1

Growth and Development

ECON 205W
Summer 2006
Prof. Cunningham
2
What is growth?
Economic growth is the increase of a
nations real output (GDP).
Results from:
Greater quantities of natural resources,
human resources, and capital,
Improvements in the quality of
resources, and
Technological advances that boost
productivity.
3
Development
Economic development is the
process by which a nation enhances
its standard of living over time.
The economic standard of living is
often defined as GDP per capita.
4
Growth and Development Models
Harrod and DomanKeynesian
Growth
SolowNeoclassical growth
Schumpetereconomic
development and institutional
change
Nurkse, Lewis, Schultztheories of
economic development
5
Sir Roy Harrod and Evsey Domar
Sir Roy F. Harrod (1900-1978), University
of London
Evsey Domar (1914- ), Johns Hopkins
and MIT
Harrod viewed himself as more of a
specialist on the intl monetary system.
An Essay in Dynamic Theory (1939),
Economic Journal.

6
Harrods Ideas
Based on two hypotheses:
Capital and labor have to combine in a fixed proportion
dictated by current technology to produce product.
The saving rate is fixed.
The rate of growth of the capital stock (the warranted
rate of growth) is defined as the ratio of two constants:
Saving and investment per unit of desired output
Stock of capital per unit of output dictated by technology.
The rate of growth of labor is called the natural rate of
growth
Society is fully utilizing the capital and labor only if the
warranted and the natural rates of growth happen to
be equal.
This is the knife edge problem. If investment is above
the warranted rate, recession follows. If investment is
below, inflation follows.
7
Domars Ideas
Essays in the Theory of Economic Growth (1957).
Assumes:
Fixed saving rate. Change in AD is proportional to the change in
investment.
The productivity of investment is constant.
Net investment adds to the capital stock, increasing potential
GDP.
Investment spending also adds to aggregate demand, but
investment spending must increase from period to period if the
potential income arising from increased capital is to be realized.
Balanced growth is a rate of income growth which maintains
full employment of all resources. To achieve balanced growth,
investment must increase at a rate equal to the product of the
potential average productivity of investment and the propensity
to save.
8
Robert M. Solow (1924- )
PhD, Harvard. Career at MIT.
Contributions across the breadth of
economics.
Nobel prize in 1987.
Solows theory on growth supports the
neoclassical view that the economy
naturally adjusts to achieve stable
equilibrium growth.
9
Joseph Schumpeter (1883-1950)
Background
1908, The Nature and Essence of Theoretical
Economics
1911, The Theory of Economic Development
1914, Economic Doctrine and Method
1939, Business Cycles
1942, Capitalism, Socialism, and Democracy
1954, History of Economic Analysis (published
posthumously)

10
Schumpeter (2)
Starts with neoclassical model.
Introduces entrepreneurship and innovation
change. The balanced, circular flow is disrupted.
Innovations drive business cycles and
development. Innovations occur in clusters.
Innovation is followed by recession and
depression, then recovery.
Breaks down economic development three
cycles:
Kitchin Cycles (40 months)
Kuznets Cycles (10 years)
Kondratieff Waves (35-55 years)
11
Schumpeter (3)
Argues that capitalism will not survive.
Rejects Ricardian and Socialist arguments for
the decline of capitalism.
Obsolescence of entrepreneurial function
Collapse of Political Strata
Institutions crumble
The cold, rational mindset of capitalism is destructive of
moral authority
Economic issues move to political sphere
Welfare state expands and takes overguided
capitalism to state capitalism, etc.
12
Theodore Schultz (1902-1998)
Background and accomplishments.
Nobel Prize, 1979. Cited his work in
growth and development, as well as
agricultural economics.
Initiated the human capital revolution
in economic thought.
Knowledge and skill are the result of
investment, and help to explain the
productivity advantages of developed
nations.
13
Schultz (2)
Human capital helps to explain three things:
We thought that K/L ratios should rise with growth,
but in fact they fall. The problem is that we are not
including the entire stock of capital.
Income has risen faster than the combined amount
of factors. That is, there appears to be increasing
returns to scale. How? Ans: better quality of factors.
To develop economies, we should not focus solely
on physical capital formation, but rather include
human capital formation.