I strongly suggest you print this out and put at the front of your development notes (a topic we have yet to start).
Economic theory seeks to explain behaviour and events by simplifying reality and developing logical sequences of ideas. There have been many different approaches to economic development, each of them adds something to our understanding but none is completely convincing in all circumstances.
Harrod-Domar
Roy Harrod initially studied the business cycle but he is best-known for ideas on economic development which were built on his earlier work. He suggested that it was possible to produce a mathematical model of development in which the savings ratio and the marginal efficiency of capital played a crucial role.
Many less developed countries struggle to save and to fund investment. The limited resources available are nearly all directed at consumption and survival. This makes it difficult for them to add to their capital stock. The Harrod-Domar model focuses on capital accumulation, which is undoubtedly one of the cornerstones of economic development. The least developed countries characteristically have very low levels of capital per person. This acts as a constraint on output and growth.
Two limitations are significant. The model assumes a constant marginal efficiency of capital though in the real world the return on investments is extremely variable. To put this simply, poor investment decisions might make little or no contribution to development if they do not result in the creation of productive assets. For example, building a luxury hotel where nobody wants to go could be a waste of available funding. By contrast, capital projects which improve power supply or transport links, for example, can sometimes stimulate rapid development. The model also works best with a closed economy, whereas foreign direct investment and international trade have been important in the development of many countries.
Rostow
The title of Rostow's main book is "The Stages of Growth: a non-Communist Manifesto". He identified five stages of economic development: traditional society, preconditions for take-off, take-off, drive to maturity, and age of high mass consumption. Whereas Karl Marx’s communist approach identified stages which entailed ‘progressive emisseration’ (worsening conditions) for the working class, Rostow saw the market system leading eventually to high mass consumption.
The stages identified by Karl Marx were flawed because he saw capitalism as a precursor to communist revolution, yet Russian and Chinese revolutions missed the capitalist stage. The stages identified by Rostow were also too rigid for complex real situations. They fitted better to western experience than recent examples of economic development in Asia, for example. Amongst other flaws, he underestimated the contribution that governments can make to development, though he did see value in aid.
Evidence from assorted countries suggests that Rostow's concept of ‘high mass consumption’ has more widespread validity than ‘progressive emisseration’. The evidence also suggests that real experience of development is sufficiently diverse to make any set sequence of stages inaccurate for many countries.
Lewis 2 sector
At the core of Lewis's work is the idea that agricultural economies often use labour inefficiently, with underemployment and/or unemployment. Transferring labour to secondary activity is seen as likely to lead to improvements in output and productivity, spurring development. This could be expected to entail rising wages and urbanisation.
Empirical evidence does suggest that the least developed countries tend to concentrate most activity on primary industries, also that development frequently entails expanding secondary (and tertiary) industries. However, there are striking examples such as Nairobi, where urbanisation has resulted in the growth of shanty towns in which many people are unemployed and living with less income and in worst circumstances than agricultural communities. Lewis, perhaps, underplays the significance of capital as stressed by Harrod-Domar. His model does not explain where new industries will come from to absorb newly urbanised labour.
The value of this approach is that it emphasises the need to bring changes to an economy which increase the productivity and output of the labour force.
Dependency theory
Some more recent theorists suggest that the growth and relative affluence of the richer economies is dependent upon other countries staying poorer. The poorer economies cannot produce many goods and services and therefore import them, providing a market for industries in the richer countries. The poorer countries also frequently find themselves supplying materials and commodities to the rich at disadvantageous terms of trade.
The poorer countries come to depend on richer countries which have an interest in staying dominant. Thus, failure of poorer countries to develop can be blamed on external pressures and not just internal failures. The long-term downward trend in the relative prices of commodities (identified in the Prebish-Singer hypothesis) suggests that there might be something in dependency theory [but see food and commodity prices recently]. Some agreements, such as the Kennedy round of trade negotiations (which brought significant gains to richer countries but entailed a net loss to sub-Saharan Africa), seem to support ideas of exploitation by richer countries.
There is plentiful evidence that richer countries generally act in their own best interests, but this does not necessarily entail others staying poor. Comparative advantage theory shows that both sides can gain from trade. The rapid development of China and India in recent years shows that the largest countries in the world have been able to ‘emerge’ fairly rapidly, reducing poverty for many of their citizens. Many other countries have also achieved sustained development. The evidence from the recession starting in 2008 is that when richer countries suffer a setback, this also disadvantages many poorer countries with which they trade, suggesting a relationship with mutual success at some times and mutual failure at others. Some advocates of dependency theory seem motivated as much by political inclination as by study of the evidence.
Neoclassical theory
Advocates of neoclassical theory claim that economic development depends on free, competitive markets and on entrepreneurs having maximum liberty to operate without government interference. The dominance of this way of thinking, once called ‘The Washington Consensus’, goes part way to explaining the ‘structural adjustment plans’ which were imposed as conditions of IMF support for many less developed countries in the 1990s, sometimes with very damaging results (see ‘Globalisation and its discontents’ by Joseph Stiglitz).
Minimising the role of government entails cutting public spending, perhaps even on basic welfare. Deregulation and privatisation open the door to multinationals; in some cases this has had disastrous results for local firms. An underlying problem here is that neoclassical theory depends on markets operating efficiently, yet many markets in less developed countries (as in developed countries too) are riddled with imperfections.
Absence of effective laws, for example to enforce contracts, deters enterprise. This identifies one essential role for government. Some regulation, even on simple things such as mainly driving on one side of the road, brings benefits which everyone can agree on. There is continuing disagreement between economists on the best extent of government involvement in an economy, but not on the need for the existence of government. Even within a mainly market system, market failures and imperfections create a regulatory role for government.
China, India and others have developed rapidly with governments taking a very active role in their economies. In China, for example, utilities, heavy industry and energy are dominated by 159 state owned enterprises. In contrast, some inefficient (and perhaps sometimes corrupt) governments, for example in some African countries, seem to have held back development. The challenge, seemingly, is to combine effective government action with an environment in which entrepreneurs are able to operate effectively. There clearly is a role in successful development for market forces, for individual initiative and risk-taking.
Synthesis
Each of these approaches sheds some light on development, but none of them offers a complete picture.
Harrod-Domar emphasises the importance of building up a stock of capital. Development entails more output per capita so more labour productivity. Having more and better capital equipment can make a major contribution to productivity.
Rostow’s stages approach is too rigid to be realistic, but ideas such as ‘take-off’ and ‘high mass consumption’ are useful. Broadly, stages can be linked to the idea of bottlenecks inhibiting development and key changes stimulating progress. Lewis captures the point that less developed economies tend to focus predominantly on primary industries and that growth is generally linked to a switch to more secondary and tertiary activity, together with more urbanisation. Dependency theory sounds a cautionary note that richer countries are more likely to prioritise their own interests than those of others. However, international trade has frequently been central to development, in China for example.
Prebish-Singer emphasises the danger in relying on commodities as a means to development; though it is not clear that the long term decline in the relative prices of commodities will continue.
Neoclassical theory stresses the role of free markets. This is contentious. There is a role for incentives and entrepreneurial spirit, but the approach to decision making is perhaps less important than the quality of decisions made. Governments make mistakes, but the global banking crisis came in a market which had grown increasingly free.
The relative significance of these approaches and ideas depends on the context. Information about a country or a particular situation, such as the evidence given for data response questions, will probably include points relevant to one or more of the above approaches. Development is a complex process and it is often useful to focus on key elements, such as those identified above.
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