Balance growth- final - Mahendra B C PDF

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THEORY OF BALANCED GROWTH Introduction The theory of balanced growth was first propounded by Rosenstein Rodan in 1943, although he did not specifically use the word “Balanced growth” in his article written in titled, “Problems of Industrialization of Eastern and South- Eastern Europe”. His work is still regarded as the pioneer work which was later developed and elaborated by Ragnar Nurkse in his book “Problems of Capital Formation in the Underdeveloped Countries”. The theory hypothesises that the government of any underdeveloped country needs to make large investments in a number of industries simultaneously. This will enlarge the market size, increase productivity, and provide an incentive for the private sector to invest. The concept of balanced growth is subject to various interpretations by various authors. To some it means investing in a laggard sector or industry so as to bring it abreast of others. To others it implies that investment takes place simultaneously in all sectors or industries at once. Still to others, it means balance development of manufacturing industries and agriculture. P.A Samuelson, “Balanced Growth implies growth in every kind of capital stock constant rates.” U.N Publication, “Balanced Growth refers to full employment, a high level of investment, overall growth in productive capacity, equilibrium.” Benjamin Higgins, “A wave of capital investment in a number of industries is called Balanced Growth.” W.A. Lewis, “In development programmes, all sectors of economy should grow simultaneously so as to keep a proper balanced between industry and agriculture and between production for home consumption and production for exports the truth is that all sectors should be expanded simultaneously.” Generally, balanced growth means equal development in all sectors of the economy. It is the situation of an economy in which economic activities are conducted and expanded in balanced ways. Government should make a simultaneous investment in all sectors to achieve balance growth. Balance growth, therefore, requires balance between different consumer goods industries, and between consumer goods and capital goods industries. It also implies balance between industry and agriculture, and between the domestic and export sector. Further, it entails balance between social and economic overheads and directly productive investments, and between vertical and horizontal external economies. Thus, the theory states that there should be simultaneous and harmonious development of different sectors of the economy, so as to make available a ready market for the products of different sectors. The theory of balanced growth advocates a simultaneous setting up of a large number of mutually complementary industries that would generate demand for each other's products and thus expand the size of the market and increase inducement to invest. Hence, the synchronized application of capital to a wide range of different industries is called balanced growth. Ragnar Nurkse and Rosenstein-Rodan who are of the view that the strategy of investment should be so designed as to ensure a balanced development of the various sectors of the economy. They, therefore, advocate simultaneous investment in a number of industries so that there is a balanced growth of different industries. Let us examine the concept in detail with reference to Rodan’s and Nurkse’s formulations. Views of Rosenstein Rodan: Rosenstein Rodan gave the earliest version of the balanced growth theory. He observed that in underdeveloped countries, no new industry has a chance to survive due to limited size of market demand. He stated that the Social Marginal Product (SMP) of an investment is different from its Private Marginal Product (PMP). If different industries are planned together in accordance with their SMPs, the growth of the economy would be much more than it it would have been planned

according to their PMP. SMP is greater than PMP because of the complementarity of different industries which leads to the most profitable investment from the social point of view. According to Rodan, if investment is increased at equal rate in all types of industries, the benefit on the whole of all industries increases. As the investment made in only one place cannot help in giving social benefit, it is necessary to give emphasis on balance investment. In explaining his idea, Rodan gives the example of shoes factory, where 20000 workers were employed. If these workers spent all their wages on shoes, a market for shoes would be created. But the problem is that the workers will not spend all their wages on shoes. Since only the employees working in the same shoe factory cannot buy all the shoes, so they cannot be sold. But, if investment is made in different industries at the same time, lots of people get employment. The employees working in different industries spend money on various products produced by these industries. They can help to expand markets for one another’s products. Thus demand for shoes, as well as for goods produced by other industries increases that enables all of them to survive and grow through multiplier process. This would lead to planned industrialization. Views of Ragner Nurkse: Nurkse agreed with Rosenstein Rodan and put forward the balanced growth theory on similar lines. According to Nurkse, the vicious circles of poverty (both on the demand and the supply sides) are at work in the underdeveloped countries and are responsible for the retard in their economic development. The economic development can take place only if vicious circle of poverty is broken. The only way to break these circles is by investing in a wide range of industries which will eventually lead to - both vertical and horizontal integration of industries, a division of labour, a common pool of raw materials and technical skill, an expansion of the size of the market and better utilisation of social and economic overhead capital. The vicious circle of poverty operates both on the demand and supply side. 1. Demand Side: Vicious circle of poverty affects the demand side of capital formation. In an underdeveloped country, the level of per capita income is low which means that the people’s purchasing power is low. Owing to small incomes and low purchasing power their demand for consumer goods is low. As a result of low demand for goods, the inducement for investment is less and capital equipment per capita (i.e., per worker) is small. Since the amount of capital per capita is small, productivity per worker is low. Low per capita productivity means low per capita income, i.e., poverty. Low Income → Low demand (Low Size of Market) → Low Investment → Low capital formation→ Low Productivity → Low Income. Low Income

Low Demand

Low Productivity

Low Investment Low Capital Formation

Therefore, efforts should be made to increase the demand in these countries. The concept of balanced growth from the demand side is that several industries should be developed simultaneously and harmoniously so that all can be the customers mutually and the products of all can be sold. In this regard Rosenstein Rodan has given an example of shoes factory.

2. Supply Side: Vicious circle of poverty affects the supply side of capital formation. In the underdeveloped countries, poverty exists because the per capita income of the people is low. Due to low per capita income, the level of saving is low. Since investment depends on savings, so investment would be low due to which capital formation would be low. Low capital formation would lead to low productivity which would result in low income, i.e. Low-Income → Low Savings → Low Investment → Low Capital Formation → Low Productivity → Low Income

Low Income

Low Savings

Low Investment

Low Productivity Low Capital Formation

So, it is imperative to increase investment in order to increase demand. But investment will increase when the entrepreneurs will get impetus to invest. In other words, their products will sell and they will earn profit. Therefore, it becomes essential that several industries are set up simultaneously. Thus, the concept of balanced growth from the supply side is that various sectors of an underdeveloped economy should be developed simultaneously so that no difficulty in the path of economic development is created. For example, agriculture, industry, internal trade, transport, etc. should be developed simultaneously. According to Prof. Lewis, “The various sectors of the economy must go with the right relationship to each other or they cannot go at all.” How to Break Vicious Circle of Poverty? The economic development can take place only if vicious circle of poverty is broken. The underdeveloped countries, can resort to capital formation and accelerate the pace of economic development only by breaking the vicious circle of poverty. Once the vicious circle of poverty is broken, the economy would be on the rails to development. So, in order to break the vicious circle of poverty in the under-developed countries, it is essential to have a balance between demand and supply. Nurkes has given the following suggestion to break the vicious circle of poverty. They are as follows: 

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Complementary Demand: The vicious circle of poverty cannot be broken only by making investment in one industry or one sector. Rather, there should be overall investment in all the sectors. This is the only way to enlarge the size of the market. This is termed as complementarities of demand. In order to clear his views, Nurkse has given example of shoe industry as given by Rosenstein Rodan. It concludes that investment in shoes industry will not lead to sufficient demand. When investment will be made in several industries simultaneously, it will increase income of the employees. They will purchase goods made by each other for consumption. They will become customers mutually. Thus, the extent of the market will increase. It will lead to capital formation and thus, the vicious circle of poverty will get broken. Government intervention: Nurkse is of the view that the government must intervene in productive activities through economic planning. In underdeveloped countries, private entrepreneurs cannot come forward with so much heavy investment. This can easily be

carried out by the government only. The vicious circle of poverty can be broken by the intervention by the government. 

External Economics: Setting up of new industries and expansion of the existing industries create the external economies. The accruing of external economies leads to the law of increasing returns to scale. It leads to a fall in the cost of production and hence the price level. A fall in the price leads to the increase in demand which is helpful to break the vicious circle of poverty.

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Investment in human capital: In UDCs, the main obstacle of economic growth is the backwardness of human power. So, the investment should be made in education, technical knowledge and administrative training in UDCs. This helps to increase the production and operational capacity.

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Economic Growth: Balanced growth helps in accelerating the pace of economic growth, G.M. Meier is of the view that “Balanced Growth is a means of getting out of rut”. Nurkse is of the view that increase in investment in different branches of production can enlarge the total market. This can break the bonds of the stationery equilibrium of underdevelopment.

The Benefits of Doctrine of Balanced Growth Theory 1. Balanced Regional Development: This theory implies that all sectors should be developed simultaneously. No sector should be discriminated in the matter of development. In fact, efficiency, self-sufficiency and self-reliance is the result of balanced growth doctrine. In a sense, balanced growth is the real salvation to the problem of underdeveloped countries. Thus, it is important to have the balanced regional development. 2. Division of Labour: A wide extent of market will pave the way for more division of labour and specialization which will raise the productivity and leads to improve the quality of product. By promoting export, it helps to earn foreign exchange. Balanced growth strategy is a tool to encourage it. 3. Specialization: The balanced growth strategy helps in enlarging the size of the market. The expansion of the market leads to number of benefits. It leads to specialization. The efficiency goes up due to expertise. As a result, new innovations are encouraged. There is not only an increase in the quantity of output but there is also better quality of the products. Thus, balanced growth, through specialization helps improving both the quantity and quality of the output. 4. Possibilities of Innovations and Research: This theory encourages innovations and researches in different fields of the economy. The competition arises due to the simultaneous development of different industries. The industries which are unable to produce qualitative products, cannot stand in competition with other competitive industries and they automatically shut down their production. With the result, only efficient and optimum firms remain in the market while others will exit the market. In the modern scientific world, innovations and researches are very conducive for technical progress as they lower the cost of production. 5. Creation of Social Overhead Capital: Balanced growth is a tool for the creation of social overhead capital. When different industries develop simultaneously, the investment it is made in other social overhead works as of transportation, power jams, banking etc. This further encourages investment in human capital and material capital, which is the fundamental principle of balanced growth. 6. Wide Extent of Market: Generally, market imperfections and vicious circle of poverty obstruct the path of economic development. This problem can be solved by adopting the principle of balanced growth. The simultaneous development of different sectors helps in the production of variety of goods, which

in turn, would lead to the expansion of demand and enlargement of the market. Thus, it helps to breech the vicious circle of poverty and market imperfections. 7. Better Use of Natural Resources: Balanced growth makes the possibility of better use of natural resources in a region. As it has been observed that there are abundant natural resources in underdeveloped countries which remain unutilized or under-utilized. Thus, balanced growth doctrine provides basic facilities for its better use and allocation. 8. Less Dependence on Foreign Countries: Most of the underdeveloped countries are dependent on foreign countries even for necessities of life because they fail to adopt balanced strategy. The principle of balanced growth leads to enlarge the extent of the market and external economies. It also helps to create social overheads. As a result, there is less dependence on foreign countries. 9. Encouragement of private enterprises: Theory of balanced growth has emphasis on the importance of private investment. When investment is made in different sectors of the economy, there would be increase in the importance of private entrepreneurs. He asserts, that the private entrepreneurs can contribute considerably to economic development. 10. Breaking of Vicious Circle of Poverty: Balanced Growth Theory has laid emphasis on simultaneous investment in both the sectors, i.e., agricultural and industrial. It leads to the development of both agriculture and industry. Development of both the sectors brings- prosperity in the economy. According to Nurkse, “If there is balanced growth of the economy, it will help in breaking the vicious circle of poverty.” 11. Self-Reliance and Economic Stability: The process of balanced growth involves a number of simultaneous activities, e.g., economic planning, division of labor, specialization, increase in demand for goods and services, intersectoral balances, interregional balances etc. Hence there is no scope for wide economic fluctuations. This process implies a self-generating economy due to less dependence on foreigners. 12. Better Utilization of Capital: Balanced growth theory requires proper balance between investment in industry and agriculture. As a result of it, economic development of a country is accelerated. It encourages savings which turn into capital and thereby investment. In this way, it leads to better utilization of capital. 13. External Economies of Scale: It is balanced growth which helps in generating external economies. These economies accrue because of the increase in industries and expansion of market. In other words, external economies are those which are received by new industries over the old industries. One industry has the demand for products of other industries. For instance, if a cycle industry is set up, there is also demand for iron and rubber. As iron and rubber industries were already being existence, so cycle-industry can easily get iron and rubber. These economies are of two types:  Horizontal Economies: These economies accrue when consumer goods industries are set up. With the setting up of some consumer goods industries, setting up of other consumer goods industries is possible. The setting up of different industries enlarge the size of the market. These economies are called horizontal economies.  Vertical Economies: These economies accrue when basic industries are set up at the first instance. These lead to development of some less important industries automatically. These economies are called vertical economies. Criticisms of the Doctrine Balanced Growth Theory The balanced growth theory has been strongly criticised by lots of economists especially the unbalanced growth theorists like Albert O. Hirschman and Hans W. Singer. Some of the criticisms they raised are given below.

1. Wrong Assumptions: According to this theory, different industries and business activities have complementary relationship, so investment should be made in all sectors at the same time. The theory of balanced growth requires balanced investment to meet the growing demand and as a result there is existence of increasing returns. But, with simultaneous investment carried out in different new industries, there is bound to be competition in the demand for factors. In Less developed countries, factor supply is limited and as such, there exist a competitive rather than a complimentary relationship between industries. 2. Rise in Costs: Most of the developing economies lack sufficient capital equipment, skills, cheap power, finance and other necessary raw materials. Given the situation, a simultaneous investment in a wide range of industries would likely to raise money and real costs of production. 3. Against the Capabilities of Underdeveloped Countries: According to Hirschman, “The doctrine combines a defeatist attitude towards the capabilities of underdeveloped economies with completely unrealistic expectations about their creative abilities.” It involves the simultaneous start of several productive activities at one instance. But in an underdeveloped country, there is an acute shortage of capital resource, technical and managerial skills etc. The whole system is self-contradictory. So, it is unrealistic for the balanced growth theory to be advocating for a large investment in many industries in a developing country 4. Factors Disproportionalities: Another drawback of the theory is disproportionality in the factors of production due to deficiency of capital and surplus manpower. In some less developed countries too much labour is employed against too little capital. In such countries, labour is in abundance but capital and entrepreneurial skill are scarce. This disproportionality in factors of production creates several practical hindrance in the implementation of successful operation of balanced growth theory. 5. Ignores Potentialities of Foreign Market: Prof. Nurkse’s principle of balanced growth is based on the fact that inducement to invest is limited by the size of the market. According to him, size of the market can be enlarged through simultaneous and uniform growth of complementary industries. In this way, he ignores potentia...