Almost all underdeveloped countries regard surplus labour as waste. This surplus of labour not only contributes to the income of the country but, on the other hand, turns the productive savings of the country into a consumption waste. In recent years, economists led by Ragnar Nurkse have proposed a new article. According to this, disguised unemployment means potential savings in disguise, if you work hard, it can be used for economic development. This is a potential source of capital formation. According to Nurkse, surplus labour or disguised unemployed labour lives in a common family with their relatives and depends on their relatives' production to feed them. For the unemployed in the joint family system and joint farming, all children, nephews, cousins , and children work on family land and never worry about whether the additional employment will generate additional production. 3.2.2 Causes of Disguised Unemployment: 1. Rigidity of Essential Factors of Production: National recognition like land and other natural gifts are limited to some extent. They cannot cope with the rate of population growth. The sentiment of industrialization is not a compliment to the wave of unemployment, but in countries where domestic trade dominates, it is often generated by all members because they are committed to domestic trade. 2. Social structure: The feeling of industrialization is not a compliment to the wave of unemployment, but in countries where domestic commerce dominates, all members produce very frequently because they are engaged in domestic commerce. 3. Constant technology: In underdeveloped countries, industrialization sentiment is not a supplement to the unemployment wave, but in countries where family businesses dominate, all members appear frequently because they are committed to family businesses. 4. Population growth: 51 CU IDOL SELF LEARNING MATERIAL (SLM)
High population growth has led to a labor surplus, especially in rural areas. India is the second most populous country, with nearly 70% of its total population living in rural areas (2011 Census). There is a surplus of rural labor; however, employment in these fields is still mainly seasonal, leading to disguised unemployment. 5. Poverty: Poverty makes it impossible to buy land, so people have limited capital. Limited capital: further increasing the dependence of more and more people on limited resources. 6. Labour-intensive economy: With such a large population, labor can be obtained at a cheaper price. Therefore, it is easier to hire more people for a specific job, and this can be done by fewer people. 7. Limited skills and knowledge about better opportunities: Disguised unemployment is also caused by the limited skills of workers. In India, the majority of the population lives in rural areas in poverty-stricken areas, and people lack the right skills to be recruited in better places. 3.3 NURKSE’S THEORY OF DISGUISHED UNEMPLOYMENT AS A SAVING POTENTIAL The characteristic of disguised unemployment is that the number of people working in this field is greater than the number actually needed. As a result, the marginal productivity of some workers is zero. In other words, if some workers leave the fields, the total output will remain unchanged. This situation exists in underdeveloped countries such as India, where the growing population is absorbed only by the agricultural sector. Therefore, it can be seen from the meaning of the word that although this kind of person may seem to have a job at first glance, they are actually unemployed in disguise. Suppose a family owns a 15-acre farm. Based on the method used for cultivation, we assume that 4 workers are sufficient to take care of all operations on the farm. Therefore, this family has 6 workers. If all of them are employed on this farm, we can say that two of them are 52 CU IDOL SELF LEARNING MATERIAL (SLM)
redundant. Therefore, even if the two workers retire, the total output will remain the same. These two people are unemployed in disguise. Almost all underdeveloped countries regard surplus labour as pure waste. This surplus of labour not only contributes to the country’s income, but also turns the country’s productive savings into pure waste in terms of consumption. In recent years, economists headed by Ragnar Nurkse have put forward a new argument. Accordingly, unemployment in disguise means the potential for saving in disguise, and if appropriate efforts are made, it can be used for economic development. This is a potential source of capital formation. According to Nurkse, surplus labour or unemployed workers in disguised form live in joint households with their relatives and feed on the work of their productive relatives. The unemployed in these joint family systems and joint farms, all children, nephews, cousins and sons work on family land, and never worry about whether additional employment will generate additional income. 3.3.1 Nurkse’s Theory of Disguised Unemployment as a Saving Potential Ragnar Nurkse made the argument that disguised unemployment in an overpopulated and underdeveloped country can be a source of capital formation. According to Nurkse, disguised unemployment in underdeveloped countries constitutes disguised savings potential. Underdeveloped countries suffer mass unemployment in disguise. With existing agricultural production technology, most of the surplus labour can be removed from the land without reducing agricultural production. This surplus labour can be used for basic construction projects such as irrigation, drainage, roads, railways, houses, factories, training programs, community development, education, and sanitation. In this way, insufficient rural employment can become a source of capital formation. Nurkse divides the problem of mobilizing the unemployed who pretend to be potential savings into two parts: first, how to feed the remaining population transferred to various capital projects; second, how to provide new employees with work tools. Although the first problem can be solved to a certain extent through voluntary savings, taxation, and even the introduction of foreign capital, the seriousness of the problem requires it to be self-financing. Today, unproductive surplus workers are supported by productive 53 CU IDOL SELF LEARNING MATERIAL (SLM)
workers. The latter is making virtual savings because they produce more than they consume. But this saving is an operational waste because it is used to feed non-production workers whose contribution to production is zero or negligible. If productive farmers working on the land continue to feed their non-productive family members engaged in capital projects, their virtual savings will be converted into actual savings. However, this kind of capital formed through the use of surplus labour can only be self-financing when the transfer of potential savings potential is 100% successful. Nurkse further emphasizes as either the retirement of the surplus workers clears all the surplus food left on the earth to feed the unproductive workers in new occupations, or there is nothing that can be done. Capital formation: a) A newly employed worker may start to consume more food than he consumes on the farm; b) A farmer who remains on the farm may start to consume more food than before; and c) Assuming the problem of transporting food from the farm to the capital the cost of the project. Although it is impossible to completely stop these leaks, Nurkse suggests that this goal can be achieved through supplemental savings from other economic sectors, through government expropriation of surplus grain from farmers, and even through the imported grain to offset the decline. deficit. Values. He also emphasized the need to impose indirect taxes on basic products that enter the budget of farmers: taxes in kind, taxes on owners, and their income can help eliminate surplus food. Nurkse firmly believes that whatever mechanism is adopted, some form of state-imposed collective savings may be necessary to mobilize the savings potential implicit in disguised unemployment. The second topic refers to the financing of tools for workers in new construction projects. Although capital goods can be imported, in this case, internal savings are generally required. In some densely populated agricultural economies, not only labour is underemployed, but capital is also underemployed. Due to the small and scattered plots, a large number of farm tools, tools, and livestock are used. But if these small and scattered farms merge, some simple tools will be released that investors can use in new capital projects. In addition, the simple tools and equipment needed by newly hired workers can be manufactured by the workers themselves. These simple tools can also be imported from abroad in exchange for exports from that country. But it is crucial to import only capital goods that can easily adapt to the country’s universal factor endowments. As Nurkse stated, “In the early stages of development, the relative factor endowments of such countries may be suitable for simpler tools and equipment.” 54 CU IDOL SELF LEARNING MATERIAL (SLM)
Therefore, the process of economic development is produced by disguising the unemployed. Therefore, Nurkse correctly believes that in underdeveloped countries with overpopulation, underemployment in rural areas has potential for savings, which can be effectively used as a means of capital formation. 3.3.2 Critical Appraisal: The concept of disguising unemployment as a hidden savings potential has caused considerable controversy. Economists question the applicability of this concept in underdeveloped democratic economies. The various difficulties in his work are as follows: 1. Nurkse assumes that the propensity to consume of newly employed workers and workers remaining on the farm remain unchanged. But this is an untenable assumption. Kurihara believes that the propensity to consume in the entire economy may increase due to the transfer of disguised unemployed people to the capital goods sector. In this case, the pressure to allocate resources that could have been used to increase the production of capital goods to the consumer goods sector will increase. 2. It is not easy to mobilize the unemployed in disguise and send them to the new capital account. Their attachment to family and land is so strong that they don't like to leave their loved ones and switch to new projects. 3. In Nurkse's analysis, the problem of paying wages to workers does not arise because the entire process of capital formation is assumed to be self-financing. This is not realistic. Unless wages are paid, new capital projects cannot attract workers. As Lewis put it, \"Unpaid work can be very important in countries that use forced labour, but its scope is limited in other countries.\" 4. As the above corollary, this \"quick start\" method can only succeed under a powerful totalitarian government and has little to do with underdeveloped democracies. This method of capital formation has been successful in China, where people are forced to engage in capital projects and only provide the minimum rations needed to sustain their livelihoods. Nurkesa himself later admitted this fact: \"Some underdeveloped countries have potential domestic 55 CU IDOL SELF LEARNING MATERIAL (SLM)
resources that can be used for infrastructure. However, it is difficult to mobilize them without resorting to coercive methods. 5. Kurihara further insisted that the assumption of technological neutrality involved in Nurkse's idea of disguising unemployment as potential savings is unsustainable and unhelpful. In the process of industrialization, if the capital goods sector adopts labour-saving measures, it will limit the full mobilization of the disguised as unemployed in the economy. In this case, the capital team must grow at a faster rate to increase labour productivity. Therefore, technological progress is inevitable. 3.3.3 Conclusion From the whole discussion, it can be seen that the existence of unemployment is disguised as a hidden saving potential. Therefore, as a source of capital formation in an overpopulated underdeveloped country, it is full of many difficulties, and there is almost no viability in a married country. . Live a democratic lifestyle by yourself. Therefore, we can conclude with Viner, “Among all the phenomena called hidden unemployment', 'hidden unemployment' or underemployment, there is almost no or no such phenomenon, as long as they constitute a real society. The problem will not be fully considered. Account. Explained by a competent, informed and complete analysis of the low productivity phenomenon of occupied work, its causes, its true scope and possible remedial measures.\" 3.4 THE LEWIS MODEL OF DEVELOPMENT WITH UNLIMITED LABOUR SUPPLY The well-known development economist Arthur Lewis proposed his model of \"economic development with unlimited labour supply\", which envisages the accumulation of capital in the modern industrial sector to extract labour from the subsistence agricultural sector. Lewis has undergone some modifications and extensions from Fei and Rains, but the essence of the two models is the same. Both models (namely, one modified by Lewis and the other modified by FeiRanis) assume that there is a surplus of labour in the economy, the main component of which is huge disguised unemployment in agriculture. Furthermore, they envisioned a \"dual economic structure.\" Manufacturing, mines, and plantations represent the modern sector. Its notable feature is the use of renewable capital, 56 CU IDOL SELF LEARNING MATERIAL (SLM)
production for the market and profit, and wage-based labour and industrial employment. Organization method. On the other hand, agricultural representatives use traditional sectors that are self-sufficient or use non-renewable land based on self-employment, mainly produce inferior production technology for their use, and include surplus labour in the form of disguised unemployment. Therefore, the per capita productivity of modern sects is much higher than that of agriculture. Although the marginal productivity of agriculture is considered to be zero in a wide range, the average productivity is assumed to be a positive number, which is equal to the basic subsistence level. Lewis’ Model of Development with Surplus Labour: In the Lewis and FriRanislabour surplus model, the wage rate in the industrial sector is determined by the average productivity of agriculture. A margin is added to this average productivity (Lewis sets this margin at 30%), which is necessary to incentivize workers to move from rural to urban industry and to cope with the higher costs of urban industry. Life. In this case, the model shows how the expansion of investment and industrial production, or in other words, how the accumulation of capital outside agriculture will generate enough jobs to absorb all surplus labour in agriculture and other places. Lewis assumes that there is a self-sufficient sector with surplus labour, from which he sees the seeds of the self-sufficient sector. An important characteristic of the capitalist sector is that it uses reproducible capital and generates profits. Since the livelihood sector has surplus labour, the capitalist sector extracts labour from the livelihood sector and assumes that the supply of unskilled labour is unlimited due to rapid population growth of densely populated countries. Therefore, capitalists can get even more supply of such work at the current wage rate, that is, they do not have to increase wages to attract more labour. Therefore, the capitalist sector can expand indefinitely with unskilled labour at a constant wage rate. 57 CU IDOL SELF LEARNING MATERIAL (SLM)
The real (market) wage rate will be determined by income from the subsistence sector. But \"income\" here refers to average product rather than marginal product, and the share of products made in the livelihood sector is the same. Lewis has assumed and pointed out that the capitalists will have to pay a deposit of about 30 more than the average living wage, because the remaining workers need some incentive to move, and in any case a part of the difference is needed to make up their higher wages. high. Cost of living in urban areas. Another point to note is that in the self-sufficient sector, labour is hired to the point where its marginal product is zero. By contrast, in the capitalist sector, labour is only hired to the point where its marginal product equals the wage rate, a familiar relationship derived from marginal productivity theory. If wages exceed marginal productivity, the capitalist employer will reduce his surplus because he pays more work than he produces. Fig 3.1 Capital Expansion and Growth in Labour Employment 58 CU IDOL SELF LEARNING MATERIAL (SLM)
Figure 3.1 explains the expansion and accumulation of capital in the modern sector and the process by which labour is absorbed. OS represents the actual wages received by workers in the subsistence sector, that is, OS is an average product. Every worker in the livelihood department. OW is the fixed-wage rate of the modern sector, which is 30% higher than OS (the average agricultural product). As long as there is surplus labour in the economy, the modern sector can obtain any amount of labour at a given wage rate OW, and the wage rate will remain unchanged. For a given initial amount of industrial capital, labour demand is given by the marginal productivity curve MP1. Based on the principle of profit maximization, under the wage rate OW, the modern sector will emplo y labour OL1, and the marginal product of labour is equal to the given wage rate OW. Thus, the total labour share of the modern sector, that is, wages, will be OWQ1L1 and WQ1D will be the capitalist surplus. The accompanying drawings illustrate the process of expansion and capital accumulation of the modern sector and its absorption of labour. In theabovefig. OS represents the real wages received by workers in the livelihood sector, that is, OS is the product of each worker in the average livelihood sector. OW is the modern sector fixed wage rate, which is 30% higher than OS (the average agricultural product). As long as there is a surplus of labour in the economy, the modern sector can get any amount of work at a given wage rate OW, and the wage rate will remain unchanged. For a given initial quantity of industrial capital, the demand for labour is given by the marginal productivity curve MP1. Based on the principle of profit maximization, under the wage rate OW, the modern sector will emplo y labour OL1, and the marginal product of labour is equal to the given wage rate OW. In this way, the total labour share of the modern sector, that is, wages, will be OWQ1L1 and WQ1D will be the capitalist surplus. Profit as the Main Source of Formation of Capital: 59 CU IDOL SELF LEARNING MATERIAL (SLM)
From the above analysis of the Lewis model with the unlimited supply of labour, it is obvious that profit is the main source of capital formation. The higher the share of profit in national income, the higher the savings rate and capital accumulation rate. Therefore, with the expansion of the modern or capitalist sector, savings and investment will continue to increase as a percentage of national income. Therefore, the rate of capital accumulation relative to national income will also increase. Of course, it is assumed that all or most of the profits are automatically saved and invested. From the above, it can also be seen that the capitalist's share of profits depends on the capitalist sector's share of national products. With the expansion of capitalism or the modern sector, the share of profits in national products will increase. This increase in the share of profits in domestic products is due to the model's assumption that the wage rate remains the same and that the prices of products produced in the capitalist sector will not fall as production increases. To quote Lewis, \" At a constant real wage rate, if an unlimited supply of labour is provided, and if a part of the profit is reinvested in production capacity, then the profit will continue to grow relative to national income.\" Historically, the model ignores an important point : \"The outflow of agricultural labour that raises wages puts pressure on the rationalization of agricultural technology to introduce machinery and other capital- intensive methods, such as fertilizers. Once the labour supply decreases, industrial productivity will be reduced. The increase in agricultural productivity interacts with the increase in agricultural productivity.” Lewis’ model began with Marx’s classics, but ended with neoclassical results. happiness. The initial growth of the dual economy was largely transformed into an increase. However, contrary to Marx’s inevitable crisis, Lewis’ dual economy eventually operated smoothly as a single economy under the neoclassical rules. Between capitalist and non-capitalist sectors the difference is eliminated due to the shortage of shared labour. Lewis’s main point is that, ultimately, broader economic 60 CU IDOL SELF LEARNING MATERIAL (SLM)
growth and development can be driven by the initial supply of a large amount of cheap labour produced by the initial conditions of economic dualit y. Lewis’s model was interpreted throughout the third world as justifying the industrialization growth strategy of completing imports. Therefore, it must be attributed to ignoring the rural development of African, Asian and African companies. This is not the author’s fault. Latin America was classified as a major development scandal in the 1970s. D. W. Jorgenson provided a neoclassical explanation for the development of the \"dualism\" of the least developed countries, rejecting Lewis' influential theory of \"unlimit ed labour supply for economic development\". It should be pointed out that although Lewis's development model is simple and roughly in line with the historical experience of Western economic growth, its three key assumptions are in sharp contrast with the underdeveloped reality of most third world countries. nation. First, the model implicitly assumes that the labour transfer rate and emplo yment creation rate are proportional to the capital accumulation rate. Therefore, if there is capital accumulation that saves labour, the meaning of labour in the model will change. Second, the model assumes that there is \"surplus\" labour in rural areas, while full employment exists in urban areas. In fact, the situation in the least developed countries is the opposite: there is considerable open unemployment in urban areas, but there is almost no surplus labour in rural areas. The third key hypothesis that is inconsistent with reality is the concept of continuous urban real wages until the supply of a small amount of surplus labour is exhausted. MP said Todaro, “However, one of the most salient features of the urban wage situation in almost all developing countries is the absolute value of these wages and the trend of substantial increase relative to the average rur al income. Even if there are 61 CU IDOL SELF LEARNING MATERIAL (SLM)
labour-saving measures of modern technology transfer the bias, supported by the general shortage of rural surplus labour, the prevalence of “urban surplus” labour, and the trend of open unemployment in cities, indicates that Lewis . “However,” MP Todaro concluded, “the model has a certain analytical value because it emphasizes employment. The two main elements of the problem: structural and economic differences between the rural and urban sectors. No, and the core importance of transferring the work process between them\". This model has been criticized in theory and practice based on the following points: 1. Unrealistic hypothesis: This theory assumes that the wage rate in the capitalist sector will remain unchanged until the supply of labour in the capitalist sector is exhausted. subsistence. This seems unrealistic because, in the industrial sectors of underdeveloped economies, wage rates will continue to rise over time. The assumption of unlimited labour supply in underdeveloped countries does not make much sense, because it does not apply to countries such as South America and South Africa. To some extent, it applies to Asian countries. Surplus labour exists in rural areas, while full employment exists in urban sectors. Even this hypothesis is different from reality. 2. Limited Supply of Skilled Labour: Another limitation of the model is that if we assume that the supply of unskilled labour is unlimited, then in underdeveloped countries, the supply of qualified labour must be limited. This will bring difficulties to the implementation of industrialization and economic development plans. Professor Lewis himself admits that the limited supply of skilled labour is only a temporary bottleneck, which can be eliminated by providing facilities for training labour. But the fact is that the problem of skills training is not easy to overcome, especially in backward and underdeveloped economies. 3. Ignore Aggregate Demand: 62 CU IDOL SELF LEARNING MATERIAL (SLM)
Lewis has ignored the aggregate demand issue. He believes that everything that the capitalist sector produces is consumed alone or exported. It did not consider the demand for capitalist products from the livelihood sector. If th ere is insufficient demand for the products of the capitalist sector, the growth process can stop. 4. Ignores the labour-saving nature of technological progress: Thus, the higher the growth rate of capital formation in the modern sector, the greater the employment opportunities created in it. But if capital accumulation is achieved through labour-saving technological changes, that is to say, if the profits made by capitalists are reinvested in more mechanized labour-saving capital equipment instead of existing capital types, then employment in the industrial sector may be possible. It will not increase at all. Lewis model has been copied and modified in Figure reinvesting the profits gained in capital equipment and saving labour due to technological changes. Therefore, the marginal productivity curve does not move outward uniformly but intersects the original marginal productivity curve from above. It can be seen from the figure. When the wage rate OW remains unchange d, even if the marginal productivity curve shifts to the right, the employment of labour will not increase. It can be seen from the Figure that although labour employment and total wages (OWQL) remain unchanged, total output has increased significantly, and the OEQL area is much larger than the ODQL area. This example shows that although industrial production and the profits of the bourgeoisie may increase, the employment and income of the working class remain unchanged. Although the gross national product has increased, the working class has not benefited from it. This is not only a theoretical example but also confirmed by the industrial development experience of various developing countries. This experience shows that although industrial production has grown substantially, employment is far behind. 63 CU IDOL SELF LEARNING MATERIAL (SLM)
Fig 3.2 Capital Expansion with Labour Saving Technological Change Despite some limitations and shortcomings, the Lewis model still retains a high degree of analytical value. It pointed out the role of capit al accumulation in increasing the level of production and employment in developing countries with surplus labor. This model provides a systematic and in-depth analysis of the increasingly serious problems of the dual economy and highlights the critical importance of factors such as profits and wage rates in modern sectors in determining the rate of capital accumulation and economic growth. It emphasizes the importance of inter-sectoral relationships (i.e., the relationship between agriculture and modern industrial sectors) in the process of dual economic growth. 64 CU IDOL SELF LEARNING MATERIAL (SLM)
3.5 SUMMARY Lewis Model of dualistic economic development therefore provides a Suitable theoretical framework for studying the growth path of labour -surplus developing economies like Asian countries. It identifies the problem of disguised unemployment and underemployment in the traditional sector. It suggests how an agrarian economy could be transformed into an industrialized economy. It is a one-sided theory that propagates the development of one sector at the expense of the other. In Lewis's model, the process of transformation or structural change begins with the autonomous expansion of industrial demand, which is the result of changes in domestic consumer tastes, government procurement, or chang es in the international market. 3.6 KEYWORD Disguised unemployment:a situation in which more than the optimal (required) numbers of people are employed to undertake certain tasks. Educated unemployed:in most cases (unless notified otherwise) a person who has finished schooling (metric) and is on the lookout for emplo yment is regarded as educated unemployed. direct labour: the workers employed to make a good or provide a service, as opposed to indirect labour which does not actually make a good but provides backup to the direct labour force Economic resource: Resources which are scarce. Due to them being limited decisions will have to be made about how they are used within an economy. Poverty:A state of having inadequate income or other resources to support a household or group of households at a basic standard of living 3.7 LEARNING ACTIVITY 1. Define unemployment 65 CU IDOL SELF LEARNING MATERIAL (SLM)
_____________________________________________________________________ _____________________________________________________________________ 2. State the causes of disguised unemployment _____________________________________________________________________ _____________________________________________________________________ 3. State the causes of disguised unemployment _____________________________________________________________________ _____________________________________________________________________ 3.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain the meaning of unemployment 2. Explain the concept of disguised unemployment 3. State the features of disguised unemployment 4. Explain Social structure as a causeof disguised unemployment 5. Explain the drawbacks of Lewis Model of Development Long Questions 1. Critically examine Nurkse’s thesis of disguised unemployment as a saving potential. 2. Discuss the causes of disguised employment 3. Explain the Lewis Model of Development with Unlimited Labour Supply 4. Describe profit as the Main Source of Formation of Capital 5. Development with unlimited supplies of labour hypothesis was originally formulated by Nurkse. Explain B. Multiple Choice Questions 1. Disguised unemployment generally means a. Average productivity of labour is zero 66 CU IDOL SELF LEARNING MATERIAL (SLM)
b. Marginal productivity of labour is zero c. Total productivity of labour is zero d. None of these 2. Disguised unemployment typically leads to low level of income levels despite creating perception of high levels of employment. Disguised unemployment generally exists in a. Urban societies b. Manufacturing sector c. Agriculture d. Small-scale industries 3. Disguised unemployment is a. the rigid factor prophet same as seasonal unemployment of LDC agricultural portions in LDC agriculture and industry b. when marginal revenue productivity of labour is zero c. due to capital formation and the level of technology remaining constant d. directly related to savings and inversely related to the capital/output ratio 4. Unemployment created by some long-term change in demand or technological conditions in an economy is known as a. Frictional unemployment b. Structural unemployment c. Cyclical un-employment d. Disguised unemployment 5. According to R. Nurkse, the inducement to invest in the context of an 67 underdeveloped economy is limited mainly by the a. Lack of savings b. Size of the market CU IDOL SELF LEARNING MATERIAL (SLM)
c. Lack of investment opportunities d. Low productivity of labour 6. Which of the following statements is incorrect? a. The essence of balanced growth is that the economy should advance at a steady rate with savings equal to investment b. The thesis of development with unlimited supplies of labour was originally formulated by R. Nurkse c. The capital-output ratio is the inverse of the annual rate of return on productivity of capital d. E.D. Domar assumed that full employment of labour and capital occurred simultaneously 7. According to Lewis’s model, the dual economy grows only when a. agricultural sector uses modern equipment b. modern manufacturing sector is labour-intensive c. the modern sector increases its output share relative to the traditional sector d. agricultural sector hires labour economically 8. Development with unlimited supplies of labor hypothesis was originally formulated by a. Gustav Ranis b. R. Nurkse c. W.A.Lewis d. J. Schumpeter Answers 1-b, 2-c, 3-b. 4-b, 5-b, 6-b, 7-b, 8-b 68 CU IDOL SELF LEARNING MATERIAL (SLM)
3.9 REFERENCES References book Behari, B. 1983, Unemployment, Technology and Rural Poverty, Vicaes Ramaswamy E.A. and U. Ramaswamy (1981) : Industry and Labour, Oxford University Press, Bombay, L.C. Jain, Grass Without Roots, Oxford Publishing House. Myint, H. (1971), Economic Theory and Underdeveloped countries, Oxford University Press, 69 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 4: MODELS OF ECONOMIC GROWTH PART I STRUCTURE 4.0 Learning Objectives 4.1 Introduction 4.2 Classical model of growth 4.3 Harrod-Domar Growth Model 4.4 Harrod-Domar Model and Developing Countries 4.5 Criticism Based on Evidence 4.6 Summary 4.7 Keywords 4.8 Learning Activity 4.9 Unit End Questions 4.10 References 4.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Discuss the classical theories of economic development; Concepts of the theory of economic growth Harrod-Domar's contribution to the development of growth models 4.1 INTRODUCTION Many theories try to explain the process of economic growth. These theories are also called growth models. The growth model lists the quantitative relationships between key variables in a rigorous way. Different economists have different views on the most important factor that determines the rate of economic growth. Therefore, each index has developed a different growth model. This chapter explains the Harrod-Domar model, the classical growth theory developed in conjunction with the British Industrial Revolution. The analysis of the economic growth process is the focus of these classical economists. Classical economists tried to explain the broad forces affecting economic growth and the mechanisms behind the growth process. 70 CU IDOL SELF LEARNING MATERIAL (SLM)
Division of labour, trade profits, and capital accumulation are regarded as the main driving forces of economic growth. Productive investment and profit reinvestment are the mechanisms that produce sustained economic growth. Therefore, the change in profit rate is a decisive reference for analysing the long-term evolution of the economy. They believe that under the conditions of free competition to promote individual goals, the individual initiative will produce beneficial results for the entire society. His conclusion supports the adoption of free trade, respect for private property, and free individual enterprises. At the same time, conflicting economic interests can be reconciled through the operation of competitive market forces and the limited activities of responsible governments. The ideas of these economists are different from earlier economic ideas. Their criticism of the previous feudal society was based on the observation that a large part of the social products was not well invested, but were consumed unproductively by the ruling class. They followed the French Physiocrats to study the economic well-being of a country as a whole, rather than the mercantilists who focused on hoarding gold for the king. They separated themselves from the Physiocrats by paying attention to and celebrating the industry and capital accumulation as a source of economic prosperity. Although economists have been talking about economic growth for many years, the first official growth model was formulated in 194748, right after World War II. The extraordinary story of growth achieved by the Soviet Union through savings forced unleashed interest in growth. Especially since the Soviet Union after WWII became one of the superpowers. Furthermore, after the Second World War, the World Bank was established with the objective of rebuilding the world economy. Therefore, understanding the growth process becomes crucial. The growth stage of the Rostow can be considered as the predecessor of the HarrodDomer. According to Rostow’s theory, there are five stages of development, namely 1. Traditional Society 2. Prerequisites for take-off 3. Take-off 71 CU IDOL SELF LEARNING MATERIAL (SLM)
4. Mature driving force 5. Mass consumption era This is the take-off stage where Rosto predicts that the savings and investment rate will rise from 5% of national income to 10%. Therefore, this is a stage where the economy will embark on a path of high growth. But Rostowno has a suitable theory to determine the path to take-off. 4.2 CLASSICAL MODEL OF GROWTH The analysis of the process of economic growth is a central feature of the work of the British classical economists, mainly represented by Adam Smith, Thomas Malthus, and David Ricardo. Despite the earlier speculations of others, they must be regarded as the main precursors of modern growth theory. The ideas of this school have reached the highest level of development in Ricardo's work. The interest of these economists in the subject of economic growth is rooted in the specific conditions of their time. Specifically, they are confronted with the facts of contemporary British society and the economic and social changes that have occurred in earlier historical periods. Living in the 18th and 19th centuries, on the eve of the Industrial Revolution or in the throes, they couldn't help being moved by this change. They researched the context of what is considered a new economic system: the emergence of the industrial capitalist syst em. Political economy represents his conscious effort to scientifically explain the forces that govern the operation of the economic system, the actual processes involved in the observed changes that are taking place, and the long-term trends and results. It's time, they are moving forward. Main. The interest of classical economists in economic growth also stems from the philosophical concern about the possibility of \"progress\", which is the basic condition for the development of the social material foundat ion. Therefore, the purpose of the analysis is considered to be to determine the forces that promote or hinder such development and progress in society, to provide a basis for policies and actions that affect these forces. Ricardo’s campaign against the Co rn Law must be viewed from this perspective, just as Malthus’s concern for population growth and Smith’s attack on the monopoly privileges associated with mercantilism. Of course, for these economists, especially Smith, progress is viewed from the 72 CU IDOL SELF LEARNING MATERIAL (SLM)
perspective of national wealth growth. Therefore, the principle of national interest is regarded as the basic standard of economic policy. Progress is also conceived within the framework of the need to protect private property, and therefore also a framework to protect the interests of the owner’s class. From this perspective, they try to show that exercising individual initiative to promote personal goals under conditions of free competition will produce beneficial results for the entire society. The economic conflicts of interest of different groups can be reconciled through the operation of competitive market forces and the limited activities of \"responsible\" governments. Due to their work in economic analysis, classical economists were able to provide explanations of the general forces that affect economic growth and the mechanisms behind the growth process. An important achievement is that they realized that the accumulation of some social products and productive investment are the main driving forces of economic growth, and under the capitalist system, this occurs mainly in the form of reinvestment of profits. With this understanding, his critique of feudal society is based on the observation that a large part of social products are not invested in this way but are consumed unproductively. The explanation of the forces behind the accumulation process is considered the core of the problem of economic growth. Related to accumulation is the technological transformation of the division of labour and the transformation of production methods. In particular, Smith emphasized the extended process of division of labour, but in general, classical economists did not systematically discuss the relationship between capital accumulation and labour technological changes. Later it became the central theme of Marx's writings and was analyzed in detail. In addition to these basic forces of economic growth, they also increased the supply of labour available for production through population growth. Their analysis of the operation of these forces led them to come to a common point of view, despite their obvious differences on the specific reasons, that is, the economic growth process under the conditions they identified constituted obstacles in their way and eventually lags behind one. state. Stagnant-\"steady state\". The concept of steady-state as the end of the economic growth process is often interpreted as a \"prediction\" of the actual process of British economic development in the 19th century. There is no doubt that for a while, some (if not all) economists and their contemporaries thought so, even though Ricardo’s weighting of this particular aspect of the concept was controversial. However, more importantly, this concept is used to point to a specific 73 CU IDOL SELF LEARNING MATERIAL (SLM)
social group, the landlord class, who benefited from social products but did not contribute to its formation or \"progress\", while they supported grain. The laws and restrictions related to foreign trade hinder the only effective way out of stability, which is through foreign trade. When examining the work of classical economists, we also found that the problem of economic growth is analyzed through the application of general economic principles and the economic system as a whole rather than from the perspective of a separate economic gr owth theory. These principles make them aware of the basic modes of interdependence in the economic system and the interrelationships among the phenomena of production, exchange, distribution, and accumulation. Yet what we find in classical economic analys is is the necessary connection between analysis of value, distribution, and growth. Because of these interconnections, it is never possible to draw a clear dividing line between surveys of economic growth and surveys of other political and economic fields. The distribution of social products is considered to have a certain relationship with the performance of production work and the ownership model of the means of production. In this sense, labour, land, and capital are divided into social categories that correspond to the main class relationships between individuals in contemporary society: the working class is made up of people who provide labour, and the landlord is the person who owns land ownership or property. , And capitalists are those who own capital property, which consists of the sum of the exchange value fixed in the means of production and the \"advance payment\" that supports the workers during production. Each class receives income or product shares according to specific rules: for owners, the rules are based on the total amount of property they own: the rent per unit of land is so high, and the unit of capital is so much (and, for interest -based borrowing) The money’s financial capitalists or \"renters\" class, the interest per unit of money borrowed is so high). For workers, it is based on the amount of labour provided-so many hourly wages. Accumulation and distribution are considered to be interrelated by using different social classes to participate in products. The basis of this view is a concept inherited from the Physiocrats, that is, the social surplus is a part of the social product, the remaining part after deducting the \"necessary cost\" of production, including spent production materials and wage goods. required. Keep workers who produce social products. This surplus is distributed to the 74 CU IDOL SELF LEARNING MATERIAL (SLM)
corresponding class of owners in the form of earnings, interest, and rent. For classical economists, the possibility of accumulation depends on the scale and use of this surplus. Therefore, his analysis focuses on those aspects of distribution and related class behaviors that are directly related to the disposition of the surplus and therefore to growth. In particular, people often assume that workers spend their wages on subsistence, capitalists reinvest their earnings, and landlords spend their income in a \"life of violence.\" On the other hand, as the economy expands, accumulation will also affect income distribution. From the perspective of the entire economy and its expansion process, the size of the surp lus and the absolute strategic role of its users determine the importance of income distribution to classical economic analysis. Therefore, especially for Ricardo, studying the law of distribution has become the focus of analysis. In a letter to Malthus, R icardo wrote: “Political economics considers it to be an investigation into the nature and causes of wealth; I think it should be called an analysis of the various classes that determine the production of industrial products during their formation. An inve stigation into the law of division between the two. The most important thing in this regard is the rate of profit because it is related to accumulation. It serves both as a source of investment funds and as a stimulus for new investments. Considering the c ore position of the rate of profit in the capitalist economy for classical political economy, explaining the changes in the rate of profit associated with the process of capital accumulation and development has become a key issue in the theory of economic growth. Economic. Economic. This movement is a decisive reference for understanding the long-term evolution of the economy. The classic answer to this question, as Ricardo has more consistently posed, is that in a closed economy, there is an inevitable downward trend in the rate of profit during the accumulation process. Therefore, the accumulation process itself is blocked by its logic. 4.3 HARROD-DOMAR GROWTH MODEL Background to the Harrod-Domar Growth Model Two economists R.F. Harold and E.D. Domar developed this economic growth model almost at the same time. The ideas in the two models are different in detail but are very similar so that the two models are integrated and presented as a Harrod - 75 CU IDOL SELF LEARNING MATERIAL (SLM)
Domar model. HDM takes into account the demand and supply of the investment process, so it integrates classic analysis and Keynesian analysis. Harrod and Domar are both interested in discovering the income growth rate necessary for stable and uninterrupted economic operation. Although their models differ in the details, they reached similar conclusions. Harrod and Domar believe that investment plays a key role in economic growth. But they emphasize the duality of investment. First, it generates income and, second, it improves the productive capacity of the economy by increasing the capital stock. The first can be considered as the \"demand effect\" of the investment and the second as the \"supply effect\" of the inve st me nt . Therefore, as long as there is a net investment, real income and output will continue to expand. However, to maintain the equilibrium income level of full employment year after year, the growth rate of real income and output must be the same as the growth rate of the productive capacity of the capital stock. Otherwise, any disagreement between the two will lead to excess idle capacity, forcing entrepreneurs to reduce investment spending. Eventually, it will have an adverse effect on the economy by reducing incomes and employment in later periods and diverting the economy from the equilibrium path of stable growth. Therefore, if full employment is to be maintained for a long time, net investment should continue to increase. This further requires that real income continues to grow at a sufficient rate to ensure that the growing capital stock is full y utilized. This required revenue growth rate can be called the guaranteed growth rate or \"full load growth rate.\" The Harrod-Domar Model is used in development economics to explain economic growth rates in terms of savings levels and capital productivity. It shows that there is no natural reason for an economy to achieve balanced growth. The model was independently developed by Sir Roy F. Harrod in 1939 and EvseyDomar in 1946. The Harrod-Domar model is the predecessor of the exogenous growth model. The study of the Harrod-Domar model helps people understand the rate of economic growth in terms of capital productivity and savings levels. The Harrod -Domar model represents funds borrowed from savings agreements for investment purposes. The 76 CU IDOL SELF LEARNING MATERIAL (SLM)
model also claimed that there is no natural cause for the balanced growth of the economy. According to the Harrod-Domar growth model, the growth rate of an economy depends on two factors: the saving rate and the saving level of the economy, and the rate of capital productio n. The Capital-Output Ratio (COR) For example, if £100 worth of capital equipment produces each £10 of annual output, a capital-output ratio of 10 to 1 exists. A 3 to 1 capital-output ratio indicates that only £30 of capital is required to produce each £10 of output annually. If the capital-output ratio is low, an economy can produce a lot of output from a little capital. If the capital-output ratio is high then it needs a lot of capital for production, and it will not get as much value of output for the sa me amount of capital. Let us take an example to explain the model. If the capital equipment worth $8 is responsible for producing each $1 of annual output, then the capital -output ratio is 8 to 1. According to the model, there are three concepts of growth: Warranted growth Natural growth Actual growth The natural rate of growth refers to the rate of expansion of a labour force, as a larger labour force implies higher aggregate output. Warranted growth refers to the output growth rate. Actual growth gives the actual change of the aggregate output. The Harrod-Domar model tries to address two problems that have the possibility of occurring in the economy. The first problem deals with the relationship between the natural growth rate and the actual growth rate. The natural growth rate is determined by the factors like culture, birth rate, or general tastes while the propensity to consume or save affects the actual growth rate. The problem is that, given population growth, it is not certain that the economy will achieve enough output 77 CU IDOL SELF LEARNING MATERIAL (SLM)
growth to support total employment. The Harrod-Domar model also addresses the problem of the relationship between warranted and actual growth. When it is expected that there will be output growth, investments also need to be increased. But problems occur when the actual growth fails to meet the expectations of the warranted growth. Harrod’s 1939 model was an extension of Keynes’s static equilibrium analysis of The General Theory. The question Harrod asked was: if the condition for a static equilibrium is that plans to invest must equal plans to save, what must be the rate of growth of income for this equilibrium condition to hold in a growing economy through time? Moreover, is there any guarantee that this required rate of growth will prevail? Harrod introduced three different growth concepts: the actual growth rate (ga); the warranted growth rate (gw) and the natural growth rate (gn). The actual growth rate is defined as ga = s/c, where s is the savings ratio and c is the actual incremental capital-output ratio (i.e. the amount of extra capital accumulation or investment associated with a unit increase in output). This expression is definitionally true because, in the national accounts, savings and investment are equal. Thus s/c = (S/Y)/(I/DY) = (DY/Y), Where S is saving, I is an investment, Y is output, and DY/Y is the growth rate (ga). This rate of growth, however, does not necessarily guarantee a moving equilibrium through time in the sense that it induces just enough investment to match planned saving. Harrod called this rate the warranted growth rate. Formally, it is the rate that keeps capital fully employed, so that there is no overproduction or underproduction, and manufacturers are therefore willing to carry on investing in the future at the same rate as in the past. How is this rate determined? The investment demand is given by an accelerator mechanism (or what Harrod called ‘the relation’) with planned investment (Ip) a function of the change in output, so that Ip = crDY, where 78 CU IDOL SELF LEARNING MATERIAL (SLM)
cr is the required incremental capital-output ratio at a given rate of interest, determined by technological conditions. Planned saving (Sp) is a function of income so that Sp = sY where s is the propensity to save. Setting planned investment equal to planned saving gives crDY = sY or DY/Y = s/cr, which equals the warranted growth rate (gw). For dynamic equilibrium, the output must grow at the rate s/cr. If not, the economic system will be cumulatively unstable. If actual growth exceeds the warranted growth rate, plans to invest will exceed plans to save; and the actual growth rate is pushed even further above the warranted rate. Contra-wise, if actual growth is less than the warranted rate, plans to invest will be less than plans to save and growth will fall further below the warranted rate. This is the Harrod instability problem. Economies appeared to be poised on a ‘knife-edge’. Any departure from equilibrium, instead of being self-righting, will be self-aggravating. The American economist, EveseyDomar, working independently of Harrod, also arrived at Harrod’s central conclusion by a different route – hence the linking of their two names. What Domar realized was that investment both increases demand via the Keynesian multiplier, and also increases supply by expanding capacity. So the question he posed was: what is the rate of growth of investment that will guarantee that demand matches supply? The crucial rate of growth of investment can be derived in the following way. A change in the level of investment increases demand by DYd = DI/s, and the investment itself increases supply by DYs = Is, where s is the productivity of capital (DY/I). Therefore, for DYd = DYs we must have DI/s = Is, or DI/I = ss. That is to say, the investment must grow at a rate equal to the product of the savings ratio and the productivity of investment. With a constant savings - investment ratio, this implies output growth at the rate ss. Since s = 1/cr (at full employment), then the Harrod and Domar result for equilibrium growth is the same. Even if the actual and warranted growth rates are equal, however, guaranteeing the full utilization of capital, this does not guarantee the full utilization of labour which depends on the natural rate of growth (gn) made up of two components: the growth of the labour force (l) and the growth of labour productivity (t), both exogenously given. The sum of the two gives the growth of the labour force in efficiency units. If all labour is to be employed, the actual growth rate must match the natural rate. If the actual growth rate falls below the natural rate there will be growing unemployment of the structural variety. It should be clear that the full employment of both capital and labour requires that ga = gw = gn; a happy coincidental state of 79 CU IDOL SELF LEARNING MATERIAL (SLM)
affairs that Joan Robinson once coined ‘the golden age’ to emphasize its mythical nature. 4.4 HARROD-DOMAR MODEL AND DEVELOPING COUNTRIES How can developing countries fit into this story? The short -term (business cycle) issue is the relationship between ga and go, so I won't talk about it here. The long - term problem is the relationship between gw and gn, or the relationship between capital growth and labour growth in terms of efficiency. It is almost certain that in most developing countries, gn exceeds gw. Labour force growth (determined by population growth) can be 2% per year, productivity growth by 3% per ye ar, and natural growth rate of 5%. If the net savings rate is 9% and the incremental rate required for capital production is 3, the guaranteed growth rate is only 3%. Therefore gn>gw. This has two main consequences. First of all, this means that the effective labour force grows faster than capital accumulation, so with a fixed production coefficient, structural unemployment will occur. Secondly, this means that the performance of investment plans will be better than savings plans, because if the economy grows by 5%, there will be profitable investment opportunities with savings of more than 9%, and there will be inflationary pressures. Therefore, the simultaneous existence of unemployment and inflation in developing countries is not a paradox; it is the result of the inequality between the natural growth rate and the guaranteed growth rate. Most development policies can be understood and considered within this Harrod framework. The task is to bring gn and gw closer together; reduce gn and increase gw. The only feasible way to reduce labour growth is to reduce population growth. Harrod's model justifies population control. The second way to reduce gn is to reduce the labor-saving rate of technological progress, but this has the serious disadvantage of reducing the growth of living standards. The increase in gw can be produced by an increase in the savings rate. This is the purpose of the monetary and fiscal policy plan, with the focus on tax reform and financial liberalization policies. If countries that use more labor-intensive production technologies reduce their capital-output ratio, gross profit margins may also increase. There are ongoing debates about choosing the right technology in developing countries and whether 80 CU IDOL SELF LEARNING MATERIAL (SLM)
more labor-intensive technologies can be adopted without sacrificing production or savings. Debates on the economics of growth The Harrod (and Domar) model provides a starting point for the great debates on the economics of growth that occupied most of the economic community for at least three years between the mid-decade 1950s and 1980s. The battle line is drawn between the Neo-classical growth school in Cambridge, Massachusetts, on the one hand, and the Keynesian growth school in Cambridge, England. The main protagonists are Nicholas Cardo, Joan Robinson, and Richard Kahn. And Luigi Passinetti. It is immediately clear to both sides that if the Harrod -Domar model is representative of the real world, then all economies, rich or poor, capitalism and communism, will experience ups and downs. The variables and parameters that determine gn and gw are given independently. There is no automatic mechanism to keep these two growth rates consistent, to provide the basis for stable long -term growth below the natural growth rate. The task set by the two co nflicting camps is to develop mechanisms to reconcile the differences between gn and gw. The field in Cambridge, England focuses on the savings rate as a function of the income distribution between wages and income, which is assumed to be related to whether the economy is booming or declining. Specifically, in his model, it is assumed that the tendency to save with income is greater than that of saving with wages, and it is assumed that the share of profit in national income rises during periods of prosperity and falls during periods of recession. Therefore, if gn exceeds gw, prosperity occurs and the profit share increases, the savings rate will increase, and gw will increase toward gn. The only restriction may be the \"inflation barrier\" caused by workers who are unwilling to keep their wage share below a certain minimum. Conversely, if gn is less than gw, this will lead to a recession, the profit share will fall, the savings rate will fall, and gw will decrease towards gn. The only limit here may be the minimum profit margin acceptable to the entrepreneur, which sets a limit for the decline in profit sharing. The field of Cambridge, Massachusetts focuses on the capital-output ratio, believing that if labour grows faster than capital, the price mechanism will operate in such a way to induce the use of more labor- intensive technologies, and vice versa. Therefore, if gn exceeds gw, the capital 81 CU IDOL SELF LEARNING MATERIAL (SLM)
production ratio will decrease as gw increases to gn. If gn is less than gw, then capital productivity will increase by reducing gw to gn. However, this Neo-classical adjustment mechanism has two premises. First, the relative prices of labour and capital are sufficiently flexible. Second, there are a variety of technologies to choose from so that the economy can run easily and smoothly along with the continuous production function of input-related, capital, and labour-related production. If this is true, economies can achieve a growth equilibrium at a natural rate. However, a very counterintuitive conclusion drawn from the Neo-classical model is that investment is irrelevant to long-term growth, because the natural rat e depends on labour growth and labour productivity (determined by technological progress), both determined exogenously. Any increase in a country's saving or investment ratio will be offset by an increase in the capital-output ratio, while the long-term growth rate will remain the same. However, this argument depends mainly on the decrease in the productivity of capital as the capital/ labour ratio increases. This is the Neo-classical story that the \"new\" endogenous growth theory opposes. If there is a mecha nism to prevent capital productivity from falling as investment increases, then the investment ratio is important for long-term growth. In this sense, growth is endogenous, that is, growth is not only determined by exogenous growth. Labour force growth in terms of efficiency. 4.5 CRITICISM BASED ON EVIDENCE HDM clarifies the important determinants (and political influences) of economic development, but they are not without criticism. HDM has been criticized for the following reasons: A major problem in the Harrod-Domar model is the fixed relationship which states that output must grow at par with capital in the long term. This fixed relationship between capital and output: y= l/v K. The constant capital/output ratio implies that the percent changes in capita l stock and output must be equal. However, for a wide cross-section of LDCs, y>k. Growth accounting studies find that, roughly, net capital growth is K =2%, while y = 4.5%. Therefore, it is invalid for HarrodDomar to assume that increased capital is the on ly source, or even the primary source, of growth. Other important sources of growth are subsumed in the parameter v. For example, there can be increments in productive labour, skills, technological improvements, and soon. Studies in the 1960s empirically d etermined 82 CU IDOL SELF LEARNING MATERIAL (SLM)
the sources of growth for the United States to be rough as follows, with the residual attributed to technological progress. The Harrod-Domar model is also criticized because its implied growth is seen as inherently unstable. This instability aris es from the mismatch between the rates of growth of capital and the labour force. Recall that modern growth models differ from the classical model in assuming that L grows exogenously-it is independent of income growth. But how will an annual population growth rate of 3% match with a 2% rate of growth of the capital stock? If these two rates diverge, a mismatch must emerge between capital stock and the labour required to run the machines. There is no reason for the labour growth rate to equal output growth s/ v, except by coincidence. Thus the L growth must also differ from K growth, causing one of two things to happen: (1) unemployment, or (2) a change in the capital/labour ratio. Such conditions of unbalanced growth should cause chronic cycles. Fig 4.1 Criticism Based on Evidence The vertical axis may be interpreted as output per worker and the horizontal axis as capital stock per worker: the K/ L ratio. The production function shows output increasing linearly with K. Implicitly assuming that there is une mplo yed labour below the point of full emplo yment. There is a fixed relation between labour and machines--for example, one to-0ne. Beyond full employment there is no more labour to be matched with additional machines, so output produced levels as shown by the 83 CU IDOL SELF LEARNING MATERIAL (SLM)
kinked line OY. For balanced growth, the K/ L ratio must remain constant, so the growth of the capital stock must not outpace the growth of the labour force. Capital also must grow at the same rate n, so investment must be dK = I = nK as indicated by the straight line I = nK, along which the K/ L ratio remains constant. For equilibrium to take place savings equal investment. Such balanced growth can only occur at point O or B. While O indicates zero output, an equilibrium at B is also implausible since it lies beyond F, the full employment of labour, implying that a sizeable portion of capital is left unused. If savings lie below the required investment, however, the economy will move toward the other equilibrium at 0, which is implausible. Thus the only way to have stable growth would be if n.v = s. The investment line must coincide precisely with the (dotted) savings line, which is a very unlikely circumstance. The Harrod-Domar model implies that the growth process must be chronically unstable, but such crises are not endemic even though labour and capital growth continue at quite different rates. Despite these limitations, \"Harrod-Domar's growth model is purely laissez-faire based on the assumption of fiscal neutrality, and aims to show the progressive equilibrium conditions of advanced economies.\" Kurihara believes that they are important, \"because they represent incentives for Keynesian static savings and A stimulating attempt to make short-term investment theory and secularize it. 4.6 SUMMARY The Harrod-Domar growth model was developed by two economists separately but at the same time. Both the Harrod model and the Domar model raise the importance of saving and investing in the process of economic growth. Both models try to create conditions for stable growth; Failure to comply with these conditions will lead to imbalances, which will lead to the gap between inflation and deflation. The Harrod-Domar model was developed in the context of developed market economies. But it has been used extensively in t he formulation of planning models in developing economies. 84 CU IDOL SELF LEARNING MATERIAL (SLM)
4.7 KEYWORD Natural Growth Rate: Refers to the maximum growth rate which an economy can achieve with its available natural resources. Capital-Output Ratio:The number of units of capital required to produce a unit of output. Investment:That part of national income which is spent on the acquisition of capital goods. Savings:That part of national income which is not spent on the purchase of consumer goods. Human capital:the levels of education and skill possessed by the factor of production, labour. Productivity – This is a measure of output per unit of input. Economic growth – This is when a country’s production of goods and services increases over time. Capital stock – The total physical capital available in an economy at any given time. 4.8 LEARNING ACTIVITY 1. Define Capital-Output Ratio _____________________________________________________________________ _____________________________________________________________________ ___________________________________________________________________ 2. State the principles of capital _____________________________________________________________________ _____________________________________________________________________ 4.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 85 CU IDOL SELF LEARNING MATERIAL (SLM)
1. State the big push theory of growth. 2. State implications of Model 3. Explain Capital-Output Ratio 4. State Harrod-Domar model implications 5. According to the Harrod-Domar model, which are the determinants of economic growth? Long Questions 1. What does the Harrod-Domar model offer for the analysis of development policy? 2. Outline the Harrod-Domar Model. Discuss the possible uses and limitations of the model for developing countries. 3. Explain the criticism on the model 4. Give brief introduction on the classical model of growth 5. Explain in your own words Harrod-Domar's contribution to the development of growth models B. Multiple Choice Questions 1. The simultaneous existence of unemployment and inflation in developing countries, according to Harrod-domar Model: a. is not a paradox; it is the outcome of an equality between the natural and warranted growth rates. b. is a paradox; it is the outcome of an inequality between the natural and warranted growth rates c. is not a paradox; it is the outcome of an inequality between the natural and warranted growth rates d. is not a paradox; it is the outcome of an equality between the natural and warranted growth rates. 2. Harrod introduced three different growth concepts: a. the actual growth rate; the steady state growth rate and the natural growth rate. 86 CU IDOL SELF LEARNING MATERIAL (SLM)
b. the stationary growth rate; the warranted growth rate and the natural growth rate c. the equilibrium growth rate; the warranted growth rate and the natural growth rate. d. the actual growth rate; the warranted growth rate and the natural growth rate. 3. Harrod-Domar model of growth is based on the concepts of and their equality a. Investment and average growth rate of income. b. Actual, warranted and natural growth rate. c. Population and productivity growth. d. Productivity growth and investment growt h 4. Harrod-Domar growth model suggests that growth is a. indirectly related to savings and the capital/output ratio b. directly related to savings and the capital/output ratio c. directly related to savings and inversely related to the capital/output ratio d. directly related to the capital/output ratio and inversely related to savings 5. Which of the following models uses three distinct concepts of stages of growth a. Domar model b. Harrod model c. Ramsey model d. Lewis model 6. Who put forward the theory of social dualism a. J.H.Boeke b. A.Lewis c. G.Myrdal d. A.O.Hirshman 7. Which growth model inspired the use of capital-output ratio for development planning 87 CU IDOL SELF LEARNING MATERIAL (SLM)
a. The Harrod-Domar model b. Feldman's model c. Kaldor's model d. Solow's model 8. According to the neo-classical theory, economic development is a. Cumulative b. Gradual c. Harmonious d. All of these 9. Which of the following models uses three distinct concepts of stages of growth a. Harrod model b. Ramsey model c. Domar model d. Lewis model Answers 1-d, 2-c, 3-b. 4-b, 5-b, 6-a, 7-a, 8-a, 9- a 4.10 REFERENCES References book Meier, G, Leading Issues in Economic Development, Oxford University Press, New Delhi, 1990. Solow, R. M., Growth Theory: An Exposition, Oxford University Press, 2000. . Domar, E.D., Essays in Theory of Economic Growth, Oxford University Press, New York. Ray, D., Development Economics, Oxford University Press. 88 CU IDOL SELF LEARNING MATERIAL (SLM)
Adelman, J., Theories of Economic Growth and Development, Stanford University Press, 1961 Website https://www.britannica.com/topic/economic-growth/Theories-of-growth https://en.wikipedia.org/wiki/Harrod%E2%80%93Domar_model 89 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 5: MODELS OF ECONOMIC GROWTH PART II STRUCTURE 5.0 Learning Objectives 5.1 Introduction 5.2 Background of Growth Theory 5.3 One Sector Neo-classical Model of Growth 5.3.1 Assumptions of Neo-Classical Model of Growth 5.3.2 Main Determinants of Economic growth 5.3.3 Main features of neo-classical Growth model 5.3.4 Limitations 5.4 Rostow’s Theory of Stages of Growth 5.4.1 Critical Appraisal 5.5 Summary 5.6 Keywords 5.7 Learning Activity 5.8 Unit End Questions 5.9 References 5.0 LEARNING OBJECTIVES After studying this unit, you will be able to: State the one sector neo-classical model of growth Describe determinants of economic growth Features of neo-classical Growth model Rostow’s Theory of Stages of Growth 5.1 INTRODUCTION The Neo-classical growth model was proposed by modern economists such as Solow, Mead, and Swann. It is called the Neo-classical model because it is based on the Neo-classical assumption that substitution between factors of production (for 90 CU IDOL SELF LEARNING MATERIAL (SLM)
example, between labour and capital) is possible. In other words, the capital-labour ratio can be changed, so the economy can maintain a state of continuous growth. Neo-classical growth theory is an economic theory that describes how economic growth rates are produced by a combination of three driving forces: labour, capital, and technology. In 1956, the National Bureau of Economic Research named Robert Solow and Trevor Swan developed and introduced the long -term economic growth model. The model first considers exogenous population growth to establish growth rates, but in 1957 Solow incorporat ed technological changes into the model. The collective work of economists Tobin, Swan, Solow, Mead, Phelps, and Johnson is called the Neo-classical theory of economic growth. The assumptions made by these theorists in Neo-classical theory are based on the views and norms given by Neo-classical economists such as Alfred Marshall, Wicksell, and Pigou. 5.2 BACKGROUND OF GROWTH THEORY Economic growth means an increase in production. Economic growth has two char act er ist ics: Gradual and continuous: just as the expansion and development of forests are gradual but not sudden, the process of economic growth is also slow and continuous. Harmony and Accumulation: Economic growth is harmonious because it benefits all classes, namely workers, capitalists, and landlords. Economic growth is cumulative since industries are interdependent, the development of one industry will drive the development of another industry. Therefore, the industry enjoys an external economy. As a result, costs fall, the division of labour exp ands, and technical knowledge increases. 5.3 ONE SECTOR NEO-CLASSICAL MODEL OF GROWTH 5.3.1 Assumptions of Neo-Classical Model of Growth 1. The capital and effort are two factors of production. 2. Alternatives to work for work. 91 CU IDOL SELF LEARNING MATERIAL (SLM)
3. Production returns to a certain scale and 4. There is a complete job in the economy. 5. The economy has a perfect competition. 6. The price is flexible. 5.3.2 Main Determinants of Economic Growth According to this theory, capital accumulation is the main determinant of economic growth. Capital accumulation requires savings. The savings rate depends on two factors: (i) interest rates and (ii) income levels. When interest and income levels are high, the savings rate is also high. These two types of factoring interest are more important for capital accumulation. The production function for the neo-classical theory can be expressed as given below: Y = F (K, L, T) Where, Y = National output K = Capital stock L = Labour supply T = Scale of technological development Under the assumption of the change theory, the growth of national production (ΔY) will be equal to the marginal productivity (MP) multiplied by AK and ΔL. Hence, ∆Y = ∆K. MPk + ∆L. MPl ---------------------------------------------- (1) Where, MPl = marginal physical product of capital 92 CU IDOL SELF LEARNING MATERIAL (SLM)
MPk = marginal physical product of capital When equation 1 of (increase in national output) is divided by Y, then we get the following equation: ∆Y/Y = ∆K (MPk/Y) + ∆L (MPl/Y) -------------------------------------- (2) The first term in RHS is multiplied by K / K, and the second term is multiplied by L / L; the resulting equation is: ∆Y/Y = ∆K/Y (K * MPk/Y) + ∆L/Y (L *MPl/Y) The K * MPk and L * MP represent the total stake of capital and labour in the national output, Here, K/Y* MPk and L/Y* MPl represent the relative stake of capital and labour in the national output. Therefore, (K *MPk/Y) + (L *MPl/Y) = 1 Let us assume that (K *MPk/Y) = b, then (L *MPl/Y) = 1-b Substituting the value of (K.MPk/Y) and (L.MPl/Y) in the following equation, we get: ∆Y/Y = ∆K/Y (K *MPk/Y) + ∆L/Y (L *MPl/Y) ∆Y/Y = b ∆K/K + (1 – b) ∆T/T In the preceding equation, the values of (1- b) and b represents the elasticity of output concerning capital and labour respectively. 93 CU IDOL SELF LEARNING MATERIAL (SLM)
Therefore, according to the neo-classical theory, the economic growth rate is represented as: Economic growth (at a given technological level) = elasticity of the increase in the reference capital stock + elasticity of the product of the increase in the stock of reference capital work However, in technological change In the case of, the change in national production can be expressed as: ∆Y / Y = b ∆K / K + (1 - b) ∆T / T Therefore, In the context of technological development, the growth rate can be expressed as: Economic growth (under a given technological level) = elasticity of the product concerning the increase in the capital stock + elasticity of the product with increase regarding technological progress 5.3.3 Main Features of Neo-Classical Growth Model The following points highlight the features of the Neo-Classical growth model 1. Capital Accumulation Theory: Neo-classical economists have differences in capital theory, but the general approach is the same. They abandoned the classical view that a fixed ratio of capital and labour is required in the production of a given technology. They accepted the possibility that capital would replace labour. This means that society can accumulate capital without increasing the labour force. Therefore, the capital theory got rid of the population theory. In the case of a constant population, increasing capital accumulation will increase national income and per capita income. However, in a given state of technology, the marginal utility of capital decreases as more capital accumulates. According to neoclassicism, interest rates and income levels are the main determinants of the social savings rate. Due to the uncertainties and risks of the future, one usually prefers the present to the future. Therefore, the interest rate must be positive to induce people to save. The higher the preference for the present, the higher the interest rate should be to induce saving. The interest rate also determines the investment rate. A lower interest rate is needed 94 CU IDOL SELF LEARNING MATERIAL (SLM)
to increase the investment rate. For this reason, the rate of return on any type of capital will decrease as the supply of that type of capital increases. Third, a high investment rate will inevitably increase the price of capital goods. Neo-classical economists also analysed the process of capital formation. Given the size of the population, the process of capital accumulation is triggered by technological progress, which leads to greater investment opportunities. The demand for capital goods has increased. Interest rates went up and the savings rate went up. Due to the limited supply of factors used to produce capital goods, the relative price of capital goods also rises with the increase in investment. The high-interest rate and high price of capital goods restrict investment to the projects with the highest returns. When these projects are completed, the interest and the relative price of capital goods will fall. In other words, interest rates have fallen to the point where society is no longer willing to save, the accumulation phase ends, and the economy reaches a stable state. 2. The impact of population growth: Neo-classical also analyses the impact of specific population growth under specific technological conditions. An increase in population will increase the supply of labour, which will lower the nominal wage rate and lead to an increase in employment. Despite falling wages, the demand schedule is assumed to be fixed. Neo-classical also analysed the impact of specific population growth under specific technological conditions. An increase in population will increase the supply of labour, which will lower the money wage rate and lead to an increase in employment. Despite the drop in wages, the demand table is assumed to be fixed. 3. Development: A Gradual and Continuous Process: According to the classics, development is a gradual and continuous process of economic change. They also emphasize the harmony and accumulation of the development process. According to Professor Marshall, development occurs gradually and continuously. Appears to be influenced by Darwin and Spencer's theory of evolution. Marshall often uses biological analogies to explain the organic and evolutionary characteristics of economic systems. He said the sacred place for economists lies in economic biology rather than 95 CU IDOL SELF LEARNING MATERIAL (SLM)
economic dynamics. Emphasize that economic development is a gradual and continuous process. For Neo-classical s, the adoption of inventions and new technologies is also gradual and continuous. They believe that technological progress stems from gradual progress and the diffusion of knowledge, and that knowledge is the main force of economic development. 4. Optimism about Development: The neo-classical are generally optimistic about the future potential for continuous development. They have faith in the ability of the person to overcome the limitations imposed on the development of society. This can be done through technical progress and improving the quality of work. Unlike Ricardo does not care about the static condition of the approach. Marshall is that \"I think it is close to the quiescent state seems to be not a good reason.\" Nor do they bother about the fear of the law to reduce profits from fear of Ricardo. According to them, the improvement in the technical progress and the quality of work will produce a general trend that counteracts the increase in income. It strongly emphasizes the importance of the deepest capital process and, therefore, is very essential for economic development according to the savings. They consider economic development as a race during the accumulation of capital and population growth. Even if the labour supply is granted in constant technologies, it is possible to increase the national income for capital accumulation. Assuming there is a smooth and autonomous growth of technical knowledge and assuming that there is a society, we will be the main development requirement. 5. Significance of International Trade: In Neo-classical theory of economic development, international trade plays a vital role in increasing the national income of an economy so that it can be at a higher level of development. International trade leads to a greater degree of specialization and division of labour, which results in a better and more efficient distribution of the world's productive resources and increased production. By expanding the size of the market, it enables a country to reap the benefits of greater specialization. Therefore, a country can increase its national income by participating in international trade. The increase in national income led to more savings and capital formation, which created the conditions for rapid economic development. 96 CU IDOL SELF LEARNING MATERIAL (SLM)
Despite supporting protective tariffs, Neo-classical s generally support free trade policies. Most Neo-classical s believe that \"free trade is like honesty and it is still the best policy.\" 5.3.4 Limitations Some limitations of Neo-classical theory are as follows: a. Considering technology as a constant factor, this is not true. This is because technology is always advancing with the times b. Considering the price factor is the main factor in determining economic growth. However, an item price adjustment may be interrupted due to changes in liquidity. c. Investment functions are not included; therefore, Neo-classical theory failed to describe the expectations of entrepreneurs and their accumulation of capital. d. Treat fixed assets as identical and not real. 5.4 ROSTOW’S THEORY OF STAGES OF GROWTH To define a framework for analysing the economic development of countries, W. Rostow proposed an investment model that attempts to show how countries have moved from a traditional society to a consumer society over several decades. Rostow bases his model on studies of many countries and their economic and social histories. So, according to Rostow, development takes place in five stages: STAGE-I: THE TRADITIONAL SOCIETY Rostow uses this term to define a country that has not yet started the development process. The proportion of the population engaged in agriculture in traditional societies is very high, and a large proportion of the country's wealth is allocated to what Rostow calls \"non-productive\" activities, such as military and religious activities. The characteristics are: (a) Per capita: Within the limited scope of available technology, the upper limit of per capita output is low. (b) Agricultural employment: 97 CU IDOL SELF LEARNING MATERIAL (SLM)
A high proportion of the labor force (75% or more) is engaged in the production of agricultural products. A large part of the resources are also used in the agricultural sector. (c) Social mobility: Hierarchy, hereditary, and status-oriented social structure restricted social mobility at that time. (d) Political power: The focus of political power in is local and regional, mainly based on land ownership. Ads: STAGE-II: THE PRECONDITIONS FOR TAKE-OFF According to Rostow, the development process begins when an elite group initiates innovative economic activities. Under the influence of these well-educated leaders, the country began to invest in new technologies and infrastructure, such as water supply and transportation systems. These projects will eventually stimulate productivity gains. The characteristics are: (a) Economic progress: Economic progress has become a recognized social value. At this time, people's thinking has changed and they can think of their respective countries. (b) New companies: New types of entrepreneurial people have emerged in society. Your goal is to build a company or industry and produce products for a long time. (c) Investment: With the emergence of new entrepreneurs in the society, total investment increased from 5% to 10%, which made the growth rate of production faster than the growth rate of the population. (d) Infrastructure: Since different industries have been established in different regions of the country, transportation, more mobile communications, roads, railways, and ports are automatically required. Then build infrastructure across the country. 98 CU IDOL SELF LEARNING MATERIAL (SLM)
(e) Credit institutions: At that time, credit institutions necessary to mobilize savings for investment were developed. (f) Labor mobilization: Due to industrialization, a large part of the labor force has been transferred from the agricultural sector to the manufacturing sector. This was experienced in Britain during the \"industrialization (after 1760)\" period. (g) The birth rate dropped: 4444 At that time, medical development was slow. Citizens understand the nature of controlling birth and death rates. First, the mortality rate was controlled, and then the birth rate was controlled. This is the second stage of the demographic transition experienced by developed countries. (h) Political power: Centralized political power based on nationalism replaced land-based local or colonial power. Rostow pointed out that history provides two different modes of transformation from traditional societies: • The basic nature of socio-political structure and production technology has changed. This model has appeared in Europe, parts of Asia, the Middle East, and Africa; • Economic and technological changes. This pattern has been observed in the United States, Australia, and New Zealand. Rostow believes that: • The agricultural society should try to transform itself into an industrial society; • Commerce and commerce should not remain localized • Society should try to expand the areas of its commercial activities; • Surplus revenue will be used to create more industries and well-developed infrastructure. STAGE-III: THE TAKE-OFF STAGE 99 CU IDOL SELF LEARNING MATERIAL (SLM)
The rapid growth is the result of a limited number of economic activities, such as textiles or food. These few take-off industries have made technological advancements and increased productivity, while other economic sectors are still dominated by traditional practices. The characteristics of this stage are: (a) Investment rate: The first attribute of the take-off stage is nothing more than the investment rate. During the \"Industrial Revolution\", the investment rate was below 5% to more than 10% of national income. At this time, agricultural land was expropriated for industrialization. This led to a later depression. For this purpose, Britain needs colonialism. As a result, they came to India and other colonies for the first time for commercial purposes, and gradually seized power in this country. (b) The development of leading sectors: During the industrial revolution (after 1760), we have seen the development of specific secondary schools in every country in Europe. In the UK, we have seen tremendous development in the textile and steel industries. Since the steel industry is vital to the development of all countries, every country has experienced the growth of the European steel industry. Today, the development of a country is measured by per capita steel consumption. (c) The existence of different frameworks in society: Has a political, social and institutional framework that takes advantage of the expansion impulse of the modern sector and the potential external economic influence to take off, and gives the growth process a continuous and cumulative character. Rostow divides the economic sectors into the following three categories: • Primary growth sector, where there is a potential for high growth rates and activity, which has set off expansion forces elsewhere; • Complementary growth sector, where rapid growth directly responds to the progress of the primary sector. • Sectors that derive growth. In these sectors, growth is achieved in continuous response to growth in real income, population, etc. 100 CU IDOL SELF LEARNING MATERIAL (SLM)
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