Economic Development: From Poor To Rich

With strong reference to empirical evidence, analyse critically whether this statement is correct: ‘Economic Development may not be a gradual process of convergence by all countries and countries will move sequentially from a group of poor countries to the group of rich countries’

Introduction

Economic development has become the recent focus of attention for governments around the world. Todaro and Smith (2003) state that in strict economics terms economic development refers to the capacity of a national economy, whose initial condition has been more or less static for a long time, to generate and sustain an annual increase in its Gross National Product (GNP) at rates of 5%-7% or more. In addition to the above, it is also a planned alteration of the structure of production and employment in a manner where there is a shift from agricultural dependence to industrialisation, as well as, it should indicate an improvement in certain social indicators like, gains in literacy, schooling, health conditions and services, were also seen as principal measure of development.

The definition of economic development has evolved over the years. However, empirical evidence indicated that while economic growth levels were achieved by the developing nations, but it failed to improve the standard of living of the people. As a result economic development was redefined to incorporate reduction or elimination of poverty, inequality and unemployment within the growing context of a growing economy.

The following paper will analyse whether economic development is a sequential process or a gradual process of convergence. The arguments will be supported by empirical studies conducted in the area.

It must be highlighted that in 1950s and 60s development was seen as a series of successive stages of economic growth. It was considered to be an economic theory of development in which the right quantity and mixture of savings, investment, and foreign aid were the vital components, necessary to enable developing nations to move along an economic growth path that historically had been followed by the more developed countries. Development had become synonymous with rapid economic growth. This approach was commonly known as the linear stages approach (Lewis and Harrod-Domar model), which was replaced in the 70s by two competing economic ideological schools of thought. The first, which focused on theories and patterns of structural change; modern economic theory and statistical analysis were used to portray the internal process of structural change that a typical ‘developing’ country would undergo to succeed in generating and sustaining a process of rapid economic growth. The second, the international dependence revolution, was more radical and political in orientation. It viewed underdevelopment in terms of international and domestic power relationships, institutional and structural economic rigidities.

Amongst the other theories that explain economic growth, structural change theory focuses on the mechanism by which underdeveloped economies transform their domestic economic structures from a heavy emphasis on traditional subsistence agriculture to a more modern, more urbanized and more industrially diverse manufacturing and service economy. It employs the tools of neoclassical price and resource allocation theory and modern econometrics to describe how this transformation takes place.

In the Lewis model the underdeveloped economy consists of two sectors characterised by a traditional overpopulated rural subsistence sector and zero marginal labour productivity. Thus according to the Lewis model, the primary focus of the model was on the process of labour transfer and the growth of output and employment in the modern sector.

Although the Lewis two-sector development model is simple and roughly reflects the historical experience of economic growth in the west, however, it has been argued that its key assumptions do not fit the institutional and economic realities of contemporary developing countries. The assumption that the rate of labour transfer and employment creation in the modern sector is proportional to the rate of modern sector capital accumulation; the faster the rate of capital accumulation, the higher the growth rates of the modern sector and faster the rate of new job creation is not always true. Secondly, the notion that surplus labour exists in rural areas while there is full employment in the urban areas has also been questioned. Most contemporary research indicates that there is little general surplus labour in rural locations. Thirdly, the notion of a competitive modern-sector labour market that guarantees the continued existence of constant real urban wages up to the point where the supply of rural surplus labour is exhausted has also been criticised on the grounds of being unrealistic.

Patterns of development analysis like the earlier Lewis model is the one, focused on the sequential process through which the economic, industrial, and institutional structure of an underdeveloped economy was transformed over time to permit new industries to replace traditional as the engine of economic growth.

Studies conducted by Chenery during post war period led to identification of several characteristic features of the development process. These included the shift from agricultural to industrial production, the accumulation of physical and human capital, the change in consumer demands from emphasis on food basic necessities to manufactured goods and services, the growth of cities and urban industries as people migrate from farms and small towns, then decreasing in the process of development.

Empirical studies conducted on the process of structural change conclude that the pace and pattern of development varies according to domestic and international factors, which lie beyond the control of an individual developing nation. Despite this variation, structural change economists argue, that patterns can be identified by observing the choice of development policies and international trade and foreign assistance policies pursued by Less Developed Countries’ (LDC) governments and developed nations, respectively.

Kuznet isolated six characteristic features manifested in the growth process of almost every developed nation:

• High rates of growth per capita output and population
• High rates of increase in total factor productivity
• High rates of structural transformation of the economy
• High rates of social ideological transformation.
• The propensity of economically developed countries to reach out to the rest of the world for markets and raw materials.
• The limited spread of this economic growth to only a third of the world’s population.

Kuznet suggests that high rates of per capita results from the rising levels of factor productivity. High per capita incomes in turn generate high levels of per capita consumption, thus providing the incentives for changes in the structure of production. Furthermore, advanced technology needed to achieve output and structural changes causes the scale of production and the characteristics of economic enterprise units to change in both organisation and location. This in turn necessitates rapid changes in the location and structure of the labour force and in status relationships among occupation groups.

Kuznet suggested that rapid economic growth makes possible scientific research, which in turn leads to technological inventions and innovations, which propel economic growth even further.

Puga and Venables (1998) strongly believe that economic development may not be a gradual process of convergence by all countries. They argue that both import substitution and unilateral trade liberalisation may be successful in attracting industry, however, they attract different sectors and they believe that welfare levels are higher under trade liberalisation. According to the paper produced by Puga and Venables (1998) the logic of spatial agglomeration implies that development cannot proceed simultaneously in all countries. Instead there is a group of rich countries and a group of poor ones, and development takes the form of countries being drawn in turn out of the poor groups, and taken through a process of raid development into the rich group.

It must be highlighted that the position of developing countries today is significantly different from that of the currently developed countries when they embarked on their modern economic growth. Todaro and Smith have identified eight significant differences in initial conditions that require special analysis of the growth prospects and requirements of modern economic development:

–         Physical and human resource endowments

–         Per capita incomes and levels of GNP in relation to the rest of the world

–         Climate

–         Population size, distribution and growth

–         Historic role of international migration

–         International trade benefits

–         Basic scientific and technological research and development capabilities

–         Stability and flexibility of political and social institutions.

Contemporary developing countries are often less well endowed with natural resources than the currently developed nations were at the time when the latter nations began their modern economic growth. A few developing nations have abundant supplies of natural resources like petroleum, other minerals, and raw materials for which world demand is growing; most less developed countries especially Asia are poorly endowed with natural resources. Another important element is a country’s ability to exploit its natural resources and sustain long term. The ingenuity of managerial and technical skills of its people is an important factor on which economic growth is dependant.

Amongst many proponents of sequential progress the empirical studies provided by Murphy, Shleifer and Vishny (1998) in their ‘big push’ model also highlights, that increasing modern sector employment leads to an increase in the aggregate demand, thereby increasing profitability of modern sector firms. The one major assumption in their model was that the economy was a closed economy. This can be regarded as a criticism for the model because in the real world closed economies do not exist. Puga and Venables argue that a completely homogeneous process of economic growth for each country in the same proportion will not have any spatial effects. However, if demand for manufacturers rises faster than demand for agriculture, the relative price changes would occur which will trigger industrial relocation.

Several criticisms have been presented for the theories related to convergence. Ron Martin (1999) presented criticism of the predictions of long-run regional growth and convergence made by economists associated with geographical economics by using a reformulation of the neo-classical growth model. The standard neo-classical (Swan-Solow) growth model assumes diminishing returns to capital and labour, and holds that a relatively poor country with a lower stock of capital per worker has a higher marginal productivity of capital and a higher rate of return to capital. Thus, it predicts that poorer countries will grow faster than, and eventually catch up with, richer countries. However, while application of a new variant of the model at cross-regional level, where absolute convergence is more likely to occur because of relative homogeneity in structural, technological, institutional and social characteristics, has revealed that the rate of regional convergence is similar across the United States, the European Union, Canada, Japan, China and Australia, the rate (12 % per annum) is much lower than that which the neo-classical growth model predicts. The implications are, as Martin deduces, either that returns to labour and capital are non-diminishing, or diminish very slowly, or that interregional spillovers of capital, labour and technology are much less than expected, and hence that there are endogenous effects in regional growth (Martin, 1999).

Conclusion

Empirical studies conducted have presented various explanations for economic development. Some regard it as a sequential process, come regard it as a convergence process. However, none of the theories are without its flaws. A blend of all the factors would be essential for development. Measures are being taken in the direction to record data and statistics however, like everything every developing and less developed economy would have to follow the path of development. Thus from the preceding paragraphs it can be concluded that economic development may not be a gradual process of convergence by all countries and countries will move sequentially from a group of poor countries to the group of rich countries.

Bibliography

• Gwartney, James D., Stroup, Richard L., and Sobel, Russell S., Economics Private and Public Choice, (2000), Ninth Edition, The Dryden Press.
• Meier, G.M. and Rauch, J.E., Leading Issues In Economic Development, (2000), Seventh Edition Oxford University Press
• Perkins, Radelet, Snodgrass, Gillis and Roemer, Economics of Development, (2001), Fifth Edition, Oxford University Press.
• Sheffrin., Steven M., and O’Sullivan, Arthur, Microeconomics: Principles and Tools, (2001), Second Edition, Prentice Hall
• Taylor, John B., Principles of Economics, (1998), Second Edition, Houghton Mifflin Company
• Todaro, M.C. and Smith S.C., Economic Development, (2003), Eighth Edition, Pearson Addison-Wiley

Journal and Articles

• Puga, D. and Venables, A.J., Agglomeration and economic development: Import substitution vs. trade liberalisation, (1998), Centre for Economic Performance, Discussion Paper No. 377

Other Sources

Todaro, M.P. and Smith, S.C., Economic Development, Eight Edition, Pearson Addison-Wiley (2003), pp8-17