Transcript 5 Theories of growth and Development

Big Push Model or The theory of Big
Push
 The originator of this theory was Paul Rosenstein-
Rodan in 1943.
 Further contributions were made later on by Murphy,
Sheifer and Robert W. Vishny in 1989.
 The theory of
the Big Push emphasizes that
underdeveloped countries require large dose of
investments to embark on the path of economic
development
from
their
present
state
of
backwardness.
 This theory proposes that a 'bit by bit' investment
programme will not impact the process of growth as
much as is required for developing countries.
 In fact, injections of small quantities of investments
will merely lead to wastage of resources.
 Paul
Rosenstein-Rodan, approvingly quotes a
Massachusetts Institute of Technology study in this
regard, "There is a minimum level of resources that
must be devoted to a development programme if it is
to have any chance of success.
 Launching a country into self-sustaining growth is a
little like getting an airplane off the ground. There is a
critical ground speed which must be passed before the
craft can become airborne.
 Rosenstein-Rodan argued that the entire industry
which is intended to be created should be treated and
planned as a massive entity (a firm or trust).
 He supports this argument by stating that the social
marginal product of an investment is always different
from its private marginal product, so when a group of
industries are planned together according to their
social marginal products, the rate of growth of the
economy is greater than it would have otherwise been.
 Rosenstein-Rodan
emphasis on the external
economies to be realized through industrialization
and is advocacy of a ‘big push’ in the form of high
minimum amount of industrial investment in order to
jump over economic obstacles to development.
 A ‘big push’ or ‘critical minimum effort’ is believed
necessary to break out of a low level of equilibrium
trap. Above 10% of national income is to be invested
for take off as industry as the leading sector.
Role of the State for big push
 The
large-scale programme of industrialization
advocated by this model requires huge investments
which are beyond the means of the private sector.
 The investment in infrastructure and basic industries
(like power, transport and communications) is 'lumpy'
and has long gestation periods. The role of the state in
this theory is therefore critical for investments in
social overhead capital.
 Even if the private sector had the requisite resources to
invest in such a programme, it would not do so since it
is driven by profit motives.
 Many investments are profitable in terms of social
marginal net product but not in terms of private
marginal net product.
 Due to this there is no incentive for individual
entrepreneurs to invest and take advantage of external
economies.
 Rosenstein Rodan has presented three types of
indivisibilities and economies of scale. They are
as:
 (1) Indivisibilities in Production Function: When
so many industries are established the economies
regarding factors of production, goods, and techniques
of production are accrued. Rosenstein Rodan gives
more importance to economies which arise due to the
establishment of social overhead capital. The infrastructure consists of means of transportation,
communication and energy resources. They all
contribute to development indirectly.
 (2)
Indivisibilities
of
Demand:
The
complementarily with respect to demand requires that
UDCs should establish such industries which could
support each other. To make investment in one project
may be risky because in UDCs the demand for goods
and services is limited due to lower incomes. In other
words, the indivisibilities of demand require that at
least a certain amount of investment be made in so
many industries which could mutually support each
other. As a result, the size of market will be extended
in UDCs; or the problem of limited market will come
to an end in UDCs. It is shown with Fig.

Diagram/Figure:
 Here D1 and MR1 are the demand and marginal revenue
curves of a firm when investment is made in this single
firm. This firm sells OQ1 quantity and charges OP1 price.
Here it faces losses equal to P1cab.
 But if investment is made in so many industries the market
will be extended. In this way, the demand will increase as
shown by D4 and corresponding marginal revenue curve is
MR4. Now the equilibrium takes place at E where OQ4
quantity is produced and OP4 price is charged. As a result,
the industries are having profits equal to P4RST.
 It means that the greater investment in so many industries
may convert the losses into profits.
 (3) Indivisibility in Supply of Savings: The supply of
savings also serves as an indivisibility. A specific
amount of investment can be made in the presence of
specific savings But in case of UDCs because of lower
incomes the savings remain low.
 In the presence of these indivisibilities and non-
existence of external economies only a Big Push can
take the economy out of dole drums of poverty. It
means a specific amount of investment is necessary to
remove the obstacles in the way of economic
development.
Criticism/Demerits:
 Rosenstein theory is better in the sense that it
identified that market imperfections are the big
obstacles in the way of economic development.
Therefore, a big amount of investment will solve the
problem of limited markets, rather depending upon
market mechanism, and such heavy amounts of
investment will become helpful for economic growth.
Despite this merit, followings are the demerits of this
theory.
 i) Negligible Economies in Export, and Import
Substitute Sectors: The 'Big Push' infrastructure may
be justified on the ground of external economies. But,
according to Viner, the export sector and importsubstitute sectors are so backward in UDCs that they
hardly give rise to economies.

 (ii) Negligible Economies from Cost Reducing
Investment: The goods which are concerned with
public welfare hardly yield external economies.
Moreover, the investment which is aimed at reducing
costs does not yield economies.
 (iii) Neglecting Investment in Agri. Sector: In this
theory emphasis has been laid upon making
investment in infrastructure and industries. While it
neglects the investment to be made in agri. and its
allied sectors. As the agri. sector is the largest sector in
UDCs and it will be a mistake to ignore it.
 (iv) Inflationary Pressure: From where the funds
will come in UDCs to spend them on SOC(Standard
Of Care). If the funds are raised through foreign loans
and by printing new notes they will create inflation in
the economy.
 (v) Administrative and Institutional Difficulties:
This theory stresses upon state investment to remove
deficiency of capital. But in case of UDCs the
machinery is corrupt. There exist a lot of problems in
state machinery. The private and public sectors
compete with each other, rather supporting each
other. Consequently, there will not be the balanced
growth in the economy.
 (vi) It is Not a Historical Fact: The Big Push theory is
a recipe for the UDCs, but it has not been derived on
the basis of historical experience. As Prof. Hagen says,
"the Big Push theory lacks the historical evidences and
facts".
Harrod-Domar model
 The Harrod-Domar Model delineates a functional
economic relationship in which the growth rate of
gross domestic product (g) depends positively on the
national saving ratio (s) and inversely on the national
capital/output ratio (k) so that it is written as g = s / k.
The Harrod-Domar model in the early postwar times
was commonly used by developing countries in
economic planning.
 This model, developed independently by the British
economist Sir Roy F. Harrod and the American
economist Evsey Domar in the 1930s,
 Suggests savings provide the funds which are borrowed
for investment purposes. The model suggests that the
economy's rate of growth depends on:
 the level of saving
 the productivity of investment i.e. the capital output
ratio
 For example, if $10 worth of capital equipment
produces each $1 of annual output, a capital-output
ratio of 10 to 1 exists. 3 to 1 capital-output ratio
indicates that only $3 of capital is required to produce
each $1 of output annually.
 The Harrod-Domar model was developed to help
analyse the business cycle. However, it was later
adapted to 'explain' economic growth. It concluded
that:
1. Economic growth depends on the amount of labour
and capital.
2. As LDCs often have an abundant supply of labour it
is a lack of physical capital that holds back economic
growth and development.
 3. More physical capital generates economic growth.
 4. Net investment leads to more capital accumulation,
which generates higher output and income.
 5. Higher income allows higher levels of saving
Implications of the model
 The key to economic growth is to expand the level of
investment both in terms of fixed capital and human
capital.
 To do this policies are needed that encourage saving
and/or generate technological advances which enable
firms to produce more output with less capital i.e.
lower their capital output ratio.
Problems of the model
 Economic growth and economic development are not
the same. Economic growth is a necessary but not
sufficient condition for development
 Practically it is difficult to stimulate the level of
domestic savings particularly in the case of LDCs
where incomes are low.
 Borrowing from overseas to fill the gap caused by
insufficient savings causes debt repayment problems
later.
 The law of diminishing returns would suggest that as
investment increases the productivity of the capital
will diminish and the capital to output ratio rise.
Example:
 If you have capital output ratio (K) is 3, and the
saving ratio is 18%, what will be the growth of
GNP? Make necessary comments. We know,
 ΔY/Y = S/K
 Here,
 Capital-output ratio
=K
 Saving ratio
=S
 Growth of GNP = ΔY/Y= ?
 ΔY/Y = 18%/3= 6%
=3
=18%
 This 6% GNP growth implies that the country is
staying in underdeveloped category.
 If the countries want to go to develop stage, its GNP
growth has to be 7%. For achieving this, 21% saving
ratio is needed. So, here the saving gap is 3% which
can be meet up by either through foreign aid or private
foreign investment.
Nurkse's Model of Vicious Circle of
Poverty (VCP) and Economic
Development:
 Definition and Explanation:
 According to Prof. Nurkse:
 "It is the vicious circle of poverty (VCP) which is
responsible for backwardness of UDCs".
 Vicious circle of poverty:
 "Implies a circular constellation of forces tending to act
and react in such a way as to keep a country in the state
of poverty".
 In such state of affairs the process of capital formation
remains obstructed and restricted. This VCP is
presented as:
 We start with low real income which results in a
meager savings which in turn will check investment.
 Low level of investment would create deficiency of
capital which in second round leads to low
productivity. This again results in low income. Here,
the circle perpetuates the low level of development.
 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.
Diagram/Figure:
 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 agri. labor force
can be mobilized for financing capital formation. And
the parents of such disguised unemployed will go on
feeding them. It means that in Nurkse's model the
hidden food surplus will finance the process of
economic growth.
Shortcomings/Flaws of the Model:
 (i) 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.
 (ii)
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.
 (iii) 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.
 (iv) Utilization Of Disguised is Not a New Idea:
Nurkse says that the labor have much more leisure.
But it is not true. The labor perform so many works
like repair of houses, digging of canals, construction of
small roads and cutting of forests etc. Therefore, it is
not possible to withdraw these people from lands.
 (v) Misleading and Over Simplified: According to
Bauer the idea of VCP is misleading and oversimplified because the developed countries never
passed through such situation when they where UDCs.
Mahalanobis Growth Model
 At the time of the formulation of the Second Five Year
Plan, Prof. P. C. Mahalanobis who was friend and
adviser to Late Prime Minister Jawaharlal Nehru and
who was one time member of Planning
Commission, prepared a growth model with which he
showed that to achieve a rapid long- term rate of
growth it would be essential to devote a major part of
the investment outlay to building of basic heavy
industries.
 Mahalanobis
strategy
of
development
emphasizing basic heavy industries which was
adopted first of all in the Second Plan also
continued to hold the stage in Indian planning
right up to the Fifth Plan which was terminated by
the Janata Government in March 1978, a year
before its full term of five years.
 It will be useful to explain first Mahalanobis model of
growth which provided a rationale for the heavy
industry biased development strategy.
 An important point to note is that Mahalanobis
identifies the rate of growth of investment in the
economy not with rate of growth of savings as is
usually considered by the economists but with rate of
growth of output in the capital goods sector within the
economy.
 The growth of capital goods sector in turn depends
upon the proportions of total investment allocated to
the capital goods sector and output-capital ratio in the
capital goods sector.
 Given the output-capital ratio in capital goods sector
(i.e. heavy industries), he proves that if the proportion
of total investment allocated to the capital goods is
relatively greater, the rate of growth of output of
capital goods will be greater and hence, given the
Mahalanobis assumption, the future rate of growth of
investment in the economy will be greater.
 Now, the greater the rate of investment, the greater
will be the long-term rate of growth.
 We thus see that with the rate of growth of output of
capital goods industries.
 Mahalanobis shows that the proportion of total
investment resources allocated to the capital goods
industries for each year is the most important factor
determining the long-term rate of growth of national
income.
 The Mahalanobis model has been constructed in
terms of Keynesian aggregates; national income,
investment, savings, and consumption,
 Two sectors are considered in the model; production
goods producing sector (K-sector) and consumption
goods producing sector (C-sector).
 This sectoral classification is not for an inter-sectoral
analysis of economy but for analyzing an allocation of
investment to respective sectors.
 Price situation is kept constant in his argument. And
foreign trade is not considered in his model.
 The fundamental assumptions in the Mahalanobis
model are as follows:
 (a) the saving-investment `equilibrium is maintained,
and
 (b) the production processes respective sectors are
always operated under full capacity situation.
Criticism
 In critique of the Mahalanobis heavy industry
development
strategy,
Professors
Vakil
and
Brahmanand of Bombay University put forward a
wage-goods model of development and suggested a
development strategy which accorded a top priority to
agriculture and other wage-goods industries in sharp
contrast to the Mahalanobis heavy industry biased
strategy of development.
 The most important criticism was concerned with an
absence of the demand-side consideration of products
in his theory.
Myrdal’s CC (Cumulative
Causation) theory
 Cumulative causation is a theory developed by Swedish
economist Gunnar Myrdal in the year 1956. It is a multicausal approach where the core variables and their linkages
are delineated.
 The idea behind it is that a change in one form of an
institution will lead to successive changes in other
institutions.
 These changes are circular in that they continue in a cycle,
many times in a negative way, in which there is no end, and
cumulative in that they persist in each round. The change
does not occur all at once as that would lead to chaos,
rather the changes occur gradually.
 Gunnar Myrdal developed the concept from Knut
Wicksell and developed it with Nicholas Kaldor when
they worked together at the United Nations Economic
Commission for Europe.
 Myrdal concentrated on the social provisioning aspect
of development, while Kaldor concentrated on
demand-supply relationships to the manufacturing
sector
 Myrdal’s CC theory has been adopted for explaining
various theoretical or practical problems.
 It has been typically examined by dividing into its
three different aspects.
 The first way recognizes it as CC theory simply
positioning between Young and Kaldor.
 The second recognizes it as a theory by a member of
the institutional school and considers its institutional
aspect in main.
 The third recognizes it as a theory by a member of the
Stockholm school, focusing on the monetary theory in
his early days
 They have seldom discussed how Myrdal’s CC theory
(theories), which have various theoretical contents,
should be integrated or interpreted as a whole.
 Although Myrdal has been often introduced in the
context of the history of CC theory and evaluated as a
key person in its theoretical development, his position
there has left quite ambiguous.
 Myrdal experienced three academic stages in his life: a
theoretical economist or a member of Stockholm
school, a politician, and an “institutional economist”
as he called himself.
 Though he said he had been affected by Wicksellian
monetary theory and got the first idea of his CC
theory, it was the last stage that he utilized and
emphasized CC theory as his main theoretical tool in
analyzing practical socio-economic problems.
 Myrdal’s CC theory in its final phase consists of four
theses as follows.

1. The basic thesis:
 The thesis of “backwash effects” Myrdal’s CC theory
has emphasized a divergent process.
 Such a process is well known as a typical logic of CC
theory in general. Myrdal(1957) proposed a concept of
“backwash effects” in order to explain the increasing
economic inequality between developed countries and
underdeveloped countries.
 2. The opposite or exceptional thesis:
 The thesis of “spread effects” contrary to the first
thesis, the second one is the logic of convergence.
 Although
CC theory has its importance in
emphasizing a divergent process and it is admitted
that Myrdal didn’t emphasized this thesis as much as
the first one, this thesis should be a crucial thought
because this characterizes his CC theory. Myrdal’s CC
theory doesn’t deny the potential possibility of a
convergent process.
 3. The thesis relating to the scope of the analysis:
 The thesis of the importance of institutional factors
Myrdal insists that if so-called “non-economic” factors
are excluded from the analysis, it will result in
distorting the recognition of the facts.
 According to him, it is whether it is related to the
problem, not whether it is an “economic factor”, that
decides whether the factor should be included in the
analysis.
 4. The thesis of political implications :
 Although Myrdal’s CC theory admitted the potential
possibility of convergence in the second thesis, he was
too pessimistic to think such possibility would come
true naturally.
 He rather believed in policies to turn over the
economic forces composing the “vicious” circle. He
showed the “equality” as his most important value
premise and insisted the policies based on the
“equality” will induce higher economic growth.
 Myrdal’s CC theory can be characterized in three
points.
 The first is that his CC theory is not a simple logic of
polarization process, because it includes not only
“backwash effects” but also “spread effects”.
 The second is that his CC theory is supposed to
consist of both “economic” and “non-economic”
factors.
 The third is that his CC theory exists as the
theoretical foundation of egalitarian policies.
 So Myrdal’s CC theory is the theory for “development”.
By the word of “development”, Myrdal means more
than mere increasing production.
 His CC theory includes institutional and political
factors besides the demand and supply.
 Myrdal’s CC theory should be positioned between
Young-Kaldor type CC theory and Institutional School
type CC theory. Myrdal’s CC theory might be able to
integrate those two currents with its unique
theoretical character.
 Myrdal’s CC theory allows the possibility and necessity
of the social reform by introducing policies.
 Myrdal’s CC theory can be a kind of indicator of the
direction for the further development of CC theory.