Hello and welcome to lecture 8 of the NPTEL
MOOC’s course on Economic Growth and Development.
We are continuing with the discussion on the
Strategies of Various Economic Development
and Growth Models.
In the last class, we looked at the Model
of Balanced Growth and the Unbalanced Growth.
The Balanced Growth Strategy has mostly been
forwarded as a doctrine. And the challenges
posed to the Balanced Growth Model in the
form of Unbalanced Growth Strategy was also
discussed in the last class. The last class
was planned in such a manner that in the beginning
we started with discussion of a few basic
concepts. We looked at who saves, who invest.
We went into some conceptual clarity with
regard to the concept of savings and investment.
We also looked at some of the basic concepts
that are used in economics to be able to understand
growth models such as the Marginal Private
Cost, Marginal External Cost and the Marginal
Social Cost. And we also saw how they give
rise to external economies and also externalities
as we understand them in economics.
After initiating some of the basic concepts,
we looked at the balanced growth doctrine
proponents. In lecture 5, we had gone into
the details of Ragnar Nurkse’s contribution
to balanced growth doctrine. In the last lecture,
in lecture 7 we looked at the contributions
of Rosenstein Rodan and Arthur Lewis. We saw
that Rosenstein Rodan had come up with a formulation
of the Balanced Growth Model particularly,
in the context of Eastern and South-east European
countries. He was posing it as a problem of
underdevelopment of these countries which
were completely cut off from foreign investments.
And he was looking at international division
of labour and how complementarities in demand
and supply can be created for the large agrarian
labour force existing in the Eastern and Southeastern
European countries.
We also looked at the prepositions of Arthur
Lewis in which he was talking about balanced
growth or balanced development between different
sectors such as agriculture manufacturing
and the international trade sector or the
foreign as far as the exports are concerned.
So, what we were basically trying to do as
a part of balanced growth doctrine was that
we saw that there are different forms of strategies
that have been proposed as a part of this
doctrine. And there are a lot of differences
in the way this doctrine has been proposed.
However, in the standard economic literature
they are all put together in the form of Balanced
Growth Doctrine.
A large part of last class was also devoted
to the challenges posed by the Unbalanced
Growth Strategists. And in the Unbalanced
Growth Model, we looked at mainly Albert Hirschman’s
contribution to the Unbalanced Growth Strategy.
Although we in passing discussed that there
are various proponents and some of the 3 most
important proponents are Hirschman, Singer
and Paul Streeten.
As far as Hirschman’s thesis of unbalanced
growth strategy is concerned, he was more
for creating of imbalances within the economy
through creation of convergent series of investments
or divergent series of investments. And his
proposal was that convergent series of investment
are something which are largely taken by the
private entities, the private enterprises.
The divergent series of investments are taken
up by the public agencies. And the question
was to choose which path of development will
create a smooth process of economic development.
And his proposition was that this can be done
by creating investments through excess capacities,
by creating infrastructures like Social Overhead
Capital, or creating shortages by investment
in Directly Productive Activities taken up
by the private firms.
So, essentially what he was proposing was
that if Social Overhead Capital is created
in the beginning, then the private entities
will be able to take advantage or appropriate
the economies of scale that are created by
the Social Overhead Capital. And it will be
easier for them to invest in Directly Productive
Activities and hence create output for final
consumption. However, if investments are first
made on Directly Productive Activities by
creating shortages of Social Overhead Capital,
then it will be difficult for the private
entities to carry on with investments because
they have to put the political pressure back
on the governments to be able to create Social
Overhead Capital.
And the economic system works in such a manner
that it is essentially difficult to carry
out investments in Social Overhead Capital
after creation of Directly Productive Activities
or output through Directive Productive Activities.
So, the best way forward that was proposed
by Professor Hirschman was to be able to ensure
that there is massive government investments
in Social Overhead Capital, which will then
create more output and the development path
can then move on to Directly Productive Activities,
ultimately leading to a growth of National
Income or Gross National Product.
After the proposition made by Hirschman with
regard to investment in Social Overhead Capital,
we also looked at Hirschman’s focus on carrying
out investments in only those industries which
have the maximum linkages. So, he was talking
about identifying industries which have forward
linkages and backward linkages. So that simultaneous
investment can be carried out in various industries.
So, it was important that we look at the total
linkages that are being created in the economy
by adding up the backward linkages and the
forward linkages.
Now, in today’s lecture we will focus on
Schumpeter’s Analysis of Growth and Rostow’s
Stages of Growth Theory. In the last class,
I had given you a snapshot or a timeline of
development thinking that has come to be since
the late 19th century. And if you look at
the timeline of development thinking, we can
probably put Schumpeter’s Analysis of Growth
in the category of development thinkers that
looked at development as Universal History.
And of course, Rostow’s Stages of Growth
is one of the most important structural models
of growth that have come to be.
So, this class is divided into two and is
planned in such a manner that I will be focusing
on two strategies of development or growth
if you may like to call them. One is Schumpeter’s
Analysis of Growth, the second is Rostow Stages
of Growth. And after discussing the major
characteristics of these two strategies of
development, I will again go back to clarifying
some of the basic concepts that are important
to understand growth models and that are important
to understand lectures in economics. And this
is for the benefit of all students coming
from different disciplines.
Joseph Schumpeter can be identified as a political
economist and he lived between 1883 and 1950.
He was an Austrian economist. And later went
into Harvard and settled in the USA. His major
influences surround the ideas of what we today
know as evolutionary economics. He has also
written widely on the history of economic
analysis. Towards the later part of his career,
he was writing on business cycles engaging
a lot with Keynesian economics and taking
from Marxian study on capitalism, he also
had a great deal to say about the demise of
capitalism. However, the large part of his
focus was on entrepreneurship and innovations.
And some of you who are conversant with some
of the basic text books of microeconomics
would know that when we are introduced to
the study of factors of production, the most
common example of factors of production that
are taken up are land, labour and capital.
And many of you would see that in the later
years, the term organization also started
getting added on to the very basic factors
of production. This term organization or entrepreneurial
activities within the economy that is a crucial
factor of production, is the contribution
of professor Schumpeter to economic analysis.
Now, consider this situation; that in the
early 1960’s Ghana and South Korea were
almost at similar levels of development. However,
South Korea, the East Asian country went on
to become one of the most industrialized countries
of the world whereas, Ghana continue to be
one of the most underdeveloped African countries.
South Korea advanced to such a great degree
that it ended up providing developmental aid
and assistance to many African countries.
Whereas, Ghana has gone through a series of
frustrating coups that has seen economic stagnation
and negligible participation in the global
trading system in spite of they having gold
mines and world class cocoa plantations. So,
these images basically talk to us about inequality
existing in the world.
Now, if one has to talk about economic transformation
taking place or inequalities getting bridged,
this is not a thesis which emerged most recently.
Professor Schumpeter can be given the credit
of talking about economic transformation well
ahead of time. And the seeds of rapid economic
transformation, the ideas of rapid economic
transformation he brought out in his seminal
work in the form of a book which came out
in 1911, titled ‘The Theory of Economic
Development: An Enquiry Into Profits, Capital,
Credit, Interest and Business Cycle’.
So, this book was considered to be ground
breaking. In this book Schumpeter outlined
a very important role of innovation and entrepreneurship
in economic development. He was in fact, making
a very bold attempt in departing from the
existing theories of economic equilibrium
that dominated classical economics texts of
this time. And Schumpeter’s work was appropriately
called “the Theory of Economic Development”
because it described a world that is analogous
to large parts of today’s emerging countries.
In fact, Schumpeter’s ideas on entrepreneurship
and innovation have been largely talked about
in the context of the emerging countries.
At first glance it would appear that the lack
of application of Schumpeter’s ideas to
emerging countries was a historical oversight,
given that most of them were colonies at the
time of his writing. However, these countries
were desperately searching for alternative
development models that would free them from
dependence on their former colonial masters.
Now, Schumpeter was writing during the ascendancy
of neoclassical economics. And neoclassical
economics placed considerable emphasis on
mathematical equilibrium models and Schumpeter
was constantly rejecting them. He tried to
frame economic development as an evolutionary
process. So, he was laying the foundations
of looking at economics as a very complex
system. It is therefore, not surprising that
Schumpeter’s work has been consistently
excluded from compilations of studies on economic
development. Although, it has seen reemergence
in the 1990's particularly with the coming
in of the new growth theory and growth models
where the emergence of the knowledge economy
in contributing to economic growth and not
just human capital formation.
Schumpeter’s of course, he has written widely
on this subject till his death in 1950.
But some of the most important ideas with
regard to Schumpeter’s theory of economic
development that are discussed are the following.
The one is circular flow. Second is the role
of entrepreneur or the role of entrepreneur
as a change agent. The third is the cyclical
process or business cycle and the fourth is
end of capitalism. Schumpeter, taking from
Marx was also talking about the end of capitalism
through the process of what he liked to call
as creative destruction.
Now, what is this complex system? The economy
as a complex system that Schumpeter was talking
about? Schumpeter was mostly concerned with
overall system transformation in the same
way that his critics wanted to see rapid economic
change in emerging countries. So, he pioneered
the application of complex systems thinking
to economic development. And he was mostly
concerned at looking at development or change
over time, which is why he adopted and evolutionary
approach that recognize the importance of
history.
Now, his idea was that there is static equilibrium
which the neoclassical economics were also
talking about. And what were the major characteristics
of this static equilibrium? There is a circular
flow that is taking place within this model.
A first is that there are economic activities
taking place in the static equilibrium model.
And these economic activities are essentially
repetitive and they follow familiar routine
course. So, there is a group of suppliers
and there are group of the producers and consumers.
All the producers know aggregate demand for
goods and they adjust the supply of output
accordingly. This means demand and supply
are in equilibrium at each point of time.
And the production processes are such that
the economic system is producing an optimum
level of output at its maximum use and there
is no possibility of wastage of resources.
And the firms are working in a state of competitive
equilibrium. Under the stationary equilibrium
situation, the prices are equal to the average
cost.
And this is the circular flow of economic
activities that is taking place within this
static settings.
Now given the statics setting, he proposes
that to make it dynamic and consistent with
development, changes must take place in the
flow system. Changes must take place in this
equilibrium system and these changes can be
brought through innovations. When he is talking
about innovations, he is talking about different
kinds of innovations here. There maybe innovation
in terms of introduction of a new product
or there may be introduction of a new method
of production or opening up of new markets
or finding new sources of supply of raw materials
and semi-manufactured goods or carrying out
of new organization of an industry like the
creation of a monopoly.
Definitionally when he was talking about innovation,
he basically meant that there is a change
in the existing production system and that
is to be introduced by the entrepreneur with
a view to making profits and reducing costs.
So, this concept of innovation is closely
linked with Schumpeterian concept of development.
Some of the key elements here are that first,
he considers the process of economic development
to be endogenous and driven by the creation
of new combinations including new products,
new production methods, new organization forms,
new markets, new sources of raw materials
and inputs. And second these combinations
are carried out by entrepreneurs who are motivated
to undertake certain actions.
Thirdly the entrepreneur is a change agent
here, whose actions disturb the static equilibrium
that we have just discussed before, the steady
state and they cause economic discontinuities.
And finally, there will be the emergence of
credit providing institutions such as the
government that play a key role in stimulating
entrepreneurial activities. In his view, it
is the credit providing institutions that
take risk by providing funding to entrepreneurs.
Let me repeat this system of circular flow
proposed by Schumpeter once again. So, he
is giving a very key role to entrepreneurs
and innovations in creating disequilibrium
within this circular flow system. And like
the neoclassical economists, he is also beginning
his analysis with a static equilibrium position.
And the static equilibrium position is a competitive
equilibrium by the producers and the consumers
are in full information about what is happening
in the market. The producers know what is
the aggregate demand for goods and they have
adjusted the supply of output accordingly.
Therefore, there is a demand and supply equilibrium
at each point of time. And the economic system
is producing optimum level of output and there
is no wastage of resources anywhere which
means that there is full employment equilibrium
in this system.
Now, given this circular flow of economic
activities that is happening within this competitive
equilibrium system, if there is something
that needs to make it dynamic and consistent
with development, if economic development
has to take place, some kind of creative destruction
must happen. And this creative destruction
or these changes can be brought through the
role of innovations. And innovation have to
be carried out by the entrepreneurs is what
his preposition is. And this innovation can
be of various kinds, the innovation can be
in the form of a new product or new production
processes, it can be identification of new
markets, finding of new markets, finding out
new sources of supply of raw materials and
semi manufactured goods and so on and so forth.
And there are certain special characteristics
that this entrepreneur or innovator is supposed
to be possessing in the Schumpeterian analysis
of the process of development. The entrepreneur
occupies the central place in the development
process because he initiates development in
a society and carries it forward. And he is
very cautious in telling us that entrepreneurship
or entrepreneur is very different from managerial
activities of the organization. It is not
that the organization has staff and there
are managerial activities being carried out
by the staff, the entrepreneur is someone
who is the risk taker and who is much superior
than the managerial staff carrying out their
everyday managerial tasks. The entrepreneur
is someone who gets a lot of joy out of creating,
getting things done or simply of exercising
his energy and ingenuity.
And there are a number of things that are
necessary for the performance of this entrepreneurial
function. The one is of course, there should
be proper technical knowhow. It should be
available to the entrepreneur for introducing
new products and new combinations of factor
products. Capital resource should be made
available to the entrepreneurs through the
banks and other financial institutions because
credit is one of the factors that enables
the entrepreneur to buy producer’s goods
which he needs for conducting of new experiments
and innovations.
There is also role of profits as far as the
function of the entrepreneur is concerned.
Why does an entrepreneur innovate? The entrepreneur
innovates because he wants to earn profits
and profits are conceived as a surplus over
costs here, a difference between the total
receipts and outlay. So, profits arise due
to the dynamic changes resulting from an innovation.
So, the static equilibrium constitutes a circular
flow and to be able to break this circular
flow some amount of dynamism needs to come
into the system, into the static equilibrium
model. And this dynamism can come in by breaking
the circular flow by bringing in innovations
and providing a key role to the entrepreneur.
So, his theory of economic development basically
says that, economic development itself is
a dynamic and discontinuous process and society
progresses through trade cycles. And in order
to break the circular flow, the innovating
entrepreneurs are financed by bank credit
expansion. Schumpeter took example of the
emergence of railroads as one of the ways
in which creative destruction can take place.
Schumpeter’s destructive model was railroads,
which is the key infrastructure that had profoundly
transformed the world he studied. For Schumpeter
railroads were not just a source of economic
development, but also a driving force in improving
human welfare. And now, rail road expansion
did not involve creating new technologies
but deploying existing ones.
What did it involve? It involved the leadership
of groups in successfully dealing with politicians
and local interest, in the solution of problems
of management and of development in the regions
of the roads opened up. So, the entrepreneurial
function was performed by either individuals
or groups of people whose tasks were unrelated
to the act of taking financial risks. So,
Schumpeter’s example of railroads has two
important policy implications. First is that
it underscores the importance of physical
infrastructure in emerging countries. And
such infrastructure and the associated institutional
changes creates opportunities for entrepreneurs
not only to participate in its construction,
but also to expand opportunities for new businesses.
The second implication is that infrastructure
transforms the economic system in a discontinuous
way by not only disrupting previous economic
practices but also by expanding opportunities
for new economic combinations. In his later
writings Schumpeter also brought in the idea
of business cycle largely influenced by Keynes.
.
And in however, Schumpeter approach to business
cycle is historical and statistical and analytical.
He believed that it is not just economic factors
that contribute to the operation of the business
cycle or a crisis, but also noneconomic factors.
And Schumpeter concluded that crisis is the
process by which economic life adapts itself
to the new economic conditions. He was often
making reference to economic sociology. And
he was saying that there is a lot of non-economic
factors that go on to the creation of business
cycles within the economy. So, he was also
talking about the boom periods and the depression
periods. During the boom period, the new product
start appearing in the market with the entrance
of new entrepreneurs. The old ones disappear
and consequently the prices of old products
fall, but that also leads to a decline in
investment and leads to unemployment. And
therefore, there is a fall in aggregate demand
within the economy giving rise to uncertainty
and risks. And then a wave of pessimism sweeps
the entire economy, the boom periods end and
the depression phase starts.
Schumpeter believed in the existence of long
waves of upswings and downswings. And once
the upswing ends according to him, the long
wave of downswing begins and the painful process
of readjustment starts. And the economic forces
of recovery come into operation and ultimately
bring about a revival.
Drawing from Marx, Schumpeter was also talking
about the end of capitalism. However, there
is a difference between Marxian theory of
end of capitalism and Schumpeter’s analysis
of the end of capitalism. Marx was basically
talking about the overthrow of capitalism
by a class of proletarians. But Schumpeter
was talking about the end of capitalism because
of institutional decay within capitalism.
And these were some of important points that
he was trying to make, first is the obsolescence
of the entrepreneurial function. Schumpeter
observed that the success of early captains
of industry have made innovation a routine
activity. It tends to degenerate into a dis-personalized
routine activity carried on in a business
through trained managers. Therefore, the entrepreneurial
function itself decays. There may be destruction
of institutional framework which was another
factor responsible for weakening the foundations
of capitalism. The entrepreneur by his own
success may tend to destroy not only his economic
and social functions, but also the institutional
framework within which he works. And another
way in which this may become possible is the
destruction of protecting political strata.
With the progress of capitalism not only the
functions of the entrepreneur and the institutional
framework of capitalism crumble, but the group
that protected early capitalism politically
is also destroyed.
So, basically how do we fit Schumpeter’s
Analysis of Economic Development within the
larger canvas of growth and development? In
the larger canvas of growth and development
we can categorize Schumpeter under the development
thinkers who looked at development as universal
history. That the reason that economic development
can be analyzed in an evolutionary process.
And Schumpeter was giving a very big role
to innovations and the entrepreneur. He says
that in a static equilibrium where the producers
and the consumers are in a static equilibrium,
where demand is equal to supply and there
is full employment of resources, there is
no resource wastage taking place in the economy,
economic development can take place only if
there is constant dynamism within the economy.
And this dynamism can be provided not just
by human capital formation but by the role
played by a superhuman, a superhuman who is
basically in the form of an innovator or an
entrepreneur. So, that was the importance
he was giving to entrepreneurship. And through
this formulation he was trying to lay a lot
of emphasis on the idea of human capabilities
and government intervention or government
support that should be provided to the private
entrepreneur to be able to take the risks
and create discontinuity within the economy
by disturbing the static equilibrium and bringing
about economic development.
In his later writings he started writing about
business cycles, but he was one of the economists
who was giving a lot of importance to non-economic
factors that may create business cycles. So,
this is how we can sum up Schumpeter’s analysis
of economic development, that it is innovations
and support to innovations that can bring
about economic development within a country.
However, if we look at the debate of the development
of the 1950's and the 1960's you would see
that a very little attention has been given
to Schumpeter’s ideas and particularly in
the context of the emerging countries. And
the core of the rejection was basically an
epistemological clash between Schumpeter’s
systems approach to economic transformation
and that of his critics who are dear to a
more static linear and incremental view of
economic change. So, Schumpeter central themes
of innovation and entrepreneurship focused
on endogenous transformation and evolution
of economies while his critics who focused
on the importance of central planning relied
on equilibrium models reflected in the role
of bureaucracies as economic sources of stability.
Now, after having looked at the basic ideas
of Schumpeter, let us now move on to Walt
Whitman Rostow. In the last class we categorised
Rostow as one of those thinkers, who proposed
classical theories of economic development,
who looked at linear Stages of Growth models.
And Rostow was one of those very influential
thinkers of the 1950's and 1960's, who viewed
the process of development as a sequence of
historical stages. And this view was largely
popularized by Rostow. And he was writing
after the Second World War and he proposed
his Stages of Growth theory as a non-communist
manifesto which is supposed to bring about
a modern economic history under capitalism.
Rostow was introducing theory of growth in
five universal stages. And his proposition
was that, all countries will necessarily pass
through these five stages. So he was building
on a historical pattern of the then developed
countries and his claim was that transition
from underdevelopment would necessarily pass
through these 5 stages.
That of the traditional society, the pre-conditions
for take-off, the period of takeoff, the drive
to maturity and the age of high mass consumption.
And the decisive stage is the take-off stage
through which developing countries are expected
to transit, considered to be necessary to
induce per capita growth.
So, basically his proposition was that and
this was based upon the experiences of the
then developed countries at the time when
the debate on growth and development was taking
momentum. These are necessarily the 5 stages
the countries will pass through. And let us
look at what are the characteristics of these
5 stages and let me also bring to your attention
at this point that a lot of discussion has
gone on with regard to various country categorizations
that whether they have reached the take off
stage and what happens after the take-off
stage.
So, there is a lot of debate and literature
surrounding this idea of take-off and whether
some countries have taken off and if some
countries took off, what are the conditions
or what are the pre-conditions under which
they took off and if some countries have not
taken off, what are the conditions under which
we could not take-off. So, let us now look
at some of the characteristics of each of
these 5 universal stages that Rostow was talking
about. The first he was talking about a traditional
society. A traditional society is one of the
simplest and primitive forms of social organization.
And the major characteristics of this traditional
society are that they have very low per capita
incomes and there is a very limited range
of available technology and there is the low
ceiling per of per capita output. Second important
characteristic was that a very large proportion
of the workforce in this society is employed
in agriculture. And they are devoted in the
production of agricultural goods. High proportion
of resources are also devoted to the agricultural
section. And a careful look at these characteristics
will tell you that most of the so-called underdeveloped
or less developed countries of the world qualified
to be categorized under this traditional society.
The third important point was with regard
to social mobility. That there is very less
mobility as far as the social status of individuals
within this traditional society is concerned.
In other words, the traditional society is
very hierarchical, hereditary, status oriented
social structure. In the Indian context you
can think of caste as one of the indicators
of the hierarchy that probably Rostow is talking
about. So, which means in a traditional society,
it is almost impossible for people to move
from one social hierarchy to another.
Another characteristic of traditional society
was political power. The centre of gravity
of political power is localistic, region bound
and primarily based on land ownership. So,
the more land ownership, the more the political
power. So, it is asset based land ownership,
it is not very democratic in nature.
And when the movement from the traditional
society to the pre-conditions for takeoff
stage takes place, then there are certain
progressive elements that must have creeped
into this otherwise barbaric and primitive
psyches of members of society. So, people
are trying to break free from the rigidities
of the traditional society and a scientific
attitude or a quest for knowledge and there
is a questioning mindset of people which is
emerging in such a society.
And what are the features of such a society?
There is economic progress, modern education
is being imparted to the people in the society.
So, economic progress becomes an accepted
social value and the change of human mind
is taking place as they are able to think
about their respective countries. New enterprises
are emerging. The objective is to establish
a firm or industry and produce output for
a long time. Investments are taking place,
new infrastructure is getting created. In
other words, modern science and technology
has made forays into the so-called traditional
society. And that provides the pre-condition
for take-off to the next stage which is the
state that all developing countries are supposed
to live to.
Apart from these characteristics the other
pre-conditions for takeoff stage is that creation
of credit institutions. Sufficient credit
institutions may be created. For example,
the banking system, the financial system,
so that investment can take place within the
economy. Mobilization of work force due to
industrialization: a large proportion of work
force can be shifted from agriculture to the
manufacturing sector. And this is something
which was experienced in Britain in the time
of industrialization and the post-industrial
period and so on.
Another characteristic is again the progress
of modern science and technology that can
bring down birth rates. So, medical science
is supposed to be slowly developing during
the pre-conditions to take-off. Citizens are
supposed to understand the essence of control
of birth rate and bringing down death rates.
At first the death rate is to be controlled
and then the birth rate is to be controlled.
So, the second stage is a stage of demographic
transition which is experienced by the developed
countries where population stabilizing because
both death rates and birth dates are declining.
Also, political power is centralized based
on nationalism replacing the land based localistic
or colonial power.
Now, after the pre-conditions of the take-off
stage, the take-off stage. It marks the transition
of the traditional society from a backward
to one which is on the verge of freeing itself
from the elements that bring down its growth.
And it is one stage in which there is a dynamic
change in the society and there is a meteoric
rise in the standard set by the members of
society in industry, in agriculture, science
and technology, medicine etcetera. And this
is the path of development that was taken
by the highly industrialized nations of the
world.
And for a large part of the 1950's and 1960's
development literature actually focused on
trying to device development policies or economic
policies that can at least bring about the
transition of the so-called less developed
countries from the traditional society stage
to the stage of take-off. So, there are certain
sophisticated characteristics of this take-off
stage as well.
First is the rate of investment. The take-off
stage should have very high rates of investment.
For this purpose and for example, in India
after the attainment of independence, rate
of investment was increased in the economy
by carrying out the policy of industrialization.
Then the second characteristic is development
of one leading sector. And invariably in the
take-off stage the sector which receives the
largest investment is the industrial sector
and existence of different frameworks in the
society. So, there is existence of political,
social and institutional framework which exploit
impulses to expansion in the modern sector
and the potential external economies affect
the take-off and give the process of growth
a sustained and cumulative character.
The 4th stage is the stage of drive to maturity.
Maturity in the context of Rostow’s theory
basically means that a society is advancing
on all fronts. And each and every effort to
stimulate the economy meets with success and
the time period when a society tastes success
is a rather long one and progress made on
all fronts is there to stay. There are certain
economic characters of this stage, one is
that there is a shift in occupational distribution.
For example, due to industrial revolution
many industries were established in Britain
and in Western European countries, the workforce
shifted from agricultural to the manufacturing
sector. This drive to maturity is one where
the shift from agriculture to the manufacturing
sector is taking place or has taken place
to a very large extent. And this is something
which is being seen, which was claimed being
seen in the context of many so-called underdeveloped
countries in the 1970’s and in the 1980's
when the boost to industrialization was taking
place.
The second economic character of this drive
to maturity, there is a shift in consumption
pattern. A new type of workforce gets created
that are termed as white-collared workers,
and they are mainly officials or managing
officials of factory’s governing body. Due
to high income, their preferences also shifts
from necessary to luxury goods. They consuming
more of comfort and luxury goods. As a result,
the consumption pattern of non-agricultural
goods also increases and this lead to development
of existing industries and variation in tastes
and preferences taking place more rapidly
in this period. There is also a shift in consumption
of the leading sector. The change in composition
was observed to vary from country to country.
For example, the Swedish take-off was initiated
by timber exports, wood pulp and paste-board
products followed by the emergence of railways,
hydropower, steel and animal husbandry and
dairy products.
So, different countries may experience different
kinds of development in this drive to maturity.
There has to be one leading sector which takes
the country, which moves the country towards
economic development.
There are certain non-economic factors of
the drive to maturity which were also identified
by Rostow. One is entrepreneurial leadership
which is one of the important drivers of this
stage in drive to maturity.
And the final stage of Rostow Stages of Growth
was the very high stage of mass consumption.
It is a consumerist society and there is very
high consumption of consumer goods and services
and so on.
Now, there is a lot of critique of the Stages
of Growth Theory and I like to pinpoint one
of the criticisms that has been dealt with
very severely in the 1990's and the 2000s
particularly is that, the Stages of Growth
that was propounded by Rostow has not been
uniform in the so-called developing countries
of the world. Even today we see the co-existence
of the traditional and the modern sector.
And this is something which is also the criticism
that was put forward as a challenge to Louis
model of Dual Sector of Agriculture and Industry.
So, there is a coexistence of the traditional
and the modern sector. So that take-off to
the high stage of growth, whether is only
high consumption of goods and services, a
highly consumerist society has actually not
taken place in many of the developing countries
of the world. Although as far as the highly
industrialized nations of the world are concerned,
for example Japan, some of it may prove to
be true. Therefore, the Rostow’s Stages
of Economic Growth Model lost its appeal among
many economists particularly in the post 1980's
and 1990's period.
Now, having given you a brief overview of
what are the basic characteristics of Schumpeter’s
and Rostow’s growth theories or theories
of economic development, let me run you through
some of the very basic concepts which one
needs to know to be able to have a good grasp
over the growth models. In the last lecture
I used the term referred to as Multiplier
and Accelerator while I was discussing Hirschman’s
thesis of unbalanced growth.
Now let me very briefly introduce to you what
is a multiplier. So, in economics when we
are dealing with growth models or macroeconomic
aggregates, we are referring to the Keynesian
multiplier.
This is a concept which was worked on by Keynes.
It was popularized by Keynes. It was first
developed by an economist called F A Khan
in the early 1930's. But Keynes refined it
and multiplier is usually shown in the form
of a ratio. And this is basically a ratio
of change in income to change in investment.
So, k is equal to ∆Y by ∆ I. Here ∆I
stand for increment in investment and ∆Y
stands for the resultant increase in income.
And multiplier is basically the ratio of increment
in income to the increment in investment.
So, whenever there is an investment taking
place in the economy, what is the rate at
which income changes and what are the forces
that increases this income is what is captured
by the multiplier. For example, if as a result
of investment of rupees 100 crores, the National
Income increases by rupees 300 crores, then
the multiplier is equal to 3. If as a result
of investment of rupees 100 crores, total
National Income increases by rupees 400 crores,
multiplier is 4. So, the multiplier is therefore,
a ratio of increment in income to increment
in investment. And ∆I stands for increment
in investment and ∆Y stands for increment
in income.
The question is why the increase in income
is many times more than the initial increase
in investment? Suppose government undertakes
investment expenditure equal to rupees 100
crores on say, some public works, construction
of rural roads. For this government will pay
wages to the laborers engaged, prices for
the materials to the suppliers and remunerations
to other factors who make contribution to
the work of road building. So, the total cost
will amount to rupees 100 crores. And this
will increase incomes of people equal to rupees
100 crores. But this is not all. The people
who receive 100 crores will spend a good part
of their income on consumer goods. Therefore,
some marginal propensity to consume of the
people will increase and let us say of this
100 crores, they will spend rupees 80 crores
on consumer goods which would increase incomes
of these people who supply consumer goods
equal to rupees 80 crores. And with every
additional increase in income there will be
progressively less part of the income received
to be saved. Thus, income will not increase
by only rupees 100 crores, which was initially
invested in the construction of roads, but
by many more times. So, the concept of multiplier
is very important in macroeconomic understanding
of growth and how growth take place within
the economy. Corresponding to the multiplier,
there is a concept of accelerator.
The accelerator basically measures the changes
in investment goods industry as a result of
long-term changes in demand in consumption
goods industries. So, the principle of acceleration
states that if the demand for consumption
goods rises, there will be an increase in
the demand for equipments and machines which
produce these goods. But the demand for machines
will increase at a faster rate than the increase
in demand for the product.
The principle of acceleration enables us to
understand the process of income generation
more clearly. A certain level of income could
be attained by multiplier action alone. But
along with accelerator, the process of income
propagation is speeded up. So, for example,
in the last class, when I was referring to
Hirschman’s thesis of creating excess capacity
within the economy by investing in Social
Overhead Capital and the external economies
arising out of the Social Overhead Capital
being appropriated by the private entities
to be able to enter into Directly Productive
Activities, we are referring to the accelerator
principle here. Where the principle of acceleration
creates a situation in the economy where the
private entities can take advantage of the
external economies created out of the creation
of Social Overhead Capital.
You can also look at accelerator as a functional
relationship between the demand for consumption
goods and demand for machines which make them.
And usually the acceleration coefficient,
Nu(v) is equal to the change in investment
to the change in consumption expenditure.
And it primarily depends upon two factors;
the Capital Output Ratio and the durability
of the capital equipment.
Let us also very briefly look at what is Capital
Output Ratio and Incremental Capital Output
Ratio. For example, if I put you a question
that why is the rate of economic growth falling
in India. And one of the explanations you
would give is that the savings rate in the
country is falling and lower the savings and
investment rate, it will lead to lower growth.
Now so, economic growth in any country among
other things is the function of the level
of savings and the rate of investment. And
any additional investment required to increase
output is termed as the Incremental Capital
Output Ratio (ICOR). So, it is basically a
metric that assesses marginal amount of investment
capital necessary for an entity to generate
the next unit of production. So, for example,
if a 10 percent additional capital is required
to push the overall output by 1 percent, the
ICOR or the Incremental Capital Output Ratio
will be 10. Lower the ICOR the better it is.
ICOR reflects how efficiently capital is being
used to generate additional output. So, a
country with ICOR of 3 is better than a country
with ICOR of 5. So, you can look at it. So,
the growth rate and the savings ratio and
the Incremental Capital Output Ratio; ‘G
is equal to s by v’ is the mathematical
relationship between growth, rate, savings
rate and the Incremental Capital Output Ratio.
This concept of Capital Output Ratio, I will
discuss again when we are discussing the Harrod
Domar model in the next classes. The Capital
Output Ratio is often used as an investment
criterion and it plays a very key role in
the Harrod Domar model of growth. Let us also
briefly look at the savings and investment
relationship that I have also spoken about
in the last class.
For the benefit of most of you, let us first
begin with a two sector model. We are assuming
here that equilibrium occurs when income received
equals aggregate desired expenditures. So,
one of the first identities that we are working
out is income is nothing but a summation of
consumption expenditures plus investment expenditures.
So, Y is equal to C + I. Now if you recall
the National Income identities that we had
briefly looked in the first lecture of this
course, I had said that you know GNP or GDP
can be calculated by the income method and
the product method. So, when we are looking
at GNP, it could mean income or it could mean
product. So, as aggregate output and income
are always equal and consumption is identical
in both places, the rest of the equation must
also be equal.
So, if Y is equal to C + I which is income
is equal to consumption plus investment. And
Q are output which is the Gross National Product
is nothing but the summation of consumption
and savings. And if Y is equal to Q then C
+ S is equal to C + I. So, in the ultimate
identity in a two sector model without international
trade, we consider savings to be equal to
investment. So, whatever is getting leaked
out of the system is getting injected back
into the system in the form of investments.
So, basically GDP comprises of consumption,
investment, government spending and net exports.
C + I + G + Xn or X – m. You may consider
both which is basically exports minus imports,
the net of exports that is a total GDP that
gives out the total output or total income
within the economy.
And C is the largest sector of GDP. So, consumption
is mostly the largest sector of a country.
And 
when we say consumption function we are basically
seeing that consumption as a function of income.
So, if income rises by how much consumption
rises. And although there is a linear relationship
between consumption and income as income rises
consumption rises, but not as quickly. So,
similarly consumption also varies with disposable
income which is basically total income minus
the taxes.
I will end this lecture with two more basic
concepts that we use. One is, the concept
of Average Propensity to Consume and the concept
of Average Propensity to Save.
So, there are two ways to view the consumption-income
relationship. One is as the ratio of total
consumption to total disposable income. And
the second is as a relationship of changes
in consumption to changes in disposable income.
Average Propensity to Consume is basically
the total consumption divided by the total
disposable income. And Average Propensity
to Save is total savings divided by the total
disposable income.
Similarly, the concept of Marginal Propensity
to Consume which is looking at a ratio of
change in consumption to change in income.
With regard to investment there are two important
concepts which needs to be kept in mind.
One is autonomous investment and the second
is induced investment. Autonomous investment
is not sensitive to changes in income. In
other words, it is independent of income changes
and is not guided or induced by profit motive
only. And autonomous investments are primarily
made by the government and are not based on
considerations of profit. And induced investment
is that investment which changes with the
change in income and that is why it is called
income elastic. In a free enterprise capitalist
economy, investments are induced by profit
motive. And such investment is very responsive
to changes in income that is induced investment
increases as income increases.
So, to end today’s lecture, in today’s
lecture, we looked at two important strategies
of economic development. One proposed by professor
Joseph Schumpeter and the other by W W Rostow.
Schumpeter’s strategy of development can
be categorized under the development thought
characterized as universal history where economic
history is taken as one of the pillars in
which the economic development strategies
can be analyzed. Schumpeter provided a big
role to innovation and entrepreneurship in
creating discontinuity within the circular
flow of static equilibrium system, such that
economic development can take place.
Rostow was focusing on 5 stages of economic
growth. Again Rostow was considered to be
a structuralist. He was proposing a structural
model, where based upon the example of the
highly industrialized nations of the world,
his proposition was that all countries necessarily
need to pass these 5 stages of economic growth.
However, Rostow’s proposition has also faced
various criticisms particularly in the year
1980's and the 90 and the 2000’s. Because
the experience of the developing countries
have shown us that the traditional sector
and the modern sector co-exist and the take-off
stage has never really been reached by the
developing countries of the world.
In the next class, taking off from the Balanced
and Unbalanced Growth Model and Rostow’s
and Schumpeter’s ideas on economic development,
we will look at The Big Push Theory. What
were the major concerns of the Big Push Theory
and what were the major proposed proposals
made by the Big Push Theory. And we will also
look at the Critical Minimum Efforts Thesis
as proposed by professor Leibenstein.
Thank you.
