THE EVOLUTION OF GROWTH MODELS

Understand the evolution of economic thought regarding growth

Understand what are the determinants of economic growth.
• Introduce the economic thinking of The Physiocrats and Mercantilists
• Describe Adam Smith’s concepts of the division of labor (specialization) and
exchange
• Smithian model of economic development
• Explain diminishing returns and the role it played in the growth models of
Thomas Malthus
• Discuss the Classical economist’s emphasis on the dynamic evolution of
income shares and how dynamic influenced economic growth.
• This topic will examine the models of economic growth and development that
were popular among economist before middle of the twentieth century.

1. Models of Economic Development

 All models are simplified patterns that humans perceive and then used to
make sense of the complexity that they actually observe.
 Some early social thinkers during the seventeenth and eighteenth centuries
linked economic development to the expansion of certain industries or
sectors of the economy.
 In a number of European countries in the 1700s, it became popular to
subsidize, protect, and otherwise favor certain industrial and commercial
activities.
 According to one such group of thinkers referred to as Mercantilist, the
growth of commerce and industry were synonymous with economic
development.

2. Mercantilists
 Mercantilism was the theory of trade adopted by the major European powers
from roughly 1500 to 1800. It advocated that a nation should export more
than it imported and accumulate bullion (especially gold) to make up the
difference.
 The exportation of finished goods was favored over extractive industries like
farming.
 Mercantilists argued that national wealth is created by transforming raw
materials into final products and by expanding that transformation process,
or what was commonly called industry, a society becomes wealthier.
 With more industry, a society generates more surplus over and above the
basic subsistence production that merely permits humanity to survive.
 A greater specialization in industry requires more trade in order to acquire
more raw materials and open more markets for industrial products.
 Free trade provides several advantages over mercantilism for individuals, businesses
and nations. In a free trade system, individuals benefit from a greater choice of goods
for purchase at affordable prices. Mercantilism restricts imports, which reduces the
choices available to consumers in the marketplace
  However, mercantilist thinker argued that since the greatest surplus is
obtained from industry, not from the production of the raw materials, foreign
trade should be manipulated to favor domestic industry and facilitate the
acquisition of raw materials abroad.
 Protectionist mercantilist policies also had an important and positive impact
on the state that enacted them. Protectionism against foreign industrial
products was seen as the best way to maximize the highly profitable
transformative activity within a country.
 Buying industrial, or transformed, products from other countries was
equated with a loss of national wealth.
 Mercantilist thinking was fully compatible with colonialism because they
viewed the conquest of foreign territories as necessary to secure sources of
raw materials for the industries.
 Mercantilist in England, France, Spain and Portugal ban industrial
production in their colonies and, instead, requires colonies to buy all
industrial products from the mother country.

3. Physiocrats
• School of French economies thinkers, argued that the wealth of nation was
derived from agriculture.
• They saw the natural order, or what they termed as physiocracy, the
economy as a steady interaction between the productive class (farmers), the
sterile class (industrial workers and artisans) and the proprietor class.
• They argued that farmers were the source of all wealth and trues production;
the other two classes appropriated part of what the productive produced.
• Generally favored an economy policy of laissez-faire ie; minimal government
restriction and taxation.
• Because they saw government as part of the sterile class that appropriated
part of what the productive class produced.
• Francois Quesnay, the member of the school, developed his Tableau
Economique which was the first known diagrammatic model of an economic
system.
• The table was a circular flow diagram that showed how each sector of the
economy depended on the other sectors; one sector’s supply of production
depended on the demand of other sectors.
• For example; Farmers produced inputs for the sterile class, and the farmers
purchased the goods produced by the sterile class.
• The Physiocrats were almost certainly wrong about the insignificance of
transformative (industrial) activities in the economy,
• Transformation added nothing to the economy’ s basic production of
agricultural products.
• But their point that some sectors of the economy are more productive than
others is quite important.
4. Adam Smith - Adam Smith’s Model of Economic Change
• Adam Smith in 1776 published An inquiry into the Nature and Causes of the
Wealth of Nations ( The Wealth of Nations for short)
• Smith’s work became the basis for the classical and Neoclassical schools of
economic thought.
• Adam Smith identified many important characteristics of growing economies.
• For example, Smith suggested that the division of labor was a fundamental
characteristic of economic growth.
• Today we refer the division of labor as specialization.
5. Specialization
• There are at least three ways in which specialization is linked to the growth
of economic output.
• First, Smith noticed that at the early stage of Industrial Revolution,
specialization led to economies of scale in production.
• The resources are more productive when they are brought together in a
single large production facility rather than being spread among a large
number of small production units.
• In other to specialize and exploit economies of scale production had to be
into large business organization.
• The second way in which the specialization increases economic efficiency is
by permitting individual resources to be allocated among different tasks
according to their peculiar abilities and capacities.
• Smith used the idea to promote free trade and international specialization
across countries.
• Each nation should concentrate on producing those goods for which it is
best endowed rather than seeking to do everything for themselves.
• David Ricardo later, extended Smith’s idea into the concept of comparative
advantage.
• The third way in which specialization may increase economic efficiency is if
it promotes technological change.
• Adam Smith’s writings indicate he viewed specialization, or the division of
labor, as a potential contributor to long-term technological progress.
• Smith’s suggestion has been incorporated into several recent growth models
and now commonly referred to as learning by doing.
• The longer one performs a task, the more productive one gets at doing it.

6. The importance of institutions

• Smith fully recognized the general role of institutions in a system of markets.
 • Institutions- laws, regulations, customs, legal system, religions, and social
pressures that encourage or constrain the economic behavior of people.
7. National Welfare
• Another Adam Smith’s contributions to economic development theory is his
discussion of what constitutes the economic welfare of a nation.
• Smith made it very clear that it is the standard of living of the entire
population that matters for the welfare of the nation.
• Some of the key points Adam Smith makes in his Wealth of Nation are:
• As an economy grows, it becomes more complex and the division of labor, or
specialization, increase
• The increased specialization that accompanies economic growth is only
possible of exchanges between individuals within and across countries
increase, and thus international trade should not be restricted.
• There is and association between specialization and creation new technology
because specialization promotes what we would now refer to as learning by
doing and intentional R&D investment
8. The Classical Economist and Diminishing Returns
• The Industrial Revolution accelerated the growth of output in Europe during
the late 1700s and early 1800s.
• The economist who followed Adam Smith, the so-called Classical economist.
9. Malthus’ Theory of Population
• Thomas Robert Malthus, the early nineteenth century British economist, is
best known for his theory of population.
• Malthus (1798) hypothesized that food supply would not grow at constant
rate because a fixed quantity of land would result in ever smaller gains in
output rate
• Population to grow in a geometric progression and food production was
constrained to grow only in arithmetic progression.
• Because a fixed quantity of land would result in even smaller gain in output
as the additional people sought to grow more food for their subsistence.
10. The Classical Model
• The Classical, of the early to mid-nineteenth century, accepted Malthus’
population hypothesis as a basic premise.
• To capture the influence of the resource scarcity hypothesized by the
Classical, begin by building a general model of production.
• For simplicity, suppose that output is a function of labor and land
• Amount of land is fixed in quantity, but labor can grow or contract
depending on birth and death rates.
 • Suppose that output is determined by how much labor is combined with a
fixed stock of arable land.
• This implies a production function, which is a mathematical construct that
links output to varying set of inputs, of the general form
• Y= f(L,N)
• Where Y is real output,
• N is the variable amount of labor, and
• L is the fixed amount of arable land
• The classical economist hypothesized that, in the case where variable
labor supply is combined with fixed supply of land, labor is subject to
diminishing returns.
• That is, for each additional worker employed, output increases by less
and less because each additional worker has less and less land to
work on.
• The relationship between Output, Fixed capital and Labor
• Y=F(K,N) (in the short run, capital stock assumed to be fixed)
• Marginal product of labor=MPN
• MPN, is the increase in output associated with a one- unit increase in labor
while holding K constant.
• Diminishing returns to labor; the production function slopes upward, but
their slopes become less steep the more labor is added to production
• As producer adds workers, without increasing the total amount of capital,
each new worker raises output by less than the one before.
• A production function has constant, increasing, or decreasing returns to
scale by asking what happens to output when we double the amount of
input (K,L).
• If output doubles, then the technology exhibits constant returns to scale
• If output more than doubles (or less than doubles), it exhibits increasing
returns to scale (or decreasing returns to scale)
11. GROWTH AND FACTORS OF PRODUCTION
Factor productivity
• Factor productivity measures the contribution of each factor of production to
output.
• Average labor productivity is obtained by dividing national output by total
employment in the economy:

• Kt / Lt is known as capital intensity,(i.e., the amount of capital per worker)