 8 in developed
countries.

In the mid-1970s, more than 1 billion people, almost half the population of the
developing world (excluding China), were living on diets deficient in essential
calories. One-third of them were children under 2 years of age. These people were
concentrated in the poorest countries. In the 1990s, the situation continued to
deteriorate in sub-Saharan Africa, with deep declines in food consumption and
widespread famine. In both Asia and Africa, over 60% of the population barely
met minimum caloric requirements necessary to maintain adequate health.

The extent of human deprivation in terms of some key health indicators is also
another indicator of the low standard of living of these nations. For example, 766
million people in poor countries are without access to health services, 1.2 billion
do not have access to safe drinking water, 1.9 billion (almost half the population)
live without sanitation facilities, and 158 million children under age 5 are
malnourished. Another often-used measure of child malnutrition is the percentage
of children who are underweight. In the early 1990s, statistics revealed that 67%
of the children in Bangladesh were underweight, 63% in India, 43% in South
Africa, 42% in Vietnam, 38% in Ethiopia, and 36% in Ghana and Nigeria.

The access to clean drinking water is one of the most important measures of
sanitation. Waterborne diseases such as typhoid fever, cholera, and a wide array
of serious or fatal diarrhea illnesses are responsible for more than 35% of the

37
deaths of young children in developing countries. Most of these diseases and
resulting deaths would be quickly eliminated with safe water supplies.

To make matters worse, medical care is an extremely scarce social service in

many parts of the developing world. In 1995, the number of doctors per 100,000
people averaged only 4.4 in the least developed countries, compared with 217 in
the developed countries. The ratio of hospital beds to population is similarly
divergent between these two sets of nations.

Moreover, when one realizes that most of the medical facilities in developing
nations are concentrated in urban areas where only 25% of the population
resides, the woefully inadequate provision of health care to the masses of poor
people becomes strikingly clear. For example, in India, 80% of the doctors
practice in urban areas where only 20% of the population resides. In Bolivia,
only one- third of the population lives in cities, but 90% of the health facilities
are found there. In Kenya, the population-to-physician ratio is 672 to 1 for the
capital city of Nairobi and 20,000 to 1 in the rural countryside where 87% of the
Kenyan population lives. In terms of health expenditures, more than 75% of
LDC government outlays are devoted to urban hospitals that provide expensive,
Western-style curative care to a minority of the population.

Finally, no discussion of health problems would be complete without mentioning

the terrible human toll that AIDS is inflicting on millions of people in
developing countries. After tuberculosis, AIDS is now the second leading
infectious cause of death among adult men and women. To date, an estimated 6
million people worldwide have died of AIDS and more than 30 million have
contracted the human immunodeficiency virus (HIV) that causes it. 90% of all
these people live in LDCs. At the beginning of 1998, out of the total number of
these victims 66% of them were residing in Africa while Asia and Latin America
had 21% and 4.3% respectively.

38
Education: the spread of educational opportunities is the final indicator of the
very low levels of living that is pervasive in developing nations. The attempt to
provide primary school educational opportunities has probably been the most
significant of all LDC development efforts. In most countries, education takes
significant share of the governments’ budget.

Yet in spite of some impressive quantitative advances in school enrollments,

literacy levels remain strikingly low compared with the developed nations. For
example, among the least developed countries, literacy rates average only 45% of
the population. The corresponding rates for other Third World nations and the
developed countries are approximately 64% and 99%, respectively. There is high
level of children dropout of primary and secondary school, and out of the
estimated illiterate adults, more than 60% are women. Moreover, the education of
children who do attend school regularly is often irrelevant to the development
needs of the nation in which they live.

We can summarize the major illustrations of low standard of living of the poor
nations by listing the following points. Firstly, there is low relative levels and, in
many countries, slow growth rates of national income. Moreover, the real per
capita income is either growing at a low level or in many countries stagnating.
The pattern of income distribution of the poor countries is highly skewed with the
top 20% of the population receiving 5 to 10 times as much income as the bottom
40%. Consequently, great masses of Third World populations are suffering from
absolute poverty, with up to 1.3 billion people living on subsistence incomes of
less than $370 per year.

The low standard of living is also manifested in the social aspects. Large
segments of the populations are suffering from ill health, malnutrition, and
debilitating diseases, with infant mortality rates running as high as 10 times those

39
in developed nations. In education, these countries are characterized by low levels
of literacy, significant school dropout rates, and inadequate and often irrelevant
educational curricula and facilities.

Most important is the interaction of all six characteristics, which tends to rein-
force and perpetuate the pervasive problems of "poverty, ignorance, and
disease" that restrict the lives of so many people in the developing world.

ii. Low levels of Productivity

In addition to low levels of living, developing countries are characterized by rela-
tively low levels of labor productivity. The concept of a production function is
often used to describe the way in which societies go about providing for their
material needs. Production function is systematically relating outputs to different
combinations of factor inputs for a given technology.

But in less developed countries the concept of technical engineering concept of a

production function must be broadened by adding some important factors. Among
its other inputs, this includes managerial competence, access to information,
worker motivation, and institutional flexibility. Throughout the developing world,
levels of labor productivity are extremely low compared with those in developed
countries.

This can be explained by a number of basic economic concepts. For example, the
principle of diminishing marginal productivity states that if increasing amounts of
a variable factor (labor) are applied to fixed amounts of other factors (e.g., capital,
land, materials), the extra or marginal product of the variable factor declines
beyond a certain number.

40
Low levels of labor productivity can therefore be explained by the absence or
severe lack of "complementary" factor inputs such as physical capital or
experienced management. To raise productivity, according to this argument,
domestic savings and foreign finance must be mobilized. This is to generate new
investment in physical capital goods and build up the stock of human capital (e.g.,
managerial skills) through investment in education and training.

Institutional changes are also necessary to maximize the potential of this new
physical and human investment. These changes might include such diverse
activities as
• the reform of land tenure, corporate tax, credit, and banking structures;
• the creation or strengthening of an independent, honest, and efficient
administrative service; and
• the restructuring of educational and training programs to make them more
appropriate to the needs of the developing societies. These and other non
economic inputs into the social production function must be taken into
account if strategies to raise productivity are to succeed.

One must also take into account the impact of worker and management attitudes
toward self-improvement; people's degree of alertness, adaptability, ambition, and
general willingness to innovate and experiment; and their attitudes toward manual
work, discipline, authority, and exploitation. Added to all these must be the
physical and mental capacity of the individual to do the job satisfactorily. The
economic success stories of "The Four Asian Tigers" -South Korea, Singapore,
Hong Kong, and Taiwan-are often attributed to the quality of their human
resources, the organization of their production systems, and the institutional
arrangements undertaken to accelerate their productivity growth.

41
The conditions of physical health most clearly reveals the close linkage that exists
between low levels of income and low levels of productivity in developing
nations. It is well known, for example, that poor nutrition in childhood can
severely restrict the mental and the physical growth of individuals. Poor dietary
habits, inadequate food, and low standards of personal hygiene in later years can
cause further deterioration in a worker's health and can therefore adversely
influence attitudes toward the job and the other people at work.

The worker's low productivity may be due in large part to physical lethargy and
the inability, both physical and emotional, to withstand the daily pressures of
competitive work. We may conclude, therefore, that low levels of living and low
productivity are self-reinforcing social and economic phenomena in poor
countries. It can also be said that they are the principal manifestations of and
contributors to their underdevelopment.

iii. Population Growth and Dependency Burdens

Statistics on demographic evolution by country show that the present rhythm of
global population growth is largely the result of the acceleration of growth in the
developing regions. Consequently, the population of the Third World rose from
1.7 billion in 1950, to 3.313 billion in 1980 and 4.036 billion in 1990. During the
same year, the population of the developed countries stood respectively at 832
million, 1.137 billion and 1.210 billion. The demographic load of the Third World
has been accentuated. it share from the total population has been continuously
increasing to be 66.9% in 1950, 74.4% in 1980, 76.9% in 1990 and around 80% at
the end of the 20th century and beginning of the 21st century. The percentage of
the population of the developed countries has fallen from 33.1% to 20% in the
course of the same period.

42
This swift population growth in developing countries is due to their higher birth
rate as compared to death rate, though death rate also is high. Birthrates (the
yearly number of live births per 1,000 population) in less developed countries are
30 to 40, whereas those in the developed countries are less than half that figure.
The crude birthrate is probably one of the most efficient ways of distinguishing
the less developed from the developed countries. There are few less developed
countries with a birthrate below 20 per 1,000 and no developed nations with a
birthrate above it.

Death rates (the yearly number of deaths per 1,000 populations) in Third World
countries are also high relative to the developed nations. However, these poor
nations have benefited from the progress of medicine for the masses and the
campaigns against endemic disease. This was followed by fall in mortality. Hence,
the differences in death rate between developing and developed countries are
substantially smaller than the corresponding differences in birthrates. As a result,
the average rate of population growth is now about 2.0% per year in Third World
countries (2.3% excluding China). Even there are certain African countries
approaching and even exceeding 3% per annum. This is as compared to
population growth of 0.5% per year in the industrialized world. According to UN
projections, now a days four out of five inhabitants of the planet are coming from
the developing countries.

These high birthrates have considerable socioeconomic implication. Children

under the age of 15 make up almost 40% of the total population in these countries.
This is as opposed to less than 21% of the total population in the developed
countries. Thus in most developing countries, the active labor force has to support
proportionally almost twice as many children as it does in richer countries. By
contrast, the proportion of people over the age of 65 is much greater in the
developed nations.

43
Both older people and children are often referred to as an economic dependency
burden. This means that they are nonproductive members of society and
therefore must be supported financially by a country's labor force (usually defined
as citizens between the ages of 15 and 64). The overall dependency burden (i.e.,
both young and old) represents only about one-third of the populations of
developed countries but almost 45% of the populations of the less developed
nations. Moreover, in the latter countries, almost 90% of the dependents are
children, whereas only 66% are children in the richer nations.

We may conclude, therefore, that not only are Third World countries character-
ized by higher rates of population growth, but they must also contend with greater
dependency burdens than rich nations. The circumstances and conditions under
which population growth becomes a deterrent to economic development is a crit-
ical issue.

iv. High Unemployment and Underemployment

One of the principal manifestations of and contributors to the low levels of living
in developing nations is their relatively inadequate or inefficient utilization of
labor in comparison with the developed nations. In the 1980s the unemployment
and underemployment problem became increasingly pronounced and emerged as
one of the most serious development problems.

Unemployment increased as a result of the fact that employment has been

growing during the past at a rate which is much slower than the rate of growth of
the labour force. Stagnating economic growth, the austerity programs
implemented as a result of the Structural Adjustment Programs (SAPs) and high
levels of rural-urban migration combined to precipitate this situation. For example,
the ILO estimates that in the 1990s productive employment in sub-Saharan Africa
increased by only 2.4 per cent per annum at a time when Africa labour force
grown by a much faster rate of 3.3 per cent a year.

44
Unemployment in the developing world averaged 8% to 15% of the labor force.
The unemployment rates in the 1980s for selected African countries were:
Botswana, 3.2%; Cote d’Ivoire, 20%; Ethiopia 23%; Kenya, 16.2%; Nigeria,
9.7%; Senegal, 17.3%; Somalia, 22.3%; Tanzania, 21.6%; Zambia, 19% and
Zimbabwe, 18.3% (ILO, 1991).

The unemployed exhibit two important characteristics, namely their youthfulness

and their high level of education. Youth (the age group of 15 to 24)
unemployment rates are on the average twice higher than adult unemployment
rates. Unemployment is also creeping up the educational ladder. When the
underemployed are added to the openly unemployed and when "discouraged
workers" -those who have given up looking for a job-are added in, almost 35% of
the combined urban and rural labor forces in poor nations is unutilized.

Given recent and current birthrates in most LDCs, their labor supply will be
expanding rapidly for some time to come. This means that jobs will have to be
created at equivalent rates simply to keep pace. Moreover, in urban areas rural -
urban migration is causing the labor force to grow at explosive annual rates of 5%,
to 7% in many countries (especially in Africa). The prospects for coping effec-
tively with rising levels of unemployment and underemployment and for dealing
with the frustrations and anxieties of an increasingly vocal and educated but
unemployed youth are frighteningly poor. The dimensions and implications of the
unemployment and migration problem will be discussed in detail in part two of
development economics.

45
v. Substantial Dependence on Agricultural Production and
Primary-Product Exports

The vast majority of people in LDCs live and work in rural areas. Over 65% are
rurally based, compared to less than 27% in economically developed countries.
Similarly, 58% of the labor force is engaged in agriculture, compared to only 5%
in developed nations. Agriculture contributes about 14% of the GNP of
developing nations but only 3% of the GNP of developed nations.

There is striking difference between the proportionate size of the agricultural pop-
ulation in Africa, which constitutes (68%) and South Asia (64%) versus North
America (3%). But the average productivity of agricultural labor is almost 35
times greater in North America than in Asia and Africa combined. Although
international comparative figures are often of dubious quality regarding both
precision and methods of measurements, they nevertheless give us rough orders of
magnitude. Even after making necessary adjustments for Third World non-
marketed agricultural output, the differences in agricultural labor productivity
would still be very sizable.

Agricultural productivity is low not only because of the large numbers of people
in relation to available land but also because LDC agriculture is often
characterized by primitive technologies, poor organization, and limited physical
and human capital inputs. Technological backwardness persists because Third
World agriculture is predominantly noncommercial peasant farming.

In many parts of the world, especially in Asia and Latin America, it is

characterized further by land tenure arrangements in which peasants rent rather
than own their small plots of land. Such land tenure arrangements take away
much of the economic incentive for output expansion and productivity
improvement.

46
Even where land is abundant, primitive techniques and the use of hand plows,
drag harrows, and animal (oxen, and donkey) or raw human power necessitate
that typical family holdings be not more than 5 to 8 hectares. In fact, in many
countries, average holdings can be as low as 1 to 3 hectares. The number of
people that this land must support both directly and indirectly often runs as high
as 10 to 15 people per hectare. It is no wonder that efforts to improve the
efficiency of agricultural production and increase the average yields of rice, wheat,
maize, soybeans, and millet are now and will continue to be top-priority
development objectives.

Dependence on Primary Exports: Most economies of less developed countries

are oriented toward the production of primary products. These primary
commodities form their main exports. For example, for all non-Asian developing
countries, these primary products account for over 70% of exports. Except in
countries blessed with abundant supplies of petroleum and other valuable mineral
resources and a few leading Asian exporters of manufactured goods, most LDC
exports consist of basic foodstuffs, nonfood cash crops, and raw materials. In sub-
Saharan Africa, primary products account for over 80% of total export earnings.

Most poor countries need to obtain foreign exchange in addition to domestic

savings in order to finance priority development projects. Although private
foreign investment and foreign aid are a significant but rapidly declining source
of foreign exchange, exports of primary products typically account for 60% to
70% of the annual flow of foreign currency into the developing world.

Even though exports are so important to many developing nations, LDC export
growth (excluding oil exports) has barely kept pace with that of developed coun-
tries. Consequently, even in their best years, most non-oil-exporting developing

47
nations have been losing ground to the more developed countries in terms of their
share of total world trade. In 1950, for example, the LDCs' share was nearly 33%.
It has fallen in almost every year since and currently stands at around 20%.

Countries with the poorest 20% of the world's population did even worse. By
1991, their share of world trade had fallen to 1.4%, while countries with the
richest 20% had captured 85% of world trade. Most of the success in export
promotion since 1970 has been captured by a few OPEC countries in the 1970s
and the Four Asian Tigers, along with a few other NICs in the 1980s and 1990s.
The majority of LDCs have experienced a continuing decline in their share of
world trade.

vi. Imperfect Markets and Incomplete Information

Starting from the 1980s almost every developing country is moving toward the
establishment of a market economy for many reasons. Many countries did so at
the behest of the World Bank, which kept advocating "market-friendly" economic
policies as preconditions for loans. There seemed to be a growing consensus that
there had been too much government intervention in the workings of Third World
economies. This government intervention is sighted by many as the major cause
of the problems in the poor nations. Hence, free market and unfettered
competition are considered as the key to rapid economic growth.

But the presumed benefits of market economies and market-friendly policies

depend heavily on the existence of institutional, cultural, and legal prerequisites
that are taken for granted in the industrial societies. In many LDCs, these legal
and institutional foundations are either absent or extremely weak. They include

the existence of a legal system that enforces contracts and validates property
rights;

48

a stable and trustworthy currency;

an infrastructure of roads and utilities that results in low transport and
communication costs so as to facilitate interregional trade

a well-developed system of banking and insurance,

formal credit markets that select projects and allocate loanable funds on the
basis of relative economic profitability and enforce rules of repayment, and

substantial market information for consumers and producers about prices,
quantities, and qualities of products and resources as well as the credit-
worthiness of potential borrowers.
These six factors, along with the existence of economies of scale in major sectors
of the economy; thin markets for many products due to limited demand and few
sellers; widespread externalities (costs or benefits that accrue to companies or
individuals not doing the producing or consuming) in production and
consumption; and the prevalence of common property resources (e.g., grazing
lands, waterholes) mean that markets are often highly imperfect.

Moreover, information is limited and costly to obtain, thereby often causing

goods, finances, and resources to be misallocated. Therefore, the existence of
imperfect markets and incomplete information systems remains a common
characteristic of developing nations and an important contributing factor to their
state of underdevelopment.

vii. Dominance, Dependence, and Vulnerability in International

Relations

For many less developed countries, a final significant factor contributing to the
persistence of low levels of living, rising unemployment, and growing income
inequality is the highly unequal distribution of economic and political power
between rich and poor nations. These unequal strengths are manifested in

49
economic and non economic aspects of the relationships. Economically, the
dominant powers of rich nations control the pattern of international trade. They
have also the ability to dictate the terms whereby technology, foreign aid, and
private capital are transferred to developing countries.

Other equally important aspects of the international transfer process can serve to
inhibit the development of poor nations. One subtle but nonetheless significant
factor has been the transfer of First World values, attitudes, institutions, and stan-
dards of behavior to Third World nations. Examples include the colonial transfer
of often inappropriate educational structures, curricula, and school systems; the
formation of Western-style trade unions; the organization and orientation of
health services in accordance with the curative rather than preventive model; and
the importation of inappropriate structures and procedures for public bureaucratic
and administrative systems.

Of even greater potential significance may be the influence of rich-country social

and economic standards on developing country salary scales, elite lifestyles, and
general attitudes toward the private accumulation of wealth. Whether there are
market-friendly policies or extensive government intervention, such attitudes can
often lead to corruption and economic plunder by a privileged minority.

Finally, the penetration of rich-countrys' attitudes, values, and standards also

contributes to a problem widely recognized and referred to as the international
brain drain. Brain drain is the migration of professional and skilled personnel,
who were often educated in the developing country at great expense, to the
various developed nations. Examples include doctors, nurses, scientists, engineers,
computer programmers, and economists.

50
The net effect of all these factors is to create a situation of vulnerability among
Third World nations in which forces largely outside their control can have
decisive and dominating influences on their economic and social well being

Review Questions on Chapter II

1. Discuss the characteristics of Ethiopia that make it to be categorized as one

of the developing countries by taking actual figures when appropriate.
2. Define poverty, what are the methods of its measurement and explain the
determinant(s) of poverty
3. Low labour productivity is one of the features of developing countries.
Using an economic concept, explain the reasons for this condition of
developing countries as distinguished from the developed countries.
4. Provide the explanations for the dominance-dependence relationships
between developing and advanced countries.
5. Argue for and against the success of market friendly policies in developing
countries.
6. Ethiopia is one of the largest nations in Africa in terms of physical and
population size. Discuss the advantages and disadvantages of this size in
development.

51
 Chapter III

Growth Models and Theories of Development

In the previous chapter, we have discussed the dimensions of the problems of

developing countries, which may be called their diversities and common
characteristics. Generally, we have tried to make an assessment of the factors that
make these countries to be categorized as poor countries. We have also assessed
the differences among them that should be observed in formulating development
policies and strategies.

Now it is time to look at some of the available tools useful in explaining

development problems and formulating relevant development policies and
strategies. These helpful instruments are the growth models and development
theories. There are different theories explaining the diverse development
problems of countries at different social, economic, political, and institutional
circumstances.

This chapter is divided into two major parts: the growth models and development
theories. The first part discusses four growth models divided in to two which are
the Harrod-Domar growth models and the neoclassical growth models. Then we
will proceed to the discussion of some of the major development theories.

3.1 Growth Models

3.1.1 The Harrod-Domar Growth Model

The growth model that was particularly popular with economic planners just after
World War II came to be known as the Harrod-Domar model, since it was based
on independently published articles by Roy Harrod and Evsey Domar. The fact
that the two authors independently produced identical models was not surprising.

52
This is because their models were simple extensions of John Maynard Keynes’s
well-known macroeconomic model, which dominated economic thinking in the
1940s.

The Harrod-Domar model makes similar assumptions to the Keynesian

macroeconomic model. These include:
• Since there is unlimited amount of unemployed labour, output can be
increased without triggering price increases.
• As there is abundant labour to keep the capital-labour ratio constant, this
leads also to the assumption of constant marginal product of capital
(capital output ratio).
• With constant capital-output ratio, therefore, output growth is directly
proportional to new investment in new capital.
• Moreover, this model assumes that productive investment is always equal
to saving.
Each model is discussed one by one below.

a. Harrod's Growth Model

As mentioned above, Harrods original model is a dynamic extension of keynes'
static equilibrium analysis. In this regard, there are three questions that Harrod
raised and tried to answer. In keyens' General Theory, the condition for income
and output to be in equilibrium (in a closed economy) is that plans to invest
equals plans to save. Hence, Harrod asked if changes in income induce
investment, what must be the rate of growth of income for plans to invest to equal
plans to save in order to ensure a moving equilibrium in a growing economy
through time?

53
Secondly, in static Keynesian theory, if equilibrium between saving and
investment is disturbed, the economy corrects itself and a new equilibrium is
achieved via the multiplier process. Then the second question is if growth
equilibrium is disturbed, will it be self-correcting or self-aggravating? And lastly,
will this equilibrium rate be equal to the maximum rate of growth that the
economy is able to sustain given the rate of growth of productive capacity? If not
what will happen?

To explain this condition, Harrod distinguished three different growth rates.

These are
Actual growth rate (g)
Warranted growth rate (gw)
Natural growth rate (gn)

The actual growth

The actual growth rate is defined as

g = s/c-------------------el

Where: s = the ratio of saving to incomes (S/Y)

c = the actual incremental capital output ratio, that is the ratio of
extra capital accumulation or investment to the growth of output

(∆K/∆Y=I/∆Y)

The expression for the actual growth is definitionally true since it expresses the
accounting identity that saving equals investment. This can be shown as
g = s/c = (S/Y)/ (I/∆Y)
= (S/Y) (∆Y/I)
= ∆Y/Y, given S=I The change over the level (∆Y/Y) represents the rate of
growth of output.

54
We need more than a definitional equation, however, to know whether the actual
growth rate will provide the basis for steady advances in the future. This means
that it keeps plans to invest and plans to save in line with one another at full
employment. This is where the warranted rate & natural rate of growth become
important.

Warranted rate of growth

Warranted rate is that rate of growth which, if it occurs, will leave all parties
satisfied. At this rate producers have produced neither more nor less than the right
amount. To state matters otherwise, warranted rate of growth will put all parties
into a frame of mind which will cause them to give such orders as will maintain
the same rate of growth. In other words, it is the rate that induces just enough
investment to match planned saving and therefore keeps capital fully employed so
that manufacturers are willing to carry on investment in the future at the same rate
as in the past. It is determined as:
Plans to save at any time are given by the Keynesian saving function

S == sY ------------------------------e2

The demand for investment is given by the acceleration principle. This is

where cr is the accelerator coefficient measured as the required amount of extra
capital or investment to produce a unit flow of output at a given rate of interest,
determined by technological condition. Thus

Cr = ∆Kr/∆Y = I/∆Y
I = Cr∆Y -----------------------------------e3

For planned savings to equal planned investment therefore, we have

sY = Cr∆Y-------------------------------------------e4

55
And the required rate of growth for a moving equilibrium through time is

∆Y/Y= s/cr = gw----------------------------------e5

This is the warranted rate of growths (gw). For dynamic equilibrium, output
must grow at this rate. The condition for equilibrium is that
g=gw
From e5 and el, this means
gc == gwcr
(g/gw = cr/c)

Suppose there is disequilibrium such that actual growth rate exceeds the
warranted rate. It is easily seen that if g>gw then c<cr, which means that actual
investment falls below the level required to meet the increase in output. There
will be a shortage of equipment, a depletion of stocks and an incentive to
invest more. The actual growth rate will then depart even further from the
warranted rate.

Conversely, if the actual growth rate is less than the warranted growth rate
(g<gw) then c>cr. In this case, there will be a surplus of goods and investment
will be discouraged, causing the actual growth rate to fall even further below
the equilibrium rate.

Thus, as Harrod points out, in the dynamic field we have a condition opposite
to that in static field. A departure from equilibrium instead of being self-
righting will be self-aggravating. This is the short-term trade cycle problem in
Harrod's growth model.

But even if growth proceeds at the rate required for full utilization of the capital
stock and a moving equilibrium through time, this still does not guarantee the full
employment of labour, which depends on the natural rate of growth.

56
The natural growth rate
The natural growth rate is derived from the identity:

Y = L (Y/L)
Where L = Labour
Y/L = Productivity of labour
Or taking the rate of growth
Y=1+q

The natural rate of growth is therefore made up of two components: the growth of
labor force (l), and the growth of labour productivity (q) both exogenously
determined. The natural rate of growth plays two roles in Harrods model.
1. It defines the rate of growth of productive capacity or the long run full
employment equilibrium growth rate.
2. It sets the upper limit to the actual growth rate. If g>gw, g can only
continue to diverge from gw until it hits gn. When all available labour has
been fully absorbed, g can not be greater than gn in the long-run. The long-
run question for an economy then is the relationship between gw and gn.
With fixed coefficient of production, the full employment of labour
requires
g= gn
The full emp1oyment of labour and capital requires
g = gw = gn . .
This is a state of affairs, which Jean Robinson called it the golden age

Long-Run Disequilibrium
If gw >gn, there will be a tendency towards chronic depression. This is because the
actual rate of growth will never be sufficient to stimulate investment demand to
match the amount of saving at full employment equilibrium. There is too much
capital and too much saving. This was the problem during the 1930's. Here the

57
economy is in a state of stagnation. Savings are not fully utilized and the
economy suffers from over accumulation of capital. This will produce excess
capacity, rising inventories and unemployment. Here Harrod suggest reduction of
savings, which also reduce gw.

On the other hand, if gw < gn, there will be a tendency towards demand inflation
because there will be a tendency for the actual rate of growth to exceed that
necessary to induce investment to match saving.

Relevance of the Model to Developing Countries

In most developing countries, the natural growth rate exceeds the warranted rate.
If the population growth is say 2% and labour productivity is growing at 3%, this
gives a rate of growth of the labour force in efficiency units of 5%. If the net
savings ratio is, say 9% and the required incremental capital-output ratio is 3, this
gives a warranted growth rate of 3%. This has two main consequences.
1. It means that the effective labor force is growing faster than capital
accumulation, which is part of the explanation for growing unemployment
in LDCs
2. It implies greater plans to invest than plans to save, and therefore resulting
inflationary pressure. If gn= 5% and cr =3, there will be profitable
investment for 15% saving whereas actual saving is only 9%.

Given the inequality gn≠gw or (l+q) ≠ (s/cr), Harrod suggested four ways in which
gn and gw might be reconciled. If the problem is gn>gw):
a) reduce the rate of growth of the labour force. Measures to control
population size can be justified on the grounds, as a contribution to solving
the problem of unemployment.

58
 b) a reduction in the rate of growth of labour productivity would help, but this
would of course reduce the growth of living standards of those in work.
c) a rise in the saving ratio could narrow the gap. This is at the heart of
monetary & fiscal policies in UDCs.
d) reducing the capital-output ratio through the use of more labour intensive
techniques.

b. Domar’s Model
The American economist Evsey Domar, working independently of Harrod, also
arrived at Harrod's central conclusion, although by a slightly different route. A
basic principle emphasized by Domar and incorporated in all modern growth
theory is the dual effect of net investment. In other words Domar recognized
that investment is a double-edged sword: net investment constitutes a demand
for output, and it also increases the capacity of the economy to produce output.
If the expanded capacity is to be fully utilized, aggregate demand in the next
period will have to exceed that of this period. Thus, in general, as long as there
is net investment in one period after another, aggregate demand must rise
period after period if expanding productive capacity resulting from net
investment is to be fully utilized.

Hence, the question that Domar asked is what rate of growth of investment
must prevail in order for supply to grow in line with demand (at full
employment)? In the words of Domar, if investment increases both productive
capacity and generates income, it provides us with both sides of the equation,
the solution of which may give the required rate of growth.

Increase in Capacity Output

The basic theory involves a simple production function that relates the generation
of total output to the stock of capital via the capital-output ratio. Taking the

59
technique of production as given, some specified amount of capital goods is
necessary to produce a given amount of output. If we let ‘K’ represent the capital
stock and Y the level of output, we may define the average capital output ratio as
K/Y.

In contrast, the marginal capital output ratio ∆K/∆Y tells us how much additional
capital is necessary to produce a specified addition to that flow of output. To
simplify the analysis, we assume that the constant ∆K/∆Y equals K/Y so that K/Y
is also constant (because technology is constant)

The reciprocal of the average capital-output ratio, Y/K, represents the average
productivity of capital. Given an increase in the capital stock, ∆K, ∆Y/∆K
indicates the ratio of the increase in output to the increase in capital stock. In the
simple model Y/K=∆Y/∆K. This ratio of output to capital stock is designed by δ
(sigma), which Domar calls the “potential social average productivity.”

Since ∆K in any period equals that period’s net investment, I, ∆Y/∆K= δ may also
be expressed as ∆Y/I= δ or ∆Y = δI. From this it follows that the cumulative net
investment of any period increases capacity output by δI. This is the most
important relationship in the model.

It must be noted that ∆Y is not necessarily the actual, or realized, increase in output but
rather the potential increase possible with full utilization of the expanded productive
capacity. Since the actual increase need not necessarily equal the potential, let us now
distinguish the actual, or realized, increase from the potential by appending subscripts:
∆Yr and ∆Yp.

60
Increase in Aggregate Demand
In a two-sector economy, aggregate demand equals the sum of consumption and
investment expenditures. With a stable consumption function, consumption
expenditures will rise only as a result of a rise in income and therefore a rise in
investment expenditure is necessary to initiate a rise in income. Consequently, we
may determine the total rise in expenditures, or income that will result from any
given rise in investment by using the simple multiplier expression:

∆Y = (1/s) X (∆I), where s is marginal propensity to save

This rise in income, or expenditure, is matched by an equal rise in actual output,
since, with a stable price level, output responds in proportion to the rise in
demand. With subscript ‘r’ designating realized or actual, we have

∆Yr =∆I/s

The Equilibrium Rate of Growth

There is some rate of growth at which the increase in actual output in each period,
∆Yr, will just equal that period’s increase in capacity output, ∆Yp. This rate at
which ∆Yr=∆Yp is called the Equilibrium Rate of Growth.

To determine equilibrium in a growing economy, Domar starts with the

assumption that the economy is at full employment equilibrium. From an original
period in which there is equilibrium as given by Yr = Yp, it follows that if the rate
∆Yr/Yr remains equal to the rate ∆Yp/Yp period after period, Yr will remain equal
to Yp period after period. In such situation, aggregate realized output grows as fast
as aggregate potential output, thereby producing a path of equilibrium growth
over time.

61
Since ∆Yr = ∆I/s and ∆Yp = δI, the equilibrium rate is also that at which ∆I/s = δI.
The left side shows the increment to aggregate realized output for the period,
since this is equal to the increment of aggregate demand, it may be called the
demand side. The right side shows the increment to productive capacity for the
period and as such may be called the supply side. On the right side of the
equation, we find not the change in net investment for the period but the total net
investment for the period. The reason of course is that total net investment for the
period times the average productivity of capital determines the change in
productive capacity. Thus Domar's fundamental equation is

∆I/s = δI multiplied by s yields

∆I = sδI then, dividing by I
∆I /I = sδ
δ

The left side of the equation now gives the required rate of growth of net
investment. If actual output is to rise as fast as potential output, the growth rate of
net investment must be sδ
δ, or the propensity to save multiplied by the productivity
of capital.

Although ∆I is subject to a multiplier that makes ∆Y greater than ∆I, we can see
that the growth rate of actual output, ∆Yr/Yr must be the same as the growth rate
of investment, ∆I/I. Since in equilibrium ∆Yr = ∆Yp and since ∆Yp = δI, it
follows that ∆Yr = δI. Furthermore, since I = sY in equilibrium, then by
substitution ∆Y= sδY and ∆Y/Y = sδ. Therefore

∆I /I = ∆Y/Y = sδ

The rate at which actual output and investment must grow in order that actual
output remains equal to potential output is determined by the propensity to save
and the productivity of capital. If δ = 1/cr (at full employment), then the Domar

62
result for equilibrium will be
∆I/I = s/cr

which is the same as Harrod's result for equilibrium growth

Similarities and differences between Harrod and Domar Models

Similarities

Both models have studied the requirement of steady growth with
reference to developed countries

Assumptions of both models are similar

Investment or capital accumulation has a central place in both models in
the problem of economic growth

According to both approaches given the capital output ratio so long as
APS = MPS the equality of saving and investment satisfies the conditions
of equilibrium rate of growth

The Harrod model suggests that for an economy to be constantly at
equilibrium, it should grow at gw. In Domar’s model full employment
rate of growth is δs. Harrods gw is similar to Domar's δs and Domar's δ is
the reciprocal of Harrods cr

Differences

Harrod uses incremental capital output ratio and the accelerator to
build up his model. But Domar relies on incremental output capital
ratio (i.e inverse of incremental capital output ratio) and multiplier to
formulate his model

Harrod assumes certain behavioral pattern for entrepreneurs and
deduce that it induces investment. In domar's model, no such
behavioral pattern has been assumed. He thinks that proper change in
investment comes exogenously.

63

For Harrod, business cycle is an integral part of the growth process.
Domar, however, accommodates fluctuations by allowing δ to
fluctuate.

The causal relationship between investment and income is reverse in
both models. Harrod says that investment is Cr multiplied by changes
in income. According to him income first changes and investment
adjusts to it. Thus, income is the active factor in the model. Domar
says that investment multiplied by accelerator is equal to increase in
income. Thus investment is the active factor in domar's model. In his
exposition, investment first increases and income resulting from it is δ
times the investment.

Criticisms of Harrod-Domar (H-D) Model

Fixed coefficient production function: The H-D model assumes that

labour and capital are used in fixed proportions. However, this is
untenable. The capital labour ratio changes with the changes in factor
prices, i.e. one factor is substituted for another factor. Hence, we cannot
ignore substitution of inputs. But H-D model does not allow such
substitutability

Constant assumptions: The H-D model is also criticized for its
unrealistic assumptions. It assumes that interest rate and prices are
constant. it also assumes that the marginal propensity to save
(APS=MPS) and capital output ratio are constants. But in reality, they are
likely to change in the long run. As economies develop MPS will be
higher. A steady rate of growth can, however, be maintained with out this
assumptions. Domar himself admitted this and said that the whole
problem can be easily reworked with variable αandδ.

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The effect of technological progress has not been incorporated in both
the models. These models have been derived from the examination of
industrial society at a particular point in trade cycle of economic activity.

Both models ignore human capital formation

The two models also fail to consider changes in the general price level.
Price changes always occur overtime and may stabilize otherwise
unstable situations.

3.1.2 Neoclassical Growth models

The neoclassical growth models are based on four propositions:

1. Growth rate is independent of saving-income ratio and investment-income
ratio. According to neoclassical economists higher saving-income ratio and
investment-income ratio can be offset by high capital-output ratio (COR)
and a low productivity of capital because they assume diminishing returns
to capital.

Growth of output in the long run is determined by technological progress

and the rate of growth of labour force indicated by efficiency units. The
latter is the rate of growth of labour force plus the rate of growth of
productivity of labour.

2. The level of per capita income, however, depends on savings and

investment ratios to GDP (or income). The level of PCI varies positively
with savings and investment ratios to income and negatively to population
growth.

3. Poor countries with smaller capital per head must grow faster than
developed countries with higher capital per head leading to convergence in
per capita income.

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 4. Neoclassical models are based on flexibility where as H-D models are
based on rigidity. In H-D model, there is no substitutability of factors, but
neoclassical model allows substitutability of factors based on price of
factors.

The rigidities of the H-D model led to economists to explore theories that permit
greater flexibility. Solow’s model and Meade’s model are the two neoclassical
models that are discussed below.

A. Solow’s Model of Long-run Growth

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.
In the introduction of his 1956 paper, Robert Solow explained the rationale for his
neoclassical growth model: “A remarkable characteristic of the Harrod-Domar
model is that it consistently studies long-run problems with the usual short-run
tools. Instead one thinks of the long run as the domain of the neoclassical analysis,
the land of the margin”. The model is based on the following assumptions:

• One composite commodity is produced and output is regarded as net output after
making allowance for the depreciation of capital
• There are constant returns to scale. In other words, the production function is
homogeneous of degree one
• The factors of production - labour and capital - are paid according to their
marginal physical productivities
• Prices and wages are flexible
• There is perpetual full employment of labour and stock of capital
• Labour and capital are substitutable for each other and there is unitary elasticity
of substitution between the factors.
• There is neutral technical progress
• The saving ratio is constant

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Given these assumptions, Solow shows in his model that with variable technical
coefficient there would be a tendency for capital-labour ratio to adjust itself
through time in the direction of equilibrium ratio. If the initial ratio of capital to
labour is more, capital and output would grow more slowly than labour force and
vice versa.

Therefore, combining variable proportions of the factors and using flexible factor
prices, Solow showed that the growth path of output was not inherently unstable.
If the labour force grows faster than the stock of capital, the price of labour would
fall relative to the price of capital. If capital grew faster than labor, the wage rate
would rise. Solow’s model is convergent to equilibrium path (steady state) to start
with any capital labour ratio with factor substitutability.

Gw=Gn and equilibrium path is stable.

To show the model, Solow takes output as a whole, the only commodity, in the
economy denoted as Y(t). If saving is denoted by S and the rate saving is sY(t).
K(t) is the stock of capital. Then net investment is the rate of increase of this
stock of capital, i.e., dk/dt or K. So the basic identity is

K=sY…………………………………….e1

The production function which shows constant returns to scale is given by

Y=f(K,L) ……………………………….e2

Inserting e2 in e1 we get
K=sf(K,L) ………………………………e3

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In e3, L represents total employment.

Since population growth is exogenously determined, the labour force increases at

a constant relative rate n. Thus

L(t)=Loe nt……………………………..e4

In the absence of technological change n is Harrod's natural rate of growth. L(t) is

the available supply of labour at a time (t). The right hand side of equation e4
shows the compound rate of the growth of labour force from period '0' to period 't'.
Alternatively equation e4 can be regarded as a supply curve of labour. Hence,
substituting e4 in e3, we get

K= sf(k,Loe nt)………………………..e5

He regards this basic equation as determining the time path of capital

accumulation, k, that must be followed if all available labour is to be fully
employed. It provides the time profile of the community’s capital stock which
will fully employ the available labour. Once we determine the time path of
capital stock & labour force, we can compute the time path of the real output
from the production function.

Solow concludes that when production takes place under the usual neoclassical
conditions of variable proportions and constant returns to scale, no simple
opposition between natural and warranted rates of growth is possible. There may
not be any knife-edge. The system can adjust to any given rate of growth of the
labour force, and eventually approach a state of steady proportional expansion i.e.

∆K/K=∆L/L =∆Y/Y

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Critical Appraisal of Solow’s model
The solow model is a major improvement over the H-D model. The H-D model is
at best a knife edge balance in a long run economic system where the saving ratio,
the capital output ratio and the rate of increase of the labour force are the key
parameters. If the magnitudes of these parameters were to slip even slightly from
the dead center, the consequences would be either growing unemployment or
chronic inflation in Harrods model. This balance is poised by the equality of Gw
(which depends on saving & investing habits of households and firms) and Gn
(which depends, in the absence of technical change, on the increase of labour
force).

According to Solow's model, this delicate balance between Gw & Gn follows

from the crucial assumption of fixed proportions in production whereby there is
no possibility of substituting labour for capital. If this assumption is abandoned,
the knife edge balance between Gw and Gn also disappears with it. He therefore,
builds a model of long run growth without the assumption of fixed proportions in
production demonstrating steady state of growth.

Solow’s model is a neoclassical model which retains the main features of the H-D
model such as homogeneous capital, proportional saving function, and a given
growth in the labour force. However, unlike the H.D model, it demonstrates
steady state of growth paths. The assumption of substitutability between labour
and capital gives the growth process adjustability and makes it more realistic

In Solow’s model, the long run rate of growth is determined by an expanding

labour force and technical progress. Thus Solow has put aside all the difficulties
and rigidities of the H.D mode. Despite these ascertains of Solow’s model, it is
weak in many respects.

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 1. Solow’s model takes only the problem of balance between Harrod’s Gw &
Gn and leaves out the problem of balance between G & Gw.
2. In Solow’s model investment function is absent once it is introduced. The
Harrodian problem of instability quickly appears in the Solow’s model.
3. Solow’s model is based on the assumption of labour augmenting technical
progress. However, low or falling wages do not induce the capitalist to
substitute the already in use capital-intensive technique.
4. Solow’s model is based on the unrealistic assumption of homogeneous
capital, homogeneous labour etc but capital goods are highly
heterogeneous and pose problem of aggregation.
5. Solow leaves out the causative of technical progress and treats the latter as
an exogenous factor in the growth process. He thus ignores the problems
of inducing technical progress through the process of learning, investment
in research & capital accumulation.
6. Solow assumed flexibility of factor prices, which may bring difficulties in
the path towards steady growth. For instance the rate of interest may be
prevented from falling below a certain minimum level due to the problem
of liquidity trap.

b. Meade’s Neo Classical Model of Economic Growth

Professor J. E. Meade has constructed a neoclassical model of economic growth.
This model is designed to show the way in which the simplest form of economic
system would behave during a process of equilibrium growth. It is based on the
following assumptions
i. The economy is closed and laissez-faire
ii. Perfect competition in the product and input markets
iii. There is perfect substitutability between the two commodities- consumption
goods and capital goods- which are produced in the economy
iv. Labour and capital (machines) have homogeneous units.

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 v. The ratio of labour to machinery can be changed both in the short and long run.
Meade calls this the assumption of perfect malleability of machinery
vi. Factors are paid according to their marginal productivity
vii. Flexibility of wages and interest rates. All savings are invested via flexibility of
interest rate and all workers can be fully employed via flexibility of wages.
viii. Elasticity of factor substitution is unity.

In Meade’s model, the net output produced depends upon four factors.
• The net stock of capital available in the form of machines
• The amount of labour force available
• The availability of land and natural resources
• The state of technical knowledge which continues to improve through time.
This relationship is expressed in a production function as:
Y= f(K,L,N,t)

Where Y is net output or net national income, K is the existing stock of capital, L
the labour force, N Land & natural resources, t is time, signifying technical
progress.

Assuming the amount of land to be fixed, output can increase when there is an
increase in K, L and t. This relationship is shown as:

∆Y= V∆K + W∆L + ∆Y' ………………………….e1

Where: ∆Y= change in output

∆Y'= change in output due to technological progress
∆L & ∆K= changes in labour and change in capital respectively
V= marginal product of capital
W= marginal product of labour

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V is different from the inverse of incremental capital output ratio, because it
measures the increase of output due to added unit of capital holding other inputs
constant.

Dividing both side of e1 by Y, we get proportional growth rate of output. That is

∆Y/Y = V∆k/Y + w∆L/Y + ∆Y[/Y………………e2

Equation e2 can be rewritten as:

∆Y/Y = Vk/Y. ∆K/K + WL/Y. ∆L/L + ∆Y[/Y……..e3

∆Y/Y= proportionate growth rate of output

∆K/K= proportionate change in capital
∆L/L= proportionate change in labour
∆Y[/Y= proportionate change in output due to technical progress
Vk/Y= relative elasticity of capital
WL/Y= relative elasticity of labour

Equation e3 shows that the rate of growth of output or the economic growth rate is
equal to the sum of
• the elasticity of output with respect to capital (or the relative contribution
of capital to output) multiplied by the rate of growth of capital stock plus
• the elasticity of output with respect to labour (or the relative contribution
of labour to output) multiplied by the rate of growth of labour force plus
• the rate of growth of output due to technological change.

Assuming y stands for ∆Y/Y, l for ∆L/L, k for ∆K/K, U for Vk/Y, Q for WL/Y, r
for ∆Y[/Y, then equation e3 can be rewritten as

Y=Uk + Ql + r

The real index of growth of an economy is the growth rate of real income per
head rather than the growth rate of income (y). The growth rate of real income per

72
head is given by subtracting the growth rate of population (l) from the growth rate
of income (y). Example, if income grows by 8% and population grows by 3%,
then the growth rate of per capita income is 5%.

Y-l = Uk + Ql + r-l
Uk- l+Ql + r
Y-l = Uk – (1-Q)l + r ………………………..e4

Equation e4 reveals that the growth rate of real income per head is raised in two
ways:
• by the increase in the rate of capital stock (k) weighted by its proportional
marginal product (u) and;
• by an increase in the rate of technical progress (r).
But it is depressed by the growth rate of population (l) weighted by one minus the
proportional marginal product of labour (1-Q).
The part of the equation [-(1-Q)] shows the tendency for diminishing returns as
the quantity of labour is increased on a given amount of land and capital.

One of the important factors contributing to the growth rate of output is the
annual rate of capital accumulation in the economy. This fact is implied in the
element Uk. U=VK/Y, and k=∆K/K, but ∆K, the addition to the stock of capital is
equal to the savings out of the net national income. Therefore, ∆K= sY, and k =
∆K/K = sY/K where sY represents the amount annually added to the stock of
capital through savings.

Hence, Uk= VK/Y x sY/K = Vs, which means that capital accumulation
contributes to rate of output growth. So, the basic growth relationship can be
expressed as
y - l = vs - (1- Q)l + r

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where it is possible to observe the following points:
• Assuming l and r to be given and constant, changes in growth rate would
be determined by the behaviour of V, S, and Q over time
• If there is no change in population (l) and technical progress (r), an
increase in the rate of savings (s) would raise capital per head and bring a
decline in the marginal product of capital (V).
• If technical progress takes place, V will tend to rise instead of declining.
Under these conditions, the rate of growth of income per head over time
would rise which in turn would tend to raise S.
• There will be a tendency for S to rise still further due to a change in
income distribution towards larger profits caused by the above-mentioned
factors.
We may conclude that with a constant population (l=0), real income per head
depends upon the rate of capital accumulation (VS) and technical progress (r).
The equation is

y-l = VS - (1 - Q)l + r
Since l=0 y=VS + r
If the rate of technical progress along with population growth is assumed to be
constant, the growth rate in income per head will vary directly with VS.

The state of Steady Growth: is a state in which the growth rate in total output
(income) is constant and so is the growth rate in income per head. It is assumed
that population is growing at a constant proportionate rate (l) and the rate of
technical progress does not change.

The state of steady economic growth requires the existence of the following three
conditions to ensure a constant growth rate in total income:
• Elasticity of substitution between the various factors are equal to unity

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 • Technical progress is neutral towards all factors
• The proportion of profit saved, wages saved, and of rent saved are all
constant.
Given that
• the growth rate of income is y=Uk + Ql + r and
• U, Q, l, and r are assumed to be constant
Therefore, for y to be constant (as required by the steady economic growth),
k should be constant. We know that k=SY/K. But S is assumed to be constant
above. So k will be constant if Y/K is constant. Y/K will be constant if the rate of
growth of Y and K is the same which implies the equality of y and k itself, i.e.,
y=k. Therefore, Meade came into the obvious conclusion that the growth rate of
income will be constant if the growth rate of capital stock (k) is equal to the
growth rate of national income (y).

Critical Growth Rate: The equilibrium position ultimately depends upon the rate
of accumulation of the capital stock. According to Meade, there is a critical
growth rate of the capital stock which makes the growth rate of income equal to
the growth rate of capital stock. If we denote the critical growth rate by ‘a’ then
the basic relationship will be
a= Ua + Ql+r
a-Ua= Ql+r
a(1-U)= Ql +r
a= (Ql + r)/1-U

It is this critical rate which will make y=k and keep the growth rate of the national
income constant at the steady growth level. If at any time there is any deviation
from this level of steady growth, forces will set in to bring the growth rate of the
capital stock at the equilibrium level of (Ql + r)/1-u. Suppose k or SY/K >
(Ql+r)/1-U. In this situation income will be growing at a lower rate than the

75
capital stock. As a result savings will decline, so will the growth rate of capital.
The converse is also true when SY/K<Ql+r/1-U.

Criticism of Meade’s model

Meade’s model has been severely criticized due to its unrealistic assumptions.
• Its assumption of the classical tradition of perfectly competitive economy
where all production units are assumed to be independent of each other is
unrealistic.
• The assumption that capital is homogenous is unrealistic, besides; it is very
difficult to find marginal products of labour & capital.
• The assumption that forces of competition are sufficiently strong so that
changes in relative scarcity are reflected in relative price changes and that
employers are sufficiently sensitive to these price changes that they respond
by changing their use of inputs are unrealistic.
• The assumption of only constant returns to scale is also defective. In the
growth process, there are increasing returns to scale rather than constant
returns to scale.
• The model also completely neglects the role of institutional factors in the
development process.
Despite to these defects, the Meade model has the chief merit of demonstrating
the influences of population growth, capital accumulation and technical progress
on the growth rate of national income and per capita real income over time.

3.2 Theories of Development

3.2.1 Rostow’s Stage of Economic Growth

Walt W. Rostow uses the historical approach to explain the process of economic
development. The essence of Rostow's stages of growth is that it is logically and
practically possible to identify stages of development and to classify societies

76
according to those stages. According to him, there are five stages of economic
growth; namely, Traditional Society, Pre-conditions for the Take-off, Take-off,
drive to Maturity, and Age of Mass Consumption.

The Traditional Society

The traditional society is defined as one whose structure is developed within a
limited production and backward technology. That means production function is
based on pre-Newtonian science and technology. The social structure is
hierarchical in which family and class connections play a dominant role. Political
power is concentrated in the hands of the landed aristocracy. More than 75% of
the population is engaged in agriculture, which is the main source of income for
the state and the peasants.

The “Pre-condition for Take-off”

Rostow calls the stage between feudalism and take-off the transition stage. During
the transition period all the pre-conditions for sustained economic development
are created. It started in Western Europe and Britain at the end of the 15th century
and the beginning of the 16th century, when the medieval age ended and modern
age began. During this age reasoning and scepticism replaced feudalism and led
to the rise of nation states. Such pre-conditions require a number of radical
changes, which include: -

i) the main economic requirement in the transition period is that

1. the level of investment should be raised to at least 10% of the national
income so as to ensure self-sustaining growth.
2. the main direction of investment must be in building of social
overhead capita, especially transportation and telecommunication to
enlarge the market size.

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 3. a technological revolution in the agricultural sector and a transfer of
surplus from agriculture to industry.
4. an expansion of imports especially capital goods
ii) on the social front
1. a new elite (middle class) must emerge to fabricate the industrial
society, and it must supersede in authority the land-based elite of the
traditional society
2. Surplus must be channeled by the new elite from agriculture to
industry.
iii) Politically, the establishment of an effective modern government is vital.

Take-off
Take-off is defined by Rostow as “an industrial revolution tied directly to
radical changes in the methods of production having their impact over a
short period of time which lasts for two decades.” The take-off is the most
important stage in the life of the society. Economic growth is a normal condition
of the society. Forces of modernization operate against the habits, institutions,
the values and interest of the traditional society and make a decisive break
through. The following are three necessary conditions for take-off:
i) a rise in the rate of productive investments to a level in excess of
10% of the national income in order for per capita income to rise
sufficiently to guarantee adequate future levels of saving and
investment
ii) the development of one or more substantial manufacturing sector
with a high growth rate and
iii) the existence of political, social and institutional framework which
can foster economic development.

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Historically, domestic finance for take-off seems to have come from two main
sources.
• From diversion of part of the product of agriculture. Example in Japan,
USSR
• From enterprising landlords voluntarily ploughing back rents into commerce
and industrial.
There are two approaches for take-off:
Aggregate approach-this is based on Harrod model of growth
G = s/y for growth either s/y must be high or c must be low
c

Leading-sector approach: Rostow emphasized on the importance of leading

growth sector for the take-off. This approach is based on the principle of
unbalanced growth theory. It assumes that simultaneous growth in all the sectors
is not possible because of limitation of resources. Some sectors of the economy
will play a leading role. Example, railway transports industry, iron and steel etc.
Different industries played leading role in different countries example, textile in
UK; iron and steel, shipbuilding, and textile in Japan etc.

Rastow argues that an industry can play the role of leading sector in the take-off
stage provided that four conditions are met:

• That the market for the product is expanding rapidly to provide a firm
basis for the growth of output
• That the leading sector generates secondary expansion
• .That the sector has an adequate and continual supply of capital from
ploughed back profits .
• The new production functions can be continually introduced into the sector,
meaning scope for increased productivity

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The take-off period is different for different countries. The take-off stages for
some of the developed countries are

UK 1783-1802
France 1840-60
USA 1843-60
Germany 1850-73
Japan 1878-90
Russia 1890-1914

Drive to maturity stage

This stage is defined by Rostow as a period when a society has effectively applied
the range of modern technology to develop the bulk of its resources. This calls
for a period of sustained economic growth extending over four decades. This
period is required for new production techniques to take the place of old ones and
the economy being able to absorb unexpected internal and external shocks.
Rostow sees the development of the steel industry as one of the symbols of
maturity. In this stage, three significant changes take place:
a) The character of the working forces changes. They become skilled and
organized. Their real wages start increasing. People prefer to live in
urban areas than in rural areas.
b) The character of entrepreneurship changes. They become polished,
polite and efficient
c) The society becomes more industrialized and it leads to more and more
changes.

Age of High Mass Consumptions

During this stage, the balance of attention of society is shifted from supply to
demand for goods and services and from problems of production to consumption

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and welfare. There is a greater tendency towards mass consumption of durable
consumer goods, maintaining full employment and an increasing sense of security
which leads to high rates of population growth.

It should be pointed out, however, that Rostow’s last two stages – “Drive to
Maturity” and “Age of Mass consumption” describe a developed industrial
economy and are the result of successful take-off. the characteristic elements of
the second and third stages- 'pre-conditions for take-off' and 'Take-off' are also
more or less similar.

Criticisms of Rostow's Model

Rostow’s model has been severely criticized and rejected as both an absurdity,
and an inappropriate basis for development. In spite of many years of striving
and actually satisfying its pre-conditions especially through the achievement of its
savings investment target of 20–25% neither take-off nor self-sustained
development has occurred in most Third world Countries. Rostow’s stages of
growth have thus been rejected on several grounds.

First, it is too rigid, mechanical and deterministic with each stage rigidly leading
to the next. There is no possibility of skipping or merging stages.

Second, the universal applicability claimed for the model is false and totally
absurd. Rostow’s pure traditional society based on the ‘dual’ society thesis
cannot be found in any underdeveloped country because all of them have
undergone centuries of relationships and change with industrialized and other
countries, especially through trade.

Third, the linear conception of history in the stages of growth is a-historical.

History has not stood still since the Industrial Revolution of 1750s and it is

81
ridiculous to suggest that all underdeveloped countries must now travel the route
of the currently industrialized countries. For one thing, the newly industrialized
countries (NICs) of South-East Asia did not travel that route with enslavement
and colonization, for example.

3.2.2 Surplus Labour Theory

Prof. Arthur Lewis has developed a very systematic theory of economic
development with unlimited supply of labour. This theory is one of the best-
known early theoretical models of development that focused on the structural
transformation of a primary subsistence economy. Lewis' model starts with the
assumption of a dual economy with a modern industrial sector and a traditional
subsistence sector. Lewis believed that in the traditional sector of many
underdeveloped countries there is unlimited supply of labour at subsistence wage.

Surplus Labour means the existence of such a large population in the rural sector
so that the marginal productivity of labour has fallen to zero. This condition is
also called disguised unemployment. The essence of the development process in
this type of an economy is the transfer of labour resources from the agricultural
sector where they add nothing to production to the more modern industrial sector,
where they create a surplus. Economic development takes place when capital
accumulates as a result of withdrawal of surplus labour from the subsistence to
the modern industrial sector. The situation of subsistence wage and surplus labour
is illustrated below.

Fig. 3.1 shows the marginal product of successive units of labour added to the
land. OW is the subsistence wage. At this wage, there is unlimited supply of
labour. The productivity of labour increases at the beginning but after X units of
labour, marginal product of labour declines. Owing to diminishing returns, after
X1 units of labour, marginal contribution of labour to output falls below the

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subsistence wage. And after X2 units of labour, the contribution of labour to
output becomes negative and total product will decline with successive additions
of labour beyond X1. All the labour beyond X1 is considered as surplus labour and
is in a completely elastic supply to the industrial sector at whatever the industrial
wage.

Fig. 3.1: Subsistence wage and surplus labour

Managerial Product of labour

The
Subsistence Wages
W
Units of
0 Labour added
X1 X2 MPl
X

To attract labour from agriculture to industrial sector they must be offered wages
which is higher than the wages they get in the agricultural sector. Lewis assumes
that urban wages will have to be at least 30% higher than average rural income to
induce workers. As indicated on Fig. 3.2 below, industrial wage, WI, is greater
than agricultural wage, WA. Employments in the industrial sector would hire
labourers to the point where it is profitable to do so. It means that they will
employ workers up to that point where the marginal productively of workers
equals wage rate.

After paying the wages the remaining part of output creates profits of the
employer. A part of the profit is reinvested by the capitalist in the industrial sector.

83
By investing more capital, he can introduce new capital equipments, more raw
materials, etc. The expansion of the industrial sector makes it possible to employ
new employees. This for Lewis is the essence of the development process. The
stimulus to investment comes from the rate of profit, which must rise over time
because all the benefits of increased productivity accrue to capital as real wage is
constant. This process continues.

Criticisms of Surplus Labor Theory

Although the Lewis two-sector development model is simple and roughly
reflects the historical experience of economic growth in the west, some of its key
assumptions do not fit the institutional and economic realities of most
contemporary developing countries.

1. Lewis assumes that due to competitive labour market, the wage rate remains
constant in the urban sector for a long time. It is an unrealistic assumption.
2. If the method of production in the industrial sector is capital intensive and
labour saving, this theory will not work
3. It considers lack of skilled labourers as a temporary bottleneck in the
development process of underdeveloped countries. But it is a serious
problem.
4. Lack of entrepreneurial initiative is another problem that affects the
industrial expansion of developing economies
5. It is unrealistic to assume that there is high unemployment in rural areas and
full employment in urban areas. In most developing countries the reverse is
true. Schultz argued that MP of labour in the over-crowded agricultural
sector is not zero. So, when there is shift the workers from agricultural to
industry, the agricultural production decreases
6. Mobility of labour from agriculture to industrial sector is not easy.
Differences in language and customs, problem of housing, high cost of

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 living in urban sector and the attachment of the people to their family land
are some factors that affect the labour mobility.
7. It is a one sided theory because the theory does not consider the possibilities
of progress in the agricultural sector.

3.2.3 Dualistic Theories

Dualism indicates a situation where types of parallel phenomena co-exist. It
represents the existence and persistence of increasing divergences between rich
and poor nations and rich and poor peoples on various levels. Specifically, the
concept of dualism embraces four key elements.
1. Different sets of conditions of which some superior and others inferior can
co-exist in a given space. An example is Lewis's notion of the co-existence
of modern and traditional methods of production in urban and rural sectors.
Another is the coexistence of powerful and wealthy industrialized nations
with weak, impoverished peasant societies in the international economy.
2. This co-existence is chronic and not merely transitional. It is not due to a
temporary phenomenon, in which case time could eliminate the discrepancy
between superior and inferior elements.
3. Not only do the degrees of superiority or inferiority fail to show any sign of
diminishing, but they even have an inherent tendency to increase. For
example, the productivity gap between workers in developed countries and
their counterparts in most less developed countries seems to widen with each
passing year.
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 elements, let alone "trickle down" to it.

Dualism has been perceived in different ways such as: social, technological,
financial, and geographic dualism.

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a. Social dualism
The theory of social dualism was developed by a Dutch economist J.H. Bocke.
The theory of social dualism is a general theory of economic and social
development of UDCs. It is based on his studies of the Indonesian economy.

Dr. Bocke maintains that there are three characteristics of a society in the
economic sense. They are the social spirit, the organizational forms and the
techniques dominating it. The interdependence of these characteristics is called
the social system or social style. If there is only one social style in a society it is a
homogeneous society. When a society possesses two or more social systems
simultaneously it is a dual or plural society. A dual society according to Bocke is
characterized by the existence of an advanced imported Western system and an
indigenous pre-capitalist agricultural system.

The sector which is under Western influence and supervision uses advanced
techniques and the average standard of living is high. The latter is with low levels
of technique, economic and social welfare. Bocke defines social dualism as the
clashing of an imported social system with an indigenous social system of another
style. Most frequently the imported social system is high capitalism.

Some of the important characteristics of the eastern sectors of a dualistic economy

which distinguish it from a western society are the following. The needs of the
society are limited. People are influenced more by social rather than economic
needs. Goods are evaluated according to their prestige value rather than value in
use. Native industries are not properly organized. It faces problems related to
capital shortage, unskilled workers, poor technology and market imperfections.
People invest more in regular profit giving enterprises. Labour is unorganized
and people are reluctant to leave the village community. Here urban development
takes place at the cost of rural life.

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Bocke argued these distinctive factures of the eastern economy makes it
impossible to apply the western economic theory in underdeveloped countries.
For example, it is not possible to apply the marginal productivity theory of
distribution to explain the allocation of resources or the distribution of income in
UDCs because of the immobility of resources in such economies. It is not
possible to apply the same policy for the whole economy of developing countries
because what is beneficial for one society may be harmful for the other.

In underdeveloped countries, limited wants and limited purchasing power hamper

all economic development. Increase in food supply or industrial goods will bring
a glut of commodities in the markets with the consequent fall in prices and
depression. Wants of the people are limited. All these does not mean that Bocke
is against agricultural and industrial development of UDCs. He is in favour of a
slow process of industrialization and agricultural development adaptable to the
dualistic structure of the society.

Criticisms of Social Dualism

Prof. Benjamin Higgins put forward the following arguments against this theory.

1. It is argued that Bocke’s contention that people in UDCs have limited

wants is unrealistic
2. According to Bocke, eastern casual worker is unorganized, passive and
silent. Higgins criticized it taking the trade union of eastern economics
3. Eastern labour is not immobile
4. It is argued social dualism is not peculiar to UDCs alone. It exists in
developed nations too.
5. “conspicuous consumption” is not peculiarity of eastern economies

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 6. Higgins said that Bocke fails to provide a distinctive economic and
social theory for UDCs. His dualistic theory is merely a description of
the eastern society.
7. Bocke’s theory centers more on socio-cultural aspects rather than
economics. So it fails to provide solutions to economic problems of
UDCs.

b. Technological Dualism

As an alternative to Boeke’s social dualism, Benjamin Higgins has developed the

theory of technological dualism. Technological dualism implies the use of
different production functions in the advanced sector and the traditional sector of
the economies of underdeveloped countries. The existence of such dualism has
accentuated the problem of structural or technological unemployment in the
industrial sector and disguised unemployment in the rural areas.

UDCs are characterized by structural disequilibrium at the factor level.

Disequilibrium at the factor level may arise either because the same factor
receives different returns in different uses or because price relationships among
factor are out of line with factor availabilities. Disequilibrium leads to
unemployment or underemployment in UDCs.

Higgins builds his theory around two goods, two factors of production and two
sectors with their own factor endowments and production functions. Of the two
sectors, the industrial sector is engaged in plantations, miners, refineries, large
scale industries etc. It is capital intensive and there is no technical substitutability
of factors which are combined in different proportions (fixed technological co-
efficient).

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The rural sector is engaged in producing food stuffs, handicrafts and it consists of
very small industries. It has variable technical co-efficients of production so that
it can produce the same output with a wide range of techniques and alternative
combinations of labour and capital.

Of the two sectors, the industrial sector develops and expands with the aid of
foreign capital. Since this sector is capital intensive with fixed technical co-
efficient, it is not possible to create employment opportunities at the same rate at
which population grows. Industrialization may even bring a relative decline in
the proportion of total employment in that sector. The surplus has no other
alternative except to seek employment in the rural sector. Since the availability of
land and capital are limited here, the employment of more and more labourers
will lead to diminishing returns and it will create disguised unemployment.

Criticisms of Technological Dualism

1. Technical co-efficient are not fixed in industrial sector.

2. Factor prices do not depend on factor endowments alone
3. Higgins theory neglects institutional and psychological factors
4. Higgins neglects the possibilities to use labour absorbing techniques in
urban sector
5. He failed to explain the nature and size of disguised unemployment
C. Financial Dualism:

Prof. Myint has developed the theory of financial dualism. Financial dualism
refers to the co-existence of different interest rates in the organized and
unorganized money markets in the LDCs. The rate of interest in the unorganized
money market is higher than that in the organized money market in the modern
sectors. The unorganized money market consists of the non-institutional lenders

89
such as village money lenders, land lords, shopkeepers, traders, etc. They charge
very high interest rates on loans. It is so because there is a real shortage of
savings in the traditional sector. These money lenders occupy strategic positions
in the village economy and create monopoly power over the peasants.

In the organized money market of LDCs the interest rates are low and credit
facilities are abundant. The organized money market consists of the commercial
banks and other financial institutions which lend short term credit at low interest
rate in the modern business sector.

This has created economic dualism between the traditional and modern sector.
The fiscal and monetary measures followed in LDCs favoured the interests of the
modern sector as against the traditional sector. More investment is made in the
modern sector. The agricultural and small scale sector suffers due to these
reforms.

3.2.4 The Process of Cumulative Causation

The process of cumulative causation is a hypothesis of geographic dualism,

applicable to nations and regions within nations. This can be advanced to
account for the persistence of spatial differences in a wide variety of
development indices, including employment, per capita income (PCI), rates of
growth of industrialization and trade. As such the process of cumulative
causation is a direct challenge to static equilibrium theory, which predicts that
the working of economic forces will cause spatial differences to narrow.

Myrdal contends that in the context of development both development and social
force produce tendencies towards disequilibrium and that the assumption in
economic theory that disequilibrium situations tend towards equilibrium is false.

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Myrdal replaces the assumption of stable equilibrium with what he calls the
hypothesis of circular and cumulative causation

To describe the process of circular and cumulative causation, let's start with a
country in which all regions have attained the same stage of development, as
measured by the same level of PCI. Then assume that an exogenous shock
produces a disequilibrium situation with development proceeding more rapidly in
one region than another. The proposition is that economic and social forces will
tend to strengthen the disequilibrium situation by leading to cumulative expansion
in the favoured regions at the expense of other regions, which then become
comparatively worse off, retarding their future development

According to Myrdal, the multiplier accelerator mechanism produce increasing

returns in the favoured regions. Instead of leading to equality, the forces of
supply and demand interact with each other to produce cumulative movements
away from spatial equilibrium. To illustrate this, let's take two regions A and B
having identical wage levels WA = WB.

Then assume that a stimulus of some sort cause the demand for labour to rise in
region A, and therefore, wages to rise in region A relative to region B. Since
labour tends to respond to differences in economic opportunities of this sort, the
wage discrepancy may be assumed to induce labour migration from region B to
region A. Equilibrium theory predicts that there will be a tendency for wage
levels to be equalized once more through a reduction in labour supply in region B
and an increase in labour supply in region A.

According to the hypothesis of cumulative causation however, changes in supply

may be expected to react on demand in such a way as to counteract the tendency
towards equilibrium. Migration from region B erodes the area of human capital

91
and entrepreneurs, and depresses the demand for goods and services and factors
of production. Movement in to region A, on the other hand, will tend to stimulate
enterprise and the demand for products, adding to the demand for factors of
production. Thus once development difference appears, there is a set in motion a
chain of cumulative expansion in the favoured region. This is what Myrdal called
a backwash effect. On other regions, it causes development differences in general
to persist or even diverge.

Capital movements and trade also play a part in the process of cumulative
causation. In a free market, capital and labour will move to the area where the
prospective return is highest, and this will be the region where demand is
buoyant. Capital, labour and entrepreneurship will tend to migrate together.

Such is the potential strength of the backwash effects of the process of circular
and cumulative causation that professor Hirshman has suggested that the lagging
regions may possibly be better-off if they become-sovereign political states. This
is because mobility of factors of production could be more easily controlled,
competition between the leading and lagging nations could be lessened etc.

Despite these potential advantages of nationhood for a backward region,

Hirschman' argues against sovereignty. Because he believes that the forces
making for the interregional transmission of growth are likely to be more
powerful than those making for international transmission.

Hirschman recognizes the continued existence of backwash effects and argues

that, to offset them, a nation that is concerned with developing its backward
regions should provide certain equivalents of sovereignty, such as a separate tax
system and right to protect certain activities. Policies must be designed to reduce
what he calls the polarization effects of interregional differences in development

92
and to strength the trickle down effects.

The trickle down effects are the favourable repercussions on backward regions
emanating from expanding regions which Myrdal calls spread effect. These
trickledown effects consist of an increased demand for the back ward areas'
products and the diffusion of technology and knowledge. In Myrdal's view, the
spread effects, are weaker than the backwash effects, and if interregional
differences are to be narrowed, nations must rely on state intervention.

The alternative is automatic procedure. A time must eventually come when

increasing costs in the expanding region will halt expansion. The higher costs of
living and the external diseconomies produced by congestion will ultimately
outweigh the benefits of greater efficiency and higher money returns to the factors
of production. The process of migration will then be halted, and possibly reversed.

3.2.5 A Model of Low Level of Equilibrium trap

There are two major interrelated reasons why rapid population growth may be
regarded as a retarding influence on development. First, rapid population
growth may not permit a rise in per capita incomes sufficient to provide
savings necessary for the required amount of capital formation for growth.
Second, if population growth outstrips the capacity of industry to absorb new
labour, either urban unemployment will develop or rural underemployment
will be exacerbated, depressing productivity in the agricultural sector. It is not
inconceivable, moreover, that rises in per capita income in the early stages of
development may be accompanied by, or even induce, population growth in
excess of income growth, holding down per capita incomes to a subsistence
level.

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Models of the low level equilibrium trap attempt to integrate population and
development theory. Its focus is on the interdependence between population
growth, per capital income and national income growth. One such model is
given by Nelson which contains the basic equation that deals with the
determination of net capital formation, population growth and income growth.

Capital formation

Capital formation takes place through saving and new land brought into
cultivation. That is,
dk=dk' + dr
Where k= capital
K' =saving created capital
r = land
According to Nelson dr is insignificant and we should concentrate on saving
creating capital. It is assumed that all savings are invested. The relationship
between rate of saving per capital (dk' 1/p) and income per capital (o/p) is shown
below.

Fig. 3.3: Per capita income and saving

dk'/p

dk'/p Per capita income is so low up

to the level (o/p)' that there is
dis-investment (dis-saving)
0 x assumed to be at a constant
c o/p rate, c. Beyond (o/p)' the rate
of saving per capita rises
linearly with per capita income.
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 (o/p)'

The same tendency of relationship can be obtained in an equation form,

dk'/p = b[(o/p) - x] Where (o/p) > (o/P)'

and
= -c, where (0/P) ≤ (0/P)'

Population Growth

The trend in population growth is shown below

Fig. 3.4: Growth rate of population and per capita income
dp/p
dp/p

dp*/p
S
0/P
(0/P)'

With rising per capita income (PCI), population growth (dp/p) is first assumed to
be increasing owing to falling death rate. Then at a critical level of PCI (O/P)',
population growth reaches the maximum (dp/p)* when the death rate has fallen to
the minimum. The same relationship can be obtained using an equation for
dP/p = P [(o/p) - s]
Where (o/p) < (o/P)'
And
= dP*/P, where (O/P) ≥ (0/P)'

S is the subsistence level of PCI. At PCI below S, dP/p is negative since the death
rate would exceed the birth rate.

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Growth of National Income

Income is assumed to be a linear homogeneous function of factor inputs,

O=Tf(K, L)
Where: K = Capital
L = Labour
T = an index of total productivity
From the assumptions of the model, the income growth curve can be drawn as:
Fig. 3.5: Growth rate of income

do/o

do/o

0 o/p
x=s

Where x=s (taken from the above two figures), population is stationary. The rate
of savings-created capital per head is zero, and therefore income will be
stationary (do/o=o). With rising PCI beyond this stationary equilibrium, growth
increases because of increase in the labour force and capital per head. As
population growth reaches a maximum, however, and savings as a percentage of
national income approach a constant, income growth will level of. In the absence
of technical progress, growth will ultimately decrease owing to the law of
variable proportions. In this case due to a fall in the capital-labour ratio.

By combining the population growth diagram and the national income growth

96
diagram, we get a diagrammatic representation of the possibility of a low-level
equilibrium trap situation in which PCI is permanently depressed.

Fig. 3.6 Growth rate of income and population

do/o , dp/p

dp/p

do/o
0 o/p
s=x a q

Any level of PCI between the subsistence point (s= X) and 'a' will be
accompanied by a growth of population faster than the growth of income, forcing
PCI down. The equilibrium level of PCI will be where the population growth
curve cuts the income curve from below. One such point is to the left of 'a' is
where s = x. This point represents the low level of equilibrium trap. Any level of
PCI below 'a' will force PCI down to this subsistence level. Conversely, any PCI
beyond 'a' will mean a sustained rise in PCI until the two curves cross at q. This
would be a new stable equilibrium.
3.2.6 The Big Push Theory

The theory of big push is associated with the name of Paul N. Rosentern Rodan.
The theory says that a big push or a large comprehensive program is needed in the
form of a high minimum amount of investment to overcome the obstacles for
development in UDCs. According to him, launching a country into self
sustaining growth is a little like lifting an airplane off the ground. There is a

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critical ground speed which must be passed before the air craft can become air
borne. The theory states that proceeding bit-by-bit investment program will not
lead the economy successfully through the development path. For sustained
development, a minimum amount of investment is necessary. Rodom
distinguished three types of indivisibilities and external economies.

Indivisibilities in the Production Function

Rosentein Rodan stated that indivisibility of inputs, outputs or processes of

production lead to increasing returns. Increasing returns play a significant role in
lowering the capital output ratio. The services of social overhead capital (SOC)
or indirectly productive activity play a significant role in this regard. SOC has a
long gestation period, a minimum durability, they are lumpy, and it is irreversible
in time. Therefore, it must precede the directly productive activity (DPA).

Indivisibilities of Demand

The indivisibility or complementarity of demand requires a simultaneous setting

up of interdependent industries in UDCs. Rosenstein Rodan used his famous
example of shoe factory to explain his view point. If the entire investment is
made only in one industry, lack of demand may result in overproduction. If
instead the investment is made in different industries at the same time,
complementarity of demand reduces the risk of finding a market and increases the
incentive to invest. In short, a minimum quantum of investment in interdependent
industries is essential to overcome the market imperfections.

Indivisibilities in the Supply of Saving

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A high income elasticity of saving is the third indivisibility in Rodan’s theory. A
high minimum size of investment requires a high volume of savings. It is
difficult to achieve it in a poor country because of low income. To overcome this,
when income increases due to an increase in investment, the marginal rate of
savings should be much higher than the average rate of savings. According to this
theory, high investment leads to high level of employment, increased income, and
increased saving which again leads to increased investment. Thus an initial
investment is a precondition for saving.

This theory is not free from certain defects:

1) It neglects investment in agricultural sector. In fact developing

economies are agrarian economies. Thus a large amount of
investment is needed in agriculture in such projects as irrigation.
2) It generates inflation since the high investments in the basic industries
do not directly increase goods and services.
3) In a poor country there are so many administrative and institutional
difficulties.
4) Rosenstain Rodan’s theory is not a historical explanation of how
development takes peace.

Applicability to Less Developed Countries (LDCs)

The development of complementary industries and basic industries are important

in LDCs. But the problem is that there is no sufficient capital and skilled
manpower to develop them.

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3.2.7 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.
To some writers, 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 investment takes place simultaneously in all
sectors of the national economy. Still to others, it implies the balanced
development of agricultural and industrial sectors of the economy.

To this extent, balanced growth calls for maintaining the balance between the
different consumer and capital good industries. It also calls for ensuring balance
between agriculture and industry and between the domestic and export sectors of
the national economy. Additionally, it requires balance between social and
economic overheads and directly productive investment.

Moreover, the economists in favour of the balanced growth postulated the balance
between supply side and demand side. The supply side consists of simultaneous
development of all interrelated sectors, i.e., intermediate goods, raw materials,
power, agriculture, transport, and consumer good industries. The demand side
comprises provision of employment opportunities which increase income and
thus demand of the consumers.

Rodan was the first to develop the theory of balanced growth without using these
words. His main contention was that often social marginal product (SMP) of an
investment is different from its private marginal product (PMP). When industries
are planed in accordance with their SMPs, the rate of growth of the economy is
greater than it would have been otherwise. It is complimentarity of different

100
industries which leads to the most profitable investment from the stand point of
the society.

It is here that he gives the famous example of a shoe factory. Suppose a large
shoe factory is started in a region where 20,000 unemployed workers earn their
wages on shoes, a market for shoes would be created. But the trouble is that the
workers will not spend all their wage on shoes. If instead a whole series of
industries were started which produce the consumption goods on which the
workers would spend their income, all industries would expand via the multiplier
process.

This idea has been developed and elaborated by Nurkse in his thesis. According
to Nurkse, Vicious circles of poverty are at work in UDCs. To attain
development, these vicious circles must be broken. Individual decisions related
to investment cannot save the problem. According to him, “More or less
synchronized application of capital to a wide range of different industries” will
help to break the vicious circles.

To sum up in the words of Lewis, “in development programme all sectors of the
economy should grow simultaneously so as to keep a proper balance between
industry and agriculture and between production for home consumption and
production for exports”.

Criticisms of Balanced Growth

1) It is argued that a simultaneous establishment of a number of industries is

likely to raise money and real cost of production. Kindleberger observed

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 that instead of starting with new industries Nurkse’s model does not
consider the possibility of cost reduction in the existing industries.
2) Balanced growth strategies are beyond the capability of UDCs. In these
nations, the availability of resources for simultaneous development on
many fronts are generally lacking
3) The doctrine of balanced growth presupposes increasing returns. But this
is a wrong assumption.
4) Dis-proportionalities in factors of production and shortage of resources
make the theory unrealistic in LDCs. This theory is applicable in a
developed country.

3.2.8 Unbalance Growth

The theory of unbalanced growth is the opposite of the doctrine of balanced

growth. The dissatisfaction with the theoretical underpinnings of the balanced
growth theory gave rise to a new school of though that of unbalanced growth
which has an intellectual as well as a practical appeal. Mainly Walt Rostow
and more particularly Albert Hirschman were who propounded the theory in a
systematic manner.

To Rostow, as noted earlier, for an economy to cross the stage of traditional

society and achieve take-off, it is essential for it to increase the rate of
productive investment from 5% to 10% or more. This is possible only if
investment is undertaken in two or more sectors of the national economy.
This will lead to the development of related industries and as a result of
increased production, profits will increase and which 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

102
development in the less developed countries. Investments in strategically
selected industries or sectors of the economy, will lead to new investment
opportunities and so pave the way for further economic development

There are two types of projects, according to Hirschman, convergent series

and divergent series. The projects which appropriate more external
economies than they create are called convergent series. Some investments on
the other hand create more external economies than they appropriate. These
projects are called divergent series. While choosing the project for investment
divergent series of investment must be followed.

Hirschman said unbalancing the economy can be made either by selecting

social overhead capital investment (SOC) or by selecting directly productive
activities (DPA). If without proper development of the social overhead
facilities, investments are made on directly productive activities, the cost of
production will be high. So in an UDC, unbalancing the economy by giving
importance first to the investment on SOC is more advisable. It will create
possibilities for the development of the DPA. He is neither in favour of
complete privatization nor infavour of complete state planning. He preferred a
mixed economy.

According to this theory investment should be made in selected sectors rather

than simultaneously in all sectors of the economy. UDE does not possess
sufficient capital and other resources to invest simultaneously in all sectors.
Hirschman regards economic development as a “chain of disequilibria” that
must be kept alive rather than eliminated. But this theory is also criticized on
several grounds:

Criticisms of Unbalanced Growth

103
 1. according to Paul Streeton, Hirschman’s theory failed to say what is the
optimum degree of imbalance, where to imbalance and how much in
order to accelerate economic growth
2. Streeton argued that Hirschman expected a simultaneous expansion of
the economy through balancing it. He neglected the influence of the
growth retarding forces
3. Lack of basic facilities. There may be lots of difficulties in procuring
technical personnel, raw materials and basic facilities like transport,
power and even markets for the products produced.
4. Technical flexibility (factor mobility) of resources is limited in the
underdeveloped countries. It adversely affects growth process.
5. Hirschman’s development strategy is largely related to maximizing
investment decisions. In an UDC, not only investment decisions but
also administrative, managerial and policy decisions are important.
6. The investment on SOC which does not directly increase the amount of
goods and services is also inflationary.

Similarity of Balanced and Unbalanced Growth Theories

• Nurkse argued that private investment is incapable of breaking the vicious

circle of poverty and government investment is indispensable. Hirschman
also called for investment in SOC which is based on state plans. However,
the unbalanced growth theory is far more applicable than the balanced
growth theory.

Review Questions on Chapter III

104
a. In a developing country, if population grows at a rate of 2%,
productivity of labour improves at 2%, saving ratio is 10% per
annum, and the capital-output ratio is 5 how do you explain the
condition of Gw and Gn? How can equilibrium growth rate be
attained?
b. It is said that there is knife-age balance in the Harrod's model.
Explain the meaning
c. According to Domar investment is double-aged sword. Elaborate
this hypothesis.
d. Take one from the stages identified by Rostow which is relatively
applicable to the present condition of Ethiopia and compare and
contrast with Ethiopia taking the social, economic, and political
characteristics of the country.
e. The unbalanced growth theory proposes certain key sector(s)
should be selected to promote development. by taking one or more
industrial sectors in Ethiopia, justify how the sector will meet the
desired purpose of development.
f. In what attribute is the surplus theory applicable to Ethiopia? And in
what aspects not?

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