DEVELOPMENTAL ECONOMICS

Part – 1 – (c) Notes by Economics Harbour

A branch of economics that focuses on improving the

economies of developing countries.
 Developmental Economics

Developmental Economics
NOTES BY ECONOMICS HARBOUR

ECONOMIC GROWTH AND DEVELOPMENT

Economic Growth implies the change in per capita income, while economic development means
economic growth plus change. Change here may be welfare changes or distributional changes.

Modern Economic Growth

Features of Modern Economic Growth; given by Kuznets:

1. High rates of growth per capita product (10 times) and population (5 times).
2. Rise in productivity:

Increase in rate of per capita product

Improvement in quality of inputs

Creates efficiency and productivity

3. High Rate of Structural Transformation: Shift away from agriculture to non-agricultural
sectors.
4. Increased urbanisation

Economic development :- features

1. Process: Social (Control of population), technological (new technology) or economic forces
(efficient use of resources).

Dynamic Changes => Increase in Real National income of the country

Economic Development is a dynamic Process
2. Real National Income :-
Positive relationship between Real National Income and Economic development
Stability of price is an essential condition for promoting development.
3. Long Period
Real National Income should continue to rise in Long run.
Accelerates development

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Developmental Economics

According to G.M. Meier, Development is of two types:

Development

Initiating Development Sustaining

Development
(Increase in real (Increase in real
national income for national income for
short run) long run)

Amartya Sen’s Concept of Development: He gave the concept in 1980s in his work “Development
as Freedom”. According to him, development would mean if
there is:

1. Capabilities to function: Entitlements give a right in the

society, which further decides their capabilities to function.
2. Included freedom: Principal means of achieving
development/ Removing un-freedoms like lack of political
freedom, famine and under-nourishment)
Dudley Seers, in his work “The Meaning of Development”
(1969), took three indicators which would reflect whether
development has occurred or not. The indicators are: Amartya Sen
1. Unemployment
2. Poverty
3. Inequality

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 Developmental Economics

Decline in any of them would lead to development

Denis Goulet introduced three core values of development in his

work “The Cruel Choice: A New Concept in the Theory of
Development” which are:

1. Life sustenance: Ability of a person to meet his basic

needs, which can be in the form of reduction in absolute poverty,
hunger, etc.
2. Self-Esteem: Ability to be a person, that is, kind of things
a person enjoys like self-esteem, dignity, etc. In other words, there
should not be a feeling of inferiority complex.
3. Freedom: Freedom from servitude, person should be free
from miseries, exploitation, etc.

Denis Goulet

Characteristics of an Under-Developed Economy

1. General Poverty
2. Agriculture: Main occupation
3. Dualistic economy
4. Under-developed natural resources
5. Demographic features
6. Unemployment and disguised unemployment
7. Economic backwardness
8. Lack of enterprise and initiative
9. Insufficient capital equipment
10. Technological backwardness
11. Foreign trade orientation

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Developmental Economics

SUSTAINABLE DEVELOPMENT

Amartya Sen was the major contributor in the concept of Sustainable Development. The concept
appeared in 1987 in “Our Common Future: The Brundtland Report”.

Sustainable development means meeting the needs of present generation without compromising
the needs of future generation.

Environmental Accounting

It was given by David Pearce and Jeremy Warfard.

Environmental accounting is done using the formula:

Total capital = Human capital + manufacturing capital + Environment Capital

NNP = GNP – Dm - Dn

Where: NNP = Net National Product; GNP = Gross National Product; Dm = Depreciation of
manufacturing capital; Dn = Depreciation of environment capital

NNP = GNP – Dm – Dn – A – R
Where: A = Averting expenditure; R = Restoring Expenditure

Indian Scenario:
To promote the concept of sustainable development, Ministry of Environment and Forests (MOEF)
was set up in 1985.

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 Developmental Economics

INDEX OF DEVELOPMENT
Features of a good index:

1. It should not assume a single pattern of development

2. Any index should not be specific to cultural values.
3. It should lend itself to comparisons.
4. It should be able to reflect results and not inputs.
5. It should be easy to construct and comprehend.
The types of Index are:

1. Gross National Product: Initially the change in gross

national product was considered to be an indicator of
development. However, it had its own flaws:
a. It was an index of production only.
b. It didn’t tell about the quality of life of people.

2. Physical Quality of Life Index (PQLI): The PQLI index was given by Morris D. Morris in
1979. He used three indicators:
a. Life Expectancy at age 1: The best till date was for Sweden in 1973 (77 years) and worst
Gunnia Bissau in 1950 (28 years).
b. Infant Mortality: It is the number of deaths per 1000 live births. The best value was 9
(Sweden in 1973) and worst 229 (Taiwan in 1950).
c. Literacy: It only considered general ability to read and write. The best was 100 and worst 0.
As a result, the value of the index ranges from 0 to 100 with 0 to be the worst scenario and 100
to be the best.

PQLI = (Life Expectancy at age 1 + Infant Mortality + Literacy)/3

Demerits of the index:

a. It has been considered to be a limited measure.

b. Arbitrary weights are taken in the index.
c. This index does not tell us about how social structure is changing.
d. It does not reflect the quality of life results in terms of justice, freedom.

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Developmental Economics

Relationships

Variables Relationship

Life Expectancy and Infant Mortality Negative Relationship

Rate

Life Expectancy and Literacy Positive Relationship

Literacy and Infant Mortality Negative Relationship

3. Human Development Index (HDI): It was given by Amartya Sen and Mehboob-Ul-Haq in
1990 and was published by UNDP.
Indicators in HDI are:
a. Income or Standard of living: the proxy variable for this is real per capita income.
b. Education/Knowledge Indicator: Two variables are used:
 Adult Literacy: Weight attached to it is 2/3.
 Gross Enrolment Ratio (Number of years of schooling): Weight attached to it is
1/3.
c. Longevity/Health Index: The proxy variable used is life expectancy at age zero.
HDI = 1/3 (Income + Education + Longevity)
HDI value ranges between zero and one where zero is considered to be the worst while one is
considered to be the best.

HDI value Overall 182 nations are ranked

and India ranks 135 with HDI
0 to 0.499 Low Level of human development
value 0.612.
0.5 to 0.799 Medium level of human development Rank 1: Norway
Rank 2: Australia
0.8 to 1.0 High level of human development Rank 3: U.S.A.

Merits:
a. It is better than PQLI Index because it is more sensitive to
quality of life, education and health.
b. It shows disaggregated picture for men and women.
Demerits:

a. It overstates the years of schooling.

b. We cannot judge the quality of schooling.

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 Developmental Economics

THEORY OF BIG PUSH

The theory of big push was given by Rodenstein Rodan in 1943 in his work “Problems of
Industrialization of East and South-East Europe”

Assumptions of this model are:

1. Oligopolistic structure.
2. Economies of scale.
Points to note

 A firm will be influenced by what other firms are doing.

 Probability of one firm will depend on how the firms are operating.
 Co-ordination amongst firms is important.
 The theory talks about indivisibilities: External economies which
will result from wide scale production and hence cheap raw
materials and wide extent of markets.
There are four areas of indivisibilities:

1. Production indivisibilities: The theory

states that initial capital requirements should be high.
Greater level of output would result in decreased cost
and thus capital-output ratio decreases.
2. Demand indivisibilities: It suggests that
investment in a number of ventures at the same time
would be profitable. The concept was widely
publicised in Nurkse’s book namely “Problems of
capital formation in Underdeveloped countries”.
3. Supply indivisibilities: Usage of savings
should be in profitable ventures.
4. Psychological indivisibilities: The
environment in which development takes place
should be created so that people can adapt to that
environment.
The theory also talks about complementarities, that is, interdependence. It implies that investment in
one firm are dependent upon investments of other firms.

The theory of big push gives importance to government’s role.

In short, the main elements of the theory are:

1. Government’s role
2. Savings
3. Foreign capital
4. Foreign trade
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Developmental Economics

Need for Big Push

1. Urbanisation effects
2. Infrastructure effects
3. Training effects
4. Inter-temporal effects : Avoid co-ordination failure

Demerits:

1. The theory didn’t consider the role of small

capital.

2. Problems of shortage in capital, dynamic

entrepreneurs, skilled labour, etc. are ignored.

3. The theory might not be suitable for under-

developed countries.

4. The theory suggests measures to increase

employment and hence expansion of effective

demand, which could lead to high inflation levels

in the economy.

5. The theory neglected the agriculture sector and its role completely.

6. According to Jacob Viner, the economies are cost reducing and not output expanding.

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 Developmental Economics

CRITICAL MINIMUM EFFORT THESIS

The theory is given by Harvey Leibenstein in his work “Economic Backwardness and Economic
Growth” in 1957 and provides a strategy for development.

 The theory suggests that to break the vicious circle of poverty, the economy should move to
critical level in terms of investment.
 It is based on Malthusian theory of population which states that with increase in income,
population will initially increase but will decrease at a later stage because of cost of bringing up
the family.
 The theory talks about shocks (Income depressing factors) and stimulants (Income increasing
factors). In case of under-developed economies, shocks is greater than stimulants. In case of
developed economies, shocks are less than the stimulants.
 Initially in the process of development, shocks is greater than stimulants but after some time, due
to institutional factors, the stimulants become greater than shocks.
 Stimulants in an economy depends upon:
1. Attitude of people and the motivation aspect.
2. Activities of the growth agents (innovators)
3. Creation of positive sum incentive (factors which change the attitudes of people and will help
in increasing income) and discourage zero sum incentives (factors which have no effect on
income and only leads to transferring income).
 Leibenstein talks about two types of incentives in the under-developed countries:

Incentives

Positive sum incentives

Zero-sum incentives (these promote and induce
(these have zero effect on the economic growth. These are
economic growth. These important for development
incentives have a distributive process because they bring a
effect) change in attitudes and
aspirations of the people. )

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Developmental Economics

 According to Leibenstein, the income depressing factors are as follows:

1. Entrepreneurial activities focussing
on maintaining the economic status.
2. Conservative attitude of the labour
class.
3. Reluctance to accept new ideas and
innovations
4. Expenditure influenced by
conspicuous consumption and
demonstration effect.
5. Population and unlimited supply of
labour.
6. High capital-output ratio.
 To promote growth, following are the important factors:
1. Expansion of growth agents
2. Creation of economic opportunities
3. Expansion of secondary and tertiary sectors
4. Creation of social environment
5. Internal peace and international co-operation.
6. Break vicious circle of poverty
 Leibenstein gives an important role to the entrepreneur as a growth agent. According to him,
“growth agents are those individuals who have the capacities to carry out growth contributing
activities.”
 Need for Critical Minimum Effort are:
1. To overcome internal diseconomies: Producing on a large scale to neutralize
diseconomies. Therefore, investments should be made in leading sectors.
2. For achieving balanced growth: Each industry should be of minimum size to achieve
balanced growth. This is due to the interdependence between the industries.
3. To overcome depressants like high death rate, etc. Therefore, investments should be
made in public health services.
4. To generate growth momentum
 Difficulties in achieving Critical Minimum Effort are
1. Lack of entrepreneurs
2. Limited investment opportunities: Under-developed countries have limited investment
opportunities due to structural rigidities.
3. Deficiency of capital
4. Scarcity of resources like skilled labour, technical expertise, etc.
Demerits of the theory are:
1. It didn’t consider government’s role into consideration.
2. It didn’t consider the time element.
3. Relation between per capita income and population growth is not a simple affair.
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 Developmental Economics

THEORIES OF DEVELOPMENT
1. Classical Theory of Development
The theory is given by Adam Smith who is known
as the Father of Political Economy and is the
Founder of Classical School of Economics.
Smith’s work is “An Enquiry into the Nature and
Causes of the Wealth of Nations”.
He gave the following views on development:
a. Classicals were in favor of free trade.
b. Capital accumulation is the central point of
this theory around which the entire theory of
development revolves. Thus, capital
accumulation should be encouraged, that is,
economic agents should be encouraged to save
more and spend less.
c. Promoted the concept of division of labor and
specialization which would increase the
productivity of workers.
d. In favor of Laissez-Faire policy, that is, no
government intervention.
e. Natural law: The classicals supported
freedom of action for the society which would
take care of individual’s welfare.
f. The classicals promoted the concept of
invisible hand.
According to Adam Smith, the development is not sudden and abrupt, rather it is a cumulative
and slow process.

2. Ricardian Theory of Development

Ricardo gave the theory of development in his book “Principles of Political Economy and
Taxation” (1817). He gave the main role to the capitalists who accumulate capital from the
profits which is the primary source of capital accumulation.
It is also considered to be the theory of distribution which determines the shares of different
factors- land, labour and entrepreneur.
Assumptions of the theory:
a. Perfect competition
b. Full employment
c. Supply of land is fixed.
d. Only purpose of land is production of corn.
e. Demand for corn is perfectly inelastic.
f. Subsistence wages are being paid to the labour.
g. State of technology is given.
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Developmental Economics

Ricardo uses marginal principle and surplus principle, according to which first rent is
determined. The remaining earning is divided into wages and profits.

Factor Income Dependent upon

Profits Wages

Wages Price of Corn

Price of corn Productivity of land

According to Ricardo, it is the productivity of land which determines the level of agricultural
profit and it occupies the central place in the Ricardian system of development.

Stationary State: Features of a stationary state are:

a. Profits tend to decline.

b. It is the state in which the rent increases and profits and wages decrease.
c. Profits become equal to zero and there is no capital accumulation.
d. Wages become equal to the subsistence level.
e. Stationary state arises due to increase in population and fixed supply of products.
According to the theory, international trade provides opportunities for fresh investments and
thus should be free from government interference.

Classical Criticism
Operation of the law of diminishing returns is criticized. In case of a new technology, the law
fails to operate.

3. Marxian Theory of Development

The theory of development was given in his
book ‘Das Capital’ in 1867.
The basis of this theory was that we move
from a classless society to that with class.
Marx’ main ideas of development are:
a. The materialistic interpretation of
history.
b. Theory of class struggle
c. Theory of surplus value
d. The concept of reserve army
e. Economic development under
capitalism
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Historical Materialism: Marx introduced the concept of historical materialism stating that any
change in the society will have its base in economic causes or policies.
Movements in the society will be in the following stages:
a. Primitive/Asiatic Society: Classless society.
b. Slavery society
c. Feudal society: There is a relationship
between haves and have nots.
d. Capitalists society
Theory of class struggle: Clash of interest of two groups, that is, capitalist and working class.

Commodities: “Congealed Labour”

Value of Commodities: “Crystallised Labour”

According to this theory,

Total Capital = Constant Capital (C) + Variable Capital (V) + Surplus Value (S)

Rate of Exploitation = S/V

Organic Composition of Capital (K): It is the amount of labour equipped with capital.

K = C/V or C/C+V
𝑺
𝑽
Rate of Profit = 𝑪
+𝟏
𝑽

Rate of profit can increase with the help of following factors:

a. Increase in technology
b. Reduce the working hours of labour for subsistence.

Increase in Decrease Industrial Doom of

Technology in Labour Reserve capitalism Socialism
Army

Reproduction Schema
a. Simple Reproduction Schema: Under this, production is equal to consumption. There is no
scope for accumulation for investment.
Department 1: Produces Capital goods; production of department 1 is the consumption of
department 2.
Dept 1: C1 + V1 + S1 = C1 + C2
This implies, V1 + S1 = C2
Dept 2: V1 + S1 + V2 + S2 = V2 + S2 + C2
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Developmental Economics

This implies, V1 + S1 = C2

b. Expanded Reproduction Schema: Under this, the production in department 1 is greater than
the demand by department 2.
V1 + S1 + C1 > C1 + C2
V1 + S1 > C2

Theory of Crisis: The theory of crisis is due to over production.

The theory of crisis is characterized by:
a. Falling rate of profit
b. Unbalanced growth of different sectors
Under consumption
The process is as follows:

Over Labour Wages Reduced

Production Unemployment decrease purchasing
power

Capitalists believe in capital accumulation which leads to under consumption and hence a glut
in the economy.

4. Schumpeter Theory of Development

Schumpeter’s ideas about economic development first appeared in his book “The Theory of
Economic Development” in 1911. According to him, the development is a spontaneous and
discontinuous change in the flow channels which causes a disturbance in equilibrium and
hence alters and displaces the equilibrium state forever. In simple words, development is a process
of creative destruction because development is the spontaneous change in something which is
already existing.

Schumpeter gave the concept of circular

flow which had the following features:
a. It is the existing situation of
equilibrium.
b. Demand = Supply
c. Perfect Competition
d. Full employment
e. Static State
f. No profits, that is, average cost is equal
to the price.

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 Developmental Economics

According to Schumpeter, development will happen only when circular flow is disturbed. The
circular flow can only be disturbed through innovations or any new discoveries.

There can be five kinds of innovations:

a. New product
b. New method of production
c. New source of raw material
d. New industrial organisation
e. New market
Source of Innovations/Role of inventors or innovators

 Schumpeter gave a very important role to the innovators.

 He believed that an environment for development should be
created.
 Innovators will be willing to take the risk.
 Innovators’ main task is to manage funds.
The qualities must for an innovator are:

 He should have a technical know-how.

 Services of other factors.
People will prefer to work as innovators because:

 For their own joy.

 For superiority
 For wealth purposes
Crisis

 It is the process of creative destructions.

 Through process of development, old things
are replaced by new things.
 Primary wave of expansions (upswings) will be
followed by secondary wave (downswings).
 Creative destruction will start when the
gestation period will get over.
 Innovations are copied by others in the form of
swarm like clusters.
Demerit is that it might not be applicable to under-developed economies.

 Role of innovator is over-emphasized

 Role of real savings is ignored.
 The theory is not applicable to under-developed economies.

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Developmental Economics

MODELS OF GROWTH
1. Harrod Domar Model: Harrod gave his model in 1939 and Domar in 1946-47. The main
variables in their theory were Investment (I) and Savings (S). Besides this, they explored the
dual nature (demand and supply) of Investment. Investment will create income and hence
generate demand (demand effect). On the other hand, investment will add to the productive
capacity of the economy and hence create supply of productive capital (supply effect). Also
according to them, the net investment should continue in the economy. However, income should
be able to incorporate the increased investment. Therefore, the theory talks about growth rate of
investment and growth rate of income/output.
Harrod: “Deepening Aspect of Investment” (Each worker has more tools to work with.)
Domar: “Widening Aspect of Investment” (Each worker has more pieces of equipment of the
same type.)

General Assumptions of the theory:

a. Full employment
b. No government interference
c. Closed economy
d. No lags in adjustment
e. Average propensity to save (APS) =
Marginal Propensity to Save (MPS)
f. Propensity to save and capita coefficient are
constant, that is, they follow constant returns
to scale.
g. Income, Investment and Savings are taken to
be in the net sense.
h. Savings and Investment are equal in ex-ante
and ex-post sense.
Harrod Model:

According to the Harrod Model, neutral technical progress was labour augmenting.

Assumptions of Harrod Model:

a. (Saving(s)/Income(y)) is assumed to be constant.

b. Neutral technical progress is labour augmenting.
c. (Capital/Income) and (Labour/Income) are constant.
d. Constant returns to scale.
Harrod gave three concepts of growth:

a. Actual Growth Rate (G): It implies growth rate of output in a period of time.
∆𝐲 𝐒𝐚𝐯𝐢𝐧𝐠 𝐈𝐧𝐜𝐨𝐦𝐞 (𝐒)
G= or G = 𝐂𝐚𝐩𝐢𝐭𝐚𝐥 𝐈𝐧𝐜𝐨𝐦𝐞 (𝐂)
𝐲

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 Developmental Economics

b. Warranted Growth Rate (GW): It is the full capacity or potential growth rate which tells us
the entrepreneurial equilibrium.
GWCr = S
Where: Cr is the required capital to maintain warranted growth rate.

c. Natural Growth Rate (GN): It is the maximum growth rate or full employment that can be
achieved. In other words, it is the maximum growth rate that can be supported by labour
growth and technical progress.
In case of Harrod Model, if G = GW which implies C = Cr. It is known as Knife Edge
Equilibrium.

However, if there is an inequality between G and GW, then;

Case 1:

Supply > Demand;

G < GW
Deficiency of Problem of Over Stagnation or
demand because
they are not fully Production Depression
absorbed

C > Cr Actual Amount of

Capital > Required
Amount
MEC decreases in
long run
Depression and
Unemployment

Case 2:

Growth rate of
G > GW income >
Growth rate of
Demand >
Supply Inflation
output

Actual Amount Deficiency of

C < Cr of capital <
required
amount
capital leading
to fall in
production
Secular Inflation

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Equilibrium is reached when G = GW = GN which is known as knife edge equilibrium when labour
growth is considered. At this point, the equality is maintained between Growth Rate of Investment,
Growth Rate of Income and Growth Rate of Labour.

Domar Model

Main assumptions of the theory are:

a. Income generation will take place through increase in investment through the multiplier
process.
b. Investment is also induced by output growth and entrepreneur confidence.
c. Productive capacity will be created by Investment and will depend upon potential average
productivity of Investment.
d. Employment is a function of labour utilisation rate.
e. Junking (Depression): If junking, then capital is wasted and hence level of investment will
fall.

Domar used Kurihara’s equations. At full employment level,

yd = I/s
where I = Investment and s = marginal propensity to save

ys = k.σ
where: k = real capital stock and σ = productivity of capital

yd = ys

I/s = k. σ

I = k. σ.s (Condition for steady growth)

If we take the change concept,

∆I = ∆k. σ.s

∆I/∆k = σ.s

∆I/I = σ.s (Razor Edge Equilibrium and the condition to maintain steady growth)

∆I/I > σ.s Leads to increase in purchasing power

and hence Inflation

∆I/I < σ.s Leads to over-production and thus

Depression

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Main points of the theory:

1. Investment is the central theme.
2. Increased capacity leads to increased output and increase in employment.
3. Concepts of growth rate.
4. Business cycles are taken as deviations from the path of steady growth.
Similarities in the theory
1. Similar assumptions
2. Keynesian Saving = Investment; a condition for steady growth
3. Model is addressed to advanced economies and not backward economies.
4. Introduced dynamic elements
5. Assume fixed K/O and L/O
6. Exponential equilibrium path.
7. Knife edge equilibrium inherent
Differences in the theories:

Basis Harrod’s Model Domar’s Model

Long run Labour shortage deflecting “Under-Investment” sapping

difficulty growth. growth.

Position of Determinant of natural growth Shortage of labour may lead to fall

labour input rate, key element. in investment; optional.

Equilibrium Unstable Undermines investment incentives.

Reason for Fixed interest rate, low For convenience

fixed K/O sustainability.

State of Labour unemployment Idle capacity exists.

economy

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2. Meade Model: It is also known as Steady Growth rate model. Given in his work “A Neo-
Classical Theory of Economic Growth” in 1961.

Assumptions:
a. There are two kinds of goods: Consumption goods and Capital Goods.
b. Two factors of production: Land and Labour.
c. No government interference.
d. Closed Economy
e. Full employment
f. Machinery is the only form of capital.
g. Perfect substitution between consumption and capital goods.
h. Prices are not changing.
i. Considered depreciation of capital because of which capital will be replaced.
j. Perfect Competition

Q = F (K, L, N, t)
Where: Q = Output; K = Capital; L = Labour; N = Land (constant); t = technology (constant
technical progress)

∆y = v∆K + w∆L + ∆y’

Where: v = Capital productivity; w = Labour productivity; ∆y’ = rate of change in output because
of technical progress.

Similarity in Harrod-Domar Model is that the baselines are the same for both the models.
While Harrod-Domar Models are different in the sense that both have used the concept of
accelerator but Harrod’s accelerator concept is more technical.

Dividing the above equation with y, we get;

∆𝐲 𝒗. 𝑲. ∆𝐊 𝒘. 𝑳. ∆𝐋 ∆𝐲′
= + +
𝒚 𝒚. 𝑲 𝒚. 𝑳 𝒚

Simplifying it,

y = uk + Ql + r
Per capita changes would be depicted by y-l; where
l is the labour growth.

y-l = uk + Ql-l + r
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y-l = uk – l (1-Q) + r

where y – l is the per capita output growth

Oh my God!!!
Steady growth conditions: So many
equations!!!!!
a. Elasticity of substitution between all factors is unity.
Not again…..
b. Population growth is constant.
c. Proportion of wages, rents and profits saved are the same.
d. Neutral technical progress for all factors.
∆𝒚 ∆𝑲
Steady State = =
𝒚 𝒌

u, Q are constant; r = constant and l = constant

Critical rate of capital accumulation which will help in

∆𝑦 ∆𝐾
achieving the equality between and .
𝑦 𝑘

y=k=a

a = ua + Ql + r

a – ua = Ql + r

a(1-u) = Ql + r
𝑸𝒍+𝒓
a= (Critical rate of Capital accumulation)
𝟏−𝒖

If Capital (K) Income growth Savings Capital

is more than a < capital decrease decreases
growth

Income growth Savings Capital

If K < a > Capital increase increases
growth

Growth of income depends on:

 Productivity of capital
 Limit of savings
 Development of technology

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Developmental Economics

Conditions of steady growth:

 The elasticity of substitution between various factors is unity.

 Technical progress is neutral at a constant rate for all factors.
 Proportions of wages, rents and profits saved are constant.
 Growth rate of population is constant.

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STRUCTURAL TRANSFORMATION MODELS

The structural transformation models focus on how the structure of the economy changes with the
development.

1. Lewis Theory of Development: The theory was given by Arthur Lewis in 1954. It is also known
as the “Model of Unlimited Supply of Labor”. The theory provides solution to the excess labor
supply in the developing nations. The theory states that with the movement of labor from rural to
urban sector, the traditional society transforms into the modern society.

The theory has following assumptions:

a. The theory assumes a dual economy, that is, co-existence of Agriculture/ Subsistence/ Traditional
sector and Industrial/Manufacturing/Modern sector.
b. Wages:

Wages

Agriculture Wages are a fixed

As MPL = 0, hence wages premium over and above
in this sector are the agricultural wages.
determined by APL. WM = WA + 30% of WA

c. Development in an economy takes place due to

transfer of labor from agriculture to industrial
sector. As a result of movement of labor from
traditional to modern sector, the capital in the
latter accumulates and output expands, thus
leading the economy towards development.
The speed with which labor moves depends on
the speed of investment in the industrial sector.
It is also assumed that the capitalists will
reinvest all the profits.
d. Supply curve of labor is perfectly elastic at
minimum wage rate till the point the entire
surplus labor is not fully absorbed in the
economy.
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e. The number of workers in rural sector are more as compared to that in the industrial sector.
So the transfer of labor would take place from rural to urban areas.
f. No capital accumulation in the agriculture sector.
g. Growth in industrial sector is self-sustaining because it absorbs the entire surplus labor.
h. There are diminishing returns to labor.

In the agriculture sector, the maximum labour which can be absorbed is equal to LA. At that point of
employment, the total product is maximum and corresponding to that the marginal product of labour
is equal to zero. The wages paid in the agriculture sector is equal to WA. The labour beyond LA point,
is the surplus labour which is then absorbed in the manufacturing sector.

In the manufacturing sector, the labour is paid a wage which is higher than the wages paid in the
agricultural sector (WM and is fixed). So when L1 labour produces TPM(KM1) output, wages paid are
WM and there is surplus left. That surplus is then re-invested which shifts the total product curve
upwards. The process continues till all the surplus labour is absorbed in the agricultural sector.

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2. Fei-Ranis Model: Given in 1964 in their work “Development of the Labour Surplus Economy”.
It is an improvement over Lewis Model. Even this model assumes co-existence of a dual
economy, that is, agriculture and industrial economies.

The assumptions of the model are:

a. Labor moves from rural to urban sector through the process of development.
b. The economy experiences diminishing returns to a factor.
c. Output in agriculture is a function of land and labor. On the other hand, output in
manufacturing sector is a function of labor and capital.
d. Surplus of agriculture sector finances the development of industrial sector.
e. Wages in agriculture sector are at a subsistence level, that is, they are at a constant institutional
wage rate.
f. Supply of labor is perfectly elastic.
g. Marginal product of excess labor is zero.
h. Returns to scale are constant.
i. Closed Economy

Profits and Hidden rural savings are

reinvested

Increase in Capital Accumulation

Profits increase

Wages increase

Labour supply increases till the point

surplus labour is absorbed.

Three ratios given by Fei-Ranis Model:

𝑳𝒂𝒃𝒐𝒖𝒓 𝒑𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒗𝒆𝒍𝒚 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅
a. Labour Utilisation Ratio (r) = 𝑮𝒊𝒗𝒆𝒏 𝒂𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒍𝒂𝒏𝒅 𝒐𝒓 𝒄𝒂𝒑𝒊𝒕𝒂𝒍
𝑻𝒐𝒕𝒂𝒍 𝒂𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒘𝒐𝒓𝒌𝒆𝒓𝒔
b. Labour Endowment Ratio (s) = 𝑳𝒂𝒏𝒅
𝑳𝒂𝒃𝒐𝒖𝒓 𝒑𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒗𝒆𝒍𝒚 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅
c. Non-redundancy coefficient (T) = 𝑻𝒐𝒕𝒂𝒍 𝒍𝒂𝒃𝒐𝒖𝒓 𝒇𝒐𝒓𝒄𝒆

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T = r/s

Criticism:

 Migration is not easy.

 Marginal Product is not equal to zero.
 Funds raising process is difficult.
 Assumption of closed economy not valid.

3. Harris-Todaro Model of Migration

Harris gave his model in 1970 and Todaro gave his model in 1969. The model came in reaction
to the Lewis Model. According to it, any labor migrated from rural sector may remain
unemployed even after going to urban sector. This view was completely against the Lewis Model.

The following assumptions were taken into

consideration:
a. Migration is entirely an economic phenomenon.
b. Migration to urban areas is in excess of urban jobs.
Growth rate is both likely and possible so that the
labor which has migrated may remain either
unemployed or underemployed in the informal
sector.
c. Migration decision is influenced by the expected
urban rural income differentials rather than the
actual differentials. Decision of migration is
financially and psychologically made.
d. Migrants want to maximize their expected gains
from migrations.
e. The possibility of getting an urban job varies
directly with employment rate in the urban areas.

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At the subsistence level of wages (WA* and WM*), all the labour is employed in both the sectors.
Manufacturing sector then sets an institutionally determined wage rate, that is, ̅̅̅̅̅
𝑊𝑀 . Therefore, the
labour employed in manufacturing sector now decreases and reached LM. At that point, if we assume
full employment, the wages in agricultural sector would reduce to WA** because labour supply has
increases in that sector and hence the wages have decreased.

The decision of migrating will depend upon:

𝑳
WA = 𝑳 𝑴 ∗ ̅̅̅̅̅
𝑾𝑴
𝑼𝑷

Where:

WA = Wages in agriculture

LM = Labour in manufacturing sector

̅̅̅̅̅
𝑊𝑀 = Institutional wages in manufacturing sector

LUP = Labour in urban pool with or without the employment

𝐿𝑀
If WA > ∗ ̅̅̅̅̅
𝑊𝑀 , Then migration would take place from urban to rural sector.
𝐿𝑈𝑃

𝐿
If WA < 𝐿 𝑀 ∗ ̅̅̅̅̅
𝑊𝑀 , then migration would take place from rural to urban sector.
𝑈𝑃

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Migration can be initiated when:

a. Wages in manufacturing sector are set at a higher level.

Agricultural productivity becomes

low

Marginal productivity decreases

Wages decrease

Incentive to migrate

The number of labor in

manufacturing sector can be
controlled by:
a. Increase the labour productivity in
agricultural sector.
b. Focus on labour intensive industries.
c. Education
d. Minimising the factor price
distortions.

4. Balanced Growth Theory:

The theory of balanced growth was promoted by Ragnar Nurkse, Lewis, Allen Young, Rodan.
According to the balanced growth theory, all sectors should grow together. The investments
should be made simultaneously in all the sectors. Moreover, the state intervention is required
and hence more requirement of capital. The theory focuses on creating social overhead capital
which would further generate economies of scale.
Following were the theories for balanced growth:

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Big Push Theory: By Rosenstein Rodan

(Planning industrialisation and balance in supply approach)

Vicious Circle of Poverty: By R. Nurkse

(Breaking of vicious cycle of poverty by application of capital to
wide range of industries)

Lewis Theory of Development

(Balance between agriculture and industries, material and human
capital, export and import, etc.)

The following are the requirements for any

economy to follow the path of balanced growth:
a. More Capital
b. State intervention
c. Formulation of plans
d. Co-ordination and co-operation between
different sectors of the economy.

Merits of Balanced Growth Theory:

a. Balanced growth would help in creating social overhead capital.
b. It creates economies of scale.
c. Balanced growth leads to specialisation and division of labour.
d. Wide extent of market.
Demerits of Balanced Growth Theory

a. The theory is not suitable for under-developed economy.

b. The theory ignores the effect of inflation on the economy.
c. Deficiency of capital and other resources in developing countries.
d. Ignored the existence of disproportionality in factors of production.

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5. Unbalanced Growth
The theory was first propounded by
Hirschman in his work “The
Strategy of Economic
Development” (1958). Other
proponents of the theory were H.W.
Singer, Paul Streeton, R. Rostow,
Kindleberger.
The theory focused upon
deliberately creating imbalance
between the sectors of an economy.
Investment should be made in
leading sectors which will further
create economies for other sectors.

Unbalanced growth theory focused on two types of series:

a. Convergent Series
Source of Investment is from private enterprises.

They appropriate more economies than they create.

It is not beneficial from the social point of view.

b. Divergent Series
They create more economies.

Source of investment is from the public domain.

It is beneficial from the social point of view.

Moreover the Unbalanced growth theory talked about two strategies which are as follows:

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Strategies

Social overhead Directly Productive

capital to Directly Activities to Social
Productive Overhead Capital
Activities

Let’s discuss them in detail:

a. Social Overhead Capital to Directly Productive Activities: Social Overhead activities

are the basic services given to primary, secondary and tertiary sectors. Therefore,
they are known as “Pressure Relieving Investment”.

Development takes place through excess capacity

It is a smooth process.

It is pressure relieving.

More preffered

b. Directly Productive Activities to Social Overhead Capital: These are “Pressure

Creating Investment”

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It is followed due to shortage of social overhead capital

It is pressure creating

The productive activities have an incentive to improve the

social overhead capital to generate economies of scale.

Merits of the theory:

a. It is a better strategy for under-developed economies, due to
shortage of capital in those nations.
b. It is useful for industrial development.
c. The theory involves a linkage effect as one sector generates
development process in other sectors.
d. It is a short term strategy.
e. Resources are not wasted.
f. Creation of economies and is thus known as “Powerhouse for generation of external
economies”.
g. Promotes self-reliance as it focuses on expansion of leading sectors.
h. Generation of economic surplus.
i. Skill formation: Creating better facilities.
Demerits of the theory:

a. The unbalanced growth strategy may lead to inequalities.

b. It focusses too much on industrial development.
c. The resources may not be used optimally.
d. Degree of imbalance not discussed.
e. Neglect of resistance.
f. Lack of basic facilities.
g. Disadvantage of localisation like slums, etc.
h. Danger of inflation as investment takes place in capital goods industries.
i. Neglect of agriculture.

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The difference between Balanced Growth and Unbalanced Growth Strategies are as
follows:

Balanced Growth Unbalanced Growth

The investment is simultaneous. The investment is done in one sector at a

time.

It is a long term strategy. It is a short term strategy.

Capital requirement is more in case of Capital requirement is less in case of

balanced growth. unbalanced growth.

6. Prebisch-Singer Thesis
The theory was given in 1950s and it highlights the
negative impact of trade. The theory divides the world
into two parts:
a. The centre: It is a group of developed nations.
b. The Periphery: It is a group of under-developed
nations.

As we know that,
𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐞𝐱𝐩𝐨𝐫𝐭𝐞𝐝 𝐠𝐨𝐨𝐝
𝐓𝐞𝐫𝐦𝐬 𝐨𝐟 𝐭𝐫𝐚𝐝𝐞 =
𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐢𝐦𝐩𝐨𝐫𝐭𝐞𝐝 𝐠𝐨𝐨𝐝

The developing countries do not benefit from trade because they produce primary goods. As a
result, the resources would be transferred from developing to developed nations through trade,
hence deteriorating the economic conditions of the periphery.

7. Cumulative Causation Theory

The theory was given by Myrdal on the basis of backwash effects and spread effects. Myrdal
assumes a type of multiplier-accelerator mechanism producing increasing returns in the favoured
region.
According to him, the economy experiences two kinds of effects:

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Effects

Spread Effects
Backwash Effect (These are positive
(Negative effects from externalities. The
development in one area development in one area
to another.) initiates development in
surrounding area.)

It is also stated that the developing nations do not develop because in case of them the backwash
effects are greater than spread effects.

8. Low Level Equilibrium Trap

The theory was given by R. Nelson in his work “Theory of Low Level Equilibrium Trap” in
1956. The theory is based on the Malthusian Theory of Population. According to this,

Per capita Income

increases more than Population increases
subsistence level

However, population and per capita income are positively related only till some point, beyond
which rise in per capita income won’t have much effect on the population levels.

According to the theory, the economies facing a low level equilibrium trap will also experience a
situation of ‘slack’. By slack it means that those economies will not be able to achieve maximum
possible rate of growth.

Income is a function of labour and capital, assuming technology to remain constant. Also, labour
is a constant proportion of the population.

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Growth rate of capital (dk/k) comes from:

a. Addition to capital stock
b. Land brought under cultivation.
dk/k = f(per capital income)

Land is positively related to population and

negatively related with land already under
cultivation.

Per capita income changes due to:

a. Rate of growth of population

(dP/P = f(Y/P)) where P is the
population.
b. Rate of growth of income (dY/Y
= f(Y/P)) where Y is the income.

With the increase in per capita income above the

minimum subsistence level, the population tends to increase. However, when the growth rate of
population reaches an upper physical limit, it starts declining with further increase in the per
capita income.

Lower the difference between the slopes of the two curves, weaker will be the trap.

Reasons for low level equilibrium trap are as follows:

a. Inefficient production processes.

b. Correlation between per capita income and population.
c. Slack
d. Social structure of the economy.
Policy options:

a. Increase the productivity and amounts of capital and labour.

b. Change the social system.
Demerits:
a. No rigid and simple functional relationship between per capita income and rate of population
growth.
b. No rigid and simple relationship between per capita income and growth rate of income.
c. Neglects time element.

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9. Vicious Circle of Poverty

The theory was propounded by Nurkse, Gunar
Myrdal. Nurkse gave the theory in his work
namely “Problem of Capital Formation in
Under developed countries” in 1953.
According to the theory, a country is poor
because it is poor. The theory focused on the
supply of capital, stating that the inducement to
invest is limited by capital.

Supply of Capital = f(Willingness to save,

ability to save)
Demand for Capital = f(Inducement to
invest)

The theory was explained from both the

demand as well as supply side.

From the supply side:

Low Low
Poducitvity Income

Low Low
Capital Saving
Formation

Low
Investment

From the demand side:

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Low Low Income

Productivity

Low
Low Capital demand,
hence Small
Market

Low
Inducement
to invest

Measures to Break Vicious Circles

a. Investment by both public and private investment.
b. Investment in production oriented policies will help curb inflation levels.
c. Growth of population should be checked.

10. Model of Capital Accumulation / Golden Age Model

The model was given by Mrs. Joan Robinson in 1963. She used the Marx’ concept of Expanded
Reproduction Schema; Keynes’ Income theory (Inflationary gap, effective demand, hoarding),
Harrod’s concept of Balanced Growth and Neutral technical progress. Besides this, she also used
Kalecki’s saving function that states capitalists save all and workers spend all.

The focus of this theory is on Capital accumulation and profit maximization.

Savings and income (ex-ante) equalise through changes in income levels.

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Following were the assumptions taken in the

theory:
a. Two factors of production: Labour and
Capital
b. Entire income is divided into wages and
profits.
c. Wage earners consume everything and do
not save. Profit earners will invest
everything and consume nothing.
d. Neutral technical progress.
e. Fixed technical coefficient
f. Laissez-faire
g. Closed economy
h. Prices are not changing
i. Elements of monopoly power encourage
saving through their influence on income
distributed.
Main idea of the theory was that rate of capital accumulation and rate of profits are to be brought in
equilibrium.

y = wL + ΠK

where y = income, w = wages, L = labour Π = rate of profit, K = capital

ΠK = y – wL

Π = (y – wL)/K

Dividing the numerator and denominator by L, we get;

Π = (y/L – w)/(K/L)

Where y/L = labour productivity and (y/L – w) give us the net return on capital

We know that savings and investment equalise through the changes in income levels, that is,

S = I …(1)

Capitalists save everything, therefore,

S = ΠK

Investment is nothing but the change in capital, and can be represented as,

I = ∆K

So, substituting the values in (1), we get;

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ΠK = ∆K

Rearranging the terms, we get;

∆K/K = Π

The above equation signifies the desired/warranted rate of capital accumulation, where ∆K/K is the
rate of growth of capital.

If ∆K/K > Π , then any further investment will not be profitable. The capital should be accumulated
till the point the equality is maintained.

Features of Golden Age

a. Smooth and steady state
b. Full employment
c. Production activities are being carried out smoothly.
d. Population is growing at a constant rate.
e. Capital accumulation is fast enough to equip all the labour.
f. Profits are also constant.
g. Wages will increase with output per person.
h. Potential growth rate is realised. Potential growth rate is the maximum rate of capital
accumulation which can be maintained and achieved at constant profit rate.

Golden Age: Robinson also gave the concept of golden age. Under the golden age, we
consider the labour growth rate, capital growth rate and rate of profits. The golden age is
achieved when the equality is maintained between all the three variables, that is,

∆K/K = ∆L/L = ∆Π

Static State
A static state is the state when the growth rate becomes zero and profits are also zero. Also, the net
return is absorbed in wages.

The state is also known as the state of economic bliss.

However,

If ∆N/N > ∆K/K Money wages decrease, keeping the

price constant, which implies, real
wages decrease and hence profits
decrease.

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If ∆N/N < ∆K/K Changes will take place in such a way

that will absorb all the excess capital.

Types of Golden Age

Golden age is parallel to the steady state. Following are the types of golden age:

a. Limping Golden Age: Rate of capital accumulation is well below full employment level,
which would lead to unemployment. In simple terms, capital accumulation is less than the
labour growth rate.
b. Leaden Golden Age: It is a situation of mass unemployment and there is a fall in the standard
of living.
c. Restrained Golden Age: Under this, the desired rate of accumulation is not achieved because
output per worker doesn’t support it.
d. Bastard Golden Age: According to this, the desired rate of accumulation is not achieved
because of rise in prices, that is, inflation.
Platinum Age

Under the platinum age, the initial rate of investment/consumption is not suitable for desired rate
of growth to take place.

The types of Platinum Age are:

a. Galloping: (Investment/Consumption)
is not suitable. So when there is an
increase in investment, wages decrease.

b. Creeping: (Investment/consumption) is too high

for possible growth to take place. Full employment is
already achieved, profits are high, but labour growth is not
high.

c. Bastard Platinum Age:

Investment/consumption) is not suitable, the
economy is free from the threat of inflation and
there is rise in wages.

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Similarity between Harrod Domar Model and

Joan Robinson Model are:

a. Both the theories postulate fixed capital

coefficient and technical neutrality.
b. According to both the theories, there is no
automatic mechanism by which adjustment
could be brought about between natural
growth rate and warranted growth rate.
c. Knife-edge equilibrium is inherent in both the
models.

Differences between Harrod Domar Model and Joan Robinson Model are:

Robinson’s Model Harrod-Domar Model

Growth rate is determined Growth rate is determined by

by profit-wage saving-income ratio and
relationship and productivity of capital.
productivity of labour.

Labour is the ultimate Capital is the prime source of

source of capital capital accumulation.
accumulation.

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SOLOW MODEL
The model was given by Solow in 1956 in his
work “A Contribution to the Theory of
Economic Growth” and is also known as
Exogenous Growth Model or Neo Classical
Growth Model.

Under this, the technical progress and

population growth rate are treated to be
exogenous in nature.

It is different from Harrod-Domar Model in

the following ways:

a. Harrod-Domar Model states fixed technical

coefficient and Solow Model assumes
variable technical coefficient.
b. Under Harrod-Domar Model, there is a
tendency of divergence from equilibrium
while in case of Solow Model, there is a tendency
of convergence towards the equilibrium.
Assumptions of the model:

a. Single good is being produced.

b. There are two factors of production: Labour and Capital
c. Full employment of resources.
d. Perfect competition
e. Labour and Capital are substitutable.
f. Labour is paid a wage as per their marginal product.
g. Variable technical coefficient
h. Flexible price, and follows an interest-wage system.
i. Assumes constant returns to scale.
j. Production function is homogenous of degree 1.
k. There is a dual economy, that is, agriculture sector and industrial sector.

According to the theory, any Capital- Labour Ratio (K/L) will move towards the equilibrium.

Important abbreviations in the theory:

yt = Real Income

S = Savings

S’ = Rate of savings = S.yt

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K = Capital stock

K’ = Change in capital stock = I

K’ = S(yt)

y = f(L,K)

This implies that;

K’ = S.f(L,K)

L here is exogenously determined and is equal to L0ent

K’ = S.f(L0ent, K)

Further,

r’ = S[F(r,1)] – nr

Where: F(r,1) implies with 1 unit of labor, r units are produced and nr= increment in labour

S[F(r,1)] means the increment in capital, r = K/L, r’ = ∆(K/L), n = Change in labour or (L’/L)

If r’ = r Equilibrium K/L

Rate of growth of capital = rate of growth of

labour

If r’ < r Labour is growing at a faster rate than capital

Equilibrium K/L is less than the actual K/L

If r’ > r Labour growth us slower than the capital

growth.

Equilibrium K/L is more than the actual K/L

A point to note is that rate of growth is steady and is maintainable.

Limitations of the theory:

1. Unrealistic assumptions of the theory.

2. The theory does not give any time frame to achieve the growth rate.
3. The theory doesn’t link the technical progress with capital accumulation.
4. No role has been given to business expectations.

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KALDOR’S MODEL
The model was given in 1957. It relates technical progress with capital accumulation. Kaldor gave
importance to non-economic factors also in the development process. He followed the Keynesian’s
theory and Harrod’s analysis.

Assumptions of the theory

1. In short run, supply will be inelastic.
2. He divided the society into two sections:
Labour and Capitalists. Entire income is
divided into wages and profits.
Wages include the income of the marginal
labour while profits include the income of the
capitalists, entrepreneurs and property
owners.
3. Total Savings = Savings out of wages +
Savings out of profits.
4. All macro concepts are shown at constant
prices.
5. Constant returns to scale
6. Marginal propensity to consume for workers
is more than the marginal propensity to
consume for capitalists.
Kaldor gave the theory in two respects: Firstly, when population remains constant. Secondly, when
population is expanding.

1. Constant Population
Under this,
Proportionate growth rate of income or output = Proportionate growth rate of output per head.
Savings = αPt + β(yt – Pt)
Where: αPt = Savings out of profits and β(yt – Pt) are savings out of wages

Investment:
𝑃
Kt = α’yt-1 + β’𝐾𝑡−1 *yt-1
𝑡−1
It = ∆Kt = Kt+1 - Kt

Growth Rate of Output/Real income:

𝐼
∆y = a’’ + b’’𝐾𝑡
𝑡
Where: a’’ = Coefficient of technical progress and b’’ = capital per head

Conditions to achieve stable equilibrium

a. Savings > Investment
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b. Pt ≤ yt – w
c. Pt > minimum profit margin for investment to continue

2. Expanding Population
Under this, the proportionate growth rate of income or output is the sum total of proportion of
output per head and proportionate change in the working population.
We assume that the population is an increasing function of increase in income upto a certain point
after which the population is stagnant.

ENDOGENOUS GROWTH MODELS

Endogenous growth models, also known as New Growth Theory, treat technical progress to be
endogenous in nature. They also assume that similar technical conditions are not available to all
countries.

Endogenous growth models focus on:

1. Human Capital
2. Knowledge
3. Innovations
4. Research and Development
5. Investment
These theories consider the spillover effects or externalities of investment in technology.
Moreover, they do not assume constant returns to scale to be a necessary condition. According to
them, increasing returns to scale is also possible.

1. Romer’s Model
The model is also known as Learning by Investment and was given in 1986.
According to Romer’s Model, creation of knowledge is a sub-product of Investment. Knowledge
is considered to be a non-rival good. The model also considers the possibility of externalities, that
is, returns to investment help in creating more knowledge. However, it is quite possible that
knowledge may show decreasing returns.
The focus of the theory was on Research & Development which helps in creating more
knowledge.
Features of knowledge:
a. Sub-product of Investment
b. Non-rival good
c. Knowledge may show decreasing returns.

Assumptions of the theory

a. Growth is derived from a firm/industry.

b. Industry produces under constant returns.
c. The model assumes a Cobb-Douglous type of production function.

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d. Assumes a steady state of growth, that is,

𝐝𝐲 𝐝𝐊
=
𝐝𝐭 𝐝𝐭
e. Labour is allocated for two purposes:
i) For current production
ii) For creation of knowledge
g= rate of growth of knowledge + rate of growth of labour

2. Lucas Model

The Lucas Model was given in 1948. The theory focused upon investment in human capital.

According to the theory, growth rate is defined as:

g= Growth rate of labour + Growth rate of per capital Investment in human capital
Features of Lucas model:
 Total output is divided into two parts, namely, investment in knowledge and current
production.
 Technological progress is endogenously determined.
 The model uses a cobb-douglas production function.
 The model assumes a constant returns to scale.

3. Arrow’s Learning by Doing

The theory focused upon how you gain by learning by doing which helps in decreasing the
average cost. In other words, a firm, over time, learns to produce more efficiently and increases
its stock of knowledge. Workers become more familiar with the work as volume of output
increases.

RELAX!!!!!!!!!!!!

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TECHNICAL PROGRESS
By technical progress we mean inventing a new technology and improving it through innovation and
diffusion in the society.

Technical Progress

Neutral Technical Progress Capital Saving technical Labour saving technical

(Produce more of output progress progress
with increase in capital and (Same amount of output (Same amount of output
labour in the same can be produced with can be produced with
proportion, that is, keeping lesser amount of capital) lesser amount of labour)
K/L ratio the same.

The concept of Neutral Technical progress were given by following economists:

1. Hicks’ Neutral technical Progress: Under this, efficiency of all factors increases in the same
proportion and the ratio of marginal productivities of the factors, that is, MPK/MPL is constant
for a given K/L ratio.
y = t.f(K,L) where t = technology index

2. Harrod’s Neutral Technical Progress: Harrod’s Neutral Technical Progress is labour

augmenting, that is, the labour efficiency improves. As a result, marginal productivity of
labour (MPL) increases with a given constant K/L ratio. Relative input shares remain the same
for a given capital-output (K/O) ratio.
y = f(K, T(t)L)

3. Solow’s Neutral Technical Progress: It is capital augmenting. As a result, marginal

productivity of capital (MPK) will increase with a given K/L ratio. Relative input shares
remain the same for a given labour-output (L/O) ratio.
y = F(T(t)K, L)

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DEPENDANCY MODEL
These models were given in 1970s.

Following are the types of dependency models:

1. Neo-Colonial Dependence Model: It is an extension of Marxian analysis. According to the

model, the dependence relationship between developed and developing nations will occur due to
inequalities between them.

2. False-Paradigm Model: According to the model, the dependency is a result of incorrect

framework of development which is followed by the developing nations. In other words, experts
provide incorrect framework to the developing nations.

3. Dualism: Dualism states the co-existence of two separate worlds. There is a chronic difference
between the two worlds which tends to increase over time. Developed nations do not help the
developing counterparts.

Types of Dualism:

Dualism

Technological
Dualism
Social Dualism By Higgins Ecological Dualism Financial Dualism
By: H.Boeke (Different techniques (Difference in the By: Hla Myint
(Existence of East & of production endowments of the (Unequal access to
West together) (Labour or capital natural resources) financial credit)
intensive) in different
parts of the world)

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SOME IMPORTANT THEORIES

1. Rostow’s Stages of Economic Growth: It was given in 1960. The theory talks about five stages
of economic growth:

Traditional Stage
(The output per head is very low and tends not
to rise)

Pre-conditions to take-off/Preparatory Stage

(changes in 1) society's attitude towards science, risk
taking, etc. 2) Adaptability of labour force, 3) political
soverignty, 4) development of financial institutions)

Take off stage

(Rate of investment increases, and thus the real output
increases. There is a rise in per capita output)

Drive to Maturity
(less reliance on imports. It is a stage of increasing
sophistication of the economy)

Stage of Mass Consumption and Production

(Affluent population, availability of durable and
sophisticated consumer goods, hi-tech industries, etc. )

According to Rostow, Development depends on six propensities:

a. Propensity to develop fundamental sciences.

b. Propensity to apply sciences to economic needs.
c. Propensity to accept innovations.
d. Propensity to seek material advance.
e. Propensity to consume
f. Propensity to have children

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Features of Traditional Society:

a. Agriculture: Uses Primitive methods of production.
b. Law of diminishing returns in agriculture.
c. Absence of modern science and technology.
d. Structure of the society is based on inheritance.
e. Political power with big landlords.
f. State’s expenditure done on glory of the rulers, etc.
g. Increase/Decrease in population based on Malthusian Lines.

Features of the Drive to Maturity Stage:

a. Composition of work-force changes: In take off stage, 75% of the population works in agriculture,
while in case of drive to maturity stage, it is only 20%.
b. Character of leadership changes: More efficient managers take the place.
c. Society aspires for new things.

2. Two-Gap Model: The model was given by Chenery and Strout in 1966. The basis of the theory
is Harrod-Domar Model. The theory aims to calculate the amount of foreign aid required to
overcome two constraints:
a. Saving-Investment Gap
b. Foreign Exchange Gap
E–Y=I–S=M–X=F
Where: E = National Expenditure; Y = National Income; I = Investment; S = Savings; M = Import;
X = Export; F = Net Capital Income

The theory suggests that to fill the gap we need the external or foreign aid. In other words,

I – S = M – X (in the ex-post sense)

Assumptions:
a. Savings and foreign exchange cannot be substituted for each other.
b. Potential savings cannot be transformed into exports.
c. Export promotion and import substitution policies are ruled out.
d. Assumes structural rigidities and non-substitutability between different types of goods.

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TECHNIQUES OF PLANNING
Following are the techniques of planning:

1. Physical Planning: It refers to physical allocation of resources. Under this, we compute the
investment coefficient.
2. Financial Planning: The planning is usually done in monetary terms, that is, it estimates the size
of investment in money terms.
3. Planning by Investment/Indicative Planning: System is free from any restrictions, but there are
still some controls and regulations.
4. Planning by Direction: The central authority directs to achieve the goals.

Classification of Planning

1. Structural and Functional Planning:

Structural Planning:
 Change in socio-economic institution.
 Under-developed countries.
 Big changes.
Functional Planning:

 Work within specified framework.

 Only repair
 Should not be adopted by under-developed countries.
 Economic magnitude changes.
2. Planning by Inducement and Planning by Direction:
Planning by Inducement:
 Objective achieved by persuasion and not compulsion.
 Free play of market forces.
 Relies on monetary and fiscal measures.
Planning by Direction:
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 Compulsion and controlling authority

 Deprives consumer of their superiority
 Inflexible
 Expensive
 Excessive standardisation and kills initiative
3. Democratic Planning and Socialist Planning
Democratic Planning:
 Planning within democratic framework
 Contradicts free economy
 People participate in determining objectives
Socialist Planning

 Planning authority is supreme

 Execution by orders and direction
 No economic and political freedom.
4. Indicative Planning and Imperative Planning
Indicative Planning:
 Information is provided which is used for forecasting or decision making.

Imperative Planning

 Implementation of plans by enforcement

 Directive planning or planning by direction.
5. Perspective planning and Short Term Planning
Perspective Planning:
 Long term planning (15-20 years)
 Focuses on major problems.

Short-Term Planning

 4-6 years
 Activities like training manpower, road building, etc.
6. National Planning and Regional or Micro Planning
National Planning:
 National boundaries.
 Focuses on optimal utilisation of resources.
Micro Planning: Small region

7. Sectoral Planning and Area Planning

Sectoral Planning: For sectors of the economy like primary, secondary, tertiary.
Area Planning: Specific Area

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8. Physical Planning and Financial Planning:

Physical Planning: Real Resources
Financial Planning: Monetary resources
9. Centralised and Decentralised Planning
Centralised Planning: Central Authority
Decentralised Planning: Regional or Local Bodies also take part.

HISTORY OF PLANNING IN INDIA

YEAR DETAILS
1934 M. Visvesvary
Book: “Planned Economy for India”
1937 National Planning Committee
Chairman: Pt. Jawaharlal Nehru
Report Submitted: 1948
1943 “A Plan for Economic Development in India” or “Bombay Plan”
Eight Bombay Industrialists
Aimed to increase per capita income by 100% (Rs 65 to Rs 130) in 15 years.
How? By increasing agricultural production by 130% and by increasing industrial
output by 500%.
1943 People’s Plan (M.N. Roy)
Highest priority to agriculture and consumer goods industries
1944 Department of Planning and Development was established.
1950 Planning Commission was established
January 1, NITI Ayog
2015
(National Institute for Transforming India)
Replaced Planning Commission, Involved states in Economic Policy Making in India.

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NITI AAYOG
(National Institute for Transforming India)

Date of Establishment: January 1, 2015

Replaced Planning Commission. Involved states in Economic

Policy Making in India

Members of NITI Aayog

1. Chairperson: P.M. Narendra Modi

2. CEO: Sindhushree Khullar
3. Vice Chairperson: Arvind Panagariya
4. Ex-Officio Members: Rajnath Singh, Arun Jaitley, Suresh Prabhu, Radha Mohan Singh
5. Special Invitees: Nitin Gadkari, Smriti Zubin Irani, Thawar Chand Gehlot
6. Full-time members: Bibek Debroy and V.K. Saraswat
7. Governing Council: All C.M and Lieutenant Governors of UTs

Objectives and Opportunities of NITI Aayog

1. Government to become an enabler and not the provider of first and last resort.
2. Progress from food security to mix of agricultural production.
3. India to be an active player and debates on the global commons.
4. Potential of vibrant middle-class to be fully realised.
5. Improve India’s entrepreneurial, scientific and intellectual human capital
6. Incorporate geo-economic and geo-political strength of NRIs.
7. Use of technology

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INVESTMENT CRITERIA
The investment criteria tells us how the resources are allocated in such
a way that profits are maximised.

1. Capital Turnover Criteria/Rate of turnover

criteria/Marginal rate of return criteria: The theory was
given by J.J. Polak and Buchanan. It states that the capital-
output ratio should be minimum. The investments should be
in the projects where minimum capital resources are used to
produce maximum output.
The theory is beneficial for developing nations.

2. Social Marginal Productivity Criteria (SMV Criteria):

The theory was given by Kahn & Chenery. According to the
theory, capital should be used till the time marginal
productivity of capital is equalised in all the uses.

3. Reinvestment Criteria/Marginal Per Capita

Reinvestment Quotient: The theory was given by Galenson
and Leibenstein. The theory focuses on future growth and
hence measure the extent to which we can save for future use.

4. Net Present Value Criteria: To get the net present value, we

deduct the cost from the present value. The main objective of
our investment should be to maximise the present value.
5. Time Series Criterion: Given by A.K. Sen. The main
objective is to maximize output within a given period of time.

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PLAN MODELS

Aggregative Multi-Sectoral Multi-Sectoral

Models Models Models
• These are also • Plans will be • The planning
known as Macro made for begins from the
Models. It different sectors base. Project level
considers the and those are variables are
entire economy a combined to form given which will
one model. one plan. be used to
However, it Examples: Input- prepare the
doesn’t work for Output Models, models
the developing Mahalanobis
countries. Model
Examples are
Harrod-Domar
Model, Two-Gap
Model

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