Development Economics guide, Unit 1, step 3 of 10Guide overview Next step

Step 3: Theories of Growth and Structural Change

By the EconTutorials team. 13-minute read with 6 practice questions.

MatchesA-level growth and development models · IB Economics barriers to growth · undergraduate growth and development

In 30 seconds

Harrod-Domar: growth = savings rate ÷ capital-output ratio. Poor countries save little, so they grow slowly: the “savings gap”.
Solow: capital has diminishing returns, so long-run growth in income per head comes from technology (total factor productivity), not capital alone.
Lewis dual-sector model: surplus farm labour moves to higher-productivity industry, raising output without raising wages at first.
Rostow’s stages: traditional society, preconditions, take-off, drive to maturity, mass consumption.
Endogenous growth theory adds human capital, research and ideas, which need not suffer diminishing returns.

Harrod-Domar: the savings gap

The model links growth to investment: $ g = \frac{s}{k} $, where $ s $ is the savings ratio and $ k $ is the capital-output ratio (how many units of capital make one unit of output a year).

Worked example

A country saves 12% of GDP and has a capital-output ratio of 4. Population grows 2% a year. What happens to income per head? How much saving is needed for 4% growth per head?

1GDP growth $ g = 0.12/4 = 3\% $.

2Income per head grows about $ 3\% – 2\% = 1\% $ a year.

3For 4% per head, GDP must grow 6%: $ s = g \times k = 0.06 \times 4 = 24\% $.

ResultThe country must double its saving rate, or fill the gap with foreign aid, FDI or borrowing. This is the classic argument for aid.

Solow: why capital is not enough

In the Solow model each extra unit of capital adds less output than the last. A country that only accumulates machines reaches a steady state where income per head stops growing. Sustained growth then needs technological progress. The model also predicts conditional convergence: poorer countries with similar savings and institutions should grow faster and catch up.

Key termsTotal factor productivity (TFP): output growth not explained by more capital or labour; it reflects technology, skills and efficiency. Convergence: the tendency for poorer economies to grow faster than richer ones. Structural change: the shift of workers and output from agriculture to industry and services.

Lewis: moving labour out of farming

Arthur Lewis split the economy into a traditional farm sector with surplus labour (marginal product near zero) and a modern sector. Industry can hire workers at a wage just above subsistence, earn profits, reinvest them and keep expanding until the surplus is gone (the Lewis turning point), after which wages rise. China’s migration of hundreds of millions of rural workers to coastal factories is the best modern example.

Case studies for this step (in the 100 Case Studies pack)

Case 63: China’s Four Decades of Growth. High investment, rural-urban migration and TFP gains from reform: Harrod-Domar, Lewis and Solow in one country.
Case 2: Singapore’s Land Constraint. How a city-state with no resources became one of the world’s wealthiest economies through human capital and openness.
Case 94: India’s IT Leapfrog. Service-led development without industrialisation, and what it means for the Lewis and Rostow models.

Apply every growth model to real data: 100 Economics Case Studies for $9 (was $15).Get the 100 cases · $9

Common mistakeUsing Harrod-Domar as if more investment always means more growth. It ignores diminishing returns, the quality of investment and whether the capital is used productively. Many aid-funded projects in the 1960s–80s raised investment without raising growth.

Exam tipPair each model with a limitation: Harrod-Domar ignores technology; Solow treats technology as unexplained; Lewis assumes no unemployment in cities and that profits are reinvested; Rostow is a description, not a cause.

Practise: 6 questions

Try each one on paper first, then check the worked answer.

EasyQ1. Write the Harrod-Domar growth equation. Show worked answer

$ g = s/k $: growth equals the savings ratio divided by the capital-output ratio.

EasyQ2. Name Rostow’s five stages in order. Show worked answer

Traditional society; preconditions for take-off; take-off; drive to maturity; age of high mass consumption.

MediumQ3. Savings are 20% of GDP and $ k = 5 $. Find GDP growth. Show worked answer

$ g = 0.20/5 = 4\% $ a year.

MediumQ4. Why does the Solow model predict that growth from capital alone will stop? Show worked answer

Diminishing returns to capital: each extra machine adds less output, while depreciation rises with the capital stock. Eventually new investment only replaces worn-out capital, so capital and income per head stop rising unless technology improves.

MediumQ5. What is the Lewis turning point? Show worked answer

The point where surplus rural labour has been absorbed by the modern sector, so industry must pay higher wages to attract more workers. Studies suggest China reached it around the late 2000s, when coastal factory wages began rising fast.

ExamQ6. Using China as an example, assess how well the Lewis model explains rapid growth. [10] Show worked answer

Fits: massive migration from farms to coastal factories; low wages kept exports competitive; high profits reinvested (investment above 40% of GDP) [4]. Limits: the hukou system restricted migration; growth also relied on reform, FDI and TFP, not just labour transfer; the model ignores urban unemployment [4]. Judgement: Lewis explains the labour side of China’s boom well but needs Solow-style productivity and institutions for a full account [2].

Check yourself

1. In the Solow model, long-run growth per head comes from

Capital has diminishing returns; only technology keeps income per head growing.

2. The Lewis model assumes the traditional sector has

Surplus labour with near-zero marginal product can move to industry at no loss of farm output.

3. A “savings gap” is filled in Harrod-Domar thinking by

Foreign capital can raise investment above domestic saving.

Your score: 0 out of 3

The short version

Harrod-Domar: $ g = s/k $; poor countries face a savings gap.
Solow: diminishing returns, so technology drives long-run growth.
Lewis: moving surplus farm labour to industry powers early growth.
Use China, Singapore and India as evidence.

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Next: step 4 of 10Industrial Policy and the Developmental State