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Models of Economic Growth.docx

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University of Toronto Mississauga
Michael H O

Home Models of Economic Growth Models of Economic Growth Classical Model of Economic Growth Every nation strives after development. Economic progress is an essential component, but it is not the only component. Economic development is not purely an economic phenomenon. In an ultimate sense, it must encompass more than the material and financial side of people‘s lives. Economic development should therefore be perceived as a multidimensional process involving the reorganization and reorientation of entire economic and social systems. In addition to improvements in incomes and output, it typically involves radical changes in institutional, social, and administrative structures. Finally, although development is usually defined in a national context, its widespread realization may necessitate fundamental modification of the international economic and social system as well. The classical theories of economic development consist of following four schools of thought: 1. Linear-stages-of-growth model: Theorists of the 1950s and 1960s viewed the process of development as a series of successive stages of economic growth through which all countries must pass. It was primarily an economic theory of development in which the right quantity and mixture of saving, investment, and foreign aid were all that was necessary to enable developing nations to proceed along an economic growth path that historically had been followed by the more developed countries. Development thus became synonymous with rapid, aggregate economic growth. This linear-stages approach was largely replaced in the 1970s by two competing economic schools of thought – theories of structural changeand international-dependence theories. 2. Theories and patterns of structural change: Theories and patterns of structural change uses modern economic theory and statistical analysis in an attempt to portray the internal process of structural change that a ―typical ‖developing country must undergo if it is to succeed in generating and sustaining a process of rapid economic growth. Structural-change theory focuses on the mechanism by which under-developed economies transform their domestic economic structures from a heavy emphasis on traditional subsistence agriculture to a more modern, more urbanised, and more industrially diverse manufacturing and service economy. It employs the tools of neo-classical price and resource allocation theory and modern econometrics to describe how this transformation process takes place. Two well-known representative examples of the structural-change approach are the ‗two-sector surplus labour‘ theoretical model of Sir W. Arthur Lewis, and the ‗patterns of development‘ empirical analysis of Hollis B. Chenery and his co-authors. 3. International-dependence revolution: The international-dependence revolution was more radical and political in orientation. It viewed underdevelopment in terms of international and domestic power relationships, institutional and structural economic rigidities, and the resulting proliferation of dual economies and dual societies both within and among the nations of the world. Dependence theories tended to emphasize external and internal institutional and political constraints on economic development. Emphasis was placed on the need for major new policies to eradicate poverty, to provide more diversified employment opportunities, and to reduce income inequalities. International-dependence models view developing countries as troubled by institutional, political, and economic rigidities, both domestic and international, and caught up in a dependence and dominance relationship with rich countries. Within this general approach there are three major streams of thought – the neo-colonial dependence model, the false-paradigm model, and the dualistic-development thesis. 4. Neoclassical or free-market counterrevolution: This theory is also known as neo-liberal theory. Throughout of the 1980s and 1990s, the neoclassical or free-market counterrevolution approach prevailed. It emphasizes the beneficial role of free markets, open economies, and the privatisation of inefficient public enterprises. Failure to develop, according to this theory, is not due to exploitive internal and external forces as expounded by dependence theorists. Rather, it is primarily the result of too much government intervention and regulation of the economy. In the 1980s, the political ascendancy of conservative governments in the United States, Canada, Britain, and West Germany brought aneoclassical counterrevolution in economic theory and policy. In developed nations, this counterrevolution favoured supply-side macroeconomic policies, rational expectations theories, and the privatisation of public corporations. In developing countries it called for freer markets and the dismantling of public ownership, central planning, and government regulation of economic activities. Neo-classicists obtained controlling votes on the boards of the world‘s two most powerful international financial agencies — the World Bank and the International Monetary Fund. In conjunction and with the simultaneous erosion of influence of organizations such as the International Labour Organization (ILO), the United Nations Development Program (UNDP), and the United Nations Conference on Trade and Development (UNCTAD), which more fully represent the views of LDC delegates. The neo-classical approach states that underdevelopment arises from:  Poor resource allocation due to incorrect price policies, and  Government‘s intervention in the economic activities. Neo-classical or neo-liberal approach states that economic growth can be put to spur by:  Permitting competitive free markets to flourish,  Privatising state-owned enterprises,  Promoting free trade and export expansions,  Welcoming investors from developed economies, and  Eliminating the plethora of government regulations and price distortions in factor, product and market. 1. Linear-stages-of-growth model: Following are the growth models studied under linear-stages: (a) Rostow’s Stages of Growth: The stages-of-growth model of development is taken by most of the newly independent countries. According to Walt W. Rostow doctrine, the transition from underdevelopment to development can be described in terms of a series of steps or stages through which all countries must proceed. According to Rostow, it is possible to identify all societies, in their economic dimensions, as lying within one of five categories:  The traditional society,  The pre-conditions to take-off into self-sustaining growth,  The take-off,  The drive to maturity, and  The age of high mass-consumption. Rostow also clarified that these stages are not merely a way of generalising certain factual observations about the sequence of development of modern societies. He argued that the advanced countries had all passed the stage of take-off into self-sustaining growth and the under-developed countries that were still in either the traditional society or the pre-conditions stage. One of the principal strategies of development necessary for any take-off was the mobilisation of domestic and foreign saving in order to generate sufficient investment to accelerate economic growth. (b) Harrod-Domar Model: This model, developed independently by RF Harrod and ED Domar in the l930s, suggests savings provide the funds which are borrowed for investment purposes. The model suggests that the economy's rate of growth depends on:  the level of saving  the productivity of investment i.e. the capital output ratio For example, if $10 worth of capital equipment produces each $1 of annual output, a capital-output ratio of 10 to 1 exists. A 3 to 1 capital-output ratio indicates that only $3 of capital is required to produce each $1 of output annually. The Harrod-Domar model was developed to help analyse the business cycle. However, it was later adapted to 'explain' economic growth. 2. Structural-change theory: Following economic growth model represents the structural-change theory: (a) Lewis Theory of Development: It is one of the best-known early theoretical models of economic development that focused on the structural transformation of a primarily subsistence economy was that formulated by Noble-prize winner Sir W. Arthur Lewis in the mid 1950s. His theory was later modified by his followers. The Lewis two-sector economy model became the general theory of the development process in surplus-labour Third-World nations during most of the 1960s and 1970s. In the Lewis model, the underdeveloped economy consists of two sectors:  A traditional, overpopulated rural subsistence sector characterised by zero-marginal labour productivity. Lewis classify this as ‗surplus-labour‘ in the sense that it can be withdrawn from the agricultural sector without any loss of output, and  A high, productivity modern urban industrial sector into which labour from the subsistence sector is gradually transferred. The primary focus of the model is on both the process of labour transfer and the growth of output and employment in the modern sector. Both labour transfer and modern-sector employment growth are brought about by output expansion in that sector. (b) Patterns of Development: The patterns of development analysis of structural change focuses on the sequential process through which the economic, industrial and institutional structure of an underdeveloped economy is transformed over time to permit new industries to replace traditional agriculture as the engine of economic growth. In addition to the accumulation of capital both physical and human, a set of interrelated changes in the economic structure of a country are required for the transition from a traditional economic system to a modern one. These structural changes involve virtually all economic functions, including the transformation of production and changes in the composition of consumer demand, international trade and resource use as well as changes in socio- economic factors such as urbanisation, and the growth and distribution of a country‘s population. 3. International-dependence revolution: Within this general approach, there are three major streams of thought: (a) Neo-Colonial Dependence Model: It is an indirect outgrowth of Marxist thinking. It refers to the existence and continuance of underdevelopment in a highly unequal international capitalist system. The international system is dominated by uneq
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