Theories of Growth and DevelopmentTheories of Growth- Harrod-Domar Model- Solow Growth Model- Two-Sector Models- New Growth Theory- Coordination Failures- Big Push- Kremers O-Ring Theory

Theories of Growth and DevelopmentDevelopment Theories- Structuralist School of Thought- Rostows Linear Stages of Growth- Neo-Marxist Approach- Neoclassical Counterrevolution

Theories of Growth and DevelopmentHarrod-Domar Model- fixed coefficient production function (L)- constant returns to scale- equation: g=(s/v) dwhere g = growth rate s = savings rate v = capital productivity (ICOR) d = depreciation rate

Harrod-Domar Growth Model A Flow chart modelv= K/Y ora=Y/KCapital Capital/Output Ratio or Productivity

GDPsSaving RateCSdDepreciation RateDInIgProduction function

Factors Explaining the growth rateAccording to Harrod-Domar modelgs

a

dSaving rateCapital productivityCapital depreciationRate ofEconomicGrowthExplained variable Explanatory Variables++_

Theories of Growth and DevelopmentHarrod-Domar Model- message: you save more, and make productive investments, then economy would grow- economic analysts use this framework to predict growth or calculate the amount of saving required to achieve target growth rate- eg. What is g? if s=.24, v=.03, d=.05?- then from g= (s/v) d- g = (.24/.03) - .05 = .03 (3 percent growth)

Theories of Growth and DevelopmentHarrod-Domar Model- Strengths: (1) small data requirements, (2) easy to use/estimate, and (3) accuracy for short period, in absence of shocks in the economy- Weaknesses: (1) not true: savings-investment is sufficient for growth, (2) no substitution effect in capital-labor, (3) role of technology in growth process

Theories of Growth and DevelopmentSolow Growth Model- neoclassical production function with diminishing marginal returns to capital (curve)- constant returns to scale, but with focus on intensification of factor inputs (K and L)- equation 1: y = f(k)where y = output per worker k = capital per worker- message: capital per worker is fundamental to the growth process

Theories of Growth and DevelopmentSolow Growth Model- equation 2: k = sy (n+d)kwhere sy = saving per worker (+) k = capital per worker n = population (-) d = depreciation (-)- messages: (1) change in k is positively related to saving (investment) per worker, (2) change in k is negatively related to population growth, and (3) depreciation erodes capital stock

Theories of Growth and DevelopmentSolow Growth Model

Theories of Growth and DevelopmentSolow Growth Model

Theories of Growth and DevelopmentSolow Growth Model- solow residual: Y= A f(K, L)- A as residual refers to technological change- Technological change is either labor augmenting (human capital from health/education) or capital augmenting (new innovations and processes)

Theories of Growth and DevelopmentSolow Growth Model- strengths: (1) flexibility on K-L mix, (2) diminishing marginal returns on capital, (3) impact of growth on savings, population, depreciation and technology- weaknesses: (1) not provide full explanation for growth, (2) one-sector does not imply resource allocation, and (3) does not explain factor accumulation and productivity growth explicitly

Theories of Growth and DevelopmentTwo-Sector Models- Started by David Ricardos basic assumptions: (1) agricultural production is subject to diminishing returns, and (2) labor surplus similar to rural unemployment, underemployment or disguised unemployment- Two-sector labor surplus model by Fei and Ranis (1964) and Lewis (1955) assumes that (1) marginal product of labor in agriculture is zero, and (2) institutionally fixed minimum wage- Neoclassical two-sector model emphasized the balance between growth in agriculture and industry

Theories of Growth and DevelopmentNew Growth Theory- Endogenous growth, the importance of knowledge, research and development- Romer (1986) Y= A(R) f(R,K,L)where A(R) = public knowledge stock R = private research K = physical capital L = labor- message: countries are more experienced in research through learning by doing (knowledge)

Theories of Growth and DevelopmentCoordination Failures (Underdevelopment)- Big Push: to create markets for industrial output, all industries have to grow together, each employing workers who would demand the output of other industries- message: no firm wants to industrialize first

Theories of Growth and DevelopmentCoordination Failures (Underdevelopment)- Kremer O-Ring Model: linked to explosion of Challenger (which exploded because of the O-ring malfunctioning), thus production must function as a whole to work- message: advanced countries build/specializes on spaceships, poorer countries build/specialize on tea products

Theories of Growth and DevelopmentStructuralist School of Thought- State-led development as main driver- Import substitution and tariff- State-owned enterprises- Public Goods- BUT, the rich became richer, poor became poorer

Theories of Growth and DevelopmentRostows Stages of Growth- (1) traditional society, (2) pre-conditions to take-off, (3) take-off, (4) drive to maturity, (5) age of high mass consumption- Applied in Europes Marshall Plan- BUT, failed on account of structural causes of low savings and investment in developing countries

Theories of Growth and DevelopmentNeo-Marxist Approach- Dependency approach- Developing nations cannot pass the Advanced stage of development without moving to socialism- Advanced economies exploit developing economies unless they resort to social revolution or unrest- Provocative BUT, flawed and too formalistic

Theories of Growth and DevelopmentNeoclassical Counterrevolution- Private Markets are Key to Development- Privatization, Decentralization, Free Trade Advocacy, Deregulation- Lead to the formulation of the Washington Consensus

Theories of Growth and DevelopmentNeoclassical Counterrevolution

1. Fiscal discipline 2. A redirection of public expenditure priorities toward fields offering both high economic returns and the potential to improve income distribution, such as primary health care, primary education, and infrastructure 3. Tax reform (to lower marginal rates and broaden the tax base) 4. Interest rate liberalization 5. A competitive exchange rate 6. Trade liberalization 7. Liberalization of inflows of foreign direct investment 8. Privatization 9. Deregulation (to abolish barriers to entry and exit) 10. Secure property rights

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