Neo-Classical Theory of Growth [ Biz/ed Virtual Developing Country ]

The Virtual Developing Country is a case study of Zambia. There are a series of field trips available looking at different issues connected with economic development. This trip is the Copper Tour and this page looks at the neo-classical theory of growth.

Theories

Neo-Classical Theory of Growth

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Neo classical theory maintains that economic growth is caused by:

  • increase in the labour quantity (population growth)
  • improvements in the quality of labour through training and education
  • increase in capital (through higher savings and investment)
  • improvements in technology

Underdevelopment is seen as the result of the government's inefficient utilisation of resources and state intervention in markets through regulation of prices. The neo classical lobby argue that government control inhibits growth because it encourages corruption, inefficiency and offers no profit motive for entrepreneurship.

They argue therefore, that the root cause of underdevelopment lies with the governments of the LDCs themselves. Only when governments adopt polices that aim to free up markets and improve the supply side, will the economy grow and development occur. This results in a shift of the long-run aggregate supply as shown in the diagram below. The potential level of output of the economy is then higher.

Long-run aggregate supply - right shift

Neo classical economists advocate the following strategies should be encouraged:

  • Competitive free markets
  • Privatisation of state owned industries
  • A move from closed (no trade) to open (trading) economies
  • Opening up the domestic economy through encouraging free trade (i.e. abolish tariffs and quotas) and foreign direct investment.

These policies will stimulate investment, higher output and income and hence higher savings.

Problems of the model
This model makes a number of unrealistic assumptions and ignores a number of crucial issues

  • The assumption is that the creation of a free market and a private enterprise culture is possible and desirable.
  • The existence of market failure such as externalities associated with economic growth are ignored
  • The problem of uneven distribution of income is ignored

Next theory - Population Pyramids >>


Related Glossary Items:
Market Failure
Neo Classical Theory
Supply Side Policies
Aggregate Supply
Investment
Free Market Economy

Related Issues:
Privatisation of State Owned Enterprises
The Structural Adjustment Policies of the IMF

Related Theories:
Supply Side Approaches
The Causes of Economic Growth
The Arguments for Privatisation