Jan 30 2012
Models of Economic Growth and Development
Published by Jason Welker at 3:28 am under Economic Growth,Growth,Human Development Index,IB Economics,Standard of Living
As we study economic development in year 2 IB Economics, we examine different models for economic growth. Growth in GDP is not the only determinant of economic development, which in order to be measured effectively must account for human welfare determinants such as life expectancy, literacy rates, child mortality rates, distribution of income, and so on. However, it has been shown throughout history that economic growth, or the increase in real output and income, correlates directly with improvements in development factors like those above.
The reason? Increases in national income usually mean at least some levels of improvement in access to basic necessities for the average citizen in a developing country. Also, higher incomes mean more savings, which means greater access to capital for investment by entrepreneurs. More investment leads to greater productivity and rising incomes for those who join the emerging industrial and service sectors that usually accompany economic growth. Furthermore, rising incomes mean more tax revenue for governments, whose spending on public goods like education, health care, and infrastructure result in real improvements in standard of living for not just the emerging upper and middle classes, but the poor as well.
Of course, the following models can be observed to varying degrees among the world’s developing economies today. Some of these models will fail to play out if the institutional and political environment fails to create a stable atmosphere for savings and investment. What you should notice, however, is the underlying importance of savings in all three models. Poor countries suffering from low savings and, even worse, capital flight, are doomed to a cycle of poverty, where funds for investment leading to productivity increases are never made available due to instable institutions like banking and politics. To put a poor country on a path towards economic growth and development, a strategy is needed. Such strategies will be covered in a later post. For now, let’s look at the models:
Harrod-Domar Growth Model:
The model suggests that the economy’s rate of growth depends on:
- the level of saving
- the productivity of investment i.e. the capital output ratio
The Harrod-Domar model was developed to help analyse the business cycle. However, it was later adapted to ‘explain’ economic growth. It concluded that:
- Economic growth depends on the amount of labour and capital.
- As LDCs often have an abundant supply of labour it is a lack of physical capital that holds back economic growth and development.
- More physical capital generates economic growth.
- Net investment leads to more capital accumulation, which generates higher output and income.
- Higher income allows higher levels of saving.
Lewis Structural Change (dual-sector) Model:
Many LDCs have dual economies:
- The traditional agricultural sector was assumed to be of a subsistence nature characterised by low productivity, low incomes, low savings and considerable underemployment.
- The industrial sector was assumed to be technologically advanced with high levels of investment operating in an urban environment.
Lewis suggested that the modern industrial sector would attract workers from the rural areas.
- Industrial firms, whether private or publicly owned could offer wages that would guarantee a higher quality of life than remaining in the rural areas could provide.
- Furthermore, as the level of labour productivity was so low in traditional agricultural areas people leaving the rural areas would have virtually no impact on output.
- Indeed, the amount of food available to the remaining villagers would increase as the same amount of food could be shared amongst fewer people. This might generate a surplus which could them be sold generating income.
Those people that moved away from the villages to the towns would earn increased incomes:
- Higher incomes generate more savings.
- Increased savings meant more fund available for investment.
- Increased investment meant more capital and increased productivity in the industrial sector, higher wages, more incentive to move from low productivity agriculture to high productivity industry, the circle continues…
Rostow’s Model – the 5 Stages of Economic Development:
In 1960, the American Economic Historian, WW Rostow suggested that countries passed through five stages of economic development.
According to Rostow development requires substantial investment in capital. For the economies of LDCs to grow the right conditions for such investment would have to be created. If aid is given or foreign direct investment occurs at stage 3 the economy needs to have reached stage 2. If the stage 2 has been reached then injections of investment may lead to rapid growth.
About the author: Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course.
Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this authorRelated posts:
- Does economic growth = economic development? Not for China’s rural poor…
- Lesson Plan: Sources of Economic Growth and Development
- “Fair Trade” coffee and economic development
- Mali’s Weed: Is this an economic development, economic growth, supply or demand issue??
- IB: Economic development and fertility rates in India
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I think that it is a Lewis Dual Sector model illustrates the growth that China has experienced. The Lewis dual sector model splits the economy into two sectors, which are manufactured and rural. Productivity is really low in the rural sector then becomes much higher in the manufactured sector, which is what instigated the development. The model suggests that workers from the agricultural sector transfer to the manufactured sector in order to have a higher standard of living. The manufactured sector is attractive because it guarantees higher wages and a higher quality of life. Big firms came in and set up in China in order to attract a lot of cheap labor. Even though it was cheap labor to them, the workers in China experienced a huge increase in their wages. The majority of the workforce in China that was working in the manufactured sector now works in the agricultural sector. Moreover, the profits that are made from the manufactured companies are reinvested into the urban sector. As a result, there is more population in the big cities in China. It wouldn’t be the Harrod-Domar Growth Model because it is mainly to do with savings, which China didn’t have before it developed. It also wouldn’t be the Rostow model because China didn’t fulfill all the stages in this model.
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I think that China has been following most closely the Lewis Structural Change model for two simple reasons. Firstly the assumptions of the model seem to fit the current situation of China in which a lot of surplus labor for the subsistence farming sector of the economy have migrated to areas with high industrial capacity and become employees of the secondary sector of the economy. The Lewis model effectively splits the economy into a low productivity rural sector and a high productivity industrial sector which is very reflective of the Chinese economy. Poor people in the countrysisde have no access to infrastructure and such aids to development and therefore have an incentive to move to industrial areas for higher wages and hence a higher income and standard of living. Although the Rostow model may also apply as Chinese society slowly moves from the agricultural world to the industrial world, I think that change has been to slow and not inclusive enough to be accurate. There remains too large a portion of people in the Chinese inner provinces such as Henan that depend on subsitence farming for their to be a true generalised move forward on the Rostow model. And the Harrod-Dommar model although also true regarding China's abundance of cheap labor their is currently only a minor lack in infrastructure in Chian as firms from the West were quick to outsource and invest into Chinese firms ensuring that China had the capital necessary for industrialisation. For these reasons I believe that the Lewis Model is most accurate when representing economic development in China.
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I strongly agree with Nathan and Penny that China’s development and current situation may best be described and predicted by the Lewis Structural Change (dual-sector) Model. The model is clearly related to the current situation of China, since it evidently predicts the redistribution of the labor force from the agricultural sector outside the cities towards the secondary sector with high industrial and manufacturing capacity. This shift can be seen in the development of China’s economy over the past years. As the name of the model predicts, a split in the economy of China in an agricultural sector and an industrial sector is represented by the Lewis Structural Change (dual-sector) Model. The traditional agriculture sector described by the model clearly relates to China’s economy, since low productivity, low incomes, low savings and considerable underemployment have impacted China’s development over the past years. The other sector however, can be seen as technologically advanced and in interaction with urban areas, where communication is easy and progress can be seen. Due to this split of the economy a large incentive for relatively poor people from the country side can be seen, as there is a surplus in labor in the agricultural areas, however a need for labor in the manufacturing sector of China. This attraction of labor to urban areas was caused by higher wages, which were offered by the manufacturing firms and the very low productivity of the agricultural sector which not even severed the supply of food. In my opinion the Rostow Model does not represent China’s development to the full extend, since the gap from stage 1 to stage 2 already seems too large for the Chinese agricultural sector, due to the lack in sufficient tools and the lack of productivity which restrains Chinese agricultural businesses from specialization.
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All these models place investment of capital as essential for the increase in productivity and output, leading to economic growth. China's growth has ben no exception to this in that the rapidly developing industrial manufacturing sector has been the main leader in China's economic growth. Although the Harrod Domar growth model explains the situation China was in before economic growth occurred with a surplus of labour and lack of physical capital, the Lewis Structural Change model also incorporates the explanation of the migration from the primary, agricultural sectors to the secondary, manufacturing sectors in highly industrialized areas. The Rowstow model on the other hand goes further than the growth China has experienced as tertiary, service sectors are not yet dominant in China. I therefore think that the Lewis Model best fits China. China's traditional agriculture sector produced low incomes for farmers, therefore low savings and little or no opportunity for investment in capital. Underemployment and low crop returns due to the need to share between an overpopulated village also contributed to a form of a 'poverty cycle' from which the Chinese couldn't escape. However, the introduction of a technological and industrial sector in urban areas provided the opportunity and incentive to work hard to reap benefits for farmers to be attracted to jobs in the manufacturing sectors where incomes and the standard of living would be higher. This shift into higher income sectors means more savings and a greater possibility of acquiring capital for investment by entrepreneurs contributing to further economic growth.
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I think the model above which best shows the growth and development of china over the last few decades is the Lewis Structural Change (Dual-Sector) model. This model outlines a shift from workers being mostly in the traditional agriculture sector to a technology based manufacturing sector. The structure states that the agricultural sector had low productivity and low incomes, which we heard from the pod-cast was definitely the case in China in the past. It suggests that works will move into the manufacturing sector because of the higher incomes and therefore a higher quality of life. We know there is a vast manufacturing sector in China currently, not only do they have a very large trade surplus, but mostly likely half of the objects in the room around us are produced in China from clothing to electronics. Furthermore, the Lewis Structural Change model shows that as more profit is make in the manufacturing sector it is reinvested in capitol growth therefore causing this large production sector to keep expanding which is very reflective of the growth China has experienced. The other models have elements that link to China's development, such as availability to cheap labor, however they do not fit as closely as the Lewis Structural Change model.
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I agree with all the following posts above. Looking at the Lewis Structural Change model, It is quite clear to see that China certainly follows this model. Split into the manufacturing and rural sectors, China's recent history of Communism has clearly followed the trend of moving from a rural based sector producing agricultural goods towards the manufacturing sector. China's rapid economic growth is due to the movement from agricultural sectors towards the manufacturing sector. This movement illustrates the increase in incomes for households leading to larger savings and more savings for further investments. As more and more people move from the rural areas towards urban areas, the increase in human capital and the further investments in the industrial sector account for a higher economic growth for China. This can be seen since higher incomes lead to a larger incentive for people to move from rural areas to industrial areas.
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Each model represents a different way in which economic development and growth could take place. In the example of China and its great economic growth and development over the last few years the Lewis Dual Sector model is best used to explain the process. Before China developed communism had led to the fact that the largest and only sector was the a primary sector, agriculture. As the rules loosen the manufacturing sector in the urban areas become more attractive to the rural people. Which lead to a flow of labor from the primary sector to the secondary sector. The people now working in the manufacturing sector can enjoy high incomes and can therefore also save. These savings become essential for investments and through the shift from agricultural goods to manufacturing good, the nation has been able to grow economically as well as develop.
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The Harrod-Domar model states that the rate of growth of output of an economy depends on the proportion of output or income saved. It also illustrates the constraint of many LEDCs, a lack of sufficient savings to finance investment in physical capita. If the level of domestic savings is insufficient to finance the necessary investments for economic growth, domestic savings may be supplemented by foreign aid or foreign direct investment. Despite this model having valid assumptions, I think it is naïve to solely focus on savings. There are numerous other factors faced by LEDCs such as political or cultural barriers. I also think this model ignores the importance of human and natural capital in an economy. Similarly, the Lewis Structural change model tries to eliminate the dual sector, referring to two different circumstances existing simultaneously (e.g poverty and wealth), and moving a predominantly agricultural economy to an industrial one. As already mentioned, China does appear to have followed this model-rapid economic growth and high rural to urban migration. However, I feel that, despite the successful industrial sector, China is still subject to massive social disparities, especially in rural areas. In fact, I think that rural poverty has increased as most economically active members leave, to work in the cities, leaving behind the most unproductive members of society: children and the elderly. Also, due to the rural locations of some villages the absence of merit goods such as education and health care will prevent less affluent people from rising above poverty. In effect, the profits made from the industrial sector should be reinvested into rural areas, in order for such people to escape the cycle of poverty.
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China’s economic development and growth can be explained by the Lewis Dual Sector model. Workers moved from a traditional agriculture sector that includes low productivity, low incomes and considerable underemployment to a manufacturing sector which is technologically advanced with high levels of investment operating in urban environment. The traditional agriculture sector is definitely something that China experienced in the past. The workers moved into the manufacturing sector to improve their standards of living as they would earn higher incomes and the amount of food available to the remaining villagers would increase. Evidence shows that China now shifted to the manufacturing sector because many electronics and clothing is made in China as well as they have a trade surplus; their value of exports exceeds the costs of imports. As more profit is made from the manufacturing sector it can be reinvested in labor and capital to make even more profit. This causes production to increase, increasing China’s growth even more.
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I think that the model that best shows the growth of China over the last decades is the Lewis Structural Change model. In china the traditional agriculture sector produced really low incomes for workers who had therefore no savings (and no investment). With the introduction of technology and of a industrial sector, workers were able to work more efficiently and to have higher profits. So the movement from the agricultural sector to the manufacturing sector led to higher incomes and therefore higher savings, creating the possibility to invest more. China’s economic growth is due to this change from primary to secondary sector which made more people move to urban areas and specialize in the industrial sector.
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I believe that the model above which best illustrates the growth and development of China over the previous decades is the Lewis Structural Change model. The model shows the shift of China's mainly rural agricultural production providing no savings under Communism towards producing manufactured goods resulting in a larger amount of savings. A larger amount of savings is a result of workers receiving higher incomes. These higher incomes and savings can lead to investment which would lead to further economic growth. Higher incomes and larger savings would also attract an increasing amount of rural workers to the urban areas increasing the output of the nation.
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China's rapid economic growth in the past few decades has been due to its transition from the traditional agricultural sector to a manufacturing sector. Lewis suggested that "the modern industrial sector would attract workers from the rural areas" and this is what has been happening in China. Due to the migration from rural areas to rapidly growing cities and towns, approximately 500 million Chinese citizens have been pulled out of poverty since the manufacturing sector provides them with higher wages and improved standards of living. The Lewis Structural Change (dual-sector) model correctly depicts China's current situation. Many rural citizens continue to move into cities in order to work in the manufacturing sector to earn higher salaries and therefore save more money. Increased savings means that more funds are available for investment so the economy continues to grow. In addition, the high productivity in China's exporting industries has allowed China to stop depending on imports. The current problem however, is the inequality that exists between urban and rural centers in China. Most of the investments are taking place in large cities instead of rural villages so standards of living continue to be considerably lower than those in the urban centers.
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When it comes to which model best describes Chinas growth, I believe it is the Lewis Structural Change Model. The model illustrates a clear shift from the agricultural sector to the manufacturing sector. This is evidently what China has experienced and why it has become such a manufacturing giant. More and more workers in the agricultural sector have moved into the cities to work in industries as the wages are higher thus leading to higher household incomes. The model shows the excess of labor, due to the considerable underemployment, from the agricultural sector which has switched to the manufacturing sector. The higher household incomes lead to an increase in savings as well creating an incentive to invest as well. Higher incomes also improves their standards of living for the workers as compared to in the rural areas. The increased investment triggers a rise in productivity in the industrial sector as more capital is available. The productivity and higher wages attract the workers from the rural areas which increases the output of the nation. This increase in output by the manufacturing sector has contributed to the rapid economic growth in China. Compared to the models the Lewis Structural Change(Dual-Sector) Model is the most accurate fit representing China's economic growth.
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As has been previously said numerous times, China is following the Lewis Structural Model which shows the growth China has experienced. The model splits the economy into a low (rural) productivity sector and and high productivity sector. That with surplus labour, the traditional agricultural sector will move into the manufacturing sector which would be appealing with the higher wages and better standard of living that comes with it. This fits very well with China with it's large rural agricultural sector that forces Chinese people under the poverty line. The movement into the higher wage sector will allow these people to spend more money and therefore allow the government to reinvest that money into the poor areas to build up things like infrastructure in towns and villages.The Harrod-Domar Growth Model wouldn't fit as well because it focuses more on investment and savings which might better apply to country's with high GDPs and low amounts of poverty.
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In my opinion, the model which shows the growth and development of China over the last decade the best is the Lewis Structural Change Model. According to this model, people started leaving the rural areas dominated by farming to move into bigger cities dominated by the industrial sector. The wages offered by the industrial sector were greater than the income provided by farming. Therefore, this resulted in a higher quality of life as surplus savings could be used to buy goods that would otherwise have been out of reach for most people. In addition, the profits made by the industrial sector was reinvested to expand it even further. We know that this is the case due to the fact that China makes a vast amount of products that are used in the developed world. This can also be verified by the large trade surplus China has. While the Lewis Structural Model is the main model that applies to China's growth, the Harrod-Domar Model why the increased incomes of the workers led to an increase in the standards of living. Including the Harrod- Domar model into the Lewis Structural Model gives a good approximation of how China has been able to grow.
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Looking at the models described in the above blog post, I think it is quite clear that China has been following the Lewis Structural Change (dual-sector) model. Possessing both a traditional agricultural sector and a manufacturing sector, China has seen its manufacturing sector boom lately. The rapid economic growth that China has been experiencing is due to the movement of the surplus labor into the manufacturing sector. As a result, there is an increase in the income of the households which results in greater savings. These savings allow for greater investment, leading to capital growth. As more Chinese people switch from the agricultural sector to the manufacturing sector, this effect is amplified and leads to more economic growth.
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I think that the Lewis Dual Sector model best fits the growth China experienced. This model describes a shift from mainly traditional agricultural labour to mainly technology manufacturing based labour. This structure indicates that the agricultural sector does not have as high productivity as the technology based sector, as well as lower incomes. This can very well be applied to china as we heard in the podcast that their incomes were very low when they were based mainly in the agricultural sector. This model also indicates that moving to the technological sector will increase incomes and subsequently also better that standard of life. Right now China manufactures a vast range of goods and exports these goods all around the world. This massive manufacturing and trading sector in China's economy has lead to them having an immense trade surplus. The Lewis Structural Change model also suggests that as profit is made in the manufacturing sector it is also reinvested into to increase capital growth. This continuous expansion matches the growth that China has been experiencing the past few years . So overall I think the Lewis Structural Change model fits this growth best, however other models have specific elements that would also fit China's growth.
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I think that China has followed the Harrod – Domar Growth Model rather than the other models since the country’s economy was fully dependent upon agricultural output 30 years ago. Since giving property rights to farmers the economy has experienced enormous growth rates over the last decades, since this right is an incentive for farmers to work harder and to maximize the potential output. However in recent years China has followed the Lewis Structural Change Model as well, since a lot of people have migrated to cities to work in the manufacturing industry, which is China’s greatest source of income today.
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I think that the Harrod-Domar Growth Model illustrates China's economy as it was during communist rule. It illustrates that economic growth is dependent on a large amount of physical capital, which is not what China possessed. What China did have though, was an abundant supply of labour. However this supply of labour certainly didn't receive much income and so were not able to make large investments. The lack of investment meant that there was never a large amount of capital accumilation which should have led to a larger output and higher incomes, but unfortunately never did.
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They get uniformity in their studies with the IB schools in India
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