Study Notes

Balanced Growth Theory

Balanced Growth Theory

Introduction

 The advocates of the balanced growth strategy suggest that no single strategy will take us
to towards the attainment of the goal of economic development.
 Therefore, not only has the strategy to be changed from time to time as the situation may
require, but it may be necessary sometimes to strike a balance between the alternative
strategies.
 This gave birth to the idea of balanced growth theory.
 Balanced growth has a horizontal as well as a vertical aspects.
 Some of the definitions of balanced growth given by different protagonists are follows:
 According to P L Samuelson, “Balanced Growth implies growth in every wind of
capital stock at constant rates.”
 In the words of Benjamin Higgins “a wave of capital investment in a number of
industries is called Balanced Growth.”
 To W.A. Lewis “in development programmes, all sectors of economy should grow
simultaneously so as to keep a proper balance between industry and agriculture and
between production for home consumption and production for exports.”
 According to C.P. Kindleberger “balanced growth implies that the investment takes
place simultaneously in all sectors or industries at once, more or less along the lines
of the slogan. You cannot do anything until you can do everything.”
 Alak Ghosh said “planning with balanced growth indicates that all sectors of the
economy will expand in same proportions, so that consumption, investment and
income will grow at the same rates.”
 R F Harrod viewed “balanced growth aims at equality between growth rate of
income, growth rate of output and growth rate of natural resources.”
 The three illustrious propounders of the balanced growth theory are Rosanstein Rodan, W
A Lewis and Ranger Nurkse.

The Theory

 The balanced growth theory emphasizes on the investment in a proportionate manner in all
the sectors of development, so that goal of holistic development is achieved.
 Therefore, the propounders of the balanced growth theories suggested that the investment
must take place simultaneously in all the sectors of development i.e., agriculture and
industry; between domestic and export sector; and between social and economic overhead
in order to facilitate balanced development.
 Broadly different types of balanced development strategies to be adopted in an economy
are as follows:
(i) Balance between agriculture and industry

The balanced growth approach advocates that the industry and agriculture or primary and
secondary sector are not competitive but they are complementary to each other. The growth
of one sector depends on the development of the other. For example, for the growth of agro-
based industries, industries require rising productivity in the agriculture sector and similarly,
for raising agricultural productivity, agriculture also requires implements which are supplied
by the industries. Therefore, the development of complementarities promotes the

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Balanced Growth Theory

development of both the sector. Lewis has remarked that “if agriculture stagnates, the
capitalist sector cannot grow, capitalist profit remains a small part of the national income and
savings and investments are correspondingly small. Smooth economic development
requires that industry and agriculture should grow together.”

(ii) Balance between Domestic and Foreign Trade

Another important aspect of balanced growth is the balance between domestic and foreign
trade. The domestic and foreign trades are interconnected. The expansion of domestic trade
creates marketable surplus that leads to the expansion of foreign trade. More import and
less export create imbalances in foreign trade, which favour mostly developed countries as
against the developing countries. Meir and Baldwin have remarked that the domestic sector
must grow in balance with foreign sector.

(iii) Balance between Demand and Supply of Factors

One of the drawbacks of underdeveloped countries is factor disproportion in

underdeveloped countries. In some cases abundant labour is pitched against the little
capital and less resources are exploited, while on the contrary, too little of labour is pitched
against plenty of resources. This type of allocation upsets the entire system which greatly
hampers the balanced development. For example, the primary sector has abundance of
labour and the supply of skilled labour in the industrial sector is less as compared to the
primary sector. This excess availability of labour in the primary sector create imbalance in
supply of factors of production. This also applies to other factors of production as capital and
land etc. Hence, it requires balance between demand for and supply of factors of
production.

Rosenstein Rodan’s Theory of Balanced Growth

 Rosenstein Rodan advocated “big push” theory which emphasizes that a “big push” or a
large comprehensive investment is needed in order to overcome the obstacle to
development in an underdeveloped economy.
 The theory states that investing in “bit by bit” or in piecemeal will not enable an
economy to successfully be on the development path. Rather preferably a minimum
amount of investment is necessary for enabling an economy to successfully be in the
development and growth path.
 The key factor in Rosenstein Rodan’s theory of development is “indivisibility”. According to
him, indivisibility of inputs, outputs or processes lead to increasing returns.
 He considered social overhead capitals such as power, transport and communication
have greater indivisibility feature and are indirectly productive and have a long
gestation period.
 They cannot be imported rather internally generated. Their installations require a ‘sizable
initial lump’ of investment.
 The social overhead capital is characterized by four indivisibilities:
(i) it is irreversible in time;
(ii) it has minimum durability;

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(iii) it has long gestation period and

(iv) it has an irreducible minimum industry mix of different kinds of public utilities.

 These indivisibility characteristics of social overhead capital are key to production process.
 Not only indivisibility of production function or process, Rosenstein-Rodan also advocated
for indivisibility in demand and supply of saving in order to keep the market dynamic and
vibrant.
 Big-push investment in various types of industries will create multiple cross-cutting demands
for each other industries product.
 According to Rodan unless there is assurance that the necessary complementary
investment will occur, any single investment project may be considered too risky to be
undertaken at all.
 The indivisibility of demand requires setting up of interdependent industries.
 The other indivisibility which Rodan stressed is the supply of saving. A high quantum of
investment requires a high volume of savings. However, in the underdeveloped economies
savings are low because of low income.
 To reduce the gap between income and expenditure, the rate of saving should be created.
 In the words of Rosenstein Rodan, a high minimum quantum of investment requires a high
volume of saving, which is difficult of achieve in low income underdeveloped countries.
 The way out of the vicious circle is to have first an increase in income and to provide
mechanisms which assure that savings are higher.
 The application of Rosenstein Rodan’s big push theory in under developed countries
requires balance in three major sector-
o balance between social overheads (SOCs) and directly productive activities (DPAs);
o balance between consumers’ goods industries and producers’ goods industries and
o oriental and vertical balance within consumer goods sector.

Criticisms of Rosenstein Rodan’s Theory

(i) The ‘big push’ theory cannot be effectively adopted in developing countries because
of lack of capital, skilled labour and dynamic entrepreneurial abilities
(ii) Maintaining the coordination between different sectors is a big challenge. According
to H. Myint, it is very difficult to coordinate the various plans of development in Big
Push theory.
(iii) The developing economies are basically agricultural economies. However, the Big
Push theory lays emphasis on huge investment in industrial sector, which in a way
neglects the agricultural sector.
(iv) The theory gives too much importance to ‘indivisibility’. Too much indivisibility will
pose practical problems in the process of globalization which lays stress on flexibility
and reforms.
(v) Rosenstein Rodan has given limited importance to role of international trade in
development. Jacob Viner pointed out that underdeveloped economies realize
greater economies from world trade independently to home investment.

W.A. Lewis’s Theory of Unlimited Supply of Labour

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Balanced Growth Theory

 W. Arthur Lewis’ theory is based on his proposition of unlimited supply of labour.

 Like the classical economists, he believed that in underdeveloped economies supply of
labour is unlimited at a subsistence wage rate.
 The economic development takes place when these surplus labour are withdrawn from the
“subsistence sector” and are placed in “capitalist sector” through capital accumulation.
 In other words, transfer of labour from the labour surplus agriculture sector to the industry
sector will promote the balanced development of both the sectors.
 Lewis model divides the economy into two sectors i.e. the Capitalist sector and the
Subsistence Sector.
 The capitalist sector is defined as “the part of the economy which uses reproducible capital,
and pays capitalists for the use there of”.
 In the capitalist sector, the use of capital is controlled by capitalist, who hire the services of
the labour. On the other hand, the subsistence sector, does not use reproducible capital.
 In subsistence sectors the total productivity is lower as compared to capitalist sector. The
labourers employed in the subsistence sector are generally backward, illiterate and
unskilled. On the other hand, the labourers in the advanced capitalist sector are literate,
sophisticated and skilled.
 In other words, marginal productivity of labour deployed in subsistence sector is negligible,
zero or even negative. Whereas those labourers employed in the capitalist sector have high
marginal productivity of labour and are more productive.
 In this dualistic situation, for the development of the economy, new industries can be
established or existing industries can be expanded by transferring labour from the
subsistence sector.
 However, the industries require skilled labour, according to Lewis, skilled labour is only a
‘quasi bottleneck or a temporary bottleneck’ which can be removed by providing training
facilities to the unskilled labour.
 Lewis proposed that gainful employment of the unlimited labour force requires that rate of
savings and investments should be at least 15 percent of national income. This is a central
problem for the developing countries having low capital formation. The development of the
developing countries therefore requires high capital accumulation.
 On the basis of above analysis, it can be concluded that unskilled labour is not a bottleneck
to economic development in majority of under developed countries but the capital formation
is a sine-qua-non.
 The key to economic development in Lewis’ model is capital formation and this is possible
when the capitalist use a part of its surplus in reinvestment for creation of new capital. They
lead to increase in employment and productivity.
 In the process, the capitalist draws labour from the subsistence sector and this reinvestment
of profit continues till entire surplus is absorbed. Thus, profits and their reinvestment have
great importance in economic growth.
 The four important components of Lewis theory are:

(i) role of technology in development;

(ii) role of private capitalist in development process,

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(iii) role of government and

(iv) role of bank credit.

 Lewis describes that the relationship between capital, technological progress and
productivity is critical determinant of development. Capital and technological knowledge are
critical factors for higher economic growth and development.
 Lewis is of the opinion that the growth of technological knowledge outside the capitalist
sector is important, as it raises the level of wage and reduces capitalist surplus.
 Secondly, according to Lewis, neither the salaried class nor the petty businessmen were to
add to capital formation. He therefore opined that the state capitalists and indigenous private
capitalists create capital out of profits and therefore, the earned profit should be promoted
for the purpose of capital formation and subsequently economic growth.
 Thirdly, saving plays a crucial role in the development of an economy. Lewis observes that
savings are to be done by people who receive profit or rent. Higher the saving higher will be
investment and finally the capital formation which will promote economic development. It is
because of increased savings, the capitalist sector of the economy expands leading to
expansion in national output and level of employment.
 Lastly, bank also plays a critical role in the economic development of a nation. Capital is not
only created out of profits earned, it can also be created as a result of net increase in money
supply, especially bank credit. Creation of banks acts as a stimulator of growth in national
income. It raises both output and employment.
 According to Lewis, this growth process will not continue forever, but will come to a halt for
the following reasons i.e., growth of capitalist sector will reduce the surplus labour in
subsistence sector, resulting in rise in wage of labour in capitalist sector. This will further
result in fall in the capitalist surplus. It will reduce capital formation and reverse the
expansionary process.

Criticisms of Lewis’ Unlimited Supplies of Labour Theory

(i) The theory assumes that in the capitalist sector wage rate will remain constant till
surplus labour in the capitalist sector is exhausted which is unrealistic.
(ii) The assumption of unlimited supplies of labour in developing countries is also
unrealistic.
(iii) This is a one sided theory, reason being that it considers expansion of capitalist
sector and does not talk about the role of agriculture or subsistence sector in
development. However, agriculture plays an important role in development.
(iv) The Lewis’ theory assumes that the marginal productivity of labour in over-populated
underdeveloped countries is zero or negligible. However, Schultz was of the opinion
that the marginal productivity of labour in over populated underdeveloped countries
would not be zero.
(v) It is also very difficult to find out the exact number of surplus labour who would move
from the subsistence to the capitalist sector. Furthermore, the mobility of labour is
also not easy.

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(vi) Lewis assumes that withdrawal of labour from the subsistence agriculture sector to
capitalist sector will not affect the productivity in the subsistence sector. However, in
actual, it will affect the productivity.

Ragnar Nurkse’s Theory of Balanced Growth

 R. Nurkse’s theory of balanced growth believes that the underdeveloped countries are
suffering from the vicious circle of poverty, which is detrimental to economic development in
these countries.
 According to him “a circular constellation of forces, tending to act and react upon one
another in such a way as to keep a country in a state of poverty”.
 This vicious circle of poverty adversely affects the accumulation of capital in economically
underdeveloped countries.
 If this vicious circle of poverty is broken then development will follow.
 According to Nurkse “the expansion of market can be realized only through a process of
balanced growth, where people in different countries, working with new and better tools,
become each other’s consumer.”
 The vicious circle works on both demand and supply side.
 On the supply side, there is small capacity to save due to low level of income, the low level
of income result in low productivity which is again due to deficiency of capital which is the
effect of low capacity to save.
 On the contrary, on the demand side, the inducement to invest is low due to low demand in
the economy, which is because of low income.
 This is how the vicious circle works on both supply and demand side.
 Operation of vicious circle of poverty limits the size of the market in underdevelopment
countries.
 Nurkse believes that the vicious circle of poverty can be broken through balanced growth.
 He was of the view that vicious circle can be broken by enlarging the size of the market
which cannot be done by individual investor.
 It would be possible with the help of a group of investors in the market.
 Therefore, enlargement of market is possible with the help of development of
complementary industries.
 This can break the vicious circle of poverty and release the forces of growth and expansion.
He also suggested that market size can be expanded by salesmanship and advertisement
and infrastructure development.
 Nurkse was of the view that the principle of balanced growth needs a balance between
different sectors of the economy during the process of economic growth and development.
 These are:

(i) balance between agriculture and industry;

(ii) balance between domestic and foreign trade; and

(iii) balanced between demand and supply factors.

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Balanced Growth Theory

 While talking of the balance between agriculture and industry, Lewis viewed that if
agriculture stagnates, the capitalist sector cannot grow, capitalist profit remains a small part
of the national income and saving and investments are correspondingly small. Smooth
economic development requires that industry and agriculture should grow together.
 Secondly, the balanced growth must promote trade within and across the countries. In other
words, there should be rise in trade within the country and also enhancement of foreign
trade. Nurkse suggested that balanced growth is a good foundation for international trade as
well as a way of filling the vacuum at the periphery.
 Thirdly, the balanced growth implies that different parts of the economy should grow in a
smooth and harmonious manner so that no part is ahead of the other. It requires balance
between the demand and the supply of factors of production.

Criticisms of Nurkse’s Theory of Balanced Growth

(i) Nurkse’s type of growth is difficult to achieve. Hirschman and Paul Streeten and
others have argued that due to the lack of capital in developing countries, it is difficult
to achieve balanced growth.
(ii) One of the most important question remains that for balanced growth in the
underdeveloped countries they require a huge investment for which the
underdeveloped countries have to depend on the developed countries which is a
difficult proposition.

Merits of Balanced Growth Theory

(i) The balanced growth theory emphasized that all the sectors should develop
simultaneously and no sector will be discriminated. In a way, it will promote balanced
regional development.
(ii) The balanced development will create external economies. The benefits created in one
sector will push investment in the other sector and will provide boost to the new
industries from the existing industries.
(iii) The balanced growth of both agriculture and industrial sector will create social overhead
capital. When different industries develop simultaneously, the investment is called for in
social overhead capital for the promotion of various sectors.
(iv) The balanced development will reduce the dependence of underdeveloped countries on
the foreign countries. The principle of balanced growth leads to enlarge the extent of the
market and external economies. This process will lead to self-generating economies and
as a result, there is less dependence on foreign countries
(v) It will boost foreign trade as expansion of both internal and external markets of the
product of an economy will to a great extent promote foreign trade
(vi) It will lead to better utilization of both natural and human resources of an economy.
(vii) Balanced growth can pare the way for division of labour and thus can raise the
specialization and productivity of labour force.

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Balanced Growth Theory

Criticisms of Balanced Growth Theory

 According to Singer “balanced growth can neither solve the problem of underdeveloped
countries, nor do they have sufficient resources to achieve balanced growth”.
(i) The balanced growth theory is more suitable to developed countries than developing
countries. The developed countries can effectively implement balanced growth
process as they possess sufficient resources, technology and entrepreneurs.
(ii) Disproportionality in the factors of production due to deficiency of capital and surplus
manpower. In many of the developing countries too much of labour is employed
against too little capital. This disproportionality will create many hurdles in the path of
development.