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CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT
Development as Growth and the Linear Stages Theories
The following are the growth theories based on linear stages (Smith & Todaro, 2015):
• Rostow’s Stages of Growth. This growth theory was proposed by Walt W. Rostow, an American
economic historian. According to him, the transition from underdevelopment to development can
be described in terms of a series of steps or stages through which all countries must proceed.
Rostow argued that economies must go through these developmental stages towards greater
economic growth. Moreover, countries must accumulate savings in order to realize movement from
traditional to developed societies and eventually achieve take-off. The logical sequence of Rostow’s
Stages of Growth is as follows (Economics Online, n.d.):
1. Traditional society. This stage is dominated by agriculture and barter exchange, and where
science and technology are not understood or exploited.
2. Pre-take-off stage. This stage is manifested by the development of education and an
understating of science, the application of science to technology and transport, and the
emergence of entrepreneurs and a simple banking system, and hence rising savings.
3. Take-off. This stage is demonstrated by organized systems of production, positive growth
rates in economic sectors, and the modernization of traditional methods and norms.
4. Drive to maturity. This stage is described by an ongoing movement towards a diverse
economy, with massive growth in many sectors of economy.
5. Stage of mass consumption. This stage is manifested by citizens enjoying high and rising
consumption per capita/individual, and where economic rewards are spread more evenly.
• Harrod-Domar Growth Model. This growth theory emphasizes the importance of savings and
investment. According to this theory, there are two (2) determinants of economic growth rate as
follows:
1. Capital-output ratio. It expresses the units of capital required to produce a unit of output
over a given period of time. This shows how much new capital is needed to create a given
amount of new national income. For instance, the capital required to acquire a unit of a ripe
mango is P10, and the income which can be derived from selling the said commodity is P2.
Then, the ratio of ripe mango to the income derived by selling it would be 10:2 = 5.
2. Net savings ratio. This refers to the savings expressed as a proportion of disposable income
over some period of time. This shows how much is saved from a given amount of national
income. For instance, after payment of bills and setting a budget for a particular period of
time, one can still save P10 from P100 earnings.
These two (2) ratios affect the rate of growth. Essentially, the higher the savings ratio, the more an
economy will grow. Likewise, the higher the capital-output ratio, the higher the rate of growth.
For Harrod and Domar, economies must save and invest a certain proportion of their income to
grow at a certain rate – failure to develop is caused by the failure to save, and accumulate capital.
For take-off to happen, savings must be accumulated (Economics Online, n.d.).
Structural Change Models
The structural-change theory is based on the hypothesis that underdevelopment is due to underutilization
of resources arising from structural or institutional factors that have their origins in both domestic and
international dualism. Development therefore requires more than just accelerated capital formation
(Smith & Todaro, 2015). The different theories of development based on structural change are as follows
(Economics Online, n.d.):
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• Lewis Model. This is formulated by Nobel laureate W. Arthur Lewis in 1955 and dominated
development theory between the 1960s and 1970s. It is also known as the two-sector model and
the surplus labor model. It focuses on the need for countries to transform their economic structure,
away from agriculture, which has low productivity of labor towards industrial activity, which tends
to have high productivity of labor. This model argues that the development of economy begins with
two (2) sectors as follows:
1. Rural agricultural sector. According to this model, the marginal productivity of agricultural
labor is virtually zero. Marginal productivity refers to the extra output gained by adding one
(1) unit of labor when all other inputs are held constant. As such, Lewis argued that
transferring workers to the more productive, urban, industrial sector out of agriculture does
not reduce productivity in the whole economy.
2. Urban industrial sector. According to this model, industrial firms make profits that can be
reinvested into even more industrialization, and capital starts to accumulate. As soon as
capital accumulates, further economic development can sustain itself. This model also
suggests that industrialization could promote high-paying jobs, can create more multiplier
effects because of the forward and backward linkages, and help increase the value of the
product that is being produced. Forward linkage refers to an investment to subsequent stages
of production or product development. Backward linkage, on the other hand, refers to an
investment to facilities and machinery and equipment that will complement the stages of
production or product development.
• Fisher-Clark Model. This is formulated by Allen Fisher in 1935. This theory suggests that economic
progress would lead to the emergence of a large service sector, which followed the development of
rural agricultural and urban industrial sectors. According to this model, there are two (2) essential
reasons for the emergence of the service sector as follows:
1. High income elasticity of demand. There is generally a high-income elasticity of demand for
services, especially leisure, tourism, and financial services. Income elasticity of demand
measures the responsiveness of the quantity demanded for a good or service to a change in
income. As incomes rise, demand for services increases and more employment and national
output are allocated to service production. For example, in the UK and many developed
economies over two-thirds of all workers are employed in the service sector.
2. Low productivity of labor. Productivity in the service sector is lower than in the
manufacturing sector because it is harder to apply new technology to many services. This
means that over time prices of services rise relative to primary and secondary goods. The
effect of high-income elasticity of demand and low productivity is that an increasing
proportion of national income and consumption is allocated to the service sector.
The International-Dependence Revolution
The different theories of development based on international-dependence revolution are as follows
(Smith & Todaro, 2015):
• The Neocolonial Dependence Model. The main proposition of this model is that underdevelopment
exists in developing countries because of the continuing exploitative economic, political, and
cultural policies of former colonial rulers toward less developed countries. Underdevelopment is an
economic situation characterized by persistent low levels of living in conjunction with absolute
poverty, low income per capita, low rates of economic growth, low consumption levels, poor health
services, high death rates, high birth rates, dependence on foreign economies, and limited freedom
to choose among activities that satisfy human wants.
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• The False-Paradigm Model. The main proposition of this model is that developing countries have
failed to develop because their development strategies (usually given to them by Western
economists) have been based on an incorrect model of development, one that, for example,
overstresses capital accumulation or market liberalization without giving due consideration to
needed social and institutional change.
• The Dualistic-Development Thesis. The main proposition of this model is based on dualism. Dualism
is the coexistence of two (2) situations or phenomena (one desirable and the other not) that are
mutually exclusive to different groups of society (e.g. extreme poverty and prosperity, modern and
traditional economic sectors, growth and stagnation, and higher education amid large-scale
illiteracy of some countries).
The Neoclassical Counterrevolution: Market Fundamentalism
The different theories of development based on market fundamentalism are as follows (Smith & Todaro,
2015):
• Free Markets. The system whereby prices of commodities or services freely rise or fall when the
buyer’s demand for them rises or falls or the seller’s supply of them decreases or increases. This
involves theoretical analysis of the properties of an economic system operating with free markets,
which is often under the assumption that unregulated market performs better than one with
government regulation.
• Public-choice Theory. This is also known as the new political economy approach. This theory states
that self-interest guides individual behavior and that governments tend to be inefficient and corrupt
because people use government to pursue their own agendas.
• Market-friendly approach. This approach recognizes that there are many imperfections in the
products and markets of developing-country, and that governments do have a key role to play in
facilitating the operation of markets through “nonselective” (market-friendly) interventions.
Examples include investing in physical and social infrastructure, health care facilities, and
educational institutions, and by providing a suitable climate for private enterprises.
• Solow Growth Model. This model of economic growth analyzes changes in the level of output in an
economy over time as a result of changes in the population growth rate, the savings rate, and the
rate of technological progress (Corporate Finance Institute, 2019).
References
Corporate Finance Institute. (2019). What is the solow growth model? Retrieved October 22, 2019, from
[Link]
Economics Online. (n.d.). Linear growth theories. Retrieved August 16, 2019, from
[Link]
Economics Online. (n.d.). Structural change theory. Retrieved August 16, 2019, from
[Link]
Smith, S. & Todaro, M. (2015). Economic development (12th ed.). United Kingdom: Pearson Education, Inc.
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