TheMarshall Plan(officially theEuropean Recovery Program,ERP) was the American initiative to aidEurope, in which theUnited Statesgave economic support to help rebuild European economies after the end ofWorld War IIin order to prevent the spread of SovietCommunism.[1]The plan was in operation for four years beginning in April 1948.[2]The goals of the United States were to rebuild war-devastated regions, removetrade barriers, modernize industry, and make Europe prosperous again.[3]The phrase "equivalent of the Marshall Plan" is often used to describe a proposed large-scale rescue program.Paul Narcyz Rosenstein-Rodan(19021985) was an economist of Jewish origin born inKrakw, who was trained in theAustrian traditionunder Hans Mayer inVienna. His early contributions toeconomicswere in pure economic theory onmarginal utility, complementarity, hierarchical structures of wants and the pervasive Austrian School issue of time.

Rosenstein-Rodan emigrated toBritainin 1930, and taught atUniversity College Londonand then atLondon School of Economicsuntil 1947. He then moved to theWorld Bank, before moving on toMIT, where he was a professor from 1953 to 1968.He is the author of the 1943 article "Problems of Industrialisation of Eastern and South-Eastern Europe" - origin of the Big Push Model theory - in which he argued for planned large-scale investment programmes in industrialisation in countries with a large surplus workforce in agriculture, in order to take advantage of network effects, viz economies of scale and scope, to escape the low level equilibrium "trap". He thus developed a theme laid out byAllyn Youngin his 1928 article "Increasing Returns and Economic Progress", in which the latter himself expanded a theme formulated by Adam Smith in 1776.TheInternational Institute of Social Studies(ISS) awarded its Honorary Fellowship to Paul Rosenstein-Rodan in 1962.His sister was the Polish painter and poetErna Rosenstein.Thebig push modelis a concept indevelopment economicsorwelfare economicsthat emphasizes that a firm's decision whether to industrialize or not depends on its expectation of what other firms will do. It assumeseconomies of scaleandoligopolisticmarket structure and explains when industrialization would happen.The originator of this theory wasPaul Rosenstein-Rodanin 1943. Further contributions were made later on byMurphy, Shleifer andRobert W. Vishnyin 1989. Analysis of this economic model ordinarily involves usinggame theory.The theory of the model emphasizes thatunderdeveloped countriesrequire large amounts of investments to embark on the path ofeconomic developmentfrom their present state of backwardness. This theory proposes that a 'bit by bit' investment programme will not impact the process of growth as much as is required for developing countries. In fact, injections of small quantities of investments will merely lead to a wastage ofresources.Paul Rosenstein-Rodan, approvingly quotes aMassachusetts Institute of Technologystudy in this regard, "There is a minimum level ofresourcesthat must be devoted to... adevelopmentprogramme if it is to have any chance of success. Launching a country into self-sustaining growth is a little like getting anairplaneoff the ground. There is a criticalground speedwhich must be passed before the craft can become airborne...."[1]Rosenstein-Rodanargued that the entire industry which is intended to be created should be treated and planned as a massive entity (afirmortrust). He supports this argument by stating that the socialmarginal productof an investment is always different from its privatemarginal product, so when a group ofindustriesare planned together according to their social marginal products, therate of growthof the economy is greater than it would have otherwise been.The three indivisibilities[edit]According to Rosenstein-Rodan, there exist three indivisibilities inunderdeveloped countries. These indivisibilities are responsible forexternal economiesand thus justify the need for a big push. The externalities are as follows-1. Indivisibility inproduction function2. Indivisibility ofdemand3. Indivisibility in the supply ofsavingsIndivisibility in production function[edit]Indivisibilities in theproduction functionmay be with respect to any of the following: Inputs Processes OutputsThese lead to increasing returns (i.e.,economies of scale), and may require a high optimum size of a firm. This can be achieved even in developing countries since at least one optimum scale firm can be established in many industries. But investment insocial overhead capitalcomprises investment in all basic industries (likepower, transport or communications) which must necessarily come before directly productive investment activities. Investment in social overheadcapitalis 'lumpy' in nature. Such capital requirements cannot be imported from other nations. Therefore, heavy initial investment necessarily needs to be made in social overheadcapital(this is approximated to be about 30 to 40 percent of the total investment undertaken byunderdeveloped countries). Social overhead capital is further characterized by four indivisibilities:1. Irreversibility in time: It must precede other directly productive investments2. Minimum durability of equipment:. Any lesser level ofdurabilityis either impossible due to technical reasons or much lessefficient3. Long gestation periods: The investment in social overheadcapitaltakes time to generate returns and its impact in the economy is not immediately or directly visible4. Irreducible minimum social overhead capitalindustry mix: Investment needs to be of a certain minimum magnitude and spread across a mix of industries, without which it will not significantly impact the process of growth.Indivisibility (or complementarity) of demand[edit]Developing countries are characterized by low per-capita income and purchasing power. Markets in these countries are therefore small. In aclosed economy, modernization and increased efficiency in a single industry has no impact on the economy as a whole since the output of that industry will fail to find a market. A large number of industries need to be set up simultaneously so that people employed in one industry consume the output of other industries and thus createcomplementarydemand.To illustrate this, Rosenstein Rodan gives the example of a shoe industry. If a country makes large investments in the shoe industry, all the disguisedly employed labor from the other industries find work and a source of income, leading to a rise in production of shoes and their own incomes. This increased income will not be expended only on buying shoes. It is conceivable that the increased incomes will lead to increased spending on other products too. However, there is no corresponding supply of these products to satisfy this increased demand for the other goods. Following the basicmarket forcesof demand and supply, the prices of these commodities will rise. To avoid such a situation, investment must be spread out amongst different industries.The situation may be different in anopen economyas the output of the new industry may replace former imports or possibly find its market by way of exports. But even if the world market acts as asubstitutefor domestic demand, a big push is still needed (though its required size may now be reduced due to the presence of international trade).Indivisibility in the supply of savings[edit]High levels of investment require a corresponding high level of savings. We cannot always rely on foreign aid as the huge levels of investments in the differentsectorsneed to be made not only once, but multiple number of times. Hence domestic savings are a must. But in an underdeveloped economy,this is a challenge due to the low income levels.Marginal rate of savingsneeds to be increased following the rise in incomes due to higher investment.How the big push works[edit]

Fig.1Consider a country whose economy is characterized by a large number ofsectorswhich are so small that any increase in the productivity of one sector has no impact on the economy as a whole. Each sector can either rely on traditional methods or switch to modern methods of production which would increase its efficiency. Let us assume that there areworkers in the economy andsectors. Each sector therefore hasworkers.Using traditional technology, a sector would produceamount of output, with each worker producing one unit of the commodity.Using modern technologya sector would produce more as the productivity would be greater than one unit per worker. However, a modern sector would require some of the workers (say) to perform administrative tasks.In figure 1, the x-axis represents the labor employed and the y-axis represents the level of production. The production in the traditionalsectoris given by the curve T and the production in the modern sector is given by M. The curve M has a positive intercept on the x-axis, implying that even with zero production, there is a minimum level ofworkers who still remain employed for carrying out administrative activities. With our assumption ofworkers in the economy, the modern sector will have a higher level of productivity than the traditional sector. The production function of the modern sector is steeper than that of the traditional sector because of the higher productivity of workers in the former. The slope of both production functions is, whereis the marginal labor required to produce an additional unit of output. This level ofis lower for the modern sector than it is for the traditional sector.

Fig.1Assume that the traditional sector pays workers one unit of output which is subsequently spent equally by them in all sectors. The modern sector pays higher wages to workers. If all the workers are employed by the traditional sector, then the demand generated for the output of each sector is. We have two possible cases: Wages are low When low wages are prevalent in the economy, say, a firm which faces demandwill need to employworkers if it wants to modernize. This will cost the firm.Now, wages are low. Therefore.This implies that costs (given by) are lower than the earnings (given by). So the firm makes a profit and will choose to modernize (even if other firms do not). Wages are high When high wages are prevalent in the economy, say, a firm which faces demandwill make losses if no other firms choose to modernize.This is because.This implies that costs (given by) are higher than the earnings (given by).However, if all the other firms have modernized, the firm faces a higher demand, arising out of higher income levels of workers of these modernized firms. The firm will hence choose to modernize as well so that it makes profits:.

Indivisibilities and external economies[edit]The concept ofexternalitiesis relevant for the Industrialization ofunderdeveloped countries, where decisions are to be made regarding distribution of savings among alternativeinvestment opportunities. These arise from the interdependence in market economies.[3]Pecuniary economiesareexternal economiestransmitted through theprice system, as prices are thesignallingdevice (under conditions ofperfect competitionin a market economy). They arise in an industry (say industry X) due to internal economies of overcoming technical indivisibilities. This reduces the price of its product, which will benefit another industry (say industry Y) which use this output as an input or a factor of production.[4]Subsequently, the profits of industry Y will rise, leading to its expansion and generating demand for the output of industry X. As a result, industry X's production and profits also expand.[5]However inunderdeveloped countries, conditions ofperfect competitionare not present due to thedecentralizedand differentiated nature of the market. Prices fail to act as asignalling systemin the following ways:[3] Prices express the situation as it is and do not predict future economic situations Prices can decide present productive activities but cannot determine investments which would be appropriate for developing countries The response of the private sector to price signals is inadequate and imperfect due to the differentiation and decentralisation in developing countriesThis justifies the need for centralized pan-industry planning of investment in Developing countries, as the private sector cannot undertake such planning.Enlargement of the market sizeis another important externality which arises from the complementarity of industries. There exists an incentive to expand the scale of operations because the employees of one industry become the customers of another industry. In terms of products too (as in the above example of industries X and Y), one industry generates demand for the output of the other when the scale of operations increase.[6]Marshallian economiesalso accrue to a firm within a growing industry, resulting from agglomeration of industrial districts or clusters in a particular area. These occur due to the following advantages of agglomeration identified byAlfred Marshall:1. Spillover of information2. Specialization and division of labor3. Development of a market for skilled labor.[5]Availability of skilled labouris an externality which arises when industrialization occurs, as workers acquire better training and skills. This is not achievable by mere establishment of a few industries, but requires a large program of industrial growth. It is one of the most important external economies because absence of skilled labor is a strong impediment to industrialization.[7]Role of the State[edit]The large-scale programme of industrialization advocated by this model requires huge investments which are beyond the means of the private sector. The investment in infrastructure and basic industries (like power, transport and communications) is 'lumpy' and has long gestation periods. The role of the state in this theory is therefore critical for investment in social overheadcapital. Even if the private sector had the requisite resources to invest in such a programme, it would not do so since it is driven by profit motives.[7]Many investments are profitable in terms of social marginal net product but not in terms of private marginal net product. Due to this there is no incentive for individual entrepreneurs to invest and take advantage of external economies.[1]Criticisms[edit]The theory has been criticized byHla MyintandCelso Furtado, among others, primarily on the grounds of the massive effort required to be taken byunderdeveloped countriesto move along the path of industrialization. Some of the major criticisms are as follows. Difficulties in execution and implementation: The execution of related projects during the course of industrialization may involve unexpected or unavoidable changes due to revisions of plans, delays and deviations from the planned process.Hla Myintnotes that the various departments and agencies involved in the process of development need to coordinate closely and evaluate and revise plans continuously. This is a challenging task for the governments of developing countries.[4] Lack of absorptive capacity: The implementation of industrialization programmes may be constrained by ineffective disbursement,short-term bottlenecks,macroeconomicproblems and volatility, loss of competitiveness and weakening of institutions.Creditis often utilized at low rates or after long time lags. There is often a loss of competitiveness due to theDutch diseaseeffect.[8] Historical inaccuracy: When viewed in light of historical experience of countries over the last two centuries, no country displayed any evidence of development due to massive industrialization programmes.Stationary economiesdo not develop simply by making large-scale investment in social overheadcapital.[9] Problems in mixed economies: In amixed economy, where theprivateandpublic sectorsco-exist, the environment for growth may not be a conducive one. Unless there is acomplementaritybetween the sectors, there is bound to arise competition between them, with thegovernment departmentskeeping their plans confidential out of fear ofspeculative activitiesby theprivate sector. The private sector's activities are simultaneously inhibited due tolack of informationof government policies and the general economic situation[4] Neglect of methods of production: Rather thancapitalformation, it is productive techniques which determine the success of a country ineconomic development. The big push model ignores productive techniques in its support forcapitalformation and industrialisation.[9] Shortage of resources in underdeveloped countries: Eugenio Gudin criticizes the theory of the big push on the grounds thatunderdeveloped countrieslack thecapitalrequired to provide the big push required for rapiddevelopment. If an underdeveloped nation had amplecapitalsupply and scarcefactors, it would not be classified asunderdevelopedat all. Limitedresourceavailability is the first impediment to such countries. Though this problem may be overcome by foreign aids, industrialization may not take off as expected if the aid flows are volatile.[8] Ignores the agricultural sector: With its heavy emphasis on industry, the model finds no place for agriculture. This is a gaping flaw in the theory, as in mostunderdeveloped countriesit is this sector which is large and has laborsurplus. Investments in agriculture need to go hand-in-hand with those in industry so as tostimulatethe industrial sector by providing a market for industrial goods. If neglected, it would be difficult to meet the food requirements of the nation in theshort runand to significantly expand thesize of the marketin thelong run. Inflationary pressures: It follows from the neglect of the agricultural sector thatfood shortagesare likely to occur with industrialization. Though it would take time for investments in social overheadcapitalto yield returns, thedemandwould increase immediately, thus imposinginflationary pressureson the economy. Cost escalations may even cause projects to be postponed and thedevelopmentprocess in general to slow down.[1] Dependence on indivisibilities: The emphasis of this theory on indivisibility of processes is too much, as investments need not necessarily be on such a large scale to be economic.Social reformsare ignored, which are vital if a country is to grow on the basis of its ownresourcesand initiatives.Developmentis bound to intensify if social reform is a part of the industrialization process.[

Ragnar Nurkse(5 October[O.S.22 September]1907,Kru,Estonia 6 May 1959, nearLake Geneva,Switzerland) was anEstonian[1]international economist and policy maker mainly in the fields of international finance and economic development.

Life[edit]Ragnar Nurkse was born inKruvillage,Governorate of Livoniaof theRussian Empire(now inKru Parish,Rapla County,Estonia), son of anEstonianfather who worked himself up from lumberjack to estate manager, and anEstonian-Swedishmother. His parents emigrated toCanadain 1928.After aRussian-speaking primary school, Nurkse attended the elite Cathedral School of Tallinn, the most prestigious,German-languagesecondary school in the city, from where he graduated with higher honors in 1928. He continued his education at the Law School and the economics department of theUniversity of Tartufrom 1926 to 1928, and then in economics at theUniversity of Edinburgh. He graduated with a first class degree in economics, under professor SirFrederick Ogilvie, in 1932. He earned aCarnegieFellowship to study at theUniversity of Viennafrom 1932 to 193.Nurkse served in the Financial Section and Economic Intelligence Service of theLeague of Nationsfrom 1934 to 1945. He was the financial analyst and was largely responsible for the annual Monetary Review. He was also involved with the publication of The Review of World Trade, World Economic Surveys, and the report of the Delegation on Economic Depressions entitled "The Transition from War to Peace Economy".In 1945, Nurkse accepted an appointment at theColumbia UniversityinNew York City. He was a visiting lecturer at Columbia from 1945 to 1946, was a member of the Institute for Advanced Study inPrinceton, New Jersey, from 1946 to 1947, and then returned to Columbia as an Associate Professor of Economics in 1947. In 1949, he was promoted to Full Professor of Economics, a position which he held almost until his death in 1959. Nurkse spent a sabbatical (1954-1955) at theNuffield Collegeof theUniversity of Oxford, and in 1958-1959, another one studying economic development in theUniversity of Geneva, and lecturing around the world.In 1958, Ragnar Nurkse accepted a Professorship of Economics and the Director of International Finance Section position atPrinceton University. However, before he could fully resume it, when Nurkse returned toGenevain the spring of 1959, he died suddenly at the age of 52.For his 100th anniversary on 5 October 2007, the Estonian Postal Service commemorated Nurkse with an international letter stamp. A large stone monument with a plaque will also be unveiled across the house he was born in Kru. He was also honored earlier in 2007 by the inauguration of a Lecture Series by theBank of Estoniaand an international conference byTallinn University of Technology'sTechnology Governanceprogram. An economicsprofessorshipat Columbia is named in his honor.

Work[edit]Main article:Ragnar Nurkse's Balanced Growth TheoryNurkse is one of the founding fathers of Classical Development Economics. Together withRosenstein-RodanandMandelbaum, he promoted a 'theory of the big push', emphasized the role of savings and capital formation in economic development, and argued that poor nations remained poor because of avicious circleofpoverty. Among his major works areInternational Currency Experience: Lessons of the Interwar Period(1944), the foundation of theBretton Woods Agreement,Conditions of International Monetary Equilibrium(1945), andProblems of Capital Formation in Underdeveloped Countries(1953).The balanced growth theory is aneconomic theorypioneered by the economistRagnar Nurkse(19071959). The theory hypothesises that the government of any underdeveloped country needs to make large investments in a number of industries simultaneously.[1][2]This will enlarge the market size, increase productivity, and provide an incentive for the private sector to invest.Nurkse was in favour of attaining balanced growth in both the industrial and agricultural sectors of the economy.[3]He recognised that the expansion and inter-sectoral balance between agriculture and manufacturing is necessary so that each of these sectors provides a market for the products of the other and in turn, supplies the necessary raw materials for the development and growth of the other.Nurkse andPaul Rosenstein-Rodanwere the pioneers of balanced growth theory and much of how it is understood today dates back to their work.[4]Nurkse's theory discusses how the poor size of the market in underdeveloped countries perpetuates its underdeveloped state.[5][6]Nurkse has also clarified the various determinants of the market size and puts primary focus on productivity.[3][7]According to him, if the productivity levels rise in a less developed country, its market size will expand and thus it can eventually become a developed economy. Apart from this, Nurkse has been nicknamed an export pessimist, as he feels that the finances to make investments in underdeveloped countries must arise from their own domestic territory.[1]No importance should be given to promoting exports.Size of market and inducement to invest[edit]The size of a market assumes primary importance in the study of what induces investment in a country. Ragnar Nurkse referenced the work ofAllyn A. Youngto assert that inducement to invest is limited by the size of the market.[9]The original idea behind this was put forward byAdam Smith, who stated thatdivision of labour(as against inducement to invest) is limited by the extent of the market.[7]According to Nurkse, underdeveloped countries lack adequatepurchasing power.[7]Low purchasing powermeans that thereal incomeof the people is low, although in monetary terms it may be high. If the money income were low, the problem could easily be overcome by expanding themoney supply; however, since the meaning in this context is real income, expanding the supply of money will only generateinflationarypressure. Neither real output nor real investment will rise. It is to be noted that a low purchasing power means that domesticdemandfor commodities is low. Apart from encompassing consumer goods and services, this includes the demand forcapitalas well.The size of the market determines the incentive to invest irrespective of the nature of the economy.[6]This is because entrepreneurs invariably take their production decisions by taking into consideration the demand for the concerned product. For example, if an automobile manufacturer is trying to decide which countries to set up plants in, he will naturally only invest in those countries where the demand is high.[7]He would prefer to invest in a developed country, where though the population is lesser than inunderdeveloped countries, the people are prosperous and there is a definite demand.Private entrepreneurs sometimes resort to heavyadvertisingas a means of attracting buyers for their products. Although this may lead to a rise in demand for that entrepreneur's good or service, it does not actually raise theaggregate demandin the economy. The demand merely shifts from one provider to another.[5]Clearly, this is not a long-term solution.Ragnar Nurkse concluded,"The limited size of the domestic market in a low income country can thus constitute an obstacle to the application of capital by any individual firm or industry working for the market. In this sense the small domestic market is an obstacle to development generally.

The process of economic development as per Ragnar Nurkse's Balanced Growth Theory

Determinants of size of market[edit]According to Nurkse, expanding the size of the market is crucial to increasing the inducement to invest. Only then can the vicious circle of poverty be broken. He mentioned the following pertinent points about how the size of the market is determined:

Determinants of size of marketMoney supply[edit]Main article:Money supplyNurkse emphasised thatKeynesian theoryshouldn't be applied to underdeveloped countries because they don't face a lack ofeffective demandin the way thatdeveloped countriesdo.[7]Their problem is to do with a lack of realpurchasing powerdue to low productivity levels. Thus, merely increasing the supply of money will not expand the market but will in fact causeinflationary pressure.Population[edit]Nurkse argued against the notion that a large population implies a large market.[5]Though underdeveloped countries have a large population, their levels of productivity are low. This results in low levels of per capita real income. Thus, consumption expenditure is low, and savings are either very low or completely absent. On the other hand, developed countries have smaller populations than underdeveloped countries but by virtue of high levels of productivity, their per capita real incomes are higher and thus they create a large market for goods and services.Geographical area[edit]Nurkse also refuted the claim that if a country's geographical area is large, the size of its market also ought to be large.[1]A country may be extremely small in area but still have a large effective demand. For example, Japan. In contrast, a country may cover a huge geographical area but its market may still be small. This may occur if a large part of the country is uninhabitable, or if the country suffers from low productivity levels and thus has a lowNational Income.Transport cost and trade barriers[edit]The notion that transport costs and trade barriers hinder the expansion of the market is age-old. Nurkse emphasised thattariffduties, exchange controls,import quotasand othernon-tariff barriers to tradeare major obstacles to promoting international cooperation in exporting and importing.[7]More specifically, due to high transport costs between nations, producers do not have an incentive to export their commodities. As a result, the amount ofcapital accumulationremains small. To address this problem, the United Nations produced a report in 1951[10]with solutions for underdeveloped countries. They suggested that they can expand their markets by forming customs unions with neighbouring countries. Also, they can adopt the system of preferential taxation or even abolish customs duties altogether. The logic was that once customs duties are removed, transport costs will fall. Consequently, prices will fall and thus the demand will rise. However, Nurkse, as an export pessimist, did not agree with this view.[8]Export pessimism is a trade theory which is governed by the idea of "inward looking growth" as opposed to "outward looking growth". (SeeImport substitution industrialization)Sales promotion[edit]Often, it is true that a company's private endeavour to increase the demand for its products succeeds due to the extensive use of advertisement and other sales promotion technique. However, Nurkse argues that such activities cannot succeed at the macro level to increase a country's aggregate demand level.[7]He calls this the"macroeconomic paradox".[7]Productivity[edit]Main article:ProductivityNurkse stressed productivity as theprimary determinant of the size of the market. An increase in productivity (defined as the output per unit input) increases the flow of goods and services in the economy. As a response, consumption also rises. Hence, underdeveloped economies should aim to raise their productivity levels in all sectors of the economy, in particular agriculture and industry.[3]

The process of how increased productivity leads to economic development and growthFor example, in most underdeveloped economies, thetechnologyused to carry out agricultural activities is backward. There is a low degree of mechanisation coupled with rain dependence. So while a large proportion of the population (70-80%) may be actively employed in the agriculture sector, the contribution to the Gross Domestic Product may be as low as 40%.[7]This points to the need to increase output per unit input andoutput per head. This can be done if the government provides irrigation facilities,high-yielding varietyseeds, pesticides, fertilisers, tractors etc. The positive outcome of this is that farmers earn more income and have a higher purchasing power (real income). Their demand for other products in the economy will rise and this will provide industrialists an incentive to invest in that country. Thus, the size of the market expands and improves the condition of the underdeveloped country.Nurkse is of the opinion thatSay's Lawof markets operates in underdeveloped countries. Thus, if the money incomes of the people rise while the price level in the economy stays the same, the size of the market will still not expand till the real income and productivity levels rise. To quote Nurkse,"In underdeveloped areas there is generally no 'deflationary gap' through excessive savings. Production creates its own demand, and the size of the market depends on the volume of production. In the last analysis, the market can be enlarged only through all-round increase in productivity. Capacity to buy means capacity to produce."[3]

Export pessimism[edit]Citing the limited size of the market as the main impediment in economic growth, Nurkse reasons that an increase in productivity can create avirtuous circle of growth.[7]Thus, a large scale investment programme in a wide array of industries simultaneously is the answer. The increase in demand for one industry will lead to an increase in demand for another industry due tocomplementarity of demands. As Say's Law states,supply creates its own demand.[11]However, Nurkse clarified that the finance for this development must arise to as large an extent as possible from the underdeveloped country itself i.e. domestically.[12]He stated that financing through increased trade orforeign investmentswas a strategy used in the past - the 19th century - and its success was limited to the case of the United States of America. In reality, the so-called "new countries" of the United States of America (which separated from the British empire) were high income countries to begin with.[8]They were already endowed with efficient producers, effective markets and a high purchasing power. The point Nurkse was trying to make was that USA was rich in resource endowment as well as labour force. The labour force had merely migrated from Britain to USA, and thus their level of skills were advanced to begin with. This situation of outward led growth was therefore unique and not replicable by underdeveloped countries.In fact, if such a strategy of financing development from outside the home country is undertaken, it creates a number of problems.[12]For example, the foreign investors may carelessly misuse the resources of the underdeveloped country. This would in turn limit that economy's ability to diversify, especially if natural resources were plundered. This may also create a distorted social structure.[8]Apart from this, there is also a risk that the foreign investments may be used to finance private luxury consumption. People would try to imitate Western consumption habits and thus abalance of payments crisismay develop, along with economic inequality within the population.Another reason exports cannot be promoted is because in all likelihood, an underdeveloped country may only be skilled enough to promote the export of primary goods, say agricultural goods.[7]However, since such commodities faceinelastic demand, the extent to which they will sell in the market is limited.[7]Although when population is at a rise, additional demand for exports may be created, Nurkse implicitly assumed that developed countries are operating at thereplacement rateof population growth. For Nurkse, then, exports as a means of economic development are completely ruled out.[1]Thus, for a large-scale development to be feasible, the requisite capital must be generated from within the country itself, and not through export surplus or foreign investment.[6][12]Only then can productivity increase and lead to increasing returns to scale and eventually create virtuous circles of growth.[8][12]Role of state[edit]AfterWorld War II, a debate about whether a country should introducefinancial planningto develop itself or rely onprivate entrepreneursemerged. Nurkse believed that the subject of whoshouldpromote development does not concern economists. It is an administrative problem.[7]The crucial idea was that a large amount of well dispersed investment should be made in the economy, so that the market size expands and leads to higher productivity levels, increasing returns to scale and eventually the development of the country in question.[7]However, it should be noted that most economists who favoured the balanced growth hypothesis believed that only the state has the capacity to take on the kind of heavy investments the theory propagates. Further, the gestation period of such lumpy investments is usually long and private sector entrepreneurs do not normally undertake such high risks.[5]Reactions[edit]Ragnar Nurkse's balanced growth theory too has been criticised on a number of grounds. His main critic wasAlbert O. Hirschman, the pioneer of thestrategy of unbalanced growth.Hans W. Singeralso criticised certain aspects of the theory.Hirschman stressed the fact that underdeveloped economies are called underdeveloped because they face alack of resources, maybe not natural resources, but resources such as skilled labour and technology.[7]Thus, to hypothesise that an underdeveloped nation can undertake large scale investment in many industries of its economy simultaneously is unrealistic due to the paucity of resources.[13]To quote Hirschman,"If a country were ready to apply the doctrine of balanced growth, then it would not be underdeveloped in the first place."[13]Hans Singer asserted that the balanced growth theory is more applicable to cure an economy facing acyclicaldownswing.[7]Cyclical downswing is a feature of an advanced stage of sustained growth rather than of thevicious cycle of poverty. Hirschman also stated that during conditions of slack activity in developed countries, the stock of resources, machines and entrepreneurs are merely unemployed, and are present as idle capacity. So in this situation, simultaneous investment in a large number of sectors is a well-suited policy. The various economic agents are temporarily unemployed and once the inducement to invest starts operating, the slump will be overcome. However, for an underdeveloped economy, where such resources are absent, this principle doesn't fit.[7]Another contention was Nurkse's approval ofSay's Law, which theorises that there is nooverproductionor glut in the economy.[11]Supply (production of goods and services) creates a matching demand for the output and this results in the entire output being sold and consumed. However, Keynes stated that Say's Law is not operational in any country because people do not spend their entire income - a fraction of it is saved for future consumption.[11]Thus, according to Nurkse's critics, his assumption of Say's Law being operational in underdeveloped countries needs greater justification.[7]Even if the section of savers is few, the tenet of putting emphasis on supply rather than demand has been widely discredited.[11][14]Nurkse states that if demand for the output of one sector rises, due to the complementary nature of demand, the demand for the output of other industries will also experience a rise.[7]Paul Rosenstein-Rodan to spoke of a similar concept called "indivisibility of demand" which hypothesises that if large investments are made in a large number of industries simultaneously, an underdeveloped economy can become developed due to the phenomenon of complementary demand.[7]However, both Nurkse and Rosenstein-Rodan only took into consideration the situation of industries that producecomplementary goods.[7]There aresubstitute goodstoo, which are in competition with each other. Thus if the state pumps in large investments into the car industry, for example, it will naturally lead to a rise in the demand for petrol. But if the state makes large scale investments in the coffee sector of a country, the tea sector will suffer.Hans Singer suggested that Nurkse's theory makes dubious assumptions about the underdeveloped economy.[7]For example, Nurkse assumes that the economy starts with nothing at hand.[5]However, an economy usually starts at a position which reflects the previous investment decisions undertaken in the country,[7]and at any given moment, an imbalance already exists. So the logical step would be to take on those investment programmes which compliment the existing imbalance in the economy. Clearly, such an investment cannot be a balanced one. If an economy makes the mistake of setting out to make a balanced investment, a new imbalance is likely to appear which will require still another "balancing investment" to bring equilibrium, and so on and so forth.[7]Hirschman believed that Nurkse's balanced growth theory wasn't in fact a theory of growth.[1]Growth implies the gradual transformation of an economy from one stage to the chronologically next stage. It entails the series of actions which leads the economy from a stage of infancy to that of maturity.[7]However, the balanced growth theory involves the creation of a brand new, self-sufficient modern industrial economy being laid over a stagnant, self-sufficient traditional economy. Thus, there is no transformation.[13]In reality, adual economywill come into existence, where two separate economic sectors will begin to coexist in one country. They will differ on levels of development, technology and demand patterns. This may create inequality in the country.

Albert Otto Hirschman(bornOtto-Albert Hirschmann; April 7, 1915 December 10, 2012) was an influentialeconomistand the author of several books onpolitical economyandpolitical ideology. His first major contribution was in the area ofdevelopment economics.[1]Here he emphasized the need forunbalanced growth. Because developing countries are short of decision making skills, disequilibria to stimulate these and help mobilize resources should be encouraged. Key to this was encouraging industries with a large number of linkages to other firms.His later work was in political economy and there he advanced two simple but intellectually powerful schemata. The first describes the three basic possible responses todeclinein firms or polities:Exit, Voice, and Loyalty. The second describes the basic arguments made byconservatives: perversity, futility and jeopardy, inThe Rhetoric of Reaction.InWorld War II, he played a key role in in rescuing refugees inoccupied France.

Life[edit]Hirschman was born inBerlin, Germany, the son of Carl and Hedwig Marcuse Hirschmann, and brother ofUrsula Hirschmann.[2]After he had started studying in 1932 atFriedrich-Wilhelms-Universitt, he was educated at theSorbonne, theLondon School of Economicsand theUniversity of Trieste, from which he received his doctorate in economics in 1938.[2]Soon thereafter, Hirschman volunteered to fight on behalf of theSpanish Republicin theSpanish CivilWar. After France surrendered to the Nazis, he worked withVarian Fryto helpmany of Europe's leading artists and intellectualsto escape to the United States; Hirschman helped to lead them fromoccupied Franceto Spain through paths in thePyrenees Mountainsand then to Portugal.ARockefeller Fellowat theUniversity of California, Berkeley(19411943), he served in theUnited States Army(19431946) where he worked in theOffice of Strategic Services,[3]was appointed Chief of the Western European and British Commonwealth Section of theFederal Reserve Board(19461952), served as a financial advisor to theNational Planning Board of Colombia(19521954) and then became a private economic counselor inBogot(19541956).Following that he held a succession of academic appointments in economics atYale University(19561958),Columbia University(19581964),Harvard University(19641974) and theInstitute for Advanced Study(19742012).Hirschman helped develop theHiding hand principlein his 1967 essay 'The principle of the hiding hand'.In 2003, he won the Benjamin E. Lippincott Award from theAmerican Political Science Associationto recognize a work of exceptional quality by a living political theorist for his bookThe Passions and the Interests: Political Arguments for Capitalism before Its Triumph.In 2007, theSocial Science Research Councilestablished an annual prize in honor of Hirschman.[4]He died at the age of 97 on December 10, 2012.The Passions and the Interests[edit]This is a history of the ideas laying the intellectual groundwork for capitalism. Hirschman describes how thinkers in the seventeenth and eighteenth centuries embraced the sin of avarice as an important counterweight to humankind's destructive passions. Capitalism was promoted by thinkers including Montesquieu, Sir James Steuart, and Adam Smith as repressing the passions for "harmless" commercial activities. Hirschman noted that words including "vice" and "passion" gave way to "such bland terms" as "advantage" and "interest."Hirschman described The Passions and the Interests as the book he most enjoyed writing. According to Hirschman biographer Jeremy Adelman, the book reflected Hirschman's political moderation, a challenge to reductive accounts of human nature by economists as a "utility-maximizing machine" as well as Marxian or communitarian "nostalgia for a world that was lost to consumer avarice."

Unbalanced growthis a natural path ofeconomic development.Undeveloped countriesstart from a position that reflects their previousinvestmentdecisions and development. Accordingly, at any point in time desirable investment programs that are not in themselves balanced investment packages may still advance welfare. Unbalanced investment can complement or correct existing imbalances. Once such an investment is made, a new imbalance is likely to appear, requiring further compensating investments. Therefore, growth need not take place in a balanced way. Supporters of the unbalanced growth doctrine includeAlbert O. Hirschman,Hans Singer,Paul StreetenandMarcus Fleming.Introduction[edit]The theory is generally associated with Hirschman. He presented a complete theoretical formulation of the strategy. Underdeveloped countries display common characteristics: low levels ofGNIper capita and slow GNI per capita growth, large income inequalities and widespreadpoverty, low levels ofproductivity, great dependence onagriculture, a backward industrial structure, a high proportion of consumption and low savings, high rates of population growth and dependency burdens, high unemployment and underemployment, technological backwardness anddualism. In a less-developed country, these characteristics lead to scarce resources or inadequate infrastructure to exploit these resources. With a lack of investors and entrepreneurs, cash flows cannot be directed into various sectors that influence balancedeconomic growth.Hirschman contends that deliberate unbalancing of the economy according to the strategy is the best method of development and if the economy is to be kept moving ahead, the task of development policy is to maintain tension, disproportions anddisequilibrium. Balanced growth should not be the goal, but rather the maintenance of existing imbalances, which can be seen from profit and losses. Therefore, the sequence that leads away from equilibrium is precisely an ideal pattern for development. Unequal development of various sectors often generates conditions for rapid development. More-developed industries provide undeveloped industries an incentive to grow. Hence, development of underdeveloped countries should be based on this strategy.The path of unbalanced growth is described by three phases:1. Complementarity2. Induced investment3. External economiesSinger believed that desirable investment programs always exist within a country that represent unbalanced investment to complement the existing imbalance. These investments create a new imbalance, requiring another balancing investment. One sector will always grow faster than another, so the need for unbalanced growth will continue as investments must complement existing imbalance. Hirschman states If the economy is to be kept moving ahead, the task of development policy is to maintain tensions, disproportions and disequilibria.[citation needed]This situation exists for all societies, developed or underdeveloped.Complementarity[edit]Complementarity is a situation where increased production of one good or service builds up demand for the second good or service. When the second product is privately produced, this demand will lead to imports or higher domestic production of the second product, as it will be in the interests of the producers to do so. Otherwise, the increased demand takes the form of political pressure. This is the case for such public services such aslaw and order,education,waterandelectricitythat cannot reasonably be imported.Induced investment[edit]Complementarity allows investment in one industry or sector to encourage investment in others. This concept of induced investment is like amultiplier, because each investment triggers a series of subsequent events. Convergence occurs as the output of external economies diminishes at each step. Growth sequences tend to move towardsconvergenceordivergenceand the policy is usually concerned with preventing rapid convergence and promoting the possibility of divergence.[clarification needed]External economies[edit]New projects often appropriate external economies[clarification needed]created by preceding ventures and create external economies that may be utilized by subsequent ones. Sometimes the project undertaken creates external economies, causing privateprofitto fall short of what is socially desirable. The reverse is also possible. Some ventures have a larger input of external economies than the output. Therefore Hirschman says, "the projects that fall into this category must be net beneficiaries of external economies".[citation needed]Social Overhead Capital[edit]Social Overhead Capital (SOC) is defined as basic services without which primary, secondary and tertiary productive activities cannot function. In a narrow sense, Social Overhead Capital is defined to includetransportationandelectricity, while in a wider sense, it includes allpublic services, including law and order and education. Criteria for classifying an asset as Social Overhead Capital include: The services provided by the activity should facilitate a great variety of economic activities. The services provided should be subject to public control. The services cannot be imported. The investment needed to provide services should be characterized by some unevenness as well as by highcapital output ratio.Development via capital imbalances[edit]The strategy of unbalanced growth has been discussed within the frameworks of development through shortage of SOC and development through excess of SOC.In the first case, the country invests in direct productive activities (DPA). Direct productive activity increases demand for SOC, inducing investment. In the second case, SOC expands, which reduces the cost of services, inducing investment in DPA.[clarification needed]The cost of producing any unit of output of DPA is inversely proportional to SOC.[clarification needed]The economy's major objective is to attain increasing output of DPA.One of theparadoxesof development is that poor countries cannot afford to be economical.[clarification needed]According to Hirschman, resources are not scarce per se, but the ability to employ those resources may be lacking. To explain unbalanced growth, Hirschman assumes that the country invests in either DPA or SOC. Both paths set upincentivesand an evaluation of their respectiveefficiencydepends on the strengths of entrepreneurial motivations and the response to public pressure of the authorities responsible for SOC.

The major characteristic of the two paths of development is that they yield excess dividends. SOC built ahead of demand creates this demand by making a country more attractive to DPA investors. DPA that outpaces SOC development, creates demand to expand SOC.Balanced growthof DPA and SOC is not achievable in underdeveloped countries, nor it is not a desirable policy, as it does not set up the incentives and the pressure that make for this dividend of induced investment decisions.[clarification needed]Backward and forward linkages[edit]Hirschman introduces the concept of backward and forward linkages. A forward linkage is created when investment in a particular project encourages investment in subsequent stages of production. A backward linkage is created when a project encourages investment in facilities that enable the project to succeed. Normally, projects create both forward and backward linkages. Investment should be made in those projects that have the greatest total number of linkages. Projects with many linkages will vary from country to country; knowledge about project linkages can be obtained through input and output studies.Most underdeveloped economies are primarilyagrarian.Agricultureis typically at a primitive stage and hence possesses few linkages, as most output goes for consumption or exports. Therefore it is said[who?]that underdeveloped countries are lacking in interdependence and linkages.An example of an industry that has excellent forward and backward linkages is the steel industry. Backward linkages include coal and iron ore mining. Forward linkages include items such as canned goods. While this industry has strong linkages, it is not a good leading sector. Any industry that has a high capital/output ratio and causes significant costs to other businesses has the potential to hurt the developing economy more than it helps it. A better leading sector would be the beer industry.[citation needed]Linkages and last industries[edit]The development of an economy using the unbalanced method depends on the linkages between sectors. Hirschman suggests that the best strategy is induced industrialization. This type of development will create more backward and forward linkages and should be the first step taken.Industries that transform semi-manufactured goods into goods needed by final demand are called "last industries" or "enclave import industries".In underdeveloped countries, industrialization takes place through such industries, through plants that add final touches to unfinished imported products. Examples are metal fabricating industries, pharmaceutical laboratories and assembly and mixing plants. Such industries have many advantages, as they often require the smaller amounts of capital available in such economies and without having to rely on unreliable domestic producers. Therefore underdeveloped countries set up such "last industries" first. These industries create long chains of backward linkages.Colombia,BrazilandMexicoare examples of countries that followed this path.Protection and subsidy of import-replacing industries should come, but at a later stage. The Last Industry Strategy has disadvantages. It can slow the creation of domestic production. Industrialists who have begun working with imports may not accept domestic alternative products that reduce demand for their output. Creating last industries first can create loyalty toward foreign products and distrust of domestic products and their quality. Banks may get used to extending credit for shorter, smaller capital requirements.Disadvantages[edit]Disadvantages of the last industry strategy include inhibition of domestic production as domestic demand grows. This is because industrialists who work with imported material will often be hostile to the establishment of domestic industries, because domestic goods are of lower quality, the number of domestic suppliers is small, downstream competition may intensify once inputs are available domestically and competitors may be able to locate closer to the upstream suppliers.Last/first may accustom domestic consumers to imported goods, making it harder for local producers to find customers. Further, financing may be easier for import-based business.Critical appraisal[edit]This sectionpossibly containsoriginal research.Pleaseimprove itbyverifyingthe claims made and addinginline citations. Statements consisting only of original research may be removed.(March 2012)

The theory of unbalanced growth has generated positive and negative reactions: It pays insufficient attention to the question of the precise composition, direction and timing of imbalances. What is the optimum degree to which imbalance should be created in order to accelerate growth? This theory leaves too much to chance. There is little discussion on how to overcome discrepancies between private and social profitabilities of development projects. It neglects agriculture. In heavily populated countries with agricultural economies, neglect of agriculture could be suicidal. Shortage of agricultural goods can emerge as a serious constraint to industrialization; unless income from agricultural goods expands, the market for industrial products remains limited. Unbalanced growth can also lead to emergence of inflationary pressures in the economy, as a shortage of agricultural commodities will push up commodity prices. This theory is useful in those countries where there is significant state control. For instance insocialistcountries, this strategy is followed with some success. In a socialist society, the consumption of all people is maintained at a modest level, thus reducing demand for consumer goods.Sir William Arthur Lewis(January 23, 1915 June 15, 1991) was aSaint Lucianeconomist well known for his contributions in the field ofeconomic development. In 1979 he won theNobel Memorial Prize in Economics.

The "Lewis Model"[edit]Lewis published in 1954 what was to be his most influential development economics article, "Economic Development with Unlimited Supplies of Labour" (Manchester School). In this publication, he introduced what came to be called theDual Sector model, or the "Lewis Model."Lewis combined an analysis of the historical experience of developed countries with the central ideas of the classical economists to produce a broad picture of the development process. In his theory, a "capitalist" sector develops by taking labour from a non-capitalist backward "subsistence" sector. At an early stage of development, the "unlimited" supply of labour from the subsistence economy means that the capitalist sector can expand for some time without the need to raise wages. This results in higher returns to capital, which are reinvested in capital accumulation. In turn, the increase in the capital stock leads the "capitalists" to expand employment by drawing further labor from the subsistence sector. Given the assumptions of the model (for example, that the profits are reinvested and that capital accumulation does not substitute for skilled labor in production), the process becomes self-sustaining and leads to modernization and economic development.[6][7]The point at which the excess labor in the subsistence sector is fully absorbed into the modern sector, and where further capital accumulation begins to increase wages, is sometimes called the "Lewisian turning point" . It has recently been widely discussed in the context of economic development in China.[8]The Theory of Economic Growth[edit]Lewis publishedThe Theory of Economic Growthin 1955 in which he sought to provide an appropriate framework for studying economic development, driven by a combination of curiosity and of practical need.[7]

Lewis model of development with surplus labourThedual-sector modelis a model indevelopmental economics. It is commonly known as theLewis modelafter its inventorSir William Arthur Lewis, winner of theNobel Memorial Prize in Economicsin 1979. It explains the growth of a developing economy in terms of alabourtransition between two sectors, the capitalist sector and the subsistence sector.HistoryInitially the dual-sector model as given by W.A Lewis was enumerated in his article entitled "Economic Development with Unlimited Supplies of Labor" written in 1954 bySir Arthur Lewis, the model itself was named in Lewis's honor. First published inThe Manchester Schoolin May 1954, the article and the subsequent model were instrumental in laying the foundation for the field of Developmental economics. The article itself has been characterized by some as the most influential contribution to the establishment of the discipline.Assumptions1. The model assumes that a developing economy has a surplus of unproductive labor in the agricultural sector.2. These workers are attracted to the growing manufacturing sector where higher wages are offered.3. It also assumes that the wages in the manufacturing sector are more or less fixed.4. Entrepreneurs in the manufacturing sector make profit because they charge a price above the fixed wage rate.5. The model assumes that these profits will be reinvested in the business in the form of fixed capital.6. An advanced manufacturing sector means an economy has moved from a traditional to an industrialized one.

TheoryW.A Lewis divided the economy of an underdeveloped country into 2 sectors:The capitalist sectorLewis defined this sector as "that part of the economy which uses reproducible capital and pays capitalists thereof". The use of capital is controlled by the capitalists, who hire the services of labor. It includes manufacturing, plantations, mines etc. The capitalist sector may be private or public.The Subsistence SectorThis sector was defined by him as "that part of the economy which is not using reproducible capital. It can also be adjusted as the indigenous traditional sector or the "self employed sector". The per head output is comparatively lower in this sector and this is because it is not fructified with capital. The "Dual Sector Model" is a theory of development in which surplus labor from traditional agricultural sector is transferred to the modern industrial sector whose growth over time absorbs the surplus labor, promotes industrialization and stimulates sustained development. In the model, the subsistence agricultural sector is typically characterized by low wages, an abundance of labour, and lowproductivitythrough a labour intensive production process. In contrast, the capitalist manufacturing sector is defined by higher wage rates as compared to the subsistence sector, higher marginal productivity, and a demand for more workers. Also, the capitalist sector is assumed to use a production process that iscapitalintensive, so investment and capital formation in the manufacturing sector are possible over time as capitalists' profits are reinvested in the capital stock. Improvement in the marginal productivity of labour in the agricultural sector is assumed to be a low priority as the hypothetical developing nation's investment is going towards the physical capital stock in the manufacturing sector.Relationship between the two sectorsThe primary relationship between the two sectors is that when the capitalist sector expands, it extracts or draws labor from the subsistence sector. This causes the output per head of laborers who move from the subsistence sector to the capitalist sector to increase. Since Lewis in his model considers overpopulated labor surplus economies he assumes that the supply of unskilled labor to the capitalist sector is unlimited. This gives rise to the possibility of creating new industries and expanding existing ones at theexisting wage rate. A large portion of the unlimited supply of labor consists of those who are in disguised unemployment in agriculture and in other over-manned occupations such as domestic services casual jobs, petty retail trading. Lewis also accounts for two other factors that cause an increase in the supply of unskilled labor, they are women in the household and population growth.

The agricultural sector has a limited amount of land to cultivate, the marginal product of an additional farmer is assumed to be zero as thelaw of diminishing marginal returnshas run its course due to the fixed input, land. As a result, the agricultural sector has a quantity of farm workers that are not contributing to agricultural output since their marginal productivities are zero. This group of farmers that is not producing any output is termed surplus labour since this cohort could be moved to another sector with no effect on agricultural output. (The term surplus labour here is not being used in aMarxistcontext and only refers to the unproductive workers in the agricultural sector.) Therefore, due to the wage differential between the capitalist and subsistence sector, workers will tend to transition from the agricultural to the manufacturing sector over time to reap the reward of higher wages. However even though the marginal product of labor is zero, it still shares a part in the total product and receives approximately the average product.

If a quantity of workers moves from the subsistence to the capitalist sector equal to the quantity of surplus labour in the subsistence sector, regardless of who actually transfers, general welfare and productivity will improve. Total agricultural product will remain unchanged while total industrial product increases due to the addition of labour, but the additional labour also drives down marginal productivity and wages in the manufacturing sector. Over time as this transition continues to take place and investment results in increases in the capital stock, the marginal productivity of workers in the manufacturing will be driven up by capital formation and driven down by additional workers entering the manufacturing sector. Eventually, the wage rates of the agricultural and manufacturing sectors will equalize as workers leave the agriculture sector for the manufacturing sector, increasing marginal productivity and wages in agriculture whilst driving down productivity and wages in manufacturing.

The end result of this transition process is that the agricultural wage equals the manufacturing wage, the agricultural marginal product of labour equals the manufacturing marginal product of labour, and no further manufacturing sector enlargement takes place as workers no longer have a monetary incentive to transition.Surplus labor and the growth of the economySurplus labor can be used instead of capital in the creation of new industrial investment projects, or it can be channeled into nascent industries, which are labor intensive in their early stages. Such growth does not raise the value of the subsistence wage, because the supply of labor exceeds the demand at that wage, and rising production via improved labor techniques has the effect of lowering the capital coefficient. Although labor is assumed to be in surplus, it is mainly unskilled. This inhibits growth since technical progress necessary for growth requires skilled labor. But should there be a labor surplus and a modest capital, this bottleneck can be broken through the provision of training and education facilities. The utility of unlimited supplies of labor to growth objectives depends upon the amount of capital available at the same time. Should there be surplus labor, agriculture will derive no productive use from it, so a transfer to a non agriculture sector will be of mutual benefit. It provides jobs to the agrarian population and reduces the burden of population from land. Industry now obtains its labor. Labor must be encouraged to move to increase productivity in agriculture. To start such a movement, the capitalist sector will have to pay a compensatory payment determined by the wage rate which people can earn outside their present sector, plus a set of other which include the cost of living in the new sector and changes in the level of profits in the existing sector. The margin capitalists may have to pay is as much as 30 per cent above the average subsistence wage,WW1in figure which represents the capitalist sector is shown byN;OWis the industrial wage. Given the profit maximization assumption, employment of labor within the industrial sector is given by the point where marginal product is equal to the rate of wages, i.e.OM.

Since the wages in the capitalist sector depend on the earnings of the subsistence sector, capitalists would like to keep down productivity/wages in the subsistence sector, so that the capitalist sector may expand at a fixed wage. In the capitalist sector labor is employed up to the point where its marginal product equals wage, since a capitalist employer would be reducing his surplus if he paid labor more than he received for what is produced. But this need not be true in subsistence agriculture as wages could be equal to average product or the level of subsistence. The total product laborONPMis divided between the payments to labor in the form of wages,OWPM, and the capitalist surplus, NPW. The growth of the capitalist sector and the rate of labor absorption from the subsistence sector depends on the use made of capitalist surplus. When the surplus is reinvested, the total product of labor will rise. The marginal product line shifts upwards tot the right, that is toN1. Assuming wages are constant, the industrial sector now provides more employment. Hence employment rises byMM1. The amount of capitalist surplus goes up fromWNPtoWN1P'. This amount can now be reinvested and the process will be repeated and all the surplus labor would eventually be exhausted. When all the surplus labor in the subsistence sector has been attracted into the capitalist sector, wages in the subsistence sector will begin to rise, shifting the terms of trade in favor of agriculture, and causing wages in the capitalist sector to rise. Capital accumulation has caught up with the population and there is no longer scope for development from the initial source, i.e. unlimited supplies of labor. When all the surplus labor is exhausted, the supply of labor to the industrial sector becomes less than perfectly elastic. It is now in the interests of producers in the subsistence sector to compete for labor as the agricultural sector has become fully commercialized. It is the increase in the share of profits in the capitalist sector which ensures that labor surplus is continuously utilized and eventually exhausted. Real wages will tend to rise along with increases in productivity and the economy will enter into a stage of self-sustaining growth with a consistent nature.Capital accumulationThe process of economic growth is inextricably linked to the growth of capitalist surplus, that is as long as the capitalist surplus increases, the national income also increases raising the growth of the economy. The increase in capitalist surplus is linked to the use of more and more labor which is assumed to be in surplus in case of this model. This process of capital accumulation does come to an end at some point. This point is where capital accumulation catches up with population so that there is no longer any surplus labor left. Lewis says that it the point where capital accumulation comes to a stop can come before also that is if real wages rise so high so as to reduce capitalists' profits to the level at which profits are all consumed and there is no net investment. This can take place in the following ways:1. If the capital accumulation is proceeding faster than population growth growth which causes a decline in the number of people in the agricultural or subsistence sector.2. The increase in the size of the capitalist or industrial sector in comparison to the subsistence sector may turn theterms of tradeagainst the capitalist sector and therefore force the capitalists to pay the workers/laborers a higher percentage of their product in order to keep their real income constant.3. The subsistence sector may adopt new and improved methods and techniques of production, this will raise the level of subsistence wages in turn forcing an increase in the capitalist wages. Thus both the surplus of the capitalists and the rate of capital accumulation will then decline.4. Even though the productivity of capitalist sector remains unchanged, the workers in the capitalist sector may begin to imitate the capitalist style and way of life and therefore may need more to live on, this will raise the subsistence wage and also the capitalist wage and in turn the capitalist surplus and the rate of capital accumulation will decline.CriticismThe Lewis model has attracted attention of underdeveloped countries because it brings out some basic relationships in dualistic development. However it has been criticized on the following grounds:

1. Economic development takes place via the absorption of labor from the subsistence sector where opportunity costs of labor are very low. However, if there positive opportunity costs, e.g. loss of crops in times of peak harvesting season, labor transfer will reduce agricultural output.2. Absorption of surplus labor itself may end prematurely because competitors may raise wage rates and lower the share of profit. It has been shown that rural-urban migration in the Egyptian economy was accompanied by an increase in wage rates of 15 per cent and a fall in profits of 12 per cent. Wages in the industrial sector were forced up directly by unions and indirectly through demands for increased wages in the subsistence sector, as payment for increased productivity. In fact, given the urban-rural wage differential in most poor countries, large scale unemployment is now seen in both the urban and rural sectors.3. The Lewis model underestimates the full impact on the poor economy of a rapidly growing population, i.e. its effects on agriculture surplus, the capitalist profit share, wage rates and overall employment opportunities. Similarly, Lewis assumed that the rate of growth in manufacturing would be identical to that in agriculture, but if industrial development involves more intensive use of capital than labor, then the flow of labor from agriculture to industry will simply create more unemployment.4. Lewis seems to have ignored the balanced growth between agriculture and industry. Given thelinkagesbetween agricultural growth and industrial expansion in poor countries,if a section of the profit made by the capitalists is not devoted to agricultural development, the process of industrialization would be jeopardized.5. Possible leakages from the economy seem to have been ignored by Lewis. He assumes boldly that a capitalist's marginal propensity to save is close to one, but a certain increase in consumption always accompanies an increase in profits, so the total increment of savings will be somewhat less than increments in profit. Whether or not capitalist surplus will be used constructively will depend on the consumption- saving patterns of the top 10 percent of the population. But capitalists alone are not the only productive agents of society. Small farmers producing cash crops in Egypt have shown themselves to be quite capable of saving the required capital. The world's largestcocoaindustry inGhanais entirely the creation of small enterprise capital formation.6. The transfer of unskilled workers from agriculture to industry is regarded as almost smooth and costless, but this does not occur in practice because industry requires different types of labor. The problem can be solved by investment in education and skill formation, but the process is neither smooth nor inexpensive.The model assumes rationality,perfect informationand unlimited capital formation in industry. These do not exist in practical situations and so the full extent of the model is rarely realised. However, the model does provide a good general theory on labour transitioning in developing economies.Empirical tests and practical application of the Lewis model1. Empirical evidence does not always provide much support for the Lewis model.Theodore Schultzin an empirical study of a village inIndiaduring the influenza epidemic of 191819 showed that agricultural output declined, although his study does not prove whether output would have declined had a comparable proportion of the agricultural population left for other occupations in response to economic incentive. Again disguised unemployment may be present in one sector of the economy but not in others. Further, empirically it is important to know not only whether the marginal productivity is equal to zero, but also the amount of surplus labor and the effect of its withdrawal on output.2. The Lewis model was applied to the Egyptian economy by Mabro in 1967 and despite the proximity of Lewis's assumptions to the realities if the Egyptian situation during the period of study, the model failed firstly because Lewis seriously underestimated the rate of population growth and secondly because the choice of capital intensiveness in Egyptian industries did not show much labor using bias and as such, the level of unemployment did not show any tendency to register significant decline.3. The validity of the Lewis model was again called into question when it was applied to Taiwan. It was observed that, despite the impressive rate of growth of the economy of Taiwan, unemployment did not fall appreciably and this is explained again in reference to the choice of capital intensity in industries in Taiwan. This raised the important issue whether surplus labor is a necessary condition for growth.

Lewis Model Of Unlimited Supply Of LaborInitially the dual-sector model as given by W.A Lewis was enumerated in his article entitled Economic Development with Unlimited Supplies of Labor written in 1954 by Sir Arthur Lewis, the model itself was named in Lewiss honor. First published in The Manchester School in May 1954, the article and the subsequent model were instrumental in laying the foundation for the field of Developmental economics. The article itself has been characterized by some as the most influential contribution to the establishment of the discipline.The Nobel Laureate, W. Arthur Lewis in the mid 1950s presented his model of unlimited supply of labor or of surplus labor economy. By surplus labor it means that part of manpower which even if is withdrawn from the process of production there will be no fall in the amount of output. Lewis model makes the following assumptions :1. There is a dual economy i.e., the economy is characterized by a traditional, over-populated rural subsistence sector furnished with zeroMPL,and the high productivity-modern urban industrial sector.2. The subsistence sector does not make the use of Reproducible capital, while the modern sector uses the produced means of capital.1. The production in the advanced sector is higher than the production in traditional and backward sector.2. According to Lewis, the supply of labor is perfectly elastic. In other words, the supply of labor is greater than demand for labor. The following are the sources of unlimited supply of labor in UDCs.3. Because of severe increase in population more than required number of laborers are working-with lands the so called disguised unemployed.4. (ii) In UDCs so many people are having temporary and part time jobs, as the shoeshines, loaders, porters and waiters etc. There will be no fall in the production even their numbers are one halved.(iii) The landlords and feudals are having an army of tenants for the. sake of their influence, power and prestige. They do not make any contribution towards production, and they are prepared to work even at less than subsistence wages.(iv) The women in UDCs do not work, as they just perform household duties. Thus they also represent unemployment.5. The high birth rate in UDCs leads to grow unemployment.

Walt Whitman Rostow(also known asWalt RostoworW.W. Rostow) (October 7, 1916 February 13, 2003) was aUnited Stateseconomistand political theorist who served asSpecial Assistant for National Security AffairstoU.S. PresidentLyndon B. Johnsonin 1964-8.Prominent for his role in the shaping ofUS foreign policyinSoutheast Asiaduring the 1960s, he was a staunchanti-communist, noted for a belief in the efficacy ofcapitalismandfree enterprise, strongly supportingUS involvement in the Vietnam War. Rostow is known for his bookThe Stages of Economic Growth: A Non-Communist Manifesto(1960), which was used in several fields ofsocial science.His older brotherEugene Rostowalso held a number of high government foreign policy posts.

The Stages of Economic Growth[edit]In 1960 Rostow publishedThe Stages of Economic Growth: A Non-Communist Manifesto, which proposed theRostovian take-off modelofeconomic growth, one of the major historical models of economic growth, which argues that economic modernization occurs in five basic stages of varying length: traditional society, preconditions for take-off, take-off, drive to maturity, and highmass consumption. This became one of the important concepts in thetheory of modernizationinsocial evolutionism. Rostow's thesis was criticized at the time and subsequently as universalizing a model of Western development that could not be replicated in places like Latin America or sub-Saharan Africa.The book impressed presidential candidateJohn F. Kennedy, who appointed Rostow as one of his political advisers, and gave advice. When Kennedy became president in 1961, he appointed Rostow as deputy to his national security assistantMcGeorge Bundy. Later that year Rostow became chairman of the U.S. State Department's policy planning council. After Kennedy's assassination, his successorLyndon B. Johnsonpromoted Rostow to Bundy's job after he wrote Johnson's first state of the union speech. As national security adviser Rostow was responsible for developing the government's policy in Vietnam, and was convinced that the war could be won, becoming Johnson's main war hawk and playing an important role in bringing Johnson's presidency to an end.WhenRichard Nixonbecame president, Rostow left office, and over the next thirty years taught economics at theLyndon B. Johnson School of Public Affairsat theUniversity of Texas at Austinwith his wifeElspeth Rostow, who later became dean of the school. He wrote extensively in defense of free enterprise economics, particularly indeveloping nations.TheRostow's Stages of Growthmodel is one of the major historical models ofeconomic growth. It was published by American economistWalt Whitman Rostowin 1960. The model postulates that economic growth occurs in five basic stages, of varying length:[1]1. Traditional society2. Preconditions for take-off3. Take-off4. Drive to maturity5. Age of High mass consumptionRostow's model is one of the morestructuralistmodels of economic growth, particularly in comparison with the 'backwardness' model developed byAlexander Gerschenkron, although the two models are not mutually exclusive.Rostow argued that economic take-off must initially be led by a few individualsectors. This belief echoesDavid Ricardo'scomparative advantagethesis and criticizesMarxistrevolutionaries' push for economic self-reliance in that it pushes for the 'initial' development of only one or two sectors over the development of all sectors equally. This became one of the important concepts in thetheory of modernizationinsocial evolutionism.Overview[edit]Below is a detailed outline of Rostow's 5 Stages: Traditional society characterized by subsistence agriculture or hunting & gathering; almost wholly a "primary" sector economy limited technology; A static or 'rigid' society: lack of class or individual economic mobility, with stability prioritized and change seen negatively Pre-conditions to "take-off" external demand for raw materials initiates economic change; development of more productive, commercial agriculture & cash crops not consumed by producers and/or largely exported widespread and enhanced investment in changes to the physical environment to expand production (i.e. irrigation, canals, ports) increasing spread of technology & advances in existing technologies changing social structure, with previous social equilibrium now in flux individual social mobility begins development of national identity and shared economic interests Take off manufacturing begins to rationalize and scale increases in a few leading industries, as goods are made both for export and domestic consumption the "secondary" (goods-producing) sector expands and ratio of secondary vs. primary sectors in the economy shifts quickly towards secondary textiles & apparel are usually the first "take-off" industry, as happened in Great Britain's classic "Industrial Revolution" Drive to maturity diversification of the industrial base; multiple industries expand & new ones take root quickly manufacturing shifts from investment-driven (capital goods) towards consumer durables & domestic consumption rapid development of transportation infrastructure large-scale investment in social infrastructure (schools, universities, hospitals, etc.) Age of mass consumption the industrial base dominates the economy; the primary sector is of greatly diminished weight in economy & society widespread and normative consumption of high-value consumer goods (e.g. automobiles) consumers typically (if not universally), have disposable income, beyond all basic needs, for additional goodsRostow claimed that these stages of growth were designed to tackle a number of issues, some of which he identified himself; and wrote, "Under what impulses did traditional, agricultural societies begin the process of their modernization? When and how did regular growth become a built-in feature of each society? What forces drove the process of sustained growth along and determined its contours? What common social and political features of the growth process may be discerned at each stage? What forces have determined relations between the more developed and less developed areas; and what relation if any did the relative sequence of growth bear to outbreak of war? And finally where is compound interest taking us? Is it taking us to communism; or to the affluent suburbs , nicely rounded out with social overhead capital; to destruction; to the moon; or where?"[2][3]Rostow asserts that countries go through each of these stages fairly linearly, and set out a number of conditions that were likely to occur ininvestment,consumptionand social trends at each state. Not all of the conditions were certain to occur at each stage, however, and the stages and transition periods may occur at varying lengths from country to country, and even from region to region.[4]Theoretical framework[edit]Rostow's model is a part of theliberal school of economics, laying emphasis on the efficacy of modern concepts offree tradeand the ideas ofAdam Smith. It disagrees withFriedrich List's argument which states that economies which rely on exports of raw materials may get "locked in", and would not be able to diversify, regarding this Rostow's model states that economies may need to depend on raw material exports to finance the development of industrial sector which has not yet of achieved superior level of competitiveness in the early stages of take-off. Rostow's model does not disagree withJohn Maynard Keynesregarding the importance of government control over domestic development which is not generally accepted by some ardent free trade advocates. The basic assumption given by Rostow is that countries want to modernize and grow and that society will agree to thematerialisticnorms of economic growth.[5]Stages[edit]Traditional societies[edit]An economy in this stage has a limited production function which barely attains the minimum level of potential output. This does not entirely mean that the economy's production level is static. The output level can still be increased, as there was often a surplus of uncultivated land which can be used for increasing agricultural production. States and individuals utilize irrigation systems in many instances, but most farming is still purely for subsistence. There have been technological innovations, but only on ad hoc basis. All this can result in increases in output, but never beyond an upper limit which cannot be crossed. Lacking modern science and technology, such innovation as occurs spreads slowly and inconsistently and is sometimes reversed or lost. Trade is predominantly regional and local, largely done through barter, and the monetary system is not well developed. Investment's share never exceeds 5% of total economic production.Wars, famines and epidemics like plague cause initially expanding populations to halt or shrink, limiting the single greatest factor of production: human manual labor. Volume fluctuations in trade due to political instability are frequent; historically, trading was subject to great risk and transport of goods and raw materials was expensive, difficult, slow and unreliable. The manufacturing sector and other industries have a tendency to grow but are limited by inadequate scientific knowledge and a "backward" or highly traditionalist frame of mind which contributes to low labour productivity. In this stage, some regions are entirely self-sufficient.In settled agricultural societies before the Industrial Revolution, a hierarchical social structure relied on near-absolute reverence for tradition, and an insistence on obedience & submission. This resulted in concentration of political power in the hands of landowners in most cases; everywhere, family & lineage, and marriage ties, constituted the primary social organization, along with religious customs, and the state only rarely interacted with local populations and in limited spheres of life. This social structure was generally feudalistic in nature. Under modern conditions, these characteristics have been modified by outside influences, but the least developed regions and societies fit this description quite accurately.Pre-conditions to take-off[edit]In the second stage of economic growth the economy undergoes a process of change for building up of conditions for growth and take off.Rostowsaid that these changes in society and the economy had to be of fundamental nature in the socio-political structure and production techniques.[3]This pattern was followed in Europe, parts of Asia, the Middle East and Africa. There is also a second pattern in which he said that there was no need for change in socio-political structure because these economies were not deeply caught up in older, traditional social and political structures. The only changes required were in economic and technical dimensions. The nations which followed this pattern were in North America and Oceania (New Zealand & Australia).There are three important dimensions to this transition: firstly, the shift from an agrarian to an industrial or manufacturing society begins, albeit slowly. Secondly, trade and other commercial activities of the nation broaden the market's reach not only to neighboring areas but also to far-flung regions, creating international markets. Lastly, the surplus attained should not be wasted on theconspicuous consumptionof the land owners or the state, but should be spent on the development of industries, infrastructure and thereby prepare for s