Download Stage Theories of Economic Development

NS4053
Winter Term 2014
Theories of Economic Development
Stage Theories
Economic Development Theories I
• A number of theories or approaches to economic
development
• Theories attempt to capture key interrelationships
among economic variables
• Purpose is to explain the causal relationships among
these variables
• Intent is not only to understand the world better but
also provide a basis for policy
• Impossible to consider all the factors influencing
economic development is a single theory
• Must determine which variables are crucial and which
are irrelevant
• Still reality is so complicated that a simple model may
omit critical variables in the real world
• Each theory may be best for a specific setting but not 2
all situations.
Economic Development Theories II
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Broad Classes of Theories
Stage Theories
• Rostow – 5 stages
• Bremer and Kasarda – failed take-off – New Second World
• Porter – modern upgrading
• Sachs – environmental settings
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• World Economic Forum competitiveness stages (empirical section)
Trap Theories
• Vicious Circles
• Balanced vs. Unbalanced Growth
• Big Push Theories
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• Middle Income Trap
Sector/Dualism Models
• Lewis – classical model
• Fei-Ranis – two sector
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Rostow Stage Theory I
• Rostow Stage Theory
• Basic idea that when economic change occurs, it
occurs quickly
• growth not a continuum, but rather goes through a
particular sequencing
• Main stages of growth in Rostow:
• Traditional society
• The preconditions for takeoff
• The takeoff
• The drive to maturity and
• The age of high mass consumption
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Rostow Stage Theory II
• Stage 1: Traditional Society
• Rostow does not have much to say about this state
• Presumably based on attitudes and technology before
turn of eighteenth century
• After Newton widespread belief that external world
• subject to a few knowable laws
• systematically capable of productive manipulation
• Stage 2: Precondition Stage
• Stage includes radical non-industrial changes through
• Increased transport investment to enlarge market and
production specialization
• Revolution in agricultural to feed a growing urban population
• Expansion of imports including capital financed by exporting
natural resources
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Rostow Stage Theory III
• Changes in the preconditions stage including including
increased capital formation require a political elite
interested in economic development
• This interest may be stimulated by:
• Nationalist reaction against foreign domination
• Or simply desire to have a higher standard of living
• Stage 3: Take-off
• Central stage in Rostow framework
• Entails a decisive expansion occurring over twenty to
thirty years – during which time
• There is a radical transformation of a country’s society
• Barriers to growth finally overcome
• Forces making for widespread progress dominate society so that
growth becomes normal
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Rostow Stage Theory IV
• Takeoff is a dramatic movement in history
• Major take-offs cited by Rostow
• Beginning of the industrial revolution in late eighteenth-century
Britain
• Pre-Civil War railroad and manufacturing development in the
U.S.
• The period after the 1848 revolution in Germany
• The years after the 1868 Meiji restoration in Japan;
• Rapid growth of the railroad, coal, iron and heavy engineering
industries in the quarter century before 1917 Russian Revolution
• Periods starting within a decade of India’s independence (1947)
and
• Communist victory in China (1949)
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Rostow Stage Theory V
• Three conditions must be satisfied for the take-off:
• 1. Net investment as a percentage of Net National Product
(NNP) increases sharply:
• from 5% or less to greater than 10%
• If an investment of 3.5 % of NNP leads to growth of 1% yearly
then 10.5% of NNP is needed for a 3% growth
• 2. At lease one substantial manufacturing sector growth
rapidly
• Growth of a leading manufacturing sector spreads to its
input suppliers
• Ideal industry – spectrum of backward linkages
• Indirect linkages also important
• Historically textiles: wide indirect effects on demand for coal,
iron, machinery and transport
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Rostow Stage Theory VI
• 3. Political, social and institutional framework
• Quickly emerges to exploit modern expansion implies:
• Mobilizing capital through retained earnings from rapidly
expanding sectors
• An improved system to tax high income growts, especially in
agriculture
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• Developing banks and capital markets
Where state initiative is lacking the culture must support a
new class of entrepreneurs prepared to risk innovation
Stage 4: Drive to maturity
A period of growth that is regular, expected, and selfsustained
Labor force that is predominantly urban, increasingly
skilled, less individualist, and more bureaucratic
Workers look increasingly to the state to provide economic
security
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Rostow Stage Theory VII
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Stage 5: Age of high mass consumptions
Reached in the U.S. in 1920s
Western Europe in 1950s
Characterized by automobile, suburbanization and a wide
spectrum of consumer goods
Rostow: other societies may choose a welfare state or
international military and political power
Critique of Rostow
Rostow in vogue with U.S. government officials in the
1960s especially in international aid agencies
Held out hope for sustain growth in developing countries
after substantial initial infusions of foreign assistance
The main criticisms center around historical fact and
conceptual vagueness in the Rostow model
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Rostow Stage Theory VIII
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Historical facts
• Many historians see that the advanced countries experienced gradual
growth occurring over long periods of time rather than a rapid takeoff
• Historians do not find rapid accelerations in investment and growth in
the now advance countries
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• Rostow’s conditions defined so vaguely that they stretch to cover any
case
Conceptual problems
• Rostow’s stages imprecisely defined are difficult to test scientifically
• If stages are to explain how development is caused – must be defined
in terms other than economic development – the variable the theory is
trying to explain
• Traditional society and high mass consumption define rather than
explain reasons for development
• Past economies – primitive, ancient, medieval and those of the
presently developed countries of a century or tow are all placed in a
single category, traditional society.
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Rostow Stage Theory IX
Various criticisms of Rostow:
• Theory does not take into account dualism – countries
where a modern sector coexists with more backward
activities – theory implies homogenous economies
• Frequently characteristics of one of Rostow’s stages are not
unique to it
• Why would the agricultural revolution, capital imports and
social overhead investment of preconditions stage not be
consistent with the abrupt increase in investment rates
during take-off stage
• Why would the development of leading sectors or
emergence of an institutional framework exploiting growth
not take place in preconditions stages as well as during
take-off?
• Why would the abrupt increase in growth and investment
rates during takeoff not continue through drive to maturity?
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Rostow Stage Theory X
• Unlike Marx, Rostow’s approach does not show how the
characteristics and processes of one stage move society to
the next stage
• How do we explain the reactively effortless self sustained growth
after take-off?
• Presumably some obstacles to growth have been removed
• What are they and how does his theory explain their removal
• Rostow’s premise is that economic modernization implies a
change from an underdeveloped economy to one similar to
those in North America and Western Europe -- many
variants of development
• Rostow assumes one path to development – as has turned
out may variations with somewhat different sequencing
• In retrospect neglected institutional/governance change
that sets stage for further growth and development
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Brenner/Kasarda Stages I
• One of the major flaws of the Rostow theory was that it did
not anticipate failed-takeoffs.
• According to Rostow once a country took off, continued
growth was assured
• Brenner and Kasarda’s stage model provides an explanation
for failed takeoffs
• Their model, “New Second World” has three phases.
• The first or early phase begins when a low income country
starts to industrialize rapidly
• An agrarian transition is often launched and
• the complex transformations – urbanization, income growth
and economic diversification accompany
• Process similar, but not identical to Rostow’s take off if
countries growth for a decade or more.
• In this case, country reaches the middle New Second World
phase
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Brenner/Kasarda Stages II
• In the second phase, industrial production per capita may
now be around three times what it was whan the transition
started
• Growth in low-value-added manufacturing is rapid and
sustained.
• Incomes rise and a middle class emerges
• If this middle phase continues for 10-20 years, the country
would likely reach the advanced phase – often a time of
recurring economic crisis and political turmoil
• Many countries in the first stage have failed to move
forward to the middle stage largely because of growthlimiting policies and institutional rigidities
• Failure to make progress through the early stage as it did in
post World War I Russia and now much of the Middle East
can lead to violence
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Brenner/Kasarda Stages III
• Those who don’t make it out of the first stage have
comment elements:
• Slowness in adopting choice-based systems: systems encompassing
both market-based economies and
• democratic political institutions and organization
• No indexes of choice-based systems exist
• Closest proxy is Frasier Institute’s Economic Freedom Index
– basically property rights and free choice
• If reforms not undertaken – take-off fails and individual
dashed hopes, frustration/resentment increases – may be a
cause of terrorism in some countries
• Transition from second to third stage often derailed by lack
of financial reform – Asia Crisis, Argentina
• Can derail countries, resulting in long periods of sup-par
growth and internal instability
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Bremer/Kasarda Stage Theory
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Porter’s Stage Theory I
• Porter’s model centers around competitiveness and
the ways countries can increase their competitive
position
• Main proposition:
• Developing countries are often tripped up by microeconomic
failures
• Unless firms are fundamentally improving their operations and
strategies and competition is moving to a higher level
• Growth snuffed out as jobs fail to materialize
• Wages stagnate
• Returns to investment prove disappointing
• Successful economic development requires progress on multiple
fronts simultaneously
• Reform efforts need to be tightly connected to the current stage
of each country’s development
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Porter’s Stage Theory II
• As an economy progresses, the constraints to continued
advancement shift
• At strategic points in the development process, the whole
basis of national competitiveness must be transformed
• This requires a change in many aspects of company strategy
as well as new requirements for the national business
environment
• Central challenge in economic development is how to create
conditions for rapid and sustained productivity growth
• Stable political/legal institution and sound macroeconomic
policies create the potential for improving national
prosperity
• But wealth is actually created at the micro-economic level –
in the ability of firms to create goods and services using
productive methods
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Porter’s Stage Theory III
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The microeconomic foundations of productivity rest on:
• The sophistication with which companies in the country compete, and
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• The quality of the micro-economic business environment
The sophistication of companies is intertwined with the quality of the
business environment
More sophisticated strategies by companies require
• More highly skilled people, better information,
• Improving infrastructure, more advanced institutions and
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• Stronger competitive pressures
Private sector not only a consumer of the business environment but
also plays a role in shaping it
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Porter’s Stage Theory IV
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Moving to more sophisticated ways of competing depends on
parallel changes in the business environment
The business environment consists of fur interrelated influences:
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Porter’s Stage Theory V
• Government can play a significant role in development
because it affects many aspects of the business
environment:
• Quality of factor conditions through its training and
infrastructure polices
• Sophistication of home demand derives in part from
regulatory standards and processes, consumer protection
laws government purchasing and openness to imports
• Successful economic development is a process of successive
upgrading in which the business environment evolves to
support and encourage increasingly sophisticated and
productive ways of competing
• Nations at different levels of development face distinctly
different challenges
• Explains why so many disagreements in international
organizations such as WTO – countries positions on key
issues often conflict with best interests of other countries.
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Porter’s Stage Theory VI
• Economic development is therefore a sequential process
• The influence of one part of the microeconomic business
environment depends on others with certain elements more
critical at different stages of development
• Three main stages defined in terms of their characteristic
competitive advantages and modes of production
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Porter’s Stage Theory VII
Factor Driven Stage:
• Basic factors conditions such as low-cost labor and
access to natural resources are dominant sources of
competitive advantage and international products
• Firms produce commodities or relatively simple
products designed in other more advanced countries
• Technology assimilated through imports, foreign
direct investment and imitation
• Companies compete on price and lack direct access to
consumers
• They have limited roles in value chain and are focused
on assembly, labor intensive manufacturing and
resource extraction
• Environment highly sensitive to world economic
cycles, commodity price trends and exchange rate
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fluctuations
Porter’s Stage Theory VIII
Investment Driven Stage
• Efficiency in producing standard products and services
becomes dominant source of competitive advantage
• Products and services produced become more
sophisticated, but technology and designs largely
from abroad
• Countries not only assimilate technology but also
develop the capacity to improve on it
• National business environment supports heavy
investment in efficient infrastructure and modern
production methods
• Economy concentrated on manufacturing and on
outsourced service exports
• It is susceptible to financial crisis and external,
sector-specific demand shocks
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Porter’s Stage Theory IX
Innovation-Driven Stage
• Ability to produce innovative products and services at
the global technology frontier, using the most
advanced methods becomes the dominant source of
competitive advantage
• National business environment is characterized by
strengths in all areas, together with presence of deep
clusters
• Institutions and incentives supporting innovation are
well developed
• Companies compete with unique strategies tha are
often global in scope
• An innovation-driven economy has a high service
share and is resilient to external shocks
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Porter’s Stage Theory X
• Empirical Testing: Business Environment and
Productivity (per capita income)
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Porter’s Stage Theory XI
• Current Competitiveness Index: Country Ranking
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Porter’s Stage Theory XII
• Porter’s framework shows why countries find transition to a
new stage development difficult
• Such inflection points require wholesale transformation of
many interdependent dimensions of competition
• Many countries find that their reliance on sustained
infrastructure investments, original equipment
manufacturing for multinationals and government guidance
of the economy to boost efficiency are insufficient to
support higher levels of prosperity
• Yet current level of wages and domestic costs makes them
vulnerable to competition from lower wage countries
• Need to move to innovation driven economy
• To do this companies need to
• move to new types of strategies,
• Change investment priorities
• Government’s role in the economy needs to shift
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Defining Iraq's Post-war Economy
Iraq's post-war economy was a complicated mix of different
models, each of which required a different policy remedy
Model
Transition Economy
Remedy
Creation of a market system, with openness to
trade and integration into global economy.
Failed State
Restoration of law and order, government
services and an open trade regime to resolve
group grievances and halt economic decline
Rentier Economy
Diversification away from oil and curbing the
government’s authoritarian tendencies
Post-conflict Economy
Restoration of social and physical capital, as well
as stability,economic
before initiating
economic
reforms.
Increased
freedom,
improved
Failed Take-off Economy regulatory institutions and anti-corruption
measures.
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Post-War Economic Strategy I
• US post-war economic strategy in Iraq was initially based
largely on only the Transition Economy/Shock Therapy
model:
• This model is an extreme version of shock therapy focus on longterm efficiency
• Its goal was to wipe the slate clean and start the economy anew
• The strategy aimed to create an open economy with low taxes to
promote foreign private investment
• Its emphasis was on creating macroeconomic stability and an
independent central bank, with government remaining largely
passive in dealing with economy
• It aimed for high job creation through rapid private sector
investment and expanded output, with foreign direct investment
(FDI) and profitable imbalances from massive reconstruction
projects as its key ingredients--an unbalanced development
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strategy
Post-war Economic Strategy II
• The post-war economic strategy assumed that the
government must reduce its role in the economy, expand
the play of market forces, and undertake key reforms:
• Liberalizing economic activity, prices and market operations
• Establishing political accountability for economic performance,
as well as public responsiveness to private sector economic
needs
• Developing indirect, market-oriented Instruments for
macroeconomic stabilization
• Using these instruments to increase market-based employment
opportunities for Iraqis
• Achieving effective enterprise management and economic
efficiency, usually through privatization
• Second-stage -- establishing an institutional framework to secure
property rights, rule of law, and transparent market-entry
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regulations.
Post-War Strategy Dynamics
• Iraq’s post-war strategy was intended to create Portertype mechanisms of private-sector-induced reforms
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Flaws in Initial Economic Strategy
• With time, it became apparent that initial economic strategy
was unsuited to Iraqi reality. It created an environment more
favorable to criminals and extremists than to private
investors intent on rebuilding the economy
• The economic plan shut large numbers of Iraqis with no skills or
capital out of the economic process and fueled widespread anger
• It was impossible to attract the private investment on which the
strategy depended in the face of political and economic uncertainty
• The inability to produce sustainable short-run economic gains made
economic reforms an easy target for extremist groups
• US-led initial reforms did not lead to second stage of Iraqi-led
institutional reforms but, instead, created a vacuum that was filled by
existing organized religious and criminal groups
• The incomplete reforms and inadequate price controls created
profitable Black Market opportunities
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Sachs: Patterns of Development I
• Sachs approach not a stage theory like Porter
• Rather wants to tailor make analysis to groups of
countries that share unique environments
• Identifies five different patterns of development –
each related to
• underlying geography,
• economic policies and
• resource endowments
• Group 1: Endogenous growth – (similar to Porter’s
final stage)
• Countries have self sustaining increases in income generated by
technological innovation
• Innovation raises national income, which in turn stimulates
further innovation in a positive feed-back process
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Sachs: Patterns of Development II
• Group 2: Catching up Growth (similar to Porter’s
intermediate stage)
• Countries with low-level technology and incomes narrows the
income gap with the higher technology and richer countries
through a process of technological diffusion and capital inflows
• Group 3: Resource Based Growth
• Economies experience cycles of per capita income mainly as the
result of resource booms and busts
• Group 4: Malthusian Decline
• Countries in this group often have falling per capita income
caused by population pressures outstripping the carrying
capacity of the local economy
• Country neither innovating nor successfully adopting
technologies from abroad
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Sachs: Patterns of Development III
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Sachs: Patterns of Development IV
• Group 5: Economic Isolation
• Economic disadvantage that results from an economy’s
physical or policy-induced isolation from world markets
• Policy Implications for Each Group
• Group 1: Endogenous growth countries
• Innovation rather than capital accumulation the main
factor in growth and income increases
• In theory
• These countries might not hit diminishing returns but
• Could accelerate growth over time through investments in R&D,
knowledge bases and education
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Sachs: Patterns of Development V
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Sachs Patterns of Development VI
• Group 2: Catching up Countries
• Growth greatly influenced by technological diffusion from
abroad
• Problem: countries that rely wholly on imported
technologies will lag behind technological innovators even if
they are able to absorb new technologies of the leading
countries at a high rate
• Therefore should strive to support home-grown innovation
to eventually become endogenous growth economies in
their own right
• Typically requires
• substantial public investment in education and government scientific
laboratories
• carefully designed laws governing intellectual property rights
• increased interaction of government laboratories, universities and
private business
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Sachs: Patterns of Development VII
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Group 3: Resource based growth
In the past half century natural-resource-rich countries have
faired poorly -- generally growing less rapidly than resource scarce
economies
Several theories offered:
• Prebisch theory –
• natural resource economies vulnerable to a secular loss in the terms
of trade
• caused by technological innovations in leading countries leading to
substitutes for natural resources
• Dutch Disease effects
• Strengthening of exchange rates in boom years leads to loss of
competitive exporting countries, overdependence on resource rents
• Failure of Governance
• Much time and effort spent rent-seeking
• Institutions to sustain non-resource development not developed
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Sachs: Patterns of Development VIII
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Resource Economies - best strategies
Diversify – lay foundation for non-resource development
Entails investing in human capital
Strong exchange rate will not block new sectors if skills of
labor force are also increasing
Group 4: Malthusian Decline Countries
Many experiencing long-term decline in living standards
that transcends terms-of-trade shocks of cyclical
phenomena
Often severe demographic pressures due to high birth rates
Many African countries facing infectious diseases and low
levels of food production
Vicious cycle of undernourishment and vulnerability to
diseases
Need to break cycle before development can proceed
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Sachs: Patterns of Development IX
• Group 5: Economically Isolated Countries
• Problem: sea based freight still the cheapest form of
international transportation
• Countries far from coastal ports face tremendous
burden in shipping bulky products
• 28 landlocked countries with a population of at least
one million
• None are rich or growing rapidly on a consistent basis
• Hindered by geographical location
• Foreign investors do not view these countries as
effective platforms for export oriented investment
• Hard to attract kind of assembly operations which
have been important stepping stones in countries with
more favorable location
• New information technologies may be best strategy –
requires large investments in education.