Big Push Model
Encyclopedia
The big push model is a concept in development economics
or welfare economics
that emphasizes the fact that a firm's decision whether to industrialize or not depends on its expectation of what other firms will do. It assumes economies of scale
and oligopolistic
market structure and explains when industrialization would happen.
The originator of this theory was Paul Rosenstein-Rodan
in 1943. Further contributions were made later on by Murphy
, Shleifer and Robert W. Vishny
in 1989. Analysis of this economic model usually involves using game theory
.
The theory of the model emphasizes that underdeveloped countries
require large amounts of investments
to embark on the path of economic development
from their present state of backwardness. This theory proposes that a 'bit by bit' investment programme will not impact the process of growth
as much as is required for developing countries. In fact, injections of small quantities of investments will merely lead to a wastage of resources
.
Paul Rosenstein-Rodan
, approvingly quotes a Massachusetts Institute of Technology
study in this regard, "There is a minimum level of resources
that must be devoted to... a development
programme if it is to have any chance of success. Launching a country into self-sustaining growth is a little like getting an airplane
off the ground. There is a critical ground speed
which must be passed before the craft can become airborne...."
Rosenstein-Rodan
argued that the entire industry which is intended to be created should be treated and planned as a massive entity (a firm
or trust). He supports this argument by stating that the social marginal product
of an investment
is always different from its private marginal product
, so when a group of industries
are planned together according to their social marginal products, the rate of growth
of the economy is greater than it would have otherwise been.
. These indivisibilities are responsible for external economies
and thus justify the need for a big push. The externalities are as follows-
may be with respect to any of the following:
These lead to increasing returns (i.e., economies of scale
), and may require a high optimum size of a firm. This can be achieved even in developing countries since at least one optimum scale firm can be established in many industries. But investment in social overhead capital
comprises investment in all basic industries (like power, transport or communications) which must necessarily come before directly productive investment activities. Investment in social overhead capital
is 'lumpy' in nature. Such capital requirements cannot be imported from other nations. Therefore, heavy initial investment necessarily needs to be made in social overhead capital
(this is approximated to be about 30 to 40 percent of the total investment undertaken by underdeveloped countries
).
Social overhead capital is further characterized by four indivisibilities:
, modernization and increased efficiency in a single industry has no impact on the economy as a whole since the output of that industry will fail to find a market. A large number of industries need to be set up simultaneously so that people employed in one industry consume the output of other industries and thus create complementary demand.
To illustrate this, Rosenstein Rodan gives the example of a shoe industry. If a country makes large investments
in the shoe industry, all the disguisedly employed labor from the other industries find work and a source of income, leading to a rise in production of shoes and their own incomes. This increased income will not be expended only on buying shoes. It is conceivable that the increased incomes will lead to increased spending on other products too. However, there is no corresponding supply of these products to satisfy this increased demand for the other goods. Following the basic market forces
of demand and supply, the prices of these commodities will rise. To avoid such a situation, investment
must be spread out amongst different industries.
The situation may be different in an open economy
as the output of the new industry may replace former imports or possibly find its market by way of exports. But even if the world market acts as a substitute
for domestic demand, a big push is still needed (though its required size may now be reduced due to the presence of international trade).
need to be made not only once, but multiple number of times. Hence domestic savings are a must. But in an underdeveloped economy,this is a challenge due to the low income levels.Marginal rate of savings
needs to be increased following the rise in incomes due to higher investment.
which are so small that any increase in the productivity of one sector has no impact on the economy as a whole. Each sector can either rely on traditional methods or switch to modern methods of production which would increase its efficiency. Let us assume that there are l workers in the economy and n sectors. Each sector therefore has l/n workers.
Using traditional technology, a sector would produce l/n amount of ouput, with each worker producing one unit of the commodity.
Using modern technology a sector would produce more as the productivity would be greater than one unit per worker. However, a modern sector would require some of the workers (say h) to perform administrative tasks.
In figure 1, the x-axis represents the labor employed and the y-axis represents the level of production. The production in the traditional sector
is given by the curve T and the production in the modern sector is given by M. The curve M has a positive intercept on the x-axis, implying that even with zero production, there is a minimum level of h workers who still remain employed for carrying out administrative activities. With our assumption of l/n workers in the economy, the modern sector will have a higher level of productivity than the traditional sector. The production function of the modern sector is steeper than that of the traditional sector because of the higher productivity of workers in the former. The slope of both production functions is 1/m, where m is the marginal labor required to produce an additional unit of output. This level of m is lower for the modern sector than it is for the traditional sector.
Assume that the traditional sector pays workers one unit of output which is subsequently spent equally by them in all sectors. The modern sector pays higher wages to workers. If all the workers are employed by the traditional sector, then the demand generated for the output of each sector is D1 = l/n.
We have two possible cases:
Now, wages are low. Therefore
w1l* < D1
This implies that costs (given by w1l*) are lower than the earnings (given by D1). So the firm makes a profit and will choose to modernize (even if other firms do not).
w2l* > D1
This implies that costs (given by w2l*) are higher than the earnings (given by D1).
However, if all the other firms have modernized, the firm faces a higher demand D2, arising out of higher income levels of workers of these modernized firms. The firm will hence choose to modernize as well so that it makes profits:
w2l* < D2
is relevant for the Industrialization
of underdeveloped countries
, where decisions are to be made regarding distribution of savings among alternative investment opportunities
. These arise from the interdependence in market economies.
Pecuniary economies
are external economies transmitted through the price system
, as prices are the signalling
device (under conditions of perfect competition
in a market economy). They arise in an industry (say industry X) due to internal economies of overcoming technical indivisibilities. This reduces the price of its product, which will benefit another industry (say industry Y) which use this output as an input or a factor of production. Subsequently, the profits of industry Y will rise, leading to its expansion and generating demand for the output of industry X. As a result, industry X's production and profits also expand.
However in underdeveloped countries
, conditions of perfect competition
are not present due to the decentralized and differentiated nature of the market. Prices fail to act as a signalling system
in the following ways:
This justifies the need for centralized pan-industry planning of investment in Developing countries, as the private sector cannot undertake such planning.
Enlargement of the market size is another important externality which arises from the complementarity of industries. There exists an incentive to expand the scale of operations because the employees of one industry become the customers of another industry. In terms of products too (as in the above example of industries X and Y), one industry generates demand for the output of the other when the scale of operations increase.
Marshallian economies also accrue to a firm within a growing industry, resulting from agglomeration of industrial districts or clusters in a particular area. These occur due to the following advantages of agglomeration identified by Alfred Marshall
:
Availability of skilled labour is an externality which arises when industrialization
occurs, as workers acquire better training and skills. This is not achievable by mere establishment of a few industries, but requires a large program of industrial growth. It is one of the most important external economies because absence of skilled labor is a strong impediment to industrialization
.
. Even if the private sector had the requisite resources to invest in such a programme, it would not do so since it is driven by profit motives.
Many investments are profitable in terms of social marginal net product but not in terms of private marginal net product. Due to this there is no incentive for individual entrepreneurs to invest and take advantage of external economies.
and Celso Furtado
, among others, primarily on the grounds of the massive effort required to be taken by underdeveloped countries
to move along the path of industrialization
. Some of the major criticisms are as follows.
Development economics
Development Economics is a branch of economics which deals with economic aspects of the development process in low-income countries. Its focus is not only on methods of promoting economic growth and structural change but also on improving the potential for the mass of the population, for example,...
or welfare economics
Welfare economics
Welfare economics is a branch of economics that uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution associated with it...
that emphasizes the fact that a firm's decision whether to industrialize or not depends on its expectation of what other firms will do. It assumes economies of scale
Economies of scale
Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...
and oligopolistic
Oligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
market structure and explains when industrialization would happen.
The originator of this theory was Paul Rosenstein-Rodan
Paul Rosenstein-Rodan
Paul Narcyz Rosenstein-Rodan was an Austrian economists of Polish-Jewish origin born in Kraków, who was trained in the Austrian tradition under Hans Mayer in Vienna...
in 1943. Further contributions were made later on by Murphy
Kevin M. Murphy
Kevin Miles Murphy is the George J. Stigler Distinguished Service Professor of Economics at the University of Chicago Booth School of Business and a Senior Fellow at the Hoover Institution....
, Shleifer and Robert W. Vishny
Robert W. Vishny
Robert Ward Vishny is an American economist and is the Myron S. Scholes Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. He was the Eric J. Gleacher Distinguished Service Professor of Finance at the University of Chicago Booth School of Business.He...
in 1989. Analysis of this economic model usually involves using game theory
Game theory
Game theory is a mathematical method for analyzing calculated circumstances, such as in games, where a person’s success is based upon the choices of others...
.
The theory of the model emphasizes that underdeveloped countries
Developing country
A developing country, also known as a less-developed country, is a nation with a low level of material well-being. Since no single definition of the term developing country is recognized internationally, the levels of development may vary widely within so-called developing countries...
require large amounts of investments
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
to embark on the path of economic development
Economic development
Economic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...
from their present state of backwardness. This theory proposes that a 'bit by bit' investment programme will not impact the process of growth
Economic growth
In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...
as much as is required for developing countries. In fact, injections of small quantities of investments will merely lead to a wastage of resources
Resource
A resource is a source or supply from which benefit is produced, typically of limited availability.Resource may also refer to:* Resource , substances or objects required by a biological organism for normal maintenance, growth, and reproduction...
.
Paul Rosenstein-Rodan
Paul Rosenstein-Rodan
Paul Narcyz Rosenstein-Rodan was an Austrian economists of Polish-Jewish origin born in Kraków, who was trained in the Austrian tradition under Hans Mayer in Vienna...
, approvingly quotes a Massachusetts Institute of Technology
Massachusetts Institute of Technology
The Massachusetts Institute of Technology is a private research university located in Cambridge, Massachusetts. MIT has five schools and one college, containing a total of 32 academic departments, with a strong emphasis on scientific and technological education and research.Founded in 1861 in...
study in this regard, "There is a minimum level of resources
Resource
A resource is a source or supply from which benefit is produced, typically of limited availability.Resource may also refer to:* Resource , substances or objects required by a biological organism for normal maintenance, growth, and reproduction...
that must be devoted to... a development
Economic development
Economic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...
programme if it is to have any chance of success. Launching a country into self-sustaining growth is a little like getting an airplane
Fixed-wing aircraft
A fixed-wing aircraft is an aircraft capable of flight using wings that generate lift due to the vehicle's forward airspeed. Fixed-wing aircraft are distinct from rotary-wing aircraft in which wings rotate about a fixed mast and ornithopters in which lift is generated by flapping wings.A powered...
off the ground. There is a critical ground speed
Ground speed
Ground speed is the speed of an aircraft relative to the ground. Information displayed to passengers through the entertainment system often gives the aircraft groundspeed rather than airspeed....
which must be passed before the craft can become airborne...."
Rosenstein-Rodan
Paul Rosenstein-Rodan
Paul Narcyz Rosenstein-Rodan was an Austrian economists of Polish-Jewish origin born in Kraków, who was trained in the Austrian tradition under Hans Mayer in Vienna...
argued that the entire industry which is intended to be created should be treated and planned as a massive entity (a firm
Firm
A firm is a business.Firm or The Firm may also refer to:-Organizations:* Hooligan firm, a group of unruly football fans* The Firm, Inc., a talent management company* Fair Immigration Reform Movement...
or trust). He supports this argument by stating that the social marginal product
Marginal product
In economics and in particular neoclassical economics, the marginal product or marginal physical product of an input is the extra output that can be produced by using one more unit of the input , assuming that the quantities of no other inputs to production...
of an investment
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
is always different from its private marginal product
Marginal product
In economics and in particular neoclassical economics, the marginal product or marginal physical product of an input is the extra output that can be produced by using one more unit of the input , assuming that the quantities of no other inputs to production...
, so when a group of industries
Industry
Industry refers to the production of an economic good or service within an economy.-Industrial sectors:There are four key industrial economic sectors: the primary sector, largely raw material extraction industries such as mining and farming; the secondary sector, involving refining, construction,...
are planned together according to their social marginal products, the rate of growth
Economic growth
In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...
of the economy is greater than it would have otherwise been.
The three indivisibilities
According to Rosenstein-Rodan, there exist three indivisibilities in underdeveloped countriesDeveloping country
A developing country, also known as a less-developed country, is a nation with a low level of material well-being. Since no single definition of the term developing country is recognized internationally, the levels of development may vary widely within so-called developing countries...
. These indivisibilities are responsible for external economies
Network effect
In economics and business, a network effect is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it.The classic example is the telephone...
and thus justify the need for a big push. The externalities are as follows-
- Indivisibility in production functionProduction functionIn microeconomics and macroeconomics, a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs...
- Indivisibility of demandDemand- Economics :*Demand , the desire to own something and the ability to pay for it*Demand curve, a graphic representation of a demand schedule*Demand deposit, the money in checking accounts...
- Indivisibility in the supply of savings
Indivisibility in production function
Indivisibilities in the production functionProduction function
In microeconomics and macroeconomics, a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs...
may be with respect to any of the following:
- InputsFactors of productionIn economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
- Processes
- OutputsOutput (economics)Output in economics is the "quantity of goods or services produced in a given time period, by a firm, industry, or country," whether consumed or used for further production.The concept of national output is absolutely essential in the field of macroeconomics...
These lead to increasing returns (i.e., economies of scale
Economies of scale
Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...
), and may require a high optimum size of a firm. This can be achieved even in developing countries since at least one optimum scale firm can be established in many industries. But investment in social overhead capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
comprises investment in all basic industries (like power, transport or communications) which must necessarily come before directly productive investment activities. Investment in social overhead capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
is 'lumpy' in nature. Such capital requirements cannot be imported from other nations. Therefore, heavy initial investment necessarily needs to be made in social overhead capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
(this is approximated to be about 30 to 40 percent of the total investment undertaken by underdeveloped countries
Developing country
A developing country, also known as a less-developed country, is a nation with a low level of material well-being. Since no single definition of the term developing country is recognized internationally, the levels of development may vary widely within so-called developing countries...
).
Social overhead capital is further characterized by four indivisibilities:
- Irreversibility in time: It must precede other directly productive investments
- Minimum durability of equipment:. Any lesser level of durabilityDurable goodIn economics, a durable good or a hard good is a good that does not quickly wear out, or more specifically, one that yields utility over time rather than being completely consumed in one use. Items like bricks or jewellery could be considered perfectly durable goods, because they should...
is either impossible due to technical reasons or much less efficient - Long gestation periods: The investment in social overhead capitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
takes time to generate returns and its impact in the economy is not immediately or directly visible - Irreducible minimum social overhead capital–industry mix: Investment needs to be of a certain minimum magnitude and spread across a mix of industries, without which it will not significantly impact the process of growth.
Indivisibility (or complementarity) of demand
Developing countries are characterized by low per-capita income and purchasing power. Markets in these countries are therefore small . In a closed economyAutarky
Autarky is the quality of being self-sufficient. Usually the term is applied to political states or their economic policies. Autarky exists whenever an entity can survive or continue its activities without external assistance. Autarky is not necessarily economic. For example, a military autarky...
, modernization and increased efficiency in a single industry has no impact on the economy as a whole since the output of that industry will fail to find a market. A large number of industries need to be set up simultaneously so that people employed in one industry consume the output of other industries and thus create complementary demand.
To illustrate this, Rosenstein Rodan gives the example of a shoe industry. If a country makes large investments
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
in the shoe industry, all the disguisedly employed labor from the other industries find work and a source of income, leading to a rise in production of shoes and their own incomes. This increased income will not be expended only on buying shoes. It is conceivable that the increased incomes will lead to increased spending on other products too. However, there is no corresponding supply of these products to satisfy this increased demand for the other goods. Following the basic market forces
Free market
A free market is a competitive market where prices are determined by supply and demand. However, the term is also commonly used for markets in which economic intervention and regulation by the state is limited to tax collection, and enforcement of private ownership and contracts...
of demand and supply, the prices of these commodities will rise. To avoid such a situation, investment
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
must be spread out amongst different industries.
The situation may be different in an open economy
Open economy
An open economy is an economy in which there are economic activities between domestic community and outside, e.g. people, including businesses, can trade in goods and services with other people and businesses in the international community, and flow of funds as investment across the border...
as the output of the new industry may replace former imports or possibly find its market by way of exports. But even if the world market acts as a substitute
Substitute good
In economics, one way we classify goods is by examining the relationship of the demand schedules when the price of one good changes. This relationship between demand schedules leads economists to classify goods as either substitutes or complements. Substitute goods are goods which, as a result...
for domestic demand, a big push is still needed (though its required size may now be reduced due to the presence of international trade).
Indivisibility in the supply of savings
High levels of investment require a corresponding high level of savings. We cannot always rely on foreign aid as the huge levels of investments in the different sectorsEconomic sector
An economy may include several sectors , that evolved in successive phases.* The ancient economy was mainly based on subsistence farming....
need to be made not only once, but multiple number of times. Hence domestic savings are a must. But in an underdeveloped economy,this is a challenge due to the low income levels.Marginal rate of savings
Marginal propensity to save
The marginal propensity to save refers to the increase in saving that results from an increase in income i.e. The marginal propensity to save might be defined as the proportion of each additional dollar of household income that is used for saving. It is also used as an alternative term for the...
needs to be increased following the rise in incomes due to higher investment.
How the big push works
Consider a country whose economy is characterized by a large number of sectorsEconomic sector
An economy may include several sectors , that evolved in successive phases.* The ancient economy was mainly based on subsistence farming....
which are so small that any increase in the productivity of one sector has no impact on the economy as a whole. Each sector can either rely on traditional methods or switch to modern methods of production which would increase its efficiency. Let us assume that there are l workers in the economy and n sectors. Each sector therefore has l/n workers.
Using traditional technology, a sector would produce l/n amount of ouput, with each worker producing one unit of the commodity.
Using modern technology a sector would produce more as the productivity would be greater than one unit per worker. However, a modern sector would require some of the workers (say h) to perform administrative tasks.
In figure 1, the x-axis represents the labor employed and the y-axis represents the level of production. The production in the traditional sector
Economic sector
An economy may include several sectors , that evolved in successive phases.* The ancient economy was mainly based on subsistence farming....
is given by the curve T and the production in the modern sector is given by M. The curve M has a positive intercept on the x-axis, implying that even with zero production, there is a minimum level of h workers who still remain employed for carrying out administrative activities. With our assumption of l/n workers in the economy, the modern sector will have a higher level of productivity than the traditional sector. The production function of the modern sector is steeper than that of the traditional sector because of the higher productivity of workers in the former. The slope of both production functions is 1/m, where m is the marginal labor required to produce an additional unit of output. This level of m is lower for the modern sector than it is for the traditional sector.
Assume that the traditional sector pays workers one unit of output which is subsequently spent equally by them in all sectors. The modern sector pays higher wages to workers. If all the workers are employed by the traditional sector, then the demand generated for the output of each sector is D1 = l/n.
We have two possible cases:
- Wages are low – When low wages are prevalent in the economy, say w1, a firm which faces demand D1 will need to employ l* workers if it wants to modernize. This will cost the firm w1l*.
Now, wages are low. Therefore
w1l* < D1
This implies that costs (given by w1l*) are lower than the earnings (given by D1). So the firm makes a profit and will choose to modernize (even if other firms do not).
- Wages are high – When high wages are prevalent in the economy, say w2, a firm which faces demand D1 will make losses if no other firms choose to modernize. This is because
w2l* > D1
This implies that costs (given by w2l*) are higher than the earnings (given by D1).
However, if all the other firms have modernized, the firm faces a higher demand D2, arising out of higher income levels of workers of these modernized firms. The firm will hence choose to modernize as well so that it makes profits:
w2l* < D2
Indivisibilities and external economies
The concept of externalitiesExternality
In economics, an externality is a cost or benefit, not transmitted through prices, incurred by a party who did not agree to the action causing the cost or benefit...
is relevant for the Industrialization
Industrialisation
Industrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
of underdeveloped countries
Developing country
A developing country, also known as a less-developed country, is a nation with a low level of material well-being. Since no single definition of the term developing country is recognized internationally, the levels of development may vary widely within so-called developing countries...
, where decisions are to be made regarding distribution of savings among alternative investment opportunities
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
. These arise from the interdependence in market economies.
Pecuniary economies
Pecuniary externality
A pecuniary externality is an externality which operates through prices rather than through real resource effects. For example, an influx of city-dwellers buying second homes in a rural area can drive up house prices, making it difficult for young people in the area to get onto the property...
are external economies transmitted through the price system
Price system
In economics, a price system is any economic system that affects its distribution of goods and services with prices and employing any form of money. Except for possible remote and primitive communities, all modern societies use price systems to allocate resources...
, as prices are the signalling
Price signal
A price signal is a message sent to consumers and producers in the form of a price charged for a commodity; this is seen as indicating a signal for producers to increase supplies and/or consumers to reduce demand.- Free price system :...
device (under conditions of perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
in a market economy). They arise in an industry (say industry X) due to internal economies of overcoming technical indivisibilities. This reduces the price of its product, which will benefit another industry (say industry Y) which use this output as an input or a factor of production. Subsequently, the profits of industry Y will rise, leading to its expansion and generating demand for the output of industry X. As a result, industry X's production and profits also expand.
However in underdeveloped countries
Developing country
A developing country, also known as a less-developed country, is a nation with a low level of material well-being. Since no single definition of the term developing country is recognized internationally, the levels of development may vary widely within so-called developing countries...
, conditions of perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
are not present due to the decentralized and differentiated nature of the market. Prices fail to act as a signalling system
Price signal
A price signal is a message sent to consumers and producers in the form of a price charged for a commodity; this is seen as indicating a signal for producers to increase supplies and/or consumers to reduce demand.- Free price system :...
in the following ways:
- Prices express the situation as it is and do not predict future economic situations
- Prices can decide present productive activities but cannot determine investments which would be appropriate for developing countries
- The response of the private sector to price signals is inadequate and imperfect due to the differentiation and decentralisation in developing countries
This justifies the need for centralized pan-industry planning of investment in Developing countries, as the private sector cannot undertake such planning.
Enlargement of the market size is another important externality which arises from the complementarity of industries. There exists an incentive to expand the scale of operations because the employees of one industry become the customers of another industry. In terms of products too (as in the above example of industries X and Y), one industry generates demand for the output of the other when the scale of operations increase.
Marshallian economies also accrue to a firm within a growing industry, resulting from agglomeration of industrial districts or clusters in a particular area. These occur due to the following advantages of agglomeration identified by Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...
:
- Spillover of information
- Specialization and division of labor
- Development of a market for skilled labor.
Availability of skilled labour is an externality which arises when industrialization
Industrialisation
Industrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
occurs, as workers acquire better training and skills. This is not achievable by mere establishment of a few industries, but requires a large program of industrial growth. It is one of the most important external economies because absence of skilled labor is a strong impediment to industrialization
Industrialisation
Industrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
.
Role of the State
The large-scale programme of industrializationz advocated by this model requires huge investments which are beyond the means of the private sector. The investment in infrastructure and basic industries (like power, transport and communications) is 'lumpy' and has long gestation periods. The role of the state in this theory is therefore critical for investment in social overhead capitalCapital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
. Even if the private sector had the requisite resources to invest in such a programme, it would not do so since it is driven by profit motives.
Many investments are profitable in terms of social marginal net product but not in terms of private marginal net product. Due to this there is no incentive for individual entrepreneurs to invest and take advantage of external economies.
Criticisms
The theory has been criticized by Hla MyintHla Myint
Hla Myint was a Burmese professor of economics noted as one of the pioneers of development economics. He stressed, long before it became popular, the importance export-orientation as the most useful "engine of growth". After obtaining a Ph.D...
and Celso Furtado
Celso Furtado
Celso Monteiro Furtado was an important Brazilian economist and one of the most distinguished intellectuals of his country during the 20th century. His work focuses on development and underdevelopment and on the persistence of poverty in peripheral countries throughout the world...
, among others, primarily on the grounds of the massive effort required to be taken by underdeveloped countries
Developing country
A developing country, also known as a less-developed country, is a nation with a low level of material well-being. Since no single definition of the term developing country is recognized internationally, the levels of development may vary widely within so-called developing countries...
to move along the path of industrialization
Industrialisation
Industrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
. Some of the major criticisms are as follows.
- Difficulties in execution and implementation: The execution of related projects during the course of industrializationIndustrialisationIndustrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
may involve unexpected or unavoidable changes due to revisions of plans, delays and deviations from the planned process. Hla MyintHla MyintHla Myint was a Burmese professor of economics noted as one of the pioneers of development economics. He stressed, long before it became popular, the importance export-orientation as the most useful "engine of growth". After obtaining a Ph.D...
notes that the various departments and agencies involved in the process of development need to coordinate closely and evaluate and revise plans continuously. This is a challenging task for the governments of developing countries.
- Lack of absorptive capacity: The implementation of industrialization programmes may be constrained by ineffective disbursement,short-term bottlenecks, macroeconomicMacroeconomicsMacroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...
problems and volatility, loss of competitiveness and weakening of institutions. CreditCredit (finance)Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...
is often utilized at low rates or after long time lags. There is often a loss of competitiveness due to the Dutch diseaseDutch diseaseIn economics, the Dutch disease is a concept that purportedly explains the apparent relationship between the increase in exploitation of natural resources and a decline in the manufacturing sector...
effect.
- Historical inaccuracy: When viewed in light of historical experience of countries over the last two centuries, no country displayed any evidence of development due to massive industrializationIndustrialisationIndustrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
programmes. Stationary economies do not develop simply by making large-scale investment in social overhead capitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
.
- Problems in mixed economies: In a mixed economyMixed economyMixed economy is an economic system in which both the state and private sector direct the economy, reflecting characteristics of both market economies and planned economies. Most mixed economies can be described as market economies with strong regulatory oversight, in addition to having a variety...
, where the privatePrivate sectorIn economics, the private sector is that part of the economy, sometimes referred to as the citizen sector, which is run by private individuals or groups, usually as a means of enterprise for profit, and is not controlled by the state...
and public sectorsPublic sectorThe public sector, sometimes referred to as the state sector, is a part of the state that deals with either the production, delivery and allocation of goods and services by and for the government or its citizens, whether national, regional or local/municipal.Examples of public sector activity range...
co-exist, the environment for growt] may not be a conducive one. Unless there is a complementarity between the sectors, there is bound to arise competition between them, with the government departmentsMinistry (government department)A ministry is a specialised organisation responsible for a sector of government public administration, sometimes led by a minister or a senior public servant, that can have responsibility for one or more departments, agencies, bureaus, commissions or other smaller executive, advisory, managerial or...
keeping their plans confidential out of fear of speculative activitiesSpeculationIn finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...
by the private sectorPrivate sectorIn economics, the private sector is that part of the economy, sometimes referred to as the citizen sector, which is run by private individuals or groups, usually as a means of enterprise for profit, and is not controlled by the state...
. The private sector's activities are simultaneously inhibited due to lack of informationInformation asymmetryIn economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry, a kind of market failure...
of government policies and the general economic situation
- Neglect of methods of production: Rather than capitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
formation, it is productive techniques which determine the success of a country in economic developmentEconomic developmentEconomic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...
. The big push model ignores productive techniques in its support for capitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
formation and industrialisationIndustrialisationIndustrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
.
- Shortage of resources in underdeveloped countries: Eugenio Gudin criticizes the theory of the big push on the grounds that underdeveloped countriesDeveloping countryA developing country, also known as a less-developed country, is a nation with a low level of material well-being. Since no single definition of the term developing country is recognized internationally, the levels of development may vary widely within so-called developing countries...
lack the capitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
required to provide the big push required for rapid developmentEconomic developmentEconomic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...
. If an underdeveloped nation had ample capitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
supply and scarce factorsFactors of productionIn economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
, it would not be classified as underdeveloped at all. Limited resourceResourceA resource is a source or supply from which benefit is produced, typically of limited availability.Resource may also refer to:* Resource , substances or objects required by a biological organism for normal maintenance, growth, and reproduction...
availability is the first impediment to such countries. Though this problem may be overcome by foreign aids, industrializationIndustrialisationIndustrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
may not take off as expected if the aid flows are volatil.e
- Ignores the agricultural sector: With its heavy emphasis on industryIndustryIndustry refers to the production of an economic good or service within an economy.-Industrial sectors:There are four key industrial economic sectors: the primary sector, largely raw material extraction industries such as mining and farming; the secondary sector, involving refining, construction,...
, the model finds no place for agricultureAgricultureAgriculture is the cultivation of animals, plants, fungi and other life forms for food, fiber, and other products used to sustain life. Agriculture was the key implement in the rise of sedentary human civilization, whereby farming of domesticated species created food surpluses that nurtured the...
. This is a gaping flaw in the theory, as in most underdeveloped countriesDeveloping countryA developing country, also known as a less-developed country, is a nation with a low level of material well-being. Since no single definition of the term developing country is recognized internationally, the levels of development may vary widely within so-called developing countries...
it is this sector which is large and has labor surplusEconomic surplusIn mainstream economics, economic surplus refers to two related quantities. Consumer surplus or consumers' surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay...
. Investments in agriculture need to go hand-in-hand with those in industry so as to stimulate the industrial sector by providing a market for industrial goods. If neglected, it would be difficult to meet the food requirements of the nation in the short runLong run and short runIn macroeconomics, the long run is the conceptual time period in which there are no fixed factors of production as to changing the output level by changing the capital stock or by entering or leaving an industry. The long run contrasts with the short run, in which some factors are variable and...
and to significantly expand the size of the market in the long runLong run and short runIn macroeconomics, the long run is the conceptual time period in which there are no fixed factors of production as to changing the output level by changing the capital stock or by entering or leaving an industry. The long run contrasts with the short run, in which some factors are variable and...
.
- Inflationary pressures: It follows from the neglect of the agricultural sector that food shortagesFamineA famine is a widespread scarcity of food, caused by several factors including crop failure, overpopulation, or government policies. This phenomenon is usually accompanied or followed by regional malnutrition, starvation, epidemic, and increased mortality. Every continent in the world has...
are likely to occur with industrializationIndustrialisationIndustrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
. Though it would take time for investments in social overhead capitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
to yield returns, the demandDemand (economics)In economics, demand is the desire to own anything, the ability to pay for it, and the willingness to pay . The term demand signifies the ability or the willingness to buy a particular commodity at a given point of time....
would increase immediately, thus imposing inflationary pressuresInflationIn economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
on the economy. Cost escalations may even cause projects to be postponed and the developmentEconomic developmentEconomic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...
process in general to slow down.
- Dependence on indivisibilities: The emphasis of this theory on indivisibility of processes is too much, as investments need not necessarily be on such a large scale to be economic. Social reformsReform movementA reform movement is a kind of social movement that aims to make gradual change, or change in certain aspects of society, rather than rapid or fundamental changes...
are ignored, which are vital if a country is to grow on the basis of its own resources and initiatives. DevelopmentEconomic developmentEconomic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...
is bound to intensify if social reform is a part of the industrializationIndustrialisationIndustrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...
process.
See also
- Rostow's stages of growth
- Ragnar NurkseRagnar NurkseRagnar Nurkse was an Estonian international economist and policy maker mainly in the fields of international finance and economic development.-Life:...
- Ragnar Nurkse's Balanced Growth TheoryRagnar Nurkse's balanced growth theoryThe balanced growth theory is an economic theory pioneered by the economist Ragnar Nurkse . The theory hypothesises that the government of any underdeveloped country needs to make large investments in a number of industries simultaneously...
- Virtuous circle and vicious circleVirtuous circle and vicious circleA virtuous circle and a vicious circle are economic terms. They refer to a complex of events that reinforces itself through a feedback loop. A virtuous circle has favorable results, while a vicious circle has detrimental results...
- Critical minimum effort theoryCritical minimum effort theoryThe critical minimum effort theory has been given by Harvey Leibenstein, in his book Economic Backwardness and Economic Growth. This theory relates to overpopulated and underdeveloped or developing nations such as India and Indonesia.This theory is based on Malthusian theory of population. This...
- Strategy of unbalanced growthStrategy of unbalanced growthUnbalanced growth is a natural path of development. Undeveloped countries start from a position that reflects their predecessor's previous investment decisions and development. Accordingly at any point of time they are highly desirable investment programs which are not in themselves balanced...
- Low level equilibrium trap
- Dual economyDual economyA dual economy is the existence of two separate economic sectors within one country, divided by different levels of development, technology, and different patterns of demand...
Further Reading
- http://m.domaindlx.com/cihanyuksel2/Two%20Concepts%20of%20External%20Economies.pdf
- http://www.colorado.edu/Economics/morey/externalitylit/meade-ej1952.pdf
- http://www.wider.unu.edu/publications/working-papers/discussion-papers/2007/en_GB/dp2007-#
- 05/_files/78515953270128788/default/dp2007-05.pdf
- http://www.econometricsociety.org/meetings/wc00/pdf/1269.pdf
- http://www.centrocelsofurtado.org.br/adm/enviadas/doc/25_20060719190655.pdf
External Links
- http://monthlyreview.org/2006/05/01/the-neoliberal-rebirth-of-developmentEconomic developmentEconomic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...
-economics - http://are.berkeley.edu/~adelman/WORLDEV.html