IIUI/IIIE/FALL2007/PZJ/DE1 1. Theories of development 1.1. Classical theories: 1.1.1.

Economic Growth: In this view national economic performance is measured in terms of economic growth. Therefore, we start with the analysis of historical growth of national income/output of developed countries. By doing that we will first examine the role of leading factors of production and then identify common characteristics of these countries. Role of capital, labor and technology in growth process: Capital accumulation: Capital is accumulated by saving a part of present income and investing it in order to augment future output/income. The stock of physical capital is increased by new factories, machinery, equipments and materials. These directly productive investments are supplemented with social and economic infrastructures including roads, electricity, water, sanitation, communication, etc. The infrastructures facilitate and integrate economic activities. For example, investment by a farmer in a new tractor may increase the total output of vegetables he can produce, but without adequate transport facility to get this extra product to the market, his investment may not add anything to national food production. Similarly, improvement in irrigation may improve the quality of agricultural lands by raising productivity per hectare. If 100 hectares of irrigated lands produce same output as 200 hectares of non-irrigated lands both using same other inputs, the installation of irrigation is equivalent of doubling the quantity of non-irrigated lands. Use of chemical fertilizers and control of insects with pesticides may have equally beneficial effects in raising the productivity of farmlands. Investment in human resources can improve its quality and have same or even more powerful effects on production. Formal schooling, vocational and on-the-job training programs and informal education may augment human skill by investing in buildings, equipments and materials. The advanced and relevant training of teachers, as well as good text books in economics and management may improve the quality of leadership and increase the productivity of a given labor force.

All these investments lead to capital accumulation. Capital accumulation may add new resources (for example clearing of unused lands) or upgrade the quality of existing resources (for example irrigation), but its essential feature involves a trade-off between present and future consumption. Labor force: Population growth and the associated increase in labor force have traditionally been considered a positive factor in stimulating economic growth. A larger labor force means more productive workers, and a large overall population increases the potential size of domestic market. However, it is questionable, whether rapid population growth in surplus labor developing countries exerts a positive or negative influence on economic progress. Obviously, it will depend on the ability of the economic system to absorb and economically employ these added workers. Now assuming technology as given let us see how capital and labor interact via the production possibility curve to expand output of a society.

Resource: Todaro: 81 In above figure the production possibility curve portrays the maximum attainable output combinations of two commodities, rice and radios, when all resources are fully and efficiently employed. With unchanged technology, if the resources (capital/labor) are doubled, the entire production possibility curve will uniformly move upward from PP to PP. More radios and more rice can now be produced. It follows that output will be higher than before and the process of economic growth is underway. Note that even if the resources are underutilized as at point X a growth of productive sources can result in a higher output as on point
2

X, even though there may still be widespread unemployment or underutilized/idle capital. But note also that there is nothing deterministic about resources growth leading to higher output growth as attested by poor growth record of many contemporary developing countries. Nor is resource growth even a necessary condition for short-run economic growth, because the better utilization of existing idle resources can raise output level substantially as portrayed in the movement from X to X. However, in the long-run the improvement and upgrading of resources are principal means of accelerating growth of output. Now, instead of assuming proportionate growth of all factors of production, let us assume that only capital or land is increased in quality and quantity. Figure 3.2 shows that if radio manufacturing is a relatively large user of capital equipment and the rice production is a relatively land-intensive process, the shift in production possibility curve will be more pronounced for radios when capital grows rapidly and for rice when the growth is in the quality and quantity of land:

Resource: Todaro: 82 However, because under normal conditions both products will require both factors, albeit in different combinations, the production possibility curve still shifts slightly outward along the rice axis when only capital is increased and to the radio axis when only land is expanded. Technology: Technological progress results from new and improved ways of doing tasks such as growing crops, making clothing or building houses, etc. There are three kinds of technological progress. Neutral technological progress occurs when higher output levels are achieved with the same quantity and combination of factor inputs. Simple innovations can result in higher output and greater consumption for all
3

individuals. In terms of production possibility analysis neutral technological change that, say, doubles total output is conceptually equivalent to a doubling of all productive inputs. The outward shifting of production possibility curve in figure 3.1 could therefore also be a representation of neutral technological progress. By contrast, technological progress may either be labor-saving or capital-saving, which means higher levels of output can be achieved with the same quantity of labor or capital inputs. Computers, Internet, automated looms, electric drills, tractors, and mechanical plough, etc. can be classified as products of labor-saving technological progress. Capital-saving technological progress is a rare phenomenon, because most of technological research is conducted in developed countries, where the mandate is to save labor, not capital. The indigenous low-cost, laborintensive (capital-saving) techniques of production like rotary-power weeders and threshers, foot operated bellow pumps, and mechanical sprayers for small-scale agriculture, are essential ingredients in any longrun employment-oriented development strategy in developing countries. Labor-augmenting technological progress occurs when the quality or skill of the labor force are upgraded for example use of electronic communication for classroom instruction. Similarly, capital-augmenting technological progress results in more productive use of capital goods, for example, the substitution of steel for wooden plows in agricultural production. We can use production possibility curve to examine two specific examples of technological progress. The innovation of highly productive hybrid rice seed (IR8) enabled Asian farmers to double or tipple their yield. This land-augmenting technological progress permitted higher output levels in agricultural production. In terms of production possibility curve the higher yielding rice could be depicted in figure 3.3 by an outward shift of the same curve along with the rice axis with unchanged radio axis:

Resource: Todaro: 83-84

4

Similarly, the invention of transistor led to an enormous growth of radio production. Figure 3.4 shows that the technology of transistor has caused the production possibility curve to shift outward on radio axis with unchanged rice axis. Conclusion: Investments that improve the quality and quantity of existing physical and human resources, and raise the productivity of resources through invention, innovation and technological progress, are primary factors of economic growth.

Common characteristics of developed countries: Kuznet defined economic growth of a country: a long-term rise in capacity to supply increasingly diverse economic goods to its population, this growing capacity based on advancing technology and the institutional and ideological adjustments that it demands. (Kuznet:1971). Kuznet identified six characteristics manifested in the growth process of all developed nations, namely: 1. High growth rates of per capita output and population 2. High rates of increase in total factor productivity 3. High rates of structural transformation of the economy 4. High rates of social and ideological transformation 5. International economic outreach 6. Limited international spread of economic growth 1. High growth rates of per capita output and population: During the epoch of modern economic growth developed countries have experienced high growth rates of per capita output and population. Since 1770 these countries achieved average annual growth rate of 3% for total output (real GNP). This rate imply a doubling time of roughly 35 years. 2. High rates of increase in total factor productivity: The above said countries also achieved high rate of total factor productivity (TFP). Easterly and Levine have shown that productivity growth explains most of per capita output growth of these countries and capital accumulation (share of capital) explains only a small part. Many
5

countries continue to accumulate capital even while their economies shrink. Other economies grow rather quickly despite a relatively low level of investment. Other studies showed that rate of total productivity increase account for 50-75% of the historical growth of per capita output in developed countries. 3. High rates of structural transformation of the economy: Structural and sectoral changes include the gradual shift away from agricultural to non-agricultural activities, a significant change in the scale or average size of productive units (small families, enterprises, concerns), and a corresponding shift in the spatial location and occupational status of the labor force away from rural to urban centers. For example in the USA labor force share in agriculture was 53.5% in 1870. By 2000 this figure has declined to 2%. 4. High rates of social and ideological transformation: In developed countries occurred social transformation in the form of urbanization and adoption of modern ideals, attitudes and institutions. Rationality took place and substituted age-old traditional practices with modern methods of thinking, acting, producing, distributing and consuming. Rationality also requires a coordinated system of economic planning and policy measures for economic growth and development. Another factor of social transformation is promotion of more equality in status, opportunities, wealth, incomes and levels of living. Similarly, improved institutions and attitudes are other prerequisites of economic growth. Among the social institutions needing changes are outmoded land tenure system, social and economic monopolies, educational structures, and systems of administration and planning. In the area of attitudes, the concept of modern workers embodies such ideals as efficiency, diligence, orderliness, punctuality, frugality, honesty, rationality, integrity and self-reliance, cooperation, and willingness to take the long view. 5. International economic outreach: An important characteristic of developed countries is ongoing propensity to reach out to the rest of the world for primary products and raw materials, cheap labor, and lucrative markets for their manufactured products. 6. Limited international spread of economic growth: The spread of sustained economic growth is still largely limited to less than one-third of worlds population. Just 15% of worlds population enjoys a majority of worlds income.
6

Conclusion: The six characteristics of modern economic growth are interrelated and mutually reinforcing. High rates of per capita output result from rapidly rising level of factor productivity. High per capita incomes in turn generate high levels of per capita consumption, thus providing the incentives for changes in the structure of production (as income rises, the demand for manufactured products rises at a much faster rate than the demand for primary products). Advanced technology needed to achieve these output and structural changes causes the scale of production and the characteristics of economic enterprise units to change in both organization and location. This in turn necessitates rapid changes in the location and structure of the labor force and in status relationships among occupational groups. Rapid economic growth makes possible basic scientific research, which in turn leads to technological inventions/innovations, which propel economic growth even further. Over 90% of scientific research is undertaken in rich countries. This research and resulting technological progress can often be of little direct benefit to poor countries whose resources and institutional conditions differ greatly from those of the developed countries.

Historical growth and differing conditions of developing countries: 1. Physical and human resource endowments: According to Todaro developing countries are less endowed with natural resources than developed countries had at the time of their take off for modern growth. Similarly, the difference in skilled human resource endowments is more pronounced. The ability of a country to exploit its natural resources and to initiate and sustain long-term economic growth is dependent on, among other things, the ingenuity and the managerial and technical skill of its people and its success to critical market and product information at minimal cost. The populations of todays developing countries are generally less educated, less informed, less experienced and less skilled than their counterparts were in the early days of economic growth in the West. While the argument of lack of education and skill in developing countries is a valid one, no significant relevance is found for a shortage of natural resources in developing countries. As a matter of fact early industrialized countries including UK, France and Germany, were short of natural resources and these countries secured natural resources through colonialism. 2. Relative level of per capita income and GNP: According to Todaro four-fifths of worlds population at present living in developing countries has in average lower level of per capita income than their counterparts had at the time of take off in nineteenth century. Moreover, at that time todays developed nations were economically in advance of the rest of the world. They could therefore take advantage of their strong financial position to widen the income gap between them and other countries. Todaro does not explain the rational of high per capita income of developed nations at the time of their take off. The history of colonialism clearly reveals that countries like Great Britain were exploiting their colonies in the nineteenth century. At that time economic stagnation or even regression in the colonies was quite understandable. However, a number of todays developing countries, though depend upon developed countries in many aspects, are yet in a position to increase the rate of economic growth.

3. Climatic differences: Almost all developing countries are situated in tropical or subtropical climatic zones and most of economically successful countries are located in the temperate zones. According to Todaro extreme of heat and humidity negatively affect health and productivity. However, the reduction of loss of efficiency and productivity to the tropical climatic zones is questionable. Firstly, loss of efficiency and productivity can also occur in cold climatic zones. Extreme coldness may also causes work and health difficulties. Secondly, a number of economically successful countries like USA and Australia are also located in tropical climatic zones. The extreme cold climate in the West may be a cause of colonial expansion and not of economic growth. 4. Population, distribution and growth: Before and during early growth years Western nations experienced a very slow rise in population growth. As industrialization proceeded, population growth rates increased primarily as a result of falling death rates but also because of slowly rising birth rates. The population growth rates in Europe and North America did not exceed 2% per annum. By contrast, the populations of many developing countries have been increasing at annual growth rates in excess of 2.5% over the past few decades. 5. International migration: One main reason of modest growth rate of population in developed countries was international migration. From 1847 to 1907 more than 5 million surplus rural labors from Europe migrated to North America and Australia. After 2nd World War a similar migration took place from Southern to Northern Europe as well as from developing to developed countries. In this way the home government were relieved of the cost of providing for unemployed labor and because a large percentage of workers earnings were sent home. At present there is limited scope for reducing the pressure of overpopulation in developing countries through international migration due to restrictive nature of immigration laws in developed countries. There are estimated 6 million illegal migrants. These migrants are perceived as taking jobs away from poor, unskilled citizen workers and causing upward pressure on local taxes to support public services for them. Many of the legal migrants from developing to
9

developed countries are highly educated and skilled workers. Since the great majority of these migrants move on a permanent basis, this perverse brain drain not only represents a loss of valuable human resources a constraint to future economic progress of developing countries. For example, between 1960 and 1990, more than a million high-level professional and technical workers from the developing countries migrated to USA, Canada, and the United Kingdom alone. 6. Growth stimulus of international trade: International trade has been called the engine of growth for developed countries. Rapidly expanding export markets provided an additional stimulus to growing local demands that led to the establishment of large scale manufacturing industries. This capital accumulation in turn stimulated further production, made possible increased imports, and led to a more diversified industrial structure. Today the situation of many developing countries is very different. With the exception of a few East Asian countries, the non oil exporting countries face formidable difficulties to generate rapid economic growth on the basis of world trade. Since 1st World War many developing countries have experienced a deteriorating trade. Their exports have expanded not as fast as exports of developed countries. Their terms of trade have declined steadily. The developed countries, with the help of advanced science and technology, are more competitive and develop more new products. These countries also resort to various forms of trade barriers, if certain developing countries may become lower-cost producers of competitive products. 7. Research and development capabilities: Research and technological development have played vital role in the growth process of developed countries. Advancement in the stock of knowledge increased growth and growing surplus in turn strengthened the process of scientific research and development of new products. Over 90% of world research and development (R&D) expenditures originate in developed countries. Research funds are spent on solving the economic and technological problems of concerns to rich countries according with their own economic priorities and resource endowments. Rich countries are mainly interested in the development of sophisticated products, large markets, and technologically advanced production methods using large inputs of capital and high level of skill and management while economizing on their relatively scarce supplies of
10

labor and raw materials. The poor countries, by contrast, are much more interested in simple products, simple designs, saving of capital, use of abundant labor, and production for smaller markets. Their dependence on foreign technologies can create and perpetuate economic dualism. Contemporary developing countries are in an extremely disadvantageous competitive position. In contrast, developed countries in their early growth process were scientifically and technologically greatly in advance of the rest of the world. 8. Stability of political and social institutions: Well before industrial revolution, the developed countries of today were at that time independent consolidated nation-states able to pursue national policies on the basis of consensus towards modernization. In contrast, many developing countries of today have only recently gained political independence and have yet to become consolidated nationstates with an effective ability to formulate and pursue national development strategies. Until stable and flexible political institutions can be consolidated with broad public support, the present social and cultural fragmentation of many developing countries is likely to inhibit their ability to accelerate national economic progress. With the end of the cold war and the rapid globalization, social and political stability has assumed even greater importance for economic development. The internal flow of hot money was never more evident than after the devaluation of Mexican Peso in 1994. Huge money was withdrawn from foreign investors in a process of financial market contagion. A similar scenario presented itself during the Asian Crisis of 1997-98 with widespread economic panic. Researchers have found that growth is ore influenced by the stability of political regime. The systems the colonizers put in place to extract resources from colonies while maintaining their own dominance, rather than to encourage economic development, in many cases still remain in place, and have proven tragically difficult to reform.

11

Are living standards of developing and developed countries converging? If the growth experience of developing and developed countries were similar, there are two important reasons to expect that developing countries would be catching up by growing faster than developed countries. The first reason is due to technology transfer. Eve if royalty must be paid, it is cheaper to replicate technology than to undertake original R&D. This would enable developing countries to move immediately to high productive techniques of production. As a result they should be able to grow much faster than the todays developed countries are growing now. The second reason to expect convergence is based on factor accumulation. Todays developed countries have high levels of physical and human capital. Thus, marginal product of capital, and profitability of investments, would be lower in developed countries due to law of diminishing rate of returns. That is, the impact of additional capital on output would be expected to be smaller in a developed country than in a developing country where capital is scarce. As a result we would expect higher investments and growth rates of output in developing countries, until approximately equal levels of capital per worker were achieved. Given one or both of two conditions, technology transfer and rapid capital accumulation, incomes would tend to converge in the long run. However, evidence of convergence is very hard to find in the data. In fact there is slight tendency for the poorer countries to grow more slowly than the rich countries. Conclusion: Due to very different initial conditions the historical experience of Western economic growth is of limited relevance for contemporary developing countries. However, complementary technological, social and institutional changes are quite important for long-term economic growth. Developing countries will generally have to do more than simply emulating policies followed by todays developed countries while they were in their early stages of development.

12