School of Economics | Models of Growth
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Models of Growth

In this note we will study

  1. Dependency theories
  2. Neoclassical Growth Model.
  3. Endogenous Growth Model.
  4. An a little on alternative model to sustainable development.

  1. Dependency Theories.
    1. During the 1970s, the international dependency theories viewed developing countries as beset by institutional, political and economical rigidities. Developing countries were caught up in a dependence and dominance relationship with developed nations.
    2. The neocolonial dependence model is basically a Marxist approach. It says that underdevelopment is due to the historical evolution of a highly unequal international capitalist system of rich country-poor country relationships. Developed nations are intentionally exploitative or unintentionally neglectful towards developing countries. Underdevelopment is thus externally induced. Developing countries are destined to be the sweatshops of the rich nations (through their multinationals for example) and depend on developed nations for manufacturing goods that are high-value-added. Many developing countries were forced to become exporters of primary commodities by their colonial masters. Many of these countries still depend on primary commodities after independence. However, with average prices of primary commodities falling substantially (by half in many cases) since 1950s, dependence on primary commodities export is impoverishing to these countries. The economies of Zambia and Nigeria had been negatively affected by falling prices for their commodities exports. However, countries like Thailand and Malaysia who used to depend heavily on tin, rubber and palm oil are able to diversified into manufacturing exports. These countries went on to develop strong manufacturing sector.
    3. False-paradigm Model says that underdevelopment is due to faulty and inappropriate advice provided by well-meaning but often uninformed, biased, and ethnocentric international (often western) expert advisers to developing countries. Here, IMF and World Banks took a lot of blame from the advocators of this model. Joseph Stiglitz in Making Globalization Works and Jeffrey Sachs in The End of Poverty documented some cases where inappropriate advices were given by expert advisers from developed countries to developing nations.
      Box 1. An Case of Misdirection.Eucalyptus is a fast growing tree in favorable conditions and its wood has good commercial value. Encouraged by international advisers, this tree was introduced to many parts of India indiscriminately in the 1970s. In Bangalore, a dry zone, yields were only 20% of the projected figure by the government. In Western Ghats, eucalyptus plantations were taken up on a large scale by clear-felling of excellent rainforest. Unfortunately, these eucalyptus trees were attack by fungus called pink disease and rendered the plantation useless. The losers in this case were the local Indian farmers and environmental quality of India.If the advice of these international advisers were helpful they usually benefit the urban elites. Some economists argue that loans provided to developing countries in the 1960s and 1970s contribute to debt crisis in some developing countries in the 1980s.
    4. Dualistic-development Thesis. This thesis recognizes the existence and persistence of increasing divergences between rich and poor nations, and between rich and poor people at various levels. The urban elites in developing countries will remain rich and become richer. The wealth of these elite will not trickle down to the rest of the society. According to the World Bank, the average for the richest twenty countries in the world was 15 times the average for the poorest twenty countries in 1960, and in 2000 it is 30 times — twice as high.
      However, case studies of Taiwan, South Korea, China, Costa Rica, Sri Lanka, and Hong Kong demonstrated that higher income levels can be accompanied by falling and not rising inequality. The inverted Kuznet Curve shows that as income per capita continues to increase inequality of income can be reduced.
    5. Basically, dependency theories highlight the need for major new policies to eradicate poverty, to provide more diversified employment opportunities, and to reduce income inequalities. The Marxist approach to growth would recommend nationalization of industries that are controlled by foreign companies (especially those from the western colonists and multinationals ) and implement state-run production to reduce foreign controls on local economy.
    6. Criticisms:
      1. Dependency theories offer little explanation for economic growth and sustainable development. They tell us little on how to obtain economic growth.
      2. The actual economic experience of developing countries that pursued nationalization and introduced state-run production had been mostly negative. Nationalized companies were usually badly managed. Consequently, the operations were inefficient and productivity fell. Falling output led to falling export earnings. This was bad news for growth.
  2. Neoclassical Growth Model.
    1. Neoclassical Growth Model owed its origin to Robert Solow (in 1956) and Trevor Swan (in 1956). The neoclassical growth model says that grow due to increased capital stock as in Harrod-Domar Model can only be temporary because capital is subjected to diminishing marginal returns. The economy can achieve a higher long-run growth path only with a grow in labor supply, labor productivity or capital productivity. Variation in growth rate is explained by difference in the rate of technological change which affects labor and capital productivity. Advances in technology however is independent of the rate of investment, that is technology is exogenous to the model.
    2. In the 1980s, Reaganomics and Thatcherism were the buzzwords. These policies recommended small government with little government intervention in the market, reduced distortions in the market, promoted free markets, encouraged competition and regarded multinationals in favorable lights.
    3. Underdevelopment is seen as the product of poor resource allocation, incorrect pricing policies and too much state interventions that cause market distortion.
    4. The answer is promotion of free markets and laissez-faire economics through privatization and deregulation.
    5. Governments should also have market-friendly approaches to address externality problems. Governments should invest in physical and social infrastructure, health care facilities, education and provide suitable climate for private enterprises. Governments should also be friendly towards multinationals and attract Foreign Direct Investment (FDI) as this policy brings injection into the economy.
    6. Criticisms:
      1. Economic growth does not means development. Policies that promote economic growth may benefit the rich in the expense of the poor and the environmental qualities (more environmental degradation). A smaller government could also mean less social facilities for the poor.
      2. South Korea, Singapore, Japan, and China do not have genuine free market economies but are economic success stories. In fact, governments in these countries play active roles in directing their respective economies.
      3. Solow-Swan Model suggests that low capital to labor ratio in developing countries means that the rate of return on investment is high but this is not supported by historical data.
      4. The residual in Solow-Swan Model which is attributed to technology only explains 50% of historical growth in developed nations. There is much room for improvement in this model.
  3. Endogenous Growth Model.
    1. This model is called Endogenous growth model because it makes technology a part of the model and not as a residual as in Solow-Swan Model. This model tries to explain the rate of technological change.
    2. Persistent economic growth is determined by the system governing the production process as technology is now part of the model. Economic growth is a natural consequence of long run equilibrium.
    3. The model allows potentially increasing return to scale from higher level of capital investment, especially investment that has positive externalities. Capital is expanded to encompass human capital .
    4. Human productivity could increase due to higher skill attainment and learning-by-doing. The latter suggests that experience allows a worker to have higher productivity.
    5. Human capital can be encouraged through education and skill-training programmers.
    6. The rate of technological change can increase due to higher investment in R&D. R&D may also confer positive externality to knowledge-intensive industries.
    7. Protection of intellectual property rights is important because this legal monopoly gives incentive to carry out R&D.
    8. The model implies an active role for government to promote human capital formation (through education, better access to health care, and better nutrition) and encourage knowledge-intensive industries. To achieve the latter, some government even took the trouble to pick future industrial winners. Japan in the past promoted chemical and heavy-industry. More recently it promoted biochemical industry. Malaysia, for example, established a whole new town called Cyberjaya to attract knowledge-intensive industries and R&D into the country.
    9. Criticisms:
      1. Developing countries cannot take full advantage from the recommendation of this model that is based on neoclassical principles of efficient free market because of poor infrastructure, inadequate institutional structures, and imperfect capital and good markets. Many developing countries, for instance, do not have adequate protection for intelligent property rights and insurance markets that encourage entrepreneurship.
      2. The model fails to explain why low-income countries where capital is scarce have low rates of factory capacity utilization.
  4. Alternative sustainable development model.
    Economic growth should not be allowed to degrade the environment and in the expense of future generations. Growth should be the kind that benefits the world’s poorest people, and that local participation should shape development programmers and projects. Development should ideally empower the poorest people and usually women through better nutrition, education, and active participation in political, social and economic activities. An ideal development model should help the economy to accumulate not only physical but also human as well as natural capitals. Natural capitals can be increased by aforestation, reforestation, replenishing fish stocks in waterways and lakes, converting abandoned farmlands into natural parks and promoting biodiversity in government-run parks. This model recommends an integrated approach that consider economics, social, political and environmental issues.
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