Objectives today

1. Objectives today • Discuss how potential sources of growth are used in theories of economic development

2. Economic Growth and Development Theories • Classical model • Growth stage theories • Dual economy models • Dependency theories • Exogenous growth theories • Endogenous growth theories • Transactions costs/collective action

3. Classical Model (late 1700’s & early 1800’s)(Malthus) • Wages are at subsistence level • Favorable event leads to capital accumulation • Increased demand for labor • Wages in short run • Population growth • Demand for food • Land fixed so food prices , real wages • population

4. This (Classical) Model failed to consider the following factors and therefore did not predict correctly: • Factors which lower birth rates • Technological progress Therefore, in Classical model, law of diminishing returns constrains growth in the long run

5. Growth stage theories • Fred List (mid 1800’s) – stages based on shifts in occupational distribution • Savage • Pastoralism • Agriculture • Agriculture and manufacturing • Agr., manufacturing, and commerce He called for import substitution

6. Growth stage theories (continued) • Karl Marx (late 1800’s) – stages based on changes in technology, property rights, and ideology • Primitive communism • Ancient slavery • Medieval feudalism • Industrial capitalism • Socialism and communism He felt class struggles drive classes through these stages. One class has land and capital. Other class has labor.

7. Growth stage theories (continued) • W. W. Rostow (1950’s) • Traditional society • Precondition for takeoff • Takeoff • Drive to technological maturity • Age of high mass consumption *Sectors decline due to declining income and price elasticities of demand *Capital accumulation and technological change will lead to emergence of leading sectors

8. Growth stage theories (continued) • Colin Clark (1930’s) • Agriculture • Manufacturing • Tertiary or services Growth results from: • Increased output per worker in any sector • Workers moving from sectors with low output per worker to high output per worker Technological change important

9. Harrod-Domar model (1950) • Savings leads to economic growth • Output per unit of capital up leads to economic growth Led policymakers to focus on capital-led industrial growth The H-D model: g=s/k where: g = rate of growth in national income s = savings rate k = ratio of capital to output

10. Main features of labor-surplus dual-economy model • 2 sectors – agriculture & industry • Marginal product of labor in agriculture • Wage rate in agriculture equals average product of labor in agriculture • Land fixed • Wage rate higher in industrial sector • Marginal product of labor in industry equals the wage rate

11. (features continued) • Labor moves from agriculture to industry • Profits reinvested in capital items resulting in greater M P & demand for labor • Shifts in M P of labor creates more profits, etc. • This happens as long as marginal cost of labor is constant • If marginal cost of labor (wage rate) goes up, profits stop increasing as fast and eventually the process stops.

12. Traditional (Ag.) Sector Modern (Ind.) Sector Agricultural Total Product Industrial Total Product Redundant labor 0 Labor 0 Labor Agricultural Marginal Product Industrial Marginal Product Marginal product curve P1 P0 P2 Q P3 Profit P W Wages 0 N3 N2 N1 N0 Labor 0 L0 L1 L2 L4 Labor

13. Why might the marginal cost(supply) curve of labor turn up? • Surplus labor used up so industry must offer higher wages • Supply of food does not keep up with the demand for food so wages must rise What does this say about the need for technological progress in agriculture?

14. Weaknesses in the model • Says nothing about the cost of moving people and food • May not have excess labor in some countries • Says nothing about cost of and how to develop the agricultural sector • Assumes profits reinvested in labor-intensive industries (what if not invested or invested in capital-intensive industries due to subsidies)? • Ignores international trade

15. Can extend model to open economy • If natural resources are poor: can export labor-intensive industrial goods (examples: Taiwan & Korea) and import food • If natural resources rich: can export agricultural products and use foreign exchange to develop industry (examples: Thailand & Malaysia)

16. Dependency theories (1950’s, 60’s, 70’s • Center – developed countries and elites within developing countries • Periphery – poor in developing countries Center develops at the expense of the periphery

17. Why dependency? • Center has monopoly power • Low price and income elasticities for goods produced by the periphery • High price elasticity of demand for goods imported by the periphery from the center Result: periphery receives less and less for exports and pays more and more for imports

18. Dependency theory suggests that countries become self-sufficient What do you think?

19. Lessons from each theory • Classical theory – savings & capital investment important • Diminishing returns to labor • Growth stage theories – structural change with development • Class struggles over distribution • Dual economy theories – food is important wage good • Surplus labor may facilitate capital formation • Technological change in agriculture important • Dependency theories – interdependent world • History important • Political and social power important

20. More Recent Development Thinking • Role of Human capital • Importance of Institutional differences • Rule of law • Enforceable property rights • Need to minimize policy distortions • Importance of freely flowing information

21. Transactions costs, Collective Action, and Institutions • Costs of transacting are key obstacles holding countries back from developing. • Transactions costs include the costs of adjustment, information, measuring attributes, and negotiating, monitoring, and enforcing contracts • Because of these costs, people take advantage of others

22. Transactions costs, Collective Action, and Institutions (continued) • People often act collectively to influence public decisions in ways that help them but hurt society at large • Therefore with transactions costs and collective action, institutions and asset distribution matter • Need institutions to control behavior through property rights, laws, and policies

23. Conclusions • Agriculture can provide labor, food, and capital for overall economic development • Rising food prices relative to industrial prices is a symptom of the need to invest in new technologies for agriculture • In light of transactions costs and collective action, and societies that become less personal as development occurs, institutions are needed that establish and enforce the “rules of the game”