EconomicDevelopment,12thEd.M.P.TodaroandS.C.SmithSlidesforChapterThree

UpdatedandExpandedStephenC.Smith

Fall2017ssmith@gwu.edu

3.1ClassicTheoriesofEconomicDevelopment:FourApproaches

•  Linearstagesofgrowthmodel•  TheoriesandPaIernsofstructuralchange•  InternaKonal-dependencerevoluKon•  Neoclassical,freemarketcounterrevoluKon

3.2DevelopmentasGrowthandLinear-StagesTheories

•  AClassicStatement:Rostow’sStagesofGrowth

•  Harrod-DomarGrowthModel(someKmesreferredtoastheAKmodel)

SimplifiedHarrod-DomarGrowthModel

•  Harrod-DomarGrowthModelDerivaKon•  Y=(1/c)*K•  LinearrelaKonshipassumed,so,•  ΔY=(1/c)*ΔK;or,•  ΔY=SNet/c•  DividingbyY:ΔY/Y=(SNet/Y)/c;so,•  Growth=(sNet)/c;thatis,•  Growth=Netsavingsrate/ICOR

TheHarrod-DomarModel-SimplifiedVersion,AlternateDerivaKon

TheHarrod-DomarModel-SimplifiedVersion

•  EquaKon3.7isalsoobenexpressedintermsofgrosssavings,inwhichcasethegrowthrateisgivenby

(3.7’)whereδistherateofcapitaldepreciaKonThederivaKonfollowsinthenexttwoslides:

TheHarrod-DomarModel–Incorpora9ngCapitalDeprecia9on

Harrod-Domar (or “AK”) Model: Derivation of disaggregated treatment of depreciation

€

ICOR ≡ c ≡ΔKΔY

€

ΔY =1cΔK

€

ΔK = I G −δKAnd,

€

ΔY =1cI G −δK[ ]

€

ΔY =1cI G −

1cδK

€

IG ≡ SG( )

€

ΔYY

=SG

Yc−δYY

=

SG

Y%

& '

(

) *

c−δ

€

ΔYY

=sG

c−δSo,

Harrod-Domar (or “AK”) Model: Derivation of disaggregated treatment of depreciation (cont.)

Illustrative Exercise on Growth Potential

‘Back-of-the-envelope’calculaKonswiththeH-D(orAK)growthmodel.

Suppose sG = .125, δ=.04, c =2.5

€

gTOT =.1252.5

− .04 = .01Then,

ButifsG=.175,δ=.03,c=2.5

€

gTOT =.1752.5

− .03 = .04Then,

Consider Waste: Suppose the ‘technical ICOR’ is 2, but 1/5 is wasted.

Effective ICOR is:

€

x45"

# $ %

& ' = 2⇒ x = 2

54"

# $ %

& ' = 2.5

€

sG

c 54"

# $ %

& ' −δSo, growth =

δ=.03sG=.15c=2.5

€

gr =.152.5

− .03 = .03

Illustrative Exercise on Growth Potential (continued)

Illustrative Exercise: Growth Targets (e.g. “India”)

•  Supposeacountryhasagrosssavingsrateof20%,adepreciaKonrateof3%,andanlCORof2.5.

•  UsingtheHarrod-Domargrowthmodel,findtheimpliedrateofgrowthoftotalGDPin“India.”

•  Answer:Growth=.2/2.5-.03=.05(i.e.,5%)•  Howmuchwouldtherateofsavingshavetoincreasetoraisethe

growthrateoftotalGDPto9%?(ArecentlydiscussedtargetinIndia)

•  Answer:Nowthesavingsrateisyourunknown.•  Growth=s/2.5-.03=.09,sos/2.5=.12ors=.3(thatis,up10

percentagepointsfrom20%to30%)•  Thisisawaytothinkabouttargetedgrowthratesandrequired

savingsalsowhenthistopicisconsideredfurtherinChapter11

CriKcismsoftheStagesModel

•  NecessaryversussufficientcondiKons

3.3Structural-ChangeModels

•  TheLewistwo-sectormodel

Figure3.1TheLewisModelofModern-SectorGrowthinaTwo-SectorSurplus-LaborEconomy

CriKcismsoftheLewisModel

•  RateoflabortransferandemploymentcreaKonmaynotbeproporKonaltorateofmodern-sectorcapitalaccumulaKon

•  Surpluslaborinruralareasandfullemploymentinurban?

•  InsKtuKonalfactors?•  AssumpKonofdiminishingreturnsinmodernindustrialsector

Figure3.2TheLewisModelModifiedbyLaborsavingCapitalAccumulaKon:EmploymentImplicaKons

EmpiricalPaIernsofDevelopment-Examples

•  Processesareverytypicalbutnotuniversal,soobenreferredtoas“stylizedfacts”:

•  Switchfromagriculturetoindustry(andservices)

•  Rural-urbanmigraKonandurbanizaKon•  SteadyaccumulaKonofphysicalandhumancapital

•  PopulaKongrowthfirstincreasingandthendecreasingwithdeclineinfamilysize

3.4TheInternaKonal-DependenceRevoluKon

•  Theneocolonialdependencemodel–  Legacyofcolonialism,Unequalpower,Core-periphery

•  Thefalse-paradigmmodel–  Pipallsofusing“expert”foreignadvisorswhomisapplydeveloped-

countrymodels•  ThedualisKc-developmentthesis

–  Superiorandinferiorelementscancoexist;Prebisch-SingerHypothesis•  CriKcismsandlimitaKons

–  DoesliIletoshowhowtoachievedevelopmentinaposiKvesense;accumulaKngcounterexamples

3.5TheNeoclassicalCounterrevoluKon:MarketFundamentalism

•  ChallengingtheStaKstModel:FreeMarkets,PublicChoice,andMarket-FriendlyApproaches–  Freemarketapproach–  Publicchoiceapproach–  Market-friendlyapproach

•  MainArguments–  DeniesefficiencyofintervenKon–  Pointsupstateownedenterprisefailures–  Stressesgovernmentfailures–  TradiKonalneoclassicalgrowththeory-withdiminishingreturns,cannot

sustaingrowthbycapitalaccumulaKonalone

FromtheAppendix:EquilibriumintheSolowGrowthModel

FromtheAppendix:TheSolowNeoclassicalGrowthModel

( ) ( ) (A3.2.4)k sf k n k = +

( *) ( ) * (A3.2.5)sf k n k= +

Appendix3.2TheSolowNeoclassicalGrowthModel:TheSolowEquaKon

Δk = sf (k)− (δ + n)k (A3.2.4)

EquilibriumisfoundwhereΔk=0,asinequaKonA3.2.5onthenextslide.Note:WecanalsouseequaKonA3.2.4abovetoprovidea“heurisKc”proofbycontradicKon–makinguseofFigureA3.2.1–toseethattheequilibriummustbewhereΔk=0:otherwisekisgrowingtothelebofk*andshrinkingiftotherightofk*.

FromtheAppendix:Interpreting the Solow equilibrium equation

•  Interpretating of the Solow Equilibrium in Equation (A3.2.5) and the preceding figure (A3.2.1),

•  sf(k*) is savings per worker, and is just equal to the sum of:

•  δk*, the amount of capital (per worker) needed to replace depreciating capital, and,

•  nk*, the amount of capital (per worker) that needs to be added due to population (labor force) growth.

sf (k*) = (δ + n)k * (A3.2.5)

TheSolowEquaKon:AHeurisKcNumericalExample

•  Note:ThisheurisKcexampleaddressesthecapitalperworkercomponent,notproducKon(outputperworker)

•  Incomedependsuponcapital(K)perworker(L):i.e.,K/L•  BeforeK/Lcangrowwemustinvesttomakeallowancefora)

depreciaKon;andb)growthofthelaborforceL•  Toillustrate,considera10-workereconomygrowingto12workers;

iniKallyK/L=2;anddepreciaKon=.05•  ToincreaseK/Lto2.5wemustinvest:•  1unitofKfordepreciaKonallowance:(20)*(.05)=1•  4unitsofKfor“capitalwidening”(equippingthenewworkerswith

thesamecapitalastheexisKngworkers)•  6unitsofKfor“capitaldeepening,”tofinallyincreasetheK/LraKo,

uptowhereeachworkerhas2.5unitsofcapitaltoworkwith•  Overall,theKstockgrowsfrom20to30,i.e.,30/12=2.5

Contributions and Limitations of the four schools

•  Capital Fundamentalism –  Points up importance of investment, and of efficiency of capital allocation –  Investment may be necessary but is not sufficient. Broader context matters

•  Structural/Empirical Patterns of Development –  Careful empirical evidence can remove theories from contention –  But, still need theory to interpret data, avoid cart-before-horse policies

•  Dependency –  Existing international relations/ trade/ investment can place constraints on

pattern of development –  But, growing number of counter-examples of stronger versions of

dependency theory; good performance of “globally” integrated countries •  Market Fundamentalism

–  Governments fail (e.g. in SOEs, planning) and we must account for this –  But, markets also fail in developing countries; the East Asia experience

shows that government role can be constructive

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-26

3.6ClassicTheoriesofDevelopment:ReconcilingtheDifferences

•  Governmentsdofail,butsodomarkets;abalanceisneeded•  MustaIendtoinsKtuKonalandpoliKcalrealiKesindevelopingworld•  Developmenteconomicshasnouniversallyacceptedparadigm•  InsightsandunderstandingsareconKnuallyevolving•  Eachtheoryhassomestrengthsandsomeweaknesses

Appendix3.1:ComponentsofEconomicGrowth

•  CapitalAccumulaKon,investmentsinphysicalandhumancapital–  Increasecapitalstock

•  GrowthinpopulaKonandlaborforce•  Technologicalprogress

– Neutral,labor/capital-saving,labor/capitalaugmenKng

FigureA3.1.1EffectofIncreasesinPhysicalandHumanResourcesontheProducKonPossibilityFronKer

FigureA3.1.2EffectofGrowthofCapitalStockandLandontheProducKonPossibilityFronKer

FigureA3.1.3EffectofTechnologicalChangeintheAgriculturalSectorontheProducKonPossibilityFronKer

FigureA3.1.4EffectofTechnologicalChangeintheIndustrialSectorontheProducKonPossibilityFronKer

Appendix3.2TheSolowNeoclassicalGrowthModel:TheSolowEquaKon

Δk = sf (k)− (δ + n)k (A3.2.4)

EquilibriumisfoundwhereΔk=0,asinequaKonA3.2.5onthenextslide.Note:WecanalsouseequaKonA3.2.4abovetoprovidea“heurisKc”proofbycontradicKon–makinguseofFigureA3.2.1–toseethattheequilibriummustbewhereΔk=0:otherwisekisgrowingtothelebofk*andshrinkingiftotherightofk*.

Appendix3.2EquilibriumCondiKonfortheSolowNeoclassicalGrowthModel

( *) ( ) * (A3.2.5)sf k n k= +

FigureA3.2.1EquilibriumintheSolowGrowthModel

Interpretation of Solow equilibrium equation

•  Interpretating of the Solow Equilibrium in Equation (A3.2.5) and the preceding figure (A3.2.1),

•  sf(k*) is savings per worker, and is just equal to the sum of:

•  δk*, the amount of capital (per worker) needed to replace depreciating capital, and,

•  nk*, the amount of capital (per worker) that needs to be added due to population (labor force) growth.

sf (k*) = (δ + n)k * (A3.2.5)

FigureA3.2.2TheLong-RunEffectofChangingtheSavingRateintheSolowModel

Note: The more detailed general derivations that follow in the next slides is supplemental material for students who are interested

€

YL

= yLet

DefiniKon:K(t+1)–K(t)≡ΔK

€

KL

t +1( ) −KL

t( )#

$ % &

' ( = Δ

KL≡ Δk

Δkk=ΔKK

−ΔLL≡ΔKK

− n

Δkk=sY −δK( )K

− nSubstituting,

Δkk= sy L

K− δ + n( ) = sy

k− δ + n( )

*Note: The first term corresponds to the form on the previous page, because we have just multiplied it by L/L and used the definitions. Now, multiplying through by k, we have:

€

Δk = sf k( ) − δ + n( )kThe Solow Equation

Appendix3.2TheSolowNeoclassicalGrowthModel

( ),Y F K L =

( ),1 or ( )Y L f K L y f k= =

y Ak=

( ) ( )sf k n k = +

( ) ( )k sf k n k = +

( )1( ) ( ) ( ) ( )Y t Y t A t L t =

ComparaKveCaseStudy:SouthKoreaandArgenKna

ComparaKveCaseStudy:ArgenKnaandSouthKorea*SouthKorea•  1:StagesofGrowth:ThetheoryislargelyconsistentwithSouthKorea’s

historicaleconomicgrowthexperience•  HugeshareofinvestmentinnaKonalincome-hasbeenamongthehighestin

theworld•  ThoughSouthKoreaneconomymaturedmuchfasterthanRostow'stheory

predicted,thegapbetweentradiKonalandadvancedtechnologycanbecrossedmuchfasterwithmoderninternaKonaltrade.

•  2StructuralPaIerns:•  TheLewismodelofdevelopmentislargelyconsistentwiththegrowthof

Koreaeconomy•  RapidlyincreasingagriculturalproducKvity•  Shibsoflaborfromagriculturetoindustry•  SteadygrowthofthecapitalstockandofeducaKonandskills•  DemographictransiKonfromhightolowferKlity

*ThankstoJinHoKimforpreparingtheChapter3casestudyslides

ComparaKveCaseStudy:SouthKorea,conKnued

SouthKorea(conKnued)•  3:DependencyTheory:•  SouthKoreaposesseriouschallengetothedependencerevoluKonmodels•  StrongdependenceininternaKonalrelaKons:U.S.militaryinSouthKoreafrom

1950,U.S.aidduring1950s,heavydependenceoninternaKonaltrade:•  Dependencytheorywouldpredictretardeddevelopment,but....•  SouthKoreaisanexcepKon:Themagnitudeofforeignaid,self-interestofU.S.;

during1960-1990,theKoreaneconomyusedIndustrialpolicythatdependencyschoolapplauds(ex:Samsung,LG,Hyundai);someconsideredthisunfairtradeagainstU.S.

•  4NeoclassicalTheory:•  SouthKoreaalsochallengestheseapproaches•  Thegovernmentmakingextensiveuseofdevelopmentplanning•  WiderangeoftaxbreaksandincenKvestoinducefirmstofollowgovernment

direcKvesandintervenKons•  InducingfirmstomoverapidlyuptheladderofdynamiccomparaKveadvantage

withdirectedtechnologicalgrowth

Chapter3CaseStudy:ArgenKna•  StagesofGrowth:ThisapproachisinconsistentwithArgenKna’s

economicgrowthhistory

•  RostowdatedArgenKna'sprecondiKonsfortakeoffasanextendedperiodbefore1914;andconcludedthattakeoffinsomesensebeganintheFirstWorldWarbutinthemid-1930ssustainedtake-offwasinaugurated,whichhejudgedsuccessfulby1960

•  ArgenKnahadanegaKvegrowthratethroughoutthe1965-1990period;inthe1980sdomesKcinvestmentshrankata-8.3%rate

•  LikemanyotherLaKnAmericanandAfricancountriesinthe1970sand1980s,ArgenKnademonstrateddevelopmentprogressisnotirreversible,andthatsustainedgrowthcancometoanend

Chapter3CaseStudy:ArgenKna(cont.)

•  2.StructuralPaIerns:•  ArgenKnaexhibitedmanyoftheusualstructuralpaIernsofdevelopmentasagriculturalproducKvityrose,industrialemploymentgrew,urbanizaKontookplace,ferKlityfell,amongothers

•  However,thesestructuralregulariKeswereobservedevenaslivingstandardsinthecountrystagnated

•  Illustratessomeshortcomingsofthemodel

Chapter3CaseStudy:ArgenKna(conclusion)

•  3.DependencyTheory:•  ArgenKna’seconomichistoryislargelyconsistentwiththedependencerevoluKon

approach•  ArgenKnareliedtoalargeextentonexporKngprimarygoods;andtherealprices

ofthesegoodsfellcomparedtoimports•  MulKnaKonalcorporaKonsplayedalargerole;andArgenKnawasunabletocreate

itsownviablemanufacturingexportindustries,ulKmatelyhavingtosubmittostringentstructural-adjustmentprograms.

•  4.NeoclassicalTheory:•  ArgenKnaalsoofferssomevindicaKonforneoclassicalcounterrevoluKontheory•  FaultyintervenKonistrestricKons,ineffocientstateenterprise,biasagainst

producKonforexports,andunnecessaryredtapeendeduphurKngindustryandentrepreneurship.

•  Governmentpolicyconsistentlyseemedtosupportprivilegedinterestsratherthanbroadergoalsofdevelopment;andapparentlygovernmentfailurewasworsethanmarketfailureinArgenKna

ConceptsforReview•  Autarky•  Averageproduct•  Capital-laborraKo•  Capital-outputraKo•  Center•  Closedeconomy•  Compradorgroups•  Dependence•  Dominance

•  Dualism•  False-paradigmmodel•  Freemarket•  Free-marketanalysis•  Harrod-Domargrowthmodel•  Lewistwo-sectormodel•  Marginalproduct•  Marketfailure

ConceptsforReview(conKnued)•  Market-friendlyapproach•  NecessarycondiKon•  NeoclassicalcounterrevoluKon•  Neocolonialdependencemodel•  NetsavingsraKo•  NewpoliKcaleconomyapproach•  Openeconomy•  PaIerns-of-developmentanalysis•  Periphery

•  ProducKonfuncKon•  Public-choicetheory•  Self-sustaininggrowth•  Solowneoclassicalgrowthmodel•  Stages-of-growthmodelof

development•  Structural-changetheory•  StructuraltransformaKon•  SufficientcondiKon•  Surpluslabor•  Underdevelopment