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THEORIES OF ECONOMIC DEVELOPMENT

Pre-Industrial Revolution. Diminishing returnsLittle technological changeLittle growth in per capita incomeAngus Maddison studiesWorld GDP per capita (1990 $s)Year 0$425Year 1000$420 (collapse of Roman Empire)Year 1500$545Year 1820$675 (Capitalist Epoch)Year 1995$5,180. Adam Smi

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THEORIES OF ECONOMIC DEVELOPMENT

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    1. THEORIES OF ECONOMIC DEVELOPMENT

    2. Pre-Industrial Revolution Diminishing returns Little technological change Little growth in per capita income Angus Maddison studies World GDP per capita (1990 $s) Year 0 $425 Year 1000 $420 (collapse of Roman Empire) Year 1500 $545 Year 1820 $675 (Capitalist Epoch) Year 1995 $5,180

    3. Adam Smith-Optimistic Wealth of Nations (1776) Division of labor ? Specialization ? Greater productivity ? More income & wealth ? Accumulation of capital ? ... Limited by extent of the market - exchange More economic freedom-free trade Little technological change Production for consumption (human well-being)

    4. Thomas Malthus-Pessimistic Essay on the Principle of Population (1798) Economics is the “dismal science.” (Carlyle) Known for his population theory Population growth geometrically and food grows arithmetically. Diminishing returns As income rises, population rises causing per capita income to fall back to subsistence.

    5. Malthus Population growth geometric 1,2,4,8... Food growth arithmetic 1,2,3,4,... Subsistence std of living Positive Checks-death, famine, disease, war. Preventive Checks-moral restraint, delay marriage. Not consistent with evidence overall – tremendous growth in per capita income over last 200 years.

    6. David Ricardo-Pessimistic British political economist Developed idea of “comparative advantage.” Strong supporter of free trade. Diminishing returns Pop? D(food)? P(food)? Rent? (landowners benefit capitalists & workers do not) “Iron law of wages” never above subistence

    7. Karl Marx-Pessimistic/Optimistic Communist Manifesto & Das Kapital Historical materialist – History is about changes in the “mode of production” feudal?capitalism?”dictatorship of proletariat” (socialism)?full communism Capitalist phase is most dynamic and revolutionary using new technologies and globalizing. While dynamic, economy is punctuated by increasingly severe crisis that ultimately bring down the capitalist system.

    8. Joseph Schumpeter-Optimistic Austrian economist who taught at Harvard for many years. Dynamic model of the capitalist process. Capitalism as “creative destruction.” Entrepreneur is transitory monopolist earning monopoly profits. Entrepreneur is key to technological change.

    9. Harrod-Domar Model ß? = K/Y constant capital-output ratio. Therefore, ß=?K/?Y. S=sY=I=?K. Using (2) ß?Y=?K=sY. Divide by Y gives: ß?Y/Y=?K/Y=sY/Y=s.

    10. 6. Solve for ?Y/Y=s/ß=g where g is growth rate of output. 7. So now we have g=s/ß. 8. Example, assume ß=4, s=12% then g=3%. Remember in closed economy investment rate equals saving rate. 9. If target growth rate is 6% we have to invest 24%.

    11. 10. We have a financing gap of 12% or 24%-12%. 11. We fill that with foreign aid. 12. That’s the theory. Simple and persuasive except its assumptions are unrealistic. It assumes ß is constant and K/L ratio is constant. No role for technological change.

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