DEVELOPMENT ECONOMICS

Meaning of Development Economics

The term development may mean different things to different people.

In strictly economic terms, development has traditionally meant the capacity of a national economy to
generate and sustain an annual increase in its GNP (say 5-7% or more).

Development Economics is a multi-dimensional concept. Each dimension has multiple indicators. It

involves changes over time in the economy and institutions, political and social structures, and cultural
values.

Development implies progress or improvement, which in turn means that we make value judgments
about what is desirable or undesirable.

PAUL STREETEN

“Development economics means modernization, and modernization means transformation of human

beings.

Development as an objective and as a process embrace a change in fundamental attitudes to life, work,
and social, cultural, and political institutions”.

MICHAEL TODARO

Development economics analyses or investigates “requirements for affecting rapid structural and
institutional transformations of entire societies in a manner that will most efficiently bring the fruits of
economic progress to the broadest segments of their populations”.

He argues that three core values should serve as a conceptual basis and practical guidelines for
understanding the “inner meaning” of development.

These core values are:

1. The ability to meet basic needs- food, shelter, health, and protection.
2. To be a person (self-esteem- a sense of worth and self-respect, of not being used as a tool by
others for their ends).
3. To be able to choose (freedom of choice), i.e., an expanded choice for societies (including
freedom from oppression, material wants, and more excellent protection from environmental
disasters).

HANS SINGER (1969-95)

Development is a growth plus change, social and cultural as well as economic, qualitative, and
quantitative.

DUDLEY SEERS

It was the British economist Dudley

 He posed the question:

Must required “What are the necessary conditions for a universally accepted aim, the realization of the
potential of human personality”?
  He Argues that if economic growth did not reduce poverty, inequality, and unemployment,
economic development could not occur.

FREDRICK NIXSON

Development is thus a normative concept, and the definition of development will vary between
individuals, political parties, and countries.

SUSTAINABLE DEVELOPMENT.

This is defined as “Development that meets the needs of the present generation without compromising
the ability of the future generation to meet their own, needs”

A key concept of this definition lies in its emphasis on maintaining intergenerational welfare overtime

DAVID PEARCE

Providing a bequest to the next generation of an amount and quality of wealth which is at least equal to
that inherited by the current generations.

With wealth defined to include both the human-made and natural stocks of Assets.

The above notions of development raise enormous political and social issues:

1. Are any countries developed based on Todaro criteria (countries may be rich but not the same
as development)?
2. Are current development models sustainable, given the depletion of the earth’s natural Wealth
and the environmental problems (the depletion of the Ozone layer and the destruction of the
rain forests that are receiving increasing attention?
3. Can economists Alone provide answers to these questions?

If we accept that development economics embodies value judgment, economic growth, and
development are not synonymous.

Economic growth refers to an increase in the productive capacity of an economy. In other words, it
refers to an increase in the real GDP of an economy overtime.

Economic development occurs when an increase in the productive capacity of an economy, i.e.
economic growth, leads to an improvement in the standard of living of the people in an economy by the
reduction in the level of poverty, unemployment, and inequality.

Thus, economic development can occur only when economic growth has led to a reduction in the level
of poverty, unemployment, and inequality.

Economic growth is only a necessary but not a sufficient condition for economic development to
occur. The sufficient condition is a reduction in the poverty, unemployment, and inequality gap
among the various class in a society.

 GDP per capita might be increasing, but at the same time, poverty might be increasing,
inequality in the distribution of income might be rising, and massive environmental damage
might be occurring.

Therefore, it is not easy to describe such a situation as progress.

Economic growth might be necessary, but it is not a sufficient condition.

MEASUREMENTS OF DEVELOPMENT

We can use real GDP per capita to indicate the level and the need for development at a given time.
However, we should not use real GDP per capita growth as the sole development indicator over time.
Real GDP per capita growth is usually a necessary but insufficient condition for development.

PROBLEMS WITH CALCULATING NATIONAL INCOME

Problems associated with calculating national income in poor countries and its use as an indicator of
development.

a. The necessary data are often incomplete, unreliable, or not available.

b. The accounting conventions are not necessarily appropriate; the services of women working in
the household are excluded from national statistics. Yet, in many poor countries, especially in
sub-Sahara Africa, women are often responsible for running the family farm and working in the
households.
c. In most poor countries, there is a large subsistence sector, farmers may consume a large
proportion of what they produce rather than send it to the market, where it would be counted to
calculate national income. Statisticians allow this non-marketed component of the output for
rural capital formation that does not enter the national accounts- house building and irrigation
ditches. Still, it is generally accepted that the value of these activities is underestimated, thus
biasing the downward trend of the national figures for poor countries.
d. Income may be overstated for developed countries/economies because several items included
as income might better be seen as a cost and hence excluded from income- for instance, the cost
of traveling to work and heating the home in temperate countries.
e. Per capita income tells us nothing about the distribution of income. Two countries with similar
per capita incomes (average revenue per person) may have important implications for the nature
and characteristics of the development process.

HUMAN DEVELOPMENT INDEX AND HUMAN POVERTY INDEX

HUMAN DEVELOPMENT INDEX (HDI)

The HDI is a composite indicator. The HDI ranges between 0 and 1.

The most ambitious attempt to measure development is the HDI.

HDI measures the amount of development occurring at a particular point in time. It is a composite
statistic of the Life Expectancy Index (LEI), Income Index, and Education Index. It accounts for the
longevity, literacy, and standard of living.

The HDI has been adjusted by the (UNDP) to consider income distribution and gender inequalities,
and it can be disaggregated to take into account racial inequalities and regional disparities within
countries.

HUMAN POVERTY INDEX (HPI)

The Human Poverty Index (HPI) measures the extent of deprivation in the proportion of people not
benefitting from the development process. The deprivation in longevity is measured by the percentage
of people not expected to survive to age 40; the deprivation in education is represented by the
percentage of adults not educated; and the deprivation in the standard of living is represented by the
percentage of people not getting safe drinking water, good access to medical facilities, and the
percentage of children not living above age 5.

The difference between the HDI and HPI is that the former measures progress in a community or a
country as a whole; the HPI measures the extent of deprivation, the proportion of people not benefiting
from the development process.

COMMON CHARACTERISTICS OF DEVELOPING COUNTRIES

Developing countries share specific unique common characteristics. It is evident that most of these
nations still struggle with health, social amenities, and education issues. Challenges associated with
public health include some of the common characteristics that may be noted within developing states.

Some of these characteristics are:

1. LOW LIVING IS CHARACTERIZED BY LOW INCOMES, INEQUALITY, POOR HEAL

TH, AND INADEQUATE EDUCATION.

 General levels of living are low for the majority of people in developing countries.
 This applies not only to those in rich countries but also to small elite groups within their
societies.
 Low levels of living are seen in terms of low incomes (poverty), limited education, and short
life expectancies.
 Developing countries also face high infant mortality rates and a general sense of hopelessness.

2. LOW LEVELS OF PRODUCTIVITY

 Developing countries face low levels of living, deprivation in human development, and
relatively low levels of labor productivity.
 The production function concept is used to explain how societies meet material needs by
relating outputs to factor inputs and technology.
 A broader conceptualization of the production function is needed, including inputs like
managerial competence, access to information, worker motivation, and institutional flexibility.
 Labor productivity levels in developing countries are lower compared to developed countries,
highlighting the need for improvements in various areas to boost productivity

3. HIGH RATES OF POPULATION GROWTH AND DEPENDENCY BURDENS

 More than five-sixths of the world's population live in less developed countries, while less than
one-sixth live in developed nations.
 Birth rates in less developed countries are generally high, while those in developed countries
are lower.
 Crude birth rates are an efficient way to distinguish between less developed and developed
countries.
 Few less developed countries have a birth rate below 20 per 1,000, and no developed nations
have a birth rate above it.
 Death rates in developing countries are high relative to developed nations.
4. SUBSTANTIAL DEPENDENCE ON AGRICULTURAL PRODUCTION AND PRIMARY
PRODUCT EXPORT.

The vast majority of people in LDCs live and work in rural areas.

 Over 56% are rurally based, compared to less than 27% in economically developed countries.
Similarly, 58% of the labour force is engaged in agriculture, compared to only 5% in developed
nations.
 Agriculture contributes hugely to the GNP of developing nations but is minimal to the GNP of
developed countries.
5. PREVALENCE OF IMPERFECT MARKETS AND INCOMPLETE INFORMATION
There is a growing consensus that excessive government intervention in developing economies has
been detrimental. Free markets and unfettered competition are believed to be crucial for rapid
economic growth. However, the benefits of market economies and market-friendly policies rely on
certain prerequisites. These prerequisites include strong legal and institutional foundations, which
are often lacking in less developed countries (LDCs). LDCs need a legal system that enforces
contracts and validates property rights, a stable currency, and reliable infrastructure. Additionally,
availability of loanable funds and enforcement rules of repayment are important for economic
development. LDC markets are imperfect, and incomplete information systems justify a more active
role of government in economic activities
6. DOMINANCE, DEPENDENCE, AND VULNERABILITY IN INTERNATIONAL
RELATIONS.

ROSTOW’S STAGES OF GROWTH AND DEVELOPMENT

Walt W. Rostow published The Stages of Growth: A Non-Communist Manifesto. In it, he argued that
all countries experienced a similar sequence of development and that countries differed with respect to
the stages they were at any point in time. He suggested five stages:

THE TRADITIONAL SOCIETY

At this stage, the economy relies on subsistence agriculture, intensive labour, and limited trade. The
population lacks a scientific perspective on the world and technology.

 Rostow emphasized the importance of entrepreneurs in the transformation process because of

the relevance of applying scientific methods in industries.
 He further maintained that political and social commitment must be present to alter society
from traditional to modern.
 He introduced the “leading sector doctrine” This doctrine means that the growth of primary
sectors, such as mining and agriculture, will remarkably affect the rest of the economy. He,
however, did not tell us how to create this “leading sector” where it is non-existent.
 He also talked about “cluster-sectors,” “an idea which is similar to Schumpeter idea of “clusters
of followers.”
 He said that because an economy can decelerate, growth cannot be automatic, and therefore,
there was a need to prevent this condition.

During this stage, there is also an increase in population growth because there is an improvement in
health conditions during industrial growth. He also emphasized that there should be a population
resources balance, as happened in the case of Argentina and the USA in their early stages of
development.
THE TRANSITIONAL STAGE OR THE PRE-CONDITION FOR TAKE-OFF

This is a stage where agriculture is likely to be well developed, followed by improvement in

transportation. This idea is similar to Colin Clarke’s thesis that economic development occurs more or
less automatically if you first improve your agricultural sector.

 At this stage, He described a concept called “reactive nationalism”. This theory explains that
the advance of civilization is caused by problems that emerged from society for which a
response or a solution evolved.
 The problem should not, however, be of such magnitude that will discourage society from trying
to solve it.
 Under this stage, he recommended: “reactive nationalism must occur.”

THE TAKE-OFF PERIOD

At this stage, economic growth is normal. Almost all growth constraints that inhibit steady growth have
been removed.

 At this stage, there is an increase in savings and investment from five percent (5%) to ten
percent (10%) of GNP to be ploughed back into the economy.
 This stage also witnessed the development of a substantial manufacturing sector with a high
growth rate. The political, social, and institutional framework becomes developed to manage
the increased growth in the economy.
 One of the principal thrust strategies of development necessary for any take-off was mobilizing
domestic and foreign savings to generate sufficient investment to accelerate economic growth.

DRIVE TO MATURITY:

At this stage, 10 to 20 percent of GNP must be put back into the economy to counteract and consolidate
the Take-Off.

 He said there are approximately 60 years after take-off before the “drive to maturity” stage is
reached.
 The distinction between the drive to maturity and the take-off stages is not very clear, but it
seems as if the new leading sector appears to boost the old leading sectors. For example, we
have the railway in the third quarter of the 19th century in Britain superimposed by new leading
sectors like steel, chemicals, shipping, electrical and service industries.

THE STAGE OF HIGH MASS CONSUMPTION:

One of the distinguishing features of this stage is a highly advanced employment structure for the whole
economy.

In other words, the economies of Britain, the US, Germany, Japan, etc., are so developed that you have
similar jobs all over the countries. That is in terms of paid type and general conditions of service.

 At this stage, there is also a well-defined and technologically more complex form of
industrialization.
 At this stage, countries can also afford consumer durable goods such as cars, refrigerators. TV
household equipment, etc., at a very cheap and affordable level.

- Prosperous industrialized market economies are in stages Four and Five

- Poor countries are typically in stages one and two

- Stage two is the transitional stage where changes in agriculture, transport, and international trade occur

- Entrepreneurs emerge during the transitional stage

- The take-off period follows stage two, lasting 10 to 20 years

- During the take-off period, the rate of investment doubles, leading economic sectors emerge, and self-
sustaining growth begins

- The concept of a take-off is crucial in the stages theory of growth and development.

CRITICISMS

a. It is difficult to distinguish between the end of one stage and the beginning of another.
b. The stage of high mass consumption is not the “end” of development; otherwise, rich countries
undergo structural change (de-industrialization, slumps, and booms, and they differ among
themselves (for instance, compare the UK and Japan).
c. The notion of a traditional society, unchanging and common to all poor countries, is not valid.
d. The condition of today’s poor countries is different from that of the non-rich countries when
they were at comparable levels of GNP per capita.
e. Professor Robert Solow believed that Rostow does not present a theoretical model, i.e., the
relationship between an economic variable and another economic or non-economic variable, so
his theory has little analytical content.
f. Professor Nell. An economist historian of great reputation, attacked Rostow’s periodization and
insisted that industrialization in Britain started in the 16th century.

Logically, no country can replicate the development experience of another country, as the development
of one country changes the economic environment within which the other countries develop (Abdulai
S. Brima).

HARROD DOMAR MODEL OF ECONOMIC GROWTH AND DEVELOPMENT

The Harrod-Domar growth model was formulated by two economists; Harrod and Domar. The Harrod-
Domar model of growth is a model which describes the amount of investment needed to achieve a given
level of economic growth.

For economic growth to occur, new investment in the form of capital stock are necessary.

If we assume that the capital stock bears some direct relationship with Gross National Output (GNP),
then any net addition to capital stock increases investment which produces increment in the output level.

Harrod-Domar equations certainly predicts a negative relationship between growth and the capital-
output ratio but because the capital-output ratio is assumed to be fixed, then it is the ICOR that
determines economic growth and not the other way round.

If we assumed that the capital-output ratio is (k), savings is a proportion of national income (s), and that
total new investment is determined by the level of savings(S), we can determine a model that explains
economic growth:

Savings (S) is some proportion of national income (𝑠𝑌),

Investment is the change in capital stock denoted by ∆K,

The capital-output ratio bears some fixed relationship with output as expressed by:
∆𝐾 = 𝑘∆𝑌
𝐼 = ∆𝐾
𝐼 = 𝑘∆𝑌

At equilibrium 𝑆 = 𝐼
𝑠𝑌 = 𝑘∆𝑌

g=

Where g is the growth rate.

HINTS

 Savings leads to investment S = I

 Investment leads to changes in capital stock (k)
 Constant capital-output ratio
 Incremental Capital Output Ratio (ICOR): This is an increase in the Gross National Output
(Y) due to a net addition to capital stock in the form of new investment assuming that there is
some direct relationship between capital stock(K) and total GNP(Y).
 The Manufacturing sector will yield the economic growth and not the agricultural sector, because
productivity in the Manufacturing sector is faster and greater than the agricultural sector

CRITICISMS

a. Is it the level of savings that restricts investment, or is it the lack of profitable investment that
restricts savings?
b. The original model assumed a closed economy, but once foreign trade is introduced, the
significant constraints on economic growth might well be the availability of foreign exchange
rather than domestic savings.
c. Is the capital-output ratio fixed? Neo-classical economists would argue that capital and labour
will be substituted for one another depending on the relative prices and hence influencing (k)
d. K will vary between sectors of the economy (it may be lower in agriculture, for example, than
for industry), and thus, growth will be determined by the distribution of investment between
sectors.
e. It is highly misleading to calculate the ICOR by dividing the savings or investment ratio by the
output growth rate. Apart from the fact that the economy may not be operating at total capacity,
it implies that the assumption that increases in output are attributed to increased capital is not
valid.

LEWIS MODEL

 The dual-sector model was introduced by W. A. Lewis in 1954 in his article "Economic
Development with Unlimited Supplies of Labour."
 The model was named in Lewis's honor and was first published in The Manchester School in May
1954.
 This model played a significant role in the development of developmental economics.
 Lewis's article has been described as one of the most influential contributions to the establishment
of the discipline

ASSUMPTIONS

The model assumes that a developing economy has a surplus of unproductive labour in the agricultural
sector.

a. These workers are attracted to the growing manufacturing sector, where higher wages are
offered.
b. It also assumes that the wages in the manufacturing sector are more or less fixed.
c. Entrepreneurs in the manufacturing sector make a profit because they charge a price above
the fixed wage rate.
d. The model assumes that these profits will be reinvested in the business as fixed capital.
e. An advanced manufacturing sector means an economy has moved from traditional to
industrialized.

THEORY

He divided the economy of an underdeveloped country into 2 sectors:

THE CAPITALIST SECTOR

He defined this sector as "that part of the economy which uses reproducible capital and pays capitalists
thereof". The use of capital is controlled by the capitalists, who hire the services of labour. It includes
manufacturing, plantations, mines, etc. It may be private or public.

THE SUBSISTENCE SECTOR

He defined this sector as "that part of the economy which is not using reproducible capital." It can also
be adjusted as the indigenous traditional sector or the "self-employed sector." The per-head output is
comparatively lower in this sector, and this is because it is not fructified with capital.

The "Dual Sector Model" is a theory of development in which surplus labour from the traditional
agricultural sector is transferred to the modern industrial sector, whose The subsistence sector growth
over time absorbs the surplus labour, promotes industrialization and stimulates sustained development.

DIFFERENCES

 The subsistence agricultural sector is characterized by low wages, abundant labor, and low
productivity.
 The capitalist manufacturing sector has higher wage rates, higher marginal productivity, and a
demand for more workers.
 The capitalist sector uses a capital-intensive production process.
 Investment and capital formation in the manufacturing sector are possible over time as capitalists'
profits are reinvested in the capital stock.
 The hypothetical developing nation's investment is focused on the physical capital stock in the
manufacturing sector rather than improving the marginal productivity of labor in the agricultural
industry.

RELATIONSHIP BETWEEN THE TWO SECTORS

 The primary relationship between the capitalist and subsistence sectors is that when the
capitalist industry expands, it draws labor from the subsistence sector.
 In Lewis' model, he assumes that the supply of unskilled labor to the capitalist sector is
unlimited, which allows for the creation of new industries and expansion of existing ones.
 A large portion of the unlimited labor supply consists of those in disguised unemployment in
agriculture and other over-manned occupations.
 Factors such as women in the household and population growth also contribute to the increase
in the supply of unskilled labor
 The agricultural sector has a limited amount of land to cultivate, and the marginal product of
an additional farmer is assumed to be zero.
 Surplus labor in the agricultural sector refers to farmers who are not contributing to agricultural
output and can be moved to another sector without affecting agricultural production.
 Workers tend to transition from the agricultural to the manufacturing sector over time due to
the wage differential.
 The total agricultural product remains unchanged while the total industrial product increases
with the addition of labor, but this also drives down marginal productivity and wages in the
manufacturing sector.
 Over time, as the transition continues and investment increases the capital stock, the marginal
productivity of workers in the manufacturing sector will be driven up by capital formation and
driven down by additional workers entering the sector.
 Eventually, the wage rates of the agricultural and manufacturing sectors will equalize, and no
further manufacturing sector enlargement takes place as workers no longer have a monetary
incentive to transition.

DIAGRAMS

CRITCISMS

a. If there are positive opportunity costs, e.g., loss of croups in times of peak harvesting season,
labour transfer will reduce agricultural output.
b. Absorption of surplus labour may be halted prematurely due to competitors raising wage rates
and reducing profit shares. Wages in the industrial sector have been driven up by unions and
demands for increased productivity. In the poorest countries, there is a significant wage gap
between urban and rural areas, leading to high levels of unemployment in both sectors.
c. Lewis model underestimates impact of rapidly growing population on poor economy - Effects
on agricultural surplus, capitalist profit share, wage rates, and overall employment opportunities
- Growth rate in manufacturing not accurately identified as in agriculture - Industrial
 development with more capital than labor can lead to increased unemployment - Flow of labor
from agriculture to industry can exacerbate unemployment.
d. Lewis ignored the importance of balancing growth between agriculture and industry. - There
are linkages between agricultural growth and industrial expansion in poor countries. - If the
profit made by capitalists is not invested in agricultural development, industrialization could be
at risk
e. Lewis ignored possible linkages from the economy and assumed a capitalist's marginal
propensity to save is close to one. - An increase in profits will lead to an increase in
consumption, resulting in savings being somewhat less than the profit increment.
f. The transfer of unskilled labour from agriculture to the industry is regarded as almost smooth
and costless, but this does not occur in practice because the industry requires different types of
labor. The problem can be solved by investment in education and skill formation, but the
process is neither smooth nor inexpensive.

The model assumes rationality, perfect information, and unlimited capital formation in industry. These
do not exist in practical situations, so the model's full extent is rarely realized.

However, the model does provide a good general theory on labour transitioning in developing countries.

SURPLUS LABOUR is defined as that part of the labour force that can be removed without
reducing the total amount of output produced, even when the input of other factors remains
constant.

 Application of LEWIS MODEL to developing country like Sierra Leone

SCHUMPETER'S UNSTABLE GROWTH MODEL

 Professor Schumpeter was an Austrian economist who presented his economic development
theory in 1912 and his theory of the business cycle in 1939.
 His theory emphasized that economic growth is not steady but rather characterized by booms
and falls.
 This explains the undulating nature of growth graphs in many capitalist countries.
 Schumpeter strongly advocated for pure capitalism despite its problems and drew inspiration
from Marx's philosophy.
 He believed that some collapse of the capitalist system, similar to classicalists and Marx, was
necessary

HIS PREPOSITIONS

Proposition 1: The Production Function

𝑶 = 𝑭 (𝑳, 𝑲, 𝑸. 𝑻)

K is Supply of land

Q is Goods and inventories used in production

T is Technical progress

O is Output

This is the same as the classicalist and the Marxian schools.

Proposition: 2 Savings depend on Wages. Profit and Interest Rates

𝑺 = 𝑺 (𝑾. , 𝜫, 𝒓)

He defined savings as the amount that opts for future consumption and investment. Both the workers
and capitalists do save, and the level of savings increases as incomes rise. He introduced a new concept
in Neo-classical economics terms: savings tend to increase with interest rate. In other words, the
proportion of a given wage or profit income saved will rise as the interest rate rises.

Proposition 3 Investment can be divided into Induced and Autonomous Investment

𝑰 = 𝑰𝒊 + 𝑰𝒂

Schumpeter identified two types of investment:

Induced investment: Which is being stimulated by recent increases in output, income, sales, or profit
(short-term investment)

Autonomous investment: Which includes all investment for long-term consideration, such as
introducing significant technological changes in production (disturbing the existing production
function)

Proposition 4 Induced Investment depends on the Profit, Goods in Stock, and the Interest Rate
Level.

𝑰𝒊 = 𝑰𝒊 (𝜫, 𝒓, 𝑸)

Induced investment tends to rise as current profit increases and tends to fall as the interest rate goes up,
thereby establishing a relationship between profit (Π) and interest rate (r)

Proposition 5 Autonomous Investment depends on Resource Discovery and Technological

Progress.

𝑰𝒂 = 𝑰𝒂 (𝑲, 𝑻)

Autonomous investment is the primary determinant of innovation, and innovation means any significant
changes in the production function that increase output. He identified five primary forms of innovation.

 Introduction of new goods or a new quality of an old existing good

 A new method of production based on new scientific-technological discoveries
 Opening up of new markets
 Discovery of new sources of resource supply
 New organization of the industry

Proposition 6 Technological Progress and the Rate of Resource Discovery depends on the Supply
of Entrepreneurs.

Schumpeter focuses on the leading role to be played by an entrepreneur in the economy. The primary
function of an entrepreneur is as follows:

 To identify opportunities for the autonomous type of investment

 Choose good managers
  To raise money that may not be his own and cannot be regarded, therefore, as a capitalist as
such
 The entrepreneur transforms inventions into economic goods because inventions by themselves
have minimal economic effect

Proposition 6 → Technological Progress depends on the Supply of Entrepreneurs.

𝑻 = 𝑻 (𝑬)

Where E = increase in the supply of entrepreneurs

T-Technological Progress

Proposition 7 →Resource Discovery depends on the Supply of Entrepreneurs

𝑲 = 𝑲 (𝑬)

Where E = increase in the supply of entrepreneurs

K = rate of resource discovery

 Baumol (1990) suggests that the supply of entrepreneurial talent remains constant, and
economic growth is primarily influenced by institutions that promote productive, unproductive,
or destructive outcomes.
 North (1990) supports this argument by stating that economic growth is driven by incentive
structures that encourage effort and investment, which are determined by institutions.
 Bygrave and Minniti (2000) further emphasize that the establishment of society's "rule of the
game" through institutions shapes future productive structures.

Proposition 8 The Supply of Entrepreneurs depends on the Rate of Profit and the Social Climate.

𝛦 = 𝛦 (𝛱, 𝛸).

Where X = the Sociological climate

II the Level of profit E the Supply of Entrepreneurs

E= the Supply of Entrepreneurs

 Schumpeter emphasized sociological factors in entrepreneurship, similar to Marx.

 The social climate plays a crucial role in fostering entrepreneurship according to Schumpeter.
 Unlike Marxian theorists, Schumpeter's approach does not rely on a class structure

Proposition 9 GNP depends on the Relationship between Savings and Investment on the one hand
and the super Multipliers on the other hand:

 Schumpeter believed that credit creation could finance an excess of investment over voluntary
savings.
 This would increase GNP in monetary terms by a multiplier of the original gap between
investment and savings.
 On the other hand, if there is an excess of voluntary savings over investment, it would decrease
GNP in real terms by a multiplier of the original gap. This is represented as:
 𝜟𝑶 = 𝑲(𝑰 − 𝑺)

𝛿𝑂 𝛿𝐼 𝛿𝑆
It also implies that 𝛿𝑡
= 𝐾 [𝛿𝑡 − 𝛿𝑡 ]

This means that the rate of change of GNP depends on the super multiplier, which is 𝑲 (𝑺 − 𝑰), i.e., the
gap between savings and investment.

Proposition 10 The Wage Bill depends on the level of Investment

This equation is common to both the classicalists and to Marx. In that, wage income tends to increase
with increases in investment

𝑾 = 𝑾(𝑰)

Proposition 11 the Social Climate is reflected by the Distribution of Income

𝜲 = 𝜲 (𝜫/𝜲)

An attempt to put a squeeze on profit or the distribution of income through trade unions, government
legislation such as progressive income tax, and all such factors will dampen or damage the sociological
climate.

Schumpeter explains that the Great Depression of the 1930s was a direct result of public works
spending, labour legislation, progressive tax structure etc, that were introduced.

The economic climate was disturbed because the 'rule of the game' changed, rather drastically, which
discouraged entrepreneurship and retarded investment. All these forms of government interventions
have an impact on the relationship between wages and development (where wages can be taken to be
profit-after tax in the short run)

Proposition 12 GNP is equal to Profit plus Wages

𝜪 = 𝜫+𝑾

This is the same identity in the classical and Marxian models

SCOPE OF SCHUMPETER'S SYSTEM

 Schumpeter's model is based on a general equilibrium with costs equal to revenue in perfect
competition.
 The circular flow of income is disturbed by innovation in a capitalist system.
 Investment supply is typically financed by monetary expansion rather than increased savings.
 New investment leads to a chain reaction of events, including increased consumer goods and a
contraction in the money supply.
 The process can result in some firms experiencing heavy losses and a decrease in innovation spirit,
potentially leading to a depression.

THE MAXIAN MODEL OF GROWTH AND COLLAPSE

 Marx and Engels co-authored the "Communist Manifesto" in 1846, with Das Kapital being a
significant work that laid the foundation for a controversial economic theory.
 Marx's work is considered classical due to its historical context during the Industrial Revolution in
Europe, providing a perspective on the evolution from primitive communism to capitalism to
socialism and ultimately communism.
 The collapse of capitalism is predicted by Marx not only for economic reasons but also sociological
ones, with class conflict arising from labor exploitation.
 Marx's contributions to economic development include an economic interpretation of history,
defining the motivating forces of capitalistic development, and proposing a planned economic
development system.
 Key economic concepts identified by Marx include value and distribution theory, as well as the
analysis of the business cycle.

For a critical analysis, I am more concerned with the Marxist idea of surplus value.

 According to Marxian philosophy, the value of a commodity is determined by the labor put into its
production.
 The value of labor is considered as the means of subsistence required to sustain the laborer, which
is determined by the number of hours worked.
 If a laborer works for ten hours but only takes six hours to produce goods that generate wages for
their subsistence, they will be paid wages equivalent to six hours.
 The remaining four hours of labor, which the laborer receives nothing for, is referred to as "surplus
value" and goes to the capitalist as profit in the form of rent or interest.
 The rate of surplus value is calculated by dividing surplus value by variable capital.
 The rate of profit from the extra value is determined by dividing surplus value by the sum of variable
and constant capital.: RP-S/V+C.

Proposition 1: The Production Functions of Marx

𝑸 = 𝑭 (𝑳. 𝑲, 𝑸. 𝑻).

 The Marxian model of production function is derived from classical theories and is represented
similarly.
 Technological progress is emphasized by Marx as essential for capitalist growth.
 Marx places more importance on the role of the entrepreneur compared to classical theorists.
 Marx recognizes the interdependence between technological progress and development.
 The labor variable (L) in the Marxian production function differs from classical theorists as it
considers the unemployment component of labor supply.
 Marx concludes that changes in population and labor supply do not necessarily vary.
 Marx demonstrates that England and its colonies were two sectors of the same economy with the
same production function.