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Rosenstein-Rodan: from marginal utility to a pioneer in economic development and possibly socio-economics.

"There is much of the past that is in the present, so also there is much of the present that will be in the future."

John Kenneth Galbraith

1. Introduction

In his "Toward a Counter - Counterrevolution in Development Theory," Paul Krugman identifies the emergence of what he calls "high development theory" between the years 1943 and 1958. What Krugman refers to is the type of economics that was associated with such names as Rosenstein-Rodan, Fleming, Nurkse, Myrdal, Scitovsky, and Hirschman. (1993, p. 55). This body of thought, indeed, attracted many creative minds and was marked by a great deal of intellectual excitement. According to Krugman, "this theory's golden age began with Rosenstein-Rodan (1943) and more or less ended with Hirschman (1958)." (Ibid. p. 16). While, in disagreement with Krugman, writers such as Joseph Stiglitz argue that "high development economics never died" (1993, p. 41), it is generally believed that its beginnings are to be found in the year 1943.

This body of thought began when, in 1943, Paul Rosenstein-Rodan (1902-1985) published his "Problems of Industrialization of Eastern and Southern Europe" in the Economic Journal. With this article, Rosenstein-Rodan, an Austrian/Neoclassicist, emerged as the leading pioneer in the field of economic development. As Chakravarty has argued, he was "one of the very few economists who have helped to open up a field of inquiry with its own distinctive problems" (1983, p. 73). Being "a leader in the efforts of the economic profession to understand the problems of the poor nations of the world and to assist in their development (Bhagwatti and Eckaus, 1972, p. 7), Rodan is regarded by various writers as "the originator of the areas of economic inquiry known as development programming" (Chakravarty, p. 73). Rosenstein-Rodan's 1943 paper, which assumed excess agrarian population, the need for social overhead capital (i.e. infrastructure), and pecuniary and technological externalities in underdeveloped countries and thus the prevalence of market failures in those countries, emphasized a visible rather than the Smithean notion of the invisible hand, the theory of the big push, strategic complementarity, and, as a means of correcting distortions associated with indivisibilities, externalities and various failures, the programming of investment projects.

With these, Rodan also emerged as a socio-economists.

Rosenstein-Rodan is well-known for his contributions in the field of development economics. However, it will be argued that Rosenstein-Rodan did not begin as a development economist and a model for socio-economists - an advocate of market-failure based theories of development economics and a protagonist of massive, organized structural change; nor did he start as an opponent of the Smithean notion of the invisible hand. As we will argue, long before his pioneering works in the field of development economics, he began writing in Vienna during the 1920s as a neo-classicist who was "only interested in the theory of choice, i.e., utility, theory, and considered any applied economics to be impure and of no interest" (Rodan's letter to Dragoslav Avranovic, May 18, 1982).

My attempt in this paper is to demonstrate the evolution of Rodan's thinking from a neoclassicist to a development programming theorist. Obviously, the catastrophic experience of the 1930s and the relative success of Keynesian activism, the successes of early Soviet planning and later on the Marshall Plan, as well as Allyn Young's analysis of increasing returns and Marshall's discussions of externalities, constituted major influences on the evolution of his thinking. However, it will be argued that the theories he developed in his 1943 paper and beyond were not totally unrelated to his previous works. For example, Rodan's 1943 article and his subsequent works related the notion of complementarity to the rationale, for planning and the doctrine of the big push. Further, his 1943 article and subsequent papers linked hierarchical structure of wants to income elasticities of demand in underdeveloped countries. These works also linked the role of time in economic theory to the choice of an economic period for allocation of scarce resources. It will be argued that his early works in Vienna also contained these economic concepts.

The paper will also discuss, in brief, the various contributions of Rodan to the field of economic development.

2. His early writings in Vienna

Rosenstein-Rodan (1902-1985) did not begin as a development economist. During his early years, he had no interest in economic policy, and did not work in applied economics. His writing career began in Vienna during the 1920s when he wrote as a pure theorist, working on marginal utility theory, the role of time in economic theory, and monetary theory. He was also interested in the history of economic thought. In the words of Bhagwati and Eckaus, "for his first decade and a half as an economist, Rosenstein-Rodan was among the purest of the pure. During this period he wrote seminal papers on utility and valve theory and his interests extended into other fields such as monetary theory. He was also renowned as the authority on the history of economic thought and was a great bibliophile in that area" (1972, preface, p. 7).

In a 1982 letter to Dragoslav Avramovic, Rosenstein-Rodan wrote, "In Vienna in the 1920s I was only interested in the theory of choice, i.e., utility theory, Austrian variety, and considered applied economics to be impure and of no interest" (Pioneers, 1984, p. 223).

During the first phase of his intellectual activity, Rosenstein-Rodan produced several theoretical papers. Among these was his paper "Grenznulzen" (Marginal Utility) which was published in 1926. Wolfgang Stopper's English translation of this paper appeared in 1960. However, it had also been translated to Japanese in 1930, and to Italian in 1937. This paper was greatly praised by Schumpeter. According to Joseph Schumpeter, "a brilliant and compact survey of arguments and counter arguments (concerning the Austrian School theory of utility in equilibrium analysis) has been presented by P. N. Rosenstein-Rodan in the article Grentnutzen (marginal utility) in the German encyclopedia, 4th edition, Volume IV, 1927" (1954, p. 1056).

In Vienna, he also wrote two important articles dealing with time: "Das Zeitmoment in der Mathematishen Theories des Wirtsch Gleinch-gewihtes" (The Element of Time in the Mathematical Theory of Economic Equilibrium) published in 1929, and "The Role of Time in Economic Theory" which was published in 1934 (a modified version of this article was also published in 1936). In his 1929 article, Rodan dealt with the problem of lagged adjustment to equilibrium which could result in non-convergent oscillation. This problem, which was also discussed by other writers - Arthur Hanau, Henry Schultz, Jan Tinbergen, and Umberto Ricci - was named "cobbweb" by Nicholas Kaldor in 1934. However, according to Lionel Robbins, (as suggested by Avramovic, p. 225), Rodan was ahead of others. Rosenstein-Rodan's arguments concerning the stability of multiple market equilibrium was developed further by Paul Samuelson and Lange, to be extended even further by Arrow, Horwicz and others (Chakravarty, p. 73).

Before 1943, he also wrote "Complementarieta Prima della Tre Fase del Progresso dell's Economia Pura" (Complementarity: The First of Three Phases of Progress of Pure Economics). This paper, published in Italian, appeared in 1934, and, had, apparently, influenced John Hicks in his theory of complementarity. Another paper Rosenstein-Rodan published before his 1943 Economic Journal article, was "Co-ordination of the General Theories of Money and Price." This paper was published in Economica in 1936. This paper, like the ones before, was also in pure theory.

3. Transition to economic development

During WWII, Rosenstein-Rodan was transformed from a pure theorist to a policy advocate, in particular as it concerned the underdeveloped countries. In the preface to their (edited) book, Bhagwati and Eckaus write: "The Second World War was a watershed in his career, however. He anticipated the great struggle, participated in the economic policymaking that its exigencies required, and turned early to an examination of the passing problems of the post-war world" (1972, p. 73).

Rodan's transformation to a development economist occurred during his studies in London. As he stated shortly before his death, "During the Second World War, I proposed in London the formation of a group to study the problems of economically underdeveloped countries instead of the more usual work on current economic problems related to the war" (1984, p. 207).

His proposal led to the formation of a study group at the Royal Institute for International Affairs (Chatham House). This study group was active during the years 1942 to 1945 dealing with the problems of underdeveloped countries. Rodan's 1943 Economic Journal paper, indicating his break with the past, was the product of these three years. The 1943 paper, according to Paul Krugman, "inspired many interpretations. Some economists read it as essentially Keynesian, a story about interaction between the multiplier and the accelerator. Rosenstein-Rodan himself seems to have had some more or less Keynesian idea about effective demand in mind, with (as we will see) considerable justification. Other economists saw it as an assertion that growth must be somehow balanced in order to be somehow successful. Hirschman (1958) cast The Strategy of Economic Development as an argument with - and refutation of Rosenstein-Rodan (and others of the balanced-growth school), which I will argue was both a misunderstanding and self-destructive. Yet other economists tried to generate low-level equilibrium taps by invoking such mechanisms as interactions among income, savings, and population growth" (Ibid., p. 16). Whatever the interpretations, the fact is that Rodan's 1943 paper signified a break with his past.

What caused this transition? Was there a structural break in the development of Rodan's economic thought that coincided with the events of the Second World War? In his Comment on Rodan's 1984 paper, Avramovic stated the influence of the catastrophic experience of the 1930s (and its Keynesian remedies) on the transformation of Rodan's economic thinking (1984, p. 224). The example of Soviet planning (and its relative success during the 1930s), and the implicit assumption of a limited absorptive capacity of the world market in the 1943 paper seem to have influenced the Chatam House study group that Rosenstein-Rodan presided over. And, certainly, the success of the Marshall Plan later on too influenced his works of the late 1940s and the 1950s. These factors had created a pro-government activism consensus after WWII. In the words of Mrinal Datta-Chaudhuri, "The success of Keynesian activism in fighting the Great Depression in western countries, the success of the Marshall Plan in engineering the quick reconstruction of the war-damaged economies of Western Europe, and the achievements of the Soviet industrialization drive in the 1930s had created a virtual intellectual consensus in the world on the power of the visible hand" (1990, p. 26).

This pro-visible-hand consensus made things easier for Rodan to emphasize the big push policy, programming and other notions contradicting the Smithean notion of the invisible hand.

Rosenstein-Rodan's 1984 article described the essence of his early thought about development as "natura facit saltum-nature does make a jump, the opposite of the motto natura non facit saltum that Alfred Marshall thought appropriate for economics" (p. 207). However, it seems that the development of Rodan's thought did not take a very sharp and abrupt leap. In other words, some of the elements of development theory which he developed in various papers, including his 1943 Economic Journal paper, can also be found in his Vienna papers. In fact, many themes he developed in 1943 and beyond can even be found in his 1926 paper on marginal utility, to be developed further in other pre-1943 papers. As he stated later, "the seeds of my development analysis had been planted earlier when I became interested in the themes of complementarity and the hierarchical structure of wants, together with the role of time - that is, the choice of an economic period over which an individual allocates his scarce resources. The dynamics of wants and their interrelatedness were much more important to me than the neoclassical attempt at precise characterization of the properties of the utility function" (1984, p. 210).

As an example, Rosenstein-Rodan's 1926 article on marginal utility introduced the theme of complementarity. He developed this theme further in his paper on complementarity that he published in 1934. This theme was made an important component of his 1943 Economic Journal essay, his 1957 article "Notes on the Theory of The Big Push" and other post-1942 essays. In the 1943 article, as an example, complementarity constitutes the rationale for economic planning. In that article we read: "complementarity of different industries provides the most important set of arguments in favor of a large planned industrialization" (p. 205). In the same article he indicates that: "the planned creation of such a complementary system reduces the risk of not being able to sell, and, since risk can be considered as cost, it reduces costs" (p. 206). The risk-reducing ability, and the need for the big push, are particularly emphasized in his 1957 "Notes on the Theory of the Big Push." At the end of a rather long paragraph explaining the value of complementary, he states that "what was not true in the case of one single shoe factory will become true for the complementary system of one hundred factories and farms. The new produces will be each other's consumers and will verify Say's Law by creating an additional market. The complementarity of demand will reduce the risk of not finding a market. Reducing such interdependent risks naturally increases the incentive to invest" (p. 62). Next page we read: "Complementarity of demand will reduce the marginal risk of growing and diversified investments but will be below a minimum threshold at which the complementarity of demand may therefore be called indivisibility of demand" (p. 63).

ln the next section of the same article, he even extends the theme of complementarity to an open economy. "In an open economy a shoe factory may replace former imports or may be efficient enough to find export markets. The world market can be a substitute for the additional domestic market required in a closed economy" (p. 63).

In the 1926 marginal utility essay, Rodan also discussed the hierarchical structure of wants. To Rodan, it is only when certain categories of wants have been fully satisfied that people generally look towards others (see Chakravarty, pp. 73-4). Rosenstein-Rodan, in subsequent works, related this concept to the low elasticity of demand in less developed countries and the necessity of the big push, since, to him, "the low elasticities of demand in low-income countries make it much more difficult, however, to fit supplies to demands. The difficulty of fitting demand to supply on small scale constitutes a higher risk in a small market than in a large and growing one" (1984, p. 213).

In his 1957 "Notes on the Theory of the Big Push" he had stated that: "The risk of any single investment in any one industry is increased by the fact that various goods are highly imperfect substitutes for each other in low income underdeveloped countries. The southwest corner of the indifference map shows very high degrees of convexity. Demand for most goods will therefore be highly inelastic. Low elasticities of demand make it much more difficult to fit supplies to demands. The difficulty of fitting demand to supply on a small scale constitutes a risk which is higher in a small than in a large and growing market" (pp. 62-63).

The marginal utility article and two later articles dealing with the question of time in economic theory discuss the choice of an economic period over which scarce resources ought to be allocated. As Chakravarty also argues, from the beginning "the dynamics of wants and their interrelatedness were much more important to Rosenstein-Rodan than any attempt at precise characterization of the properties of the utility function of the study of the conditions under which such a function can be said to exist" (p. 74).

In three of his articles, Rosenstein-Rodan introduced "the concept of a rolling plan, and suggests a decomposition procedure for planning overtime through introducing a conceptual device called block of wants which implies a certain degree of flexibility in the expression of preference ordering overtime and the need for acquiring a command over versatile assets to cope with the problem of uncertainty of the future as well as with its open-endedness" (Ibid.).

Specifically, Rodan saw three different sets of problems associated with time. Firstly, he saw the problem concerning the determination of the length of time which economic activity (say a plan) has in view. In other words, the problem of the economic period (1934, p. 77). Secondly, he saw the problem of the disposition of time between different uses. In other words, the problem of viewing time as an economic good (1934, p. 78). Thirdly, to him, a problem may arise when we investigate the actual process of change through time. This problem is what he called the problem of the velocities of adjustment (Ibid.).

These problems that he observed in his early theoretical papers became relevant in his efforts in dealing with planning (programming) and the question of the big push that he dealt with during his post-1943 writings.

4. Rosenstein-Rodan's contributions in the 1943 article

In his 1984 article, Rosenstein-Rodan described his early thinking that emerged with the 1943 Economic Journal essay and his other works during the 1940s and the 1950s as "natura facit soltum, - nature does make a jump, the opposite of the motto natura non facit soltum" that Alfred Marshall thought appropriate for economics (1984, p. 207). Describing that early thinking about development, Rodan stated that: "not traditional static equilibrium theory but an analysis of the disequilibrium growth process is what is essential for understanding economic development" (Ibid., p. 207). In other words, beginning with the 1943 paper (in which Eastern and Southern Europe are viewed as underdeveloped economies), he tried "to study the dynamic path toward equilibrium, not merely the conditions which must be satisfied at the point of equilibrium" (1984, p. 208).

Seeking that objective, the 1943 paper introduced four new "innovations." Rodan's first innovation in the 1943 article had to do with the assumption that disguised unemployment was prevalent among underdeveloped countries, and that although a sign of weakness of these economies, it could also be regarded as a source of strength and development. In the 1943 article, regarding the prevalence of disguised unemployment in underdeveloped economies, we read: "there exists an agrarian excess population in Eastern and Southern Europe amounting to 20-25 million people out of the total population of 100-110 million, i.e., that about 25% of the population is either totally or partially ("disguised unemployment") unemployed. The waste of labor is by no means confined to rich industrial countries. It is considerably greater in poor agrarian countries" (1943, p. 202).

The concept of disguised unemployment was discussed further in Rodan's 1956 article "Disguised Unemployment and Under-Employment in Agriculture." Of course, Rodan claims no originality in terms of being the first writer to discuss this concept. In fact, without providing any reference, his 1956 article states that disguised unemployment had emerged in the 1920s (1956, p. 1). However, what Rodan's 1943 article did accomplish was to make it one of the "cornerstones" of the theory of economic development (1956, p. 1). J. L. Buck's book Chinese Farm Policy discussed disguised unemployment in 1930, and D. Warriner had mentioned it in his 1939 book Economics of Peasant Farming. Many writers also discussed the issue during the 1950s (before his 1956 paper on the subject). M. Dobbs' Some Aspects of Economic Development: Three Lectures discussed it in 1951, R. Nurkse's Problems of Capital Formation discussed it in 1953 and A. Lewis discussed disguised unemployment in his Economic Development with Unlimited Supply of Labor in 1954.

According to Rodan, disguised unemployment, although a weakness, "may also be a source of development and strength" (1984, p. 208). It was in seeking these benefits that various development economists developed "dualism" models or placed emphasis on labor-intensive methods of industrialization. As Rodan's 1956 article pointed out, some economists voiced opposition against the notion of disguised unemployment. Jacob Viner and Haberler denied the existence of this phenomena in general and N. V. Sovani pointed out that there is hardly any removable surplus population in Indian agriculture (1956, p. 1). Opposition also came from T. K. Schultz's 1956 book on the role of government in economic growth. Schultz stated that: "I know of no evidence for any poor country anywhere that would even suggest that a transfer of some small fraction, say 5%, of the existing labor force out of agriculture, with other things equal, could be made without reducing its production" (quoted by Rodan, 1956).

Rodan's second innovation had to do with his emphasis on pecuniary external economies, which yield economies of scale (i.e., increasing returns). This concept had been treated by Marshall before. However, for Marshall, as pointed out by Rodan, it was only regarded "a second order of smalls." In the 1943 and subsequent articles, Rodan viewed it to be more important. For Rodan, to take advantage of these externalities, what is needed is simultaneous planning of several complementary industries.

Regarding this "innovation," Rosenstein-Rodan had been influenced by Allyn Young's 1928 article "Increasing Returns and Economic Progress." Since, according to Allyn Young, increasing returns occur to a firm not only with the growth of its size but also with the growth of the industry and of the industrial system as whole (1928, pp. 527-542). Explaining this position, Roger Sandilands argues that: "A larger market promotes more roundabout capitalistic method of production, but it is the very process of specialization in its many guises that permits lower production costs all round, including in the capital goods industries. Thus, in a growing economy firms could be expected to obtain specialized inputs at lower real cost" (1997, pp. 10-11). According to Rodan, more emphasis should be given to increasing returns by emphasizing the indivisibility of the production function as well as that of demand. As a result of the indivisibility of demand, investment projects have high risks because of the uncertainty of whether their products would find a market. But when investment occurs on a wide front, the new producers will become each other's customers, and the complementarity of demand will reduce the risk of not finding a market. This risk reduction is, in essence, a form of external economies.

Rodan's third innovation in the 1943 article was his assumption that "before building consumer goods factories, a major indivisible block of social overhead capital or infrastructure must be built and sponsored because private market initiatives will not create it in time" (1984, p. 208).

To him, "in order to build a factory one would have to build a bridge or finish a road or a railway line or later an electric power station. Each of these elements in the so-called social overhead capital requires a minimum high quantum of investment which could serve, say, fifty factories but would cost far too much for one" (Ibid.).

Rodan's fourth innovation in the 1943 paper had to do with his emphasis on technological externalities which are not based on indivisibilities but very largely due to what he calls "inappropriability." These technological externalities are also not a second order of smalls. To him, the process of industrialization of underdeveloped countries was and is largely based on the advantages of training, learning on the job, and the formation of human capital (see 1984, p. 9). To explain this externality, Rodan compares production under the system of wage labor with that under slavery. These technological externalities, according to Rodan, are relevant under the system of wage-labor since whoever invested in the training of the worker would run the risk of not being able to appropriate the benefit of increased productivity. To him, however, under the system of slavery, the increase in slave skills was appropriated by the slave owner (the investor). In other words, as he also explained in 1984, "the training and education of workers under competitive market conditions would therefore be below optimum. This is a widespread phenomenon, not so rare as the bucolic example in a pastoral economy of not knowing whose bees alight on whose apple trees to produce honey" (1984, p. 209). The function of this externality (as well as pecuniary externality) was obvious to Rodan in 1943, although Tibor Scitovsky's clarifications in his 1954 J.P. E. paper helped to explain it a great deal. In the 1943 article Rodan wrote, "the first task of industrialization is to provide for training and skilling of labor which is to transform Eastern European peasants into full-time or part-time industrial workers. The automatism of laissez-faire never worked properly in that field. It broke down because it is not profitable for a private entrepreneur who invests in training labor. There are no mortgages on workers - an entrepreneur who invests in training workers may lose capital if these workers contract with another firm. Although not a good investment for a private firm, it is the best investment for the state. It is also a good investment for the bulk of industries to be created when taken as a whole, although it may represent irrecoverable costs for a small unit. It constitutes an important instance of the Pigovian divergence between private and social marginal net product where the latter is greater than the former" (1943, pp. 204-205).

5. The theory of the big push

The theory of the big push was the logical consequence of Rodan's theory of development which began with the 1943 Economic Journal article. As he himself stated in 1984, "My thinking during the 1940s led to the theory of the "big push" (1984, p. 210). Here, Rodan quotes his 1957 The Objectives of U.S. Economic Assistance Programs). The theory of the big push was elaborated in his 1957 paper "Notes on the theory of Big Push." However, Paul Krugman (perhaps unaware of the 1957 paper) refers to the 1943 paper as one dealing with the big push. As he states in his Counter-Counterrevolution paper, "The Big Push Paper of Rosenstein-Rodan (1943) has inspired many interpretations" (p. 16).

According to the theory of the big push, "there is a minimum level of resources that must be devoted to a development program if it is to have any chance of success. Launching a country into self-sustaining growth is a little like getting an airplane off the ground. There is a critical ground speed which must be passed before the craft can be airborne" ("Notes on Theory of the Big Push", p. 57).

To Rodan, in achieving economic development, proceeding bit by bit will not add up in its effects to the sum total of the single bits. A minimum quantum of investment is a necessary, though not sufficient, condition of success. This, in a nutshell, is the contention of the theory of the big push" (Ibid.).

Rosenstein-Rodan believed that the theory of the big push contradicts the conclusions of the traditional static equilibrium theory (and reverses the famous motto natura non facit saltum) in three different ways. First, the theory of the big push "is based on a set of more realistic assumptions of certain indivisibilities and non appropriabilities in the production functions even on the level of static equilibrium theory. These indivisibilities give rise to increasing returns and to technological external economies" (Note on the Theory of the Big. Push, p. 57).

The second way the theory of the big push contradicts the conclusions of the static equilibrium theory is that in dealing with the problems of growth, the theory of the big push "examines the path towards equilibrium, not the conditions at the point of equilibrium only. At a point of static equilibrium net investment is zero. The theory of growth is very largely a theory of investment. Moreover, the allocation of investment - unlike the allocation of given stocks of consumer goods (equilibrium of consumption), or of produces' goods (equilibrium of production) - necessarily occurs in an imperfect market, that is, a market on which prices do not signal all the information required for an optimal solution. Given an imperfect investment market, pecuniary external economies have the same effect in the theory of growth as technological external economies" (Ibid., pp. 57-58 our emphasis).

The third reason he gives for that contradiction is that, to him, in addition to the risk phenomena and imperfections characterizing investment, the markets in underdeveloped countries are even more imperfect than in developed countries. The price mechanism in the imperfect markets of the underdeveloped economies cannot, therefore, be relied upon to provide the signals that guide a perfectly competitive economy toward an optimum position (Ibid.).

To Rodan, underlying the need for a big push is the pervasiveness of underdevelopment and that of disguised unemployment. Assuming that mass migration and resettlement of the massive number of disguised unemployment peasants to the urban centers is not feasible, in 1944 Rodan argued that: "the movement of machinery and capital towards labor, instead of moving labor towards capital, is the process of industrialization which, together with the agrarian movement, is the most important aspect of economic development of the depressed areas" (International Affair, p. 161).

For him, the crucial task of economic development was to achieve sufficient investment to mobilize the unemployed and underemployed for the purpose of industrialization. To reach an optimum size of the industrial enterprises, to him, the area of industrialization must be sufficiently large. This requires simultaneous creation of several complementary industries.

6. Programming and economic development

Beginning with the 1943 article, and rejecting the Smithean notion of the invisible hand, Rosenstein-Rodan emphasized the need for programming in the attempt to achieve economic development. The following elements, all requiring programming on the Part of the state, were introduced in the 1943 article.

1. Successful industrialization of underdeveloped economics requires the creation of a new institutional framework (by the state): "An institutional framework different from the present one is clearly necessary for the successful carrying out of industrialization in international depressed areas" (1943, p. 204).

2. The necessity of infrastructural investments. To Rosenstein-Rodan, a minimum infrastructural investment (i.e., social overload capital) is necessary if the process of industrialization is to be carried out. To him, the provision of this minimum is beyond the abilities of the private sector.

3. As he argued, "the first task of industrialization is to provide for training and 'skilling' of labour which is to transform Eastern European peasants into full-time or part-time industrial workers. The automation of laissez-faire never worked properly in that field" (1943, pp. 204-5).

4. As he stated, "Complementarity of different industries provides the most important set of arguments in favour of a large-scale planned industrialization" (Ibid.). This reduces costs, since it reduces the risk of not being able to sell.

5. The divergence between private and social costs are not negligible. Thus, programming on the part of the state is necessary.

6. To guarantee the international movement of capital, governments must be involved (Ibid., p. 209). Without this government guarantee, international investors will not risk their capital.

The detailed theoretical proof of his concept of programming, however, was first presented in his 1954 paper "Programming in Theory and in Italian Practice." The first section of the paper, entitled "Is Programming Necessary?", begins by first presenting what he calls the liberal classical doctrine: that "the free and unimpeded mechanism of market forces would lead to a maximum national income," and that "any conscious deliberate active policy designed to influence the amount and the composition of investment could not raise national income" (1954, p. 1). Obviously, as an advocate of programming, Rodan's 1943 thinking opposes this classical view. His opposition to this classical view is stated in the introduction to the 1954 Programming paper. It is stated that "It is the contention of this paper that the opposite is true, that an economic policy designed to influence the amount and composition of investment can raise the rate of economic growth and increase the national income" (1954, p. 1).

What does he mean by programming? According to Rodan, "programming is just another word for rational, deliberate, consistent, and coordinated economic policy" (Ibid., p. 3). To him, the aim of programming is "to assure the maximum national income through time. For this purpose it tries to maximize the amount and to optimize the composition of investment" (Ibid., p. 3). Concerning the means of programming he writes, "the means employed may be either indirect (i.e., monetary, fiscal and commercial policy, as well as providing information on economic trends. . .) or direct (public investment)" (Ibid., p. 4).

To him, "Even if no direct means were to be employed, programming would be necessary in order to inform investors of short- and long-run trends, notably of intersectoral demands resulting from complementarity of industries (revealed by a periodically revised input-output table) and indirect effects of investment on future demand of domestic, imported, or so far exported goods. Such an information might guide and favorably influence the composition of investment" (1954, pp. 4-5).

To Rodan, maximization of national income would be reached, according to the classical liberal school, when the price mechanism functions on assumption of competitive conditions in four stages (i.e. equilibrium). (1) Allocation of given stock of consumer goods, (2) Allocation of production on assumption of given stock of equipment, land and labor. (3) Allocation of investment on assumption of given stock of labor, land, and capital. A fourth equilibrium condition is provided by the Say's law" (1954, p. 1).

To Rodan, the price mechanism does not work in all the four stages (equilibrium). To him, the price mechanism "works perfectly under assumption in the first stage, i.e., in the allocation of given stocks of consumer goods. It works less perfectly, but tolerably well on the second stage, when we replace the assumption of given stocks of consumer goods by flows of supply of these goods from given stocks of equipment, raw materials and labor" (Ibid., p. 2).

To Rodan, the price mechanism does not work in the third equilibrium, since the amount and composition of investment is assumed to be determined by a multitude of individual investment decisions (Ibid.). Rodan provides various reasons for the individual investment decisions to lead to nonoptimal allocation of resources (Ibid.). Among the masons are: 1) The investor maximizes the private, not the social net marginal product. 2) External economies are not sufficiently exploited. 3) Complementarity of industries is so great that simultaneous inducement rather than hope for autonomous coincidence of investment is called for. 4) Lifetime of equipment is long (say ten years) so that the investor's foresight is likely to be more imperfect than that of the buyer, the seller or the producer. 5) The individual investor's risk may be higher than that confronting an over-all investment program. 6) The costs of an erroneous investment decision are high; punishment in the form of loss of capital afflicts not only the investor but also the national economy. 7) Because of the indivisibility of lumpiness of capital, large rather than small changes are involved. Yet the price mechanism works perfectly only under the assumption of small changes. 8) Capital markets though often well organized are notoriously imperfect markets, governed not only by prices but by institutional or traditional rationing quotas (Ibid., pp. 2-3).

Rodan concludes that "the investment theory is indeed the weakest link in the classical liberal theory" (Ibid., p. 3).

7. Concluding remarks

Joseph Stiglitz remarked in 1989 that "A study of LDCS is to economics what the study of pathology is to medicine; by understanding what happens when things do not work well, we gain insight into how they work when they do function as designed. The difference is that in economics, pathology is the rule: less than a quarter of mankind lives in the developed economies" (quoted by Pranab Bardhan, 1993, p. 131).

It is as a result of this importance that many theoretical developments in the theory of development have turned out to be very useful for economic theory as a whole. These developments occurred during the years Krugman calls the years of high development theory [1943-58], as well as later. In his 1993 J. E. P. essay, Pranab Bardhan listed new developments in economic theory with roots in the theory of economic development. Among these spillovers from development economics we can include the efficiency wage theory, dynamic externalities, multiple equilibria and hysteresis, persistence of dysfunctional institutios, the principle-agent models and missing markets, the enforcement problem in international loan contracts, project evaluation literature in development as a branch of cost-benefit analysis, the study of rent-seeking activity, dualism models in labor economics, and the theory of commodity price stabilization (pp. 131-136).

These contributions were possible because the post-1943 literature of economic development, for which Rodan was a pioneer, insisted that traditional Walrasian economics cannot be regarded very useful in the diagnosis and treatment of the underdevelopment economies. By emphasizing the prevalence of market failures (the investment types emphasized by Rodan and informational-based failures emphasized by Stiglitz) in the underdevelopment economies, development economists went beyond the traditional treatment of the economies in dealing with the underdeveloped economies (see Hosseini, 1997). This made possible the development of the afore-mentioned spillovers to economic theory proper. For example, many development economists in the 1950s and the 1960s, in explaining the coexistence of significant positive wage and massive unemployment and underemployment, essentially developed the efficiency wage theory (see Leibenstein, 1957; Mazundar, 1959). In dealing with the above-mentioned problems, these writers had to go beyond the confines of the market-clearing Walrasian equilibrium.

Or, as stated above, beginning with Rosenstein-Rodan's 1943 paper, development economists such as Rodan (1943), Nurkse (1953) and Scitovsky (1954) made an impressive contribution in the case of "pecuniary" external economies (as well as technological ones).

Many developments in the economics of information also developed in dealing with the problem of underdevelopment. Stiglitz tried to use microeconomics in explaining the formation of agrarian institutions in poor countries in an environment of pervasive risks, information asymmetry, and moral hazard. One of the first fully worked out models of the principal-agent problem was developed by Stiglitz when he was studying the ancient share-cropping institution in the underdeveloped countries as a compromise between risk and work-incentive effects. In fact, even Akerlof's famous lemon paper (1970) was motivated by his experiences in India (Bardhab, 1993, p. 135).

And, Anne Krueger's, 1974 paper on rent-seeking activity was developed as she studied trade restrictions in underdeveloped countries.

Rosenstein-Rodan, as a pioneer in the field of economic development, studied the dynamic path toward equilibrium, rather than the conditions that must be satisfied at the point of equilibrium. In dealing with the underdeveloped economies, he saw, at least implicitly, the need for de-emphasizing the relevance of traditional (Walrasian) theories. As such, he paved the way for many more writers who made substantial contributions to both economic development and economic theory.


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Author:Hosseini, Hamid
Publication:The Journal of Socio-Economics
Date:Mar 1, 1999
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