Development Theory of Adam Smith Ricardian Theory of

Development Theory of Adam Smith Ricardian Theory of Development Malthusian Theory Rostow's Stages of economic Growth/Rostovian take-off Model 5. Dependency Theory 6. Myrdal’s CC (Cumulative Causation) Theory 1. 2. 3. 4.

Development Theory of Adam Smith �British economist Adam Smith (1723 -1790) is regarded as the father of classical economics. His work ‘An Enquiry into the nature & causes of wealth of nation published in 1976, was primarily concerned with problem of economic development.

Assumption: 1. Laissez-faire or individualism exists in economy. 2. Free economy/invisible hand determines the price. 3. Producers want to maximize profit and consumer wants to maximize state facilities. 4. An open economy is considered. No restriction in international trade. 5. The long run period is considered. 6. Distribution of wealth in done through the interaction of demand & supply.

Basic feature & analysis of theory � 1. Natural law: �Adam Smith believed in natural law doctrine. He thought that it is the best way of development. In his opinion each individual was led by an “invisible hand” which will guide market mechanism. He regarded every person the lest judge of his self interest. Since every individual of left free, will seek to maximize his own wealth. Therefore, all individual, if left free, will maximize aggregate wealth. Adam smith was against the intervention of government in the development of business, trade & commerce of a country.

� 2. Division of labour: �The development theory of Adam Smith starts from division of labour. He attributed that development increases productivity through the 1) increase in efficiency of labour 2) saving in time 3) invention of large member of labour saving machine. However development is limited by the extent of market implies that development increases with the extension of the market.

� 3. Capital accumulation: �Capital accumulation is a necessary condition for economic development. Production depends upon investment. Investment depends on savings. But almost all saving resulted from capital investment & renting of landed. So only capitalist and landlords were held to be capable of saving. The labour classes were considered to be incapable of saving. This belief was based on “iron law of wage”.

� 4. Agent of growth: �Adam Smith considered the producer, farmer &businessmen & the agent of economic growth. It was free trade, enterprise &competition that led farmer, producer & businessmen to expand the market which ultimately made economic development possible.

� 5. Taxation system: �Adam Smith in his “wealth of Nation” Book emphasized increase in investment for development. He argued that taxation system not go against capital formation and investment. That is why he was always against the tax on profit. Because such tax discourage the entrepreneurs to investment more.

� 6. International Trade: �Adam Smith was supporter of free trade. Because its encourage division of labor. He argued that when society progresses it tends to increases population. It is a part of development.

� 7. Dual role of interest rate in development process: �Adam Smith recommended natural rate of interest for economic development for following two reasons. �It optimizes the use of capital investment. �Such interest rate helps to finance loan to the investors.

� 8. Why do capitalists make investments? �According to Adam Smith investment are made because the capitalists expects to earn profit on the climate for investment as well as actual profit.

� 9. Process of growth: �In this theory the economy growth likes a tree. The process of growth is cumulative. When there is prosperity as a result of progress in agriculture, manufacturing, industries & commerce, it leads to capital accumulation, technical progress, increase in population, expansion of market, division of labour and rise in profit continuously. All this happens in smith progressive state.

� 10. Stationary state: �Progressive state is not endless. It ultimately leads to stationary state. It is the scarcity of natural resources that finally stops growth. In this state capital accumulation stops, population becomes stationary, profits are the minimum, wages are at the subsistence level(maximum), there is no change in per capital income and production and the economy reaches the state of stagnation.

Ricardian Theory of Development �Smith David Ricardo (1782 -1823) presented his views a economic development in an unsystemic manner in his book of “The principles of political economy and taxation”. �Ricardo never any theory of development. He simply discussed theory of distribution.

Assumption: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. AII lands are used for the production of crop. Law of diminishing return of land. The supply of land is fixed. Demand for corn in perfectly inelastic. Labor & capital are variable input. State of technical knowledge is given. All workers are paid a subsistence wage. Price of labor is given. Demand for labor depends on capital accumulation. There is no perfect competition. Capital accumulation results from profit.

Basic features and analysis of theory � 1. Division of rent, profit and wage: �In Ricardo system the whole economy consists of a big firm fixed in supply, which is engaged in properly only by applying homogenous unit of labor & capital. The entire produce is distributed among landlords , capitalists as rent , profit & wage while interest is included in profit.

� 2. Process of capital formation: �Ricardo said that capital formation depends on two factors : power to save and will to save. power to save depends on net income of the society, which is a surplus out of total output after meeting the cost of worker’s subsistence. The size of the surplus of net income depends on following : �The profit rate �Increase the wage �Declining profit in after industries �Other sources of capital accumulation �Taxation �Fare trade �Ricardo also explain the following issues :

�Ricardo also explained the following issues: � 3. Law of diminishing return � 4. Growth of population � 5. Ultimate stationary state

Malthusian Theory �Malthus did not regard the process of development as automatic. Rather it required consistent efforts at the part of the people. �Malthus was concerned with the ‘’ Progress of wealth’’ of a country. By Progress of wealth, he meant economic development which could be achieved by increasing the wealth of a country. Malthus was interested in short run development rather than the long run. Malthus explained only the obstacles to economic development but how the development could be achieved was not discussed in his essay. That is why his development theory was pessimistic rather than optimistic.

Explanation � 1. Population growth & economic development: �Population growth by itself is not sufficient to bring about economic development. Rather it is the result of development process. Malthus said that an increase of population cannot take place without appropriate increase in wealth.

� 2. Process of accumulation: �The process of accumulation is higher profit. Profits come from the savings of the capitalization, because workers are too poor to save. If capital is save more &spend less on consumer goods development will be retard.

� 3. Deficiency of effective demand: �It is not true that commodities are always exchanged for commodities. In fact the great mass commodities are directly consumed by labor rather than for commodities. Since worker, who are consumer, receive less than the value of the product, they cannot buy all the commodities which leads excessive commodities. This leads to fall in prices, profits, saving, investment and formation capital.

� 4. The role of production and distribution: �Malthus regarded production and distribution as the two grand element of wealth. If they are confined in right proportions, they can increase the wealth of the country in a short run. But if they are confined in undue proportion it may take many thousand years to increase wealth. So Malthus emphasized maximum proportion and optimum allocation of resources for increasing wealth.

� 5. Factors of economic development: �Malthus defined the problem of economic development as one of explaining the difference between potential GNP and actual GNP. The main problem is to achieve the potential GNP. �Malthus told that if land, labor, capital and organization are employed in right proportion, they maximize the production two major sectors like agriculture and industry of the country. �Besides these Malthus also mentioned same noneconomic factors for economic development. These are security of property, good constitution, excellent law and administrations hard working people, general attitude of the people.

� 6. Economic stagnation: � Malthus beloved that supply of labor is inelastic in the short run. Supply of capital can be increased faster than increase of population. Wages rise due to this competition, but raise in wages do not increase efficient demand because workers prefer leisure to increased consumption. As a result, prices fall, profit decline and investment also decline and development stagnant.

Criticism �It is Malthus who denied says law “supply creates its own demand “and laid emphasis upon the importance of effective demand. �He pointed out same factors which promote and hinder economic development. In particular, he pointed out the importance of technological progress, equitable distribution of wealth, internal and external trade, public works programme, administration , hard work and balanced growth. �Despite all virtues, Malthus theory has certain limitation and weakness.

� 1. Capital accumulation is not only cause of stagnation: �low consumption expenditure is not a permanent issue. It can be applicable for a temporary period. � 2. Commodities not exchanged for commodities directly: �Malthus argued that commodities are not exchanged for commodities but they are exchanged for labor. In fact, labor is not a correct measure of commodities. In real world, commodities are measured by real prices and not by labor.

� 3. Unproductive consumer retard progress: � Malthus suggests spending by unproductive consumer to increase effective demand, which ultimately supporting idle persons. � 4. Capital accumulation may not reduce profits: �Malthus thought that capital accumulation reduces the demand for consumer goods. More savings leads more capital formation. Mass savings will reduce consumption, but this is not true capital accumulation. Actually increases the demand for commodities.

� 5. One side saving base: � Like smith Malthus believed that only landlord and capitalist can save not labor. But this is erroneous view. In modern world, in many countries, poor labor can save. Expense income earners can save more than profit earners. � 6. Excessive population is not only obstacle to economic development: � Malthus meant so, but it is wrong. Development of chain is progressing having a population of 120 crores.

Rostow's Stages of economic Growth/Rostovian take-off Model �The Rostow's Stages of economic Growth model (also called "Rostovian take-off model") is one of the major historical models of economic growth. It was developed by W. W. Rostow. The model postulates that economic growth occurs in five basic stages, of varying length. 1. Traditional society 2. Pre- take off Stage 3. Take-off Stage 4. Drive to maturity 5. High mass consumption

(1)The Traditional Society: It has following feature a) Values are determined by traditions. b) Sense of invisible hand works in people mind c) Production structure is controlled by ancient technology d) Agriculture is the main occupation e) Political power was consented in the hand of the landed aristocracy. f) Trade is limited within the country g) Major part of national income is spent on unproductive sector

(2) Pre- take off Stage: a) Change in values due to economic development b) New entrepreneurs come forward in economic activities c) Investment rate increase from 5%-10% and production rate exceeds population rate. d) Social investment increase e) Financial institution appear for mobilizing capital f) Maximum population engaged in non-agricultural sector. People engaged in agriculture reduces from 75%to 40%. g) Birth rate falls h) Social mobility increases i) Political power centered on the basis of nationalism.

(3)Take-off Stage: �In such stage obstacle to development removes. Technological change occurs in industry sectors. Development curve starts rising sharply. No external forces are required for such development. Reaches to take-off stage depends on three conditions. Such asa) Investment rate must increase from 5% to more than 10%. b) One or more than one industry play leading role. c) Quick emergence of political, social and institution framework which can start secular development.

(4)Drive to maturity: �Rostow defines it as the period when a society effectively applied the range of modern technology to its resources. New production techniques take place of the old once. New leading sectors are created. Investment rate is higher over 10% of national income. �In this sector the following significant changes take place. a) People prefer to live in urban area than in rural area. b) Character of entrepreneurship changes. Non agricultural works increases. Employment in agricultural sectors reduces to about 10%. c) Skill labour force increases in non-agricultural sectors. Society feels bored of the miracles of industrialization and wants something new leading to a further change.

(5) The stage of High massconsumption: �In this stage the consumer goods, urban life and institutional education becomes available to one third to half of the population of the country. Following features are seena) National power creation and influence of the nation in globe. b) Initiatives taken to reduce inequality due to open market economy. c) Increase in consumer’s demand for durable consumer goods and high valued food items.

Criticisms Traditional stage of development is not mandatory. US, Canada, New Zealand, Australia, achieved the state of developed without facing this stage. 2. Kutznets said that pre take-off, and maturity are the different names of the same stage. 3. Such distinct five stages are actually impractical to get in a same country. 4. Rostow said that industrialization take place after agriculture mechanization. But many countries developed simultaneously with both agriculture and industry. Rostow deprived the nation from the benefits of dualism. 1.

5. The stage of high mass-consumption not chronological. The stage of HMC is so defined that certain countries like Australia and Canada entered into this stage before even reaching maturity stage. 6. The stage of maturity is puzzling and misleading. It contains all the features of the take off stage. 7. Rostow did not emphasize on the expansion of international trade. 8. Rostow’s theory is based on insufficient information or data. He made it considering the information of only 15 countries. 9. The leading sectors may not always play vital role in economic development.

Dependency Theory �Dependency refers to over reliance on another nation. Dependency theory uses political and economic theory to explain how the process of international trade and domestic development makes some LDC's ever more economically dependent on developed countries ("DC's").

�Dependency theory refers to relationships and links between developed and developing economies and regions. Dependency theory sees underdevelopment as the result of unequal power relationships between rich developed capitalist countries and poor developing ones. �Powerful developed countries dominate dependent powerless LDC's via the capitalist system. In the Dependency model underdevelopment is externally induced (i. e DC not LDC's fault) system. Growth can only be achieved in a closed economy and pursue selfreliance through planning.

�Dominant DC's have such a technological and industrial advantage that they can ensure the rules of the game' (as set out by World Bank and IMF) works in their own self interest. This partly explains the hostility shown towards the WTO in Seattle in 1999. �In this model under development is externally induced (i. e DC not LDC's fault) and only a break up of the world capitalist system and a redistribution of assets leg elimination of world debt will 'free' LDC's.

�Dependency Theory �Dependency theory is the body of theories by various intellectuals, both from the Third World and the First World, that suggest that the wealthy nations of the world need a peripheral group of poorer states in order to remain wealthy. Dependency theory states that the poverty of the countries in the periphery is not because they are not integrated into the world system, but because of how they are integrated into the system.

�These poor nations provide natural resources, cheap labor, a destination for obsolete technology, and markets to the wealthy nations, without which they could not have the standard of living they enjoy. First world nations actively, but not necessarily consciously, perpetuate a state of dependency through various policies and initiatives. This state of dependency is multifaceted, involving economics, media control, politics, banking and finance, education, sports and all aspects of human resource development.

�Any attempt by the dependent nations to resist the influences of dependency could result in economic sanctions and/or military invasion and control. This is rare, however, and dependency is enforced far more by the wealthy nations setting the rules of international trade and commerce.

�Dependency theory first emerged in the 1950 s, advocated by Paul Prebisch whose research found that the wealth of poor nations tended to decrease when the wealth of rich nations increased. The theory quickly divided into diverse schools. Some, most notably Andre Gunder Frank, adapted it to Marxism. "Standard" dependency theory differs sharply from Marxism, however, arguing against internationalism and any hope of progress in less developed nations towards industrialization and a liberating revolution.

�Former Brazilian President Fernando Henrique Cardoso wrote extensively on dependency theory while in political exile. The American sociologist Ammanuel Wallerstein refined Marxist the aspect of theory, and called it the “world system”.

Myrdal’s CC (Cumulative Causation) Theory �Cumulative causation is a theory developed by Swedish economist Gunnar Myrdal in the year 1956. It is a multicausal approach where the core variables and their linkages are delineated. � The idea behind it is that a change in one form of an institution will lead to successive changes in other institutions. �These changes are circular in that they continue in a cycle, many times in a negative way, in which there is no end, and cumulative in that they persist in each round. The change does not occur all at once as that would lead to chaos, rather the changes occur gradually.

�Gunnar Myrdal developed the concept from Knut Wicksell and developed it with Nicholas Kaldor when they worked together at the United Nations Economic Commission for Europe. � Myrdal concentrated on the social provisioning aspect of development, while Kaldor concentrated on demand-supply relationships to the manufacturing sector.

�Myrdal’s CC theory has been adopted for explaining various theoretical or practical problems. � It has been typically examined by dividing into its three different aspects. � The first way recognizes it as CC theory simply positioning between Young and Kaldor. � The second recognizes it as a theory by a member of the institutional school and considers its institutional aspect in main.

�The third recognizes it as a theory by a member of the Stockholm school, focusing on the monetary theory in his early days.

�They have seldom discussed how Myrdal’s CC theory (theories), which have various theoretical contents, should be integrated or interpreted as a whole. � Although Myrdal has been often introduced in the context of the history of CC theory and evaluated as a key person in its theoretical development, his position there has left quite ambiguous.

�Myrdal experienced three academic stages in his life: a theoretical economist or a member of Stockholm school, a politician, and an “institutional economist” as he called himself.

�Though he said he had been affected by Wicksellian monetary theory and got the first idea of his CC theory, it was the last stage that he utilized and emphasized CC theory as his main theoretical tool in analyzing practical socio-economic problems.

�Myrdal’s CC theory in its final phase consists of four theses as follows. � 1. The basic thesis: �The thesis of “backwash effects” Myrdal’s CC theory has emphasized a divergent process. �Such a process is well known as a typical logic of CC theory in general. Myrdal(1957) proposed a concept of “backwash effects” in order to explain the increasing economic inequality between developed countries and underdeveloped countries.

� 2. The opposite or exceptional thesis: � The thesis of “spread effects” contrary to the first thesis, the second one is the logic of convergence. � Although CC theory has its importance in emphasizing a divergent process and it is admitted that Myrdal didn’t emphasized this thesis as much as the first one, this thesis should be a crucial thought because this characterizes his CC theory. Myrdal’s CC theory doesn’t deny the potential possibility of a convergent process.

� 3. The thesis relating to the scope of the analysis: �The thesis of the importance of institutional factors Myrdal insists that if so-called “non-economic” factors are excluded from the analysis, it will result in distorting the recognition of the facts. � According to him, it is whether it is related to the problem, not whether it is an “economic factor”, that decides whether the factor should be included in the analysis.

� 4. The thesis of political implications : �Although Myrdal’s CC theory admitted the potential possibility of convergence in the second thesis, he was too pessimistic to think such possibility would come true naturally. � He rather believed in policies to turn over the economic forces composing the “vicious” circle. He showed the “equality” as his most important value premise and insisted the policies based on the “equality” will induce higher economic growth.

�Myrdal’s CC theory can be characterized in three points. � The first is that his CC theory is not a simple logic of polarization process, because it includes not only “backwash effects” but also “spread effects”. � The second is that his CC theory is supposed to consist of both “economic” and “non-economic” factors. � The third is that his CC theory exists as theoretical foundation of egalitarian policies.

�So Myrdal’s CC theory is theory for “development”. By the word of “development”, Myrdal means more than mere increasing production. � His CC theory includes institutional and political factors besides the demand supply. � Myrdal’s CC theory should be positioned between Young-Kaldor type CC theory and Institutional School type CC theory. Myrdal’s CC theory might be able to integrate those two currents with its unique theoretical character.

�Myrdal’s CC theory allows the possibility and necessity of the social reform by introducing policies. �Myrdal’s CC theory can be a kind of indicator of the direction for the further development of CC theory.