12.2 Theories of Economic Development and Modernization

Economic development theories explore how nations progress economically, politically, and socially. From modernization theory to dependency theory, these models attempt to explain the complex journey from traditional to developed economies, highlighting factors like savings, investment, and structural changes.

Different approaches to economic development emphasize various strategies, such as export-led growth or import substitution. While each theory has strengths and weaknesses, they all contribute to our understanding of how countries can foster growth and improve living standards for their citizens.

Theories of Economic Development

Economic Development and Modernization Theory

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• Economic development improves a nation's economic, political, and social well-being
  • Measured by increases in GDP per capita income, poverty reduction, and quality of life improvements
• Modernization theory posits that societies progress through similar development stages as economies grow
  • Move from traditional to developed by adopting modern practices socially, culturally and politically alongside economic advancement

Linear Stages and Structural Change Models

• The linear stages of growth model outlines five basic stages of economic growth
  • Traditional society, preconditions for take-off, take-off, drive to maturity, and age of high mass consumption
  • Progressing through stages requires increased savings and investment
• Structural change models focus on transforming underdeveloped economies
  • Shift from heavy emphasis on traditional subsistence agriculture to more modern, urbanized, and industrially diverse manufacturing and service economy

Neoclassical Growth Theory and Dependency Theory

• Neoclassical growth theory emphasizes the importance of increasing quantity and quality of production factors
  • Increases in capital goods, labor force, technology and human capital lead to economic growth
• Dependency theory argues that resources flow from underdeveloped "periphery" states to wealthy "core" states
  • Enriches the "core" at the expense of the "periphery"
  • Central argument of capitalism as a means of development

Approaches to Economic Development

Growth Models and Two-Sector Model

• Harrod-Domar model emphasizes importance of savings and capital productivity for growth
  • Solow model expands this to include technological change and allows for capital-labor substitution
• Lewis two-sector model posits underdeveloped economies have two sectors
  • Traditional, overpopulated rural subsistence sector with zero marginal labor productivity
  • High-productivity modern urban industrial sector where subsistence labor gradually transfers

Investment Strategies and Trade-Based Approaches

• Big push model argues comprehensive large investment needed to jump-start development and break economic stagnation
  • Contrasts with more gradual investment efforts
• Export-led growth strategies focus on developing production for export markets to drive growth
  • Import-substitution strategies emphasize replacing imports with domestic production
• Market-based approaches rely on private investment and market forces
  • Dirigiste policies involve state centrally coordinating development through planning and public enterprises

Strengths and Weaknesses of Development Theories

Linear Stages Model and Structuralist Approaches

• Linear stages model provides intuitive development "roadmap" but has limitations
  • Assumes all countries follow same path, discounts country-specific factors, can promote reductive view
• Structuralist approaches highlight important development dynamics but have critiques
  • Can discount market forces and incentives, surplus labor assumption challenged

Neoclassical Models and Dependency Theory

• Neoclassical models provide strong theoretical framework based on production functions
  • Rely on assumptions like perfect competition that don't always hold in developing economies
  • Sometimes seen as discounting sociopolitical factors
• Dependency theory describes dynamics perpetuating underdevelopment but has shortcomings
  • Less clear on how countries break out of "periphery", overly deterministic view discounting agency

Export-Led and Import-Substitution Strategies

• Export-led models have driven growth in many economies (East Asian tigers)
  • Can lead to balance of payments problems if imports not controlled
• Import-substitution often leads to inefficient industries behind protectionist walls
  • Latin American countries struggled with this approach

Institutions and Policies for Development

Institutional Environment and State Capacity

• Stable property rights, contract enforcement, independent judiciary, efficient bureaucracies, transparent governance crucial for conducive investment and market activity environment
• Effective state capacity in providing public goods and addressing market failures important
  • Should balance with avoiding excessive intervention that stifles private enterprise
  • Developmental state model credits state planning for East Asian growth (Japan, South Korea)

Trade, Human Capital, and Macroeconomic Policies

• Trade openness policies, often with export-oriented strategies, associated with higher growth
  • Caveats around managing balance of payments, ensuring domestic industry competitiveness
  • Trade protection seen as ineffective long-term
• Human capital promotion through education and health investments builds productive workforce
  • Addressing inequality important for economic and sociopolitical reasons
• Sound macroeconomic management (fiscal and monetary policies controlling inflation, deficits, debt) creates stable growth environment
  • Exchange rate policy balances competitiveness with macro stability

Industrial and Foreign Investment Policies

• Effective industrial policy and incentives can foster domestic industries and technological upgrading (South Korea, Taiwan)
  • Need to avoid capture and inefficiency
• Policies promoting FDI common for accessing capital and technology (Singapore)
  • Potential for technology and knowledge spillovers to domestic firms