Teaching Notes · Economic Development and Growth

Classical Theories of Economic Development

Before development economics turned its attention to quality of life, capability, and human development, an earlier generation of economists tried to answer a narrower question: what makes an economy grow, mechanically, in the first place? Four names tend to anchor that conversation, and it is worth knowing them well enough to recognize where later ideas, including the ones in the rest of this series, were reacting against or building on.

The four approaches are usually grouped as follows: the linear stages of growth model, theories of structural change, the international dependence revolution, and the neoclassical, free market counterrevolution. Each was, in its own time, the dominant way of thinking about development, and each eventually drew serious criticism that opened the door to the next.

Rostow's stages of growth

In 1960, the American economist and historian Walt Whitman Rostow proposed that every economy passes through the same five stages on its way to modern development, laid out in his book The Stages of Economic Growth: A Non-Communist Manifesto. The stages are traditional society, where output is limited by pre scientific technology and a rigid social structure; the preconditions for take off, when the ideas of economic progress begin to spread and the groundwork, such as infrastructure and a more commercial agriculture, gets laid; the take off itself, a relatively short period in which investment rates rise sharply and new industries expand rapidly; the drive to maturity, a longer stretch in which modern technology spreads across the whole economy; and finally the age of high mass consumption, where output shifts toward durable goods and services for a broad middle class. Rostow's framework was enormously influential in the 1960s, in part because it offered a clear policy implication: increase the savings and investment rate enough, and a country could reach take off.

The model drew sustained criticism almost as soon as it became influential. It assumes every country can and should follow the same Western path, with little regard for cultural, historical, or institutional differences between them. It has little to say about the specific obstacles facing previously colonized regions, resource exploitation, artificial colonial borders, and the civil unrest that sometimes followed independence, and it tends to treat countries that do not follow the Western pattern as simply behind rather than differently situated. Perhaps most tellingly, a number of countries, including much of Sub Saharan Africa, have appeared to remain stuck at the preconditions or take off stages for decades, which is difficult to reconcile with a model that presents the stages as a reliably one way progression.

The Harrod and Domar growth model

That emphasis on savings and investment was formalized by Roy Harrod and Evsey Domar, working independently in the late 1930s and 1940s. Their model, now usually referred to as a single Harrod and Domar model, proposes a direct relationship between how much a country saves, how efficiently it turns savings into output, and how fast it grows. The relationship is often written as a simple formula:

Growth rate = Savings rate ÷ Capital output ratio

The capital output ratio measures how many units of capital are required to produce one additional unit of output; a lower ratio means capital is being used more efficiently. The policy implication followed directly: a developing country that wanted faster growth needed either to raise its savings rate or to use capital more efficiently. This logic shaped a great deal of mid twentieth century development planning, even though later economists pointed out that savings and investment alone cannot explain growth once diminishing returns to capital set in.

Lewis's dual sector model

In 1954, the Saint Lucian economist Sir William Arthur Lewis, who later shared the Nobel Memorial Prize in Economic Sciences in 1979, proposed a structural explanation for underdevelopment rather than a purely financial one. Lewis's model, often called the dual sector model or the Lewis model of unlimited labor supply, divides a developing economy into two parts: a large traditional or subsistence sector, typically agriculture, where so much labor is employed relative to the available land and capital that an additional worker adds almost nothing to output, and a smaller modern or industrial sector with much higher productivity. Development, in this view, is the gradual transfer of workers out of the low productivity traditional sector and into the high productivity modern sector, a process financed by the modern sector reinvesting its profits. Growth continues as long as surplus labor remains in the traditional sector to draw on.

The model has been challenged on several fronts. The rate at which labor actually moves and new jobs get created does not necessarily track the rate at which the modern sector accumulates capital, since firms can choose more capital intensive techniques that create relatively few new jobs even as profits and investment rise. The model's core assumption, a genuine surplus of labor sitting idle in the traditional sector, has also been questioned empirically: in some agricultural economies there may be very little truly surplus labor to draw on without reducing farm output. A further criticism is that the model pays too little attention to the need for agricultural productivity itself to rise in order to feed a growing urban industrial workforce, and that its assumption of a constant subsistence wage in the traditional sector overlooks institutional and bargaining realities, such as land tenure arrangements and local custom, that can keep rural wages from behaving the way the model predicts.

Solow's growth model

Robert Solow's neoclassical growth model, published in 1956 and later recognized with the 1987 Nobel Memorial Prize in Economic Sciences, took direct aim at the Harrod and Domar assumption that savings alone could drive indefinite growth. Solow showed that because capital is subject to diminishing returns, an economy that grows only by accumulating more capital will eventually slow down and settle into a steady state. Sustained long run growth, in Solow's model, has to come from technological progress, treated as an exogenous, external input alongside capital and labor rather than as a byproduct of investment. The practical lesson is that development strategies built solely around physical capital accumulation, more factories, more infrastructure, tend to run into diminishing returns unless they are paired with genuine gains in technology and productivity.

Mechanically, Solow lets both capital and labor grow and shrink: investment adds to the capital stock while depreciation wears it down, and population growth adds to the labor force. The change in capital per worker in any period is simply investment minus depreciation; since investment is a constant share of output, the economy keeps accumulating capital until the amount being added through new investment is exactly offset by depreciation and labor force growth, at which point capital per worker, and output per worker, stop changing. Economists call this resting point the steady state, or sometimes the equilibrium capital to labor ratio. The model is not without its own critics: it assumes capital is a single, homogeneous and freely substitutable quantity, when in reality capital goods are highly heterogeneous and difficult to aggregate into one number, and it treats the rate of technological progress as simply given rather than explaining where it comes from.

Because the two models are so often taught side by side, it helps to see them compared directly.

The international dependence revolution

By the 1970s, a different and more political set of theories, grouped under the heading of the international dependence revolution, challenged the whole premise that development was simply a matter of accumulating enough capital or restructuring a dual economy. These theories treated underdevelopment as the product of unequal power relationships between rich and poor nations, and typically came in one of three variants.

The neocolonial dependence model places the legacy of colonialism, and the unequal, core versus periphery relationship it left behind, at the center of the explanation. In this view, developing countries remain structurally dependent on foreign capital, while local elites in the periphery collaborate with outside powers in ways that perpetuate a cycle of resource extraction and limited industrialization rather than breaking it. The false paradigm model takes a narrower aim at development policy itself, arguing that well meaning foreign experts and international institutions have repeatedly exported developed country models, such as capital intensive industrialization, that are promoted as universal solutions but are frequently unsuited to local conditions, factor endowments, and institutions. The dualistic development thesis, finally, describes how superior and inferior economic elements, a modern urban enclave alongside a traditional rural economy, for instance, can persist side by side within a single country rather than one gradually absorbing the other, with that persistent divide often traced back to colonial era economic structures.

The neoclassical, free market counterrevolution

A sharp reaction against both the structuralist and dependency traditions arrived in the 1980s, led by economists who argued that underdevelopment owed less to exploitation or market failure than to too much state intervention in the first place. This neoclassical counterrevolution is usually broken into three related strands. The free market approach emphasizes the efficiency of supply and demand operating with minimal interference, and favors privatization of state enterprises along with trade and financial liberalization. The public choice approach, closely associated with the idea that officials and bureaucrats are themselves self interested economic actors, is skeptical of large government on the grounds that political and bureaucratic rent seeking tends to produce inefficient outcomes rather than good policy, regardless of good intentions. The market friendly approach is somewhat more moderate than the other two, treating the state and the market as potentially complementary rather than opposed, so long as government sticks mainly to providing the legal and institutional framework, property rights, contract enforcement, basic infrastructure, that markets need in order to function well. Across all three variants, the central arguments are that intervention is rarely as efficient as its advocates claim, that state owned enterprises have a poor record of performance, and that government failure deserves at least as much scrutiny as the market failure it is so often invoked to correct.

Reconciling the differences

None of these four approaches has displaced the others entirely, and development economics today does not have a single, universally accepted paradigm the way, say, the theory of supply and demand functions in introductory microeconomics. Governments fail, but so do unregulated markets, and most serious analysis now looks for some balance between the two rather than treating either as automatically superior. Attention to a country's specific institutional and political realities, something the linear stages model in particular tended to overlook, has become close to a consensus requirement for any serious development strategy. Each of the four traditions covered here has genuine strengths and genuine weaknesses, and the field's understanding of what actually drives, or blocks, development continues to evolve as new evidence comes in.

Sources: Chapter 3, “Classic Theories of Economic Growth and Development,” and the companion “Framework for Analysis” lecture on growth theory, both closely following M. P. Todaro and S. C. Smith, Economic Development (Pearson); W. W. Rostow, The Stages of Economic Growth (1960); R. F. Harrod (1939) and E. Domar (1946); W. A. Lewis, “Economic Development with Unlimited Supplies of Labour” (1954); R. M. Solow, “A Contribution to the Theory of Economic Growth” (1956); and the broader dependency and public choice literatures associated with R. Prebisch, A. G. Frank, J. M. Buchanan, and G. Tullock.