UNIVERSITY OF DAR ES SALAAM

Department of Economics
EC 220: Development Economics
Instructor: V L Mughwai
 A REVIEW OF NEO-CLASSICAL
THEORIES
 Stage Theories of Development (Rostow’s Theory)
 Theories of Dualism (Lewis’ Model)
 Theories of vicious circle (simple vicious circle theory,
Nurkse’s theory, Todaro’s theory of vicious circle)
 Theories of limiting factors
Basic readings:
 Agenor, P.R. (2000), The economics of adjustment and growth.
San Diego: Academic Press
 Meier, G.M. (1976), Leading issues in economic development.
O.U.P.: New York
 Todaro, M. (1985), Economic development in theThird World.
London: Longman Publishing Group
 Chenery, H. and T. N. Srinivasan, eds. (1988), Handbook of
development economics. North Holland, Vol 2
ROSTOW’S STAGES OF GROWTH
 American economist Walt Whitman Rostow (W.W. Rostow)
published an article in 1960 titled, “Rostow’s Stages of
Economic Growth” which has become one of major historical
economic models of growth

 In this model, Rostow argue that all countries pass through a

series of stages of development as their economies grow
Five Basic Stages
1) Traditional society
2) Pre-conditions for take-off
3) Take-off
4) Drive to maturity
5) Age of high mass consumption
Global development status
LDC vs DCs
First World Economy vs Third World Economy
Water scarcity
…lack of clean water…
The USA
Wall Street…area
Robotics technology…
First World technology..
Stage 1: Traditional Society
 Characterized by subsistence agriculture, hunting and
gathering
 Limited technology
 Limited advancement due to absence of modern technology
 Lack of class and individual economic mobility
 No centralized nations or political systems (no nation states)
Note: Rostow argued that society generally begins with this
stage before progressing to other stages of development
These societies can be described as the pre-
Newtonian societies which relied on manual labor
to survive.
Traditional society … hunting and fruit gathering
Analyzing this stage…
 Limited production function which rarely attains minimum
level of potential output
 The output level could be increased as there was always
surplus of uncultivated land can be used to increase
agricultural production
 Investment share never exceed 5% of the total economic
output
 Relies on traditional methods of science and medicine
 No modern technology to facilitate rapid growth
 Growth affected by wars, famine, epidemics etc
Stage 2: Pre-Conditions to Take Off
 Shift from an agrarian to industrial/manufacturing society
begins (transition stage, discoveries and inventions,
development of transport system)
 Creation of international markets (beginning of economy
development)
 Surplus of agricultural products dues to development of
more productive commercial agriculture (cash crops not
consumed by producers but largely exported)
 Pivotal role of government
 Spread of education and knowledge (new skills)
Pre-condition to take-off conts.
 Changing social structures
 Individual social mobility begins
 Development of national identity and shared economic
interests
Analysis cont.
(4) Investment levels should be above 5% of national income
(5) Government plays a key role in development of social
overhead capital (since it is rarely profitable) … private
sector not interested in this role
(6) Notable growth in private entrepreneurship

NOTE: Agriculture plays a big role in this stage

Example: British Industrial Revolution
Stage 3: Take-Off
 Urbanization increases, industrialization proceeds and
technology breakthrough occurs
 Emergence of leading sectors (Secondary or goods producing
sector expand)
 Textile and apparel are usually the first to take-off
 Increased rate of investment and income begins to flow to
hands of capitalists who re-invest and increase the rate of
capital formation (thru govn fiscal measures using banking
institutions and capital markets)
 Loanable funds play a key role in financing for large overhead
capital /projects.
Examples of countries under take-off
Characteristics of this stage
(1) Dynamic economic growth
(2) Multiple stimuli (economic, political and social change)
(3) Key feature: rapid self-sustained growth
(4) Society driven more by economic processes rather than
traditions/norms/beliefs

NOTE: After take-off stage typically the country takes from 50

to 100 yrs to reach mature stage
3 Main Requirements for Take-Off
(1) Rate of inductive investment should be approx 5% to 10%
of the total national income or net national production
(2) Development of one or more manufacturing sectors with
high rate of growth
(3) Quick emergence of political, social and institutional
frameworks

NOTE: Take-off periods of different countries are the same as

the industrial revolutions in those countries!!
The Drive to maturity cont.
 Manufacturing shifts from investment driven (capital goods)
towards consumer durables and domestic consumption
 Rapid development of transportations systems and
infrastructure
 Large scale investment in social infrastructure (schools,
hospitals, Universities etc)
Characteristic and analysis of this
stage
 In this stage, society has effectively applied a range of modern
technologies
 10% to 20% of national income steadily invested, allowing
output to outstrip population growth
 Economy involved in international economic system
 Leading sectors determined by nature of resource
endowment not only by technology
 Takes approx 60 yrs for countries to reach this stage
Ways of Structural changes in
society in this Stage
(1) Workforce in agriculture shifts from 75% to 20%
(2) Character of leadership changes in industries and high
degree of professionalism introduced
(3) Environmental and health costs of industrialization
recognized and policy changes made
Examples of countries that reached
this stage
(1) Great Britain 1850
(2) Russia 1950
(3) USA 1900
(4) Germany 1910
(5) Canada 1950
(6) South Africa 2000
Stage 5: Age of High Mass
Consumption
 Currently experienced in may western countries where
consumption is concentrated in durable goods
 In this stage there is rapid expansion in tertiary industries and
welfare facilities
 Individual incomes are greater than necessary for buying
essentials
 Society free to choose from either concentrating in military
security issues; on equality and welfares issues OR on
developing great luxury goods for upper class
 Improved health care systems and education
 Economy flourishes..
Examples of countries that reached
this stage
 Great Britain 1950s
 USA 1930s/40s
Criticism of Rostow’s Theory
(1) Theory has a strong bias towards Western Models of
development/modernization while Western-capitalist
model is not the only path to economic progress
(2) It assumes that all countries follow the same path of
development or started the same way or would want the
same things as the US or Western European countries
(3) Does not look at variations within a country
(4) Assumes that each country is politically and economically
free
 THEORIES OF DUALISM (LEWIS’
MODEL)
The theory of dualistic economic development was developed
by Noble Prize Winner economist known as Sir W. Arthur
Lewis in 1954 through his paper titled “Economic
development with unlimited supply of labor”.
- Theory focuses on labor-surplus and resource poor
developing countries. Thus the analysis of development is in
the context of “labor-surplus economy”

- The theory assumes that the economy is comprised of

agriculture (rural) and manufacturing (urban) sectors.
Definition of the Lewis’Model
The dual sector model is a theory of development in which
surplus labor from the traditional agricultural sector is
transferred to the modern industrial sector whose growth
over time absorbs the surplus labor, promotes
industrialization and stimulates sustained development.

Lewis argues that most underdeveloped countries have dual

economies divided in two sectors, namely, the capitalist
sector and subsistence sector (agriculture) and that the
agricultural sector has unlimited amount of land to cultivate
and marginal product of an additional farmer is assumed to
be zero.
Surplus labor
The agro sector has quantity of farm workers that are not
contributing to agricultural output since their marginal
productivities are zero. These “not producing” workers are
called surplus labor
Thus, due to wage differentials these workers will tend to
transfer to capitalist sector over time to reap the rewards of
higher wages
Note: If the quantity of worker that transition from subsistence
economy to capitalist economy equals to surplus labor, then
the general welfare of the economy is improved
Surplus labor movement and
equilibrium point
Labor movement from traditional sector does not affect the
total agricultural production. However, the total production
in the manufacturing industry grows.
Over time, investment increases result into capital stock and
the marginal productivity of workers in manufacturing sector
will be driven up by capital formation and at the same time
driven down by additional workers entering the
manufacturing sector.
Eventually, wage rates of the agricultural sector and
manufacturing sector will equalize as workers leave the agro
sector while driving down wages and productivity in
manufacturing sector.
Marginal Product of Labor (MPL)
The end result:

agricultural wage = manufacturing wage

Agricultural MPL = Manufacturing MPL

At this point, there is no further manufacturing sector

enlargement taking place as workers no longer have a
monetary incentive to transition
Surplus of labor and Econ Growth
Surplus labor can be used instead of capital in creation of new
industries OR can be channeled into industries that are
labor-intensive in their initial stages. This labor (unskilled)
does not raise the value of subsistence wage.

The utility of unlimited supplies of labor to growth objectives

depends upon the amount of capital available at the same
time.

Labor must be encouraged to move to increase productivity in

agriculture. The margin that the capitalist has to pay is as
much as 30% above the average subsistence wage
Lewis’Model- main assumptions
(1) 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) Wages in the manufacturing sector are more or less fixed
(4) Capitalists (entrepreneurs) in the manufacturing sector
make profits because they charge a price above the fixed
wage rate
(5) Profits will be re-invested in the business in form of fixed
capital
Subsistence Sector - characteristics
(1) Low wages
(2) An abundance of labor
(3) Low productivity through labor-intensive production
process.
(4) People are generally backward, illiterate and unskilled

Note: The central problem in economic development theory is

to understand the process by which a community which
previously earned and invested 5% or less of its national
income converts itself to an economy where voluntary
savings are at 12 to 15% or more of its national income
Capitalist Sector - characteristics
(1) Higher wage rate compared to those offered at subsistence
sector
(2) Higher marginal productivity
(3) There is a demand for more workers
(4) Capital-intensive production process
(5) People are generally advanced, literate, sophisticated and
skilled
Capitalist surplus
The capitalist sector needs skilled workers for its expansion and
the supply of this labor is converted into capitalist surplus,
which essentially is an important prerequisite for growth
Criticism of Lewis Model
 Lewis thought of labor surplus in terms of human beings
rather than man-hours
 The assumption that no physical capital accumulation in
agricultural sector is not correct (e.g current investments in
commercial agriculture with related capital accumulation)
 The notion that labor-surplus was interpreted as zero
marginal productivity of agro labor is an unlikely event both
statistically and conceptually.
Note: According to Ted Schultz (1964)
A withdraw of large populations in agriculture does not lead to
decline in agro production/output
Criticism conts.
Sean (1967) argues that as people leave agro sector, those who
remain may work harder. i.e any withdraw of labor from
agriculture is likely to be accompanied by a reorganization of
production by those who are left behind (technology change)
Current Theoretical and Policy
Relevance of the Lewis Model

 The Model is relevant in global South and is considered a

valuable guide to policy in places such as China, India,
Bangladesh, Central America and some parts of Sub-Saharan
Africa.

 In the global South, dualism still holds the attention of both

theoretical and empirical observers since a vast percentage of
the population in still based in rural areas and engage in
agriculture as their main economic activity
THEORIES OF VICIOUS CYCLE
 Nurke’s Theory
 Todaro Model of Vicious Cycle
 Theories of Limiting Factors
What is vicious cycle of poverty
theory?
 The cycle of poverty is the “set of factors or events by which
poverty, once started, is likely to continue unless there is
outside intervention
 Once you are in poverty, everything is stacked against you
getting out

Note: Many economists believe that poverty is the basic source

of underdevelopment which is essentially made possible by a
host of factors (poor technology in the Third World
countries, presence of many social and cultural obstacles etc)
Ragnar Nurkse (1907-2007)
Developed a theory of vicious circle (also known as theory of
stagnation which describes the presence of economic forces
that can keep a country stagnated at a low income
equilibrium

Nurkse states in his theory that: a vicious circle of poverty

is a circular constellation of forces tending to act
and react upon one another in such a way as to keep
a poor country in a state of poverty.
Poverty and underdevelopment
 Most economists believe that poverty is the basic source of
underdevelopment…i.e once you are in poverty everything
else is stacked against you getting out.
 The circle of poverty is the set of factors or events that once
started is likely to continue unless there is an outside
intervention
 Cause by many cultural and social obstacles, no single factor
can be held responsible for underdevelopment (your
background and history may determine your future position
in the society,,,e.g President George W. Bush, President
Uhuru Kenyatta etc)
A poor man example

A poor man, because of low income, is underfed and under

nourished. The underfeeding makes him weak and becomes
susceptible to sickness and diseases.

Note: the conditions in LDCs are such that economic

development is very difficult. Outside intervention may be
necessary for these countries to come out of poverty in
terms of international trade, FDI, new institutional
establishment etc.
Vicious circle of poverty

A country is poor because it is poor. Being poor, a country has

little ability or incentives to save. Low savings lead to low
level of investment and to deficiency of capital. Low
investments lead to low level of productivity. And when the
productivity per workers is low, the real incomes will be low
and poverty and vicious circle is complete.
Circular relationship based on
demand-side and supply side

Nurkse argued that a circular relationship exist on both sides of

the problems of capital formation in poverty-ridden
countries of the world.

That is, due to poverty and backwardness, poor countries do

not have optimal use of resources and have no specialization
in the production process of goods and services. Also, there is
not optimal division of labor and the right skills in the
undertaking of economic activities.
On Supply-Side
There is small capacity to save resulting from low levels of real
income. The low real income is a reflection of low
productivity which in turn is due to lack of capital. The lack
of capital is a result of small or limited capacity to save and so
the circle is complete
On the Demand Side

The inducement to save is low because of small purchasing

power of the people, which is due to their small real
incomes, which, again, is due to low productivity. The low
productivity, however, is a result of the small amount of
capital used in production, which in turn may be caused by
small inducement to invest.
In summary..

• From the supply side, there is low income, low savings,

low investment, capital deficiency and low productivity.

• On the demand side, low income, low demand for goods,

limited home market and low investment.
VCP Illustration
How to Break the VCP

 According to Nurkse, a break through on demand side can be

brought about by dashing initiatives on the part of
entrepreneurs. On the supply side the disguised
unemployment ranging between 20% to 30% of total
agricultural labor force can be mobilized for financing capital
formation.
 Increases in savings: will lead to increased volumes of real
savings and mobilize foreign savings for capital formation
 Higher per capital growth rate: should be higher than pop.
Growth. This can be done by increasing the level of
employment
Breaking the circle cont.
 Efficient use of natural resources: the LDCs are not making
efficient use of their natural resources. The MNCs are
exploiting these resources more for their own economic
benefits
 Employment in human resources: low level of illiteracy rates,
malnutrition, lack of proper medical care etc are all barriers
to econ development
 Increasing stock of capital goods: motivating the wealthy to
make their savings available to investment in productive
activities rather than on luxury or previous metals
Breaking the circle…
 Role of advanced nations: expanding volumes of trade with
the LDCs; increasing flows of FDI; provision of direct aid in
basic social services (education, health care); provision of soft
loans; writing off loans/debt
 Role of government: putting in place institutional
frameworks of governance; removing political corruption
and briobery
 Shortcomings of the Model
• Entrepreneurs Responsible For Breakthrough:
According to Nurkse to break the VCP entrepreneurs will
play an important role. But he does not suggest the means
for such funds. As in poor countries the savings are low,
hence for the supply of funds the credit creation will have to
be restored. But Nurkse rejects it.

• Disguised Unemployment: According to Nurkse, the

disguised unemployment will finance for growth. But the
domestic resources are not sufficient, they can partially meet
the requirements of growth.
Shortcomings conts.
 Raw Material And Machines: Nurkse's theory fails to answer
the question from where the machines and raw material will be
provided to the labor which will be utilized for capital formation.
Moreover, why the parents will continue providing food to their
disguised unemployed offspring's once they get employment.
 Misleading and Over Simplified: According to Bauer the idea
of VCP is misleading and over-simplified because the developed
countries never passed through such situation when they where
UDCs.