the process whereby simple, low-income national economies are transformed into modern industrial economies. Although the term is sometimes used as a synonym for economic growth, generally it is employed to describe a change in a country's economy involving qualitative as well as quantitative improvements. The theory of economic development—how primitive and poor economies can evolve into sophisticated and relatively prosperous ones—is of critical importance to underdeveloped countries, and it is usually in this context that the issues of economic development are discussed.

Economic development first became a major concern after World War II. As the era of European colonialism ended, many former colonies and other countries with low living standards came to be termed underdeveloped countries, to contrast their economies with those of the developed countries, which were understood to be Canada, the United States, those of western Europe, most eastern European countries, the then Soviet Union, Japan, South Africa, Australia, and New Zealand. As living standards in most poor countries began to rise in subsequent decades, they were renamed the developing countries.

There is no universally accepted definition of what a developing country is; neither is there one of what constitutes the process of economic development. Developing countries are usually categorized by a per capita income criterion, and economic development is usually thought to occur as per capita incomes rise. A country's per capita income (which is almost synonymous with per capita output) is the best available measure of the value of the goods and services available, per person, to the society per year. Although there are a number of problems of measurement of both the level of per capita income and its rate of growth, these two indicators are the best available to provide estimates of the level of economic well-being within a country and of its economic growth.

It is well to consider some of the statistical and conceptual difficulties of using the conventional criterion of underdevelopment before analyzing the causes of underdevelopment. The statistical difficulties are well known. To begin with, there are the awkward borderline cases. Even if analysis is confined to the underdeveloped and developing countries in Asia, Africa, and Latin America, there are rich oil countries that have per capita incomes well above the rest but that are otherwise underdeveloped in their general economic characteristics. Second, there are a number of technical difficulties that make the per capita incomes of many underdeveloped countries (expressed in terms of an international currency, such as the U.S. dollar) a very crude measure of their per capita real income. These difficulties include the defectiveness of the basic national income and population statistics, the inappropriateness of the official exchange rates at which the national incomes in terms of the respective domestic currencies are converted into the common denominator of the U.S. dollar, and the problems of estimating the value of the noncash components of real incomes in the underdeveloped countries. Finally, there are conceptual problems in interpreting the meaning of the international differences in the per capita income levels.

Although the difficulties with income measures are well established, measures of per capita income correlate reasonably well with other measures of economic well-being, such as life expectancy, infant mortality rates, and literacy rates. Other indicators, such as nutritional status and the per capita availability of hospital beds, physicians, and teachers, are also closely related to per capita income levels. While a difference of, say, 10 percent in per capita incomes between two countries would not be regarded as necessarily indicative of a difference in living standards between them, actual observed differences are of a much larger magnitude. India's (India) per capita income, for example, was estimated at $270 in 1985. In contrast, Brazil's (Brazil) was estimated to be $1,640, and Italy's (Italy) was $6,520. While economists have cited a number of reasons why the implication that Italy's living standard was 24 times greater than India's might be biased upward, no one would doubt that the Italian living standard was significantly higher than that of Brazil, which in turn was higher than India's by a wide margin.

The interpretation of a low per capita income level as an index of poverty in a material sense may be accepted with two qualifications. First, the level of material living depends not on per capita income as such but on per capita consumption. The two may differ considerably when a large proportion of the national income is diverted from consumption to other purposes; for example, through a policy of forced saving. Second, the poverty of a country is more faithfully reflected by the representative standard of living of the great mass of its people. This may be well below the simple arithmetic average of per capita income or consumption when national income is very unequally distributed and there is a wide gap in the standard of living between the rich and the poor.

The usual definition of a developing country is that adopted by the World Bank: “low-income developing countries” in 1985 were defined as those with per capita incomes below $400; “middle-income developing countries” were defined as those with per capita incomes between $400 and $4,000. To be sure, countries with the same per capita income may not otherwise resemble one another: some countries may derive much of their incomes from capital-intensive enterprises, such as the extraction of oil, whereas other countries with similar per capita incomes may have more numerous and more productive uses of their labour force to compensate for the absence of wealth (wealth and income, distribution of) in resources. Kuwait, for example, was estimated to have a per capita income of $14,480 in 1985, but 50 percent of that income originated from oil. In most regards, Kuwait's economic and social indicators fell well below what other countries with similar per capita incomes had achieved. Centrally planned economies are also generally regarded as a separate class, although China and North Korea are universally considered developing countries. A major difficulty is that prices serve less as indicators of relative scarcity in centrally planned economies and hence are less reliable as indicators of the per capita availability of goods and services than in market-oriented economies.

Estimates of percentage increases in real per capita income are subject to a somewhat smaller margin of error than are estimates of income levels. While year-to-year changes in per capita income are heavily influenced by such factors as weather (which affects agricultural output, a large component of income in most developing countries), a country's terms of trade, and other factors, growth rates of per capita income over periods of a decade or more are strongly indicative of the rate at which average economic well-being has increased in a country.

The field of development economics is concerned with the causes of underdevelopment and with policies that may accelerate the rate of growth of per capita income. While these two concerns are related to each other, it is possible to devise policies that are likely to accelerate growth (through, for example, an analysis of the experiences of other developing countries) without fully understanding the causes of underdevelopment.

Studies of both the causes of underdevelopment and of policies and actions that may accelerate development are undertaken for a variety of reasons. There are those who are concerned with the developing countries on humanitarian grounds; that is, with the problem of helping the people of these countries to attain certain minimum material standards of living (standard of living) in terms of such factors as food, clothing, shelter, and nutrition. For them, low per capita income is the measure of the problem of poverty in a material sense. The aim of economic development is to improve the material standards of living by raising the absolute level of per capita incomes. Raising per capita incomes is also a stated objective of policy of the governments of all developing countries. For policymakers and economists attempting to achieve their governments' objectives, therefore, an understanding of economic development, especially in its policy dimensions, is important. Finally, there are those who are concerned with economic development either because they believe it is what people in developing countries want or because they believe that political stability can be assured only with satisfactory rates of economic growth. These motives are not mutually exclusive. Since World War II many industrial countries have extended foreign aid to developing countries for a combination of humanitarian and political reasons.

Those who are concerned with political stability tend to see the low per capita incomes of the developing countries in relative terms; that is, in relation to the high per capita incomes of the developed countries. For them, even if a developing country is able to improve its material standards of living through a rise in the level of its per capita income, it may still be faced with the more intractable subjective problem of the discontent created by the widening gap in the relative levels between itself and the richer countries. (This effect arises simply from the operation of the arithmetic of growth on the large initial gap between the income levels of the developed and the underdeveloped countries. As an example, an underdeveloped country with a per capita income of $100 and a developed country with a per capita income of $1,000 may be considered. The initial gap in their incomes is $900. Let the incomes in both countries grow at 5 percent. After one year, the income of the underdeveloped country is $105, and the income of the developed country is $1,050. The gap has widened to $945. The income of the underdeveloped country would have to grow by 50 percent to maintain the same absolute gap of $900.) Although there was once in development economics a debate as to whether raising living standards or reducing the relative gap in living standards was the true desideratum of policy, experience during the 1960–80 period convinced most observers that developing countries could, with appropriate policies, achieve sufficiently high rates of growth both to raise their living standards fairly rapidly and to begin closing the gap.

Although concern over the question of a subjective sense of discontent among the underdeveloped and developing countries has waxed and waned, it has never wholly disappeared. The underdeveloped countries' sense of dissatisfaction and grievance arises not only from measurable differences in national incomes but also from the less easily measurable factors, such as their reaction against the colonial past and their complex drives to raise their national prestige and achieve equality in the broadest sense with the developed countries. Thus, it is not uncommon to find their governments using a considerable proportion of their resources in prestige projects, ranging from steel mills, hydroelectric dams, universities, and defense expenditure to international athletics. These symbols of modernization may contribute a nationally shared satisfaction and pride but may or may not contribute to an increase in the measurable national income. Second, it is possible to argue that in many cases the internal gap in incomes within individual underdeveloped countries may be a more potent source of the subjective level of discontent than the international gap in income. Faster economic growth may help to reduce the internal economic disparities in a less painful way, but it must be remembered that faster economic growth also tends to introduce greater disruption and the need for making bigger readjustments in previous ways of life and may thus increase the subjective sense of frustration and discontent. Finally, it is difficult to establish that the subjective problem of discontent will bear a simple and direct relationship to the size of the international gap in incomes. Some of the apparently most discontented countries are to be found in Latin America, where the per capita incomes are generally higher than in Asia and Africa. A skeptic can turn the whole approach to a reductio ad absurdum by pointing out that even the developed countries with their high and rising levels of per capita income have not been able to solve the subjective problem of discontent and frustration among various sections of their population.

Two conclusions may be drawn from the above points. First, the subjective problem of discontent in the underdeveloped countries is a genuine and important problem in international relations. But economic policy acting on measurable economic magnitudes can play only a small part in the solution of what essentially is a problem in international politics. Second, for the narrower purpose of economic policy there is no choice but to fall back on the interpretation of the low per capita incomes of the underdeveloped countries as an index of their poverty in a material sense. This can be defended by explicitly adopting the humanitarian value judgment that the underdeveloped countries ought to give priority to improving the material standards of living of the mass of their people. But, even if this value judgment is not accepted, the conventional measure of economic development in terms of a rise in per capita income still retains its usefulness. The governments of the underdeveloped countries may wish to pursue other, nonmaterial goals, but they could make clearer decisions if they knew the economic cost of their decisions. The most significant measure of this economic cost can be expressed in terms of the foregone opportunity to raise the level of per capita income.

If the underdeveloped countries are merely low-income countries, why call them underdeveloped? The use of the term underdeveloped in fact rests on a general hypothesis on which the whole subject matter of development economics is based. According to this hypothesis, the existing differences in the per capita income levels between the developed and the underdeveloped countries cannot be accounted for purely in terms of differences in natural conditions beyond the control of man and society. That is to say, the underdeveloped countries are underdeveloped because, in some way or another, they have not yet succeeded in making full use of their potential for economic growth. This potential may arise from the underdevelopment of their natural resources, or their human resources, or from the “technological gap.” More generally, it may arise from the underdevelopment of economic organization and institutions, including the network of the market system and the administrative machinery of the government. The general presumption is that the development of this organizational framework would enable an underdeveloped country to make a fuller use not only of its domestic resources but also of its external economic opportunities, in the form of international trade, foreign investment, and technological and organizational innovations.

After World War II a number of developing countries attained independence from their former colonial (colonialism, Western) rulers. One of the common claims made by leaders of independence movements was that colonialism had been responsible for perpetuating low living standards in the colonies. Thus economic development after independence became an objective of policy not only because of the humanitarian desire to raise living standards but also because political promises had been made, and failure to make progress toward development would, it was feared, be interpreted as a failure of the independence movement. Developing countries in Latin America and elsewhere that had not been, or recently been, colonies took up the analogous belief that economic domination by the industrial countries had thwarted their development, and they, too, joined the quest for rapid growth.

At that early period, theorizing about development, and about policies to attain development, accepted the assumption that the policies of the industrial countries were to blame for the poverty of the developing countries. Memories of the Great Depression, when developing countries' terms of trade had deteriorated markedly, producing sharp reductions in per capita incomes, haunted many policymakers. Finally, even in the developed countries, the Keynesian legacy attached great importance to investment.

In this milieu, it was thought that a “shortage of capital (capital and interest)” was the cause of underdevelopment. It followed that policy should aim at an accelerated rate of investment. Since most countries with low per capita incomes were also heavily agricultural (and imported most of the manufactured goods consumed domestically), it was thought that accelerated investment in industrialization and the development of manufacturing industries to supplant imports through “import substitution” was the path to development. Moreover, there was a fundamental distrust of markets, and a major role was therefore assigned to government in allocating investments. Distrust of markets extended especially to the international economy.

Experience with development changed perceptions of the process and of the policies affecting it in important ways. Nonetheless, there are significant elements of truth in some of the earlier ideas, and it is important to understand the thinking underlying them.

Development economics may be contrasted with another branch of study, called growth economics, which is concerned with the study of the long-run, or steady-state, equilibrium growth paths of the economically developed countries, which have long overcome the problem of initiating development.

Growth theory assumes the existence of a fully developed modern capitalist economy with a sufficient supply of entrepreneurs responding to a well-articulated system of economic incentives to drive the growth mechanism. Typically, it concentrates on macroeconomic relations, particularly the ratio of savings to total output and the aggregate capital–output ratio (that is, the number of units of additional capital required to produce an additional unit of output). Mathematically, this can be expressed (the Harrod–Domar growth equation) as follows: the growth in total output (g) will be equal to the savings ratio (s) divided by the capital–output ratio (k); i.e., g = ^s/_k. Thus, suppose that 12 percent of total output is saved annually and that three units of capital are required to produce an additional unit of output: then the rate of growth in output is ¹²/₃% = 4% per annum. This result is obtained from the basic assumption that whatever is saved will be automatically invested (investment) and converted into an increase in output on the basis of a given capital–output ratio. Since a given proportion of this increase in output will be saved and invested on the same basis, a continuous process of growth is maintained.

Growth theory, particularly the Harrod–Domar growth equation, has been frequently applied or misapplied to the economic planning of a developing country. The planner starts from a desired target rate of growth of perhaps 4 percent. Assuming a fixed overall capital–output ratio of, say, 3, it is then asserted that the developing country will be able to achieve this target rate of growth if it can increase its savings to 3 × 4 percent = 12 percent of its total output. The weakness of this type of exercise arises from the assumption of a fixed overall capital–output ratio, which assumes away all the vital problems affecting the developing country's capacity to absorb capital and invest its saving in a productive manner. These problems include the central problem of the efficient allocation of available savings among alternative investment opportunities and the associated organizational and institutional problems of encouraging the growth of a sufficient supply of entrepreneurs; the provision of appropriate economic incentives through a market system that correctly reflects the relative scarcities of products and factors of production; and the building up of an organizational framework that can effectively implement investment decisions in both the private and the public sectors. Such problems, which generally affect the developing country's absorptive capacity for capital and a number of other inputs, constitute the core of development economics. Development economics is needed precisely because the assumptions of growth economics, based as they are on the existence of a fully developed and well-functioning modern capitalist economy, do not apply.

The developing and underdeveloped countries are a very mixed collection of countries. They differ widely in area, population density, and natural resources. They are also at different stages in the development of market and financial institutions and of an effective administrative framework. These differences are sufficient to warn against wide-sweeping generalizations about the causes of underdevelopment and all-embracing theoretical models of economic development. But when development economics first came into prominence in the 1950s, there were powerful intellectual and political forces propelling the subject toward such general theoretical models of development and underdevelopment. First, many writers who popularized the subject were frankly motivated by a desire to persuade the developed countries to give more economic aid to the underdeveloped countries, on grounds ranging from humanitarian considerations to considerations of cold-war strategy. Second, there was the reaction of the newly independent underdeveloped countries against their past “colonial economic pattern,” which they identified with free trade and primary production for the export market. These countries were eager to accept general theories of economic development that provided a rationalization for their deep-seated desire for rapid industrialization. Third, there was a parallel reaction, at the academic level, against older economic theory, with its emphasis on the efficient allocation of scarce resources and a striving after new and “dynamic” approaches to economic development.

All of these forces combined to produce a crop of theoretical approaches that soon developed into a fairly fixed orthodoxy with its characteristic emphasis on “crash” programs of investment in both material and human capital, on domestic industrialization, and on government economic planning as the standard ingredients of development policy. These new theories have continued to have a considerable influence on the conventional wisdom in development economics, although in retrospect most of them have turned out to be partial theories. A broad survey of these theories, under three main heads, is given below. It is particularly relevant to the debate over whether the underdeveloped countries should seek economic development through domestic industrialization or through international trade. The limitations of these new theories—and how they led to a gradual revival of a more pragmatic approach todevelopment problems, which falls back increasingly on the older economic theory of efficient allocation of resources—are subsequently traced.

First, there are the theories that regard the shortage of some strategic input (such as the supply of savings, foreign exchange, or technical skills) as the main cause of underdevelopment. Once this missing component was supplied—say, by external economic aid—it was believed that economic development would follow in a predictable manner based on fixed quantitative relationships between input and output. The overall capital–output ratio, mentioned above, is the most well-known of these fixed technical coefficients. But similar fixed coefficients have been assumed between the foreign-exchange requirements and total output and between the input of skilled manpower and output.

Given the broad relationship between capital accumulation and economic growth established in growth theory, it was plausible for growth theorists and development economists to argue that the developing countries were held back mainly by a shortage in the supply of capital. These countries were then saving only 5–7 percent of their total product, and it was manifest (and it remains true) that satisfactory growth cannot be supported by so low a level of investment. It was therefore thought that raising the savings ratio to 10–12 percent was the central problem for developing countries. Early development policy therefore focused on raising resources for investment. Steps toward this end were highly successful in most developing countries, and savings ratios rose to the 15–25 percent range. However, growth rates failed even to approximate the savings rates, and theorists were forced to search for other explanations of differences in growth rates.

It has become increasingly clear that there can be much wastage of capital resources in the developing countries for various reasons, such as wrong choice of investment projects, inefficient implementation and management of these projects, and inappropriate pricing and costing of output. These faults are particularly noticeable in public-sector (public enterprise) investment projects and are one of the reasons why the Pearson Commission Report of the International Bank for Reconstruction and Development (1969) found that “the correlation between the amounts of aid received in the past decades and the growth performance is very weak.” But even in the private sector there may be a considerable distortion in the direction of investment induced by policies designed to encourage development. Thus, in most underdeveloped countries, a considerable part of private expansion investment, both foreign and domestic, has been diverted into the expansion of the manufacturing sector, catering to the domestic market through various inducements, including tariff protection, tax holidays, cheap loans, and generous foreign-exchange allocations granting the opportunity to import capital goods cheaply at overvalued exchange rates. As a consequence, there developed a very considerable amount of excess capacity in the manufacturing sector of the underdeveloped countries pursuing such policies.

In the 1950s most developing countries were primary commodity exporters, relying on crops and minerals for the bulk of their foreign-exchange earnings through exports, and importing a large number of manufactured goods. The experience of colonialism, and the distrust of the international economy that it engendered, led policymakers in most developing countries to adopt a policy of import substitution. This policy was intended to promote industrialization by protecting domestic producers from the competition of imports. Protection, in the form of high tariffs or the restriction of imports through quotas, was applied indiscriminately, often to inherently high-cost industries that had no hope of ever becoming internationally competitive. Also, after the early stages of import substitution, protected new industries tended to be very intensive in the use of capital and especially of imported capital goods.

The import-substitution approach defined “industrialization” rather narrowly as the expansion of the modern manufacturing sector based on capital-intensive technology. Capital was therefore identified with durable capital equipment in the form of complex machinery and other inputs that the underdeveloped countries were not able to produce domestically. Thus, foreign-exchange requirements were calculated on the basis of the fixed technical input-output coefficients of the manufacturing sector.

With high levels of protection for domestic industry, and with exchange rates that were often maintained at unrealistic levels (usually in an effort to make imported capital goods “cheap”), the experience of most developing countries was that export earnings grew relatively slowly. The simultaneously sharp increase in demand for imported capital goods (and for raw materials and replacement parts as well) resulted in unexpectedly large increases in imports. Most developing countries found themselves with critical foreign-exchange shortages and were forced to reduce imports in order to cut their current-account deficits to manageable proportions.

The cutbacks in imports usually resulted in reduced growth rates, if not recessions. This result led to the view that economic stagnation was caused primarily by a shortage of foreign exchange with which to buy essential industrial inputs. But over the longer term the growth rates of countries that continued to protect their domestic industries heavily not only stagnated but declined sharply. Contrasting the experience of countries that persisted in policies of import substitution with those that followed alternative policies (see below) subsequently demonstrated that foreign-exchange shortage was a barrier to growth only within the context of the protectionist policies adopted and was not inherently a barrier to the development process itself.

As it became apparent that the physical accumulation of capital was not by itself the key to development, many analysts turned to a lack of education and skills among the population as being a crucial factor in underdevelopment. If education and skill are defined as everything that is required to raise the productivity of the people in the developing countries by improving their skills, enterprise, initiative, adaptability, and attitudes, this proposition is true but is an empty tautology. However, the need for skills and training was first formulated in terms of specific skills and educational qualifications that could be supplied by crash programs in formal education. The usual method of manpower planning thus started from a target rate of expansion in output and tried to estimate the numbers of various types of skilled personnel that would be required to sustain this target rate of economic growth on the basis of an assumed fixed relationship between inputs of skill and national output.

This approach was plausible enough in many developing countries immediately after their political independence, when there were obvious gaps in various branches of the administrative and technical services. But most countries passed through this phase rather quickly. In the meantime, as the result of programs in education expansion, their schools and colleges began producing large numbers of fresh graduates at much faster rates than their general rate of economic growth could supply suitable new jobs for. This created a growing problem of educated unemployment. An important factor behind the rapid educational expansion was the expectation that after graduation students would be able to obtain well-paying white-collar jobs at salary levels many times the prevailing per capita income of their countries. Thus, the underdeveloped countries' inability to create jobs to absorb their growing armies of graduates created an explosive element in what came to be called the revolution of expectations.

It is possible to see a close parallelism between the narrow concept of industrialization as the expansion of the manufacturing sector and the narrow concept of education as the academic and technical qualifications that can be supplied by the expansion of the formal educational system. If a broader concept of education, relevant for economic development, is needed, it is necessary to seek it in the pervasive educational influence of the economic environment as a whole on the learning process of the people of the underdeveloped countries. This is a complex process that depends on, among other less easily analyzable things, the system of economic incentives and signals that can mold the economic behaviour of the people of the underdeveloped countries and affect their ability to make rational economic decisions and their willingness to introduce or adapt to economic changes. Unfortunately, the economic environment in many underdeveloped countries is dominated by a network of government controls that tend not to be conducive to such ends.

Two theories emphasized the existence of surplus resources in developing countries as the central challenge for economic policy. The first concentrated on the countries with relatively abundant natural resources and low population densities and argued that a considerable amount of both surplus land and surplus labour might still exist in these countries because of inadequate marketing facilities and lack of transport and communications. Economic development was pictured as a process whereby these underutilized resources of the subsistence sector would be drawn into cash production for the export market. International trade was regarded as the chief market outlet, or vent, for the surplus resources. The second theory was concerned with the thickly populated countries and the possibility of using their surplus labour as the chief means of promoting economic development. According to this theory, because of heavy population pressure on land, the marginal product of labour (that is, the extra output derived from the employment of an extra unit of labour) was reduced to zero or to a very low level. But the people in the subsistence sector were able to enjoy a certain customary minimum level of real income because the extended-family system of the rural society shared the total output of the family farm among its members. A considerable proportion of labour in the traditional agricultural sector was thus thought to contribute little or nothing to total output and to really be in a state of disguised unemployment. By this theory, the labour might be drawn into other uses without any cost to society.

It is necessary to clear up a number of preliminary points about the concept of disguised unemployment before considering its applications. First, it is highly questionable whether the marginal product of labour is actually zero even in densely populated countries such as India or Pakistan. Even in these countries, with existing agricultural methods, all available labour is needed in the peak seasons, such as harvest. The most important part of disguised unemployment is thus what may be better described as seasonal unemployment during the off-seasons. The magnitude of this seasonal unemployment, however, depends not so much on the population density on land as on the number of crops cultivated on the same piece of land through the year. There is thus little seasonal unemployment in countries such as Taiwan or South Korea, which have much higher population densities than India, because improved irrigation facilities enable them to grow a succession of crops on the same land throughout the year. But there may be considerable seasonal unemployment even in sparsely populated countries growing only one crop a year.

The main weakness in the proposal to use disguised unemployment for the construction of major social-overhead-capital projects arises from an inadequate consideration of the problem of providing the necessary subsistence fund to maintain the workers during what may be a considerably long waiting period before these projects yield consumable output. This may be managed somehow for small-scale local-community projects when the workers are maintained in situ by their relatives. But when it is proposed to move a large number of surplus workers away from their home villages for major construction projects taking a considerable time to complete, the problem of raising a sufficient subsistence fund to maintain the labour becomes formidable. The only practicable way of raising such a subsistence fund is to encourage voluntary saving and the expansion of a marketable surplus of food that can be purchased with the savings to maintain the workers. The mere existence of disguised unemployment does not in any way ease this problem.

In earlier thinking about development, it was assumed that the market mechanisms of developed economies were so unreliable in developing economies that governments had to assume central responsibility for economic activity. This was to be done through economic planning for the entire economy (see economic planning: Planning in developing countries (economic planning)), which in turn would be implemented by active government participation in the economy and pervasive controls over all private-sector economic activity. Government participation took many forms: Public-sector enterprises (public enterprise) were established to manufacture many commodities, including steel, machine tools, fertilizers, heavy chemicals, and even textiles and clothing; government marketing boards assumed monopoly power over the purchase and sale of many agricultural commodities; and government agencies became the sole importers of a variety of goods, and they often became exporters as well. Controls over private-sector activity were even more extensive: Price controls were established for many commodities; import licensing procedures eliminated the importing of commodities not given priority in official plans; investment licenses were required before factories could be expanded; capacity licenses regulated maximum permissible outputs; and comprehensive regulations governed the conditions of employment of workers.

The consequence, frequently, was that indigenous entrepreneurs often found it more financially rewarding to devote their energies and ingenuity to the task of procuring the necessary government import licenses and other permits and exploiting the loopholes in government regulations than to the problem of raising the efficiency and productivity of resources. For public-sector enterprises, political pressures often resulted in the employment of many more persons than could be productively used and in other practices conducive to extremely high-cost and inefficient operations. The consequent fiscal burden diverted resources that might otherwise have been used for investment, while the inefficient use of resources dampened growth rates.

Related to the belief in market failure and in the necessity for government intervention was the view that the efficiency of the price mechanism in developing countries was very small. This was reflected in the view of foreign-exchange shortage, already discussed, in which it was thought that there are fixed relationships between imported capital and domestic expansion. It was also reflected in the view that farmers are relatively insensitive to relative prices and in the belief that there are few entrepreneurs in developing countries.

By the end of the 1950s the experience gained from efforts to promote economic development showed great differences among developing countries. Some had broken away relatively quickly from the import-substitution, government-control and -ownership pattern that had been the early development wisdom. Others persisted with the same policies for several decades. A great deal was learned from the experiences of different developing countries.

Despite early emphasis on industrialization through import substitution, a first major lesson of postwar experience was that there is a close connection between the rate of growth in the output of the agricultural sector and the general rate of economic development. The high rates of economic growth are associated with rapid expansion of agricultural output and low rates of economic growth with the slow growth of agriculture. This is (in hindsight, at least) to be expected, since agriculture forms a large part of the total domestic product and of the exports of the developing countries. What is more interesting is that the expansion of agricultural output was by no means confined to those countries with an abundant supply of unused land to be brought under cultivation. Taiwan and South Korea (Korea, South), with some of the highest population densities in the world, were able to expand their agricultural output rapidly by a vigorous pursuit of appropriate policies. These included the provision of adequate irrigation facilities, enabling a succession of crops to be grown on the same piece of land throughout the year; the use of high-yielding seeds and fertilizers, which raised the yields per acre in a dramatic fashion; provision of adequate incentives for producers by setting producer prices at reasonable levels; and improvements in credit and marketing facilities and a general improvement in the economic organization of the agricultural sector. Agricultural development is important because it raises the incomes of the mass of the people in the countryside; in addition, it increases the size of the domestic market for the manufacturing sector and reduces internal economic disparities between the urban centres and the rural districts.

A second conclusion to be drawn from experience is the close connection between export expansion and economic development. The high-growth countries were characterized by rapid expansion in exports. Here again it is important to note that export expansion was not confined to those countries fortunate in their natural resources, such as the oil-exporting countries. Some of the developing countries were able to expand their exports in spite of limitations in natural resources by initiating economic policies that shifted resources from inefficient domestic manufacturing industries to export production. Nor was export expansion from the developing countries confined to primary products. There was very rapid expansion of exports of labour-intensive manufactured goods. This phenomenon occurred not only in the extremely rapidly growing, newly industrialized countries (NICs)—Singapore, South Korea, and Taiwan, as well as Hong Kong—but also from other developing countries including Brazil, Argentina, and Turkey. Countries that adopted export-oriented development strategies (of which the most notable were the NICs) experienced extremely high rates of growth that were regarded as unattainable in the 1950s and 1960s. They were also able to maintain their growth momentum during periods of worldwide recession better than were the countries that maintained their import substitution policies.

Analysts have pointed to a number of reasons why the export-oriented growth strategy seems to deliver more rapid economic development than the import substitution strategy. First, a developing country able to specialize in producing labour-intensive commodities uses its comparative advantage in the international market and is also better able to use its most abundant resource—unskilled labour. The experience of export-oriented countries has been that there is little or no disguised unemployment once labour-market regulations are dismantled and incentives are created for individual firms to sell in the export market. Second, most developing countries have such small domestic markets that efforts to grow by starting industries that rely on domestic demand result in uneconomically small, inefficient enterprises. Moreover, those enterprises will typically be protected (protectionism) from international competition and the incentives it provides for efficient production techniques. Third, an export-oriented strategy is inconsistent with the impulse to impose detailed economic controls; the absence of such controls, and their replacement by incentives, provides a great stimulus to increases in output and to the efficiency with which resources are employed. The increasing capacity of a developing country's entrepreneurs to adapt their resources and internal economic organization to the pressures of world-market demand and international competition is a very important connecting link between export expansion and economic development. It is important in this connection to stress the educative effect of freer international trade in creating an environment conducive to the acceptance of new ideas, new wants, and new techniques of production and methods of organization from abroad.

Another major lesson that was learned is that poor people are, if anything, more responsive to incentives than rich people. Nominal exchange rates that are pegged without regard to domestic inflation have strong negative effects on incentives to export; producer prices for agricultural goods that are set as a small fraction of their world market price constitute a significant disincentive to agricultural production; and controls on prices and investment serve as significant deterrents to economic activity. Indeed, in most environments, controls lead to “rent-seeking” behaviour, in which resources are diverted from productive activity and instead are used to try to win import licenses, or to get the necessary bureaucratic permissions. In addition, in many countries, “parallel,” or black (black market), markets emerged, which diverted resources from activities in the official sector. In some countries, legal exports diminished sharply as smuggling and underinvoicing intensified in response to increasing discrepancies between the official exchange rate and the black-market rate.

As a corollary to the lesson that controls may strongly divert economic activity from an efficient allocation of resources, it became increasingly evident that inappropriate incentives can adversely affect economic behaviour. The response of agricultural supply to increases in producer prices is considerably stronger than was earlier believed. Likewise, individuals respond to incentives with respect to their education and training. Thus, much of the overinvestment in education referred to earlier came to be seen as the result of artificially inflated wages (wage and salary) for university graduates in the public sector and of the fact that university education was virtually free to students in many developing countries. As a consequence, students perceived an incentive to obtain university degrees, even when there was a chance that they would remain unemployed for an extended period of time. When they did eventually find employment, the high wage would compensate for their earlier period of unemployment. Privately, such behaviour makes good sense in response to existing incentives; socially, however, it represents a waste of valuable and scarce resources.

In the modern view of development, an open, expanding international economy is the greatest support that the developed countries can provide for developing countries. Foreign aid can be extremely helpful in situations in which policies are conducive to development, but development will in any event be accelerated if the international economy is experiencing healthy growth. Removal of the trade barriers that developed countries have erected against developing countries is at least as important as economic aid. Trade barriers are many. They include restrictions on temperate-zone agricultural products and sugar; restrictions on the simpler labour-intensive manufactured goods (which often can be produced more cheaply in developing countries) including especially the Multifibre Arrangement under which imports of textiles and clothing into developed countries are greatly restricted; and tariff escalation, or higher rates of duties on processed products as compared with raw materials, which discourages the growth of processing industries in the developing countries. The removal of these trade barriers can help those developing countries that have already shown their capacity to take advantage of the available external economic opportunities to grow even more satisfactorily and can also provide additional incentives for other developing countries to alter their economic policies.

Still another lesson is the desirability of slowing down the rapid population growth that characterizes most developing countries. Their average rate of population growth is about 2.2 percent per year, but there are some countries where population growth is 3 percent or more. If the aim of economic development is to raise the level of per capita incomes, it is obvious that this can be achieved both by increasing the rate of growth of total output and by reducing the rate of growth of population. Development economists of the 1950s tended to neglect population-control policies. They were partly seduced by theories of dramatically raising total output through crash investment programs and partly by the belief that population growth could be controlled only slowly, through gradual changes in social attitudes and values. But it is now recognized that some births in developing countries are unwanted. Great technical advances in methods of birth control about the same time made possible mass dissemination at very low cost. Countries where these methods were made available experienced significant declines in birth rates, although significant changes in social attitudes and values are necessary before average family size declines enough to halt population growth. As soon as birth rates stop rising, the relative increase in population in the working-age groups and the higher income available to existing family members immediately start to release resources for increasing consumption and saving.

The positive case for the expansion of the manufacturing sector may now be considered. It is based on the general assumption that the manufacturing sector will in due course become the leading sector, drawing in workers (in part, siphoning off a portion of the increase in the labour force that would otherwise tend to drive down labour productivity in agriculture) from the traditional agricultural sector and providing them with higher-productivity jobs than could be obtained in agriculture. Agricultural productivity would necessarily be rising simultaneously, as investments in that sector permitted increasing output. Whereas it was earlier thought that this process would follow the historical experience of countries such as England and Japan, the lesson from the successful developing countries is that by providing incentives and infrastructural support to encourage exports, there are significant opportunities for expansion of manufacturing of labour-intensive commodities, opportunities that can promote rapid growth.

Thus, given the much greater size of the international economy, and the much lower transport and communications costs that confront contemporary developing countries as contrasted with conditions in the 19th century, the potential for rapid growth is much greater now. Countries such as South Korea and Taiwan have experienced in a decade proportionate increases in per capita incomes that it took England and Japan a century to achieve. Whether other developing countries can follow this lead depends on a number of factors, including their economic policies and the continued growth of the international economy.

The central problem of countries with low per capita output is that they have not as yet succeeded in making use of their potential economic opportunities. To do so, they must achieve an efficient allocation of the available resources (allocation of resources) and provide incentives for resource accumulation. But efficient allocation of resources is not merely a matter of the formal optimum conditions of economic theory. It requires the building up of an effective institutional and organizational framework to carry out the allocation of resources. In the private sector this requires the development of a well-articulated market system that embraces the markets for final products and the markets for factors of production. In the public sector the development of the organizational framework requires improvements in the administrative machinery of the government, especially in its fiscal machinery.

In the setting of the developing countries, one is concerned not only with the once for all problem of efficient allocation of resources but also with improving the capacity of these countries to make a more effective use of their resources over a period of time. That is to say, one is concerned not only with the static problem of the efficient allocation of given resources with the given organizational framework but also with dynamic problems of improving the capability of this framework. From this point of view, there is no conflict, as some have maintained, between the static, or the short-run, considerations and the dynamic, or long-run, considerations. The two sets of requirements move in the same direction.

The problem of the efficient allocation of investable funds in the developing countries may be taken as an example. Static rules would require the developing countries to have higher rates of interest to reflect their greater capital scarcity. But many developing countries, under the influence of dynamic theories of economic development, have used a variety of direct and indirect controls to divert large sums of capital to the manufacturing sector in the form of loans at interest rates well below the level required to equate the demand and supply (supply and demand) of capital funds. This practice has resulted not only in a wasteful use of scarce capital resources but also in a retardation of the development of a domestic capital market. Instead of developing a unified capital market for the whole country, it aggravates the financial dualism characterized by low rates of interest in the modern sector and high rates in the traditional sector. The policy of keeping the official rate of interest below the equilibrium rate of interest also results in an excess demand for loans, leading to domestic inflation and pressure on the balance of payments and to a discouragement of the growth of domestic savings. Few private individuals are prepared to buy government securities when they frequently carry rates of interest below the rate of depreciation in the value of money. Through the pursuit of “cheap money” policies that contradict the real facts of capital scarcity, the governments of developing countries have failed to make use of the opportunity of building up a domestic capital market based on an expanding volume of transactions in government securities.

After World War II it was thought that developing countries would require foreign aid in their early stages of development. This aid would supplement the capital created by domestic savings, permitting a higher rate of investment and thus stimulating growth. It was expected that their reliance on official sources of additional capital would continue until their economies had progressed enough to gain them access to private international capital markets.

Until the 1980s this pattern seemed to evolve as predicted. In the 1950s almost all capital flows to developing countries were from official sources, in the form of foreign aid from developed countries or of resources from the multilateral institutions, the World Bank and the International Monetary Fund. In the 1960s some of the export-oriented, rapidly growing countries began to rely on private international capital (capital and interest) markets. Some, such as Singapore, attracted direct private foreign investment; others, such as South Korea, relied more on borrowing from commercial banks. In the 1970s many oil-importing developing countries were able to turn to borrowing from private sources when their economies were hit by the severe oil price increase of 1973.

The borrowing by rapidly growing countries was of the type earlier envisaged. Investment yielded a very high rate of return in these countries, so additional foreign resources could be attracted and productively used. However, some other countries borrowed in order to offset higher oil prices and in order to maintain an excess of expenditures over consumption, without developing the highly profitable investments with which to finance the debt-servicing obligations they incurred. Balance-of-payments crises and debt-servicing difficulties had been experienced by a few countries in most years since the 1950s, but with the second oil price increase and the worldwide recession of the early 1980s, developing countries increased their borrowing and total indebtedness sharply until commercial banks virtually ceased voluntary lending after Mexico experienced difficulty meeting its obligations in 1982. The result was that a large number of developing countries were unable to meet their debt obligations, as export earnings declined owing to the recession, interest rates were rising, and new money was not forthcoming.

For many heavily indebted developing countries, the consequence was a prolonged period of slow growth or even declines in outputs and incomes. The lessons were several: The buoyant conditions of the 1970s were not likely to recur, and policies that had sustained satisfactory growth rates in those conditions were not likely to do so in the future; countries that had not yet moved away from import-substitution policies and direct governmental controls would need to undertake structural adjustments rather rapidly in order to resume their growth and to restore creditworthiness; and future private lending to developing countries would need to be somewhat more discriminating as to the economic prospects of recipient countries.

Modern economic development started in Great Britain (United Kingdom), which in the 1780s accounted for a little over 1 percent of the total world population at that time. Since then, economic development has spread in widening circles to other parts of the world, spurred on by a series of technological innovations, particularly in the form of improvements in transport and communications. In the early decades of the 19th century the circle of the developed countries was limited to western Europe. By the late 19th century the circle had widened to include North America, Australia and New Zealand, and Japan. By the early 1970s about 34 percent of the total world population belonged to the developed countries, which among them had 87.5 percent of the total world GNP. What are the prospects of the still-to-develop countries of Asia, Latin America, and Africa joining this circle of economic development?

On the negative side there are a number of factors that add to their difficulties. First, the level of per capita product in the present-day developing countries is much lower than in the developed countries in their preindustrialization phase (with the exception of Japan). Second, the present-day developing countries have large population bases and are handicapped by much faster rates of population growth. Third, they have generally a much weaker social and political framework to cope with the more explosive forces of discontent engendered by their reaction against their colonial past and by their internal economic disparities.

On the positive side, the present-day developing countries can draw upon a greater store of scientific and technical knowledge from the developed countries. The potential opportunities to exploit the “technological gap” are not confined to manufacturing. Modern science and technology can make immense contributions to agriculture, as illustrated by the Green Revolution created by the introduction of improved seeds and fertilizers in some Asian and Latin-American countries. Modern methods of birth control can make a decisive contribution in the race for raising per capita incomes. In addition, as the circle of the developed countries widens, they are bound to exert an increasing upward pull on the developing countries.

The economic growth of the developed countries has generally resulted in an expanding demand for the products and sometimes for direct labour services from the developing countries. But there are also the stronger localized pulls, such as the pull of the United States economy on Mexico and the pull of western Europe on the developing countries of southern Europe. The spectacular economic growth of Japan since World War II may also exert a similar pull on neighbouring countries in East Asia.

Countries such as South Korea, Taiwan, and Singapore are rapidly approaching developed-country status, and the circle is widening still farther. Rapid growth rates are being experienced by many countries in Southeast Asia. If one considers the successful developing countries of the 1950s and 1960s, it is evident that the rapid growth of the international economy was a very positive contributing factor in their success. Future widening of the circle will no doubt depend in large part on whether the growth of the international economy attains a satisfactory level.

In conclusion, the experience of the postwar years has provided many lessons that form a basis for optimism. A great deal has been learned about the types of economic policies that are conducive to rapid economic development. Rates of growth of per capita income experienced by the developing countries have been significantly higher than had been achieved by the first countries to develop. Attainable rates of growth of per capita income appear to be far above what formerly was thought feasible. The chief potential obstacles to successful development appear to be the spectre of disintegration of the international economy, should protectionist (protectionism) pressures be increasingly effective, and the inability or unwillingness of leaders in developing countries to adopt policies conducive to rapid economic growth.